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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, 2004
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 ]
Indicated by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes [ ] No [X] State issuer's revenues for its
most recent fiscal year $3,418,180.
The aggregate market value of the issuer's Common Stock held by non-affiliates
of the registrant on June 7, 2004 was approximately $40,728,635 based on the
average of the closing bid and ask price of $0.25 as reported on the NASD's OTC
Electronic Bulletin Board system.
As of June 7, 2004 there were 162,914,541 shares of e.Digital Corporation Common
Stock, par value $.001, outstanding, 145,000 shares of Series D Preferred Stock,
stated value $10.00 per share, outstanding and 3,650 shares of Series E
Preferred Stock, stated value $100.00 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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TABLE OF CONTENTS
Page
PART I
ITEM 1. Description of Business 3
ITEM 2. Description of Property 12
ITEM 3. Legal Proceedings 12
ITEM 4. Submission of Matters to a Vote of Security Holders 12
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters 13
ITEM 6. Selected Consolidated Financial Statements 13
ITEM 7. Management's Discussion and Analysis or Plan of Operation 15
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk 26
ITEM 8. Financial Statements 26
ITEM 9. Changes In and Disagreement With Accountants
on Accounting and Financial Disclosure 26
ITEM 9A. Controls and Procedures 26
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons,
Compliance With Section 16(a) of the Exchange Act 27
ITEM 11. Executive Compensation 29
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 33
ITEM 13. Certain Relationships and Related Transactions 35
ITEM 14. Principal Accounting Fees and Services 35
PART IV
ITEM 15. Exhibits, Financial Statement Schedules
and Reports on Form 8-K 36
Signatures 65
Financial Statements and Financial Statement Schedules F-1
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.
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 our proprietary technology
platforms and engineering services to leading electronics companies to create
portable digital devices that can link to personal computers, the Internet and
other electronic devices. We market our services and technologies to Original
Equipment Manufacturers ("OEMs") and Original Design Manufacturers ("ODMs") 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/ODMs 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/ODMs. e.Digital's extensive design experience and
research enables us to supplement our clients' design specifications with
functional enhancements thereby improving the quality and usability of the end
product. We may sometimes integrate our OEMs'/ODMs' unique or proprietary
features and/or technology into new products for their product lines. We focus
our marketing efforts on OEMs/ODMs 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 OEM/ODM customers.
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 MicroOS(TM) operating system. Our revenues may result
from the sale of products, fees from engineering services, fees or royalties
from technology licensing, 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
We were incorporated in the Province of British Columbia, Canada as Norris
Communications Corp. on February 11, 1988 and on November 22, 1994 changed our
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,
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.EDIGITAL.COM. Information
contained in our Internet site is not part of this annual report.
PROPRIETARY TECHNOLOGY AND PLATFORMS
MICROOS(TM)
The technology that serves as the foundation for our Personal Digital Video,
Digital Audio and Wireless Technology Platforms is our proprietary MicroOS(TM)
operating system. MicroOS began as a voice recorder technology, but because of
its inherent flexibility, has been adapted to support audio and video storage
and playback and wireless utilities. MicroOS is compact and dynamic, responding
to a variety of user interfaces. MicroOS manages the volume and equalizer
functions, the LCD drivers and interfaces, decodes a wide variety of audio and
video files, interacts with a variety of digital rights management schemes and
supports today's most popular media storage formats including hard disk drives,
compact and embedded flash and others.
Because MicroOS offers so many options in a compact package, it is able to
manage many functions within a single device, utilizing less power, space and
operating capacity. We have enhanced and perfected MicroOS over the past several
years and as a result we believe we are able to complete projects faster and
better than our competitors. The life cycle of consumer electronics products is
very short and continues to accelerate. We believe our MicroOS core shortens the
development cycle enabling us to bring new products to market in reduced time.
Additionally, MicroOS' inherent flexibility provides the same lead time benefits
to subsequent generations of each MicroOS based product.
PERSONAL DIGITAL VIDEO PLATFORM
We have designed and developed a Personal Digital Video Platform based on our
proprietary MicroOS core. Our Personal Digital Video Platform ("PDVP")
incorporates DivX encoded material, proprietary security measures and several
OEM/ODM customizable options. The size of the PDVP ranges from 2.5 to 7" screen
sizes and is capable of achieving better than DVD quality video. The 7" version
was released in 2003 for use on commercial airline flights and personal portable
solutions are expected to reach consumers in calendar 2004.
Our first commercial release of a video-on-demand, personal video platform has
had initial success through Airline Protective Systems ("APS") and its
digEplayer(TM) branding and distribution to Alaska Airlines. The first units
shipped and were in the hands of select Alaska Airlines passengers in October
2003. In May 2004, Alaska Airlines ordered additional units. The units are
loaded with content by APS from partners such as 20th Century Fox and DMX. The
large 7" screen delivers better than DVD quality video - a key competitive
factor to others evaluating opportunities in the market.
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APS continues to aggressively market the digEplayer and is in active
negotiations with many of the worlds leading and emerging airlines and other
companies within the travel and leisure industry.
While we anticipate continued commercial success of the digEplayer, we remain
active in pursuit of other OEMs/ODMs seeking personal video platforms for their
own branding purposes. We believe there are many opportunities for new and next
generation applications of this device.
DIGITAL AUDIO PLATFORM
The Odyssey 1000 Digital Audio Player was launched in January 2003. The initial
2.5" version Odyssey 1000 served as a model to prospective OEM/ODM customers
demonstrating the full range of features that can be integrated using MicroOS.
With the introduction of the 1.8" version of the Odyssey platform for an OEM
client (Gateway's DMP-X20) in November 2003, we discontinued retail sales of the
our branded Odyssey 1000 as well as all other e.Digital branded devices in
December 2003. The mission of the Odyssey 1000 was to serve as a model for the
strength and flexibility of the MicroOS core. We believe this mission has been
realized through the latest release of the OEM branded 1.8" version. We are
working with and continue to seek new OEM/ODM customers for this platform to
provide a comprehensive, customized digital music solution to brands not yet in
the market or brands looking to enhance their existing products.
Digital Audio Platform product partnerships were announced at the 2004
International Consumer Electronics Show ("CES") in January 2004 in Las Vegas.
Partnerships with Texas Instruments, Cornice and Musical were among those
announced during the show. In February of 2004, we also announced an agreement
to design and develop digital audio products for TGE Group.
WIRELESS TECHNOLOGY PLATFORM
Each of our platforms has a direct application for wireless technology. Wireless
communications between devices and hosts will directly benefit consumers'
abilities to manage and procure content.
In June and July 2003, we made the on-time delivery of the first product based
on our Wireless Technology Platform; wireless MP3 (MPEG-1/MPEG-2 layer 3 (Motion
Picture Experts Group)) headsets for a major OEM customer. Hewlett-Packard
through OEM customer, Softeq commissioned the project for use by a multi-billion
dollar end-user customer. The headset's mechanical, hardware, software and
firmware designs were all developed by using our patented MicroOS Operating
System. The headsets incorporate embedded flash memory containing prerecorded
audio files that interact with strategically placed transmitters.
We are also integrating 802.11(Wi-Fi) technology into our Wireless Technology
Platform. We also expect to support and integrate other, new wireless
technologies into our Wireless Technology Platform, including WiMax, UWB and
others.
Recent Developments
In March 2002, we entered into a Development and Manufacturing Agreement with
Eclipse by Fujitsu Ten ("Eclipse"), a car stereo company. Under the agreement,
e.Digital received NRE fees for design and development services, as well as
revenues for the manufacture and delivery of Eclipse-branded audio products. In
April 2004, we filed a demand for arbitration against Eclipse for numerous
breaches of the contract signed by Eclipse. These breaches include cancellation
of the initial non-cancelable order, breach of the implied covenant of good
faith and fair dealing, and misappropriation of our intellectual property,
confidential, proprietary and trade secret information. As of the time of this
filing, this issue remains pending. There can be no certainty regarding the
timing and outcome of the Eclipse arbitration.
In June 2004, APS placed an order for 1,500 units of the digEplayers 5500(TM).
In May 2004, APS placed an order for 1,000 units of the digEplayers 5500(TM).
In May 2004, Fusion Digital Technology Ltd. And e.Digital unveiled the world's
first portable, personal video recorder for downloading audio and video content
from Fusion's digital video recorder and set-top boxes.
In March 2004, two other airlines announced they had begun testing the
digEplayer on their flights for possible adoption.
In February 2004, Alaska Airlines announced an expanded order of digEplayers in
the amount of up to 6,000 units over a period of five years. In May 2004, Alaska
Airlines through APS placed their first follow-on order in the amount of 620
units. Customer acceptance, demand, durability, ease of distribution and quality
of picture and sound were cited as the criteria by which the system was
selected.
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Also in February 2004, we announced a royalty bearing license agreement with Tai
Guen Enterprise Co. LTD (TGE Group), a multi-billion dollar OEM/ODM. Under the
agreement, we are developing audio products based on our proprietary MicroOS
enabled personal audio technology platform for international original equipment
and design manufacturing, branding and distribution by TGE Group and its global
customer base. The audio products being developed for TGE Group and their
customers will include a variety of high capacity, cost effective 1"- disk drive
storage solutions.
In January 2004, we were a guest in the Texas Instruments booth at the
International Consumer Electronics Show in Las Vegas, Nevada. We made several
announcements during the four day show. Below are the announcements and a
summary of their impact on e.Digital:
- "e.Digital Powers Cornice Based Digital Music Players Using
Texas Instruments' ("TI") Digital Audio Processors" - We are
developing digital music products utilizing TI's digital audio
signal processors ("DSP") and featuring the Cornice Storage
element. Our involvement with TI developing new sales and
partnership leads with OEMs and ODMs via referrals by TI.
- "Musical and e.Digital Expand Licensing Agreement to
Incorporate Cornice Storage Element" - This expanded agreement
incorporates the Cornice Storage Element with our digital
audio platform for original equipment manufacturing and
marketing through Musical. We have designed the hardware and
firmware for the new devices which are based on MicroOS
technology. The units are expected to be marketed and branded
for distribution by Musical and their customers. Previously,
we partnered with Musical to develop and distribute a 10
gigabyte hard disk drive based MP3 player/recorder with direct
encoding into MP3 format for Circuit City.
- "Eclipse Showcases In-Car Infotainment System Designed and
Developed by e.Digital" - This announcement is a significant
in that it supports our pending claim against Eclipse by
Fujitsu Ten (Eclipse). The press release edited and approved
by Eclipse, announced that the HD1213 would be available in
early 2004 and that Eclipse was accepting pre-sale orders of
the product during the show.
- "e.Digital and Cornice Partner to Provide OEM Solutions for
Portable Music Players" We are developing digital audio
products incorporating the Cornice Storage Element for
distribution by specific OEM partners and customers in 2004.
These digital audio players will feature e.Digital's MicroOS
technology and proprietary hardware and firmware as well as
Cornice's high-capacity, low-cost Storage Element.
In September 2003, e.Digital announced the royalty bearing licensing of its
Odyssey 1000 Personal Digital Jukebox Platform to a multi-billion dollar Asian
OEM. Under the terms of the agreement, the Asian OEM provides manufacturing
services of a 1.8" version of the Odyssey 1000 platform for specific OEM
branding while e.Digital supplies the technology, software, firmware and
upgrades to the products. It is through this Asian OEM that the Gateway DMP-X20
was brought to market.
INDUSTRY BACKGROUND
We design and market digital technology product platforms employing portable
storage media with the major categories being digital music recorder/players,
digital video recorder/players, and related mobile devices. We have also
developed a digital automotive technology platform and a wireless technology
platform.
PORTABLE STORAGE MARKET
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 with capacities ranging 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
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") and Sony's ATRAC3. 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.
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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. 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 to over 36
million in 2007 with hard disk drive-based players experiencing the highest
growth rate. We believe that the popularity of inexpensive or free music
compression programs such as iTunes, 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
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(TM), for one of our earlier products,
the 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.
DIGITAL VIDEO RECORDER/PLAYERS
Digital video players including DVD (digital video disc) players are increasing
in popularity with consumers. According to the Consumer Electronics Association,
DVD content 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 computer monitor or a personal video
recorder/player.
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 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.
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IN-FLIGHT ENTERTAINMENT
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.
Because the costs to retrofit an aircraft with IFE equipment can be prohibitive,
we have developed an alternative IFE system. Our portable IFE player, based upon
our PDVP, 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
airlines. 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 and ODM
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)
and portable digital video industries face choices of competing compression
formats, DRM's, and storage media.
Products designed by us are marketed under a license and/or royalty fee
arrangement. Utilizing strategic customers for product development and marketing
results in reduced development and manufacturing costs, provides high quality
products and creates a broader revenue base.
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/ODMs seeking to implement
portable digital audio and video processing. We actively seek licensing, private
label, and OEM/ODM opportunities in the digital audio and video processing
market. Our efforts include:
1. Expanding our business by developing custom products for OEM
and ODM customers - We seek to expand our business through
sales and marketing targeted at obtaining additional product
development opportunities with existing customers and new
OEM/ODM customers.
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2. Developing brand name recognition with OEM/ODM customers -
This strategy is being pursued through participation in
industry alliances, trade show participation, professional
articles and attaching our name along with OEM/ODM products to
the greatest 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/ODMs.
Our engineering team continues to enhance and update MicroOSTM
and related technology. We also devote resources to expanding
our technology to new applications. In addition to supporting
music, voice, and video processing, we believe our technology
may have applications in a wide range of products.
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/ODM
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 us to design, develop, and
manufacture a portable in-flight entertainment (IFE) device for Alaska Airlines.
This portable IFE product is being marketed and sold to other airlines by APS.
BANG & OLUFSEN - We 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.
SOFTEQ - We collaborated with Softeq on a unique digital audio player
incorporating our MicroOS technology with wireless communication technology. The
product was funded by Hewlett Packard and delivered to one of their major OEM
customers. In January 2003, Softeq subcontracted with us to develop,
manufacture, and maintain the products.
TAI GUEN ENTERPRISE GROUP ("TGE") - We have designed and licensed our technology
to TGE for a new generation HDD digital music player, which includes our MicroOS
based compressed audio manager ("MicroCAM") technology. We expect to earn
licensing fees, NRE fees and royalties from of this agreement in fiscal 2005.
MUSICAL - We previously work together under the original license agreement to
develop and distribute a 10-gigabyte hard disk drive based MP3 player/recorder
with direct encoding into MP3 format for Musical's classic brand that sold
through Circuit City. We expanded this licensing agreement to incorporate
Cornice Storage Elements with our digital audio platform for OEM and marketing
through Musical.
OTHER CUSTOMERS
We are working with a number of OEM/ODM 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 strategic partners
promote and market our work with their own. They may, from time to time, refer
customers to us. With these strategic partners, we may collaborate on projects
where both partners could benefit financially.
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 result in
increased business.
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SERVICES AND LICENSING
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 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.
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 nonexclusive 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/ODM customers and licensees. We have expertise in
developing, performing and overseeing manufacturing processes. We offer
technology transfer, manufacturing supervision, documentation, and quality
control services to our OEM/ODM customers.
LICENSING
We license technology platforms and reference designs to OEM/ODM customers. A
technology platform can be only software or a combination of software, firmware,
and hardware. OEM/ODM 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/ODM 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.
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.
MARKETING AND SALES
OEM/ODM 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/ODM customers include
Internet music participants, digital camera developers, semiconductor and DSP
manufacturers, PC manufacturers, home audio manufacturers, video technology
developers, automotive audio manufacturers, and developers of various portable
devices.
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 U.S. and international patent 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.
8
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. 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, 2004, 2003 and 2002, we spent $1,531,177,
$1,410,506 and $2,327,283, respectively, on research and development. We
anticipate that we will continue to devote substantial resources to research and
development activities. In fiscal 2004, 2003 and 2002, approximately $292,607,
$194,689 and $488,094 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. Other manufacturers, including Archos, Creative Labs,
Denon, Apple, Thompson Multimedia's RCA division, iRiver, LG Electronics,
Philips, 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.
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, 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 low-level real time operating system and
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, 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, Musical, TGE Group and others, there is no assurance we
can continue to compete against other providers of digital recording solutions,
many of whom have substantially greater resources.
9
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. Our OEM/ODM customers, and we
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 7, 2004, we employed approximately eighteen full time and two
part-time employees of whom two were in production and testing, twelve were in
research, development and engineering, three were in sales, general and
administrative and three 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.
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
which expired on July 31, 2003. From August 2002 until December 2003 we paid an
aggregate monthly lease payments of $16,606 inclusive of utilities and costs. In
January 2004, we amended the lease to reduce our space to 7,500 square feet with
an aggregate fixed lease payment of $9,290 inclusive of utilities and costs
expiring on July 31, 2006.
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. Except as set forth below, there is currently no
material pending legal proceedings to which we are party or to which any of our
property is subject.
In April 2004, we filed a demand for arbitration against Eclipse for numerous
breaches of the contract signed by Eclipse. These breaches include cancellation
of the initial non-cancelable order, breach of the implied covenant of good
faith and fair dealing, and misappropriation of our intellectual property,
confidential, proprietary and trade secret information. As of the time of this
filing, this issue remains pending. There can be no certainty regarding the
timing and outcome of the Eclipse arbitration.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
10
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, 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
Fiscal year ended March 31, 2004
First quarter $0.33 $0.12
Second quarter $0.55 $0.23
Third quarter $0.62 $0.38
Fourth quarter $0.63 $0.27
At June 7, 2004 there were 162,914,541 shares of common stock outstanding and
approximately 2,677 stockholders of record.
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.
RECENT SALES OF UNREGISTERED SECURITIES
On June 25, 2004, the Company issued 12% Subordinated Promissory Notes ("12% SP
Notes") for gross cash proceeds of approximately $675,000 to seven accredited
investors. The 12% SP Notes mature on July 1, 2005. The interst under the 12 %
SP Nates is paid in cash monthly at a rate of 12% per annum.
In connection with the 12% SP Notes the Company issued 1,350,000 Stock Purchase
Warrants ("Warrants") to the Noteholders. The Warrants are exercisable into
common shares at $0.25 per share until June 30, 2007. The Warrants provide for
cashless exercise by the Holder and have piggyback registration rights. The
Warrants also contain an anti-dillution clause adjusting the exercise price if
the Company sells equity-based securities at an effective price of less than
$0.25 per share during the term of the Warrants.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA: 2004 2003 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Revenues $3,418 $2,597 $2,417 $1,828 $490
Gross profit (loss) 689 (900) (561) 123 28
Operating loss (2,491) (5,841) (5,855) (3,873) (2,615)
Loss for the year (2,516) (6,666) (5,793) (3,646) (2,609)
Loss attributable to common stockholders (3,468) (6,727) (5,819) (8,434) (5,178)
Basic earnings per common share1 (0.02) (0.05) ($0.04) ($0.07) ($0.05)
Weighted average number of common and common
equivalent shares outstanding 155,100 140,065 130,783 127,503 114,640
11
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA:
Total Current Assets $538 $715 $2,213 $4,135 $3,655
Total Current Liabilities 1,634 2,021 4,757 1,689 1,285
Total Assets 696 895 2,744 4,495 3,807
Long-term debt, less current maturities 836 637 - - -
Series A Redeemable Preferred Stock - - - - 23
Series C Redeemable Preferred Stock - - - 796 -
Series D Preferred Stock 1,450 2,050 - - -
Series E Preferred Stock 862 - - - -
Stockholders' Equity/(Deficit) (1,774) (1,874) (2,014) 2,010 2,499
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 and is incorporated under the laws of
Delaware. The Company offers to Original Equipment Manufacturers ("OEM") and
Original Design Manufacturers ("ODMs") engineering services, as well as complete
reference designs and technology platforms with a focus on digital video,
music/voice, voice/video and player/recorders.
We offer our engineering services and technologies to OEMs (original equipment
manufacturers) and ODMs (original design manufactures) with a focus on
developing digital video, music, and voice players/recorders with potential
wireless capabilities using the latest in digital storage media (a device used
to store data) and technology. OEMs/ODMs 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/ODMs. We may sometimes integrate our OEMs/ODMs unique
or proprietary features and/or technology into new products for their product
lines. We focus our marketing efforts on OEMs/ODMs 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/ODM customers.
Services offered include custom hardware, firmware (an instruction set
programmed into a chip which determines the product's functionality and user
interface), 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, product royalties, fees from engineering services,
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.
- ---------------------
1 For information pertaining to the calculation of basic earnings (loss)
per common share, see Note 2 to the Consolidated Financial Statements
elsewhere in this report.
12
We incurred operating losses in each of the last three fiscal years and these
losses have been material. We incurred an operating loss of $2.5 million, $5.8
million and $5.9 million in fiscal year 2004, 2003 and 2002, respectively. At
March 31, 2004, we had a working capital deficit of $1.1 million. Our monthly
cash operating costs have decreased from approximately $225,000 per month at the
end of fiscal year 2003 to the current level of approximately $200,000 per
month. However, we may increase expenditure levels in future periods to support
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, 2002, 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.
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 and ODM customers and markets and (c)
raising, if necessary, additional capital and/or obtaining third party
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. 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.
13
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 have provided full valuation reserve related to our substantial deferred tax
assets. In the future, if sufficient evidence of our ability to generate
sufficient future taxable income in certain tax jurisdictions becomes apparent,
we may be required to reduce our valuation allowances, resulting in income tax
benefits in our consolidated statement of operations. We evaluate the
realizability of the deferred tax assets and assess the need for valuation
allowance quarterly. The utilization of the net operating loss carryforwards
could be substantially limited due to restrictions imposed under federal and
state laws upon a change in ownership.
Under our bylaws, we have agreed to indemnify our officers and directors for
certain events. We also enter into certain indemnification agreements in the
normal course of our business. The Company has no liabilities recorded for such
indemnities.
We do not have off-balance sheet arrangements, financings, or relationships with
unconsolidated entities or other persons, also known as "special purposes
entities" (SPEs).
RESULTS OF OPERATIONS
YEAR ENDED MARCH 31, 2004 COMPARED TO YEAR ENDED MARCH 31, 2003.
For the year ended March 31, 2004, we reported total revenues of $3,418,180 a
32% increase from total revenues of $2,597,363 for the comparable year. Product
revenue for the year ended March 31, 2004 was $2,686,894, an increase of 20%
from total product revenues of $2,224,961 for the year ended March 31, 2003. The
increase in product revenues in Fiscal year 2004 was due to the fulfillment of
the APS and Softeq contracts, offset by the termination of our e.Digital branded
products.
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
$731,286 and $372,402 for the fiscal years 2004 and 2003, respectively. The
increase of 97% in service revenues was primarily attributed to the fulfillment
of OEM/ODM contracts. We had recorded for NRE contracts an aggregate of unearned
revenue $176,443 and $311,703 at March 31, 2004 and 2003, respectively.
For the year ended March 31, 2004 we reported a $689,397 or 21% gross profit as
compared to a gross loss of $899,695 for the year ended March 31, 2003. For
fiscal 2004, costs of sales consisted of $2,438,683 of product costs and
$290,100 of contract services consisting primarily from the engineering expenses
recognized and being funded in part by our OEM customers. The increase in the
gross profit percentage is due to improved margins on OEM products delivered to
customers and termination of our low or negative margin on e.Digital branded
products. Gross profit percentage is highly dependent on sales, price, volume,
purchasing costs and overhead allocations. Gross margins may vary significantly
from period to period.
Total operating expenses (consisting of research and related expenditures and
selling and administrative expenses) were $3,017,797 and $4,942,225, for fiscal
2004 and 2003, respectively. Selling and administrative costs aggregated
$1,486,620 and $3,531,719 in fiscal 2004 and 2003, respectively. The $2,045,099
decrease in selling and administrative costs resulted from the decrease of
$1,073,482 in personal and benefits costs from the reduction of approximately 8
employees in the marketing and administrative departments, a decrease of
$246,163 in advertising and marketing costs resulting primarily from the
discontinuation of our branded products, a decrease of $193,790 in professional
services and fees, a decrease of $60,040 in facilities and related costs
resulting from the reduction of occupied leased space, a decrease of $84,884 for
bad debt expense, a decrease of $35,946 in shareholders' and related costs, a
$43,823 decrease in insurance premiums and a $105,671 decrease in depreciation
and amortization.
For the year ended March 31, 2004, research and related expenditures were
$1,531,177 compared to $1,410,506 for the year ended March 31, 2003. The
$120,671 increase in research and related expenditures resulted primarily from
an increase of $360,401 in engineering costs associated with the development of
new technologies, an increase of $19,185 in consulting services offset by a
decrease of $260,499 for personnel and related 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 $2,328,400 and $5,841,920 for the year ended
March 31, 2004 and 2003, respectively. The decrease in operating loss in fiscal
2004 compared to fiscal 2003 resulted from the positive gross margin in
combination with the decrease in operating expenses. We believe, but we cannot
guarantee, that our strategy of investing in OEM and ODM developments with
supply or royalty provisions 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, 2004 are
not necessarily reflective of operating results for future periods.
14
We reported interest expense of $121,698 and $741,435 for the years ended March
31, 2004 and 2003, respectively. The interest expense in 2004 consisted of
interest on the 15% Promissory Note. 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
We reported a loss of $2,516,343 and $6,665,802 in fiscal 2004 and 2003,
respectively.
The net loss available to stockholders for fiscal 2003 was increased in
computing loss per share by accrued dividends of $258,827 on Series D and E
stock and $693,615 as the beneficial conversion attributed to the issuance of
the Series E stock. 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.
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 typically
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.
15
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.
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.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2004, we had a working capital deficit of $1,096,104 compared to a
working capital deficit of $1,427,978 at March 31, 2003. We had $5,009 and
$138,795 of working capital invested in inventories at March 31, 2004 and March
31, 2003, respectively. We had $36,151 and $181,536 of working capital invested
in accounts receivable at March 31, 2004 and March 31, 2003, respectively.
For the year ended March 31, 2004, net cash increased by $384,048. Cash used in
operating activities was $2,056,042. The major components using cash were a loss
of $2,516,326 reduced by $112,481 of accrued interest and accretion relating to
the unsecured promissory note, $99,853 of depreciation and amortization,
$162,828 for accounts payable settlement in conjunction with the stock issuance,
$66,346 loss on fixed asset disposal. The major change in assets and liabilities
providing cash for operating activities was a decrease of $109,368 in accounts
receivable, a decrease of $133,786 for inventory, a $63,489 decrease for prepaid
and deposits and an increase of $218,192 in deferred contract charges. The major
changes in assets and liabilities using operating cash was a decrease of $6,638
in accounts payable, a decrease of $135,260 in deferred revenue and a decrease
of $17,290 in other accounts payable and accrued liabilities.
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.
At March 31, 2004, we had cash on hand of $467,954. For the year ended March 31,
2004, cash provided by financing activities was $2,584,580. During the fiscal
year ended March 31, 2004, we obtained a total of $933,500 from the issuance of
shares of Common Stock, $1,262,250 from the issuance of Series E Preferred
Stock, $269,300 from the issuance of Unsecured Notes and $152,325 from the
exercise of stock options. During the fiscal year ended March 31, 2004, we
repaid $104,754 of the 5% SP Notes. At March 31, 2003, we had cash on hand of
$83,906. For the year ended March 31, 2003, cash provided by financing
activities was $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. 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, 2004 assuming (a) existing OEM ODM arrangements, and (b)
current planned expenditures and level of operation, we believe we will require
approximately $1.5 million of additional capital resources for the next twelve
months. Some of these resources could come from improved operations. 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.
16
Since March 31, 2002, 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 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.
We are actively seeking equity and/or debt financing and intend to use proceeds
from equity sales for working capital and to repay the15% Unsecured Note. If we
are unable to secure sufficient financing, we will attempt to renegotiate the
terms of this note with the lender. There can be no guarantee that we will be
able to raise additional equity and/or renegotiate the terms of the note with
the lender. If we are able to renegotiate the terms of the note we may be unable
to determine what terms the lender may demand.
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, 2004, our contractual obligations and commercial commitments are
summarized below:
Cash Contractual Obligations by Period
- --------------------------------------------------------------------------------------------------------
Cash Contractual Obligations by Period Total Less than 1 year 1-2 years 2-3 years
- --------------------------------------------------------------------------------------------------------
15% Unsecured Note 1 $890,625 $123,405 $767,220 -
- --------------------------------------------------------------------------------------------------------
Operating Leases 2 260,120 111,480 111,480 37,160
- --------------------------------------------------------------------------------------------------------
Total Cash Obligations $1,150,745 $234,885 $878,870 $37,160
- --------------------------------------------------------------------------------------------------------
1 Includes accrued interest through December 31, 2004
2 Office sublease agreement expires July 31, 2006
FUTURE COMMITMENTS AND FINANCIAL RESOURCES
We have an accrued lease liability of $515,000 that arose in the normal course
of business for equipment delivered to the Company. This amount is approximately
five years old. 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. From August
2002 until December 2003 the aggregate monthly lease payment was $16,606. In
January 2004, we reduced our occupied space to 7,500 square feet with aggregate
monthly fixed lease payments of $9,290 inclusive of utilities and costs. As of
March 31, 2004, the total operating lease obligation under the lease for office
space is $260,120.
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 FIRST SECOND THIRD FOURTH
YEAR ENDED MARCH 31, 2004 QUARTER QUARTER QUARTER QUARTER
- ----------------------------------------------------------------------------------------
Revenues 1,153,991 1,097,915 717,910 448,364
Gross Profit (Loss) 70,858 135,502 129,742 353,295
Loss for the period (581,112) (754,013) (499,635) (682,060)
Operating Loss (509,233) (725,739) (470,554) (785,702)
Loss attributable to common (642,612) (815,513) (1,206,719) (804,418)
Basic earnings per common share (0.00) (0.01) (0.01) (0.01)
Weighted average
shares outstanding 149,072,484 154,882,753 156,774,028 159,656,053
17
FOR THE FISCAL YEAR FIRST SECOND THIRD FOURTH
ENDED MARCH 31, 2003 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 period (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 (1,942,285) (2,673,578) (1,439,760) (671,682)
Basic earnings per common share (0.01) 0.02 (0.01) (0.00)
Weighted average
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
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 April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting and reporting for derivative instruments and hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS No. 149 is effective for derivative instruments and
hedging activities entered into or modified after June 30, 2003, except for
certain forward purchase and sale securities. For these forward purchase and
sale securities, SFAS No. 149 is effective for both new and existing securities
after June 30, 2003. Management does not expect adoption of SFAS No. 149 to have
a material impact on the Company's statements of earnings, financial position,
or cash flows.
In December 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities," an interpretation of Accounting Research Bulletin
No. 51, "Consolidated Financial Statements." This pronouncement requires the
consolidation of variable interest entities, as defined, and is effective
immediately for variable interest entities created after January 31, 2003, and
for variable interest entities in which an enterprise obtains an interest after
that date. The Company does not have any variable interest entities, and
therefore, this interpretation is not expected to have a material impact on the
Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. SFAS No. 150 will be effective for financial instruments entered
into or modified after May 31, 2003 and otherwise will be effective at the
beginning of the first interim period beginning after June 15, 2003. Management
does not expect adoption of SFAS No. 150 to have a material impact on the
Company's statements of earnings, financial position, or cash flows.
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.
18
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, 2004 had an
accumulated deficit of $68.3 million. We had a loss of approximately $3.5
million, $6.7 million and $5.8 million in fiscal 2004, 2003 and 2002,
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 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:
o Unpredictable demand and pricing for our contract development
services
o Market acceptance of our OEM/ODM products by end users
o Uncertainties with respect to future customer product orders, their
timing and the margins to be received, if any
o Fluctuations in operating costs
o Changes in research and development costs
o Changes in general economic conditions
o Changes in technology
o 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 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, the results of our
contract services and the products produced for OEM/ODM 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/ODM 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 six months. However, we may need to raise additional
funds to:
o Finance unanticipated working capital requirements
o Pay for increased operating expenses or shortfalls in anticipated
revenues
o Fund increases in research and development costs
o Develop new technology, products or services
o Respond to competitive pressures o Support strategic and industry
relationships
o 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 2004, fiscal 2003 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.
Our auditors have included in their report an explanatory paragraph describing
conditions that raise substantial doubt about our ability to continue as a going
concern.
19
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 fiscal year ended March 31, 2004 three customers
accounted for approximately 73% of our revenues [2003 - 58%]. The failure to
receive orders for and produce OEM/ODM 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 e.Digital or its
OEM/ODM customers. The failure of our company or its OEM/ODM 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 OEM/ODM products, as well as
our licensing business. Selling products and attracting new OEM/ODM 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/ODM 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 recorders and 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.
20
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 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 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 three suppliers for manufacturing our product and for the
manufacturing of our OEM/ODM products, Maycom Co., Ltd., Digitalway Co., Ltd.
and an undisclosed Asian OEM/ODM. 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
in the past 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 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.
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 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 our business partners
maintain the quality of our brand, 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.
21
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:
o Quarter-to-quarter variations in operating results
o Announcements of technological innovations by us, our customers or
competitors
o New products or significant OEM/ODM design achievements by us or our
competitors
o General conditions in the markets for the our products or in the
electronics industry
o The price and availability of products and components
o Changes in operating factors including delays of shipments, orders
or cancellations
o General financial market conditions
o Market conditions for technology stocks
o Litigation or changes in operating results or estimates by analysts
or others
o Or other events or factors
We do not endorse or accept any 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 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 $0.12 to a high of $0.63 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
22
$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.
Important Factors Related to Forward-Looking Statements and Associated Risks.
This prospectus 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 $890,625, consisting
of accrued interest, the 15% 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,
2004, the market value of these investments, which were all classified as cash
and cash equivalents and certificate of deposit, and debt approximated cost.
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 40.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS & PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
The management of the Company, including the Chief Executive Officer and Chief
Accounting 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"). 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.
23
(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.
24
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 39 Chairman of the Board and Director
Alfred H. Falk 49 President, Chief Executive Officer and Director
Robert Putnam 45 Vice President and Director
Renee Warden 40 Chief Accounting Officer and Secretary
Allen Cocumelli 52 Director, Audit Committee
Victor G. Ramsauer 49 Director, Audit Committee
Steve Ferguson * 40 Vice President of Business Development
Atul Anandpura * 40 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.
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.
RENEE WARDEN - Ms. Warden joined the Company as Accounting Manager in 1991. In
1997 Ms. Warden was appointed Controller and Corporate Secretary for the company
and in 2003 was promoted to Chief Accounting Officer and Secretary. From 1993 to
2003 Ms. Warden also held the positions of Chief Accounting Officer, Secretary
and Director of Human Resources for American Technology Corporation. Ms. Warden
obtained a B.S. degree in business accounting from the University of Phoenix in
1999.
25
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 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 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, 2004, 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.
CODE OF BUSINESS CONDUCT AND ETHICS
We are in the process of adopting a "Code of Business Conduct and Ethics", a
code of ethics, which will apply to all employees, including our executive
officers. A copy of the Code of Business Conduct and Ethics once adopted will be
posted on our Internet site at www.edigital.com. In the event we make any
amendments to, or grant any waivers of, a provision of the Code of Business
Conduct and Ethics that applies to the principal executive officer, principal
financial officer, or principal accounting officer that requires disclosure
under applicable SEC rules, we intend to disclose such amendment or waiver and
the reasons therefore on a Form 8-K or on our next periodic report.
AUDIT COMMITTEE FINANCIAL EXPERT
The board of directors has determined that Victor Ramsauer is an "audit
committee financial expert" and "independent" as defined under applicable SEC
and NASDAQ rules. The board's affirmative determination was based, among other
things, upon his over 24 years as an active certified public accountant.
26
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth for the years ended March 31, 2004, 2003 and
2002, the cash compensation of Mr. Falk, President and Chief Executive Officer,
(the Named Executive Officer). No other person served as an executive officer
of the company during the fiscal year ended March 31, 2004 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, President and Chief 2004 $155,000 $-0- $9,600(1) 400,000 -0-
Executive Officer 2003 $154,974 $35,000 $9,600 (1) -0- -0-
2002 $155,269 $-0- $10,792 (1) -0- -0-
(1) Includes auto allowance of $9,600 in 2004, 2003 and 2002 and unused
vacation of $1,192 in 2002, respectively.
OPTION GRANTS
Shown below is further information on grants of stock options to the Named
Executive Officer reflected in the Summary Compensation Table shown above.
OPTION GRANTS FOR FISCAL YEAR ENDED MARCH 31, 2004
Percent of Total Potential Realizable Value
Appreciation at Assumed Annual Rates
of Stock Price
Number of Options Granted to Exercise Expiration for Option Term
Name Options Granted(1) Employees in Fiscal Year Price Date 5% / $ 10% / $
- --------------------------------------------------------------------------------------------------------------------------
Alfred H. Falk 400,000 11.7% $0.155 4/14/08 17,129 37,852
(1) These options vest 50% immediately and 50% on December 31, 2003.
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table provides information on exercised and unexercised options of
the Named Executive Officer at March 31, 2004.
Value of
Number of Securities Unexercised
Underlying Unexercised In-The-Money
Options at Options at
2004 (1) March 31, 2004 March 31,
(#) ($)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise (#) Value Realized Unexercisable Unexercisable
- ------------------------------------------------------------------------------------------------------------------------
Alfred H. Falk -0- $-0- 400,000 -0- 54,000 --
(1) Based on the last sale price at the close of business on March 31, 2004 of
$0.29.
27
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
All employees of the Company, including executive officers, are employees
at-will.
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.
28
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, 2004.
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 2004 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 23, 2004
Alex Diaz
Allen Cocumelli
Victor Ramsauer
29
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, 1999 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.
[GRPAPH]
Mar 99 Mar 00 Mar 01 Mar 02 Mar 03 Mar 04
------------------------------------------
e.Digital Corporation 100 5,918 865 588 94 171
Russell 2000 Index 100 136 113 127 92 148
Morgan Stanley High Technology Index 100 102 51 45 28 48
30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND MANAGEMENT
COMMON STOCK
The following table sets forth, as of June 7, 2004, 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 1,540,000 (1) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
Robert Putnam 1,150,000(2) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
Allen Cocumelli 526,000 (3) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
Victor Ramsauer 375,000 (4) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
Alex Diaz 560,000 (5) *
13114 Evening Creek Dr. S.
San Diego, CA 92128
All officers and directors
as a group (6 persons) 4,184,334 (6) 2.6%
* less then 1%
(1) Includes options exercisable within 60 days to purchase 425,000 shares.
(2) Includes options exercisable within 60 days to purchase 25,000 shares.
(3) Includes options exercisable within 60 days to purchase 525,000 shares.
(4) Includes options exercisable within 60 days to purchase 375,000 shares.
(5) Includes options exercisable within 60 days to purchase 200,000 shares.
(6) Includes options exercisable within 60 days to purchase 1,583,334.
Excludes unvested options to purchase 16,667 shares.
OTHER VOTING STOCK
PREFERRED STOCK
The following security ownership information is set forth as of March 31, 2004,
with respect to certain persons or groups known by us to be beneficial owners of
more than 5% of any outstanding series of our Preferred Stock.
SERIES D PREFERRED STOCK
Amount and
Nature of
Beneficial Percent of Class
Title of Class Name and Address of Beneficial owner Ownership (1) (1)
- -----------------------------------------------------------------------------------------------------
Jerry E. Polis Family Trust
980 American Pacific Dr. Suite 111
Series D Preferred Stock Henderson, NV 89014 105,000 (2) 72%
Palermo Trust
8617 Canyon View Drive
Series D Preferred Stock Las Vegas, NV 89117 30,000 (3) 21%
31
(1) Represents number of shares of Series D Preferred Stock, held as of March
31, 2004. At such date an aggregate of 145,000 shares of Series D
Preferred stock were issued and outstanding convertible into an aggregate
of 8,794,123 shares of common stock.
(2) Mr. Jerry E. Polis is trustee of the Jerry E. Polis Family Trust, and is
believed by us to have sole voting and investment power with respect to
the Series D Preferred Stock.
(3) Mr. James A. Barnes serves as trustee of Palermo Trust and President of
Sunrise Capital, Inc., and is believed by us to have sole voting and
investment power with respect to the securities held. Palermo Trust and
Sunrise Capital, Inc. disclaim beneficial ownership in these securities
except to the extent of such person's pecuniary interest in these
securities and disclaim membership in a group with any other entity or
person within the meaning of Rule 13d-5(b)(1) under the Exchange Act.
Palermo Trust and Sunrise Capital, Inc. own 30,000 and 5,000 shares of
Series D Preferred Stock, respectively.
SERIES E PREFERRED STOCK
Amount and
Nature of
Beneficial Percent of Class
Title of Class Name and Address of Beneficial owner Ownership (1) (1)
- --------------------------------------------------------------------------------------------------------------------------
Basso Equity Opportunity Holding Fund Ltd.
c/o DKR Capital Partners, LP
1281 East Main St.
Series E Preferred Stock Stamford, CT 06902 2,700 (2) 28%
- --------------------------------------------------------------------------------------------------------------------------
Richard G. Daniels
4635 Lyons Dr.
Series E Preferred Stock La Mesa, CA 91941 1,500 (3) 16%
- --------------------------------------------------------------------------------------------------------------------------
Michael R. Hamblett
4 Waterbury Ave
Series E Preferred Stock Madison, CT 00443 1,000 (4) 10%
- --------------------------------------------------------------------------------------------------------------------------
Wayne & Barbara Opperman
2183 View Crest Glen
Series E Preferred Stock Escondido, CA 92026 1,000 (5) 10%
- --------------------------------------------------------------------------------------------------------------------------
Vertical Ventures, LLC
641 Lexington Ave., 26th Floor
Series E Preferred Stock New York, NY 10022 599 (6) 6%
- --------------------------------------------------------------------------------------------------------------------------
(1) Represents number of shares of Series E Preferred Stock, held as of March
31, 2004. At such date an aggregate of 9,539 shares of Series E Preferred
stock were issued and outstanding convertible into an aggregate of
3,626,817 shares of common stock.
(2) Ms. Barbara Burger may be deemed to have voting and investment control of
the securities held by Basso Equity Opportunity Holding Fund, Ltd. Ms.
Barbara Burger disclaims beneficial ownership of the securities
beneficially owned by Basso Equity Opportunity Holding Fund, Ltd.
(3) Mr. Richard Daniels is believed by us to have sole voting and investment
power with respect to the Series E Preferred Stock.
(4) Mr. Michael R. Hamblett is believed by us to have sole voting and
investment power with respect to the Series E Preferred Stock.
(5) Mr. and Mrs. Opperman are believed by us to have joint voting and
investment power with respect to the Series E Preferred Stock.
(6) Mr. Joshua Silverman may be deemed to have voting and investment control
of the securities held by Vertical Ventures Investments, LLC. Mr.
Silverman disclaims beneficial ownership of the securities beneficially
own Vertical Ventures Investments, LLC.
32
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table sets forth information as of March 31, 2004, 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 remaining available for
outstanding options, options, warrants and rights future issuance under equity
warrants and rights compensation plans
- ---------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 14,000,000 $0.7933 3,370,747
- ---------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------------------
Total 14,000,000 3,370,747
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 July 3, 2003, the note principal
and interest in the amount of $74,532 was paid.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table describes fees for professional audit services rendered by
Singer Lewak Greenbaum & Goldstein LLP, our principal accountant, for the audit
of our annual financial statements for the years ended March 31, 2004 and March
31, 2003 and fees billed for other services rendered by Singer Lewak Greenbaum &
Goldstein LLP during those periods. These amounts include fees paid to Singer
Lewak Greenbaum & Goldstein LLP.
Type of Fee 2004 2003
Audit Fees (1) $74,417 $51,265
Audit Related Fees (2) 10,564 -
All Other Fees (3) - -
- ------------------------------------------------------------------------------
Total $84,918 $51,265
- ------------------------------------------------------------------------------
Audit Fees include the aggregate fees paid by us during the fiscal year
indicated for professional services rendered by Singer Lewak Greenbaum &
Goldstein LLP for the audit of our annual financial statements and review of
financial statements included in our Forms 10-Q.
1. Audit Fees include the aggregate fees paid by us during the fiscal
year indicated for professional services rendered by Singer Lewak
Greenbaum & Goldstein LLP for the audit of our annual financial
statements and review of financial statements included in our Forms
10-Q.
2. Audit Related Fees include the aggregate fees paid by us during the
fiscal year indicated for assurance and related services by Singer
Lewak Greenbaum & Goldstein LLP that are reasonably related to the
performance of the audit or review of our financial statements and
not included in Audit Fees. Also included in Audit Related Fees are
fees for accounting advice.
3. All Other Fees include the aggregate fees paid by us during the
fiscal year indicated for products and services provided by Singer
Lewak Greenbaum & Goldstein LLP, other than the services reported
above.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES
The Audit Committee on an annual basis reviews audit and non-audit services
performed by the independent auditor. All audit and non-audit services are
pre-approved by the Audit Committee, which considers, among other things, the
possible effect of the performance of such services on the auditors'
independence. The Audit Committee has considered the role of Singer Lewak
Greenbaum & Goldstein LLP in providing services to us for the fiscal year ended
March 31, 2004 and has concluded that such services are compatible with their
independence as our company's auditors. The Audit Committee has established its
pre-approval policies and procedures, pursuant to which the Audit Committee
approved the foregoing audit services provided by Singer Lewak Greenbaum &
Goldstein LLP in fiscal 2004.
33
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.
3.6 Certificate of Designation of Preferences, Rights and Limitations of
Series E preferred stock filed with the State of Delaware on
November 19, 2003 and filed as Exhibit 3.7 to the Company's Current
Report on Form 8-K dated November 21, 2003
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.
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.
34
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.
35
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.
36
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
37
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.
4.40.1 First Amendment to 15% Promissory Note due February 11, 2002 filed as
Exhibit 4.40.1 to the Company's form 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 and
filed as Exhibit to the Company's Form 10K dated June 26, 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) and filed as Exhibit to the Company's
Form 10K dated June 26, 2003.
4.46 Form of Series A Warrant Agreement for an aggregate of 1,712,333
shares (dated November 19, 2003) between the Company and the Series E
preferred stockholders (individual warrants differ only as to holder
and number of shares) and previously filed as exhibit 4.8 on the
Company's Form S-3 dated December 22, 2003.
4.47 Form of Series B Warrant Agreement for an aggregate of 856,166 shares
(dated November 19 2003) between the Company and the Series E
preferred stockholders (individual warrants differ only as to holder
and number of shares) and previously filed as exhibit 4.9 on the
Company's Form S-3 dated December 22, 2003.
4.48 Registration Rights Agreement between the Company and the Series E
preferred stockholders dated November 19, 2003 and filed as Exhibit
4.47 to the Company's Current Report on Form 8-K dated November 21,
2003.
4.49 Convertible Preferred Stock Purchase Agreement between the Company
and the Series E preferred stockholders dated November 19, 2003 and
filed as Exhibit 4.46 to the Company's Current Report on Form 8-K
dated November 21, 2003.
4.50 Form of 12% Subordinated Promissory Note and Warrant Purchase
Agreement entered into with certain accredited investors in a
maximum aggregate amount of $1,000,000.*
4.51 Form of 12% Subordinated Promissory Note due on July 1, 2003 between
the Company and certain accredited investors (individual notes
differ only as to amount).*
4.52 Form of Stock Purchase Warrant exercisable until June 30, 2007
issued to certain accredited investors for up to an aggregate of
2,000,000 common shares (individual warrants differ only as to
holder and number of shares).*
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 and filed previously as Exhibit 10.5 to the Company's
Annual Report on Form 10-KSB dated March 1999.
10.3.1 First Amendment to Employment Agreement between the Company and
Alfred H. Falk dated May 19, 1999 and filed previously as exhibit
10.5.1 to the Company's Annual Report on Form 10-KSB dated March 31,
2000.
38
10.4 Sublease Agreement between Smith Industries and Aerospace and the
Company dated September 1, 2000 and previously filed as exhibit
10.9.2 to the Company's Annual Report on Form 10-KSB dated March 31,
2001.
10.4.1 Amended Sublease Agreement between Smith Industries and Aerospace and
the Company dated January 1, 2004.*
10.5 Manufacturing Agreement between the Company and Eltech Electronics,
Inc. dated December 3, 1998 and previously filed as exhibit 10.10 to
the Company's Annual Report on Form 10-KSB dated March 31, 1999.
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]. Previously filed as exhibit 10.11 to the Company's
Annual Report on Form 10-KSB dated March 31, 2000.
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]. Previously filed as exhibit 10.7 to the Company's Annual
Report on Form 10-K dated March 31, 2002.
16.1 Letter dated March 19, 2003 from Ernst & Young LLP and previously
filed as Exhibit 16.1 to the Company's 8-K dated March 24, 2003.
21.1 List of subsidiaries. *
23 Consents of Experts and Council
23.1 Singer Lewak Greenbaum & Goldstein, LLP
23.2 Ernst & Young, LLP
31 Certifications *
31.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Alfred H.
Falk, Chief Executive Officer.
31.2 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Renee
Warden, Principal Accounting Officer.
32.1 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 Renee Warden, Principal Accounting
Officer.
* Filed concurrently herewith.
(B) REPORTS ON FORM 8-K.
39
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 23, 2004
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 23, 2004
- -----------------------
Alex Diaz
/s/ ALFRED H. FALK President, Chief Executive Officer June 23, 2004
- ----------------------- and Director (principal executive officer)
Alfred H. Falk
/s/ RENEE WARDEN Chief Accounting Officer and Secretary June 23, 2004
- ----------------------- (principal Financial and Accounting Officer)
Renee Warden
/s/ ROBERT PUTNAM Vice President and Director June 23, 2004
- -----------------------
Robert Putnam
/s/ ALLEN COCUMELLI Director June 23, 2004
- -----------------------
Allen Cocumelli
/s/ VICTOR G. RAMSAUER Director June 23, 2004
- -----------------------
Victor G. Ramsauer
40
INDEX TO FINANCIAL STATEMENTS
PAGE
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND
SUBSIDIARY REPORT OF SINGER LEWAK GREENBAUM & GOLDSTEIN LLP,
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-2
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND
SUBSIDIARY REPORT OF ERNST & YOUNG LLP,
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-3
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2004 AND 2003 F-4
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED
MARCH 31, 2004, 2003 AND 2002 F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
MARCH 31, 2004, 2003 AND 2002 F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8
F-1
REPORT OF SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
e.Digital Corporation and subsidiary
San Diego, California
We have audited the accompanying consolidated balance sheet of e.Digital
Corporation and subsidiary as of March 31, 2004 and 2003, and the related
consolidated statements of operations, shareholders' equity (deficit), and cash
flows for each of the two years in the period ended March 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our 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 as of March 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the two years in
the period ended March 31, 2004, in conformity with United States generally
accepted accounting principles.
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, 2005. At March 31, 2004, the
Company has a working capital deficit of $1,096,104 and a stockholders' deficit
of $1,774,073. 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. The accompanying financial
statements have been prepared assuming that the Company will continue as a going
concern.
/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
May 18, 2004
F-2
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
E. Digital Corporation and Subsidiary
We have audited the accompanying consolidated statements of operations,
stockholders' deficit and cash flows of e.Digital Corporation and subsidiary for
the year 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 audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our 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 results of their operations,
stockholders' deficit and the cash flows of e.Digital Corporation and subsidiary
for the year ended March 31, 2002 in conformity with U.S. generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. 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. The consolidated financial statements describe
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.
/s/ ERNST & YOUNG LLP
San Diego, California
May 22, 2002
F-3
e.Digital Corporation and subsidiary
CONSOLIDATED BALANCE SHEETS
[See Note 1 - Nature of Operations and Basis of Presentation]
As at March 31,
2004 2003
$ $
--------- ---------
ASSETS
CURRENT
Cash and cash equivalents 467,954 83,906
Accounts receivable, net of allowance for doubtful
accounts of $174,255 [2003 - $138,236] 36,151 181,536
Inventory, net of allowance for obsolete inventory
of $4,600 [2003-$6,435] 5,009 138,795
Prepaid expenses and other 29,085 92,574
Deferred contract charges -- 218,192
--------- ---------
TOTAL CURRENT ASSETS 538,199 715,003
--------- ---------
Property and equipment 158,638 141,397
Intangible assets -- 38,949
--------- ---------
TOTAL ASSETS 696,837 895,349
--------- ---------
LIABILITIES, PREFERRED STOCK AND
STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT
Accounts payable, trade 385,453 736,682
Other accounts payable and accrued liabilities 70,852 128,083
Accrued lease liability 515,002 515,002
Accrued employee benefits 185,737 203,027
Deferred revenue 107,056 189,425
Dividends 246,798 61,500
Unsecured promissory notes 123,405 187,984
--------- ---------
TOTAL CURRENT LIABILITIES 1,634,303 2,021,703
--------- ---------
LONG TERM LIABILITIES
Deferred revenue 69,387 122,278
Unsecured promissory notes 767,220 625,595
--------- ---------
TOTAL LIABILITIES 2,470,910 2,769,576
--------- ---------
Commitments and contingencies
STOCKHOLDERS' DEFICIT
Preferred stock, $10.00 par value, 5,000,000 shares
authorized Series D Convertible Preferred Stock,
250,000 shares designated, 145,000 and 205,000
issued and outstanding, respectively. Liquidation
preference of $1,670,883 and $2,050,000,
respectively. 1,450,000 2,050,000
Series E Convertible Redeemable Preferred Stock,
15,000 shares designated, 8,768 and 0 issued
and outstanding, respectively. Liquidation
preference of $902,715 and $0, respectively. 862,050 --
Common stock, $.001 par value, authorized
200,000,000, 160,527,868 and 147,604,343
shares outstanding, respectively. 160,528 147,605
Additional paid-in capital 64,316,408 61,022,460
Dividends (246,798) (61,500)
Accumulated deficit (68,316,261)(65,032,792)
--------- ---------
TOTAL STOCKHOLDERS' DEFICIT (1,774,073) (1,874,227)
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS DEFICIT 696,837 895,349
--------- ---------
See accompanying notes
F-4
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
[See Note 1 - Nature of Operations and Basis of Presentation]
2004 2003 2002
$ $ $
------------ ------------ ------------
REVENUES - products 2,686,894 2,224,961 1,852,933
- services 731,286 372,402 564,101
------------ ------------ ------------
3,418,180 2,597,363 2,417,034
------------ ------------ ------------
Cost of revenues - products 2,438,683 3,365,086 2,578,071
- services 290,100 131,972 399,909
------------ ------------ ------------
2,728,783 3,497,058 2,977,980
------------ ------------ ------------
GROSS PROFIT (LOSS) 689,397 (899,695) (560,946)
------------ ------------ ------------
OPERATING EXPENSES
Selling and administrative 1,486,620 3,531,719 2,967,227
Research and related expenditures 1,531,177 1,410,506 2,327,283
------------ ------------ ------------
Total operating expenses 3,017,797 4,942,225 5,294,510
------------ ------------ ------------
OPERATING LOSS (2,328,400) (5,841,920) (5,855,456)
------------ ------------ ------------
OTHER INCOME (EXPENSE)
Interest expense (121,698) (741,435) (234,533)
Loss on disposal of property and equipment (66,346) (82,949) (2,916)
Interest income 424 1,761 57,529
Other income (323) (1,259) 242,310
------------ ------------ ------------
TOTAL OTHER (EXPENSE) INCOME (187,943) (823,882) 62,390
------------ ------------ ------------
Loss before provision for income taxes (2,516,343) (6,665,802) (5,793,066)
Provision for income taxes -- -- --
------------ ------------ ------------
LOSS AND COMPREHENSIVE LOSS FOR THE YEAR (2,516,343) (6,665,802) (5,793,066)
Series E preferred stock beneficial conversion feature (693,615) -- --
Accretion on Series E preferred stock -- -- --
Accrued dividends on the Series C, D and E preferred stock (258,827) (61,500) (26,332)
------------ ------------ ------------
LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS FOR THE YEAR (3,468,785) (6,727,302) (5,819,398)
------------ ------------ ------------
Net loss per common share (0.02) (0.05) (0.04)
------------ ------------ ------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES 155,100,330 140,065,107 130,782,909
------------ ------------ ------------
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 PAID-IN CAPITAL
COMMON STOCK COMMON PREFERRED ACCUMULATED
SHARES AMOUNT STOCK STOCK DIVIDENDS DEFICIT
----------- ---------- ---------- ---------- ---------- -----------
BALANCE, MARCH 31, 2001 130,175,406 130,175 54,427,286 -- -- (52,547,592)
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 -- -- -- -- -- (5,793,066)
Accrued dividends on the
Series C preferred stock -- -- -- -- -- (26,332)
----------- ---------- ---------- ---------- ---------- -----------
BALANCE, MARCH 31, 2002 132,537,298 132,537 56,220,924 -- -- (58,366,990)
----------- ---------- ---------- ---------- ---------- -----------
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 -- -- --
Issuance of Series D preferred stock -- -- -- 2,050,000 -- --
Loss for the year -- -- -- -- -- (6,665,802)
Accrued dividends on the
Series D preferred stock -- -- -- -- (61,500) --
----------- ---------- ---------- ---------- ---------- -----------
BALANCE, MARCH 31, 2003 147,604,343 147,605 61,022,460 2,050,000 (61,500) (65,032,792)
----------- ---------- ---------- ---------- ---------- -----------
Shares issued for Cash 4,913,160 4,913 928,587 -- -- --
Stock issued on
exercise of stock options 1,019,838 1,020 151,305 -- -- --
Stock issued on exercise of warrants 808,788 809 71,131 -- -- 19
Shares issued for debt 1,052,632 1,053 198,946 -- -- --
Shares issued to vendors 195,913 196 49,067 -- -- --
Shares issued for conversion of
Series E preferred stock 1,183,073 1,183 407,519 (400,200) 8,502 (8,502)
Shares issued for conversion
of Series D preferred stock 3,500,121 3,500 661,528 (600,000) 65,028 (65,028)
Value assigned to 250,000
restricted shares of common
stock issued to vendor 250,000 250 132,250 -- -- --
Beneficial conversion feature
on Series E preferred stock -- -- 693,615 -- -- (693,615)
Issuance of Series E preferred stock -- -- -- 1,262,250 -- --
Loss for the year -- -- -- -- -- (2,516,343)
Accrued dividends on the
Series D preferred stock -- -- -- -- (224,412) --
Accrued dividends on the
Series E preferred stock -- -- -- -- (34,416) --
----------- ---------- ---------- ---------- ---------- -----------
BALANCE, MARCH 31, 2004 160,527,868 160,528 64,316,408 2,312,050 (246,798) (68,316,261)
----------- ---------- ---------- ---------- ---------- -----------
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]
2004 2003 2002
$ $ $
----------- ----------- -----------
OPERATING ACTIVITIES
Loss for the year (2,516,343) (6,665,802) (5,793,066)
Adjustments to reconcile loss to net cash used by
operating activities:
Depreciation and amortization 99,853 199,119 162,718
Allowance for doubtful accounts 36,018 64,938 73,899
Loss on disposal of property and equipment 66,346 82,949 2,916
Gain on settlement of accounts payable debt (162,828) -- --
Loss on impairment of asset -- 129,930 --
Stock issued as payment to vendor -- -- 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 112,481 442,258 234,130
Stock based compensation expense -- -- 24,600
Changes in assets and liabilities:
Accounts receivable, trade 109,368 372,035 (162,394)
Inventory 133,786 72,833 (894,436)
Prepaid expenses and other 63,506 (34,490) (35,495)
Deferred contract charges 218,192 (127,044) (91,148)
Accounts payable, trade (6,638) (47,906) 710,554
Other accounts payable and accrued liabilities (57,233) (180,152) 80,061
Accrued employee benefits (17,290) (44,875) 36,128
Deferred revenue (135,260) 181,491 112,434
----------- ----------- -----------
CASH USED IN OPERATING ACTIVITIES (2,056,042) (4,671,036) (5,312,889)
----------- ----------- -----------
INVESTING ACTIVITIES
Purchase of property and equipment (145,690) (157,286) (90,580)
Proceeds from sale of investment -- -- 30,124
Proceeds from sale of asset 1,200 -- --
Decrease (increase) in restricted cash -- 145,073 (145,073)
Decrease (increase) in certificate of deposit -- 58,696 (3,472)
----------- ----------- -----------
CASH (USED) PROVIDED BY INVESTING ACTIVITIES (144,490) 46,483 (209,001)
----------- ----------- -----------
FINANCING ACTIVITIES
Proceeds from issuance of common stock 933,500 3,475,619 --
Proceeds from issuance of Unsecured Notes 269,300 1,842,000 --
Proceeds from issuance of Series E preferred stock 1,262,250 -- --
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) --
Payment on Secured Promissory Note (104,754) -- --
Proceeds from exercise of warrants 71,959 -- 241,603
Proceeds from exercise of stock options 152,325 114,121 45,500
Deferred financing charge -- 31,500 (31,500)
----------- ----------- -----------
CASH PROVIDED BY FINANCING ACTIVITIES 2,584,580 4,263,240 2,455,603
----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS DURING THE YEAR 384,048 (361,313) (3,066,287)
Cash and cash equivalents, beginning of year 83,906 445,219 3,511,506
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR 467,954 83,906 445,219
----------- ----------- -----------
See accompanying notes
F-7
E.DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
e.Digital Corporation, (the "Company") is incorporated under the laws of
Delaware. The Company offers proprietary technology platforms and engineering
services to create portable digital devices that can link to personal computers,
the Internet and other electronic devices. The Company markets to Original
Equipment Manufacturers ("OEMs") and Original Design Manufacturers ("ODMs")
complete reference designs and technology platforms with a focus on digital
music dictation equipment, consumer electronics, digital image and video and
other electronic product markets.
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
$68,316,261 at March 31, 2004 [2003 - $65,032,792]. At March 31, 2004, the
Company had a working capital deficiency of $1,096,104. 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, 2002, 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 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 and ODM customers and new markets and (c)
raising additional capital and/or obtaining 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.
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, 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 equivalent, 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.
F-8
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, 2004, stock options,
warrants and convertible preferred stock exercisable into 19,727,293 [2003 -
16,568,070] [2002 - 7,429,412] 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.
The provisions of each of the Company's series C, D and E of preferred stock
provided for a 7%, 12% and 8% per annum accretion, respectively in the
conversion value (similar to a dividend). These amounts increase the net loss
available to common stockholders. Net loss available to common stockholders is
computed as follows:
Years ended March 31, 2004 2003 2002
------------ ----------- -----------
Net loss $ (2,516,343) $(6,665,802) $(5,793,066)
Imputed deemed dividends on Series E preferred stock (693,615) - -
Accretion on preferred stock:
Series C preferred stock, 7% stated rate - - (26,332)
Series D preferred stock, 12% stated rate (224,411) (61,500) -
Series E preferred stock, 8% stated rate (34,416) - -
------------ ----------- -----------
Net loss available to common stockholders $(3,468,785) $(6,727,302) $(5,819,398)
============ =========== ===========
GUARANTEES AND INDEMNIFICATIONS
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, including Indirect Guarantees of Indebtedness of
Others -- an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FIN 34." The following is a summary of the Company's agreements that the
Company has determined are within the scope of FIN No. 45:
The Company provides a one year limited warranty for most of its products. See
"Warranty Liabilities."
Under its bylaws, the Company has agreed to indemnify its officers and directors
for certain events or occurrences arising as a result of the officer or
director's serving in such capacity. The term of the indemnification period is
for the officer's or director's lifetime. The maximum potential amount of future
payments the Company could be required to make under these indemnification
agreements is unlimited. However, the Company has a directors and officer
liability insurance policy that limits its exposure and enables it to recover a
portion of any future amounts paid. As a result of its insurance policy
coverage, the Company believes the estimated fair value of these indemnification
agreements is minimal and has no liabilities recorded for these agreements as of
March 31, 2004.
F-9
The Company enters into indemnification provisions under (i) its agreements with
other companies in its ordinary course of business, typically with business
partners, contractors, customers and landlords and (ii) its agreements with
investors. Under these provisions the Company generally indemnifies and holds
harmless the indemnified party for losses suffered or incurred by the
indemnified party as a result of the Company's activities or, in some cases, as
a result of the indemnified party's activities under the agreement. The maximum
potential amount of future payments the Company could be required to make under
these indemnification provisions is unlimited. The Company has not incurred
material costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, the Company believes the estimated fair
value of these agreements is minimal. Accordingly, the Company has no
liabilities recorded for these agreements as of March 31, 2004.
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. 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.
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
$12,263, $64,072 and $116,488 for the years ending March 31, 2004, 2003 and
2002, respectively.
F-10
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
WARRANTY LIABILITY
The Company warrants its products to be free from defects in materials and
workmanship for a period ranging up to one year from the date of purchase,
depending on the product. The warranty is generally a limited warranty, and in
some instances imposes certain shipping costs on the customer. The Company
currently provides direct warranty service. Some agreements with OEM customers
require certain quantities of product be made available for use as warranty
replacements. International market warranties are generally similar to the U.S.
market.
The Company establishes a warranty reserve based on anticipated warranty claims
at the time product revenue is recognized. Factors affecting warranty reserve
levels include the number of units sold and anticipated cost of warranty repairs
and anticipated rates of warranty claims. The Company evaluates the adequacy of
the provision for warranty costs each reporting period. See Schedule II for
additional information regarding warranties.
INTEREST EXPENSE
Interest expense includes interest expense and non-cash amortization of debt
discount.
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.
STOCK BASED COMPENSATION
The Company has a stock-based employee and non-employee compensation plan, which
is described more fully in Note 13. 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 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% [2003 - 0%] [2002
- - 0%]; expected volatility of 96 [2003- 1.08] [2002 - 1.00] a risk free interest
rate of 1.74% [2003 - 3.16%] [2002 - 5.0%] and an expected life of 2.0 years
[2003 - 2.0 years] [2002 - 2.5 years]. The following table summarizes the
weighted average fair value of the stock options granted during the year:
F-11
Year Ended March 31, 2004 2003 2002
---------- ---------- ----------
Net loss as reported $(3,468,785) $(6,727,302) $(5,819,398)
Add: Total stock-based employee compensation recorded - - -
Deduct: Total stock-based employee compensation
expense determined under fair value
based method for all awards (273,469) (981,739) (5,183,186)
---------- ---------- ----------
Pro forma net loss $(3,742,254) $(7,709,041) $(11,002,584)
---------- ---------- ----------
Earnings per share:
Basic-as reported $(0.02) $(0.05) $(0.04)
Basic-pro forma $(0.02) $(0.05) $(0.04)
Diluted-as reported $(0.02) $(0.05) $(0.08)
Diluted-pro forma $(0.02) $(0.05) $(0.08)
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, 2004, 2003 and 2002, 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.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets and identifiable intangibles held for use are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. If the sum of undiscounted expected
future cash flows is less than the carrying amount of the asset or if changes in
facts and circumstances indicate, an impairment loss is recognized and measured
using the asset's fair value.
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.
COMMON STOCK ISSUED FOR SERVICES
The Company records compensation expense for common stock issued for services
based on the estimated fair market value. Estimated fair market value is
determined based on the quoted closing-bid stock price on the day of issuance.
STATEMENT OF CASH FLOWS
For purposes of the statement of cash flows, the Company considers all highly
liquid investments purchased with an original maturity of three months or less
to be cash equivalents.
RECLASSIFICATIONS
Certain amounts included in the prior year financial statements have been
reclassified to conform with the current years presentation. These
reclassifications have no affect on the reported net income.
F-12
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting and reporting for derivative instruments and hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS No. 149 is effective for derivative instruments and
hedging activities entered into or modified after June 30, 2003, except for
certain forward purchase and sale securities. For these forward purchase and
sale securities, SFAS No. 149 is effective for both new and existing securities
after June 30, 2003. Management does not expect adoption of SFAS No. 149 to have
a material impact on the Company's statements of earnings, financial position,
or cash flows.
In December 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities," an interpretation of Accounting Research Bulletin
No. 51, "Consolidated Financial Statements." This pronouncement requires the
consolidation of variable interest entities, as defined, and is effective
immediately for variable interest entities created after January 31, 2003, and
for variable interest entities in which an enterprise obtains an interest after
that date. The Company does not have any variable interest entities, and
therefore, this interpretation is not expected to have a material impact on the
Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. SFAS No. 150 will be effective for financial instruments entered
into or modified after May 31, 2003 and otherwise will be effective at the
beginning of the first interim period beginning after June 15, 2003. Management
does not expect adoption of SFAS No. 150 to have a material impact on the
Company's statements of earnings, financial position, or cash flows.
3. CREDIT RISK
Financial instruments totaling $504,105 [2003 - $265,442] which potentially
subject the Company to concentrations of credit risk, consist principally of
cash and cash equivalents, certificate of deposit, accounts receivable. 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 69% and 23%,
respectively of accounts receivable at March 31, 2004. Amounts owing from two
major customers comprise approximately 50%, and 26%, respectively of accounts
receivable at March 31, 2003.
4. MAJOR CUSTOMERS AND SUPPLIERS
The Company operates in one major line of business, the development, manufacture
and marketing of electronic products. Sales to three major customer comprised
approximately 36%, 26% and 11% of revenues respectively in fiscal 2004 [2003 -
one customers comprised 22%] [2002 - two customer comprised 35% and 14%]. 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 primary components from two distributors
accounting for 19% and 14% of total purchases for fiscal 2004. Purchases from
these two distributors accounted for approximately 17% and 15% 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, 2003 was $138,236.
During the year ended March 31, 2004, management increased the provision for
doubtful accounts by $36,019, and recorded no discount in the provision, and
accordingly, the provision for doubtful accounts receivable at March 31, 2004 is
$174,255.
F-13
5. 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.
6. 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, MARCH 31,
2004 2003
$ $
- -----------------------------------------------------------------------
Finished goods -- 140,581
Raw materials 9,609 4,649
- -----------------------------------------------------------------------
Reserve obsolete 4,600 6,435
- -----------------------------------------------------------------------
5,009 138,795
- -----------------------------------------------------------------------
7. STATEMENT OF CASH FLOWS
The Company had non-cash operating and financing activities and made cash
payments as follows:
2004 2003 2002
$ $ $
---------- ---------- ----------
Non-cash financing activities:
Stock based compensation expense -- 185,085 --
Common stock issued on conversion of
Series E and D preferred stock 1,073,730 -- --
Common stock issued on conversion of Series C preferred stock -- -- 822,227
Shares issued for interest -- 254,246 --
Shares issued for debt 200,000 -- --
Value assigned to 850,000 warrants granted in connection
with the issuance of the 12% SP Notes -- -- 459,470
Value assigned to 445,913 restricted common shares issued to
vendors for services 181,763 -- --
Accrued dividends on Series A and C preferred stock -- 61,500 26,332
Accrued dividends on Series D and E preferred stock 185,298 -- --
Beneficial conversion feature on the
issuance of Series E preferred stock 693,615 -- --
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 9,198 81,237 403
---------- ---------- ----------
8. PROPERTY AND EQUIPMENT
ACCUMULATED
DEPRECIATION AND NET BOOK
COST AMORTIZATION VALUE
$ $ $
--------- --------- ---------
2004
Computer hardware and software 71,985 65,678 6,307
Furniture and equipment 26,499 23,982 2,517
Machinery and equipment 79,302 60,295 19,007
Leasehold improvements 174,960 174,960 --
Tooling 204,652 73,845 130,807
--------- --------- ---------
557,398 398,760 158,638
--------- --------- ---------
F-14
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
--------- --------- ---------
For the year ended March 31, 2003, the company incurred a loss on impairment of
asset of $129,930.
9. INTANGIBLE ASSETS
ACCUMULATED NET BOOK
COST AMORTIZATION VALUE
$ $ $
--------- --------- ---------
2004
Website development costs 43,150 43,150 --
Patents 39,409 39,409 --
--------- --------- ---------
82,559 82,559 --
--------- --------- ---------
2003
Website development costs 93,150 56,437 36,713
Patents 39,409 37,173 2,236
--------- --------- ---------
132,559 93,610 38,949
--------- --------- ---------
10. 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
[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.
11. 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. On January 14, 2004, the holder of the 15% Unsecured Note agreed to
postpone principle and interest payments on the note until December 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, 2003 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. On June 10, 2003,
we redeemed the outstanding balance and accrued interest on the 24% Unsecured
Note. On July 3, 2003, the note principal and interest in the amount of $74,532
was paid.
12. 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 $3,919,000[2003 - $2,478,000] 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
2004 2003
$ $
----------- -----------
DEFERRED TAX LIABILITIES
State Taxes 652,000 482,000
Tax over book depreciation 13,000 13,000
----------- -----------
TOTAL DEFERRED TAX LIABILITIES 665,000 495,000
----------- -----------
DEFERRED TAX ASSETS
Net operating loss carryforwards 22,291,000 18,179,000
Other 212,000 235,000
----------- -----------
TOTAL DEFERRED TAX ASSETS 22,503,000 18,414,000
Valuation allowance for deferred tax assets (21,838,00) (17,919,000)
----------- -----------
NET DEFERRED TAX ASSETS 665,000 495,000
----------- -----------
NET DEFERRED TAX BALANCE -- --
----------- -----------
The net provision for income taxes in 2004 and 2003 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
------------------------
2004 2003 2002
% % %
----- ----- -----
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, 2004 of approximately $51,000,000 [2003 - $48,000,000] which will begin to
expire in 2006. The Company has state net operating loss carryforwards of
$16,000,000 [2003 - $15,000,000] 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.
13. 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 $10.00 per share.
COMMON STOCK
The issued common stock of the Company consisted of 160,527,868 and 147,604,343
common shares as of March 31, 2004 and March 31, 2003, 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 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 2004, 3,412,000 [2003 - 2,805,000] options were granted at exercise
prices ranging from $0.155 to $0.50 [2003 - $0.28 to $0.55] per share. Options
granted during 2004 and 2003 were under the 1994 Stock Option Plan. The
following table summarizes stock option transactions:
F-17
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
# $
- -------------------------------------------------------------------------------
FISCAL 2002
Outstanding March 31, 2001 5,729,000 3.1172
- -------------------------------------------------------------------------------
Granted 1,085,000 1.2824
Canceled/expired (150,000) 5.4600
Forfeited (248,250) 3.5592
Exercised (500,000) 0.1000
- -------------------------------------------------------------------------------
Outstanding March 31, 2002 5,915,750 2.9578
- -------------------------------------------------------------------------------
FISCAL 2003
Granted 2,805,000 0.4442
Canceled/expired (2,115,000) 5.4600
Forfeited (1,793,750) 1.5634
Exercised (868,750) 0.1314
- -------------------------------------------------------------------------------
Outstanding March 31, 2003 3,943,250 1.0846
- -------------------------------------------------------------------------------
FISCAL 2004
Granted 3,412,000 0.1641
Canceled/expired (2,193,747) 0.6377
Exercised (1,019,838) 0.1494
- -------------------------------------------------------------------------------
Outstanding March 31, 2004 4,141,665 0.7993
- -------------------------------------------------------------------------------
Exercisable at March 31, 2004 3,086,990 0.9947
- -------------------------------------------------------------------------------
Weighted average fair value of options granted during the year 0.08
The following table summarizes the number of options exercisable at March 31,
2004 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, 2004 MARCH 31, 2004 EXERCISE PRICE CONTRACTUAL MARCH 31, 2004
$ # # $ LIFE $
- --------------------------------------------------------------------------------------------------------------------
0.155 to 0.23 2,047,165 1,099,170 0.15 4.05 years 0.155
0.42 to 0.55 1,072,500 987,500 0.47 3.04 years 0.47
1.03 to 1.75 360,000 338,320 1.46 1.73 years 1.48
2.00 to 2.6875 437,000 437,000 2.30 1.21 years 2.30
4.09 225,000 225,000 4.09 0.42 years 4.09
- --------------------------------------------------------------------------------------------------------------------
4,141,665 3,086,990 0.79 3.31 years 0.99
- --------------------------------------------------------------------------------------------------------------------
The options generally vest over a period of two to three years.
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 was intended to provide equity incentives to
recruit and retain employees. The Plan provided for stock compensation through
grants of the Company's Common Stock. Awards of shares could 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 could 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
were not to be sold at less than fair market value. The Plan terminated on
November 9, 2003 and no shares have been issued under the Plan.
F-18
SHARE WARRANTS
The Company has outstanding share warrants as of March 31, 2004, 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
DESCRIPTION COMMON SHARES PER SHARE $ EXPIRATION DATE
- -------------------------------------------------------------------
Warrant 1,712,333 0.60 May 18, 2004
Warrant 46,189 0.19 October 5, 2005
Warrant 856,166 1.00 November 18, 2005
Warrant 550,000 0.19 September 30,2006
- -------------------------------------------------------------------
Total 3,164,688
- -------------------------------------------------------------------
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. At March 31, 2004 a total of 46,189 warrants remain outstanding.
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. At March 31, 2004 a
total of 550,000 warrants remain outstanding.
In connection with the issuance of the Series E stock, the Company issued
1,712,333 Series A and 856,166 Series B warrants with an exercise price of $0.60
and $1.00, respectively. At March 31, 2004 an aggregate of 2,568,499 warrants
remain outstanding.
COMMON STOCK ISSUED FOR SERVICES
During the year ended March 31, 2004, the Company issued 445,913 [2003 -
3,558,498] 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, 2004, the Company issued nil [2003 - 1,337,340]
[2002 - 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 AND NON-REDEEMABLE PREFERRED STOCK
The Company is authorized to issue 5,000,000 shares of $0.001 par value
preferred stock in one or more series from time to time by action of the Board
of Directors.
F-19
The following is a summary of the terms of the preferred stock series
outstanding during the two fiscal years ended March 31, 2004.
PREFERRED ISSUANCE AGGREGATE NUMBER OF SHARES
SERIES DATE PURCHASE PRICE AUTHORIZED/ISSUED TERMS
------------------ --------------- --------------- ------------------ ------------------------------------------
12% Convertible Purchase price plus 12% accretion.
Non-redeemable Convertible at $0.19 per share subject
Series D stated December 2002 $2,050,000 205,000/205,000 to certain adjustment if the company
value of $10 issues shares less then $0.19 per share.
per share
------------------ --------------- --------------- ------------------ ------------------------------------------
8% Convertible Purchase price plus 8% accretion. Convertible
Redeemable Series at $0.45 for the first 90 days following
E issued at $100 original issuance date then lower of $0.45
per share November 2003 $1,277,000 15,000/12,770 and 85% of market. With a floor of $0.19 per share.
Automatic conversion on November 19, 2005.
------------------ --------------- --------------- ------------------ ------------------------------------------
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.
On November 19, 2003, the Company issued 12,770 shares of 8% Series E
Convertible Redeemable Preferred Stock (the "Series E Stock") with a stated
value of $100 per share. Dividends of 8% per annum are payable, with certain
exceptions, either in cash or in shares of common stock ("Common Stock") at the
election of the company. The stated dollar amount of Series E Stock, is
convertible into fully paid and nonassessable shares of Common Stock at a
conversion price $0.45 per share which is fixed for the first 90 days following
the original issue date, and commencing 90 days following the original issue
date, the conversion price shall equal the lower of (i) $0.45 and (ii) 85% of
the average of the volume weighted average price per share during the ten
consecutive trading days immediately preceding the conversion date. The Series E
Stock shall be subject to automatic conversion on November 19, 2005 subject to
certain conditions.
The Series E Stock is redeemable in certain instances at the Company's option
eighteen month upon the occurrence of certain triggering events including,
without limitations, a lapse of a registration statement for ten non-consecutive
trading days and certain other events. The redemption price upon such election
following a triggering event is the greater of (a) 110% of the stated value or
(b) the product of the number of preferred shares multiplied by the closing
market price multiplied by the stated value per share divided by the then
conversion price per share.
The Company also issued to the purchasers of the Series E Stock, Series A
Warrants to purchase 1,712,333 shares of Common Stock at $0.60 per share
exercisable until May 18, 2004 and Series B Warrants to purchase 856,166 shares
of Common Stock at $1.00 per share exercisable until November 18, 2005.
The Company utilized the Black Scholes Method in valuing the Series A and B
Warrants, and calculated the relative fair value of the Series E Stock and
Series A and B Warrants. The effective conversion prices of the Series E Stock
was then determined by the Company based on the relative fair value of the
stock. Utilizing the calculated intrinsic value of the Series E Stock, the
Company calculated a beneficial conversion charge in the amount of $693,615,
which has been recorded in the loss attributed to common shareholders in the
accompanying financial statements.
In connection with the Series E Stock financings, the Company incurred as
finder's fee for $7,250 in cash and, in connection therewith, issued to such
finder a 9,666 Series A and 4,833 Series B warrant with an aggregate fair market
value of $2,755.
As of March 31, 2004, the Series D and E Stock would have been convertible into
8,794,123 and 3,626,817 shares of Common Stock, respectively. The following
table summarizes values assigned as deemed dividends for the value of the
warrants and the beneficial conversion feature on each preferred stock issuance.
F-20
Value of
Value Beneficial
Preferred Number of Warrant Warrant Assigned Conversion
Series Issuance Date Warrants Exercise Price Expiration Date to Warrant Discount
-------------- --------------- ------------ ------------------- ---------------- ----------- -----------------
7% Series B June 1999 195,000 $2.40 June 2004 $390,000 -
-------------- --------------- ------------ ------------------- ---------------- ----------- -----------------
7% Series C October 2000 230,946 $0.19, as adjusted October 2005 $582,905 $3,417,095
-------------- --------------- ------------ ------------------- ---------------- ----------- -----------------
8% Series E November 2003 1,712,333 $0.60 May 2004 $273,973 $205,600
-------------- --------------- ------------ ------------------- ---------------- ----------- -----------------
8% Series E November 2003 856,166 $1.00 November 2005 $214,042 -
-------------- --------------- ------------ ------------------- ---------------- ----------- -----------------
15. COMMITMENTS AND CONTINGENCIES
The Company may become involved in certain legal proceedings and claims which
arise in the normal course of business. As of March 31, 2004, the Company did
not have any significant litigation outstanding, and management does not expect
any matters to have a material impact on the Company's liquidity or the
financial statements taken as a whole.
In September 2002, we notified APL Direct Logistics that we are terminating the
three-year fulfillment agreement. 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 its wireless
product developed for Softeq and IFE products, DigitalWay Co., Ltd. for the
manufacture of its Odyssey. 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 equipment 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 may still be 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. From August 2002 until December 2003 the aggregate monthly lease
payments was $16,606. In January 2004, the Company amended the lease to reduce
the occupied office space to 7,500 square feet with an aggregate monthly lease
payment of $9,290 inclusive of utilities and costs and expiring on July 31,
2006. Office rent expense recorded by the Company for the year ended March 31,
2004, was $155,375 [2003 - $196,716] [2002 - $191,859].
F-21
The total operating lease obligations under the lease for office space is
$260,120 of which the Company's minimum commitments is as follows:
2004 $111,480
2005 111,480
--------
2006 37,160
--------
$260,120
========
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, 2004, the Company made $1,972 [2003 - $9,299]
[2002 -- $7,992] in matching contributions.
18. SUBSEQUENT EVENTS (UNAUDITED)
Subsequent to the fiscal year ended March 31, 2004, the Company received cash
proceeds of $1,550 for the exercise of 10,000 stock options and 5,118 shares of
Series E stock were converted into 2,376,673 common shares
On June 25, 2004, the Company issued 12% Subordinated Promissory Notes ("12% SP
Notes") for gross cash proceeds of approximately $1,000,000 to certain
accredited investors. The 12% Sub Notes mature on July 1, 2005. The interest
under the 12% Sub Notes is paid in cash monthly at a rate of 12% per annum. In
addition, each investor of $100,000 will receive Warrants on 200,000 common
shares exercisable at $0.25 per share and expiring on June 30, 2007.
19. RELATED PARTY TRANSACTIONS
In March 2003, the Company issued to a director to finance inventory purchases a
24% Unsecured Promissory Note ("24% Unsecured Note") for gross cash proceeds of
$42,000 and in April 2003 increased the note by $37,800. For the nine months
ended December 31, 2003, the Company recorded $2,782 in interest expense. On
July 3, 2003, the note principal and interest in the amount of $74,532 was paid.
F-22
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
e.Digital Corporation and subsidiary
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The consolidated
supplemental schedule II is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not a part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audits of the basic consolidated financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic consolidated financial statements taken as a whole.
Our report covering the basic financial statements indicates that there is
substantial doubt as to the Company's ability to continue as a going concern,
the outcome of which cannot presently be determined and that the financial
statements do not include any adjustments, that might result from the outcome of
this uncertainty.
/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
May 18, 2004
F-23
E.DIGITAL CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Balance at Charged to
beginning of cost and Balance at end
Description period expense Deductions of period
- ----------- -------- -------- -------- --------
Year ended March 31, 2004 $138,236 36,018 -- $174,255
-------- -------- -------- --------
Year ended March 31, 2003 $ 73,899 64,938 601 $138,236
-------- -------- -------- --------
Year ended March 31, 2002 $ -- 73,899 -- $ 73,899
-------- -------- -------- --------
F-24
RESERVE FOR OBSOLESCENCE
Balance at Charged to
beginning of cost and Balance at end
Description period expense Deductions of period
- ----------- -------- -------- -------- --------
Year ended March 31, 2004 $ 6,435 -- 1,835 $ 4,600
-------- -------- -------- --------
Year ended March 31, 2003 $ 55,965 698,594 748,124 $ 6,435
-------- -------- -------- --------
Year ended March 31, 2002 $ 16,548 39,417 -- $ 55,965
-------- -------- -------- --------
WARRANTY RESERVE
Balance at Charged to
beginning of cost and Balance at end
Description period expense Deductions of period
- ----------- -------- -------- -------- --------
Year ended March 31, 2004 $ 53,451 -- 37,662 $ 15,789
- ----------- -------- -------- -------- --------
Year ended March 31, 2003 $ 47,570 5,881 -- $ 53,451
- ----------- -------- -------- -------- --------
Year ended March 31, 2002 $ 10,000 37,570 -- $ 47,570
- ----------- -------- -------- -------- --------
F-25