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UNITED STATES 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 MARCH 31, 2003
Commission file number 0-20734
E.DIGITAL CORPORATION
(Name of small business issuer in its charter)
Delaware 33-0591385
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
13114 Evening Creek Drive South
San Diego, California 92128
(858) 679-1504
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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. Yes X No___
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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. [ X ]
State issuer's revenues for its most recent fiscal year. $2,597,363
The aggregate market value of the issuer's Common Stock held by non-affiliates
of the registrant on June 6, 2003 was approximately $29,100,669 based on the
average of the closing bid and ask price of $0.20 as reported on the NASD's OTC
Electronic Bulletin Board system.
As of June 6, 2003 there were 147,604,343 shares of e.Digital Corporation Common
Stock, par value $.001, outstanding and 205,000 shares of Series D Preferred
Stock, par value $10.00 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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TABLE OF CONTENTS
Page
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PART I
ITEM 1. Description of Business 3
ITEM 2. Description of Property 15
ITEM 3. Legal Proceedings 15
ITEM 4. Submission of Matters to a Vote of Security Holders 15
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters 15
ITEM 6. Selected Consolidated Financial Statements 16
ITEM 7. Management's Discussion and Analysis or Plan of Operation 17
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk 30
ITEM 8. Financial Statements 31
ITEM 9. Changes In and Disagreement With Accountants on Accounting and Financial Disclosure 31
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons,
Compliance With Section 16(a) of the Exchange Act 31
ITEM 11. Executive Compensation 33
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 36
ITEM 13. Certain Relationships and Related Transactions 37
ITEM 14. Controls and Procedures 37
PART IV
ITEM 15. Exhibits and Reports on Form 8-K 38
SIGNATURES
FORWARD-LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995 AND THE COMPANY DESIRES TO TAKE ADVANTAGE OF THE
"SAFE HARBOR" PROVISIONS THEREOF. THEREFORE, THE COMPANY IS INCLUDING THIS
STATEMENT FOR THE EXPRESS PURPOSE OF AVAILING ITSELF OF THE PROTECTIONS OF SUCH
SAFE HARBOR WITH RESPECT TO ALL OF SUCH FORWARD-LOOKING STATEMENTS. THE
FORWARD-LOOKING STATEMENTS IN THIS REPORT REFLECT THE COMPANY'S CURRENT VIEWS
WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. THESE FORWARD-LOOKING
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE
DISCUSSED HEREIN, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR THOSE ANTICIPATED. IN THIS REPORT, THE WORDS
"ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE" AND SIMILAR
EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED TO
CONSIDER THE SPECIFIC RISK FACTORS DESCRIBED BELOW AND NOT TO PLACE UNDUE
RELIANCE ON THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, WHICH SPEAK ONLY AS
OF THE DATE HEREOF. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE
THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT MAY
ARISE AFTER THE DATE HEREOF.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL OVERVIEW
e.Digital Corporation is a holding company that operates through a
wholly-owned California subsidiary of the same name. We offer engineering
services to leading electronics companies to create portable digital devices
that can link to PCs, the Internet and other electronic devices. We market our
services and technologies to Original Equipment Manufacturers ("OEMs") with a
focus on developing digital music, voice, and video players/recorders using the
latest in digital storage media (a device used to store data) and technology.
OEMs are business customers that license or purchase our products or our
technology to embed in their own products. We offer complete reference designs
(working, full-featured designs sometimes implemented as prototypes that can be
customized to a customers' preferred look and feel or branded and sold as they
are, according to the customer's wishes) and technology platforms (basic working
technology that can be developed into a finished consumer product, or
incorporated into an existing consumer product design) for private labeling by
OEMs. We may sometimes integrate our OEMs' unique or proprietary features and/or
technology into new products for their product lines. We focus our marketing
efforts on OEMs in various digital processing markets including digital music,
dictation equipment, consumer electronics, digital image and video and other
electronic product markets.
We have relationships with manufacturers with facilities in the United
States, China and Korea. We have expertise in developing, performing and
overseeing manufacturing processes. We apply our technology and expertise in
providing manufacturing supervision, documentation, and quality control services
to products for our OEM customers and for our e.Digital branded products. We
also use our technology to design and build "e.Digital-branded" portable digital
audio players and market them to consumers through various channels. Our primary
focus, however, is serving the development and manufacturing needs of our OEM
customers and licensees.
Services offered include custom hardware, firmware (an instruction set
programmed into a chip which determines the product's functionality and user
interface), and software development, technology platform development, product
design, manufacturing services, fulfillment services, warranty services, and
licensing of our patented file management systems. Our revenues may result from
the sale of products, fees from engineering services, fees or royalties from
technology licensing, industrial order fulfillment, technical support services,
warranty services and/or design services. In some cases, we rely on outside
subcontractors to perform services including manufacturing, testing and
certification, industrial design, and assembly.
COMPANY
Our company, then known as Norris Communications, was incorporated in
the Province of British Columbia, Canada on February 11, 1988 and on November
22, 1994 changed its domicile to the Yukon Territory, Canada. On August 30,
1996, we filed articles of continuance to change our jurisdiction to the State
of Wyoming, then on September 4, 1996, reincorporated in the State of Delaware.
On January 13, 1999, the stockholders approved a name change to e.Digital
Corporation. Our principal executive offices and primary operating facilities
are located at 13114 Evening Creek Drive South, San Diego, California 92128 and
our telephone number is (858) 679-1504. Our Internet site is located at
WWW.EDIG.COM OR WWW.EDIGITAL.COM. Information contained in our Internet site is
not part of this annual report.
RECENT DEVELOPMENTS
In July 2001, we signed a royalty-bearing licensing agreement with Bang
& Olufsen Multimedia A/S ("Bang & Olufsen"), a premier European electronics,
telephony and audio/video manufacturer. Under this licensing agreement, we
customized and provided Bang & Olufsen a MicroOS-based custom product platform
for use in their branded music product line. To date, we have received $75,000
under this agreement with respect to NRE fees only, of which $36,292 has been
deferred as of March 31, 2003. The first product developed under our licensing
agreement (the BeoSound 2 digital audio player) became available to consumers in
the United States and Canada in late June 2002, and in European markets a few
weeks later. In December 2002, Bang & Olufsen added BeoSound 2 for the Macintosh
to their product line. This was also developed in collaboration with our
engineering team. Bang & Olufsen sells their branded products through exclusive
retail stores worldwide. To date, we have received $55,625 of licensing revenues
and have recognized a total of $55,625 of revenues under this agreement.
In September 2001, we announced plans to brand and sell our own line of
digital audio products for consumers. The first product in this program was the
MXP(TM)100 digital audio player, which incorporates our MicroOS(TM) 2.0 and
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VoiceNav(TM) technologies into a handheld digital music and voice
recorder/player. In December 2001, we launched the Treo(TM) 10 and, in June
2002,Treo(TM) 15 hard-disk-drive based handheld music players with 10 GigaBytes
(GB) and 15 GB of built in storage, respectively. The Treo(TM) players are also
based on our MicroOS(TM) technology. During the 2002 calendar year we also
branded several products developed by outside manufacturers and sold them
through our resellers and our online store. These products include a line of
flash-memory-based compact digital audio players, the Odyssey(TM) 100,
Odyssey(TM) 200, and Odyssey(TM) 300, and a slim, portable CD player, called
Silhouette(TM), capable of playing home-recorded CDs. In November 2002, we
announced plans to refocus our business and marketing strategy on OEM
opportunities and de-emphasize the production and marketing of our own branded
products. The decision to move away from marketing and selling our own branded
products was driven by (i) slow payment terms by retailers, (ii) large working
capital requirements, specifically inventory, (iii) extremely competitive and
price sensitive market for consumer electronic goods in the United States; (iv)
low margins and (v) the need for high level of sales and marketing expenditures.
Directly related to our consumer product sales plans, in December 2001,
we signed a three-year agreement with APL Direct Logistics, a custom fulfillment
partner, for product distribution, fulfillment, and support services. Under the
multi-year agreement, APL Direct Logistics received our product inventory in
their distribution center in Hebron, Kentucky, and fulfilled orders directly to
consumers. These orders came from our secure online store, which had been
established at HTTP://WWW.EDIGITAL-STORE.COM. Orders also came from our
partners, from other online sales sites, from other distributors, from
resellers, or from retail stores. This agreement included provisions for APL
Direct Logistics or a subcontractor to provide call center support to answer
consumer questions and to take orders by phone when necessary. The agreement
required certain minimum payments to APL Direct Logistics and was for a term of
three years, terminating December 31, 2004. In September 2002, we notified APL
that we were terminating the agreement. In order to reduce our monthly overhead
expenses, we have brought in-house all of the fulfillment, distribution and
support services that previously had been handled by APL. At September 30, 2002,
approximately $51,922 of finished goods inventory was held at APL Direct
Logistics' facilities. In the quarter ending December 31, 2002, APL drew down on
$129,925 of the letter of credit and sold our inventory, with a value of $51,992
to reduce our obligations to APL. After applying $21,668, the December 31, 2002
balance in the prepaid freight management account at APL, we believe that the
total amount due to APL is $78,392 and have recorded this amount as a current
liability. Settlement of this liability may be either more or less than the
amount recorded in the consolidated financial statements and accordingly may be
subject to measurement uncertainty in the near term.
In March 2002, we announced that we had entered into a Development and
Manufacturing Agreement with Eclipse by Fujitsu Ten ("Eclipse"), a car stereo
company. Under the agreement, e.Digital receives NRE fees for design and
development services, as well as revenues for the manufacture and delivery of
Eclipse-branded audio products. Specifically, the agreement states that
e.Digital will provide Eclipse with engineering services to integrate file
management and compressed audio management technology designed by e.Digital into
an advanced automotive audio system. Prior to entering into the Development and
Manufacturing Agreement, we had collaborated with Eclipse for several months to
develop and deliver state-of-the-art automotive OEM and aftermarket infotainment
systems integrating the latest digital audio, voice recognition, data storage,
video, and wireless Internet technologies for sale under the Eclipse brand name.
Eclipse refers to their automotive audio system as an "infotainment" platform
because it includes not only a radio and CD Player, but also may (i) connect
wirelessly to the Internet to download music or other data, (ii) store,
organize, retrieve, and play back data, including digital audio files, from a
hard disk drive, (iii) connect wirelessly to a user's home personal computer
while parked in the driveway for purposes of downloading and/or uploading music
or other information, (iv) record radio signals to a built-in hard disk drive as
they are received and (v) recognize the driver's voice commands to perform a
variety of operations. The first system was unveiled at the 2002 International
Consumer Electronics Show in Las Vegas. To date, we have received $30,000 under
this agreement with respect to NRE fees only, of which $15,000 has been deferred
as of March 31, 2003.
In April 2002, we announced a strategic collaboration with DivXNetwork,
Inc. ("DivX Networks") of San Diego, California. DivX Networks created and
markets a motion picture compression format (the DivX(TM) codec, a leading
standard for MPEG-4 video distribution) that is used for storing, playing back,
and streaming motion pictures over the Internet. Over 80 million users worldwide
have downloaded the DivX codec and the format is frequently used for
distribution of news, information, and entertainment by corporations and video
producers including major motion picture companies. Under the agreement, we are
working with DivX to jointly develop and market a range of consumer electronics
devices that play back DivX video and provide copyright protection to encoded
video files. To date, we have received no revenues from this collaboration.
In May 2002, we signed a strategic development agreement with Digitalway
Co., Ltd., ("Digitalway") of Korea. Under the agreement, we will co-develop and
market advanced digital audio players for the consumer market. The products
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will be branded by e.Digital and marketed in the United States and Canada. The
products will be branded by Digitalway and marketed in Asia and Europe.
In October 2002, we announced a development agreement with Aircraft
Protective Systems, Inc. ("APS") to develop and market a portable, hard disk
drive-based In-Flight Entertainment, or IFE, system under contract for a leading
U.S. airline. The agreement specifies that we will manufacture and sell the
customizable digital video player through APS. The agreement includes provisions
for non-recurring engineering ("NRE") fees to be paid by APS to us for design
services plus licensing fees and royalties. To date, we have received $50,000 in
payments under this agreement with respect to NRE fees only, of which $50,000
has been deferred at March 31, 2003.
In January 2003, we launched the e.Digital Odyssey(TM) 1000, a portable
hard disk drive-based digital audio player jointly designed by e.Digital and
Digitalway, and manufactured by Digitalway. The Odyssey(TM) 1000 is based on our
MicroOS(TM) technology, and has an embedded 2.5 inch, 20 GB capacity hard drive
capable of storing and playing back up to 5,000 tracks. It has a USB (Universal
Serial Bus) 2.0 connection capable of downloading and writing up to 8 MegaBytes
(MB) per second. The Odyssey(TM) 1000 incorporates an FM radio and digital voice
recorder and a large, backlit display. It also acts as a portable hard drive and
can store and transport any type of data file including images, spreadsheets, or
other electronic documents. VoiceNavTM is included to make it easier to navigate
through a large music collection and play a selected track.
In February 2003, we announced a development agreement with independent
systems integrator Softeq Development Corporation ("Softeq"). Under the
agreement, we are collaborating with Softeq to develop a new digital audio
product using e.Digital's patented MicroOS(TM) technology and wireless
communication technology. The agreement calls for us to provide finished,
manufactured products to Softeq, who is to supply them to Hewlett-Packard for a
specific customer of Hewlett-Packard's. To date, we have received $51,000 in
payments under this agreement with respect to NRE fees only, of which $51,000
has been deferred at March 31, 2003.
We incurred operating losses in each of the last three fiscal years and
these losses have been material. We incurred an operating loss of $5.8 million,
$5.9 million and $3.9 million in fiscal year 2003, 2002 and 2001, respectively.
At March 31, 2003, we had a working capital deficit of $1.4 million. Our monthly
cash operating costs have decreased from approximately $500,000 per month at the
end of fiscal year 2002 to the current level of approximately $225,000 per
month. However, we may increase expenditure levels in future periods to support
the launch of "e.Digital" branded products and expand our OEM revenue
opportunities and continue advanced product and technology research and
development. Accordingly, our losses are expected to continue until such time as
we are able to realize supply, licensing, royalty, sales, and development
revenues sufficient to cover the fixed costs of operations. We continue to be
subject to the risks normally associated with any new business activity,
including unforeseeable expenses, delays and complications. Accordingly, there
is no guarantee that we can or will report operating profits in the future.
Since March 31, 2001, we have experienced significant losses and
negative cash flow from operations. The Company's current working capital is
sufficient to fund operations for the next three months. Our current operating
plans, including our plans to market to OEMs, require additional funds which may
take the form of debt or equity financings. There can be no assurance that any
additional funds will be available to our company on satisfactory terms and
conditions, if at all. Our company's ability to continue as a going concern is
in substantial doubt and is dependent upon achieving a profitable level of
operations and, if necessary, obtaining additional financing.
Management of our company has undertaken steps as part of a plan to
improve operations with the goal of sustaining our operations for the next
twelve months and beyond. These steps include (a) controlling overhead and
expenses ; (b) expanding sales and marketing to OEM customers and markets and
(c) raising, if necessary, additional capital and/or obtaining third party
financing.
On September 28, 2001, we issued 12% Secured Promissory Notes ("SP
Notes") for gross cash proceeds of $1,000,000 to certain accredited investors.
The SP Notes mature December 31, 2002 and are secured by our accounts receivable
and inventory. The interest under the SP Notes accrues at a rate of 12% per
annum simple interest and is payable in one installment on the maturity date. In
connection with the sale of the SP Notes, we issued warrants to purchase 750,000
shares of our common stock, $0.001 par value ("Common Stock") at a purchase
price of $0.75 per common share expiring September 20, 2006. The proceeds raised
have been allocated to the SP Notes and warrants based on their relative fair
5
values. On December 30, 2002, we issued 807,013 shares of Common Stock in
consideration for all accrued and unpaid interest. On December 30, 2002, each of
the note holders agreed to convert the unpaid principal balance totaling
$1,000,000 of the SP Notes into 100,000 Series D convertible preferred stock
(the "Series D stock").
On January 18, 2002, we issued a 5% Secured Promissory Note ("5% SP
Note") for gross cash proceeds of $1,200,000. The 5% SP Note, originally matured
on April 18, 2002 and is secured by all assets of our company including, without
limitation, our intellectual property. The interest under the 5% SP Note accrued
at a rate of 5% per annum simple interest and was payable in one installment on
maturity date. On April 17, 2002, the 5% SP Note holder agreed to extend the
maturity date of the 5% SP Note from April 18, 2002 to May 2, 2002 for no
consideration. On April 29, 2002, the 5% SP Note holder agreed to extend the
maturity date of the 5% SP Note from May 2, 2002 to October 29, 2002 and to
reduce the interest rate from 5% to 4% in exchange for (i) a $200,000 finance
fee that increased the principal amount from $1,200,000 to $1,400,000, (ii) a
minimum monthly principal reduction of $100,000; (iii) an immediate principal
repayment of $300,000 and (iv) repayment of accrued interest to April 18, 2002
of $15,000. On September 11, 2002, we redeemed the outstanding balance and
accrued interest on the 5% SP Note
On February 6, 2002, we filed a "shelf" registration statement on Form
S-3, No. 333-82272 (the "Registration Statement") to sell up to 20,000,000
shares of common stock. The Registration Statement was declared effective by the
Securities and Exchange Commission on April 29, 2002. On April 31, 2002, we sold
2,830,189 shares of Common Stock for gross proceeds of $1,500,000, and utilized
$300,000 to reduce the principal amount due under the 5% SP Note, $15,000 to
reduce accrued interest due under the 5% SP Note, and $5,105 for offering
expenses. On June 7, 2002, we sold 2,105,264 shares of Common Stock for gross
proceeds of $800,000, and utilized $250,000 to reduce the principal amount due
under the 5% SP Note and $1,000 for offering expenses. On December 3, 2002, we
sold 425,532 shares of Common Stock for gross proceeds of $200,000 and utilized
$195,000 for working capital purposes and $5,000 for offering expenses. On
October 2, 2002, we sold 446,774 shares of Common Stock for gross proceeds of
$182,000, and utilized $150,000 to reduce the principal amount of the Unsecured
Notes and $32,000 to reduce accrued interest due under the Unsecured Notes. On
November 1, 2002, we sold 455,000 shares of Common Stock for gross proceeds of
$138,500 and utilized $138,500 for working capital purposes. On November 18,
2002, we sold 445,000 shares of Common Stock for gross proceeds of $133,500 and
utilized $133,500 for working capital purposes. On November 27, 2002, we sold
450,488 shares of Common Stock for gross proceeds of $92,350 and utilized
$92,350 for working capital purposes. On December 24, 2002, we sold 555,263
shares of Common Stock for gross proceeds of $105,500 and utilized $105,500 for
working capital purposes. On January 14, 2003, we sold 678,947 shares of Common
Stock for gross proceeds of $129,000 and utilized $129,000 for working capital
purposes. On March 6, 2003, we sold 425,000 shares of Common Stock for gross
proceeds of $80,750 and utilized $80,750 for working capital purposes. On June
10, 2003, we sold 6,161,705 shares of Common Stock for gross proceeds of
$1,170,723 and utilized $203,067 to redeem all of the principal and accrued
interest on the 24% Unsecured Promissory Note, $74,137 to redeem all of the
principal and accrued interest on the 24% Unsecured Note to a director and
$893,519 for working capital purposes.
In July 2002, we issued Unsecured Promissory Notes ("Unsecured Notes")
for gross cash proceeds of $1,050,000 to certain investors to finance various
purchase orders and accounts payable. The Unsecured Notes originally matured
sixty days from issuance, commencing December 1, 2002. The interest under the
Unsecured Notes accrued at a rate of 24% per annum simple interest and was
payable in one installment on the maturity date. We have entered into a
forbearance agreement with the investors through and including December 31,
2002. On December 30, 2002, we issued 397,104 shares of Common Stock in
consideration for all accrued and unpaid interest. On December 30, 2002, each of
the note holders agreed to convert the unpaid principal balance totaling
$1,050,000 of the Unsecured Notes into 105,000 Series D stock.
On August 2, 2002, we issued 360,000 restricted shares of Common Stock
to a director for gross proceeds of $120,000. The restricted shares of Common
Stock do not have any registration rights.
On December 11, 2002, we issued a 15% Unsecured Promissory Note ("15%
Unsecured Note") for gross cash proceeds of $750,000 to an individual. The 15%
Unsecured Note, under the original term, was scheduled to mature on February 11,
2004 and payable $50,000 each month, with a final payment of $35,801 on February
11, 2004. We entered into a forbearance agreement with the noteholder through
and including December 31, 2002. On December 30, 2002, we issued 137,273 shares
of Common Stock in consideration for all accrued and unpaid interest. On
December 23, 2002, the holder of the 15% Unsecured Note agreed to (i) extend the
maturity date of the 15% Unsecured Note from February 11, 2004 to May 31, 2005;
(ii) reduce the monthly payments from $50,000 to $7,500 through December 31,
2003, representing the monthly interest on the 15% Unsecured Note and (iii)
$50,000 payments each month, beginning January 31, 2004.
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On March 17, 2003, we issued a 24% Unsecured Promissory Note ("24% Unsecured
Note") for gross cash proceeds of $42,000 to a director to finance inventory
purchases. On March 31, 2003, we repaid all accrued interest and $6,938 of
principal. At March 31, the principal amount due under the 24% Unsecured Note
was $35,454. On April 28, 2003, we received additional gross cash proceeds of
$37,800 from the same director pursuant to this same 24% Unsecured Note. On June
10, 2003, we redeemed the outstanding balance and accrued interest on the 24%
Unsecured Note.
In May 2003, we issued certain 24% Unsecured Promissory Notes ("24% Unsecured
Promissory Notes") for gross cash proceeds of $200,000 to certain accredited
investors. The 24% Unsecured Promissory Notes mature on June 30, 2004. The
interest under the 24% Unsecured Promissory Notes is payable monthly at a rate
of 12% per annum, simple interest and accrues an additional interest of 12% per
annum, simple interest to be paid at the earlier of redemption or maturity. On
June 10, 2003, we redeemed the outstanding balance and accrued interest on the
24% Unsecured Note.
On June 10, 2003, we sold 6,161,705 shares for gross proceeds of $1,170,723 and
utilized $203,067 to redeem all of the principal and accrued interest on the 24%
Unsecured Promissory Notes, $74,137 to redeem all of the principal and accrued
interest on the 24% Unsecured Note to a director and $893,519 for working
capital purposes.
INDUSTRY BACKGROUND
We design and market products employing portable storage media with the major
categories being digital voice recorders, digital music players, digital video
players, and related mobile devices. We have recently begun developing
automotive stereo products and components using our technology.
PORTABLE STORAGE MARKET
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There are two major categories of portable storage media: solid state and
miniature rotating disks including hard disk drives. We have designed our
technology to work with a wide variety of portable storage media. Our product
applications support a variety of storage media including SanDisk's multimedia
card format and Secure Digital memory card format (created by SanDisk, Toshiba,
and Matsushita-known in the United States as Panasonic), the IBM Microdrive
format, Intel's Miniature Card, CompactFlash, and others, thereby offering
customers design flexibility and choices among portable storage memory.
Capacities range from 16 Megabytes ("MB") to 80 Gigabytes ("GB") in portable
storage formats widely available from various vendors.
We believe these portable storage formats are complicated to use and generally
require a sophisticated interface and file system. A file system is a software
driver used to make portable memory components more closely emulate a
traditional disk drive and allow an understood mechanism for rapidly storing and
retrieving data with the minimal overhead allowed in a portable device. Portable
storage formats may also require the use of sophisticated power management
systems to maximize battery life in portable devices, and additionally may
require robust software interfaces with personal computing platforms for
consumers' ease of use in exchanging data files (consisting of music, pictures,
movies, voice recordings, text documents, spreadsheets, or other data) with
their personal computers.
DIGITAL MUSIC PLAYERS
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Digital audio compression technologies allow the transmission of compact disc
quality audio over the Internet. Several compression formats are currently used,
including MP3 (an open digitally encoded audio standard arising from the Moving
Picture Experts Group), Dolby Laboratories' AAC, Microsoft's Windows Media Audio
("WMA"), Sony's ATRAC3, QDesign's QDX and Lucent's Enhanced Perceptual Audio
Coder ("ePAC"). These compression formats also allow consumers to encode
(sometimes referred to as "ripping") music files from purchased, prerecorded
music CDs. They may also acquire these compressed music files from Internet
sites providing various music downloads for free or for a fee. These files may
be stored on a computer hard drive or downloaded to a portable digital music
player via a USB cable or other type of cable interface.
Some compression technologies, including the widespread MP3 format, lack
copyright protection. Downloading music from the Internet has become popular,
and music content copyright owners, including the major record companies, have
raised concerns about unauthorized copying or "pirating" of copyrighted sound
recording. The percentage of Internet users downloading music files increased
from 38% in 2000 to 44% in 2002. (Source: Ipsos-Reid, a consumer marketing
research firm.) Because pirating of copyrighted content remains a concern, we
are working to support viable digital rights management ("DRM") technology in
our portable music players.
Portable digital music players are becoming popular. In-Stat/MDR predicts that
worldwide portable digital music players unit shipments will grow from 6.8
million in 2002 to over 36 million in 2007 with hard disk drive-based players
experiencing the
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highest growth rate. We believe that the popularity of inexpensive or free music
compression programs such as RealOne, musicmatch Jukebox, Windows Media, and
WinAmp--as well as online music subscription and downloading services --will
drive demand for portable digital music players by making it easier for
consumers to create and collect digital audio files.
AUTOMOTIVE AUDIO MARKET
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Automotive audio ("autosound") products can be installed at the factory/dealer
level, or in various retail outlets after the purchaser leaves the dealership
(known as "aftermarket" purchases).
Trends in automotive stereo products include the development of an industry
known as automotive "telematics." Automotive telematics is the wireless exchange
or delivery of communication, information, and other content between the auto
and/or occupants and external sources. Telematics systems may integrate
sophisticated entertainment, information, communication, navigation, and other
systems with an onboard computer or other control system to enhance driver and
passenger safety and/or comfort. The Strategis Group, a research firm, predicts
that 84 percent of new cars sold in 2004 will feature some form of telematics
equipment, and UBS Warburg estimates that the telematics market will be worth
$47 billion by 2010.
Working with Lucent Technologies, we developed a user-independent speech
recognition interface, known as VoiceNav, for our MXPTM 100 portable digital
audio player. Based on Lucent's robust speech recognition technology, VoiceNav
marks the first time a speech recognition system has been incorporated into a
handheld device that is not connected to a network for its processing power.
VoiceNav has a 100,000-word English language vocabulary and can recognize names
and sounds not in the dictionary, without training. We believe VoiceNav will be
important to automotive stereo manufacturers and car manufacturers as it can
allow advanced stereo or telematics systems to be operated by the driver using
only voice commands or phrases. We believe this will make these sophisticated
automotive systems easier and safer to use. We are working to incorporate
VoiceNav into automotive system designs so that the driver will not have to take
his/her hands off the wheel to operate the stereo or other systems.
Automotive stereo or telematics units may store map or navigation information,
music, news, or other content for the driver to access as needed. With Eclipse
by Fujitsu Ten, we are working to develop automotive stereo and telematics
products incorporating a hard disk drive. We are also working with them to make
the hard disk drive portable and removable in automotive applications.
DIGITAL VIDEO PLAYERS
- ---------------------
Digital video players including DVD (digital video disc) players are increasing
in popularity with consumers. According to the Consumer Electronics Association,
DVD players are the fastest selling consumer electronics products in history
with more than 7 million units sold in 2002 for prices ranging from $400 to over
$1,000. DVD content, according to Wall Street Journal's May 9, 2003 edition, is
a $12 billion/year market.
Video compression formats such as MPEG-4 and DivX allow the compression and
transmission of digital video files over the Internet. They also allow consumers
to download and store on their personal computer's hard drive full-length,
two-hour, motion picture files in as little as 500 MB of storage space. These
movies can then be viewed by consumers on a personal computer monitor.
There is also a developing market for streaming delivery of video content on the
Internet. Corporations or video production companies may use streaming video to
deliver information and entertainment to users. DivXNetworks, Inc., the creator
and provider of the DivX video compression format, reports that over 80 million
users have downloaded their video playback software. This illustrates the demand
for high-quality video in manageable file sizes. The users of DivX compression
format have been limited to viewing DivX motion picture content on their
computer monitors. We are working with DivXNetworks to incorporate our digital
file management system and DRM technology with their DivX compression format
into a portable hardware product that will store video files on a built-in hard
disk drive with a minimum of 10 GB (Gigabytes) of storage capacity. We believe
there will be growing demand for a system including portable hardware that will
allow consumers to select and download movies over the Internet in digital form,
then download them to a portable player capable of feeding the video and audio
signals through a home entertainment system or built-in viewing screen and
speakers.
IN-FLIGHT ENTERTAINMENT (IFE)
- -----------------------------
In-flight entertainment (IFE) encompasses music, news, television programming,
and motion pictures presented through audio/video systems typically embedded
into an aircraft. Certain airlines are also beginning to incorporate satellite
programming and/or wireless Internet access for their passengers through
extensive built-in hardware in certain aircraft on certain routes. According to
the Wall Street Journal, airlines worldwide spend approximately $2 billion a
year on entertainment.
8
Because the costs to retrofit an aircraft with IFE equipment can be prohibitive,
we have developed an alternative IFE system. Our portable IFE player is smaller
than a typical laptop computer and has a high-quality color screen and stereo
headphones. It will be available to passengers for a small rental fee. We have
begun production of our portable IFE units for use by a domestic airline.
Although passengers may rent or purchase portable DVD players from outside
entities, we have created the first portable video players that can be rented to
passengers by the airline. Airlines can provide advertising or other branded
content for preloading, and they will collect rental revenues for the system. We
believe this type of system is attractive to airlines and other travel-related
entities because of its revenue potential, variety of content, and inexpensive
implementation.
OTHER CONSUMER ELECTRONIC PRODUCTS
- ----------------------------------
The consumer electronics market is undergoing a major technology convergence in
ever-smaller products, which combine multiple functions. Cellular phones are
incorporating PC features, even World Wide Web access, and pagers are combining
with cellular phones and voice-mail systems. Consumer electronic manufacturers
are integrating functions and devices at an extremely fast pace, and technology
consumers are eager to take advantage of "convergence" products. We believe
these trends will affect all types of portable and mobile products and
technologies.
The Internet is impacting business and technology in unparalleled ways. Music,
data, audio, and video can be downloaded through the Internet to the personal
computer creating a market for portable devices that can interface digitally.
Portable storage media prices are dropping an estimated 30% per megabyte per
year according to Cahners In-Stat Group, improving the outlook for portable
devices that employ such media. These moves, along with lower voltage storage
media and improved battery technology, are expected to expand the market for
portable and mobile devices.
The fast-paced electronics industry presents challenges for developers of
electronic products, where time to market, cost, performance, quality,
reliability, size and the need for product diversity become important focal
points in a volatile industry. Applications for our technology include portable
digital music players and voice recorders, PC peripherals, cellular phone
peripherals, e-books, video games, digital cameras, set-top boxes, home and
automotive audio units, and digital video recorders. We are focusing research
and development activities toward these product markets.
OUR STRATEGY
We are currently focusing development, sales, marketing, and support efforts
chiefly on platform and product development opportunities for OEM customers and
licensees in portable digital entertainment device markets. This includes
automotive entertainment systems. Our objective is to have our operating systems
and application designs play major roles in the growing market for portable
digital devices. Our designs are capable of playing music files encoded in a
number of different music compression formats, and can support a number of
different DRM's. The exterior appearance, button layout, and feature set in
these designs are customizable according to OEM customers' needs. We believe our
flexibility is important as the portable digital audio player (DAP) industry
faces choices of competing music compression formats, DRM's, and storage media.
Products designed primarily by e.Digital and marketed by our customers will be
marketed under a license and/or royalty fee arrangement with fees paid to
e.Digital. Utilizing strategic customers for product development and marketing
will result in reduced development and manufacturing costs, provide high quality
products and create a broader revenue base. We believe these products will be
cost competitive and provide gross margins in excess of 20%.
We offer a total solution from product design through development,
manufacturing, delivery, and support. Our strategy is to build upon our
proprietary technology to develop long-term strategic relationships with key
manufacturers in various industries. We believe we have the expertise and
experience to offer a turnkey solution to major OEMs seeking to implement
portable digital audio and video processing. We actively seek licensing, private
label, and OEM opportunities in the digital audio and video processing market.
Our efforts include:
1. Expanding our business by developing custom products for OEM customers - We
seek to expand our business through sales and marketing targeted at obtaining
additional product development opportunities with existing customers and new OEM
customers.
2. Developing brand name recognition with OEM customers - This strategy is being
pursued through participation in industry alliances, trade show participation,
professional articles and attaching our name along with OEM products to the
extent possible.
3. Expanding the technology base through continued enhancements of our
technologies and applications - We develop in-house proprietary designs,
products, features or technologies that may be private labeled or licensed to
one or more OEMs. Our
9
engineering team continues to enhance and update MicroOSTM software and related
technology. MicroCAM has been assimilated as part of our MicroOSTM system. We
also devote resources to expanding our technology to new applications. In
addition to supporting music, voice, and motion picture processing, we believe
our technology may have applications in a wide range of products including voice
pagers, answering machines, cellular phones and accessories, computers, computer
peripherals, automobile stereos and for the storage and playback of still images
and motion pictures.
4. Leverage strategic industry relationships - We have established and maintain
important strategic industry relationships and associations with a number of
related companies. We seek to leverage these relationships to offer better
technology integration and solutions to our OEM customers and to maximize subtle
but valuable marketing and co-promotion opportunities.
CUSTOMERS
- ---------
We have revenue-producing contracts or revenue-producing licensing and marketing
arrangements with the following customers:
APS (AIRCRAFT PROTECTIVE SYSTEMS) - APS selected e.Digital to design, develop,
and manufacture a portable in-flight entertainment (IFE) device for a major
domestic airline. The device incorporates a hard disk drive and securely stores
and plays back video and audio content to be provided by motion picture studios
and/or record labels. The portable device will ultimately be rented to airline
passengers as part of an IFE system providing fresh, new movies and music not
previously available to in-flight audiences.
BANG & OLUFSEN - We have licensed technology to Bang & Olufsen for use in their
branded digital audio player products. The first product developed under our
licensing agreement (the BeoSound 2 portable MP3 player) reached the retail
market in June 2002. Bang & Olufsen sells their branded products, including the
BeoSound 2, through exclusive retail stores worldwide.
DIGITALWAY - Digitalway has licensed a version of our Odyssey 1000 hard disk
drive-based portable digital audio player for their MPIO branded line of
consumer electronics. Digitalway's model HD100 is closely based on our Odyssey
1000 model. Digitalway is marketing the HD100 in Europe and is expected to
market it in Asia. Digitalway's shipments and sales of the HD100 product are
anticipated to generate licensing fees and royalties for e.Digital.
ECLIPSE BY FUJITSU TEN - For this automotive stereo manufacturer, we are
developing an automotive stereo system using a hard disk drive and our MicroOS
technology. Users will be able to store and organize thousands of tracks on the
unit, which is removable and plugs into a standard Eclipse head unit mounted in
a vehicle. Eclipse by Fujitsu Ten is 51% owned by Toyota Motor Corporation.
SOFTEQ - We are collaborating with Softeq to develop a unique digital audio
player incorporating our MicroOS technology with wireless communication
technology. The project is funded by Hewlett Packard for one of its OEM
customers. Softeq has subcontracted with us to develop, manufacture, and
maintain the products, which they will purchase on behalf of Hewlett Packard and
its OEM customer. We expect to gain NRE fees, product purchase fees, royalties,
service fees, and manufacturing margins from the completion of this project.
OTHER CUSTOMERS
- ---------------
We are working with a number of OEM customers on new products for their consumer
electronics lines and have not finalized agreements with all of these customers.
Some of our customers will not announce details of their products or marketing
plans until they begin shipping to consumer markets.
STRATEGIC INDUSTRY RELATIONSHIPS & ASSOCIATIONS
LICENSEES
- ---------
Companies with related but not competing technologies have agreed to license our
technologies and/or designs. To varying degrees, these partners promote and
market our work with their own. They may, from time to time, refer customers to
e.Digital. With these strategic partners, we may collaborate on projects where
both partners could benefit financially. We have such marketing partnerships
with Actel, Digitalway, Eastech, Maycom, Musical Electronics, Orient Power, and
PortalPlayer.
TECHNOLOGY PROVIDER PARTNERS
- ----------------------------
We rely on certain partners and/or vendors for their contributions to our
product designs and we may purchase or license components or technologies from
them. These partners may also promote or display our products or designs at
industry trade shows or in their advertising. We believe these partners add
value to our services and help generate industry goodwill that can
10
result in increased business. We have such partnerships with IBM, DivXNetworks,
Gracenote, Lucent Technologies, Microsoft Corp., Musicmatch, Inc., SanDisk,
Sony, SRS Labs, Texas Instruments, Toshiba, and Xilinx.
ASSOCIATIONS
- ------------
We maintain membership and participation in the Consumer Electronics
Association, VoiceTIMES Initiative, and the Secure Digital ("SD") Card
Association. In addition, individual employees may be associated with
professional development organizations and associations related to their
professions.
PRODUCTS, SERVICES, LICENSING, AND TECHNOLOGY
- ---------------------------------------------
Our consumer electronics products are primarily digital audio players and
related devices. Our technology and services are focused on providing digital
solutions for the portable device marketplace.
CONSUMER ELECTRONICS PRODUCTS
- -----------------------------
We have created a line of e.Digital-branded consumer electronics products for
sale to consumers. We have also served as a reseller for consumer electronics
products and accessories from certain partners, including IBM's Microdrive(TM)
removable storage media, and SanDisk's CompactFlash(TM) cards.
The MXPTM 100 is a compact, portable digital music player and voice recorder
compatible with removable IBM MicrodriveTM and CompactFlash storage media. It
was the first product to incorporate our exclusive VoiceNavTM speech recognition
user interface so the user can quickly navigate through music files by saying
the track name aloud. The MXPTM 100 plays both MP3 and Windows Media(TM) audio
files, and comes with our Music Explorer(TM) custom software application for
downloading music and other data files. The TREOTM 10 and TREOTM 15 portable
digital jukeboxes are hard disk drive-based digital audio players with large
capacity storage of 10 Gigabytes (GB) and 15 GB, respectively. The TREOTM
products play MP3 and Windows Media(TM) audio files, and also serve as a
portable hard drive for the backup and transport of all types of electronic
files and data. They are capable of holding thousands of songs and the
rechargeable battery will play for approximately 10 hours between charges.
The OdysseyTM 100, OdysseyTM 200 and OdysseyTM 300 digital audio players,
developed with Digitalway, are flash memory-based with SmartMedia(TM) card
expansion slots. They all feature MP3 file playback, very compact size, and long
battery life from single standard AA alkaline batteries. The higher-end model
(300) adds FM tuning, FM recording, direct MP3 encoding from a line in, and a
digital voice recorder. These products are compatible with PC and Macintosh
platforms.
The OdysseyTM 1000 is a personal digital jukebox, digital voice recorder, and FM
radio featuring an easy-to-use scroll wheel and VoiceNav speech recognition
technology. The 20 GB hard disk drive holds about 5,000 songs of average length
and also serves as a portable hard drive. A Universal Serial Bus (USB) 2.0
connection to the user's PC allows very fast downloads of up to 8 MB per second.
A typical CD's worth of MP3 files can be downloaded to the player in
approximately 5 seconds. A mirrored finish and holographic, color-changing logo
make this a very attractive player and the Odyssey 1000 is our most
sophisticated so far in terms of features and storage capacity.
Our continuing consumer electronics product development is almost exclusively
focused on the Odyssey 1000 and related products.
SERVICES
- --------
We offer developers of electronic products a portfolio of services within the
broad categories of design services, development services, manufacturing
services, and customer service. Our revenue has been and is expected to be
derived from a combination of fees from licensing, engineering services,
manufacturing services, warranty services, industrial design services, technical
support services, order fulfillment, and unit royalty payments.
We offer services to design electronic and portable digital products. When
developers of electronic products lack the experience or resources to work with
portable storage media to do their own design work, or they want to keep
internal engineers and designers on other work, our design services help perform
component and product design. We offer design services in areas such as circuit
design, the design and incorporation of custom digital signal processing
solutions, wireless communication, computer and Internet connectivity and
product design. We have expertise in embedded systems, digital and analog
integrated circuit design, wireless, multimedia, Internet and computer
connectivity, DSP customization, Flash memory interface and related fields.
11
In addition to design, our engineers can perform development services aimed to
convert designs into functional reference designs, prototypes and/or end
products. We are also experienced in arranging for manufacturing services
including factory hand-off and development of test procedures.
MANUFACTURING MANAGEMENT SERVICES
- ---------------------------------
We have relationships with manufacturers with facilities in the United States,
Malaysia, China and Korea. These manufacturers either have performed or are
qualified to perform manufacturing, assembly, and related services for our OEM
customers, licensees, and/or e.Digital branded consumer electronics products. We
have expertise in developing, performing and overseeing manufacturing processes.
We offer technology transfer, manufacturing supervision, documentation, and
quality control services to our OEM customers.
LICENSING
- ---------
We license technology platforms and reference designs to OEM customers. A
technology platform can be only software or a combination of software, firmware,
and hardware. OEM customers use technology platforms as components in new
products. A reference design is a more fully developed product including
completed industrial design and user interface features. A reference design may
be private labeled, as is, by licensees or it may be customized further
according to their needs. We also assist OEM customers in obtaining third-party
licenses such as music and voice compression algorithms and Digital Rights
Management systems that may be necessary before a product can be marketed.
MICROOSTM CORE TECHNOLOGY
- -------------------------
Our MicroOSTM is a low-level, real time operating system designed to
transparently manage the difficulties of writing, reading, and editing data on
Flash or related memory. It serves as system software to manage all operations
in handheld devices using either removable or embedded Flash (or related media)
for data storage. MicroOSTM is compatible with virtually all types of portable
storage memory as well as other standard Integrated Drive Electronics ("IDE")
drives. MicroOSTM facilitates advanced functionality, ease of use, flexibility,
and reliable performance in products and supports all types of data files
including voice, text, images, video and/or music.
We believe our MicroOSTM technology is an efficient, portable storage memory
file management system. The patented software architecture takes a unique
approach to file management that is robust, high-speed and efficient. This
approach is suited for the high-speed portable product market because it
requires minimal micro-controller support while providing broad product
functionality. This architecture offers OEMs the ability to reduce new product
development time and time to market, as well as produce a product featuring a
reduced chip count and correspondingly lower cost and power requirements.
MICROCAM TECHNOLOGY (MICROOSTM-BASED COMPRESSED AUDIO MANAGER)
- --------------------------------------------------------------
MicroCAM technology, which can support multiple compression formats such as MP3,
AAC, ATRAC3, WMA, ePAC, and others in a single device. MicroCAM allows for
high-bandwidth speech and music playback from a CompactFlash cartridge, other
removable or embedded Flash memory, or other Advanced Technology
Attachment/IDE/Advanced Technology Attachment Packet Interconnect embedded or
removable rotating drives such as the IBM Microdrive. MicroCAM is an integral
part of our digital music player designs and has been incorporated as a standard
feature set in MicroOSTM.
VOICENAV(TM)
- ------------
Working with Lucent Technologies, we developed a user-independent speech
recognition interface, known as VoiceNavTM, for our MXPTM 100 portable digital
audio player. Based on Lucent's robust speech recognition technology, VoiceNavTM
marks the first time a speech recognition system has been incorporated into a
handheld device that is not connected to a network or a PC for its processing
power. VoiceNavTM has a 100,000-word English language vocabulary and can
recognize names and sounds not in the dictionary, without training. VoiceNavTM
has application in portable devices, and it can be incorporated into automotive
stereo or telematics systems. VoiceNavTM can allow advanced stereo or telematics
systems to be operated by the driver using only voice commands or phrases. We
believe this will make these sophisticated automotive systems easier and safer
to use. We are working to incorporate VoiceNavTM into automotive entertainment
system designs, as well as other portable devices.
MARKETING AND SALES
OEM technology marketing and sales are performed internally, primarily by our
Vice President of Business Development, Vice President of Research and
Development, Chief Executive Officer and various technical personnel who are
heavily involved in the sales process. Targeted OEM customers include dictation
equipment manufacturers, Internet music participants, digital camera developers,
semiconductor and DSP manufacturers, PC manufacturers, home audio manufacturers,
video technology
12
developers, automotive audio manufacturers, and developers of various portable
devices.
Maycom, EASTECH, Musical Electronics, and Digitalway are licensees and marketing
partners. Their areas of interest are in Internet music players and digital
voice recorders. As turnkey manufacturing service providers, Maycom, EASTECH,
Musical, and Digitalway have access to a number of name-brand consumer
electronics customers to whom they may market product designs that include our
technology. With these licensees/marketing partners, we are marketing Internet
music player designs and other product designs worldwide to OEM companies who
license and/or label the designs for introduction to the retail market under
their brand name(s).
We primarily market our services through our strategic and industry
relationships and technical articles in trade and business journals. We also
participate in industry trade shows, either directly or in conjunction with
customers and/or strategic partners. In the last twelve months we have devoted
significant resources to creating enhanced marketing materials that supplement
custom marketing presentations to key prospects. We may in the future employ
limited and selected advertising in targeted industry publications.
INTELLECTUAL PROPERTY
We have five issued U.S. patents covering our MicroOSTM file management software
and certain technology related to portable digital devices. Our software is also
protected by copyrights. We rely primarily on a combination of patents,
copyright and trade secret protection together with licensing arrangements and
nondisclosure and confidentiality agreements to establish and protect our
proprietary rights.
The patent position of any item for which we have filed a patent application is
uncertain and may involve complex legal and factual issues. Although we are
currently pursuing trademark applications with the U.S. Patent and Trademark
Office and also have filed certain international patent applications
corresponding to our U.S. patents or applications, we do not know whether any of
these applications will result in the issuance of patents or trademarks, or, for
any patents already issued or issued in the future, whether they will provide
significant proprietary protection or will be circumvented or invalidated.
Additionally, since an issued patent does not guarantee the right to practice
the claimed invention, there can be no assurance others will not obtain patents
that we would need to license or design around in order to practice our patented
technologies, or that licenses that might be required would be available on
reasonable terms. Further there can be no assurance that any unpatented
manufacture, use, or sale of our technology or products will not infringe on
patents or proprietary rights of others. We have made reasonable efforts in the
design and development of our products not to infringe on other known patents.
We also rely on trade secret laws for protection of our intellectual property,
but there can be no assurance others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to our trade secrets or disclose such technology, or that we can
protect our rights to unpatented trade secrets.
We have also filed a number of trademark applications with the U.S. Patent and
Trademark Office including MXP, Odyssey, and MicroCAM. We have received
notification of allowance from the United States Patent Office for use of
e.Digital(TM), MicroOS(TM), Smart Solutions for a Digital World (Service Mark),
VoiceNav(R), Music Explorer(R), MXP(TM), Flashback(R), Hold That Thought(R),
Fumble Free(R) and SoundClip(R) as registered trade names. We intend to make
every reasonable effort to protect our proprietary rights to make it difficult
for competitors to market equivalent competing products without being required
to conduct the same lengthy testing and development conducted by us and not to
use any of our innovative and novel solutions to overcome the many technical
obstacles involved in developing portable devices using Flash and other portable
storage formats.
RESEARCH AND DEVELOPMENT COSTS
For the years ended March 31, 2003, 2002 and 2001, we spent $1,410,506,
$2,327,283 and $1,956,857, respectively, on research and development. We
anticipate that we will continue to devote substantial resources to research and
development activities. In fiscal 2003, 2002 and 2001, approximately $194,689,
$488,094 and $173,550 of total research and development revenue was recognized
from the company's research and development contracts. The related costs were
included in cost of services.
COMPETITION
The competition is very strong in the field of portable digital music players.
The first MP3 player was brought to market in November 1998 by Diamond
Multimedia Systems, Inc., now known as SONICblue. Other manufacturers, including
Archos, Creative Labs, Denon, Apple (Macintosh), Thompson Multimedia's RCA
division, iRiver, LG Electronics, Phillips, Samsung, Sony, Sanyo, Toshiba, and
others, have released or announced plans to sell portable digital music players,
most using the MP3 format. Other manufacturers may announce products in the
future.
13
The competition is also expected to be strong in the digital video player field.
Many large manufacturers currently market various forms of component or handheld
digital video players, including Panasonic, Sony, Samsung, Hitachi, RCA,
Audiovox, Philips, Daewoo, General Electric, and Toshiba. Other manufacturers
may announce products in the future. Although we are early adopters of the DivX
video compression technology, there can be no assurance that other manufacturers
will not create and introduce competing products also incorporating this video
compression technology.
Competition in the in-flight entertainment (IFE) industry comes from portable
DVD hardware manufactured by companies such as Sony, Samsung, Panasonic, or
Audiovox, who may sell such products to travelers or airlines. The airline
industry may also opt for embedded IFE systems, although the retrofitting costs
for an embedded system typically make our current IFE system a more attractive
option. Motion picture studios could contract competing hardware developers such
as Digital5, FullPlay, M-Systems or Datalight to create new portable products
for the IFE industry. Although our system has unique features and the support of
content providers, there can be no assurance that other manufacturers will not
create and introduce competing portable IFE products.
Barriers to entry by new competitors are not significant and new competitors in
consumer electronics are continually commencing operations. The technology of
electronics and electronic components, features and capabilities is also rapidly
changing, in many cases causing rapid obsolescence of existing products and
technologies.
Competition in the field of automotive stereo or telematics components can come
from automotive manufacturers, such as Daimler Chrysler, Volvo, Nissan, BMW, or
from electronics developers, such as Delphi Automotive Systems, SAIC, AT&T,
Motorola, Pioneer, or others. Many of these manufacturers or designers have
substantially more development and marketing resources.
We believe we have developed a leading comprehensive file management system
capable of customization for individual customer requirements. Other companies
offering file management systems include M-Systems Flash Disk Pioneers Ltd.,
Intel Corporation, FullPlay (formerly known as Interactive Objects Inc.),
Digital5 Inc., PortalPlayer Inc., I/O Magic, and Datalight Inc. In addition to
licensing file management systems, some companies develop their own file
management systems for a particular product, either in total or by adapting from
one of the competitive vendors. While this self-development is common in simple
memory management devices, we offer a system attractive for more complex
applications. Our technology will compete with other solutions; however, we will
focus on markets requiring advanced features and a robust file management
system. Although we were successful in competing against other systems in our
selection by Bang & Olufsen, APS, Softeq, Lanier, Samsung, and EASTECH, there is
no assurance we can continue to compete against other providers of digital
recording solutions, many of whom have substantially greater resources.
Our technology focuses on digital applications. Accordingly, competition for our
technology includes analog tape solutions, traditional dictation equipment, and
traditional CD recording and playback equipment. We and our OEM customers,
therefore, compete with a wide range of consumer and business product suppliers
producing a wide variety of products and solutions. The electronics product
market is highly competitive with many large international companies competing
for the consumer and business markets.
We believe our existing know-how, contracts, patents, copyrights, trade secrets
and potential future patents and copyrights, will be significant in enabling us
to compete successfully in the field of portable digital entertainment products
and systems.
EMPLOYEES
As of June 6, 2003, we employed approximately twenty-one full time and two
part-time employees of whom four were in production and testing, fourteen were
in research, development and engineering, three were in sales, general and
administrative and two were executive officers. None of our employees are
represented by a labor union, and we are not aware of any current efforts to
unionize the employees. Management of the company considers the relationship
between the company and its employees to be good.
We also engage consultants or lease engineering personnel on a temporary basis
from time to time and use other outside consultants for various services.
14
REGULATION
Our operations are subject to certain federal, state and local regulatory
requirements relating to environmental, waste management, health and safety
matters and there can be no assurance that material costs and liabilities will
not be incurred or that past or future operations will not result in exposure or
injury or claims of injury by employees or the public. Some risk of costs and
liabilities related to these matters are inherent in our business, as with many
similar businesses. Management believes its business is operated in substantial
compliance with applicable environmental, waste management, health and safety
regulations, the violation of which could have a material adverse effect on our
operations. In the event of violation, these requirements provide for civil and
criminal fines, injunctions and other sanctions and, in certain instances, allow
third parties to sue to enforce compliance. In addition, new, modified or more
stringent requirements or enforcement policies could be adopted which could
adversely affect our operations.
ITEM 2. DESCRIPTION OF PROPERTY
On July 11, 1997, we entered into a three-year joint lease agreement with
American Technology Corporation, for property located at 13114 Evening Creek
Drive South, San Diego, California. In September 2000, we amended the lease to
become an independent lessee. We entered into a three-year sublease agreement
expiring on July 31, 2003. We anticipate that we will continue to lease the
property on a month-to-month basis. We occupy approximately 13,000 square feet
with aggregate monthly lease payments of $16,606 inclusive of utilities and
costs. Under the terms of the lease, we are required to pay our proportionate
share of operating expenses that exceed expenses of the base year (2000).
We believe this facility is adequate to meet our needs for the next twelve
months given current plans. However should we expand our operations, we may be
required to obtain additional space or alternative space. We believe there is
adequate availability of office space in the general vicinity to meet our future
needs.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in routine litigation incidental to the
conduct of our business. There are currently no material pending legal
proceedings to which we are party or to which any of our property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
Our common stock trades in the over-the-counter market on the OTC Electronic
Bulletin Board. The following table sets forth, for the periods indicated, the
high and low closing bid prices for our common stock, as reported by the
National Quotation Bureau, for the quarters presented. Bid prices represent
inter-dealer quotations without adjustment for markups, markdowns, and
commissions.
High Low
---- ---
Fiscal year ended March 31, 2002
First quarter $2.07 $1.25
Second quarter $1.70 $0.73
Third quarter $1.98 $0.95
Fourth quarter $1.91 $0.86
Fiscal year ended March 31, 2003
First quarter $0.93 $0.33
Second quarter $0.71 $0.35
Third quarter $0.42 $0.18
Fourth quarter $0.23 $0.15
At June 6, 2003 there were 147,604,343 shares of common stock outstanding and
approximately 2,227 stockholders of record.
15
We have never paid any dividends to our common stockholders. Future cash
dividends or special payments of cash, stock or other distributions, if any,
will be dependent upon our earnings, financial condition and other relevant
factors. The Board of Directors does not intend to pay or declare any dividends
on our common stock in the foreseeable future, but instead intends to have the
company retain all earnings, if any, for use in the business.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED MARCH 31,
STATEMENT OF OPERATIONS DATA: 2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
Revenues $ 2,597 $ 2,417 $ 1,828 $ 490 $ 426
Gross profit (loss) (900) (561) 123 28 (562)
Operating loss (5,842) (5,855) (3,873) (2,615) (1,825)
Loss for the year (6,666) (5,793) (3,646) (2,609) (2,595)
Loss attributable to common (6,727) (5,819) (8,434) (5,178) (2,698)
stockholders
Basic earnings per common share/1/ (0.05) ($ 0.04) ($ 0.07) ($ 0.05) ($ 0.04)
Weighted average number of common
and common equivalent shares
outstanding 140,065 130,783 127,503 114,640 66,492
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
AT MARCH 31,
------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
BALANCE SHEET DATA:
Total Current Assets $ 715 $ 2,213 $ 4,135 $ 3,655 $ 376
Total Current Liabilities 2,143 4,757 1,689 1,285 1,755
Total Assets 895 2,744 4,495 3,807 461
Long-term debt, less
current maturities 626 0 0 0 98
Series A Redeemable
Preferred Stock 0 0 0 23 364
Series C Redeemable
Preferred Stock 0 0 796 0 0
Series D Preferred Stock
2,050 0 0 0 0
Stockholders' Equity/
(Deficit) (1,874) (2,014) 2,010 2,499 (1,756)
- -----------
/1/ The Report fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO AND INCLUDES
FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL
PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY
ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS,
INCLUDING THOSE DESCRIBED ELSEWHERE IN THIS ANNUAL REPORT AND UNDER THE
SUB-HEADING, "RISK FACTORS - IMPORTANT FACTORS RELATED TO FORWARD-LOOKING
STATEMENTS AND
ASSOCIATED RISKS."
GENERAL
e.Digital Corporation is a holding company that operates through a
wholly-owned California subsidiary of the same name. We offer engineering
services to leading electronics companies to create portable digital devices
that can link to PCs, the Internet and other electronic devices. We market our
services and technologies to Original Equipment Manufacturers ("OEMs") with a
focus on developing digital music, voice, and video players/recorders using the
latest in digital storage media (a device used to store data) and technology.
OEMs are business customers that license or purchase our products or our
technology to embed in their own products. We offer complete reference designs
(working, full-featured designs sometimes implemented as prototypes that can be
customized to a customers' preferred look and feel or branded and sold as they
are, according to the customer's wishes) and technology platforms (basic working
technology that can be developed into a finished consumer product, or
incorporated into an existing consumer product design) for private labeling by
OEMs. We may sometimes integrate our OEMs' unique or proprietary features and/or
technology into new products for their product lines. We focus our marketing
efforts on OEMs in various digital processing markets including digital music,
dictation equipment, consumer electronics, digital image and video and other
electronic product markets.
We have relationships with manufacturers with facilities in the United
States, China and Korea. We have expertise in developing, performing and
overseeing manufacturing processes. We apply our technology and expertise in
providing manufacturing supervision, documentation, and quality control services
to products for our OEM customers and for our e.Digital branded products. We
also use our technology to design and build "e.Digital-branded" portable digital
audio players and market them to consumers through various channels. Our primary
focus, however, is serving the development and manufacturing needs of our OEM
customers and licensees.
Services offered include custom hardware, firmware (an instruction set
programmed into a chip which determines the product's functionality and user
interface), and software development, technology platform development, product
design, manufacturing services, fulfillment services, warranty services, and
licensing of our patented file management systems. Our revenues may result from
the sale of products, fees from engineering services, fees or royalties from
technology licensing, industrial order fulfillment, technical support services,
warranty services and/or design services. In some cases, we rely on outside
subcontractors to perform services including manufacturing, testing and
certification, industrial design, and assembly.
We incurred operating losses in each of the last three fiscal years and
these losses have been material. We incurred an operating loss of $5.8 million,
$5.9 million and $3.9 million in fiscal year 2003, 2002 and 2001, respectively.
At March 31, 2003, we had a working capital deficit of $1.4 million. Our monthly
cash operating costs have decreased from approximately $500,000 per month at the
end of fiscal year 2002 to the current level of approximately $225,000 per
month. However, we may increase expenditure levels in future periods to support
the launch of "e.Digital" branded products and expand our OEM revenue
opportunities and continue advanced product and technology research and
development. Accordingly, our losses are expected to continue until such time as
we are able to realize supply, licensing, royalty, sales, and development
revenues sufficient to cover the fixed costs of operations. We continue to be
subject to the risks normally associated with any new business activity,
including unforeseeable expenses, delays and complications. Accordingly, there
is no guarantee that we can or will report operating profits in the future.
Since March 31, 2001, we have experienced substantial reduction in
cash, projected revenues and increased costs that adversely affect our current
results of operations and liquidity. Our operating plans require additional
funds which may take the form of debt or equity financings. There can be no
assurance that any additional funds will be available to our company on
satisfactory terms and conditions, if at all. Our company's ability to continue
as a going concern is in substantial doubt and is dependent upon achieving a
profitable level of operations and, if necessary, obtaining additional
financing.
17
Management of our company has undertaken steps as part of a plan to
improve operations with the goal of sustaining our operations for the next
twelve months and beyond. These steps include (a) branding and selling our own
line of digital audio products to consumers; (b) expanding sales and marketing
to OEM customers and markets; (c) controlling overhead and expenses; and (d)
raising, if necessary, additional capital and/or financing.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to product returns, bad debts, inventory valuation, intangible assets,
financing operations, warranty obligations, estimated costs to complete research
contracts and contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
We recognize license revenue and product revenue upon shipment of a
product to the customer, FOB destination or FOB shipping point depending on the
specific contract term, if a signed contract exists, the fee is fixed and
determinable, collection of resulting receivables is probable and there are no
resulting obligations. With most of our consumer electronics retailers, we do
not meet the criteria for revenue recognition upon shipment and therefore only
recognize the revenue as the product is sold through our customer to the
ultimate end-user. Research and development contract revenues on short-term
projects or service revenue is recognized once the services or product has been
delivered, the fee is fixed and determinable, collection of the resulting
receivable is probable and there are no resulting obligations. If all of the
service or product has been delivered and there is one element that is
perfunctory to the services or product that has not been delivered, revenue will
be recognized evenly over the remaining term of the undelivered element.
Research and development contract revenue on long-term projects is recognized on
the percentage of completion method if reasonable estimate of the costs and
revenues can be determined for each of the milestones; otherwise, the revenues
are recognized when the product or services have been delivered. Funds received
in advance of meeting the criteria for revenue recognition are deferred and are
recorded as revenue as they are earned. If the costs we incur on a contract are
expected to exceed the anticipated revenue we will record the loss in the period
in which the facts that give rise to the revision becomes known.
We record estimated reductions to revenue for anticipated product
returns, discounts offered to our customers and volume-based incentives. If
market conditions were to decline, we may take actions to increase the discounts
offered for future sales which will result in an incremental reduction of
revenue at the time the discounts are offered.
We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If the
financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required.
We provide for the estimated cost of product warranties at the time
revenue is recognized. Our warranty obligation is affected by the quality of the
work of our contract manufacturers, product failure rates, material usage and
costs incurred in correcting a product failure. Should actual product failure
rates, or service costs differ from our estimates, revisions to the estimated
warranty liability would be required.
We record inventory at the lower of cost or net realizable value. Cost
is determined on a first-in, first-out basis. We write down our inventory for
estimated obsolescence or unmarketable inventory equal to the difference between
the cost of inventory and the estimated market value based upon assumptions
about future demand and market conditions. If actual market conditions are less
favorable than those projected, additional inventory write-downs may be
required. As our business model now includes selling our own branded portable
digital audio products, the risk of product obsolescence has increased. The
realizable value of our inventory could deteriorate if we are unable to sell
products out of our inventory due to a lack of demand for our products or due to
technological changes in the industry.
18
RESULTS OF OPERATIONS
YEAR ENDED MARCH 31, 2003 COMPARED TO YEAR ENDED MARCH 31, 2002.
For the year ended March 31, 2003, we reported total revenues of
$2,597,363, a 7.5% increase from total revenues of $2,417,034 for the year ended
March 31, 2002. Revenues for the year ended March 31, 2003 included product
revenue of $2,224,961, an increase of 20.1% from total product revenues of
$1,852,933 for the year ended March 31, 2002. The increase in product revenues
in fiscal 2003 was due to increase in unit sales of the company's branded
products, offset by decreased sale prices.
Our development arrangements are designed to produce limited current
revenues while creating proprietary OEM products to be sold to OEM customers or
to be produced under long-term license or royalty arrangements. Service revenues
were $372,402 and $564,101 for fiscal years 2003 and 2002, respectively. The
34.0% decrease in service revenue is primarily attributable to the fulfillment
of our DataPlay project in 2002, offset by Bang & Olufson royalties received in
2003. The timing and amount of service revenues is dependent upon a limited
number of projects. At March 31, 2003 we had $311,703 and $132,132 of deferred
revenue and deferred contract charges, respectively, from NRE contracts, which
will be recognized based on the terms and conditions of each agreement.
For the year ended March 31, 2003, we reported a gross loss of $899,695
compared to a gross loss of $560,946 for the year ended March 31, 2002. For
fiscal 2003, costs of sales consisted of $3,365,086 of product costs and
$131,972 of contract services consisting mostly of research and development
labor being funded in part by the Softeq, Eclipse and APS development
agreements. For fiscal 2002, costs of sales consisted of $2,578,071 of product
costs and $399,909 of contract services consisting mostly of research and
development labor being funded in part by the DataPlay, Musical, Bang & Olufsen,
Samsung and Eclipse development agreements. Gross profit as a percentage of
revenue decreased from (23.2%) in 2002 to (34.6%) in 2003, due primarily to
reduced pricing on our TREO and MXP products. At the present time warranty costs
are not significant. We generally sell our branded products with a six-month
manufacturing warranty.
Total operating expenses (consisting of research and related
expenditures and selling and administrative expenses) were $4,942,225 and
$5,294,510, for fiscal 2003 and 2002, respectively. Selling and administrative
costs aggregated $3,531,719 and $2,967,227 in fiscal 2003 and 2002,
respectively. The $564,492 of increase in selling and administrative costs
resulted primarily from an increase in personnel and benefit costs of $804,245,
a loss on impairment of asset of $129,930, an increase of $70,381 in bad debts
and an increase of $41,514 in insurance costs, offset by a $238,653 decrease in
marketing and advertising costs.
For the year ended March 31, 2003, research and related expenditures
were $1,410,506 compared to $2,327,283 for the year ended March 31, 2002. The
$916,777 decrease in research and related expenditures resulted primarily from a
decrease in personnel and benefit costs of $675,866 and a decrease of $222,226
in the use of outside consultants. Research and development costs are subject to
significant quarterly variations depending on the use of outside services, the
assignment of engineers to development projects and the availability of
financial resources.
We reported an operating loss of $5,841,920 and $5,855,456 for the year
ended March 31, 2003 and 2002, respectively. The increase in operating loss in
fiscal 2003 compared to fiscal 2002 resulted primarily from bigger gross loss,
offset by decreased operating expenses. We believe, but we cannot guarantee,
that our strategy of investing in OEM developments with supply or royalty
provisions, when combined with our own "e.Digital" branded products, will
provide positive margins in future periods. The timing and amount of product
sales and the recognition of contract service revenues impact our operating
losses. Accordingly, there is uncertainty about future operating results and the
results for the year ended March 31, 2003 are not necessarily reflective of
operating results for future periods.
We reported interest expense of $741,435 and $234,533 for the years
ended March 31, 2003 and 2002, respectively. The interest expense in 2003
consisted primarily of interest and accretion of the discount in connection with
the SP Notes, and interest on the 5% SP Note and the Unsecured Notes. The
interest expense in 2002 consisted primarily of interest expense on the SP Notes
and the 5% SP Note and accretion of the discount in connection with the SP
Notes.
We reported other expense of $1,259 for the year ended March 31, 2003,
compared to other income of $242,310 for the year ended March 31, 2002. Other
expense of ($1,259) in fiscal 2003 consists of Delaware and California corporate
taxes. Other income in 2002 included approximately a $212,000 write-off of
accounts payable that arose in the normal course of business for services
rendered to the company or for goods delivered to the company that were
approximately five to seven years old.
19
We reported a loss of $6,665,802 and $5,793,066 in fiscal 2003 and
2002, respectively.
The net loss available to stockholders for fiscal 2003 was increased in
computing loss per share by accrued dividends of $61,500 on Series D stock. The
net loss available to stockholders for fiscal 2002 was increased in computing
loss per share by accrued dividends of $26,332 on Series C stock.
YEAR ENDED MARCH 31, 2002 COMPARED TO YEAR ENDED MARCH 31, 2001.
For the year ended March 31, 2002, we reported total revenues of
$2,417,034, a 32.2% increase from total revenues of $1,828,012 for the year
ended March 31, 2001. Revenues for the year ended March 31, 2002 included
product revenue of $1,852,933, an increase of 24.0% from total product revenues
of $1,494,747 for the year ended March 31, 2001. The increase in product
revenues in fiscal 2002 was due to the launch, during the 3rd and 4th quarter,
of our branded portable digital audio players on our website and through major
consumer electronics retailers, offset by lower product sales to Lanier. We
shipped approximately $210,000 of products to CompUSA during our last days of
the fiscal 2002 that is not included in product revenues for the year ended
March 31, 2002 as CompUSA didn't take possession of the shipment until early
April, 2002.
Our development arrangements are designed to produce limited current
revenues while creating proprietary OEM products to be sold to OEM customers or
to be produced under long-term license or royalty arrangements. Service revenues
were $564,101 and $333,265 for fiscal years 2002 and 2001, respectively. The
69.3% increase in service revenue is primarily attributable to recognition of
NRE fees associated with the fulfillment of our DataPlay agreement. The timing
and amount of service revenues is dependent upon a limited number of projects.
At March 31, 2002 we had $130,212 and $91,148 of deferred revenue and deferred
contract charges, respectively, from NRE contracts, which were recognized based
on the terms and conditions of each agreement.
For the year ended March 31, 2002, we reported a gross loss of $560,946
compared to a gross profit of $123,436 for the year ended March 31, 2001. For
fiscal 2002, costs of sales consisted of $2,578,071 of product costs and
$399,909 of contract services consisting mostly of research and development
labor being funded in part by the DataPlay, Musical, Bang & Olufsen, Samsung and
Eclipse development agreements. For fiscal 2001, costs of sales consisted of
$1,380,041 of product costs and $324,535 of contract services consisting mostly
of research and development labor being funded in part by the Maycom and Samsung
development agreements. Gross profit as a percentage of revenue decreased from
6.8% to (23.1%), due primarily to start-up costs relating to the launch of our
branded products. We generally sell our branded products with a six-month
manufacturing warranty, while the contract supply agreement on Lanier products
provided a twelve-month manufacturing warranty.
Total operating expenses (consisting of research and related
expenditures and selling and administrative expenses) were $5,294,510 and
$3,996,323, for fiscal 2002 and 2001, respectively. Selling and administrative
costs aggregated $2,967,227 and $2,039,466 in fiscal 2002 and 2001,
respectively. The $927,761 of increase in selling and administrative costs
resulted primarily from an increase in personnel and benefit costs of $462,860,
an increase in of $78,354 in marketing and advertising costs, an increase of
$268,386 for professional services, an increase in facility cost of $14,985,
offset by a $46,727 decrease in travel and related costs and a decrease of
$64,921 in public relations and stockholder costs.
For the year ended March 31, 2002, research and related expenditures
were $2,327,283 compared to $1,956,857 for the year ended March 31, 2001. An
aggregate of $191,057 and $174,831 of development costs were incurred for
contract development work during fiscal 2002 and 2001, respectively, and are
included in cost of revenues. The $370,426 increase in research and related
expenditures resulted primarily from additional personnel and benefit costs.
Research and development costs are subject to significant quarterly variations
depending on the use of outside services, the assignment of engineers to
development projects and the availability of financial resources.
We reported an operating loss of $5,855,456 and $3,872,887 for the year
ended March 31, 2002 and 2001, respectively. The increase in operating loss in
fiscal 2002 compared to fiscal 2001 resulted primarily from a negative gross
profit in fiscal 2002 and increased operating expenses. We believe, but we
cannot guarantee, that our strategy of investing in OEM developments with supply
or royalty provisions, when combined with our own "e.Digital" branded products,
will provide positive margins in future periods. The timing and amount of
product sales and the recognition of contract service revenues impact our
operating losses. Accordingly, there is uncertainty about future operating
results and the results for the year ended March 31, 2002 are not necessarily
reflective of operating results for future periods.
We reported interest expense of $234,533 and $nil for the year ended
March 31, 2002 and 2001, respectively. The interest expense in 2002 consisted
primarily of interest expense on the SP Notes and the 5% SP Note and accretion
of the discount in connection with the SP Notes.
20
We reported other income of $242,310 and $50,990 for the year ended
March 31, 2002 and 2001, respectively. Other income in 2002 included
approximately a $212,000 write-off of accounts payable that arose in the normal
course of business for services rendered to the company or for goods delivered
to the company that were approximately five to seven years old.
We reported a loss of $5,793,066 and $3,646,378 in fiscal 2002 and
2001, respectively.
The net loss available to stockholders for fiscal 2002 was increased in
computing loss per shares by accrued dividends of $26,332 on Series C stock. The
net loss available to stockholders for fiscal 2001 was increased in computing
loss per share by $3,417,094 relating to the beneficial conversion feature on
the Series C stock, accretion of the discount on Series C stock of $582,905,
premium on the Series C stock of $400,000, accrued dividends of $87,668 on
Series A and C stock and $300,000 relating to the cumulative catch-up adjustment
on the Series B stock.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2003, we had a working capital deficit of $1,427,978
compared to a working capital deficit of $2,543,657 at March 31, 2002. We had
$138,795 and $910,222 of working capital invested in inventories at March 31,
2003 and March 31, 2002, respectively. We had $181,536 and $618,509 of working
capital invested in accounts receivable at March 31, 2003 and March 31, 2002,
respectively.
For the year ended March 31, 2003, net cash decreased by $361,313. Cash
used in operating activities was $4,671,036. Major components using cash were a
loss of $6,665,802 reduced by $698,594 write-down of obsolete inventory,
$442,258 of accrued interest and accretion relating to the secured and unsecured
promissory notes, $199,119 of depreciation and amortization, $185,085 relating
to a stock option issued to a consultant and $129,930 loss on impairment of
asset. The major change in assets and liabilities providing cash for operating
activities was a decrease of $372,035 in accounts receivable and an increase of
$181,491 in deferred revenue. The major changes in assets and liabilities using
operating cash was a decrease of $180,152 in other accounts payable and accrued
liabilities and an increase of $127,044 in deferred contract charges. For the
year ended March 31, 2002, net cash decreased by $3,066,287. Cash used in
operating activities was $5,312,559. Major components using cash were a loss of
$5,793,066 reduced by $162,718 of depreciation and amortization, $202,600 of
stock issued as payment to a supplier and $234,130 of accrued interest and
accretion relating to the secured promissory notes. The major change in assets
and liabilities providing cash for operating activities was an increase in trade
accounts payable of $710,554, an increase in other accounts payable and accrued
liabilities of $80,061 and an increase of $112,434 in deferred revenue. The
major changes in assets and liabilities using operating cash was an increase in
inventory of $894,436, an increase of $91,148 of deferred contract charges and
an increase of $35,495 in prepaid expenses and other.
At March 31, 2003, we had cash on hand of $83,906. For the year ended
March 31, 2003, cash provided by financing activities increased by $4,263,240.
During the fiscal year ended March 31, 2003, we obtained a total of $3,475,619
from the issuance of shares of Common Stock, $1,842,000 from the issuance of
Unsecured Notes and $114,121 from the exercise of stock options. During the
fiscal year ended March 31, 2003, we repaid $1,200,000 of the 5% SP Notes. At
March 31, 2002 we had cash on hand of $445,219. During the fiscal year ended
March 31, 2002, we obtained a total of $2,200,000 of cash from the issuance of
the SP Notes and the SP Notes and $241,603 and $45,500 from the exercise of
warrants and stock options, respectively. Other than cash on hand and accounts
receivable, we have no material unused sources of liquidity at this time. Based
on our cash position at March 31, 2003 assuming (a) introduction of "e.Digital"
branded products, (b) expansion of existing OEM arrangements, and (c) current
planned expenditures and level of operation, we believe we have sufficient
capital resources for the next three months. However actual results could differ
significantly from management plans. The actual future margins to be realized,
if any, and the timing of shipments and the realization of royalties are subject
to many factors and risks, many outside our control.
Since March 31, 2001, we have experienced substantial reduction in
cash, projected revenues and increased costs that adversely affect our current
result of operations and liquidity. Our operating plans, including our plans to
brand and sell our own line of digital audio products, require additional funds
which may take the form of debt or equity financings. There can be no assurance
that any additional funds will be available. Our company's ability to continue
as a going concern is in substantial doubt and is dependent upon achieving a
profitable level of operations and, if necessary, obtaining additional
financing.
On September 28, 2001, we issued SP Notes for gross cash proceeds of
$1,000,000 to certain accredited investors. The SP Notes mature December 31,
2002 and are secured by our accounts receivable and inventory. The interest
under the SP Notes accrues at a rate of 12% per annum simple interest and is
payable in one installment on the maturity date. In connection with the sale of
the SP Notes, we issued warrants to purchase 750,000 shares of our Common Stock
at a purchase price of
21
$0.75 per common share expiring September 20, 2006. The proceeds raised have
been allocated to the SP Notes and warrants based on their relative fair values.
On December 30, 2002, we issued 807,013 shares of Common Stock in consideration
for all accrued and unpaid interest. On December 30, 2002, each of the note
holders agreed to convert the unpaid principal balance totaling $1,000,000 of
the SP Notes into 100,000 Series D stock.
On January 18, 2002, we issued a 5% SP Note for gross cash proceeds of
$1,200,000. The 5% SP Note, originally matured on April 18, 2002 and is secured
by all assets of our company including, without limitation, our intellectual
property. The interest under the 5% SP Note accrued at a rate of 5% per annum
simple interest and was payable in one installment on maturity date. On April
17, 2002, the 5% SP Note holder agreed to extend the maturity date of the 5% SP
Note from April 18, 2002 to May 2, 2002 for no consideration. On April 29, 2002,
the 5% SP Note holder agreed to extend the maturity date of the 5% SP Note from
May 2, 2002 to October 29, 2002 and to reduce the interest rate from 5% to 4% in
exchange for (i) a $200,000 finance fee that increased the principal amount from
$1,200,000 to $1,400,000, (ii) a minimum monthly principal reduction of
$100,000; (iii) an immediate principal repayment of $300,000 and (iv) repayment
of accrued interest to April 18, 2002 of $15,000. On September 11, 2002, we
redeemed the outstanding balance and accrued interest on the 5% SP Note
On February 6, 2002, we filed a "shelf" registration statement on Form
S-3, No. 333-82272 (the "Registration Statement") to sell up to 20,000,000
shares of common stock. The Registration Statement was declared effective by the
Securities and Exchange Commission on April 29, 2002. On April 31, 2002, we sold
2,830,189 shares of Common Stock for gross proceeds of $1,500,000, and utilized
$300,000 to reduce the principal amount due under the 5% SP Note, $15,000 to
reduce accrued interest due under the 5% SP Note, and $5,105 for offering
expenses. On June 7, 2002, we sold 2,105,264 shares of Common Stock for gross
proceeds of $800,000, and utilized $250,000 to reduce the principal amount due
under the 5% SP Note and $1,000 for offering expenses. On December 3, 2002, we
sold 425,532 shares of Common Stock for gross proceeds of $200,000 and utilized
$195,000 for working capital purposes and $5,000 for offering expenses. On
October 2, 2002, we sold 455,000 shares of Common Stock for gross proceeds of
$182,000, and utilized $150,000 to reduce the principal amount of the Unsecured
Notes and $32,000 to reduce accrued interest due under the Unsecured Notes. On
November 1, 2002, we sold 446,774 shares of Common Stock for gross proceeds of
$138,500 and utilized $138,500 for working capital purposes. On November 18,
2002, we sold 445,000 shares of Common Stock for gross proceeds of $133,500 and
utilized $133,500 for working capital purposes. On November 27, 2002, we sold
450,488 shares of Common Stock for gross proceeds of $92,350 and utilized
$92,350 for working capital purposes. On December 24, 2002, we sold 555,263
shares of Common Stock for gross proceeds of $105,500 and utilized $105,500 for
working capital purposes. On January 14, 2003, we sold 678,947 shares of Common
Stock for gross proceeds of $129,000 and utilized $129,000 for working capital
purposes. On March 6, 2003, we sold 425,000 shares of Common Stock for gross
proceeds of $80,750 and utilized $80,750 for working capital purposes. On June
10, 2003, we sold 6,161,705 shares of Common Stock for gross proceeds of
$1,170,723 and utilized $203,067 to redeem all of the principal and accrued
interest on the 24% Unsecured Promissory Note, $74,137 to redeem all of the
principal and accrued interest on the 24% Unsecured Note to a director and
$893,519 for working capital purposes.
In July 2002, we issued Unsecured Promissory Notes ("Unsecured Notes")
for gross cash proceeds of $1,050,000 to certain investors to finance various
purchase orders and accounts payable. The Unsecured Notes originally matured
sixty days from issuance, commencing December 1, 2002. The interest under the
Unsecured Notes accrued at a rate of 24% per annum simple interest and was
payable in one installment on the maturity date. We have entered into a
forbearance agreement with the investors through and including December 31,
2002. On December 30, 2002, we issued 397,104 shares of Common Stock in
consideration for all accrued and unpaid interest. On December 30, 2002, each of
the note holders agreed to convert the unpaid principal balance totaling
$1,050,000 of the Unsecured Notes into 105,000 Series D stock.
On August 2, 2002, we issued 360,000 restricted shares of Common Stock
to a director for gross proceeds of $120,000. The restricted shares of Common
Stock do not have any registration rights.
On December 11, 2002, we issued a 15% Unsecured Note for gross cash
proceeds of $750,000 to an individual. The 15% Unsecured Note, under the
original term, was scheduled to mature on February 11, 2004 and payable $50,000
each month, with a final payment of $35,801 on February 11, 2004. We entered
into a forbearance agreement with the noteholder through and including December
31, 2002. On December 30, 2002, we issued 137,273 shares of Common Stock in
consideration for all accrued and unpaid interest. On December 23, 2002, the
holder of the 15% Unsecured Note agreed to (i) extend the maturity date of the
15% Unsecured Note from February 11, 2004 to May 31, 2005; (ii) reduce the
monthly payments from $50,000 to $7,500 through December 31, 2003, representing
the monthly interest on the 15% Unsecured Note and (iii) $50,000 payments each
month, beginning January 31, 2004.
On March 17, 2003, we issued a 24% Unsecured Note for gross cash
proceeds of $42,000 to a director to finance inventory purchases. On March 31,
2003, we repaid all accrued interest and $6,938 of principal. At March 31, the
principal amount due under the 24% Unsecured Note was $35,454. On April 28,
2003, we received additional gross cash proceeds of
22
$37,800 from the same director pursuant to this same 24% Unsecured Note. On June
10, 2003, we redeemed the outstanding balance and accrued interest on the 24%
Unsecured Note.
In May 2003, we issued certain 24% Unsecured Promissory Notes for gross
cash proceeds of $200,000 to certain accredited investors. The 24% Unsecured
Promissory Notes mature on June 30, 2004. The interest under the 24% Unsecured
Promissory Notes is payable monthly at a rate of 12% per annum, simple interest
and accrues an additional interest of 12% per annum, simple interest to be paid
at the earlier of redemption or maturity. On June 10, 2003, we redeemed the
outstanding balance and accrued interest on the 24% Unsecured Note.
On June 10, 2003, we sold 6,161,705 shares for gross proceeds of
$1,170,723 and utilized $203,067 to redeem all of the principal and accrued
interest on the 24% Unsecured Promissory Notes, $74,137 to redeem all of the
principal and accrued interest on the 24% Unsecured Note to a director and
$893,519 for working capital purposes.
We are actively seeking equity financing and intend to use proceeds
from equity sales for working capital and to repay the15% Unsecured Note. If we
are unable to secure equity financing, we will attempt to renegotiate the terms
of both of these notes with the lenders. There can be no guarantee that we will
be able to raise additional equity and/or renegotiate the terms of the notes
with the lenders. If we are able to renegotiate the terms of the notes we are
unable to determine what terms the lenders may demand. If we fail to raise
additional equity and/or refinance or renegotiate the terms of the notes the
holders of the notes may have the right to take possession of our intellectual
property and all of our assets or may have the right to operate our business and
have the right to assign, sell, lease or otherwise dispose of our intellectual
property and all of our assets.
We require additional capital to finance future developments and
improvements to our technology. Should additional funds not be available, we may
be required to curtail or scale back staffing or operations. Failure to obtain
additional financings will have a material adverse affect on our company.
Potential sources of such funds include exercise of outstanding warrants and
options, or debt financing or additional equity offerings. However, there is no
guarantee that warrants and options will be exercised or that debt or equity
financing will be available when needed. Any future financing may be dilutive to
existing stockholders.
As of March 31, 2003, our contractual obligations and commercial commitments are
summarized below
- ------------------------------- ---------------------------------------------------------------
Cash Contractual Obligations by Period
- ------------------------------- ------------------- ---------------- ----------- --------------
Cash Contractual Obligations Total Less than 1 1-2 years 2-3 years
by Period year
- ------------------------------- ------------------- ---------------- ----------- --------------
15% Unsecured Note $948,301 $262,500 $600,000 $85,081
- ------------------------------- ------------------- ---------------- ----------- --------------
24% Unsecured Note /1/ 41,836 41,836 - -
- ------------------------------- ------------------- ---------------- ----------- --------------
Operating Leases /2/ 66,424 66,424 - -
- ------------------------------- ------------------- ---------------- ----------- --------------
Total Cash Obligations $1,056,561 $370,760 $600,000 $85,081
- ------------------------------- ------------------- ---------------- ----------- --------------
1 Includes accrued interest through December 31, 2003.
2 Office sublease agreement expires July 31, 2003
Certain accounts payable and the accrued lease liability reflect
management's best estimate of amounts due for matters in dispute. Settlement of
these liabilities may either be more or less than the amounts recorded in the
unaudited interim consolidated financial statements and accordingly may be
subject to measurement uncertainty in the near term.
FUTURE COMMITMENTS AND FINANCIAL RESOURCES
The accrued lease liability reflects management's best estimate of
amounts due for matters in dispute. Settlement of this liability may either be
more or less than the amount recorded in the audited consolidated financial
statements and accordingly may be subject to measurement uncertainty in the near
term.
In the future, if our operations increase significantly, we may require
additional funds. We also may require additional capital to finance future
developments, acquisitions or expansion of facilities. We currently have no
plans, arrangements or understandings regarding any acquisitions.
In September 2000, we entered into a three-year sublease agreement
expiring on July 31, 2003. We are occupying approximately 13,000 square feet
with aggregate monthly lease payments of $15,967 inclusive of utilities and
costs. The aggregate monthly lease payments increased to $16,606 beginning in
August 1, 2002. As of March 31, 2003, the total operating lease obligation under
the lease for office space is $66,424.
23
SELECTED QUARTERLY FINANCIAL INFORMATION
The following table sets forth unaudited income statement data for each
of our last eight quarters. This unaudited quarterly financial information has
been prepared on the same basis as the annual information presented elsewhere in
the Form 10-K and, in the opinion of management, reflects all adjustments
(consisting of normal recurring entries) necessary for a fair presentation of
the information presented. The operating results for any quarter are not
necessarily indicative of results for any future period.
FOR THE FISCAL YEAR ENDED MARCH 31, 2002 FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------------- ------------- ------------- -------------
Revenues $ 669,279 $ 506,996 $ 592,155 $ 655,604
Gross profit (loss) 151,996 269,780 (305,090) (677,632)
Loss for the quarter (972,628) (1,062,354) (1,864,553) (1,893,531)
Operating Loss (1,030,367) (1,080,127) (1,760,066) (1,984,896)
Loss attributable to common stockholders (985,722) (1,075,592) (1,864,553) (1,893,531)
Basic earnings per common share (0.01) (0.01) (0.01) (0.01)
Weighted average number of common and
common equivalent shares outstanding 130,175,406 130,175,406 130,402,791 130,782,909
FOR THE FISCAL YEAR ENDED MARCH 31, 2003 FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------------- ------------- ------------- -------------
Revenues $ 551,507 $ 290,290 $ 643,420 1,112,146
Gross profit (loss) (434,435) (897,938) (105,844) 538,522
Loss for the quarter (1,942,282) (2,673,578) (1,439,760) (610,182)
Operating Loss (1,805,853) (2,374,276) (1,245,669) (416,122)
Loss attributable to common stockholders (1,942,282) (2,673,578) (1,439,760) (671,682)
Basic earnings per common share (0.01) (0.02) (0.01) (0.00)
Weighted average number of common and
common equivalent shares outstanding 134,989,692 138,025,421 141,846,843 146,191,173
INFLATION
Inflation has not had any significant impact on our business.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board and the Securities and Exchange
Commission also have issued new pronouncements for future implementation as
discussed in our consolidated financial statements (see page F-1. As discussed
in the notes to the consolidated financial statements, the implementation of
these new pronouncements is not expected to have a material effect on our
consolidated financial statements.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets. Statement 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. Statement 141 also includes guidance on the initial recognition and
measurement of goodwill and other intangible assets. Statement 142 prohibits the
amortization of goodwill and intangible assets with indefinite useful lives.
Statement 142 requires that these assets be reviewed for impairment at least
annually. Intangible assets with finite lives will continue to be amortized over
their estimated useful lives. The company does not expect that the adoption of
the Statements to have a significant impact on the company's financial position
and results of operations
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (FAS 144), which addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions
of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a
segment of a business. FAS 144 is effective for fiscal
24
years beginning after December 15, 2001, with earlier application encouraged.
The company adopted FAS 144 as of April 1, 2002 and does not believe it will
have a material impact on the company's financial position and results of
operations.
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." SFAS No. 145 updates, clarifies,
and simplifies existing accounting pronouncements. This statement rescinds SFAS
No. 4, which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net of related
income tax effect. As a result, the criteria in Accounting Principles Board No.
30 will now be used to classify those gains and losses. SFAS No. 64 amended SFAS
No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS No. 44
has been rescinded as it is no longer necessary. SFAS No. 145 amends SFAS No. 13
to require that certain lease modifications that have economic effects similar
to sale-leaseback transactions be accounted for in the same manner as sale-lease
transactions. This statement also makes technical corrections to existing
pronouncements. While those corrections are not substantive in nature, in some
instances, they may change accounting practice. The Company does not expect
adoption of SFAS No. 145 to have a material impact, if any, on its financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue 94-3, a
liability for an exit cost, as defined, was recognized at the date of an
entity's commitment to an exit plan. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. The Company does not expect adoption
of SFAS No. 146 to have a material impact, if any, on its financial position or
results of operations.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." In addition, this statement amends SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include certain financial
institution-related intangible assets. The Company does not expect adoption of
SFAS No. 147 to have a material impact, if any, on its financial position or
results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," an amendment of SFAS No. 123. SFAS
No. 148 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require more prominent and more frequent disclosures in financial statements
about the effects of stock-based compensation. This statement is effective for
financial statements for fiscal years ending after December 15, 2002. SFAS No.
148 will not have any impact on the Company's financial statements as management
does not have any intention to change to the fair value method.
CERTAIN FACTORS THAT MAY AFFECT OUR BUSINESS, FUTURE RESULTS AND FINANCIAL
CONDITION
In addition to the other information in this Annual Report on Form 10-K, the
factors listed below should be considered in evaluating our business and
prospects. This Annual Report contains a number of forward-looking statements
which reflect our current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those discussed below and elsewhere herein, that could
cause actual results to differ materially from historical results or those
anticipated. In this report, the words "anticipates," "believes," "expects,"
"intends," "future" and similar expressions identify forward-looking statements.
Readers are cautioned to consider the specific factors described below and not
to place undue reliance on the forward-looking statements contained herein,
which speak only as of the date hereof. We undertake no obligation to publicly
revise these forward-looking statements, to reflect events or circumstances that
may arise after the date hereof.
FINANCIAL RISKS
We Have a History of Losses and May Incur Future Losses. We have
incurred significant operating losses in prior fiscal years and at March 31,
2003 had an accumulated deficit of $65.0 million. We had a loss of approximately
$6.7 million, $5.8 million and $3.6 million in fiscal 2003, 2002 and 2001,
respectively. To date, we have not achieved profitability and given the level of
operating expenditures and the uncertainty of revenues and margins, we will
continue to incur losses and
25
negative cash flows in future periods. The failure to obtain sufficient revenues
and margins to support operating expenses could harm our business.
We do not Anticipate Paying Dividends. We have never paid any cash
dividends on our common stock and do not anticipate paying any cash dividends in
the foreseeable future. We currently intend to retain any future earnings to
fund the development and growth of our business. An investment in our common
stock, therefore, may be more suitable for an investor that is seeking capital
appreciation rather than current yield and, as a consequence, may be more
speculative. Accordingly, investors should not purchase our common stock with an
expectation of receiving regular dividends.
We Expect Our Operating Results To Fluctuate Significantly - Our
quarterly and annual operating results have fluctuated significantly in the past
and we expect that they will continue to fluctuate in the future. This
fluctuation is a result of a variety of factors, including the following:
[] Unpredictable demand and pricing for our contract development
services;
[] Market acceptance of our e.Digtal branded products and our OEM
products by end users;
[] Uncertainties with respect to future customer product orders,
their timing and the margins to be received, if any;
[] Fluctuations in operating costs;
[] Changes in research and development costs;
[] Changes in general economic conditions;
[] Changes in technology; and
[] Short product lifecycles.
We May Experience Product Delays, Cost Overruns and Errors Which Could
Adversely Affect our Operating Performance and Ability to Remain Competitive. We
have experienced development delays and cost overruns associated with contract
development services in the past. We may experience additional delays and cost
overruns on current projects (including the sale of e.Digital branded products)
or future projects Future delays and cost overruns could adversely affect our
financial results and could affect our ability to respond to technological
changes, evolving industry standards, competitive developments or customer
requirements. Our technology, our e.Digital branded products, the results of our
contract services and the products produced for OEM customers could contain
errors that could cause delays, order cancellations, contract terminations,
adverse publicity, reduced market acceptance of products, or lawsuits by our
customers or others who have acquired our products, including OEM products.
We May Need to Obtain Additional Financing to Continue Operating our
Business. We believe that with cash on hand and proceeds from existing
development and production contracts and product sales, we have sufficient
proceeds to meet cash requirements for the next three months. However, we may
need to raise additional funds to:
[] Finance unanticipated working capital requirements;
[] Pay for increased operating expenses or shortfalls in anticipated
revenues;
[] Fund increases in research and development costs;
[] Develop new technology, products or services;
[] Respond to competitive pressures;
[] Support strategic and industry relationships; and
[] Fund the marketing of our products and services.
In the event additional funds are required, we cannot assure you that
such additional financing will be available on terms favorable to us, or at all.
If adequate funds are not available to us then we may not be able to continue
operations or take advantage of opportunities. If we raise additional funds
through the sale of equity, the sale of common stock hereunder, the percentage
ownership of our stockholders will be reduced.
Unless We Obtain Adequate Financing and Increase Our Revenues We May Be
Unable to Continue as a Going Concern. We have experienced substantial reduction
is cash, projected revenues and increased costs that adversely affected our
results of operations and cash flows. Our company has suffered recurring losses
from operations. This factor, in combination with (i) reliance upon debt and new
equity financing to fund the continuing, losses from operations and cash flow
deficits, (ii) material net losses and cash flow deficits from operations during
fiscal 2003, fiscal 2002 and prior years and (iii) the possibility that we may
be unable to meet our debts as they come due, raise substantial doubt about our
ability to continue as a going concern. Our company's ability to continue as a
going concern is dependent upon our ability to obtain adequate financing and
achieve a level of revenues, adequate to support our capital and operating
requirements, as to which no assurance can be given. In the event we are unable
to continue as a going concern, we may elect or be required to seek protection
from our creditors by filing a voluntary petition in bankruptcy or may be
subject to an involuntary petition in bankruptcy. To date, management has not
considered this alternative, nor does management view it as a likely occurrence.
26
RISKS RELATED TO SALES, MARKETING AND COMPETITION
We May Be Unable to Successfully Compete in the Electronic Products
Market Which is Highly Competitive and Subject to Rapid Technological Change. We
compete in the market for electronics products which is intensely competitive
and subject to rapid technological change. The market is also impacted by
evolving industry standards, rapid price changes and rapid product obsolescence.
Our competitors include a number of large foreign companies with U.S. operations
and a number of domestic companies, many of which have substantially greater
financial, marketing, personnel and other resources. Our current competitors or
new market entrants could introduce new or enhanced technologies or products
with features that render the company's technology or products obsolete or less
marketable, or could develop means of producing competitive products at a lower
cost. Our ability to compete successfully will depend in large measure on our
ability to maintain our capabilities in connection with upgrading products and
quality control procedures and to adapt to technological changes and advances in
the industry. Competition could result in price reductions, reduced margins, and
loss of contracts, any of which could harm our business. There can be no
assurance that we will be able to keep pace with the technological demands of
the marketplace or successfully enhance our products or develop new products
that are compatible with the products of the electronics industry.
We Rely on a Limited Number of Customers for Revenue. Historically, a
substantial portion of our revenues has been derived primarily from a limited
number of customers. For the year ended March 31, 2003 three customers accounted
for approximately 37% of our revenues. For the year ended March 31, 2002 three
customers accounted for approximately 58% of our revenues The failure to receive
orders for and produce e.Digital branded products or other OEM products or a
decline in the economic prospects of our customers or the products we may
produce for sale may have a material adverse effect on our operations.
If We Are Unsuccessful in Achieving Market Acceptance of Our Products,
It Could Harm Our Business. Sales and marketing strategy contemplates sales of
developed products to the electronics and computer software market, by us or our
OEM customers. The failure of our company or our OEM customers to penetrate
their projected markets would have a material adverse effect upon our operations
and prospects. Market acceptance of our products and those of our customers will
depend in part upon our ability to demonstrate and maintain the advantages of
our technology over competing products.
We Have Limited Marketing Capabilities and Resources Which Makes It
Difficult For Us To Create Awareness of and Demand for Our Products and
Technology. We have limited marketing capabilities and resources and are
primarily dependent upon in-house executives for the marketing of our e.Digital
branded products, as well as our OEM and licensing business. Selling products
and attracting new OEM customers requires ongoing marketing and sales efforts
and expenditure of funds to create awareness of and demand for our technology.
We cannot assure that our marketing efforts will be successful or result in
future development contracts or other revenues.
The Failure of the Digital Music Market to Create a Market for Consumer
Devices Could Harm Our Business. We believe the market for portable consumer
devices to play digital music will not develop significantly until consumers are
able to download popular digital recordings from the Internet. We believe the
availability of popular recordings will depend on the adoption of one or more
formats to limit the unauthorized reproduction and distribution of music, called
"pirated" copies. Piracy is a significant concern of record companies and
artists. The failure of the record industry to adopt solutions may delay or have
an adverse impact on the growth of this market. This failure could harm our
business. We have designed our digital music prototype to include piracy
protection and to be adaptable to different music industry and technology
standards. Numerous standards in the marketplace, however, could cause confusion
as to whether our designs and services are compatible. If a competitor were to
establish products for OEM customers with a dominant industry standard
unavailable to us, our business would be harmed.
The Success of Our Business Depends on Emerging Markets and New
Products. In order for demand for our technology, services and products to grow,
the markets for portable digital devices, such as digital voice recorders,
digital music players and other portable consumer devices, must develop and
grow. If sales for these products do not grow, our revenues could decline. To
remain competitive, we intend to develop new applications for our technology and
develop new technology and products. If new applications or target markets fail
to develop, or if our technology, services and products are not accepted by the
market, our business, financial condition and results of operations could
suffer.
Development of New or Improved Products, Processes or Technologies May
Render Our Technology Obsolete and Hurt Our Business. The electronics, contract
manufacturing and computer software markets are characterized by extensive
research and development and rapid technological change resulting in very short
product life cycles. Development of new or
27
improved products, processes or technologies may render our technology and
developed products obsolete or less competitive. We will be required to devote
substantial efforts and financial resources to enhance our existing products and
methods of manufacture and to develop new products and methods. There can be no
assurance we will succeed with these efforts. Moreover, there can be no
assurance that other products will not be developed which may render our
technology and products obsolete.
RISKS RELATED TO OPERATIONS
We May Not Be Able to Successfully Transition From an OEM Provider of
Technology and Services to a Company That Sells and Supports Its Own Branded
Products. The scale and scope of our business is changing. Since 1997, we have
been an OEM provider of technology, product development services and technology
licensing. In September 2001, we announced our intention to have manufactured
and sell our own line of e.Digital-branded products directly to consumers. In
November 2002, we announced plans to refocus our business and marketing strategy
on OEM opportunities and deempahsize the production and marketing of our own
branded products. Such activities have caused, and will continue to cause, us to
spend substantial funds for research and development, contract manufacturing,
marketing and other costs normally associated with bringing a product to market
without any assurance of market acceptance and demand for our products. Our
future growth and performance, as a consequence, is greatly dependent upon the
successful marketing of our new e.Digital branded products and will be dependent
upon the risks that are inherent in any business venture that is undergoing a
major change in its scope of its operations.
We Depend On a Limited Number of Contract Manufacturers and Suppliers
and Our Business Will Be Harmed By Any Interruption of Supply or Failure of
Performance. We rely on Maycom Co., Ltd. for the manufacture of our MXP 100 and
our wireless product developed for Softeq, Musical for the manufacture of our
TREO products, Digitalway Co., Ltd. for the manufacture of our Odyssey and IFE
products and Orient Power for the manufacture and assembly of the
Eclipse-branded audio products. We depend on our contract manufacturers to (i)
allocate sufficient capacity to our manufacturing needs, (ii) produce acceptable
quality products at agreed pricing and (iii) deliver on a timely basis. If a
manufacturer is unable to satisfy these requirements, our business, financial
condition and operating results may be materially and adversely affected. Any
failure in performance by either of these manufacturers for any reason could
have a material adverse affect on our business. Production and pricing by each
such manufacturer is subject to the risk of price fluctuations and periodic
shortages of components. We have no supply agreements with component suppliers
and, accordingly, we are dependent on the future ability of our manufacturers to
purchase components. Failure or delay by suppliers in supplying necessary
components could adversely affect our ability to deliver products on a timely
and competitive basis in the future.
If We Lose Key Personnel or Are Unable to Attract and Retain Additional
Highly Skilled Personnel Required For the Expansion of Our Activities Our
Business Will Suffer. Our future success depends to a significant extent on the
continued service of our key technical, sales and senior management personnel
and their ability to execute our strategy. The loss of the services of any of
our senior level management, or certain other key employees, may harm our
business. Our future success also depends on our ability to attract, retain and
motivate highly skilled employees. Competition for employees in our industry is
intense. We may be unable to retain our key employees or to attract, assimilate
and retain other highly qualified employees in the future. We have from time to
time experienced, and we expect to continue to experience in the future,
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications.
Because Some of Our Management are Part-Time and Have Certain Conflicts
of Interest, Our Business Could Be Harmed. Our Vice President, Robert Putnam, is
also a Vice President, Investor Relations of American Technology Corporation. As
a result of his involvement with American Technology Corporation, Mr. Putnam has
in the past, and is expected in the future to devote a substantial portion of
his time to his other endeavors and only part-time services to e.Digital.
Certain conflicts of interest now exist and will continue to exist between
e.Digital and Mr. Putnam due to the fact that he has other employment or
business interests to which he devotes some attention and he is expected to
continue to do so. It is conceivable that the respective areas of interest of
e.Digital and American Technology Corporation could overlap or conflict. It is
possible that these factors could harm e.Digital which does not have the benefit
of a full-time executive devoted to executing our strategies.
RISKS RELATED TO INTELLECTUAL PROPERTY AND GOVERNMENT REGULATION
Failing to Protect Our Proprietary Rights to Our Technology Could Harm
Our Ability To Compete, as well as Our Results of Our Operations. Our success
and ability to compete substantially depends on our internally developed
software, technologies and trademarks, which we protect through a combination of
patent, copyright, trade secret and trademark laws. Patent applications or
trademark registrations may not be approved. Even when they are approved, our
patents or trademarks may be successfully challenged by others or invalidated.
If our trademark registrations are not approved because third parties own such
trademarks, our use of these trademarks would be restricted unless we enter into
arrangements with the third-party
28
owners, which may not be possible on commercially reasonable terms or at all. We
generally enter into confidentiality or license agreements with our employees,
consultants and strategic and industry partners, and generally control access to
and distribution of our software, technologies, documentation and other
proprietary information. Despite our efforts to protect our proprietary rights
from unauthorized use or disclosure, parties may attempt to disclose, obtain or
use our solutions or technologies. The steps we have taken may not prevent
misappropriation of our solutions or technologies, particularly in foreign
countries where laws or law enforcement practices may not protect our
proprietary rights as fully as in the United States. We have licensed, and we
may license in the future, certain proprietary rights to third parties. While we
attempt to ensure that the quality of our brand is maintained by our business
partners, they may take actions that could impair the value of our proprietary
rights or our reputation. In addition, these business partners may not take the
same steps we have taken to prevent misappropriation of our solutions or
technologies.
We May Face Intellectual Property Infringement Claims That May Be
Difficult to Defend and Costly To Resolve, Which Could Harm Our Business.
Although we do not believe we infringe the proprietary rights of any third
parties, we cannot assure you that third parties will not assert such claims
against us in the future or that such claims will not be successful. We could
incur substantial costs and diversion of management resources to defend any
claims relating to proprietary rights, which could harm our business. In
addition, we are obligated under certain agreements to indemnify the other party
for claims that we infringe on the proprietary rights of third parties. If we
are required to indemnify parties under these agreements, our business could be
harmed. If someone asserts a claim relating to proprietary technology or
information against us, we may seek licenses to this intellectual property. We
may not be able to obtain licenses on commercially reasonable terms, or at all.
The failure to obtain the necessary licenses or other rights may harm our
business.
Risks Related To Government Regulation, Content And Intellectual
Property Government Regulation May Subject Us to Liability and Require Us To
Change The Way We Do Business. Our business is subject to rapidly changing laws
and regulations. Although our operations are currently based in California, the
United States government and the governments of other states and foreign
countries have attempted to regulate activities on the Internet. Evolving areas
of law that are relevant to our business include privacy law, copyright law,
proposed encryption laws, content regulation and import/export regulations.
Because of this rapidly evolving and uncertain regulatory environment, we cannot
predict how these laws and regulations might affect our business. In addition,
these uncertainties make it difficult to ensure compliance with the laws and
regulations governing the Internet. These laws and regulations could harm us by
subjecting us to liability or forcing us to change how we do business.
RISKS RELATED TO TRADING IN OUR COMMON STOCK
Investing in a Technology Stock (Such as Ours) May Involve Greater Risk
Than Other Investments Due to Market Conditions, Stock Price Volatility and
Other Factors. The trading price of our common stock has been subject to
significant fluctuations to date, and will likely be subject to wide
fluctuations in the future due to:
[] Quarter-to-quarter variations in operating results
[] Announcements of technological innovations by us, our customers
or competitors
[] New products or significant OEM design achievements by us or our
competitors
[] General conditions in the markets for the our products or in the
electronics industry
[] The price and availability of products and components
[] Changes in operating factors including delays of shipments,
orders or cancellations
[] General financial market conditions
[] Market conditions for technology stocks
[] Litigation or changes in operating results or estimates by
analysts or others
[] Or other events or factors
We do not endorse and accept no responsibility for the estimates or
recommendations issued by stock research analysts or others from time to time or
comments on any electronic chat boards. The public stock markets in general, and
technology stocks in particular, have experienced extreme price and trading
volume volatility. This volatility has significantly affected the market prices
of securities of many high technology companies for reasons frequently unrelated
to the operating performance of the specific companies. These broad market
fluctuations may adversely affect the market price of our common stock in the
future.
Low-Price Stocks and Stocks Traded on the OTC Electronic Bulletin Board
are Subject to Special Regulations and may have Increased Risk. Our shares of
common stock are traded on the OTC Electronic Bulletin Board, an electronic,
screen-based trading system operated by the National Association of Securities
Dealers, Inc. ("NASD"). Securities traded on the OTC Electronic Bulletin Board
are, for the most part, thinly traded and are subject to special regulations not
imposed on securities listed or traded on the NASDAQ system or on a national
securities exchange. As a result, an investor may find it
29
difficult to dispose of, or to obtain accurate quotations as to the price of,
our common stock. Sales of substantial amounts of our outstanding common stock
in the public market could materially adversely affect the market price of our
common stock. To date, the price of our common stock has been extremely volatile
with the sale price fluctuating from a low of $0.125 to a high of $0.80 in the
last twelve months. In addition, our common stock is subject to Rules
15g-1-15g-6 promulgated under the Securities Exchange Act of 1934 that imposes
additional sales practice requirements on broker-dealers who sell such
securities to persons other than established customers and accredited investors
(generally, a person with assets in excess of $1,000,000 or annual income
exceeding $200,000 or $300,000 together with his or her spouse). For
transactions covered by this rule, the broker-dealer must make a special
suitability determination for the purchaser and have received the purchaser's
written consent to the transaction prior to sale. Consequently, the rule may
affect the ability of broker-dealers to sell the company's securities and may
affect the ability of investors to sell their securities in the secondary
market. The Commission has also adopted regulations which define a "penny stock"
to be any equity security that has a market price (as defined) of less than
$5.00 per share or an exercise price of less than $5.00 per share, subject to
certain exceptions. For any transaction involving a penny stock, unless exempt,
the regulations require the delivery, prior to the transaction, of a disclosure
schedule prepared by the Commission relating to the penny stock market. The
broker-dealer must also disclose the commissions payable to both the
broker-dealer and the registered representative, current quotations for the
securities and, if the broker-dealer is the sole market-maker, the broker-dealer
must disclose this fact and the broker-dealer's presumed control over the
market. Finally, monthly statements must be sent disclosing recent price
information for the penny stock in the account and information on the limited
market in penny stocks.
FORWARD LOOKING STATEMENTS
Important Factors Related to Forward-Looking Statements and Associated Risks.
This annual report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Securities
Exchange Act of 1934 and we intend that such forward-looking statements be
subject to the safe harbors created thereby. These forward-looking statements
include our plans and objectives of management for future operations, including
plans and objectives relating to the products and our future economic
performance. The forward-looking statements included herein are based upon
current expectations that involve a number of risks and uncertainties. These
forward-looking statements are based upon assumptions that we will design,
manufacture, market and ship new products on a timely basis, that competitive
conditions within the computer and electronic markets will not change materially
or adversely, that the computer and electronic markets will continue to
experience growth, that demand for the our products will increase, that we will
obtain and/or retain existing development partners and key management personnel,
that future inventory risks due to shifts in market demand will be minimized,
that our forecasts will accurately anticipate market demand and that there will
be no material adverse change in our operations or business. Assumptions
relating to the foregoing involve judgments with respect, among other things, to
future economic, competitive and market conditions and future business
decisions, all of which are difficult or impossible to predict accurately and
many of which are beyond our control. Although we believe that the assumptions
underlying the forward-looking statements are reasonable, any of the assumptions
could prove inaccurate and, therefore, there can be no assurance that the
results contemplated in forward-looking information will be realized. In
addition, as disclosed above, our business and operations are subject to
substantial risks which increase the uncertainty inherent in such
forward-looking statements. Any of the other factors disclosed above could cause
our net sales or net income (or loss), or our growth in net sales or net income
(or loss), to differ materially from prior results. Growth in absolute amounts
of costs of sales and selling and administrative expenses or the occurrence of
extraordinary events could cause actual results to vary materially from the
results contemplated in the forward-looking statements. Budgeting and other
management decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause us to alter our marketing, capital
expenditure or other budgets, which may in turn affect our results of
operations. In light of the significant uncertainties inherent in the
forward-looking information included herein, the inclusion of such information
should not be regarded as a representation by us or any other person that our
objectives or plans will be achieved.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates relates primarily to
our investment in cash and cash equivalents and our debt of $812,579, consisting
of accrued interest, the 15% Unsecured Note and the 24% Unsecured Note. We do
not use derivative financial instruments in our investment portfolio and due to
the nature of our investments, do not expect our operating results or cash flows
to be significantly affected by potential changes in interest rates. At March
31, 2003, the market value of these investments, which were all classified as
cash and cash equivalents and certificate of deposit, and debt approximated
cost.
30
FOREIGN CURRENCY EXCHANGE RATE RISK
We invoice our customers in U.S. dollars for all products and purchase our
products from our suppliers in U.S. dollars. To date the foreign currency
exchange risk has not been material. We have not entered into hedging
transactions or activities.
ITEM 8. FINANCIAL STATEMENTS
The Consolidated Financial Statements of the company required to be included in
this Item 8 are set forth in a separate section of this report and commence on
Page F-1 immediately following page 43.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On March 18, 2003, Ernst & Young LLP resigned as our independent auditor. The
audit reports of Ernst & Young LLP on our financial statements for fiscal years
2002 and 2001 contained no adverse opinion or disclaimer of opinion and were not
qualified or modified as to uncertainty, audit scope or application of
accounting principles, except that Ernst & Young LLP's report for the years
ended March 31, 2002 and 2001 included an explanatory paragraph regarding our
ability to continue as a going concern.
During our two most recent fiscal years, and the interim period in fiscal 2003
to the time of termination, there were no disagreements with Ernst & Young LLP
on any matters of accounting principles or practices, financial statement
disclosure or auditing scope or procedure. We have authorized Ernst & Young LLP
to respond fully to any inquiries of our successor accountants.
During our two most recent fiscal years and the subsequent interim period in
fiscal 2003 to the date of the resignation of Ernst & Young LLP, Ernst & Young
LLP did not advise us of any reportable conditions relating to weaknesses in
internal controls.
On March 19, 2003, the Audit Committee recommended and the Board of Directors
approved Singer Lewak Greenbaum & Goldstein, LLP as the principal accountant to
audit our financial statements.
During our two most recent fiscal years and the interim period in fiscal 2003
until the engagement of Singer Lewak Greenbaum & Goldstein, LLP, we did not
consult Singer Lewak Greenbaum & Goldstein, LLP concerning the application of
accounting principles to any specified transaction, either completed or
proposed, or the type of audit opinion that might be rendered on our financial
statements in circumstances in which a written report was provided or oral
advice was provided that Singer Lewak Greenbaum & Goldstein, LLP concluded was
an important factor considered by us in reaching a decision as to the particular
issue.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS:
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
IDENTIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the company, their ages and positions
held are as follows:
NAME AGE POSITION
- ---- --- --------
Alex Diaz 38 Chairman of the Board and Director, Audit Committee
Alfred H. Falk 48 President, Chief Executive Officer and Director
Robert Putnam 44 Vice President and Director
Ran Furman 34 Chief Financial Officer and Secretary
Allen Cocumelli 51 Director, Audit Committee
Victor G. Ramsauer 48 Director, Audit Committee
Steve Ferguson * 38 Vice President of Business Development
Atul Anandpura * 39 Vice President of Research and Development
* Key employees
The terms of all directors will expire at the next annual meeting of the
company's stockholders, or when their successors are elected and qualified.
Directors are elected each year, and all directors serve one-year terms.
Officers serve at the pleasure of the Board of Directors. There are no
arrangements or understandings between the company and any other person pursuant
to which he was or is to be selected as a director, executive officer or
nominee. There are no other persons whose activities are material or are
expected to be material to the company's affairs. The company currently has two
vacancies on its board of directors.
31
BIOGRAPHICAL INFORMATION
ALEX DIAZ - Mr. Diaz joined the Board in July 2002 and was appointed
Chairman in November 2002. Mr. Diaz is Executive Vice President of Califormula
Radio Group in San Diego, where he oversees the wide area network (WAN) linking
audio, production studios, and transmitter sites, all of which he designed. He
also established a Web presence for several of Califormula's San Diego radio
stations, including Jammin' Z90, Radio Latina, and classical music station
XLNC1. Before joining Califormula, Mr. Diaz worked at Radio Computing Services
in New York. Mr. Diaz holds bachelor's degrees in mathematics and computer
science from the University of California in San Diego.
ALFRED H. FALK - Mr. Falk was appointed President and a Director of the
company in January 1997 and on July 1, 1998 he was also appointed as Chief
Executive Officer. From March 1995, prior to his appointment as President, he
served as Vice President, Business Development and Vice President of OEM and
International Sales of the company. Before joining the company, Mr. Falk was
with Resources Internationale where he served as Director of U.S. Sales from
1993 to 1995. From 1988 to 1993, Mr. Falk was the Manager of OEM Sales and
Technology Licensing for Personal Computer Products, Inc. in San Diego. From
1978 to 1988, Mr. Falk held several management positions at DH Technology and
was instrumental in its successful start up. Mr. Falk attended Palomar College
in San Marcos and Foothill College in Los Altos, California.
ROBERT PUTNAM - Mr. Putnam was appointed Vice President in April 1993. He
was appointed a Director of the company in 1995. Mr. Putnam served as Secretary
of the company from March 1998 until December 2001. He served as a Director of
American Technology Corporation ("ATC") from 1984 to September 1997 and served
as Secretary/Treasurer until February 1994, President and Chief Executive
Officer from February 1994 to September 1997 and currently serves as Vice
President, Investor Relations of ATC. He has also served, as Secretary/Treasurer
of Patriot Scientific ("Patriot") since 1989 and from 1989 to March 1998 was a
Director of Patriot. Mr. Putnam obtained a B.A. degree in mass
communications/advertising from Brigham Young University in 1983. Mr. Putnam
devotes only part-time services to the company, approximately twenty hours per
week.
RAN FURMAN - Mr. Furman joined the company in September 2001 as Chief
Financial Officer and was appointed Secretary of the company in December 2001.
Mr. Furman's past experience includes executive positions at Jesup & Lamont
Securities, Investment Banking associate at Bank of Montreal/Nesbitt Burns and
staff accountant experience with Deloitte & Touche. Mr. Furman has an MBA degree
in Finance from Columbia Business School and a BA in Business Administration
from the University of Washington
ALLEN COCUMELLI - Mr. Cocumelli was appointed to the Board of Directors on
August 25, 1999 and served as Chairman of the Board from April 2000 until
November 2002. Mr. Cocumelli has been General Counsel of Simple Network
Communications Inc. ("Simplenet") since 1996 and Chief Operating Officer of
Simplenet since November 1997. Prior to joining Simplenet, Mr. Cocumelli was in
the private practice of law. From 1978 to 1986 Mr. Cocumelli served as a manager
in the Components Manufacturing Group and as Director of Corporate Training and
Development at Intel. Mr. Cocumelli obtained a B.S. degree in Industrial
Psychology from the University of California, Los Angeles in 1972 and a J.D.
from Thomas Jefferson University in 1991. Mr. Cocumelli is a member of the
California Bar Association.
VICTOR G. RAMSAUER, CPA - Mr. Ramsauer was appointed to the Board of
Directors on April 12, 2000. Mr. Ramsauer has been a stockholder at Levitz,
Zacks and Ciceric, CPA's since 1985. Prior to joining Levitz, Zacks and Ciceric,
Mr. Ramsauer held a manager level position with Price Waterhouse from 1977 to
1985. Mr. Ramsauer received his B.S. degree in Business Administration from
California State Polytechnic University, Pomona in 1976. Mr. Ramsauer obtained
his CPA license in both California and Nevada in 1980 and 1999, respectively.
Mr. Ramsauer is a member of the American Institute of Certified Public
Accountants, the California Society of Certified Public Accountants and the
Nevada Society of Certified Public Accountants.
STEVE FERGUSON - Mr. Ferguson joined the company in 1999 as Director of
Business Development. In 2000, Mr. Ferguson was promoted to Vice President of
Sales and Marketing and was further promoted to Vice President of Business
Development in 2002. Prior to joining the company Mr. Ferguson held the position
of Chief Operating Officer and Vice President of Business Development at
Enterprise Design Group. From 1995 to 1998 Mr. Ferguson held the position of
General Manger for Arena Sports. Mr. Ferguson obtained his BS from the
University of Iowa.
ATUL ANANDPURA - Mr. Anandpura joined the company in 1999 as the Vice
President of Research and Development. From 1996 to 1999 Mr. Anandpura held the
position of Managing Director for Maycom Europe Ltd. in Surrey U.K. At Maycom,
Mr. Anandpura marketed and developed MP3 player, advanced Digital Voice Recorder
with PC Link and various
32
low power wireless communication devices. Prior to joining Maycom. From 1986 to
1996 Mr. Anandpura held the positions of Project Manager, Senior Design Engineer
for Maxon Systems Inc., in Surrey U.K. At Maxon Systems, Mr. Anandpura managed
and designed the analog, digital hardware, DSP based products and embedded
software for telephone related products for British Telecom, Matra Communication
and other companies. Mr. Anandpura obtained his Bachelor of Engineering
Electronics degree from M.S. University in Baroda, India
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 requires the company's
officers, directors and persons who own more than 10% of a class of the
company's securities registered under Section 12(g) of the Securities Exchange
Act to file reports of ownership and changes in ownership with the Securities
and Exchange Commission ("SEC"). Officers, directors and greater than 10%
stockholders are required by Securities and Exchange Commission regulation to
furnish the company with copies of all Section 16(a) forms they file.
Based solely on a review of copies of such reports furnished to the company and
written representations that no other reports were required during the fiscal
year ended March 31, 2002, the company believes that all persons subject to the
reporting requirements pursuant to Section 16(a) filed the required reports on a
timely basis with the Securities and Exchange Commission.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth for the years ended March 31, 2003, 2002 and
2001, the cash compensation of Mr. Falk, President and Chief Executive Officer,
Mr. Collier, President and Chief Operating Officer until November 11, 2002, and
Mr. Furman, Chief Financial Officer (collectively, the Named Executive
Officers). No other person served as an executive officer of the company during
the fiscal year ended March 31, 2003 and received total salary and bonus in
excess of $100,000.
SUMMARY COMPENSATION TABLE
Long Term
COMPENSATION
Name and Fiscal Annual Compensation Options All Other
-
PRINCIPAL POSITION YEAR SALARY BONUS OTHER (# OF SHARES) COMPENSATION
- ------------------ ---- ------ ----- ----- ------------- ------------
Alfred H. Falk, Chief Executive 2003 $154,974 $35,000 $9,600 (1) -0- -0-
Officer 2002 $155,269 $-0- $10,792 (1) -0- -0-
2001 $155,000 $38,750 $24,403(1) 25,000 -0-
Jim Collier, President and Chief 2003 $132,762 (2) $50,000 $31,363(3) 800,000 -0-
Operating Officer 2002 $141,346 (2) $-0- $1,997 (3) 250,000 -0-
Ran Furman, Chief Financial Officer 2003 $150,000 $25,000 $944 (5) 350,000 -0-
2002 $73,846 (4) $-0- $1,806 (5) 250,000 -0-
(1) Includes auto allowance of $9,600 in 2003, 2002 and 2001 and unused
vacation of $1,192 and $14,803 in 2002 and 2001, respectively.
(2) Mr. Collier began his employment in April 2001 and resigned as President
and Chief Operating Officer in November 2002 and resigned from the Board of
Directors in April 2003.
(3) Represents severance of $16,667 in 2003 and unused vacation of $14,696 and
$1,997 in 2003 and 2002, respectively.
(4) Mr. Furman began his employment in September 2001.
(5) Represents Company match of 401(k) of $944 and $1,029 in 2003 and 2002,
respectively and unused vacation of $777 in 2002.
33
OPTION GRANTS
Shown below is further information on grants of stock options to the Named
Executive Officers reflected in the Summary Compensation Table shown above.
OPTION GRANTS FOR FISCAL YEAR ENDED MARCH 31, 2003
Potential Realizable Value
at Assumed Annual Rates
Percent of Total of Stock Price Appreciation
Number of Options Granted to Exercise Expiration for Option Term
NAME OPTIONS GRANTED EMPLOYEES IN FISCAL YEAR PRICE DATE 5% / $ 10% / $
- ---- --------------- ------------------------ --------- --------- ------ -------
Alfred H. Falk -0-
Jim Collier (2) 50,000 (1) 1.8% $0.43 6/5/07 5,940 13,126
Jim Collier (2) 750,000 (1) 26.7% $0.43 6/5/07 89,101 196,889
Ran Furman 350,000 (1) 12.5% $0.43 6/5/07 41,580 91,882
(1) These options vest 50% immediately and 50% one year after issuance.
(2) Mr. Collier resigned as President and Chief Operating Officer in November
2002 and resigned from the Board of Directors in April 2003.
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table provides information on exercised and unexercised options of
the Named Executive Officers at March 31, 2003.
Value of
Number of Securities Unexercised
Underlying Unexercised In-The-Money
Options at Options at
March 31, 2003 March 31, 2003 (1)
(#) ($)
Shares Acquired Exercisable/ Exercisable/
NAME ON EXERCISE (#) VALUE REALIZED UNEXERCISABLE UNEXERCISABLE
- ------------------------------------------------------------------------------------------------------------------
Alfred H. Falk -0- $-0- 25,000 -0- --(2) --(2)
Jim Collier (3) -0- -0- 600,000 -0- --(2) --(2)
Ran Furman -0- -0- 300,000 300,000 --(2) --(2)
(1) Based on the last sale price at the close of business on March 31, 2003 of
$0.16.
(2) All options were out-of-the-money at March 31, 2003.
(3) Mr. Collier resigned as President and Chief Operating Officer in November
2002 and resigned from the Board of Directors in April 2003.
The company has not awarded stock appreciation rights to any employee of the
company and has no long-term incentive plans, as that term is defined in
Securities and Exchange Commission regulations. The company has no defined
benefit or actuarial plans covering any person.
The company does not have any equity compensation plans which have not been
approved by the stockholders.
EMPLOYMENT AGREEMENTS
In May 1999, the company entered into an employment agreement with Alfred H.
Falk, the company's Chief Executive Officer. The employment agreement provided
for a base salary of $155,000 per year and certain bonuses as approved by the
Board of Directors. In the event of a non-voluntary termination other than for
cause, the employee is entitled to six months severance payment. In the event of
a change of control (a new owner controls more than 51% of the company's common
stock) and employee is terminated within 12 months of the change, other than
cause, then the employee shall receive a termination payment equal to one year's
then annual compensation. The agreement was for a two year term and the
agreement has now terminated. Currently, Mr. Falk is an employee at-will. The
Board of Directors is currently reviewing this agreement.
COMPENSATION OF DIRECTORS
No direct or indirect remuneration has been paid or is payable by the company to
the directors in their capacity as directors. However, directors have received
in the past, and may receive in the future, stock options. It is anticipated
that during the next twelve months that the company will not pay any direct or
indirect remuneration to any directors of the Company in their capacity as
directors other than in the form of reimbursement of expenses of attending
directors' or committee meetings.
34
REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION
INTRODUCTORY NOTE: The following report is not deemed to be incorporated by
reference by any general statement incorporating by reference this annual report
into any filing under the Securities Act of 1933, as amended, or under the
Securities Exchange Act of 1934, as amended, except to the extent that the
Company specifically incorporates this information by reference, and shall not
otherwise be deemed filed under such Acts.
The Compensation Committee is comprised of three non-employee Board members,
Alex Diaz, Allen Cocumelli and Victor Ramsauer. The Compensation Committee
reviews and recommends to the Board the salaries, bonuses and perquisites of the
Company's executive officers. The Compensation Committee also reviews and
recommends to the Board any new compensation or retirement plans and administers
the Company's 1992 and 1994 Stock Option Plans. The Compensation Committee held
one meeting during the fiscal year ended March 31, 2003.
The primary philosophy of the Compensation Committee regarding compensation is
to offer packages which reward each of the members of senior management
proportionately to each person's individual performances and to the company's
overall financial performance and growth during the previous year.
The Board measured individual and team performance on the basis of both
quantitative and qualitative factors. The Board believes that the components of
executive compensation should include base salary, annual and long-term
incentive compensation, stock option grants and other benefits summarized below.
EXECUTIVE COMPENSATION
Base Salary -- Base salaries are intended to be competitive with market rates
and are based on an internal evaluation of the responsibilities of each
position. Salaries for executive officers are reviewed on an annual basis.
The Committee's compensation policies are particularly designed to align
executive officer and senior management salaries and bonus compensation to the
individual's performance in the short-term and to emphasize compensation from
equity, primarily employee stock options, for long-term incentives.
Long term incentives. The company's long-term incentive program consists of a
stock option program pursuant to which the Chief Executive Officer and other
executive officers (as well as other key employees) are periodically granted
stock options at the then fair market value (or higher prices) of the company's
Common Stock. These option programs are designed to provide such persons with
significant compensation based on overall company performance as reflected in
the stock price, to create a valuable retention device through standard three to
five year vesting schedules and to help align employees' and shareholders'
interests. Stock options are typically granted at the time of hire to key new
employees, at the time of promotion to certain employees and periodically to a
broad group of existing key employees and executive officers.
Compliance with Internal Revenue Code Section 162(m). Section 162(m) of the
Internal Revenue Code disallows a tax deduction to publicly-held companies for
compensation paid to certain executive officers, to the extent that compensation
exceeds $1million per officer in any year. The limitation applies only to
compensation which is not considered to be performance-based, either because it
is not tied to the attainment of performance milestones or because it is not
paid pursuant to a stockholder-approved plan. The non-performance based
compensation paid to the company's executive officers for the 2003 fiscal year
did not exceed the $1 million limit per officer. It is not expected that the
compensation to be paid to the company's executive officers for the 2004 fiscal
year will exceed that limit. The company's 1994 Stock Option Plan is structured
so that any compensation deemed paid to an executive officer in connection with
the exercise of his or her outstanding options under the 1994 Plan with an
exercise price per share equal to the fair market value per share of the Common
Stock on the grant date will qualify as performance-based compensation which
will not be subject to the $1 million limitation. Because it is unlikely that
the cash compensation payable to any of the company's executive officers in the
foreseeable future will approach the $1 million limit, the Committee's present
intention is to comply with the requirements of Section 162(m) unless and until
the Committee determines that compliance would not be in the best interest of
the company and its stockholders.
By: The Compensation Committee of the Board of Directors:
Date: June 26, 2003
Alex Diaz
Allen Cocumelli
Victor Ramsauer
35
COMPANY STOCK PRICE PERFORMANCE
The following graph compares the five-year cumulative total return on the
company's common stock to the total returns of 1)Russell 2000 Index and 2)Morgan
Stanley High Technology Index. This comparison assumes in each case that $100
was invested on March 31, 1998 and all dividends were reinvested. The company's
fiscal year ends on March 31. The past performance of the company's common stock
is no indication of future performance.
[LINE GRAPH]
-------------------------------------------------------------------------
Mar 98 Mar 99 Mar 00 Mar 01 Mar 02 Mar 03
-------------------------------------------------------------------------
e.Digital Corporation 100 213 12,575 1,838 1,200 200
Russell 2000 Index 100 83 112 94 105 76
Morgan Stanley High Technology Index 100 188 196 97 84 53
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND MANAGEMENT
COMMON STOCK
The following table sets forth, as of June 6, 2003, information regarding
ownership of the common stock, by each person known by the company to be the
beneficial owner of more than 5% of the company's outstanding common stock, by
each director and by all executive officers and directors of the company as a
group. All persons named have sole voting and investment power over their shares
except as otherwise noted.
NUMBER OF PERCENT
NAME SHARES OWNED OF CLASS
---- ------------ --------
Alfred H. Falk 1,340,000(1) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
Ran H. Furman 600,000(2) *
13114 Evening Creek Dr. S
San Diego, CA 92128
Robert Putnam 1,150,000(3) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
36
Allen Cocumelli 376,000(4) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
Victor Ramsauer 225,000(5) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
Alex Diaz 460,000(6) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
All officers and directors
as a group (6 persons) 4,151,000(7) 2.8%
* less then 1%
(1) Includes options exercisable within 60 days to purchase 225,000. Excludes
unvested options to purchase 200,000 shares.
(2) Includes options exercisable within 60 days to purchase 600,000 shares.
Excludes unvested options to purchase 600,000 shares.
(3) Includes options exercisable within 60 days to purchase 25,000 and warrants
to purchase 500,000 shares.
(4) Includes options exercisable within 60 days to purchase 375,000 shares.
Excludes unvested options to purchase 150,000 shares.
(5) Includes options exercisable within 60 days to purchase 225,000 shares.
Excludes unvested options to purchase 100,000 shares.
(6) Includes options exercisable within 60 days to purchase 100,000 shares.
Excludes unvested options to purchase 100,000 shares.
(7) Includes options exercisable within 60 days to purchase 1,550,000 and
warrants to purchase 500,000 shares. Excludes unvested options to purchase
1,150,000 shares.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table sets forth information as of March 31, 2003, with respect to
compensation plans (including individual compensation arrangements) under which
equity securities of the Company are authorized for issuance, aggregated as
follows:
- -------------------------------------------------------------------------------------------------------------------------------
Equity Compensation Plan Information
- -------------------------------------------------------------------------------------------------------------------------------
Plan Category Number of securities to be Weighted-average exercise Number of Securities
issued upon exercise of price of outstanding options, remaining available for
outstanding options, warrants and rights future issuance under equity
warrants and rights compensation plans
- --------------------------------- ------------------------------ ------------------------------- ------------------------------
Equity compensation plans
approved by security holders 14,000,000 $1.0846 4,589,000
- --------------------------------- ------------------------------ ------------------------------- ------------------------------
Equity compensation plans not
approved by security holders N/A N/A N/A
- --------------------------------- ------------------------------ ------------------------------- ------------------------------
Total 14,000,000 4,589,000
- --------------------------------- ------------------------------ ------------------------------- ------------------------------
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On March 17, 2003, we issued a 24% Unsecured Note for gross cash proceeds of
$42,000 to a director to finance inventory purchases. On March 31, 2003, we
repaid all accrued interest and $6,938 of principal. At March 31, the principal
amount due under the 24% Unsecured Note was $35,454. On April 28, 2003, we
received additional gross cash proceeds of $37,800 from the same director
pursuant to this same 24% Unsecured Note. On June 10, 2003, we redeemed the
outstanding balance and accrued interest on the 24% Unsecured Note.
ITEM 14. CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
The management of the Company, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of the
Company's disclosure controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) as of a date within 90 days prior to the filing of this
Annual Report on Form 10-K (the "Evaluation Date").
37
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that, as of the Evaluation Date, the Company's disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company, including its consolidated subsidiaries,
required to be included in the Company's periodic SEC filings.
(B) CHANGES IN INTERNAL CONTROLS.
Subsequent to the date of the evaluation, there have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls, nor were there any corrective actions required with
regard to significant deficiencies and material weaknesses.
PART IV
ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
Each exhibit marked with an asterisk is filed with this Annual Report on Form
10-K. Each exhibit not marked with an asterisk is incorporated by reference to
the exhibit of the same number (unless otherwise indicated) previously filed by
the company as indicated below.
Exhibit
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
2.6 Plan of Reorganization and Agreement of Merger, dated July 1996 and
filed as Exhibit A to the Company's July 3, 1996 Proxy Statement.
3.1 Certificate of Incorporation of Norris Communications, Inc. (as
amended through May 28, 1996) and filed as Exhibit B to the
Company's July 3, 1996 Proxy Statement.
3.1.1 Certificate of Amendment of Certificate of Incorporation of Norris
Communications, Inc. filed with the State of Delaware on January
14, 1998 and filed as Exhibit 3.1.1 to the Company's Quarterly
Report on Form 10-QSB for the quarter ended December 31, 1997.
3.1.2 Certificate of Amendment of Certificate of Incorporation of Norris
Communications Inc. filed with the State of Delaware on January 13,
1999 and filed as Exhibit 3.1.2 to the Company's Quarterly Report
on Form 10-QSB for the quarter ended December 31, 1998.
3.2 Bylaws of Norris Communications, Inc., filed as Exhibit C to the
Company's July 3, 1996 Proxy Statement.
3.3 Certificate of Designation of Preferences, Rights and Limitations
of Series A Redeemable Convertible Preferred Stock filed with the
State of Delaware on September 19, 1997 and filed as Exhibit 3.3 to
the Company's Current Report on Form 8-K dated October 3, 1997.
3.4 Certificate of Designation of Preferences, Rights and Limitations
of Series B Redeemable Convertible Preferred Stock filed with the
State of Delaware on June 24, 1999 and filed as Exhibit 3.4 to the
Company's Annual Report on Form 10-KSB dated March 31, 1999.
3.5 Certificate of Designation of Preferences, Rights and Limitations
of Series C Redeemable Convertible Preferred Stock filed with the
State of Delaware on October 4, 2000 and filed as Exhibit 3.5 to
the Company's Form S-3, dated November 3, 2000.
4.3 Form of Warrant Agreement dated June 7, 1996 for an aggregate of
$3,805,900 issued to a total of twelve investors and filed as an
Exhibit to the Company's Current Report on Form 8-K dated April 5,
1996.
4.3.1 Form of Amendment No. 1 to Common Stock Warrant between the Company
and three Warrant Holders holding an aggregate of $1,154,409 face
value of warrants granted in July and August 1996 (Each Amendment
is identical except for the dates and the name of the Warrant
Holder), filed as Exhibit 4.11.1 to the Company's Form 8-K, dated
September 10, 1997.
38
4.4 Warrant Agreement for 401,924 shares of Common Stock between the
Company and Klein Investment Group, L.P. (formerly known as Iacocca
Capital Partners, L.P.) dated August 7, 1996 and filed previously
as an Exhibit to the Company's Current Report on Form 8-K dated
August 29, 1996.
4.4.1 First Amendment to Common Stock Warrant (increasing warrants to
801,924), Termination of January 7, 1997 Letter Agreement and
Amendment to Consulting Agreement dated September 29, 1997 between
the Company and Klein Investment Group, L.P., filed as Exhibit
4.12.1 to the Company's Form 10-QSB for the quarter ended September
30, 1997.
4.6 Form of Series 98A 12% Convertible Promissory Note with Limited
Guaranty ("Notes") due May 15, 1999 between the Company and 6
investors for an aggregate of $1,000,000 (individual notes vary as
to date, amount and payee) and filed previously as Exhibit 4.6 to
the Company's Annual Report on Form 10-KSB dated March 31, 1998.
4.7 Stock Purchase Warrant dated June 3, 1998 for 571,429 Common Shares
between the Company and Renwick Corporate Finance, Inc. and filed
previously as Exhibit 4.7 to the Company's Annual Report on Form
10-KSB dated March 31, 1998.
4.8 Form of Stock Purchase Warrant dated June 12, 1998 entered into
between the Company and Elwood G. Norris and Robert Putnam for an
aggregate of 2,000,000 shares (1,500,000 shares as to Mr. Norris
and 500,000 shares as to Mr. Putnam) and filed previously as
Exhibit 4.8 to the Company's Annual Report on Form 10-KSB dated
March 31, 1998.
4.9 Form of 15% Promissory Note due December 31, 1999 for an aggregate
of $500,000 issued to three investors and filed previously as
Exhibit 4.9 to the Company's Quarterly Report on Form 10-QSB for
the quarter ended December 31, 1998.
4.10 Form of Warrant Exercisable into an aggregate of 5,000,000 shares
of Common Stock at $0.10 per share until June 30, 2000 issued to
three investors and filed previously as Exhibit 4.10 to the
Company's Quarterly Report on Form 10-QSB for the quarter ended
December 31, 1998.
4.11 Stock Purchase Warrant for 33,750 Common Shares between the Company
and Cruttenden & Co., Inc. dated July 15,1994 and filed as Exhibit
4.3 to the Company's 1995 Form 10-KSB.
4.12 Stock Purchase Warrant for 300,000 Common Shares between the
Company and CVD Financial Corporation dated July 15, 1994 and filed
as Exhibit 4.4 to the Company's 1995 Form 10-KSB.
4.12.1 First Amendment to Stock Purchase Warrant for 300,000 Common Shares
between the Company and CVD Financial Corporation dated November
14, 1994 and filed as Exhibit 4.4.1 to the Company's 1995 Form
10-KSB.
4.12.2 Second Amendment to Stock Purchase Warrant (for 300,000 shares)
between the Company and CVD Financial Corporation dated August 1,
1995 and filed as Exhibit 10.5.5 to the Company's Form 8-K dated
October 27, 1995.
4.13 Stock Purchase Warrant for 150,000 Common Shares between the
Company and CVD Financial Corporation dated July 15, 1994 and filed
as Exhibit 4.5 to the Company's 1995 Form 10-KSB.
4.13.1 First Amendment to Stock Purchase Warrant for 150,000 Common Shares
between the Company and CVD Financial Corporation dated November
14, 1994 and filed as Exhibit 4.5.1 to the Company's 1995 Form
10-KSB.
4.13.2 Second Amendment to Stock Purchase Warrant (for 150,000 shares)
between the Company and CVD Financial Corporation dated August 1,
1995 and filed as Exhibit 10.5.4 to the Company's Form 8-K dated
October 27, 1995.
4.14 Warrant Agreement for 82,100 Common Shares between the Company and
Comdisco, Inc. dated as of August 15, 1994 and filed as Exhibit 4.6
to the Company's 1995 Form 10-KSB.
4.15 Warrant Agreement No. 1 for 106,986 Common Shares between the
Company and Pennsylvania Merchant Group Ltd. dated March 1, 1995
and filed as Exhibit 4.7 to the Company's 1995 Form 10-KSB.
4.15.1 Warrant Agreement No. 2 for 87,300 Common Shares between the
Company and Pennsylvania Merchant Group Ltd. dated March 17, 1995
and filed as Exhibit 4.7.1 to the Company's 1995 Form 10-KSB.
39
4.15.2 Warrant Agreement No. 3 for 714 Common Shares between the Company
and Pennsylvania Merchant Group Ltd. dated March 20, 1995 and filed
as Exhibit 4.7.2 to the Company's 1995 Form 10-KSB.
4.15.3 First Amendments to Warrant Agreements No. 1, 2 and 3 between the
Company and Pennsylvania Merchant Group Ltd. dated as of September
29, 1997 (amended to 45,570 shares), filed as Exhibit 4.7.3 to the
Company's Form 10-QSB for the quarter ended September 30, 1997.
4.16 First Amendment to Warrant Agreement between the Company and First
Bermuda Securities Ltd. dated as of September 30, 1997 (27,500
shares), filed as Exhibit 4.10.1 to the Company's Form 10-QSB for
the quarter ended September 30, 1997.
4.17 Placement Agent's Warrant Agreement between Auerbach, Pollack &
Richardson, Inc. and the Company, filed as Exhibit 10.17 to the
Company's Form 8-K dated November 13, 1995.
4.17.1 Warrant Certificate Issued to Auerbach, Pollak & Richardson, Inc.
and filed as Exhibit 10.18 to the Company's Form 8-K dated November
13, 1995 and filed previously as an Exhibit to the Company's
Current Report on Form 8-K, dated November 13, 1995.
4.17.2 Release and Termination of Right of First Refusal and Amendment to
Warrant between the Company and Auerbach, Pollak & Richardson, Inc.
dated May 13, 1996 and filed previously as an Exhibit to the
Company's Annual Report on Form 10-KSB for the fiscal year ended
March 31, 1996.
4.17.3 Form of Amendment to Warrant Certificate and Warrant Agreement
between the Company and Auerbach, Pollack & Richardson, Inc. and
six individual assignees (identical amendments except as to the
number of shares (total of 128,067 shares) and the name of holder)
dated as of September 30, 1997, filed as Exhibit 10.18.2 to the
Company's Form 10-QSB for the quarter ended September 30, 1997.
4.18 Warrant Agreement for 150,000 Common Shares between the Company and
Higham, McConnell & Dunning dated October 10, 1996 and filed
previously as an Exhibit to Registration Statement No. 333-13779.
4.18.1 Amendment No. 1 to Stock Purchase Warrant Agreement between the
Company and Higham, McConnell & Dunning dated September 30, 1997,
filed as Exhibit to the Company's Form 10-QSB for the quarter ended
September 30, 1997.
4.18.2 Amendment No. 2 to Stock Purchase Warrant Agreement between the
Company and Higham, McConnell & Dunning dated May 27, 1999, filed
previously on the Company's Annual Report on Form 10-KSB dated
March 31, 1999.
4.19 Warrant Agreement for 500,000 shares dated January 15, 1999 between
the Company and Sunrise Capital, Inc., filed previously on the
Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.20 Form of Warrant Agreement for an aggregate of 2,907,142 shares (as
of March 31, 1999) issued at various dates between the Company and
six investors, filed previously on the Company's Annual Report on
Form 10-KSB dated March 31, 1999.
4.21 Form of Warrant Agreement for an aggregate of 1,117,857 shares (as
of March 31, 1999) dated March 1999 between the Company and four
investors., filed previously on the Company's Annual Report on Form
10-KSB dated March 31, 1999.
4.22 Warrant Agreement for 125,000 shares dated October 15, 1998 between
the Company and Renwick Corporate Finance, Inc., filed previously
on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.23 Warrant Agreement for 100,000 shares dated January 15, 1999 between
the Company and Pomerado Properties., filed previously on the
Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.24 Warrant Agreement for 195,000 shares dated June 24, 1999 between
the Company and JNC Opportunity Fund Limited, filed previously on
the Company's Annual Report on Form 10-KSB dated March 31, 1999.
40
4.25 Warrant Agreement for 137,615 shares dated June 24, 1999 between
the Company and Jesup & Lamont Securities Corporation and filed as
Exhibit 3.4 to the Company's Annual Report on Form 10-KSB dated
March 31, 1999.
4.26 Convertible Preferred Stock Purchase Agreement between the Company
and JNC Opportunity Fund Limited dated June 24, 1999 and filed as
Exhibit 3.4 to the Company's Annual Report on Form 10-KSB dated
March 31, 1999.
4.27 Registration Rights Agreement between the Company and JNC
Opportunity Fund Limited dated June 24, 1999 and filed as Exhibit
3.4 to the Company's Annual Report on Form 10-KSB dated March 31,
1999.
4.28 Warrant Agreement for an aggregate of 230,946 shares dated October
5,2000 between the Company and the Series C preferred stockholders
filed as Exhibit 4.3 on Form S-3, dated November 3, 2000.
4.29 Warrant Agreement for 138,568 shares dated October 5, 2000 between
the Company and Jesup and Lamont Securities Corporation filed as
Exhibit 4.4 on Form S-3, dated November 3, 2000.
4.30 Convertible Preferred Stock Purchase Agreement between the Company
and the Series C preferred stockholders dated October 5, 2000 and
filed as Exhibit 4.5 on Form S-3, dated November 3, 2000.
4.31 Registration Rights Agreement between the Company and the Series C
preferred stockholders dated October 5, 2000 and filed as Exhibit
4.6 on Form S-3, dated November 3, 2000.
4.32 Form of 12% Secured Promissory Note due December 31, 2002
aggregating $1,000,000 entered into with seven accredited investors
(individual notes differ only as to holder and amount) and filed as
Exhibit 4.32 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2001.
4.33 Form of Security Agreement, dated September 28, 2001 by the Company
in favor of seven accredited investors and filed as Exhibit 4.33 to
the Company's Annual Report on Form 10-K dated June 28, 2002.
4.34 Form of Stock Purchase Warrant exercisable until September 30, 2006
issued to seven accredited investors for an aggregate of 750,000
common shares (individual warrants differ only as to holder and
number of shares) and filed as Exhibit 4.32 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2001.
4.35 Form of 5% Secured Promissory Note due April 18, 2002 in the amount
of $1,200,000 entered into with Immanuel Kant International Limited
and filed as Exhibit 4.9 to the Company's Registration Statement on
Form S-3 dated April 23, 2002.
4.36 Form of Security Agreement, dated January 18, 2002 by the Company
in favor of Immanuel Kant International Limited and filed as
Exhibit 4.10 to the Company's Registration Statement on Form S-3
dated April 23, 2002.
4.37 Form of Intellectual Property Security Agreement, dated January 18,
2002 by the Company in favor of Immanuel Kant International Limited
and filed as Exhibit 4.11 to the Company's Registration Statement
on Form S-3 dated April 23, 2002.
4.38 Form of Amendment No. 1 to 5% Secured Promissory Note due April 18,
2002 in the amount to $1,200,000 entered into on April 17, 2002
with Immanuel Kant International Limited and filed as Exhibit 4.12
to the Company's Registration Statement on Form S-3 dated April 23,
2002.
4.38.1 Form of Amendment No. 2 to 5% Secured Promissory Note due April 18,
2002 in the amount to $1,200,000 entered into on April 29, 2002
with Immanuel Kant International Limited and filed as Exhibit
4.38.1 to the Company's Annual Report on Form 10-K dated June 28,
2002
4.39 Form of 24% Unsecured Promissory Notes aggregating $1,050,000
entered into with three accredited investors (individual notes
differ only as to amount) and filed as Exhibit 4.39 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 2002
4.40 Form of 15% Unsecured Promissory Notes due February 11, 2002 in the
amount of $750,000 entered into with Davric Corporation and filed
as Exhibit 4.40 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2002.
41
4.40.1 First Amendment to 15% Promissory Note due February 11, 2002 filed
as Exhibit 4.40.1 to the Company's orm 8-k dated December 30, 2002.
4.41 Form of Asset Transfer Agreement, dated July 26, 2002 by and
between the Company and Bryan Jones and Russell Clark and filed as
Exhibit 4.13 to the Company's Registration Statement on Form S-3
dated April 23, 2002.
4.42 Certificate of Designation of Preferences, Rights and Limitations
of Series D Preferred Stock filed as Exhibit 3.6 to the Company's
Form 8-k dated December 30, 2002.
4.43 Form of Conversion Agreement entered into with five holders of the
Company's 12% Promissory Notes due December 31, 2002 and three
holders of the Company's 24% Promissory Notes due December 31, 2002
filed as Exhibit 4.41 to the Company's Form 8-k dated December 30,
2002.
4.44 Form of 24% Unsecured Note to Alex Diaz dated March 17, 2003. *
4.45 Form of 24% Unsecured Promissory Note due June 30, 2004 aggregating
$200,000 entered into with three accredited investors (individual
notes differ only as to amount). *
10.1 Stock Option Plan adopted by the Company on August 21, 1992 ("1992
Plan"), filed as Exhibit 10.10 to the Company's Registration
Statement on Form 10, as amended.
10.2 Stock Option Plan adopted by the Company on September 29, 1994
("1994 Plan"), filed as Exhibit 10.10 to the Company's 1995 Form
10-KSB.
10.2.1 First Amendment to Stock Option Plan adopted by the Company on
January 26, 1996 and filed previously as Exhibit 10.14.1 to the
Company's Annual Report on Form 10-KSB dated March 31, 1998.
10.2.2 Second Amendment to Stock Option Plan adopted by the Company on
September 3, 1997 and filed previously as Exhibit 10.14.2 to the
Company's Annual Report on Form 10-KSB dated March 31, 1998.
10.2.3 Third Amendment to Stock Option Plan adopted by the Company on
November 9, 2000 and filed previously as Exhibit B to the Company's
Annual Report on Schedule 14A dated September 22, 2000.
10.3 Employment Agreement dated October 3, 1997 between the Company and
Alfred H. Falk.
10.3.1 First Amendment to Employment Agreement between the Company and
Alfred H. Falk dated May 19, 1999
10.4 Sublease Agreement between Smith Industries and Aerospace and the
Company dated September 1, 2000.
10.5 Manufacturing Agreement between the Company and Eltech Electronics,
Inc. dated December 3, 1998.
10.6 License Agreement between the Company and Maycom Co., Ltd., dated
January 4, 2000. [Portions of this Exhibit have been omitted (based
upon a request for confidential treatment) and have been filed
separately with the Securities & Exchange Commission pursuant to
Rule 24b-2].
10.6 Direct-to-Customer Fulfillment, Storage and Freight Management
Agreement between e.Digital and APL Direct Logistics, Ltd. dated
August 31, 2001. [Portions of this Exhibit have been omitted (based
upon a request for confidential treatment) and have been filed
separately with the Securities & Exchange Commission pursuant to
Rule 24b-2]. *
16.1 Letter dated March 19, 2003 from Ernst & Young LLP filed as Exhibit
16.1 to the Company's 8-k dated March 24, 2003.
21.1 List of subsidiaries. *
23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP *
23.2 Consent of Ernst & Young LLP.*
42
99.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 312 of the Sarbanes-Oxley Act of 2002, signed
by Alfred H. Falk, Chief Executive Officer. *
99.2 Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 312 of the Sarbanes-Oxley Act of 2002, signed
by Ran Furman, Chief Financial Officer. *
99.3 Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed
by Alfred H. Falk, Chief Executive Officer and Ran Furman, Chief
Financial Officer. *
* Filed concurrently herewith.
(B) REPORTS ON FORM 8-K.
On March 23, 2003, the Company filed a Form 8-k reporting an Item 4 event
relating to the resignation of Ernst & Young LLP as the Company's independent
auditor and the hiring of Singer Lewak Greenbaum & Goldstein LLP as the
Company's independent auditor.
43
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
e.Digital Corporation
By: /s/ ALFRED H. FALK
----------------------------------
Alfred H. Falk
Chief Executive Officer and
President
Date: June 26, 2003
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
NAME POSITION DATE
---- -------- ----
/S/ ALEX DIAZ Chairman of the Board and Director June 26, 2003
- ------------------------------------
Alex Diaz
/S/ ALFRED H. FALK President, Chief Executive Officer June 26, 2003
- ------------------------------------ and Director (principal executive officer)
Alfred H. Falk
/S/ RAN FURMAN Chief Financial Officer and Secretay June 26, 2003
- ------------------------------------ (principal Financial and Accounting Officer)
Ran Furman
/S/ ROBERT PUTNAM Vice President and Director June 26, 2003
- ------------------------------------
Robert Putnam
/S/ ALLEN COCUMELLI Director June 26, 2003
- ------------------------------------
Allen Cocumelli
/S/ VICTOR G. RAMSAUER Director June 26, 2003
- ------------------------------------
Victor G. Ramsauer
44
INDEX TO FINANCIAL STATEMENTS
PAGE
----
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND SUBSIDIARY
REPORT OF SINGER LEWAK GREENBAUM & GOLDSTEIN LLP, INDEPENDENT AUDITORS F-2
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND SUBSIDIARY
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS F-3
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2003 AND 2002 F-4
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED
MARCH 31, 2003, 2002 AND 2001 F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
MARCH 31, 2003, 2002 AND 2001 F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8
F-1
CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF SINGER LEWAK GREENBAUM & GOLDSTEIN LLP, INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
E.DIGITAL CORPORATION AND SUBSIDIARY
We have audited the accompanying consolidated balance sheet of E.DIGITAL
CORPORATION AND SUBSIDIARY as of March 31, 2003, and the related consolidated
statements of operations, stockholders' (deficit) equity and cash flows for the
year then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
e.Digital Corporation and subsidiary at March 31, 2003, and the consolidated
results of their operations and their cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1 to the consolidated financial statements, the Company has
experienced substantial operating losses and requires additional sources of
financing to fund operations through March 31, 2004. At March 31, 2003, the
Company has a working capital deficit of $1,427,978 and a stockholders' deficit
of $1,874,227. These conditions raise substantial doubt about the ability of the
Company to continue as a going concern. Note 1 to the consolidated financial
statements describes management's plans to address these matters. The
consolidated financial statements do not include any adjustments, which would be
necessary should the Company be unable to continue as a going concern and
therefore be required to realize its assets and discharge its liabilities in
other than the normal course of business and at amounts different from those
reflected in the consolidated financial statements.
Los Angeles, California
May 30, 2003 /s/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
F-2
CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
E.DIGITAL CORPORATION AND SUBSIDIARY
We have audited the accompanying consolidated balance sheet of e.Digital
Corporation and subsidiary as of March 31, 2002 and the related consolidated
statements of operations, stockholders' (deficit) equity and cash flows for each
of the two years in the period ended March 31, 2002. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
e.Digital Corporation and subsidiary at March 31, 2002 and the consolidated
results of their operations and their cash flows for each of the two years in
the period ended March 31, 2002 in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, the Company has
experienced substantial operating losses and requires additional sources of
financing to fund operations through March 31, 2003. At March 31, 2002, the
Company has a working capital deficit of $2,543,657 and a stockholders deficit
of $2,013,529. These conditions raise substantial doubt about the ability of the
Company to continue as a going concern. Note 1 to the consolidated financial
statements describes management's plans to address these matters. The
consolidated financial statements do not include any adjustments, which would be
necessary should the Company be unable to continue as a going concern and
therefore be required to realize its assets and discharge its liabilities in
other than the normal course of business and at amounts different from those
reflected in the consolidated financial statements.
As discussed in Note 2 to the consolidated financial statements, during the year
ended March 31, 2001, the Company changed its method of accounting for
convertible securities.
San Diego, California
May 22, 2002 /s/ ERNST & YOUNG LLP
F-3
e.Digital Corporation and subsidiary
CONSOLIDATED BALANCE SHEETS
[See Note 1 - Nature of Operations and Basis of Presentation]
As at March 31,
2003 2002
$ $
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT
Cash and cash equivalents 83,906 445,219
Certificate of deposit [note 5] -- 58,696
Accounts receivable, net of allowance for doubtful
accounts of $138,236 [2002 - $73,899] [note 3] 181,536 618,509
Inventory, net of allowance for obsolete inventory
of $6,435 [2002-$55,965] [note 7] 138,795 910,222
Prepaid expenses and other 92,574 58,084
Deferred financing charges -- 31,500
Deferred contract charges 218,192 91,148
- ------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 715,003 2,213,378
- ------------------------------------------------------------------------------------------------------------------
Property and equipment [note 9] 141,397 364,984
Intangible assets [note 10] 38,949 20,071
- ------------------------------------------------------------------------------------------------------------------
Restricted cash[note 3] -- 145,073
TOTAL ASSETS 895,349 2,743,506
- ------------------------------------------------------------------------------------------------------------------
LIABILITIES, PREFERRED STOCK AND
STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT
Accounts payable, trade 736,682 1,527,292
Other accounts payable and accrued liabilities 189,583 308,235
Accrued lease liability [note 15] 515,002 515,000
Accrued employee benefits 203,027 247,902
Deferred revenue 311,703 130,212
Unsecured promissory notes[note 11] 186,984 2,028,394
- ------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 2,142,981 4,757,035
- ------------------------------------------------------------------------------------------------------------------
LONG TERM LIABILITIES
Unsecured promissory notes[note 11] 625,595 --
- ------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 2,768,576 4,757,035
- ------------------------------------------------------------------------------------------------------------------
Commitments and contingencies [notes 4 and 15]
STOCKHOLDERS' DEFICIT
Preferred stock, $10.00 par value, 5,000,000 shares authorized
Series D Preferred Stock, 250,000 shares designated, 205,000 and 0 issued
and outstanding, respectively. Liquidation preference of $2,050,000 and $0,
respectively. [note 14] 2,050,000 --
Common stock, $.001 par value, authorized 200,000,000,
147,604,343 and 132,537,298 shares outstanding,
respectively [note 13] 147,605 132,537
Additional paid-in capital [note 11, 13 and 14] 59,430,144 54,628,608
Contributed surplus 1,592,316 1,592,316
Dividends (61,500) --
Accumulated deficit (65,032,792) (58,366,990)
- ------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' DEFICIT (1,874,227) (2,013,529)
- ------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS DEFICIT 895,349 2,743,506
- ------------------------------------------------------------------------------------------------------------------
See accompanying notes
F-4
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
[See Note 1 - Nature of Operations and Basis of Presentation]
2003 2002 2001
$ $ $
- ----------------------------------------------------------------------------------------------------------
REVENUES - products [note 4] 2,224,961 1,852,933 1,494,747
- services [note 4] 372,402 564,101 333,265
- ----------------------------------------------------------------------------------------------------------
2,597,363 2,417,034 1,828,012
- ----------------------------------------------------------------------------------------------------------
Cost of revenues - products 3,365,086 2,578,071 1,380,041
- services 131,972 399,909 324,535
- ----------------------------------------------------------------------------------------------------------
3,497,058 2,977,980 1,704,576
- ----------------------------------------------------------------------------------------------------------
GROSS PROFIT (LOSS) (899,695) (560,946) 123,436
- ----------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and administrative 3,531,719 2,967,227 2,039,466
Research and related expenditures 1,410,506 2,327,283 1,956,857
- ----------------------------------------------------------------------------------------------------------
Total operating expenses 4,942,225 5,294,510 3,996,323
- ----------------------------------------------------------------------------------------------------------
OPERATING LOSS (5,841,920) (5,855,456) (3,872,887)
- ----------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSE)
Interest expense (741,435) (234,533) --
Loss on disposal of property and equipment (82,949) (2,916) (8,842)
Interest income 1,761 57,529 184,361
Other income [note 6} (1,259) 242,310 50,990
- ----------------------------------------------------------------------------------------------------------
TOTAL OTHER (EXPENSE) INCOME (823,882) 62,390 226,509
- ----------------------------------------------------------------------------------------------------------
Loss before provision for income taxes (6,665,802) (5,793,066) (3,646,378)
Provision for income taxes [note 12] -- -- --
- ----------------------------------------------------------------------------------------------------------
LOSS AND COMPREHENSIVE LOSS FOR THE YEAR (6,665,802) (5,793,066) (3,646,378)
Series C and B preferred stock beneficial
conversion feature [note 14] -- -- (3,417,094)
Accretion on Series C preferred stock [note 14] -- -- (582,905)
Accretion of the premium of Series C preferred stock [note 14] -- -- (400,000)
Accrued dividends on the Series A, B and C and D
preferred stock (61,500) (26,332) (87,668)
- ----------------------------------------------------------------------------------------------------------
Cumulative catch-up adjustment relating to beneficial
conversion feature of Series B preferred stock [note 2] -- -- (300,000)
- ----------------------------------------------------------------------------------------------------------
LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS FOR THE YEAR (6,727,302) (5,819,398) (8,434,045)
- ----------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER COMMON SHARE:
Before cumulative effect of accounting changes (0.05) (0.04) (0.06)
Cumulative effect of accounting changes (0.00) (0.00) (0.01)
- ----------------------------------------------------------------------------------------------------------
Net loss per common share (0.05) (0.04) (0.07)
- ----------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES 140,065,107 130,782,909 127,503,365
- ----------------------------------------------------------------------------------------------------------
PRO-FORMA AMOUNTS ASSUMING THE ACCOUNTING CHANGES ARE
APPLIED RETROACTIVELY:
Net loss attributable to common stockholders for the year (6,727,302) (5,819,928) (8,134,045)
Net loss per common share (0.05) (0.04) (0.06)
- ----------------------------------------------------------------------------------------------------------
See accompanying notes
F-5
E.DIGITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'
(DEFICIT) EQUITY [See Note 1 - Nature of
Operations and Basis of Presentation]
ADDITIONAL
COMMON STOCK PAID-IN
SHARES AMOUNT CAPITAL
# $ $
- -----------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2000 126,261,182 126,261 44,893,602
Stock issued on exercise of stock options 1,127,816 1,128 185,294
Stock issued on conversion of Series A
preferred stock 267,074 267 22,572
Stock issued on conversion of Series C
preferred stock 2,469,334 2,469 3,390,553
Cumulative catch-up adjustment relating
to beneficial conversion feature of
Series B preferred stock -- -- 300,000
Series C preferred stock beneficial conversion feature -- -- 3,417,094
Value assigned to 230,946 warrants granted in
connection with issuance of Series C preferred stock -- -- 582,905
Accretion on Series C preferred stock -- -- --
Stock based compensation expense -- -- 38,000
Accretion of premium on Series C preferred stock -- -- --
Stock issued on exercise of warrants 50,000 50 4,950
Loss for the year -- -- --
Accrued dividends on the Series C preferred stock -- -- --
- -----------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2001 130,175,406 130,175 52,834,970
- -----------------------------------------------------------------------------------------------------
Stock issued on exercise of stock options 500,000 500 45,000
Stock issued on exercise of warrants 779,280 780 240,823
Stock issued on conversion of Series C
preferred stock 912,612 912 821,315
Shares issued for services 170,000 170 202,430
Value assigned to 850,000 warrants granted in
connection with issuance of the 12% SP Notes -- -- 459,470
Stock based compensation expense -- -- 24,600
Loss for the year -- -- --
Accrued dividends on the Series C preferred stock -- -- --
- -----------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2002 132,537,298 132,537 54,628,608
- -----------------------------------------------------------------------------------------------------
Shares issued for Cash 9,177,457 9,178 3,472,422
Stock issued on exercise of stock options 868,750 870 113,251
Purchase of Intangibles for stock 125,000 125 49,875
Shares issued to vendors 3,558,498 3,558 727,994
Shares issued for interest 1,337,340 1,337 252,909
Value assigned to 400,000 options issued
to consultant -- -- 185,085
Loss for the year -- -- --
Accrued dividends on the Series D preferred stock -- -- --
- -----------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2003 147,604,343 147,605 59,430,144
- -----------------------------------------------------------------------------------------------------
CONTRIBUTEDACCUMULATED
DIVIDENDS SURPLUS DEFICIT
$ $ $
- --------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2000 -- 1,592,316 (44,113,547)
Stock issued on exercise of stock options -- -- --
Stock issued on conversion of Series A
preferred stock -- -- --
Stock issued on conversion of Series C
preferred stock -- -- --
Cumulative catch-up adjustment relating
to beneficial conversion feature of
Series B preferred stock -- -- (300,000)
Series C preferred stock beneficial conversion feature -- -- (3,417,094)
Value assigned to 230,946 warrants granted in
connection with issuance of Series C preferred stock -- -- --
Accretion on Series C preferred stock -- -- (582,905)
Stock based compensation expense -- -- --
Accretion of premium on Series C preferred stock -- -- (400,000)
Stock issued on exercise of warrants -- -- --
Loss for the year -- -- (3,646,378)
Accrued dividends on the Series C preferred stock -- -- (87,668)
- --------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2001 -- 1,592,316 (52,547,592)
- --------------------------------------------------------------------------------------------------
Stock issued on exercise of stock options -- -- --
Stock issued on exercise of warrants -- -- --
Stock issued on conversion of Series C
preferred stock -- -- --
Shares issued for services -- -- --
Value assigned to 850,000 warrants granted in
connection with issuance of the 12% SP Notes -- -- --
Stock based compensation expense -- -- --
Loss for the year -- -- (5,793,066)
Accrued dividends on the Series C preferred stock -- -- (26,332)
- --------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2002 -- 1,592,316 (58,366,990)
- --------------------------------------------------------------------------------------------------
Shares issued for Cash -- -- --
Stock issued on exercise of stock options -- -- --
Purchase of Intangibles for stock -- -- --
Shares issued to vendors -- -- --
Shares issued for interest -- -- --
Value assigned to 400,000 options issued
to consultant -- -- --
Loss for the year -- -- (6,665,802)
Accrued dividends on the Series D preferred stock (61,500) -- --
- --------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2003 (61,500) 1,592,316 (65,032,792)
- --------------------------------------------------------------------------------------------------
See accompanying notes
F-6
E.DIGITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
[See Note 1 - Nature of Operations and Basis of Presentation]
2003 2002 2001
$ $ $
- -------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Loss for the year (6,665,802) (5,793,066) (3,646,378)
Adjustments to reconcile loss to net cash used by
operating activities:
Depreciation and amortization 199,119 162,718 85,142
Allowance for doubtful accounts 64,938 -- --
Loss on disposal of property and equipment 82,949 2,916 8,842
Loss on impairment of asset 129,930 -- --
Stock issued as payment to suppliers -- 202,600 --
Write-down of obsolete inventory 698,594 -- --
Stock options issued to consultant 185,085 -- --
Warrants issued as finders fee -- 53,734 --
Gain on sale of investment -- (30,124) --
Accrued interest and accretion on secured and unsecured promissory notes 442,258 234,130 --
Stock based compensation expense -- 24,600 38,000
Changes in assets and liabilities:
Accounts receivable, trade 372,035 (88,495) (257,282)
Inventory 72,833 (894,436) 63,813
Prepaid expenses and other (34,490) (35,495) (14,130)
Deferred contract charges (127,044) (91,148) --
Accounts payable, trade (47,906) 710,554 245,637
Other accounts payable and accrued liabilities (180,152) 80,061 100,952
Accrued employee benefits (44,875) 36,128 57,463
Deferred revenue 181,491 112,434 --
- -------------------------------------------------------------------------------------------------------------------
CASH USED IN OPERATING ACTIVITIES (4,671,036) (5,312,889) (3,317,941)
- -------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment (157,286) (90,580) (244,217)
Proceeds from sale of investment -- 30,124 --
Purchase of intangibles -- -- (58,150)
Decrease (increase) in restricted cash 145,073 (145,073) --
Decrease (increase) in certificate of deposit 58,696 (3,472) (55,224)
- -------------------------------------------------------------------------------------------------------------------
CASH (USED) PROVIDED BY INVESTING ACTIVITIES 46,483 (209,001) (357,591)
- -------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from issuance of common stock 3,475,619 -- --
Proceeds from issuance of Unsecured Notes 1,842,000 -- --
Proceeds from issuance of SP Notes -- 1,000,000 --
Proceeds from issuance of 5% SP Notes -- 1,200,000 --
Payment on 5% SP Notes (1,200,000) -- --
Proceeds from sale of Series C preferred stock, net of issuance costs -- -- 3,701,250
Proceeds from exercise of warrants -- 241,603 5,000
Proceeds from exercise of stock options 114,121 45,500 186,422
Deferred financing charge 31,500 (31,500) --
- -------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY FINANCING ACTIVITIES 4,263,240 2,455,603 3,892,672
- -------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS DURING THE YEAR (361,313) (3,066,287) 217,140
Cash and cash equivalents, beginning of year 445,219 3,511,506 3,294,366
- -------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR 83,906 445,219 3,511,506
- -------------------------------------------------------------------------------------------------------------------
See accompanying notes
F-7
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
e.Digital Corporation, (the "Company") is incorporated under the laws of
Delaware. The Company offers engineering partnerships to electronics companies
to create portable digital devices that can link to personal computers and the
Internet. The Company markets to Original Equipment Manufacturers complete
reference designs and technology platforms with a focus on digital music and
voice player/recorders.
The consolidated financial statements have been prepared, by management, in
accordance with accounting principles generally accepted in the United States on
a going concern basis, which contemplates the realization of assets and the
discharge of liabilities in the normal course of business for the foreseeable
future.
The Company has incurred significant losses and negative cash flow from
operations in each of the last three years and has an accumulated deficit of
$65,032,792 at March 31, 2003 [2002 - $58,366,990]. At March 31, 2003, the
Company had a working capital deficiency of $1,427,978. Substantial portions of
the losses are attributable to marketing costs of the Company's new technology
and substantial expenditures on research and development of technologies. Since
March 31, 2001, the Company has experienced substantial reduction in cash,
projected revenues and increased costs that adversely affect the Company's
current results of operations and liquidity. The Company's operating plans
require additional funds that may take the form of debt or equity financings.
There can be no assurance that any additional funds will be available. The
Company's ability to continue as a going concern is in substantial doubt and is
dependent upon achieving a profitable level of operations and obtaining
additional financing.
Management of the Company has undertaken steps as part of a plan to improve
operations with the goal of sustaining Company operations for the next twelve
months and beyond. These steps include (a) branding and selling the Company's
line of digital audio products; (b) expanding sales and marketing to additional
OEM customers and markets; (c) controlling overhead and expenses; and (d)
raising additional capital and/or financing.
There can be no assurance the Company can successfully accomplish these steps
and it is uncertain the Company will achieve a profitable level of operations
and obtain additional financing.
The Company is actively seeking additional equity financing. There can be no
assurance that any additional financings will be available to the Company on
satisfactory terms and conditions, if at all. In the event we are unable to
continue as a going concern, we may elect or be required to seek protection from
our creditors by filing a voluntary petition in bankruptcy or may be subject to
an involuntary petition in bankruptcy. To date, management has not considered
this alternative, nor does management view it as a likely occurrence.
These consolidated financial statements do not give effect to any adjustments
which would be necessary should the Company be unable to continue as a going
concern and therefore be required to realize its assets and discharge its
liabilities in other than the normal course of business and at amounts different
from those reflected in the accompanying consolidated financial statements.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies used in the
preparation of these consolidated financial statements:
PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, e.Digital Corporation (a company incorporated in
the State of California). All significant intercompany accounts and transactions
have been eliminated.
F-8
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
USE OF ESTIMATES
The preparation of consolidated 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 consolidated
financial statements and the reported amounts of revenues and expenses during
the period. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash and cash equivalents,
certificate of deposit, restricted cash, accounts receivable, accounts payable
trade, other accounts payable and accrued liabilities, accrued lease liability,
accrued employee benefits, preferred stock and unsecured promissory notes.
Management has determined that the carrying value of cash and cash equivalents,
certificate of deposit, restricted cash, accounts receivable, accounts payable
trade and other accounts payable and accrued liabilities and accrued employee
benefits approximate their fair value due to their short term nature. Management
has determined that the carrying value of the preferred stock and unsecured
promissory notes approximates its fair value based on discounted cash flows at
market rates. The fair value of the accrued lease liability is not readily
determinable as it has no fixed repayment terms.
TRANSLATION OF FOREIGN CURRENCIES
Monetary assets and liabilities denominated in foreign currencies are translated
into U.S. dollars at the rate in effect at the balance sheet date. Other balance
sheet items and revenues and expenses are translated into U.S. dollars at the
rates prevailing on the respective transaction dates. Gains and losses on
foreign currency transactions, which have not been material, are reflected in
the consolidated statements of operations.
LOSS PER SHARE
Basic loss per share is computed by dividing loss available to common
stockholders by the weighted average number of common shares outstanding for the
year. Diluted loss per share reflect the potential dilution of securities that
could share in the loss of an entity. As at March 31, 2003, stock options,
warrants and convertible preferred stock exercisable into 16,568,070 [2002 -
7,429,412] [2001 - 7,838,650] shares of common stock were outstanding. These
securities were not included in the computation of diluted loss per share
because they are antidilutive, but they could potentially dilute earnings (loss)
per share in future years.
REVENUE RECOGNITION
The Company recognizes license revenue and product revenue upon shipment of a
product to the customer, FOB destination or FOB shipping point depending on the
specific contract term, if a signed contract exists, the fee is fixed and
determinable, collection of resulting receivables is probable and there are no
resulting obligations. With most of the Company's consumer electronics
retailers, the Company does not meet the criteria for revenue recognition upon
shipment and therefore only recognizes the revenue as the product is sold
through the Company's customer to the ultimate end-user. Research and
development contract revenues on short-term projects or service revenue is
recognized once the services or product has been delivered, the fee is fixed and
determinable, collection of the resulting receivable is probable and there are
no resulting obligations. If all of the service or product has been delivered
and there is one element that is perfunctory to the services or product that has
not been delivered, revenue will be recognized evenly over the remaining term of
the undelivered element.
Research and development contract revenue on long-term projects is recognized on
the percentage of completion method if reasonable estimates of the costs and
revenues can be determined for each of the milestones; otherwise, the revenues
are recognized when the service or product is delivered. Funds received in
advance of meeting the criteria for revenue recognition are deferred and are
recorded as revenue as they are earned.
CASH EQUIVALENTS
Cash equivalents are highly liquid investments with insignificant interest rate
risk and maturities of three months or less at the date of purchase and are
recorded at cost, which approximates fair value. Cash equivalents consist
principally of investments in short-term money market instruments.
F-9
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
CERTIFICATE OF DEPOSIT
The certificate of deposit is recorded at the lower of cost and market value.
INVENTORY
Inventory is recorded at the lower of cost and net realizable value. Cost is
determined on a first-in, first-out basis.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation and amortization are
provided on the straight-line method over the estimated useful lives of the
related assets, ranging from 3 to 7 years or, in the case of leasehold
improvements, over the lesser of the useful life of the related asset or the
lease term. When assets are sold or retired, the cost and accumulated
depreciation are removed from the respective accounts and any gain or loss on
the disposition is credited or charged to income. Maintenance and repair costs
are charged to operations when incurred.
INTANGIBLE ASSETS
Intangible assets include third party costs relating to obtaining patents, which
are deferred when management is reasonably certain the patent will be granted.
Such costs are amortized to operations over the life of the patent. If
management determines that development of products to which patent costs relate
is not reasonably certain, or that deferred patent costs exceed net recoverable
value, such costs are charged to operations. Intangible assets also include
website development costs incurred during the application development stage of
the Company's website which have been capitalized and are amortized over a two
year period on the straight-line method. All other patent and website related
costs are charged to operations when incurred.
ADVERTISING
Advertising costs are charged to expense as incurred. The Company expensed
$64,072, $116,488 and $38,490 for the years ending March 31, 2003, 2002 and
2001, respectively.
LEASES
Leases entered into are classified as either capital or operating leases.
Leases, which substantially transfer all benefits and risks of ownership of
property to the Company, are accounted for as capital leases. At the time a
capital lease is entered into, an asset is recorded together with its related
long-term obligation to reflect the purchase and financing.
Rental payments under operating leases are expensed as incurred.
SHIPPING AND HANDLING COSTS
Amounts paid by customers for shipping and handling are included in product
revenues. Actual shipping and handling costs are included in product cost of
revenues.
INCOME TAXES
The Company follows the liability method of accounting for income taxes. Under
this method, deferred tax assets and liabilities are determined based on the
difference between the financial reporting and tax bases of assets and
liabilities using enacted tax rates that will be in effect for the year in which
the differences are expected to reverse.
F-10
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
STOCK BASED COMPENSATION
The Company accounts for stock-based employee and non-employee compensation
arrangements using the intrinsic value method in accordance with the provisions
of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25") and complies with the disclosure provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Under APB No. 25, compensation expense is based
on the difference, if any, on the date of the grant, between the fair value of
the Company's stock and the exercise price. The Company accounts for stock
issued to non-employees in accordance with the provisions of SFAS No. 123 and
Emerging Issues Task Force No. 96-18 "Accounting for Equity Instruments with
Variable Terms That Are Issued for Consideration Other Than Employee Services
Under FASB Statement No. 123." The fair value of stock options granted to
non-employees is determined using the Black-Scholes option pricing model. The
Company recorded compensation expense of $185,085 for options issued to a
consultant in the year ended March 31, 2003 [2002 - $24,600]. Any stock
compensation calculated is amortized over the vesting period of the individual
options, using the graded vesting method. The graded vesting method provides for
vesting of portions of the overall awards at interim dates and results in
greater vesting in earlier years than the straight-line method of amortization.
COMPREHENSIVE INCOME
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. For the years
ended March 31, 2003, 2002 and 2001, there were no material differences between
comprehensive income and net loss for the year.
SOFTWARE DEVELOPMENT COSTS
The Company accounts for software development costs in accordance with Financial
Accounting Standards Board ("FASB") Statement No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed," under which
certain software development costs incurred subsequent to the establishment of
technological feasibility are capitalized and amortized over the estimated lives
of the related products. Technological feasibility is established upon
completion of a working model. Development costs incurred subsequent to the
establishment of technological feasibility have not been significant, and all
software development costs have been charged to research and related
expenditures in the accompanying consolidated statements of operations.
SEGMENT INFORMATION
The Company identifies its operating segments based on how management internally
evaluates separate financial information (if available), business activities and
management responsibility. The Company believes it operates in a single business
segment, the development, manufacture and marketing of electronic products,
offering engineering partnerships to electronics companies to create portable
digital devices that can link to personal computers and the Internet.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets. Statement 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. Statement 141 also includes guidance on the initial recognition and
measurement of goodwill and other intangible assets. Statement 142 prohibits the
amortization of goodwill and intangible assets with indefinite useful lives.
Statement 142 requires that these assets be reviewed for impairment at least
annually. Intangible assets with finite lives will continue to be amortized over
their estimated useful lives. The Company expects to adopt FAS 141 and FAS 142
as of April 1, 2002 and does not expect that the adoption of the Statements to
have a significant impact on the Company's financial position and results of
operations
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (FAS 144), which addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions
F-11
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a
segment of a business. FAS 144 is effective for fiscal years beginning after
December 15, 2001, with earlier application encouraged. The Company expects to
adopt FAS 144 as of April 1, 2002 and does not believe it will have a material
impact on the Company's financial position and results of operations.
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." SFAS No. 145 updates, clarifies,
and simplifies existing accounting pronouncements. This statement rescinds SFAS
No. 4, which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net of related
income tax effect. As a result, the criteria in Accounting Principles Board No.
30 will now be used to classify those gains and losses. SFAS No. 64 amended SFAS
No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS No. 44
has been rescinded as it is no longer necessary. SFAS No. 145 amends SFAS No. 13
to require that certain lease modifications that have economic effects similar
to sale-leaseback transactions be accounted for in the same manner as sale-lease
transactions. This statement also makes technical corrections to existing
pronouncements. While those corrections are not substantive in nature, in some
instances, they may change accounting practice. The Company does not expect
adoption of SFAS No. 145 to have a material impact, if any, on its financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue 94-3, a
liability for an exit cost, as defined, was recognized at the date of an
entity's commitment to an exit plan. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. The Company does not expect adoption
of SFAS No. 146 to have a material impact, if any, on its financial position or
results of operations.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." In addition, this statement amends SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include certain financial
institution-related intangible assets. The Company does not expect adoption of
SFAS No. 147 to have a material impact, if any, on its financial position or
results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," an amendment of SFAS No. 123. SFAS
No. 148 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require more prominent and more frequent disclosures in financial statements
about the effects of stock-based compensation. This statement is effective for
financial statements for fiscal years ending after December 15, 2002. SFAS No.
148 will not have any impact on the Company's financial statements as management
does not have any intention to change to the fair value method.
CHANGE IN ACCOUNTING POLICY
The Company has adopted Emerging issues Task Force Issue No. 00-27 (EITF 00-27),
"Application of EITF Issue No. 98-5, Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, to
Certain Convertible Instruments," which is effective for all such instruments.
This Issue clarifies the accounting for instruments with beneficial conversion
features or contingently adjustable conversion ratios. The Company has modified
previously issued convertible preferred stock to reflect this Issue.
F-12
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
The beneficial conversion feature has been calculated by allocating the proceeds
received in the financing to the convertible instrument and to any detachable
warrants included in the transaction, and measuring the intrinsic value based on
the effective conversion price as a result of the allocated proceeds. The
previous calculation was based on a comparison of the stated conversion price in
the term of the instruments to the fair value of the stock at the commitment
date. In connection with the issuance of EITF 00-27, the Company recorded as a
cumulative catch-up adjustment $300,000 with respect to Series B stock which
increased additional paid-in capital and accumulated deficit at March 31, 2002
and increased the loss per share at March 31, 2001.
3. CREDIT RISK
Financial instruments totaling $265,442 [2002 - $1,267,497] which potentially
subject the Company to concentrations of credit risk, consist principally of
cash and cash equivalents, certificate of deposit, accounts receivable and
restricted cash. The Company maintains cash and cash equivalents with two
financial institutions. The Company performs ongoing credit evaluations of its
customers and maintains allowances for potential credit losses which, when
realized, have been within the range of management's expectations.
Amounts owing from two major customers comprise approximately 50% and 26%,
respectively of accounts receivable at March 31, 2003. Amounts owing from three
major customers comprise approximately 30%, 30% and 24%, respectively of
accounts receivable at March 31, 2002.
4. MAJOR CUSTOMERS AND SUPPLIERS
The Company operates in one major line of business, the development, manufacture
and marketing of electronic products. Sales to one major customer comprised
approximately 22% of revenues respectively in fiscal 2003 [2002 - two customers
comprised 35% and 14%, respectively] [2001 - one customer comprised 90%]. As at
December 31, 2002, the Company satisfied its contractual obligations to one of
its significant customers and has not received any additional purchase orders.
The Company's agreement with this customer has not been renewed and it expects
no additional sales from this customer.
The Company has supply agreements with three suppliers for the production of its
products. The Company has no other significant suppliers.
The Company purchases most of its Microdrive, Compact Flash and hard drive
storage media from two distributors. Purchases from these two distributors
accounted for approximately 32% of total Company purchases in fiscal 2003. One
of the distributors accounted for approximately 29% of total Company purchases
in fiscal 2002.
The provision for doubtful accounts receivable at March 31, 2002 was $73,899.
During the year ended March 31, 2003, management increased the provision for
doubtful accounts by $64,337, and recorded no discount in the provision, and
accordingly, the provision for doubtful accounts receivable at March 31, 2003 is
$138,237.
5. CERTIFICATE OF DEPOSIT
The Company is required to segregate and maintain a certificate of deposit as
security for corporate credit cards. The Company no longer maintains corporate
credit cards, and as result, as at March 31, 2003, the balance in this
restricted certificate of deposit is $nil [2002 - $58,696].
6. OTHER INCOME
Other Income of ($1,259) in fiscal 2003 consists of Delaware and California
corporate taxes. Other Income of $242,310 in fiscal 2002 is comprised primarily
of $212,000 reversal of amounts originally accrued in accounts payable that
arose in the normal course of business for services rendered to the Company or
goods delivered to the Company that were approximately five to seven years old.
F-13
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
7. INVENTORY
Inventory is recorded at the lower of cost and net realizable value. Cost is
determined on a first-in, first out basis.
MARCH 31, 2003 MARCH 31, 2002
$ $
- --------------------------------------------------------------------------------
Finished goods 134,146 805,400
RAW MATERIALS 4,649 104,822
- --------------------------------------------------------------------------------
138,795 910,222
- --------------------------------------------------------------------------------
At March 31, 2002 the provision for inventory obsolescence was $55,965. During
the year ended March 31, 2003, the provision was decreased by $49,530 without a
reduction in the opening provision, and accordingly the provision for inventory
obsolescence at March 31, 2003 amounted to $6,435.
8. STATEMENT OF CASH FLOWS
The Company had non-cash operating and financing activities and made cash
payments as follows:
2003 2002 2001
$ $ $
- -----------------------------------------------------------------------------------------------------
Non-cash financing activities:
Stock based compensation expense 185,085 -- 38,000
Common stock issued on conversion of Series A preferred stock -- -- 22,839
Common stock issued on conversion of Series C preferred stock -- 822,227 3,393,022
Shares issued for interest 254,246 -- --
Agent warrants granted in connection with the issuance
of Series C preferred stock -- -- 450,346
Value assigned to 230,946 warrants granted in connection
with the issuance of Series C preferred stock -- -- 582,905
Value assigned to 850,000 warrants granted in connection
with the issuance of the 12% SP Notes -- 459,470 --
Accrued dividends on Series A and C preferred stock 61,500 26,332 87,668
Common stock issued for intangibles 50,000 -- --
Conversion of SP Notes and Unsecured Notes into Series D
preferred stock 2,050,000 -- --
Stock issued as payment to suppliers 742,704 -- --
Cash payments for interest were as follows:
Interest 81,237 403 --
- -----------------------------------------------------------------------------------------------------
9. PROPERTY AND EQUIPMENT
ACCUMULATED
DEPRECIATION AND NET BOOK
COST AMORTIZATION VALUE
$ $ $
- --------------------------------------------------------------------------------------------------
2003
Computer hardware and software 155,310 130,310 25,000
Furniture and equipment 65,251 60,250 5,001
Machinery and equipment 91,929 68,872 23,057
Leasehold improvements 174,960 164,102 10,858
Tooling 99,152 21,671 77,481
- --------------------------------------------------------------------------------------------------
586,602 445,205 141,397
- --------------------------------------------------------------------------------------------------
F-14
2002
Computer hardware and software 189,722 99,152 90,570
Furniture and equipment 79,595 50,144 29,451
Machinery and equipment 114,969 55,616 59,353
Leasehold improvements 174,960 113,264 61,696
Testing equipment 13,198 13,198 --
Tooling 130,029 6,115 123,914
- --------------------------------------------------------------------------------------------------
702,473 337,489 364,984
- --------------------------------------------------------------------------------------------------
For the year ended March 31, 2003, the company incurred a loss on impairment of
asset of $129,930.
10. INTANGIBLE ASSETS
ACCUMULATED NET BOOK
COST AMORTIZATION VALUE
$ $ $
- --------------------------------------------------------------------------------------------------
2003
Website development costs 93,150 56,437 36,713
Patents 39,409 37,173 2,236
- --------------------------------------------------------------------------------------------------
132,559 93,610 38,949
- --------------------------------------------------------------------------------------------------
2002
Website development costs 43,150 27,756 15,394
Patents 39,409 34,732 4,677
- --------------------------------------------------------------------------------------------------
82,559 62,488 20,071
- --------------------------------------------------------------------------------------------------
11. SECURED PROMISSORY NOTES
[A] 12% PROMISSORY NOTES
On September 28, 2001, the Company issued 12% Secured Promissory Notes ("SP
Notes") for gross cash proceeds of $1,000,000 to certain investors. The SP Notes
originally matured December 31, 2002 and were secured by the Company's accounts
receivable and inventory. The interest under the SP Notes accrued at a rate of
12% per annum simple interest and under the original terms, was payable in one
installment on the maturity date. All of the holders of the SP Notes
subsequently agreed to subordinate their security interest in the Company's
accounts receivable and inventory in favor of the rights granted to the holder
of the 5% Secured Promissory Note, as hereinafter defined, so long as the 5% SP
Note was outstanding. The Company redeemed the 5% SP Note on September 11, 2002.
On December 30, 2002, the Company issued 807,013 shares of Common Stock in
consideration for all accrued and unpaid interest. On December 30, 2002, each of
the note holders agreed to convert the unpaid principal balance totaling
$1,000,000 of the SP Notes into 100,000 Series D convertible preferred stock
(the "Series D stock").
In connection with the sale of the SP Notes, the Company issued warrants to
purchase 750,000 shares of Common Stock at a purchase price of $0.75 per common
share expiring December 20, 2006. The Company has allocated $405,736 of the
proceeds raised to the warrants and $594,264 to the SP Notes based on the
relative fair value the instruments. The discount on the SP Notes has been
subject to accretion over the term of the SP Note. The Company also issued
warrants to purchase 100,000 shares of Common Stock at a purchase price of $0.75
per common share expiring December 31, 2006, as a finders' fee. The estimated
fair market value of these warrants at issuance was $91,034 and has been
recorded as a deferred financing charge related to the SP Notes of $53,734 and
$37,310 as a cost of issuing the warrants charged to Additional Paid in Capital.
The deferred financing charge has been amortized over the term of the SP Notes.
F-15
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
[B] 5% SECURED PROMISSORY NOTE
On January 18, 2002, the Company issued a 5% Secured Promissory Note ("5% SP
Note") for gross cash proceeds of $1,200,000. The 5% SP Note, originally matured
on April 18, 2002 and was secured by all assets of the Company including,
without limitation, the Company's intellectual property. The interest under the
5% SP Note accrued at a rate of 5% per annum simple interest and was payable in
one installment on maturity date. On April 17, 2002, the 5% SP Note holder
agreed to extend the maturity date of the 5% SP Note from April 18, 2002 to May
2, 2002 for no consideration. On April 29, 2002, the 5% SP Note holder agreed to
extend the maturity date of the 5% SP Note from May 2, 2002 to October 29, 2002
and to reduce the interest rate from 5% to 4% in exchange for (i) a $200,000
finance fee that increased the principal amount from $1,200,000 to $1,400,000,
(ii) a minimum monthly principal reduction of $100,000; (iii) an immediate
principal repayment of $300,000 and (iv) repayment of accrued interest to April
18, 2002 of $15,000. On September 11, 2002, the Company redeemed the outstanding
balance and accrued interest on the 5% SP Note.
12. UNSECURED PROMISSORY NOTES
[A] UNSECURED NOTES
In July 2002, the Company issued Unsecured Promissory Notes ("Unsecured Notes")
for gross cash proceeds of $1,050,000 to certain noteholders to finance various
purchase orders and accounts payable. The Unsecured Notes originally matured
sixty days from issuance, commencing December 1, 2002. The interest under the
Unsecured Notes accrued at a rate of 24% per annum simple interest and was
payable in one installment on the maturity date. Prior to maturity, the Company
entered into a forbearance agreement with the noteholders through and including
December 31, 2002. On December 30, 2002, the Company issued 397,104 shares of
Common Stock in consideration for all accrued and unpaid interest. On December
30, 2002, each of the noteholders agreed to convert the unpaid principal balance
totaling $1,050,000 of the Unsecured Notes into 105,000 shares of Series D
stock.
[B] 15% UNSECURED NOTES
On December 11, 2002, the Company issued a 15% Unsecured Promissory Note ("15%
Unsecured Note") for gross cash proceeds of $750,000 to an individual. The 15%
Unsecured Note, under the original term, was scheduled to mature on February 11,
2004 and payable $50,000 each month, with a final payment of $35,801 on February
11, 2004. The Company entered into a forbearance agreement with the investor
through and including December 31, 2002. On December 30, 2002, the Company
issued 133,223 shares of Common Stock in consideration for all accrued and
unpaid interest. On December 23, 2002, the holder of the 15% Unsecured Note
agreed to (i) extend the maturity date of the 15% Unsecured Note from February
11, 2004 to May 31, 2005; (ii) reduce the monthly payments from $50,000 to
$7,500 through December 31, 2003, representing the monthly interest on the 15%
Unsecured Note and (iii) $50,000 payments each month, beginning January 31,
2004.
[C] 24% UNSECURED NOTES
On March 17, 2003, the Company issued a 24% Unsecured Promissory Note ("24%
Unsecured Note") for gross cash proceeds of $42,000 to a director to finance
inventory purchases. On March 31, 2003, the Company repaid all accrued interest
and $6,938 of principal. At March 31, the principal amount due under the 24%
Unsecured Note was $35,454. On April 28, 2003, we issued an additional $37,800
of this same 24% Unsecured Note to the same director.
13. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. For financial statement
purposes, a change in valuation allowance of $2,478,000 [2002 - $2,034,000] has
been recognized to offset certain deferred tax assets for which realization is
uncertain. Significant components of the Company's deferred tax liabilities and
assets as of March 31, are as follows:
F-16
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
2003 2002
$ $
- --------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES
State Taxes 482,000
Tax over book depreciation 13,000 21,000
- --------------------------------------------------------------------------------------------------
TOTAL DEFERRED TAX LIABILITIES 495,000 21,000
- --------------------------------------------------------------------------------------------------
DEFERRED TAX ASSETS
Net operating loss carryforwards 18,179,000 14,999,000
Other 235,000 463,000
- --------------------------------------------------------------------------------------------------
TOTAL DEFERRED TAX ASSETS 18,414,000 15,462,000
Valuation allowance for deferred tax assets (17,919,000) (15,441,000)
- --------------------------------------------------------------------------------------------------
NET DEFERRED TAX ASSETS 495,000 21,000
- --------------------------------------------------------------------------------------------------
NET DEFERRED TAX BALANCE -- --
- --------------------------------------------------------------------------------------------------
The net provision for income taxes in 2003 and 2002 is $nil as the Company
incurred losses in those years.
A reconciliation between federal statutory income tax rates and the effective
tax rate of the Company at March 31 is as follows:
LIABILITY METHOD
2003 2002 2001
% % %
- ------------------------------------------------------------------------------------------------------
U.S. federal statutory rate 35.0 35.0 35.0
U.S. federal net operating loss rate (35.0) (35.0) (35.0)
- ------------------------------------------------------------------------------------------------------
Effective rate on operating loss -- -- --
- ------------------------------------------------------------------------------------------------------
The Company has U.S. federal net operating loss carryforwards available at March
31, 2003 of approximately $48,000,000 [2002 - $41,430,000] which will begin to
expire in 2006. The Company has state net operating loss carryforwards of
$15,000,000 [2002 - $8,661,000] which will expire beginning in 2004. The
difference between federal and state net operating loss carryforwards is due to
the 50% limitation of California loss carryforwards and to expiring California
carryforwards.
14. CAPITAL STOCK
AUTHORIZED CAPITAL
The authorized capital of the Company consists of 200,000,000 common shares with
a par value of $.001 per share and 5,000,000 preferred shares with a par value
of $.001 per share.
COMMON STOCK
The issued common stock of the Company consisted of 147,604,343 and 132,537,298
common shares as of March 31, 2003 and March 31, 2002, respectively.
STOCK OPTIONS
The Company maintains two stock option plans. The 1992 Stock Option Plan is a
non-qualified stock option plan, which entitles certain directors and key
employees to purchase common shares of the Company. A maximum of 10% of
outstanding common shares are authorized for grant under the Plan. Options are
granted at a price not less than fair market value at the date of grant, and are
subject to approval of the Board of Directors. The 1994 Stock Option Plan
entitles certain directors, key employees and consultants of the Company to
purchase common shares of the Company. The 1994 Plan covered a maximum aggregate
of 14,000,000 shares, as amended and approved by stockholders on July
F-17
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
25, 1996, January 5, 1998 and November 9, 2000. The 1994 Plan provides for the
granting of options that either qualify for treatment as incentive stock options
or non-statutory stock options.
During 2003, 2,805,000 [2002 - 1,085,000] options were granted at exercise
prices ranging from $0.28 to $0.55 [2002 - $1.02 to $2.00] per share. Options
granted during 2003 and 2002 were under the 1994 Stock Option Plan. The
following table summarizes stock option transactions:
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
# $
- -------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2001 5,729,000 3.1172
- -------------------------------------------------------------------------------------------------------
Granted 1,085,000 1.2824
Exercised (500,000) 0.1000
Forfeited (248,250) 3.5592
Cancelled (150,000) 5.4600
- -------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2002 5,915,750 2.9578
- -------------------------------------------------------------------------------------------------------
Granted 2,805,000 0.4442
Exercised (868,750) 0.1314
Forfeited (1,793,750) 1.5634
Cancelled (2,115,000) 5.4600
- -------------------------------------------------------------------------------------------------------
BALANCE, MARCH 31, 2003 3,943,250 1.0846
- -------------------------------------------------------------------------------------------------------
EXERCISABLE, MARCH 31, 2003 3,094,488 1.2077
The following table summarizes the number of options exercisable at March 31,
2003 and the weighted average exercise prices and remaining contractual lives of
the options.
WEIGHTED AVERAGE
WEIGHTED EXERCISE PRICE
RANGE OF NUMBER NUMBER WEIGHTED AVERAGE OF OPTIONS
EXERCISE OUTSTANDING AT EXERCISABLE AT AVERAGE REMAINING EXERCISABLE AT
PRICES MARCH 31, 2003 MARCH 31, 2003 EXERCISE PRICE CONTRACTUAL MARCH 31, 2003
$ # # $ LIFE $
- -----------------------------------------------------------------------------------------------------
0.088 to 0.550 2,135,000 1,693,750 0.40 3.96 years 0.39
0.555-3.00 1,380,750 1,153,238 1.67 2.99 years 1.76
3.005-5.46 247,500 247,500 4.21 1.57 years 4.21
- -----------------------------------------------------------------------------------------------------
3,943,250 3,094,488
- -----------------------------------------------------------------------------------------------------
The options generally vest over a period of two to three years.
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standard No. 123 "Accounting for Stock-Based Compensation" ("SFAS No.
123") for stock options granted to employees. Had compensation cost for the
stock option plans been determined based on the fair market value at the grant
date for awards during fiscal 2003, consistent with the provisions of SFAS No.
123, the Company's loss and loss per share for the years ended March 31, 2003,
2002 and 2001 would have been increased as follows:
2003 2002 2001
$ $ $
- --------------------------------------------------------------------------------------------------------
Loss attributable to common stockholders before
cumulative accounting change (6,727,302) (5,819,398) (8,134,045)
Additional compensation expense (981,739) (5,183,186) (5,297,669)
- --------------------------------------------------------------------------------------------------------
Pro forma loss attributable to common stockholders
before cumulative accounting change (7,709,041) (11,002,584) (13,431,714)
Cumulative accounting change -- -- (300,000)
Pro forma loss per share (0.05) (0.08) (0.11)
- --------------------------------------------------------------------------------------------------------
F-18
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
The fair value of options, used as a basis for the above pro forma disclosures,
was estimated at the date of grant using the Black-Scholes option-pricing model.
The option pricing assumptions include a dividend yield of 0% [2002 - 0%] [2001
- - 0%]; expected volatility of 1.08[2002 - 1.00] [2001 - 1.13] a risk free
interest rate of 3.16% [2002 - 5.0%] [2001 - 6.0%] and an expected life of 2.0
years [2002 - 2.5 years] [2001 - 2.5 years]. The following table summarizes the
weighted average fair value of the stock options granted during the year:
WEIGHTED AVERAGE
FAIR VALUE
OF OPTIONS
$
- ------------------------------------------------------------------------------
Exercise price is less than the fair market price of the
stock on the grant date 0.21
- ------------------------------------------------------------------------------
Exercise price is equal to the fair market price of the
stock on the grant date 0.25
Exercise price is greater than the fair market price of the
stock on the grant date N/A
Granted 0.25
THE 2000 EMPLOYEE STOCK COMPENSATION PLAN
In August 2000, the Board of Directors adopted the Company's 2000 Employee Stock
Compensation Plan (the "Plan") authorizing the issuance of 250,000 shares of the
Company's Common Stock. The Plan is intended to provide equity incentives to
recruit and retain employees. The Plan provides for stock compensation through
grants of the Company's Common Stock. Awards of shares may be made as
compensation for services rendered, directly or in lieu of other compensation
payable, as a bonus in recognition of past service or performance or may be sold
to an employee in exchange for cash, property, services rendered or other lawful
forms of consideration. Shares awarded other than for services rendered will not
be sold at less than fair market value. Unless sooner terminated, the Plan will
terminate on November 9, 2003. As at March 31, 2003, no shares have been issued
under the Plan.
SHARE WARRANTS
The Company has outstanding share warrants as of March 31, 2003, granted in
connection with private placements and convertible notes payable, entitling the
holders to purchase one common share for each warrant held as follows:
NUMBER OF EXERCISE PRICE
WARRANTS $ EXPIRATION DATE
- -----------------------------------------------------------------------------
500,000 $0.10 June 12, 2003
161,662 $0.19 October 5, 2005
850,000 $0.19 September 30, 2006
- -----------------------------------------------------------------------------
1,511,662
- -----------------------------------------------------------------------------
In connection with the issuance of the Series C stock in October 2000, the
Company issued warrants with an exercise price of $5.20. In April 2002, 161,662
warrants, which were issued to the investors and a placement agent in connection
with the Series C stock were repriced from $0.75 to $0.53. The warrants were
repriced pursuant to anti-dilution protection given to the warrant holders
triggered by the sale of shares of Common Stock in April 2002. Pursuant to the
anti-dilution protection given to the warrant holders, the warrants have been
further repriced as follows: $0.38 on June 7, 2002; $0.31 on November 1, 2002;
$0.30 on November 18, 2002; $0.205 on November 17 and $0.19 on December 24,
2002.
F-19
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
In connection with the issuance of the SP Notes, the Company issued warrants
with an exercise price of $0.75. In April 2002, 850,000 warrants, which were
issued to the investors and a placement agent in connection with the SP Note
were repriced from $0.75 to $0.53. The warrants were repriced pursuant to
anti-dilution protection given to the warrant holders triggered by the sale of
shares of Common Stock in April 2002. Pursuant to the anti-dilution protection
given to the warrant holders, the warrants have been further repriced as
follows: $0.38 on June 7, 2002; $0.31 on November 1, 2002; $0.30 on November 18,
2002; $0.205 on November 17 and $0.19 on December 24, 2002.
COMMON STOCK ISSUED FOR SERVICES
During the year ended March 31, 2003, the Company issued 3,558,498 [2002 -
170,000] [2001 - nil] shares of common stock, based on quoted market prices, to
third parties as consideration for the fair value of services provided to the
Company.
COMMON STOCK ISSUED FOR INTEREST
During the year ended March 31, 2003, the Company issued 1,337,340 [2002 - nil]
[2001 - nil] shares of common stock, based on quoted market prices, to third
parties as consideration for accrued interest on the SP Notes, the Unsecured
Notes and the 15% Unsecured Note.
14. REDEEMABLE PREFERRED STOCK
SERIES A
The Company is authorized to issue 5,000,000 shares of $.001 par value preferred
stock in one or more series from time to time by action of the Board of
Directors. During September 1997, the first series, consisting of up to 100,000
shares, was designated by the Board of Directors as Series A (the "Series A
stock"). During September and October 1997, the Company sold 99,500 shares of
Series A stock at $10 per share for gross proceeds of $995,000 and net proceeds
of $962,500. The Series A stock has voting rights equal to the number of shares
of common stock into which the Series A stock is convertible. Dividends of 8%
($0.4036 per share) per annum are cumulative and may be payable in cash or
shares of common stock, at the Company's election. The Series A stock has a
liquidation preference of $10 per share, plus accrued and unpaid dividends, with
no participation after the preference is paid.
During 1999, a total of 38,300 of Series A stock and accrued dividends were
converted into 8,466,565 shares of common stock.
Each share of Series A stock is convertible into shares of common stock computed
by dividing $10 plus accrued and unpaid dividends by the lesser of (i) $0.0875
or (ii) 80% of the average closing bid price for the common stock for the ten
trading days immediately following any and each distribution in shares,
subdivision, split-up, combination, reclassification or other change in common
stock. The Company is required to redeem the Series A stock on September 1, 2000
and upon the occurrence of certain other events. The Company may redeem the
Series A stock earlier only if there are sufficient shares available for
conversion of the Series A stock. The redemption price is $10 per share plus
accrued and unpaid dividends if there are sufficient shares available for the
conversion of the Series A stock, otherwise the redemption price is equal to the
greater of (i) $10 per share plus accrued interest and unpaid dividends or (ii)
an amount equal to a five day market price multiplied by the number of common
shares into which the Series A stock would be convertible if shares were
authorized, plus a 10% premium.
During the fiscal year ended March 31, 2001, the 1,900 shares of Series A stock
and accrued dividends were converted into 267,074 shares of Common Stock. During
the year ended March 31, 2000, 30,600 shares of Series A stock and accrued
dividends were converted into 4,066,695 shares of common stock.
SERIES B
On June 25, 1999, the Company issued 300, 7% Series B convertible preferred
stock (the "Series B stock"), par value $.001, for cash of $10,000 per share and
gross proceeds of $3,000,000. Dividends of 7% per annum are cumulative and
F-20
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
are payable, with certain exceptions, either in cash or in shares of common
stock at the election of the Company. The dollar amount of Series B stock, is
convertible into fully paid and no assessable shares of common stock of the
Company at a conversion price which is the lower of (i) $2.00 per share or (ii)
a per share amount computed on each of two adjustment dates (30 and 60 days
after registration of the underlying shares), but not less than $1.50 per share
except as may be subsequently modified as a consequence of certain possible
penalties and other adjustments. The conversion price on the two adjustment
dates is computed at a premium to the average of the three lowest of the ten day
closing bid market prices prior to and including each adjustment date. On
September 8, 1999, the adjusted conversion price was determined to be $1.50 in
accordance with the terms of the agreement set out above. The adjusted
conversion price resulted in a beneficial conversion feature in the amount of
$1,200,000 because the adjusted conversion price was less then the fair market
value of the common stock when the preferred shares were issued. This has been
recorded as a beneficial conversion feature on the issuance of the Series B
stock and increases the loss attributable to common stockholders and the
resulting loss per share for the year ended March 31, 2000.
The Series B stock was redeemable in certain instances at the Company's option
and at the holder's election upon the occurrence of certain triggering events.
The Series B stock was subject to automatic conversion on June 24, 2002, subject
to certain conditions.
In connection with the Series B stock financing, the Company incurred placement
agent fees and legal and related costs of approximately $250,000 and issued
warrants to purchase 137,615 common shares of the Company with an exercise price
of $3.27 per share until June 24, 2004. The fair value of the warrants granted
was estimated at $275,000 on the date of the grant using the Black-Scholes
options price model with the following assumptions: no dividend yield; risk free
interest rate of 6%, expected volatility of 1.844 and an expected life of 5
years. This amount was been recorded as a cost of issuance by reducing Series B
stock capital and increasing common stock additional paid in capital.
In addition, in connection with the issuance of the Series B stock, the Company
issued to the Series B stockholders, warrants to purchase 195,000 shares of
Common Stock at $2.40 per share until June 24, 2004. The fair value of the
warrants granted was estimated at $390,000 on the date of the grant using the
Black-Scholes options pricing model with the following assumptions: no dividend
yield; risk free interest rate of 6%, expected volatility of 1.844 and an
expected life of 5 years. A portion of the proceeds received, allocated to the
warrants, has been recorded as an increase in common stock additional paid in
capital. During the year ended March 31, 2000, all 300 shares of Series B stock
and accrued dividends of $79,572 were converted, in accordance with the terms of
the Series B stock agreement, into 2,053,049 shares of common stock.
SERIES C
On October 5, 2000, the Company issued 400 shares of Series C stock with a
stated value of $10,000 per share and warrants to purchase 230,946 shares of
Common Stock, at $5.20 per share until October 5, 2005, for gross proceeds of
$4,000,000. Dividends of 7% per annum are payable, with certain exceptions,
either in cash or in shares of Common Stock at the Company's election. The
conversion price for each share of Series C stock is subject to adjustment on
the 90th day following the original issue date from a fixed conversion price of
$4.33 to the lower of (i) $4.33 or (ii) 90% of the average of the five lowest
per share market values during the 20 consecutive trading days immediately
preceding the conversion date ("Adjusted Conversion Price").
The gross proceeds of $4,000,000 have been allocated to the redeemable Series C
stock and the warrants based on the relative fair value of each security at the
time of issuance. Accordingly, $3,417,094 was allocated to the redeemable Series
C stock and $582,905 was allocated to the warrants. The fair value of the
warrants granted was estimated using the Black-Scholes options price model with
the following assumptions: no dividend yield; risk free interest rate of 6%,
expected volatility of 1.6602 and an expected life of 2.5 years. The minimum
redemption premium of $400,000 on the redeemable Series C stock and the $582,905
discount from their stated value resulting from the warrants, have been accrued
and recorded as an immediate charge to losses attributable to common
stockholders to reflect the preferred stock at fair value. The warrant holders
have the option to receive shares of Common Stock equal to the number of
warrants multiplied by the difference between the average of the closing sale
prices of the Common Stock for the five trading days immediately prior to the
date of exercise and the exercise price of the warrants, divided by the exercise
price of the warrants.
F-21
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
The terms of the Series C stock provide the holders with an "in-the-money"
variable conversion rate. A beneficial conversion feature on the Series C stock
was calculated at issuance based on the difference between the effective
conversion price of the allocated proceeds and the market price of the Company's
common stock on the date of issuance. The original amount of the beneficial
conversion feature was $335,792 at inception, however, because of the
variability of the conversion ratio, it is remeasured each reporting period
until conversion, extinguishment or maturity, subject to the maximum proceeds
allocated to the Series C stock. As at March 31, 2001, the beneficial conversion
feature amounted to $3,417,095 and has been presented as a charge to losses
attributable to common stockholders over the term, amortized over the period to
the earliest conversion date.
In connection with the Series C stock financing, the Company incurred placement
agent fees and legal and related costs of approximately $300,000 and issued
warrants to purchase 138,568 shares of Common Stock at $5.20 per share until
October 5, 2005 as a placement agent fee. The fair value of the warrants granted
was estimated at $450,346 on the date of the grant using the Black-Scholes
options price model with the following assumptions: no dividend yield; risk free
interest rate of 6%, expected volatility of 1.6602 and an expected life of 2.5
years. The amount was recorded as a financing fee within Additional Paid-in
Capital. The warrant holders have the option to receive shares of Common Stock
equal to the number of warrants multiplied by the difference between the average
of the closing sale prices of the Common Stock for the five trading days
immediately prior to the date of exercise and the exercise price of the
warrants, divided by the exercise price of the warrants. If the Company at any
time, while the warrants are outstanding, issues shares of common stock or
rights, warrants, options or other securities or debt that are convertible into
or exchangeable for shares of common stock, entitling any person to acquire
shares of common stock at a price less than the exercise price of the warrants,
then at the sole option of the holder, the exercise price shall be adjusted to
mirror the conversion, exchange or purchase price for such common stock
equivalents.
During the year ended March 31, 2001, 326 shares of Series C stock and accrued
dividends were converted into 2,469,334 shares of Common Stock. During the year
ended March 31, 2002, the remaining 74 shares of the Series C stock and accrued
dividends were converted into 912,612 shares of Common Stock.
15. PREFERRED STOCK
SERIES D
On December 30, 2002, the Company issued 205,000 shares of 12% Series D
non-redeemable convertible preferred stock (the "Series D stock") with a stated
value of $10 per share. The Series D stock was issued pursuant to a conversion
agreement with all of the noteholders of the Company's $1,000,000 SP Notes and
$1,050,000 Unsecured Notes. Dividends of 12% per annum are payable, with certain
exceptions, either in cash or in shares of Common Stock at the Company's
election. The conversion price for each share of Series D stock is $0.20 subject
to certain adjustments if the Company issues shares at prices lower than $0.20.
The Company has agreed to use its best efforts to file a registration statement
for the shares underlying the Series D stock by June 30, 2003. The conversion
price was reduced to $0.19 pursuant to anti-dilution protection given to the
preferred stockholders triggered by the sale of $129,000 of shares of Common
Stock in January 2003.
16. COMMITMENTS AND CONTINGENCIES
The Company has entered into a three-year fulfillment, storage and freight
management agreement with APL Direct Logistics ending on September 30, 2004. As
part of this agreement, the Company provided APL Direct Logistics with a letter
of credit amounting to $144,724 ($145,073 at March 31, 2002) and prepaid $90,000
to APL Direct Logistics for inbound and outbound freight management services
which will be drawn down upon submission of invoices from APL. As of March 31,
2002 the Company had a balance in prepaid freight of $24,608. The Company also
paid APL Direct Logistics $14,000 for initial integration and implementation
expenses. The Company's minimum monthly commitment, which includes call center
support, is approximately $46,000. Depending on the volume of units shipped,
this amount may increase. In September 2002, we notified APL that we are
terminating the agreement. At September 30, 2002, approximately $51,922 of
finished goods inventory was held at APL Direct Logistics' facilities. In the
quarter ending December 31, 2002, APL drew down on $129,925 of the letter of
credit and sold our inventory, with a value of $51,992
F-22
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
to reduce our obligations to APL. After applying $21,668, the balance in the
prepaid freight management at APL, at December 31, 2002, we believe that the
total amount due to APL is $78,392 and has been recorded as a current liability.
Settlement of this liability may be either more or less than the amount recorded
in the consolidated financial statements and accordingly may be subject to
measurement uncertainty in the near term.
The Company relies on Maycom Co., Ltd. for the manufacture of our MXP 100 and
the wireless product developed for Softeq, Musical for the manufacture of our
TREO products, DigitalWay Co., Ltd. for the manufacture of its Odyssey and IFE
products and Orient Power for the manufacture and assembly of the
Eclipse-branded audio products. The Company depends on its contract
manufacturers to (i) allocate sufficient capacity to our manufacturing needs,
(ii) produce acceptable quality products at agreed pricing and (iii) deliver on
a timely basis. If a manufacturer is unable to satisfy these requirements, the
Company's business, financial condition and operating results may be materially
and adversely affected. Any failure in performance by either of these
manufacturers for any reason could have a material adverse affect on the
Company's business. Production and pricing by each such manufacturer is subject
to the risk of price fluctuations and periodic shortages of components. The
Company does not have supply agreements with component suppliers and,
accordingly, it is dependent on the future ability of its manufacturers to
purchase components. Failure or delay by suppliers in supplying necessary
components could adversely affect the Company's ability to deliver products on a
timely and competitive basis in the future.
Approximately $515,000 of the accrued lease liability arose in the normal course
of business for goods and services delivered to the Company and were recorded at
amounts reflected on the invoices and other documentation received from the
third party vendor. This amount is approximately five years old. The amount
owing to the vendor is still due but as the Company has had no contact with the
vendor, the amount may not require payment. Accordingly, the accrued lease
liability reflects management's best estimate of the amount that may be due.
Settlement of this liability may be either more or less than the amount recorded
in the consolidated financial statements and accordingly may be subject to
measurement uncertainty in the near term.
FACILITY LEASE
On July 11, 1997, the Company entered into a three-year joint lease agreement
with American Technology Corporation, for property located in San Diego,
California. In September 2000, the Company amended the three-year lease to
become an independent lessee and acquired an additional 1,500 square feet of
improved research and development space. The amended lease agreement expires on
July 31, 2003. The Company is occupying approximately 13,000 square feet with
aggregate monthly lease payments of $15,967 inclusive of utilities and costs.
The aggregate monthly lease payments increased to $16,606 beginning in August 1,
2002. Office rent expense recorded by the Company for the year ended March 31,
2003, was $196,716 [2002 - $191,859] [2001 - $174,793].
The total operating lease obligations under the lease for office space is
$66,422 of which the Company's minimum commitments is as follows:
$
- ------------------------------------------------------------
2003 66,422
- ------------------------------------------------------------
66,422
- ------------------------------------------------------------
17. EMPLOYEE BENEFIT PLAN
The Company had a 401(k) plan covering eligible employees, which was
discontinued in the quarter ending June 30, 2003. Matching contributions are
made on behalf of all participants at the discretion of the Board of Directors.
During the year ended March 31, 2003, the Company made $9,299 [2002 -- $7,992]
[2001 -- $6,909] in matching contributions.
18. SUBSEQUENT EVENTS
F-23
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
AUDITED
In May 2003, the Company issued a 24% Unsecured Promissory Note (24% Unsecured
Promissory Notes") for gross cash proceeds of $200,000 to certain accredited
investors. The 24% Unsecured Promissory Notes mature June 30, 2004. The interest
under the 24% Unsecured Promissory Notes is payable monthly at a rate of 12% per
annum, simple interest and accrues an additional interest of 12% per annum,
simple interest to be paid at the earlier of redemption or maturity.
UNAUDITED
On June 10, 2003, the Company sold 6,161,705 shares for gross proceeds of
$1,170,723 and utilized $203,067 to redeem all of the principal and accrued
interest on the 24% Unsecured Promissory Notes, $74,137 to redeem all of the
principal and accrued interest on the 24% Unsecured Note to a director and
$893,519 for working capital purposes.
19. RELATED PARTY TRANSACTIONS
On March 17, 2003, the Company issued a 24% Unsecured Promissory Note ("24%
Unsecured Note") for gross cash proceeds of $42,000 to a director to finance
inventory purchases. On March 31, 2003, the Company repaid all accrued interest
and $6,938 of principal. At March 31, the principal amount due under the 24%
Unsecured Note was $35,454. On April 28, 2003, we issued an additional $37,800
of this same 24% Unsecured Note to the same director.
F-24