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EX-31.1 - E DIGITAL CORP | v187751_ex31-1.htm |
EX-31.2 - E DIGITAL CORP | v187751_ex31-2.htm |
EX-32.1 - E DIGITAL CORP | v187751_ex32-1.htm |
EX-23.1 - E DIGITAL CORP | v187751_ex23-1.htm |
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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, 2010
Commission
file number 0-20734
e.Digital
Corporation
(Exact
name of registrant as specified in its charter)
Delaware
|
33-0591385
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
incorporation
or organization)
|
Identification
Number)
|
16770
West Bernardo Drive
San
Diego, California 92127
(Address
of principal executive offices) (Zip Code)
(858)
304-3016
(Registrant’s
Telephone Number, Including Area Code)
Securities
registered pursuant to Section 12(b) of the
Act: None
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock, par value $.001
(Title of
class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No
¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
¨
Yes ¨ No (not
required)
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ¨
Indicate
by check mark whether registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company
. Seethe definitions of “accelerated
filer,”
“large
accelerated filer,”
and “smaller
reporting company”
in Rule 12b-2 of the Exchange Act. (Check one):
Large
Accelerated Filer ¨ Accelerated
filer ¨ Non-accelerated
filer ¨ Smaller
reporting company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes ¨ No x
The
aggregate market value of the issuer’s Common Stock held by non-affiliates of
the registrant on September 30, 2009 was approximately $41,709,000 based on the
closing price as reported on the NASD’s OTC Electronic Bulletin Board
system.
As of
June 1, 2010 there were 286,950,900shares of e.Digital Corporation Common Stock,
par value $.001, outstanding.
TABLE
OF CONTENTS
Page
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PART
I
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||
ITEM
1.
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Business
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3
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ITEM
1A.
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Risk
Factors
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10
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ITEM
1B.
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Unresolved
Staff Comments
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16
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ITEM
2.
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Properties
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16
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ITEM
3.
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Legal
Proceedings
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17
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ITEM
4.
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Submission
of Matters to a Vote of Security Holders
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17
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PART
II
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||
ITEM
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters
and
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Issuer
Purchases of Equity Securities
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17
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ITEM
6.
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Selected
Consolidated Financial Data
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18
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ITEM
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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18
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ITEM
7A.
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Quantitative
and Qualitative Disclosures about Market Risk
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27
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ITEM
8.
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Financial
Statements and Supplementary Data
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27
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ITEM
9.
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Changes
In and Disagreement With Accountants on Accounting and Financial
Disclosure
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27
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ITEM
9A(T).
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Controls
and Procedures
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27
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ITEM
9B.
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Other
Information
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28
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PART
III
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||
ITEM
10.
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Directors,
Executive Officers and Corporate Governance
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29
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ITEM
11.
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Executive
Compensation
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30
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ITEM
12.
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Security
Ownership of Certain Beneficial Owners and Management and
Related
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Stockholder
Matters
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32
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ITEM
13.
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Certain
Relationships and Related Transactions and Director
Independence
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34
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ITEM
14.
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Principal
Accounting Fees and Services
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34
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PART
IV
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||
ITEM
15.
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Exhibits,
Financial Statement Schedules
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35
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Signatures
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39
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Financial
Statements
|
F-1
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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. BUSINESS
Overview
e.Digital
Corporation (the “Company) is a holding company incorporated under the laws of
Delaware that operates through a wholly-owned California subsidiary of the same
name. We market our eVU® mobile entertainment system for the travel and
recreational industries and licenseand enforce our Flash-R™ portfolio of flash
memory patents for use in portable devices produced by electronic product
manufacturers.
With the
inception of patent license revenue in September 2008, we determined that we
have two operating segments: (1) products and services and (2) patent licensing
and enforcement. Our products and services revenue is derived from the sale of
eVU products and accessories, content integration fees and services and from the
provision of repair and technical support services. Our patent licensing revenue
consists of intellectual property revenues from our Flash-R patent
portfolio.
Our
strategy is to market our eVU products and services to a growing base of U.S.
and international companies for use in the airline, healthcare, and other travel
and leisure industries. We employ direct sales and sales through value added
resellers (“VARs”) that provide marketing, logistic and/or content services to
corporate customers.
We are
commercializing our Flash-R patent portfolio through licensing and we are
aggressively pursuing enforcement by litigating against targeted partiesthat we
believeare infringing our patents. The international law firm of Duane Morris
LLP is handling our patent enforcement matters on a contingent fee basis. During
the period commencing September 2007 through March 2008, we filed complaints
against eight electronic product manufacturers and subsequently licensed and
settled the litigation with seven of the manufacturers and suspended the
complaint against one defendant that filed for bankruptcy. In November 2009 we
filed an additional patent infringement complaint against nineteen companies and
we have subsequently licensed and settled with three companies. While we expect
to file future complaints against additional companies and license additional
companies there can be no assurance of the timing or amounts of any related
license revenue.
Our
Company, then known as Norris Communications, was incorporated in the Province
of British Columbia, Canada on February 11, 1988 and on November 22, 1994
changed its domicile to the Yukon Territory, Canada. On August 30, 1996, we
filed articles of continuance to change our jurisdiction to the State of
Wyoming, then on September 4, 1996, reincorporated in the State of Delaware. On
January 13, 1999, the stockholders approved a name change to e.Digital
Corporation. Our principal executive offices and primary operating facilities
are located at 16770 West Bernardo Drive, San Diego, California 92127 and our
telephone number is (858) 304-3016. Our Internet site is located at www.edigital.com.Information contained in our
Internet site is not part of this annual report.
Background
on Technical Innovations
We have a
record of pioneering technical innovations and achievements in developing
portable electronic products including products developed under contract for
major OEM (original equipment manufacturer) customers. These innovations and
achievements include:
|
·
|
1990
– Released the first commercial ear telephone with an earpiece that
located both the speaker and the microphone in the ear without feedback.
(This was the first product in what ultimately became today’s line of
Jabra hands-free communication
products.)
|
|
·
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1993
– Developed the first portable digital player/recorder with removable
flash memory. Resulted in five U.S. patents on the use of flash memory in
portable devices.
|
|
·
|
1996
– Developed the first high-speed download device to store digital voice
recordings on a personal computer in compressed
format.
|
|
·
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1998
– Developed the first multi-codec (including MP3) portable digital music
player.
|
|
·
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1999
– Delivered an integrated digital voice recorder and computer docking
station system for medical transcription of voice and data for Lanier
Healthcare, LLC.
|
|
·
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2002
– Developed the first voice controlled MP3 player using our VoiceNav
speech navigation system.
|
3
|
·
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2002
– Bang & Olufsen introduced a branded digital audio player (BeoSound
2) developed by us pursuant to a license
agreement.
|
|
·
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2003
– Designed, developed and delivered wireless MP3 headsets employing our
MicroOS™ operating system to Hewlett-Packard for use at Disneyworld in
Orlando, Florida.
|
|
·
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2003
– Licensed our digital audio platform to a multi-billion dollar Asian OEM
for branding to Gateway Computers.
|
|
·
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2003
– Developed the first hard drive-based Hollywood studio-approved portable
inflight entertainment (“IFE”)
device.
|
|
·
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2006
– Introduced eVU, a next generation dedicated mobile entertainment device
with 12+ hours of playback, wireless capability and proprietary content
encryption approved by major
studios.
|
|
·
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2007
– Introduced eVU-ER, an improved dedicated portable IFE player featuring a
new power management technology providing an industry-leading 20+ hours of
continuous video playback from a single battery. eVU is available in
either a 7" or 8" high resolution LCD screen with 160 GB to 200 GB of
rugged and reliable storage.
|
|
·
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2009
–Added new features to eVU including an advanced touch screen
interface.
|
These
technical achievements and our base of technology allow us to rapidly develop or
customize electronic products for our own account or for others.
eVU
Mobile Entertainment System
Our eVU
is a portable audio/video player designed to securely play encrypted content for
the travel, leisure, healthcare and other markets. The primary use of eVU is in
the inflight entertainment (IFE) market. We are a leading producer of dedicated
portable IFE products delivering over 13,000 units since 2003 for airline use.
Our eVU model features sharp images on a 7” or 8” high resolution LCD screen, a
160 GB (Gigabytes) to 200 GB of rugged and reliable storage, high audio
fidelity, dual stereo headphone jacks, optional embedded credit card
reader/processor, optional touch screen capabilities, a full feature graphical
user interface, patent-pending hardware security technology, and 20 hours of
high resolution video playback on a single battery charge. We also have the
capability to add features and customize the product for target markets or
select customers.
We market
and sell our eVU portable mobile entertainment device to corporate customers
directly and through VARs. Generally each batch sale includes logo customization
on the device (for example an airline logo) and an initial content integration
with a customized graphical user interface (“GUI”) (for example the airline logo
appearing on startup, then a listing of content for selection by the end user).
While marketing and sales of eVUs is currently targeted primarily to the airline
industry, we believe it has applications in the healthcare, military, and other
travel and leisure markets.
We have
developed and sell accessory products to our customers and VARs allowing them to
operate a mobile entertainment business. These accessories include e.Digital
Battery Charging Stations to charge and recondition batteries and e.Digital
Content Loading Stations to upload graphical interfaces and content to multiple
players at one time. Customers also may order spare batteries depending on their
requirements.
We also
earn revenues from the provision of content integration, GUI customization,
warranty and technical support and related services to our customers and VARs.
We also offer extended maintenance and refurbishment services for customers. We
periodically integrate customer content with our proprietary GUI software to
produce a master content file (containing content and the customized GUI
interface) for rapid uploading to multiple players. Our GUI allows ease of use
and can accommodate multiple languages. Our tested and Hollywood studio approved
encryption methods protect content from being pirated. These services allow
protected content on eVU players to be periodically updated through e.Digital
Content Loading Stations by our customers or VARs or others on their
behalf.
4
Technology
Our eVU
products are based on our DVAP (Digital Video/Audio Platform) technology. Our
DVAP technology accommodates various third party video compression encoded
material, proprietary security measures and allows for many other customizable
options. Key elements include:
MicroOS
Our
proprietary MicroOS operating system serves as the software foundation for our
DVAP Platform. MicroOS was originally developed by us for use in digital voice
recorder technology, but because of its inherent flexibility, has grown and been
adapted to support audio and video storage and playback and wireless utilities.
MicroOS is compact, efficient and dynamic, responding to a variety of user
interfaces. MicroOS managesthe user interface functions, battery and power
control, the volume and equalizer functions, the LCD drivers and interfaces,
decodesprocesses 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. MicroOS efficiently manages multiple functions within a single device,
utilizing less power, space and operating capacity than many alternative
solutions.
Content Protection
Technology
We have
designed and developed a family of proprietary hardware and software encryption,
digital rights management (“DRM”), key management and data obscuration
technology for content protection. This technology was employed in our prior MP3
player products and in our current eVU products. Our latest eVU product
incorporates an implementation of this family of technology and has been tested
and approved by major Hollywood movie studios. We currently have a U.S. patent
pending on our data security technology.
Flash-R
Patent Portfolio Licensing and Enforcement
We
believe we have an important portfolio of patents (Flash-R patent portfolio)
related to the use of flash memory in portable devices and we are actively
engaged in a strategy to monetize our patent portfolio through licensing and
enforcement. In June 2006 we engaged an intellectual property consultant to
investigate, document and develop the portfolio and to liaison with outside
legal counsel. We, and our advisors, have performed due diligence on our patents
and we believe we have strong intellectual property rights that can be licensed.
Under U.S. law, an inventor or patent owner has the right to exclude others from
making, selling or using their patented invention. Unfortunately, in the
majority of cases, infringers are generally unwilling, at least initially, to
negotiate or pay reasonable royalties for their unauthorized use of third-party
patents and will typically fight any allegations of patent infringement.
Inventors and/or patent holders without sufficient financial or expert technical
resources to bring legal action may lack credibility in dealing with unwilling
licensees and as a result, are often ignored.
As a
result of the common reluctance of patent infringers to negotiate and ultimately
take a patent license for the use of third-party patented technologies without
at least the threat of legal action, patent licensing and enforcement often
begins with the filing of patent enforcement litigation. However, the majority
of patent infringement contentions settle out of court, based on the strength of
the patent claims, validity, and persuasive evidence and clarity that the patent
is being infringed. In March 2007 we selected and engaged the international law
firm Duane Morris LLP to handle certain patent enforcement matters on a
contingent fee basis. In October 2007 we announced that our Company had
commenced enforcement action with respect to our patent portfolio. During the
period from September 2008 through March 31, 2010 we licensed our patent
portfolio to ten licensees. We anticipate bringing additional patent enforcement
actions in the current fiscal year.
We
execute patent licensing arrangements with users of our patented technologies
through willing licensing negotiations and through the negotiation of license
and settlement arrangements in connection with the filing of patent infringement
litigation. We also discuss licenses without the filing of patent infringement
litigation and may enter into some future licenses with licensees without the
filing of a specific patent infringement action against such
licensee.
Some
license agreements include nonexclusive cross licenses and our policy is to
value these only if directly used in operations. To date we have not valued any
cross licenses received as they were considered part of the licensee’s overall
license and settlement strategy and are not currently used in our
products.
Our
Flash-R patent portfolio covers certain aspects of the use of flash memory,
addressing today's large and growing portable electronic products market. In
1993, we unveiled and began marketing the first digital voice recorder with
removable flash memory, powered by MicroOS. In 1996, we produced and began
marketing the first digital voice recorder interface for downloading and
managing voice recordings on the personal computer. The Flash-R portfolio is
protected through the years 2014 – 2016 and includes the following U.S.
patents:
5
|
§
|
US5491774:
Handheld record and playback device with flash
memory
|
|
§
|
US5742737:
Method for recording voice messages on flash memory in a hand held
recorder
|
|
§
|
US5787445:
Operating system including improved file management for use in devices
utilizing flash memory as main
memory
|
|
§
|
US5839108:
Flash memory file system in a handheld record and playback
device
|
|
§
|
US5842170:
Method for editing in hand held
recorder
|
Although
most fees, costs and expenses of the litigation are covered under our contingent
fee arrangement with Duane Morris, we incur support and related expenses for
this litigation. In addition to support from our management team, we currently
have one outside consultant assigned to assist, monitor and support Duane Morris
in our intellectual property litigation and licensing activities.
Markets
and Customers for Our Products and Patent Portfolio
Mobile
Entertainment
Our focus
is on our closed secure system offering high content protection in multiple use
environments. We also see future opportunities to develop devices to meet the
emerging need for digital downloads and portability.
Digital
video players and related content are increasing in popularity with consumers
especially with the emerging and growing use of digital downloads and
portability championed by increasingly sophisticated portable consumer devices.
While there may be future opportunities to develop portable consumer devices,
our focus is on our closed secure system offering high content protection in
multiple use environments such as IFE. We believe the consumer device markets
are extremely competitive and subject to rapid technology changes making
participation expensive and subject to significant risk. We believe there are
applications for closed systems such as our eVU in broad aspects of the travel
and leisure, medical, educational, government and military markets and that
these are growing markets.
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 a published industry 2007
survey, airlines worldwide spent approximately $1.45 billion on IFE
hardware.
Because
the costs to retrofit an aircraft with IFE equipment can be prohibitive, we
developed our alternative IFE system. Our portable IFE player is smaller than a
typical laptop computer and has a high-quality color screen, stereo headphones
and long battery life unattainable by computer based devices. Although
passengers may rent or purchase portable DVD players from outside entities or
bring their own portable device onboard, we created the first hard drive based
portable video player that can be rentedto passengers by the airline. We believe
this type of system is attractive to airlines and other travel-related entities
because of its revenue potential, variety of content, long battery life, content
security and inexpensive implementation.
According
to individual airline reports accumulated in April 2010, the top 10 worldwide
passenger airlineshadabout 4,700 aircraft many that we believe are not equipped
with IFE systems. There are approximately 1,500 airlines worldwide representing
a substantial market for portable IFE devices. Some of our eVU customers include
Lufthansa, Air France, Malaysia Airlines, Alitalia, as well as small short-haul
low cost carriers seeking to provide entertainment to their
customers.
According
to the American Hospital Directory there are over 6,000 hospitals and many
outpatient and other medical facilities in the U.S. that provide a market
opportunity for a portable secure device.We believe the travel and leisure
market also provides a significant market opportunity. This includes over 120
cruise ships operating internationally and over 40,000 hotels with under 150
rooms with many that do not offer in-room movies. Rail, bus, ferries and other
modes of transportation also represent markets for eVU.We also believe there may
be a market for eVU devices in the military on aircraft carriers and in other
settings where personnel have down time and seek entertainment from a robust
device with wide content variety without DVDs or tape.
Flash-R Portfolio
Licensing
We use
the services of an intellectual property consultant to assist us in
investigating and evaluating prospective licensees of our Flash-R patent
portfolio and documenting possible current and past infringement. Our initial
focus is on manufacturers of portable devices employing removable flash memory
although we do not believe our portfolio is limited to this market segment.
While we have identified a large number of products and companies that we
believe are using our patented technology, this is an ongoing process as new
products and companies are identified from our research. To date we have filed
patent infringement litigation and sought licenses from 26 companies with 10
agreeing to license terms during the discovery stage of related litigation.We
believe we are building a track record of demonstrating the strength, validity
and clarity of our patent claims and that we can build a growing licensing
business from our patent portfolio. The timing of future litigation or licensing
is subject to many factors some not within our control.
6
Our
Business Strategy
We are
leveraging and building on a leadership position in the portable IFE market to
market our eVU device to airlines and expand eVU distribution to the healthcare,
military, and other travel and leisure markets. Our objective is to have our
products play a significant role in the IFE and other related markets. We intend
to expand our business by obtaining new IFE airline customers and customers in
the healthcare, military, and other travel and leisure industries. We intend to
use both direct and VAR sales domestically and internationally to grow our
business.
We intend
to continue to monetize our portfolio of patents related to the use of flash
memory in portable devices. We expect to bring additional patent enforcement
actions in the current fiscal year. We consult with advisors and legal counsel
regarding our litigation and licensing strategy including decisions on the
timing of various actions, target companies, jurisdiction of litigation, and
other matters. There can be no assurance we can generate additional future
revenues from this activity.
Manufacturing
We have
developed a turnkey domestic manufacturing relationship with a qualified
contract electronic manufacturer for our eVU product and additional
relationships for important eVU accessories. We believe we can continue to
deliver product timely to future customers. We expect a majority of any fiscal
2011 (year ending March 31, 2011) eVU purchases to be manufactured by this
contract manufacturer. The loss of our manufacturers or the disruption in supply
from manufacturers or in the supply of components by suppliers could have a
material adverse effect on our financial condition, results of operations and
cash flows.
In fiscal
2010 (year ended March 31, 2010) we purchased primary components from various
suppliers with three suppliersaccounting for 44% of total purchases for the
fiscal year (2009 one supplier accounted for 76% of total purchases). Our
manufacturers purchase major electronic components from a limited number of
suppliers.
Marketing,
Sales and Distribution
Marketing
and sales are performed primarily by our President and Chief Executive Officer,
outside sales representatives, and various technical personnel who are involved
in the sales process. Our initial focus has been on international and regional
airlines directly and through a VAR.
A VAR
offers the ability to provide entertainment (movie, television, music,
informational, and/or educational content), supply, content refreshment and
logistic services (recharging and maintenance) and related services for
customers not able or willing to provide such services. In May 2006 we entered
into a VAR agreement with London-based Mezzo Movies Ltd. providing them
exclusive rights to certain customers in the low-cost short-haul airline market
primarily in Europe. Although the agreement and associated exclusive rights have
expired, we are continuing to provide products and services to Mezzo as a VAR
customer.
We seek
to add additional VARs, agents or joint venture partners in the airline and in
our other target markets to expand our distribution. For some customers we may
be required to add new support service capacity such as typically provided by
our larger customers or VARs.
We market
our product and 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. We employ marketing materials to supplement custom marketing
presentations to key prospects. We also employ limited and selected advertising
in targeted industry publications.
We rely
on a combination of management, our intellectual property consultant and legal
counsel in approaching licensees regarding our Flash-R portfolio and in
identifying new target licensees. We have been and may in the future be
approached by companies seeking licenses as awareness of our patent portfolio
becomes better known throughout the electronic industry.
7
Customer
Concentration and Backlog
Revenues
from two licensees each accounted for more than 10% of revenues for the year
ended March 31, 2010 (2009 – five licenses each accounted for more than 10% of
revenues). These licensees paid a one-time fee and accordingly do not provide
ongoing or future revenues. Historically, our product revenues have relied on a
few major customers. There is no assurance we will obtain any revenues from
existing customers in fiscal 2011. We are seeking to expand our eVU customer
base and reduce reliance on a few customers in future periods. We also seek to
license new targeted companies that we believe infringe our patent
portfolio.
Our
backlog fluctuates due to the timing of large orders and other factors. Our
products are manufactured with lead times of generally less than three months.
Our backlog at March 31, 2010 was $265,000 and at March 31, 2009 was $164,000.
Our order backlog does not necessarily indicate future sales trends. Backlog
orders are subject to modification, cancellation or rescheduling by our
customers. Future shipments may also be delayed due to production delays,
component shortages and other production and delivery related
issues.
Research
and Development Costs
For the
years ended March 31, 2010 and 2009, we spent $482,866and $518,649,
respectively, on research and development. We anticipate that we will continue
to devote substantial resources to research and development
activities.
Intellectual
Property
We have
five issued U.S. patents covering our MicroOS file management software and
certain technology related to the use of flash memory in 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.
We have
designed and developed proprietary hardware encryption technology for content
protection. This technology has been used in our products and has been tested
and approved by major Hollywood movie studios. We currently have a patent
application pending with the U.S. Patent Office for this
technology.
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
pursuing trademark applications with the U.S. Patent and Trademark Office and
also have filed certain U.S. 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.
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 also
filefor trade name and trademark protection when appropriate. We are the owner
of U.S. federally registered trademarks including e.Digital®, eVU®, VoiceNav®,
Music Explorer®, Odyssey®,Smart Solutions for a Digital World®, 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 memory and other portable storage
formats.
Competition
Many
large manufacturers currently market various forms of component or handheld
digital video players, including Apple, Panasonic, Sony, Samsung, Hitachi, RCA,
Audiovox, Philips, Daewoo, General Electric, Toshiba and many others. Other
manufacturers may announce products in the future.
8
Competition
in the 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 or rental outfits and custom portable IFE hardware
specifically targeted for airline use. We compete with digEcor, a former
customer that offers a competing product; The IMS Company, with their
Fujitsu-based PEA (personal entertainment appliance) product; Panasonic Avionics
portable IFE product; and products supplied by French consumer electronics
manufacturer, Archos. European producers AIRVOD Entertainment Systems and
Bluebox Avionics advertise portable IFE products that may become competitive to
eVU. Other electronic companies have or have announced products and may become
more active in the portable IFE market. The airline industry may also continue
to opt for embedded IFE systems offered by Panasonic, Thales and others. Motion
picture studios or others could contract competing hardware developers to create
new portable products for the IFE industry. Although our system was designed as
a portable IFE device and has unique features and the support of content
providers, there can be no assurance that other manufacturers will not create
and introduce new 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.
While we
do not compete with others on licensing or specific patents, we compete
generally for the attention and for funds from prospective licensees many of
which are approached frequently regarding licenses and/or are sued for patent
infringement both with and without merit. Regardless of the merits of any
infringement claim many companies find it more economical, especially in the
early stage of litigation, to defend the litigation rather than license. As our
current litigation proceeds, assuming we have success in establishing the merits
of our claims, we believe our competitive position regarding the attention and
funds from prospective licensees will improve. However long-term licensing
success may be dependent upon prevailing in the current litigation or new
litigation to judgment and possible appeal. Technological advances could also
render the use of our patented methods obsolete prior to expiration of the term
of our patents thus reducing amounts of future infringement. There can be no
assurance that we will generate any new licensing or settlement revenue in the
future.
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 and our licensing activities.
Seasonality
Our
current business is not seasonal.
Employees
As of
June 1, 2010, we employed approximately twelve full-time employees and one
part-time employee of whom twowere in production and testing, seven were in
research, development and engineering, four were in sales, general and
administrative. None of our employees are represented by a labor union, and we
are not aware of any current efforts to unionize the employees. Management
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.
Environmental
Compliance and Government Regulation
Our
operations are subject to various foreign, 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.
Portable
electronic devices must comply with various regulations related to electronics
and radiated emissions. Devices for operation on aircraft must comply with
additional emission regulations. RTCA, Inc., a global organization comprised of
industry and government representatives, develops standards to assure the safety
and reliability of all Airborne Electronics (Avionics). Manufacturers of
aircraft electronic equipment selling their products in the United States,
Europe, and around the globe must meet RTCA requirements, including
RTCA/DO-160D. Our eVU is DO-160D-certified for conducted and radiated emissions.
DO-160D is the standard procedures and environmental test criteria for testing
airborne equipment for the entire spectrum of aircraft from light general
aviation aircraft and helicopters through large commercial jets. eVU is also
U.S. FCC and European CE compliant.
9
In
Europe, we are subject to the European Union’s (“EU”) Directive on the
Restriction of Use of Certain Hazardous Substances in Electrical and Electronics
Equipment (“RoHS”). This directive restricts the placement into the EU market of
electrical and electronic equipment containing certain hazardous materials,
including lead, mercury, cadmium and chromium. We are also subject to the EU’s
Waste Electrical and Electronic Equipment Directive (“WEEE”), which regulates
the collective, recovery and recycling of waste from certain electronic
products.
Available
Information
We file
with the Securities and Exchange Commission (“SEC”) our annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports, proxy statements and registration statements. The
public may read and copy any material we file with the SEC at the SEC’s Public
Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may
also obtain information from the Public Reference Room by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding issuers, including us, that file
electronically.
Our
Internet website address is http://www.edigital.com. Our annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any
amendments to those reports filed or furnished pursuant to section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended (“the Exchange Act”)
are available free of charge through our Company’s website as soon as reasonably
practical after those reports are electronically filed with, or furnished to,
the SEC. In addition, copies of the written charters for the committees of our
board of directors, our Code of Conduct, Corporate Governance, Communication and
Whistleblower policies are also available on this website under the About Us and
Management links. We will provide any person, without charge, a copy of our
charters, codes and/or policies upon written request to Investor Relations,
e.Digital Corporation, 16770 West Bernardo Drive, San Diego, California 92127.
We may post amendments or waivers of our charters, codes, or policies, if any,
on our website. This website address is intended to be an inactive textual
reference only, and none of the information contained on our website is part of
this report or is incorporated in this report by reference.
ITEM
1A. RISK FACTORS
Cautionary
Note on Forward Looking Statements
In
addition to the other information in this annual report the factors listed below
should be considered in evaluating our business and prospects. This annual
report contains a number of forward-looking statements that reflect our current
views with respect to future events and financial performance. These
forward-looking statements are subject to certain risks and uncertainties,
including those discussed below and elsewhere herein, that could cause actual
results to differ materially from historical results or those anticipated. In
this report, the words “anticipates,” “believes,” “expects,” “intends,” “future”
and similar expressions identify forward-looking statements. Readers are
cautioned to consider the specific factors described below and not to place
undue reliance on the forward-looking statements contained herein, which speak
only as of the date hereof. We undertake no obligation to publicly revise these
forward-looking statements, to reflect events or circumstances that may arise
after the date hereof.
Financial
Risks
We Have a History
of Losses and May Incur Future Losses. Except for a profit in fiscal
2009, historically we have incurred significant losses and negative cash flow
from operations and we have an accumulated deficit of $80.0 million at March 31,
2010. Our profitability in fiscal 2009 resulted from one-time patent licensing
revenues and there is no assurance of future licensing revenues from new
licensees. Accordingly, we could continue to incur losses in the future until
product, service and/or licensing revenues are sufficient to sustain continued
profitability. Failure to achieve or maintain profitability will likely
negatively impact the value of our securities. Our ability to continue as a
going concern is in doubt and is dependent upon achieving a profitable level of
operations and if necessary obtaining additional financing.
10
Disruptions in
Financial Markets Could Continue to Adversely Affect our Business - As
has been widely reported, financial markets in the United States, Europe and
Asia have experienced extreme disruption in the past two years, including, among
other things, extreme volatility in security prices, severely diminished
liquidity and credit availability, rating downgrades of certain investments and
declining valuations of others. Governments have taken unprecedented actions
intended to address extreme market conditions that include severely restricted
credit and declines in real estate and other asset values. While we believe
these conditions have adversely impacted our customers and our business, it has
not impaired our ability to operate our business. There can be no assurance that
there will not be a further deterioration in financial markets and confidence in
major economies, which can then lead to challenges in the operation of our
business. These economic developments affect businesses such as ours in a number
of ways. The tightening of credit in financial markets adversely affects the
ability of airline customers to finance purchases and operations and could
result in a decrease in orders and spending for our products as well as create
supplier disruptions. Economic and political developments have reduced travel
and recreational spending and we believe adversely affected demand by airlines
and others for our products and services. Financial difficulties of electronics
manufacturers could also delay or reduce the likelihood of future patent
licenses. We are unable to predict the likely duration and severity of the
current disruption in financial markets and adverse economic conditions and the
effects they will have on our business and financial condition.
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:
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Unpredictable
demand and required pricing to secure customers for our products
andservices
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Uncertainty
regarding the timing and amount of any future patent licensing
revenues
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Market
acceptance of our products by our customers and their end
users
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Uncertainties
with respect to future customer product orders, their timing and the
margins to be received, if any
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Fluctuations
in product costs and operating
costs
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Changes
in research and development costs
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Changes
in general economic conditions
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Risks
and costs of warranty claims
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Changes
in technology
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Short
product lifecycles and possible obsolescence of inventory and
materials
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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.
Risks
Related to Product 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 that 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 our 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 product revenues has been derived primarily from a limited number
of customers. The failure to receive orders for and produce products or a
further decline in the economic prospects of the airline industry or our
customers or the products we may produce for sale may have a material adverse
effect on our operations. The airline industry is continuing to face a variety
of economic challenges that may adversely affect the prospects for new orders of
portable IFE systems and adversely affecting future operating
results.
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 on our in-house
executives for the marketing of our products, as well as our licensing business.
Selling products and attracting new business 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.
11
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
OneContract Manufacturer and a Limited Number of Suppliers and Our Business Will
Be Harmed By Any Interruption of Supply or Failure of Performance. We rely on one contract
manufacturer for our eVU product. We depend on our contract manufacturer to (i)
allocate sufficient capacity to our manufacturing needs, (ii) produce acceptable
quality products at agreed pricing and (iii) deliver on a timely basis. We also
rely on limited number of suppliers for eVU accessory products. If a
manufacturer is unable to satisfy our requirements, our business, financial
condition and operating results may be materially and adversely affected. Any
failure in performance by our manufacturers for any reason could have a material
adverse affect on our business. Production and pricing by 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 manufacturer 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 or our intellectual property
consultant may harm our business. Our future success also depends on our ability
to attract, retain and motivate highly skilled employees and consultants.
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 Senior Vice President,
Robert Putnam, also performs investor relations for LRAD Corporation. As a
result of his involvement with LRAD 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 LRAD
Corporation could overlap or conflict.
Risks
Related to our Patent Licensing and Enforcement Strategy
We Face Uncertain
Revenue Prospects from our Patent Enforcement Strategy.We have only
recently recognized revenue from entering into licenses for our portfolio of
flash memory patents and technologies. Our portfolio has not been tested in
court and there is no assurance we can prevail in any current or future patent
litigation. The licensing demand for our patent portfolio is subject to
fluctuation based upon the rate at which target infringers agree to pay
royalties or settle future enforcement actions, if any. There can be no
assurance of future revenues from our strategy of enforcing our flash memory
patent portfolio.Due to the nature of our licensing business and uncertainties
regarding the amount and timing of the receipt of future license fees, if any,
frompotential infringers, stemming primarily from uncertainties regarding the
outcome of enforcement actions, rates of adoption of ourpatented technologies,
the growth rates of our prospective licensees and other factors, our revenues
may vary significantly in the future, which could make our business difficult to
manage, adversely affect our business and operating results, causeour quarterly
and annual results to be below market expectations and adversely affect the
market price of our common stock.
12
Our Fee
Arrangement with Patent Enforcement Counsel Subjects Us to Certain Risks and
Substantial Costs and Fees Could Limit Our Net Proceeds From Any Successful
Patent Enforcement Actions.Our agreement for legal services and a
contingent fee arrangement with Duane Morris LLP provides that Duane Morris is
our exclusive legal counsel in connection with the assertion of our flash memory
related patents against infringers (“Patent Enforcement Matters’). Duane Morris
is advancing certain costs and expenses including travel expenses, court costs
and expert fees. We have agreed to pay Duane Morris a fee equal to 40% of any
license or litigation recovery related to Patent Enforcement Matters, after
recovery of expenses, and 50% of recovery if appeal is necessary. We are not in
control of the timing, costs and fees, which could be substantial and could
limit our share of proceeds, if any, from future patent enforcement actions.
There can be no assurance Duane Morris will diligently and timely pursue patent
enforcement actions on our behalf. In the event we are acquired or sold or we
elect to sell the covered patents or upon certain other corporate events or in
the event we terminate the agreement with Duane Morris for any reason, then
Duane Morris shall be entitled to collect accrued costs and a fee equal to three
times overall time and expenses and a fee of 15% of a good faith estimate of the
overall value of the covered patents. We have provided Duane Morris a lien and a
security interest in the covered patents to secure this obligation. Should any
of the aforementioned events occur, the fees and costs owed to Duane Morris
could be substantial and limit our revenues.
New Legislation,
Regulations or Rules Related to Enforcing Patents Could Significantly Decrease
Our Prospect for Revenue and Increase the Time and Costs Associated with Patent
Enforcement. If new legislation, regulations or rules are implemented
either by Congress, the United States Patent and Trademark Office, or the courts
that impact the patent application process, the patent enforcement process or
the rights of patent holders, these changes could negatively affect our revenue
prospects and increase the costs of enforcement. For example, new rules
regarding the burden of proof in patent enforcement actions could significantly
increase the cost of our enforcement actions, and any new standards or
limitations on liability for patent infringement could negatively impact revenue
derived from such enforcement actions. While we are not aware that any such
changes are likely to occur in the foreseeable future that impact our current
patents, we cannot assure that such changes will not occur.
Should Litigation
Be Required to Enforce Our Patents, Trial Judges and Juries Often Find It
Difficult to Understand Complex Patent Enforcement Litigation, and as a Result,
We May Need to Appeal Adverse Decisions By Lower Courts In Order to Successfully
Enforce Our Patents. It is difficult to predict the outcome of patent
enforcement litigation at the trial level. It is often difficult for juries and
trial judges to understand complex, patented technologies, and as a result,
there is a higher rate of successful appeals in patent enforcement litigation
than more standard business litigation. Such appeals are expensive and time
consuming, resulting in increased costs and delayed revenue. Although we intend
to diligently pursue enforcement litigation if necessary to monetize our
patents, we cannot predict with significant reliability the decisions made by
juries and trial courts.
Federal Courts
are Becoming More Crowded, and as a Result, Patent Enforcement Litigation is
Taking Longer. Any patent enforcement actions we may be required to take
to monetize our patents will most likely be prosecuted in federal court. Federal
trial courts that hear patent enforcement actions also hear other cases that may
take priority over any actions we may take. As a result, it is difficult to
predict the length of time it will take to complete any enforcement
actions.
As Patent
Enforcement Litigation Becomes More Prevalent, It May Become More Difficult for
Us to Voluntarily License Our Patents. We believe that the more prevalent
patent enforcement actions become, the more difficult it will be for us to
voluntarily license our patents to major electronic firms. As a result, we may
need to increase the number of our patent enforcement actions to cause
infringing companies to license our patents or pay damages for lost royalties.
This may increase the risks associated with an investment in our
Company.
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.
13
We May Face
Intellectual Property Infringement Claims That May Be Difficult to Defend and
Costly to Resolve, Which Could Harm Our Business.Although we do not
believe we infringe the proprietary rights of any third parties, we cannot
assure you that third parties will not assert such claims against us in the
future or that such claims will not be successful. We could incur substantial
costs and diversion of management resources to defend any claims relating to
proprietary rights, which could harm our business. In addition, we are obligated
under certain agreements to indemnify the other party for claims that we
infringe on the proprietary rights of third parties. If we are required to
indemnify parties under these agreements, our business could be harmed. If
someone asserts a claim relating to proprietary technology or information
against us, we may seek licenses to this intellectual property. We may not be
able to obtain licenses on commercially reasonable terms, or at all. The failure
to obtain the necessary licenses or other rights may harm our
business.
Risks Related to
Government Regulation, Content and Intellectual Property Government Regulation
May Subject Us to Liability and Require Us to Change the Way We Do
Business.Our business is subject to rapidly changing laws and
regulations. Although our operations are currently based in California, the
United States government and the governments of other states and foreign
countries have attempted to regulate activities on the Internet. Evolving areas
of law that are relevant to our business include privacy law, copyright law,
proposed encryption laws, content regulation and import/export regulations.
Because of this rapidly evolving and uncertain regulatory environment, we cannot
predict how these laws and regulations might affect our business. In addition,
these uncertainties make it difficult to ensure compliance with the laws and
regulations governing the Internet. These laws and regulations could harm us by
subjecting us to liability or forcing us to change how we do business. We are
also subject to regulations for portable electronic devices in various countries
and for the emissions of such devices in aircraft. Failure to comply with these
many regulations could harm our business or require us to repurchase products
from customers.
Compliance With
Current And Future Environmental Regulations May Be Costly, Which Could Impact
Our Future Earnings. We are subject to environmental and other
regulations due to our production and marketing of products in certain states
and countries. We also face increasing complexity in our product design and
procurement operations as we adjust to new and upcoming requirements relating to
the materials composition of our products, including the restrictions on lead
and certain other substances in electronics that apply to specified electronics
products put on the market in the European Union as of July 1, 2006 (Restriction
of Hazardous Substances in Electrical and Electronic Equipment Directive (EU
RoHS)). The European Union has also finalized the Waste Electrical and
Electronic Equipment Directive (WEEE), which makes producers of electrical goods
financially responsible for specified collection, recycling, treatment and
disposal of past and future covered products. Other countries, such as the
United States, China and Japan, have enacted or may enact laws or regulations
similar to the EU RoHS or WEEE Legislation. These and other environmental
regulations may require us to reengineer certain of our existing products to
comply with environmental regulations.
We May Incur
Liability from Our Requirement to Indemnify Certain Customers Regarding
Litigation and Certain Intellectual Property Matters. Our contracts with
major airlines are subject to future performance by us and product warranties
and intellectual property indemnifications including certain remedies, ranging
from modification to product substitution or refund. Should our products be
deemed to infringe on the intellectual property of others the costs of
modification, substitution or refund could be material and could harm our
business and adversely impact our operations.
Our Internal
Control Over Financial Reporting Is Not Adequate and May Result In Financial
Statements That AreIncomplete or Subject To Restatement. Section 404 of
the Sarbanes Oxley Act of 2002 requires significant procedures and review
processes of our system of internal controls. Section 404 requires that we
evaluate and report on our system of internal control over financial reporting
in connection with this Annual Report on Form 10-K. In addition, our independent
registered public accounting firm will be required to report on our internal
controls over financial reporting for the year ending March 31, 2011. The
additional costs associated with this process may be significant.
14
After
documenting and testing our system, we have identified a material weakness in
our accounting and financialfunctions due to a lack of oversight by an
independent audit committee. As a result, our internal control over financial
reporting is not effective. As a result of our internal control over financial
reporting being ineffective, investors could lose confidence in our financial
reports, and our stock price might be adversely affected. In addition, remedying
this or any future material weaknesses that we or our independent registered
public accounting firm might identify, could require us to incur significant
costs and expend significant time and management resources. We cannot assure you
that any of the measures we might implement to remedy any such deficiencies
would effectively mitigate or remedy such deficiencies.
Risks
Related to Trading in Our Common Stock
Sales
of Common Stock
Issuable on the Exercise
of Outstanding
Convertible
Preferred Stock, Warrantsand Options, May Depress
the Price
of Our Common
Stock.As of March 31, 2010, we had preferred stock outstanding
convertible into 5,983,700 shares of our common stock, outstanding warrants to
purchase 7,500,000 shares of our common stock and outstanding options granted to
our employees, directors and consultants to purchase 4,965,500 shares of our
common stock. The exercise prices for the options and warrants range from $0.10
to $0.23per share. In the future we may issue additional convertible securities,
options and warrants. The issuance of shares of common stock issuable upon the
exercise of outstanding or future convertible securities, options or warrants
could cause substantial dilution to holders of common stock, and the sale of
those shares in the market could cause the market price of our common stock to
decline. The potential dilution from these shares could negatively affect the
terms on which we could obtain any future equity financing.
Investing in a
Technology Stock (Such as Ours) May Involve Greater Risk Than Other Investments
Due to Market Conditions, Stock Price Volatility and Other Factors. The trading price of our
common stock has been subject to significant fluctuations to date, and will
likely be subject to wide fluctuations in the future due to:
|
·
|
Quarter-to-quarter
variations in operating results
|
|
·
|
Announcements
of technological innovations by us, our customers or
competitors
|
|
·
|
New
products or significant design achievements by us or our
competitors
|
|
·
|
General
conditions in the markets for the our products or in the electronics
industry
|
|
·
|
The
price and availability of products and
components
|
|
·
|
Changes
in operating factors including delays of shipments, orders or
cancellations
|
|
·
|
General
financial market conditions
|
|
·
|
Market
conditions for technology stocks
|
|
·
|
Litigation
or changes in operating results or estimates by analysts or
others
|
|
·
|
Or
other events or factors
|
In
addition, potential dilutive effects of future sales of shares of common stock
by stockholders and by the Company and subsequent sale of common stock by the
holders of warrants and options could have an adverse effect on the market price
of our shares.
We do not
endorse and 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 $0.10 to a high of $0.225 in the last fiscal year. In
addition, our common stock is subject to Rules 15g-1-15g-6 promulgated under the
Exchange Act 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 Securities and Exchange Commission has also adopted
regulations which define a “penny stock” to be any equity security that has a
market price (as defined) of less than $5.00 per share or an exercise price of
less than $5.00 per share, subject to certain exceptions. For any transaction
involving a penny stock, unless exempt, the regulations require the delivery,
prior to the transaction, of a disclosure schedule prepared by the Securities
and Exchange 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.
15
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 Exchange Act 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 both from product sales and licensing 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
1B. UNRESOLVED STAFF COMMENTS
None
ITEM
2. PROPERTIES
In March
2006, we entered into a sixty-two month lease, commencing June 1, 2006, for
approximately 4,800 square feet at 16770 West Bernardo Drive, San Diego,
California with a current aggregate monthly payment of $6,344 excluding
utilities and costs. The aggregate payments adjust annually with
maximum aggregate payments totaling $6,535 in the fifty-first through the
sixty-second month.
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.
16
ITEM
3. LEGAL PROCEEDINGS
Business
Litigation
On
November 13, 2009 we entered into a settlement agreement ending certain
litigation with digEcor, Inc. (“digEcor”)
agreeing to waive any right to appeal prior Court’s rulings and orders in favor
of the Company and the Company withdrawing its applications for costs of suit.
The agreement also reduced and settled the judgment (related to batteries) to
$60,000 from $80,000 that we had previously accrued resulting in $20,000 of
other income. The agreement included standard mutual release of claims and
covenants not to sue.
Intellectual Property
Litigation
In
September 2007 and March 2008, we filed complaints against eight electronic
product manufacturers in the U.S. District Court for the Eastern District of
Texas asserting that products made by the companies infringefour of our U.S.
patents covering the use of flash memory technology. These patents are part of
our Flash-R patent portfolio. By September 30, 2009 we had licensed and settled
the litigationwith seven of the manufacturers and suspended the complaint
against one defendant in bankruptcy.
In
November 2009 we filed an additional patent infringement complaint in the United
States DistrictCourt for the District of Colorado against nineteen companies
that manufacture devices using flash memory. ByMarch 31, 2010 we had licensed
and settled the litigation with three of the defendants.
Although
most fees, costs and expenses of intellectual property litigation are covered
under our arrangement with Duane Morris LLP as described above, we may incur
support and related expenses forthis litigation that may become
material.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART
II
ITEM
5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES
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.
Low
|
High
|
|||||||
Fiscal
year ended March 31, 2009
|
||||||||
First
quarter
|
$ | 0.08 | $ | 0.16 | ||||
Second
quarter
|
$ | 0.08 | $ | 0.18 | ||||
Third
quarter
|
$ | 0.08 | $ | 0.16 | ||||
Fourth
quarter
|
$ | 0.10 | $ | 0.20 | ||||
Fiscal
year ended March 31, 2010
|
||||||||
First
quarter
|
$ | 0.10 | $ | 0.17 | ||||
Second
quarter
|
$ | 0.10 | $ | 0.16 | ||||
Third
quarter
|
$ | 0.15 | $ | 0.215 | ||||
Fourth
quarter
|
$ | 0.124 | $ | 0.155 |
Holders
At June
1, 2010 there were 286,950,900 shares of common stock outstanding and
approximately 2,854 stockholders of record.
17
Dividends
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.
Equity
Compensation Plan Information
The
following table sets forth information as of March 31, 2010, with respect to
compensation plans (including individual compensation arrangements) under which
our equity securities are authorized for issuance, aggregated as
follows:
Plan Category
|
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
(a)
|
Weighted-average exercise
price of outstanding
options, warrants and
rights
(b)
|
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
|
|||||||||
Equity
compensation plans approved by security holders
|
4,715,500 | $ | 0.14 | 4,910,000 | ||||||||
Equity
compensation plans not approved by security holders (1)
|
250,000 | $ | 0.16 | -0- | ||||||||
Total
|
4,965,500 | $ | 0.15 | 4,910,000 |
(1)
consists of 250,000 shares of common stock granted to a consultant vesting on a
performance basis with an exercise price of $0.16 per share.
Recent
Sales of Unregistered Securities
Nounregistered
securities were issued during the fiscal year that were not previously reported
in a Quarterly Report on Form 10-Q or Current Report on Form 8-K.
Issuer
Purchases of Equity Securities
Not
applicable.
ITEM
6. SELECTED CONSOLIDATED FINANCIAL DATA
Not
applicable.
ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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
We are a
holding company incorporated under the laws of Delaware that operates through a
wholly-owned California subsidiary of the same name. We market our eVU mobile
entertainment system for the travel and recreational industries and licenseand
enforce our Flash-R portfolio of flash memory patents for use in portable
devices produced by electronic product manufacturers.
18
With the
inception of patent license revenue inSeptember 2008, we determined that we have
two operating segments: (1) products and services and (2) patent licensing and
enforcement. Our products and services revenue is derived from the sale of eVU
products and accessories to customers, warranty and technical support services
and content integration fees and related services. Our patent licensing and
enforcement revenue consists of intellectual property revenues from our Flash-R
patent portfolio.
Our
strategy is to market our eVU products and services to a growing base of U.S.
and international companies for use in the airline, healthcare, and other travel
and leisure industries. We employ direct sales and sales through value added
resellers (VARs) that provide marketing, logistic and/or content services to
corporate customers.
We are
commercializing our Flash-R patent portfolio through licensing and we are
aggressively pursuing enforcement by litigating against targeted parties that we
believe are infringing our patents. The international law firm of Duane Morris
LLP is handling our patent enforcement matters on a contingent fee basis. During
the period commencing September 2007 through March 2008, we filed complaints
against eight electronic product manufacturers and subsequently licensed and
settled the litigation with seven of the manufacturers and suspended the
complaint against one defendant that filed for bankruptcy. In November 2009 we
filed an additional patent infringement complaint against nineteen companies and
we have subsequently licensed and settled with three companies. While we expect
to file future complaints against additional companies and license additional
companies there can be no assurance of the timing or amounts of any related
license revenue.
Our
business is high risk in nature. There can be no assurance we can achieve
sufficient eVU or patent license revenues to sustain profitability. We continue
to be subject to the risks normally associated with introducing new products,
services and technologies, including unforeseeable expenses, delays and
complications. Accordingly, there is no guarantee that we can or will report
operating profits in future periods.
Overall
Performance and Trends
We
focused significant efforts on developing, licensing and enforcing our patent
portfolio in the fiscal years ended March 31, 2010 and 2009. We successfully
completed our first round of enforcement litigation in September 2009 when we
licensed the last of the remaining original defendants. In November 2009 we
filed additional enforcement actions against nineteen defendants, licensed our
first customer from the second round in December 2009 and by March 31, 2010 had
licensed a total of three licensees from the second round. There is a reluctance
of patent infringers to negotiate and ultimately take a patent license without
at least the threat of legal action. However, the majority of patent
infringement contentions settle out of court, based on the strength of the
patent claims, validity, and persuasive evidence and clarity that the patent is
being infringed. We believe we are building a track record of demonstrating the
strength, validity and clarity of our patent claims and that we can result in
significant future revenues from our patent portfolio.
Our eVU
IFE business remained slow during both fiscal 2010 and 2009 primarily due to
airline economics. While we are seeing increased activity and an increased
backlog at March 31, 2010 from recent orders, we are unable to predict future
sales levels in this market as orders are sporadic from both existing and new
customers. We continue to pursue business in the airline and other markets for
our eVU product line.
While we
reported a profit for the fiscal year ended March 31, 2009 (fiscal 2009), in
prior years and in the year just completed (fiscal 2010) we have incurred losses
and negative cash flow from operations. We expect to incur losses in the future
until product, service and/or licensing revenues are sufficient to sustain
continued profitability. Our ability to continue as a going concern is in doubt
and is dependent upon achieving a profitable level of operations and if
necessary obtaining additional financing.
For the
year ended March 31, 2010:
|
·
|
We
recognized a net lossof $809,420 compared to net income of $2,933,986 for
fiscal 2009. The difference in results was primarily attributable to lower
license revenues due to the timing and amount of individual license
agreements.
|
|
·
|
Our
revenues were $2.6 million in fiscal 2010 compared to $11.1 million in
fiscal 2009. During fiscal 2009 we licensed six companies out of our first
round of litigation. We filed our second round of litigation in November
2009 and licensed one last company from the first round and three
companies from the second round. As a result of the timing of such license
agreements our licensing revenues in fiscal 2010 were $1.6 million
compared to $10.1 million in fiscal 2009. eVU product and service revenues
were $954,000 in fiscal 2010 compared to $940,000 in fiscal
2009.
|
19
|
·
|
Our
gross profit for the year ended March 31, 2010 was $1.3 million or 51% of
revenues compared to $6.5 million or 59% of revenues for the comparable
prior year as a result of the reduced licensing
revenue.
|
|
·
|
Operating
expenses were $2.2 million for fiscal 2010 reduced from the $2.8 million
infiscal 2009primarily as a result of reduced legal fees from the
favorable conclusion of litigation with a former customer in November
2009.
|
Management
faces challenges in fiscal 2011 to execute its plan to grow product and service
revenues andincrease Flash-R patent portfolio license fees.The failure to obtain
additional patent license revenues or eVU orders or delays of orders or
production delays could have a material adverse impact on our operations. Our
patent licensing business is subject to significant uncertainties as to the
timing and amount of future license revenues, if any. We may also face
unanticipated technical or manufacturing obstacles and face warranty and other
risks in our business.
Critical
Accounting Policies and Estimates
The
discussion and analysis of our financial condition and results of operations is
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 but not limited to those related to revenue recognition, bad debts,
inventory valuation, intangible assets, financing operations, warranty
obligations, stock-based compensation, fair values, derivatives, income taxes,
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 that, of the significant accounting policies discussed in Note 2 to our
consolidated financial statements, the following accounting policies require our
most difficult, subjective or complex judgments:
|
·
|
revenue
recognition;
|
|
·
|
stock-based
compensation expense;
|
|
·
|
derivative
instruments and preferred stock;
and
|
|
·
|
income
taxes.
|
We
discuss below the critical accounting assumptions, judgments and estimates
associated with these policies. Historically, our assumptions, judgments and
estimates relative to our critical accounting policies have not differed
materially from actual results. For further information on our critical
accounting policies, refer to Note 2 to the consolidated financial statements
included herein.
Revenue
Recognition
As
described below, significant management judgments must be made and used in
connection with the revenue recognized in any accounting period. Material
differences may result in the amount and timing of revenue recognized or
deferred for any period, if management made different judgments.
We
recognize revenue in accordance with ASC Topic 605, Revenue
Recognition. Revenue is recognized when (i) persuasive evidence of
an arrangement exists, (ii) all obligations have been substantially performed
pursuant to the terms of the license agreement, (iii) amounts are fixed or
determinable and (iv) collectibility of amounts is reasonably
assured.
We make
estimates and judgments when determining whether the collectibility of product,
service or license fees receivable from customers is reasonably assured. We
assess the collectibility of our receivables based on a number of factors,
including past transaction
history and the credit-worthiness of customers. Management estimates regarding
collectibility impact the actual revenues recognized each period and the timing
of the recognition of revenues. Our assumptions and judgments regarding future
collectibility could differ from actual events, thus materially impacting our
financial position and results of operations.
20
Certain
license agreements provide for the payment of contractually determined paid-up
license fees in consideration for the grant of a non-exclusive, retroactive and
future license to manufacture and/or sell products covered by our patented
technologies. Generally, the execution of these license agreements also provide
for the release of the licensee from certain past and future claims, and the
dismissal of any pending litigation. Pursuant to the terms of these agreements,
we have no further obligation with respect to the grant of the non-exclusive
retroactive and future license and related releases, including no express or
implied obligation to maintain or upgrade the technology, or provide future
support or services. Generally, the agreements provide for the grant of the
license and releases upon execution of the agreement. As such, the earnings
process is generally complete upon the execution of the agreement, and as a
result, revenue is recognized upon execution of the agreement, when
collectibility is reasonably assured, and all other revenue recognition criteria
have been met. While most licenses contain similar standard provisions,
management must evaluate each agreement and make judgments to assure that
substantial delivery of contract elements has occurred, whether any significant
ongoing obligations exist subsequent to contract execution, whether amounts due
are collectible and the appropriate period or periods, in which, or during
which, respectively, the completion of the earning process occurs. Depending on
the magnitude of specific license agreements, if different judgments,
assumptions and estimates are made regarding contracts executed in any specific
period, our periodic financial results may be materially affected.
In fiscal 2010 we entered
into our first licenses providing for future royalties based on future
licensee activities. Licensees that pay license fees on a periodic basis are
required to report to us actual activity after the activity takes place. The
amount of license fees due under these license agreements each period cannot be
reasonably estimated by management. Consequently, we will recognize revenue from
these licensing agreements on a lag basis as royalties are reported provided
amounts are fixed or determinable and collectibility is reasonably assured. The
lag method allows for the receipt of licensee royalty reports prior to the
recognition of revenue.Differences between
amounts recognized and amounts that could subsequently be audited or reported as
anadjustment to those amountswill be recognized in the period such adjustment is
determined as a change in accounting estimate.
Some
license agreements include nonexclusive cross licenses and our policy is to
value these only if directly used in operations. To date the we have not valued
any cross licenses received as they were considered part of the licensee’s
overall license and settlement strategy and are not used in our products.
However we must evaluate each license with cross license rights to determine
what is being cross licensed and if it is used in our products and this requires
management to make judgments that affect our operations.
Stock-Based
Compensation
ASC Topic
718, “Compensation – Stock
Compensation,” or ASC 718, sets forth the accounting requirements
for“stock-based” compensation payments to employees, non-employee directors and
consultants and requires all stock based-payments to be recognized as expense in
the statement of operations. The compensation cost for all stock-based awards is
measured at the grant date, based on the fair value of the award (determined
using a Black-Scholes option pricing model), and is recognized as an expense
over the requisite service period (generally the vesting period of the equity
award). Determining the fair value of stock-based awards at the grant date
requires significant estimates and judgments, including estimating the market
price volatility of our common stock, future employee stock option exercise
behavior and requisite service periods. Due to our limited exercise history we
applied the simplified method prescribed by SEC Staff Accounting Bulletin 110,
Share-Based Payment: Certain
Assumptions Used in Valuation Methods - Expected Term, to estimate
expected life.
Options
or stock awards issued to non-employees who are not directors are recorded at
their estimated fair value at the measurement date and are periodically revalued
as the options vest and are recognized as expense over the related service
period on a graded vesting method. Stock options issued to consultants with
performance conditions are measured and recognized when the performance is
complete.
ASC Topic
718 requires stock-based compensation expense to be recorded only for those
awards expected to vest using an estimated pre-vesting forfeiture rate. As such,
ASC Topic 718 requires us to estimate pre-vesting option forfeitures at thetime
of grant and reflect the impact of estimated pre-vesting option forfeitures on
compensation expense recognized. Estimates ofpre-vesting forfeitures must be
periodically revised in subsequent periods if actual forfeitures differ from
those estimates. Weconsider several factors in connection with our estimate of
pre-vesting forfeitures including types of awards, employee class, andhistorical
pre-vesting forfeiture data. The estimation of stock awards that will ultimately
vest requires judgment, and to the extentthat actual results differ from our
estimates, such amounts will be recorded as cumulative adjustments in the period
the estimatesare revised. If actual results differ significantly from these
estimates, stock-based compensation expense and our results ofoperations could
be materially impacted.
Refer to
Notes 2 and 10 to our consolidated financial statements included in this report
for moreinformation.
Derivative Instruments and
Preferred Stock
We value
derivative instruments in accordance with the interpretative guidance of ASC
815-40, Derivatives and
Hedging – Contracts in Entity’s Own Equity related to the classification
and measurement of warrants and instruments with embedded conversion features.
We make certain assumptions and estimates to value our derivative liabilities.
Factors affecting these liabilities and values include changes in the stock
price and other assumptions.
21
We
accounted for preferred stock issued in fiscal 2009 that was subject to
provisions for redemption outside of our control as mezzanine equity in
accordance with ASC 480Distinguishing Liabilities from
Equity and recorded the values net of discounts for warrant values and
beneficial conversion features. These securities were recorded at fair value at
the date of issue and related discounts are being accreted over the term of the
securities. The securities were reclassified to permanent equity when the
provisions for redemption were terminated. We accounted for the related warrants
as a derivative instrument as defined in ASC 815 and treated the warrants as a
liability due to the lack of sufficient authorized shares of common stock. Upon
the authorization and reservation of shares of common stock for exercise of the
warrants we determined the warrants were no longer a derivative liability and we
reclassified the value at that date to paid-in capital. We also
determined that the termination of certain warrant redemption rights was an
effective modification of the warrant term and calculated the fair value of the
warrants immediately prior to the modification compared to the value immediately
after the modification and recorded the difference in warrant value in other
finance expenses. These matters required us to make significant assumptions and
estimates about stock volatility, stock prices and other
assumptions.
Income
Taxes
In
preparing our consolidated financial statements, we estimate our income taxes in
each of the countries inwhich we operate. While we believe we operate only in
the United States, certain licensees have withheld taxes on license payments in
foreign countries. During fiscal 2009 we determined that it was unlikely we
could recover a refund of foreign taxes withheld and that we could only use the
foreign taxes as a future credit against U.S. taxes. However in fiscal 2010 we
obtained a refund of $264,000 of foreign taxes. An additional $206,250 of
foreign taxes were withheld in fiscal 2010 and due to regulatory changes in the
foreign jurisdiction we believe it unlikely we can obtain a refund of these
taxes withheld and that they may only be used as a foreign tax credit. These
matters regarding foreign taxes requires us to make judgments and estimates
based on various assumptions and these affect our reported
operations.
Our
determination of income tax expense or benefit requires estimates including an
assessment of the current tax expense and the effects of temporary differences
resulting from the different treatment of transactions fortax and financial
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included inour consolidated balance sheet. The Company
accounts for deferred income taxes utilizing an asset and liability
method,whereby deferred tax assets and liabilities are recognized based on the
tax effects of temporary differences between thefinancial statements and the tax
bases of assets and liabilities, as measured by current enacted tax rates.
Deferred tax assetsare reduced by a valuation allowance if it is more likely
than not that some portion or all of the deferred tax asset will notbe realized.
We evaluate the realizability of our deferred tax assets by assessing our
valuation allowance and by adjustingthe amount of such allowance, if necessary.
At March 31, 2010, we had net deferred tax assets primarily resulting
fromtemporary differences between the book and tax bases of assets and
liabilities, and loss and credit carry forwards. Wecontinue to provide a 100%
valuation allowance our deferred tax assets based on an assessment of the
likelihood of theirrealization. In reaching our conclusion, we evaluated certain
relevant criteria including deferred tax liabilities that can beused to offset
deferred tax assets, estimates of future taxable income of appropriate character
within the carry-forwardperiod available under the tax laws, and tax planning
strategies. Our judgments regarding future taxable income maychange due to
market conditions, changes in U.S. or international tax laws, our business and
results ofoperations, and other factors. These changes, if any, may require
material adjustments to these deferred tax assets,resulting either in a tax
benefit, if it is estimated that future taxable income is likely, or a reduction
in the value of thedeferred tax assets, if it is determined that their value is
impaired, resulting in a reduction in net income or an increase innet loss in
the period when such determinations are made.
Our
income tax provision is based on calculations and assumptions that will be
subject to examination by the taxing authorities in the jurisdictions in which
we operate. Should the actual results differ from our estimates, we would have
to adjust the income tax provision in the period in which the facts and
circumstances that give rise to the revision become known. Tax law and rate
changes are reflected in the income tax provision in the period in which such
changes are enacted.
Other
We do not
have off-balance sheet transactions, arrangements or
obligations. Inflation has not had any significant impact on our
business.
Recently
Issued Accounting Standards
See Note 2 to our
consolidated financial statements included herein for a description of
significant recent accounting standards.Other accounting standards have
been issued or proposed by the FASB or other standards-setting bodies that do
not require adoption until a future date and are not expected to have a material
impact on our consolidated financial statements upon adoption.
22
Results
of Operations
Year
ended March 31, 2010 Compared to Year ended March 31, 2009
Year Ended March 31,
|
||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||
% of
|
% of
|
Change
|
||||||||||||||||||||||
Dollars
|
Revenue
|
Dollars
|
Revenue
|
Dollars
|
%
|
|||||||||||||||||||
Revenues:
|
||||||||||||||||||||||||
Products
|
204,735 | 8 | % | 362,079 | 3 | % | (157,344 | ) | (43 | )% | ||||||||||||||
Services
|
749,134 | 29 | % | 578,303 | 5 | % | 170,831 | 30 | % | |||||||||||||||
Patent
license
|
1,600,000 | 63 | % | 10,115,350 | 91 | % | (8,515,350 | ) | (84 | )% | ||||||||||||||
2,553,869 | 100 | % | 11,055,732 | 100 | % | (8,501,863 | ) | (77 | )% | |||||||||||||||
Gross
Profit:
|
||||||||||||||||||||||||
Product
gross profit (loss)
|
(94,343 | ) | (4 | )% | 43,407 | 0 | % | (137,750 | ) | (317 | )% | |||||||||||||
Service
gross profit
|
421,352 | 16 | % | 369,281 | 3 | % | 52,071 | 14 | % | |||||||||||||||
Patent
license
|
985,085 | 39 | % | 6,131,263 | 55 | % | (5,146,178 | ) | (84 | )% | ||||||||||||||
1,312,094 | 51 | % | 6,543,951 | 59 | % | (5,231,857 | ) | (80 | )% | |||||||||||||||
Operating
Expenses:
|
||||||||||||||||||||||||
Selling
and administrative
|
1,707,814 | 67 | % | 2,325,359 | 21 | % | (617,545 | ) | (27 | )% | ||||||||||||||
Research
and related
|
482,866 | 19 | % | 518,649 | 5 | % | (35,783 | ) | (7 | )% | ||||||||||||||
2,190,680 | 86 | % | 2,844,008 | 26 | % | (653,328 | ) | (23 | )% | |||||||||||||||
Other
expenses
|
13,916 | 1 | % | (344,457 | ) | (3 | )% | 358,373 | (104 | )% | ||||||||||||||
Income
(loss) before provision for income taxes
|
(864,670 | ) | (34 | )% | 3,355,486 | 30 | % | (4,220,156 | ) | (126 | )% |
Income
(loss) before provision for income taxes
The loss
before income tax benefit in fiscal 2010 resulted from reduced patent license
revenues. The income in the prior year was the result of significant license
revenues and related margins as discussed below. Since patent license revenues
to date have been one-time with each licensee, they are non-recurring and
accordingly there is no assurance of any future patent license revenues. We
cannot predict future license revenue from new license agreements providing for
periodic future payments tied to licensee activity.
Revenues
Revenues
for the year ended March 31, 2010 included $1,600,000 of one-time non-recurring
patent license revenue and $953,869 of eVU product and service revenues. Our
product revenues declined in part as a result of airline industry economics
resulting in reduced IFE activity. While our backlog shows an increase in recent
activity, this business is expected to continue to be sporadic in future
quarters.Our service revenues increased as a result of both increased content
related services from year over year increases in aggregate customers and from
increased repair and maintenance revenues as prior year customers are using
products no longer under warranty.
Revenues
for the year ended March 31, 2009 included $10,115,350 of one-time non-recurring
patent license revenue and $940,382 of eVU product and service revenues. We have
not yet recognized any periodic reported revenue from license agreements
providing for future royalties. In the prior year we entered into six licenses
and in the current year a total of four licenses. License fee revenues
recognized fluctuate significantly from period to period primarily based on the
following factors:
|
·
|
the
dollar amount of agreements executed each period, which is primarily
driven by the magnitude of infringement associated with a specific
licensee;
|
|
·
|
the
specific terms and conditions of agreements executed each period and the
periods of infringement contemplated by the respective payments;
and
|
|
·
|
fluctuations
in the number of agreements
executed.
|
23
In the
future the following additional factors could also impact revenue
variability:
|
·
|
fluctuations
in the sales results or other royalty per unit activities of our licensees
that impact the calculation oflicense fees
due;
|
|
·
|
the
timing of the receipt of periodic license fee payments and/or reports from
licensees.
|
Prior
year licenses included larger companies with greater magnitude of
infringement.
eVU
product sales activity has been slow during the last two years due to airline
industry economics and industry credit concerns resulting in airlines curtailing
expansion and new projects. We had backlog at March 31, 2010 of $265,000
compared to $164,000 at prior year end with the increase reflecting recent new
orders. We are pursuing new eVU business and targeting new patent licensees but
our results will continue to be dependent on the timing and quantity of eVU
orders and the timing and amount of future patent licensing arrangements, if
any. While our service revenues increased in the last year, future levels depend
on the number of customers that continue to utilize our product for IFE. Loss of
customers for which we provide content or maintenance and service revenue,
generally without long-term agreements, would negatively impact future service
revenues.
Gross
Profit
Gross
profit for fiscal 2010 was $1,312,094 or 51% of revenues. The gross
profit on product and service revenues was 34% and the gross profit on patent
licensing fees was 62% of license revenues. Gross profit for fiscal 2009 was
$6,543,951 or 59% of revenues. The gross profit on product and
service revenues was 44% and the gross profit on patent licensing fees was 61%
of license revenues. The reduction in product and service gross profit in the
current year was impacted by a $65,459 market adjustment to reduce inventory
values to the lower-of-cost or market primarily due to competitive conditions in
the IFE industry affecting planned future pricing on certain products.License
revenue costs of revenues consists primarily of contingency legal and
other direct costs associated with patent licensing.Gross profit margins
are highly dependent on revenue mix, prices charged, volume of orders,
contingency patent legal fees and costs.Management does not believe historical
gross profits percentages can be relied on as an indicator of results from
future revenues.
Operating
Expenses
Selling
and administrative costs decreased by $617,545 from fiscal 2009 to fiscal 2010.
This included a $533,000 reduction in legal fees primarily related to the
favorable resolution of customer litigation in November 2009. Salaries and
benefits decreased $205,000 primarily due to a reduction in senior management
personnel in January 2009 and other staffing reductions due to reduced eVU
activity. Professional fees increased by $71,000 primarily as a result of fees
paid to foreign tax experts that assisted in obtaining refunds ofwithheld
foreign income taxes. Noncash stock-based compensation costs increased $81,000
to $129,625 primarily due to the immediate vesting of option grants made in
fiscal 2010.
Research
and related expenditures were comparable for the two years. Stock-based
compensation expenses were $26,703 in fiscal 2010 and $26,620 in fiscal 2009. We
expect future research and development costs to be comparable to the most recent
year due to current staffing levels and projects. Should we elect to develop
significant new products or major revisions to our existing products we may
require increased internal and external research and development
costs.
Other
Income (Expenses)
Net other
expenses were $344,457 for the year ended March 31, 2009andincluded $163,559 of
interest expense including $80,300 of non-cash interest from the amortization of
debt discount and $181,157 of non-cash warrant and other finance related
expenses. Due to reduced debt balances our interest expense in fiscal 2010 was
only $17,099 and we recognized $31,015 of other income including a $20,000 gain
from reduction of amounts owed related to litigation.
Benefit
(Provision) for Income Taxes
The
provision for income taxes for the year ended March 31, 2009 of $421,500
consisted of foreign taxes withheld and paid of $264,000 on license revenues and
$157,500 accrued for California state taxes. The deferred tax expense of
$868,000 was offset by a benefit related to the decrease of the deferred tax
asset valuation allowance. The Company generated a tax liability in the state of
California due to recent legislation suspendingNOL carryforwards for the 2008
and 2009 tax years. The state tax liability of $157,500 was after a reduction of
50% from the use of allowable R&Dcredits generated in prior
years.
During
the year ended March 31, 2010 we obtained a refund of the $264,000 of foreign
taxes paid in the prior year that we previously judged was not probable of
recovery. We paid $206,250 of foreign taxes related to license revenues and due
to tax law changes we do not believe it probable that this amount can be
recovered other than as applied as a foreign tax credit. The deferred tax
benefit of $256,000 was offset by change in the valuation
allowance.
24
Income
(Loss) Attributable to Common Stockholders
The loss
attributable to common stockholders for the year ended March 31, 2010 included
the net loss after tax benefit of $809,420 increased by accrued and deemed
dividends on convertible preferred stock of $175,139 or a net loss attributable
to common stockholders of $984,559. The income attributable to common
stockholders for the year ended March 31, 2009 included the net income after
taxes of $2,933,986 reduced by accrued and deemed dividends on convertible
preferred stock of $130,320 or a net income attributable to common stockholders
of $2,803,666.
Liquidity
and Capital Resources
2009
|
2010
|
2009 to 2010
variance in $'s
|
2009 to 2010
variance in %'s
|
|||||||||||||
(in thousands, except percentages)
|
||||||||||||||||
Working
capital
|
$ | 3,277 | $ | 2,966 | $ | (311 | ) | (9.5 | )% | |||||||
Cash
and cash equivalents
|
$ | 3,814 | $ | 2,819 | $ | (995 | ) | (26 | )% | |||||||
Total
assets
|
$ | 4,478 | $ | 3,334 | $ | (1,144 | ) | (26 | )% |
2009
|
2010
|
2009 to 2010
variance in $'s
|
2009 to 2010
variance in %'s
|
|||||||||||||
Net
cash provided by (used in)
|
(in
thousands, except percentages)
|
|||||||||||||||
Operating
activities
|
$ | 2,837 | $ | (944 | ) | $ | (3,781 | ) | (133 | )% | ||||||
Investing
activities
|
$ | (4 | ) | $ | (3 | ) | $ | 1 | 25 | % | ||||||
Financing
activities
|
$ | 859 | $ | (48 | ) | $ | (907 | ) | (106 | )% |
At March
31, 2010, we had working capital of $3.0 million compared to a working capital
deficit of $3.3 million for the prior year. We had $109,000 and $94,000 of
working capital invested in accounts receivable at March 31, 2010 and 2009,
respectively. Our terms to customers vary but we often require payment prior to
shipment of product and any such payments are recorded as deposits. We expect
certain airline customers to demand commercial terms such as 30 or 60 days in
the future and this could increase our need for working capital. Patent license
payments are normally due at signing of the license or within 30-45
days.
Operating
Activities
For the
year ended March 31, 2010, net cash decreased by $995,000. Cash used by
operating activities was $944,000. Cash used by operating activities included
the net loss of $809,000reduced by net non-cash expenses of $267,000. Major
components also providing operating cash was a decrease of $105,000 in inventory
and an increase of $61,000 in deferred revenue due to increased paid orders not
yet delivered at March 31, 2010. Major components using operating cash included
a $151,000 decrease in accounts payable and a $341,000 decrease in accrued
liabilities primarily resulting from decreases in litigation related accruals
due to favorable resolution of such litigation and a reduction in state taxes
payable due to losses in the current year versus income in the prior
year.
For the
year ended March 31, 2009, net cash increased by $3.69 million. Cash provided by
operating activities was $2.84 million. Cash provided by operating activities
included income of $2.93 million increased by net non-cash expenses of $294,000.
Major components also providing operating cash was a decrease of $81,000 in
accounts receivable and an increase of $226,000 in accrued liabilities. Major
components using operating cash included a $28,000 increase in inventory and a
$583,000 decrease in accounts payable.
Investing
Activities
The
Company’s efforts are primarily on operations and currently we have no
significant investing capital needs. We have no commitments requiring investment
capital.
Financing
Activities
For the
year ended March 31, 2010, we used $47,865 of cash to make the final convertible
term note payment in November 2009. We made $350,000 of additional payments for
the seven prior months in shares of common stock issuing 2,705,515 restricted
shares. A total of $212,083 of preferred stock and accumulated dividends was
converted to common stock during the year through the issuance of 2,120,821
shares of common stock.
25
For the
year ended March 31, 2009, cash provided by financing activities was $859,000.
This included $660,000 from the sale of common stock during the year to Fusion
Capital Fund II, LLC (“Fusion”) and $700,000 cash from the sale of preferred
stock. We paid off our secured note balance of $450,000 and made term principal
payments of $51,000. During the prior year we obtained $960,000 from the sale of
common stock to Fusion, obtained $226,000 from exercises of warrants and options
and made secured note payments of $300,000.
We
currently have no sources of financing funding other than the potential exercise
of options and warrants which generally will be dependent on higher stock prices
and thus substantial uncertainty.
Debt
and Other Commitments
As
described above we paid off our convertible term debt during fiscal 2010 and
have no debt other than normal trade payables and accruals outstanding. We have
no credit lines or access or commitments for any future debt
financing.
At March
31, 2010 we were committed to approximately $224,000 as purchase commitments for
product and components as a result of preparing to build to our backlog of
orders of $265,000 at March 31, 2010. These purchase commitments are generally
subject to modification as to timing, quantities and scheduling and in certain
instances may be cancelable without penalty.
We are
also committed for our office lease as more fully described in Note 12 to our
consolidated financial statements.
Our legal
firm Duane Morris is handling Patent Enforcement Matters and certain related
appeals on our Flash-R patent portfolio on a contingent fee basis. Duane Morris
also has agreed to advance certain costs and expenses including travel expenses,
court costs and expert fees. We have agreed to pay Duane Morris a fee equal to
40% of any license or litigation recovery related to Patent Enforcement Matters,
after recovery of expenses, and 50% of recovery if appeal is
necessary.
In the
event we are acquired or sold or elect to sell the covered patents or upon
certain other corporate events or in the event we terminate the agreement for
any reason, then Duane Morris shall be entitled to collect accrued costs and a
fee equal to three times overall time and expenses accrued in connection with
the agreement and a fee of 15% of a good faith estimate of the overall value of
the covered patents. Duane Morris has a lien and a security interest in the
covered patents to secure its obligations under the agreement.
Cash
Requirements
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, 2010
and current planned expenditures and level of operationwe believe we have
sufficient capital resources for the next twelve months. Actual results could
differ significantly from management plans. We believe we may be able to obtain
additional funds from future patent licensing and eVU product sales and services
but the timing of licenses and shipments and the amount and quantities of
shipments, orders and reorders are subject to many factors and risks, many
outside our control.
Since we
have not demonstrated sustainable profitability, our Company’s ability to
continue as a going concern is in doubt and is dependent upon achieving
sustained profitability and if necessary obtaining additional financing. We
currently have no plans, arrangements or understandings regarding any
acquisitions.
Selected
Quarterly Financial Information
The
following table sets forth unaudited income statement data for each of our
Company’s last eight quarters. The unaudited quarterly financial information as
restated 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.Our quarterly operating
results have varied significantly in the past and are expected to vary
significantly in the future.
26
Quarter ended
|
6/30/2009
|
9/30/2009
|
12/31/2009
|
3/31/2010
|
FY 2010
|
|||||||||||||||
Revenues
|
$ | 223,030 | $ | 1,512,267 | $ | 284,170 | $ | 534,402 | $ | 2,553,869 | ||||||||||
Gross
profit
|
102,052 | 936,644 | 104,352 | 169,046 | 1,312,094 | |||||||||||||||
Income
(loss) for the period
|
(569,076 | ) | 348,386 | (315,285 | ) | (273,445 | ) | (809,420 | ) | |||||||||||
Operating
profit (loss)
|
(554,201 | ) | 559,154 | (584,411 | ) | (299,128 | ) | (878,586 | ) | |||||||||||
Income
(loss) attributable to common shareholders
|
(611,889 | ) | 292,498 | (360,672 | ) | (304,496 | ) | (984,559 | ) | |||||||||||
Basic
and diluted earnings (loss) per common share
|
$ | (0.00 | ) | $ | 0.00 | $ | (0.00 | ) | $ | (0.00 | ) | $ | (0.00 | ) | ||||||
Weighted
average shares outstanding (basic)
|
282,507,374 | 284,407,839 | 286,625,653 | 281,298,128 | 286,950,900 |
Quarter ended
|
6/30/2008
|
9/30/2008
|
12/31/2008
|
3/31/2009
|
FY 2009
|
|||||||||||||||
Revenues
|
$ | 377,727 | $ | 1,774,430 | $ | 3,906,033 | $ | 4,997,542 | $ | 11,055,732 | ||||||||||
Gross
profit
|
114,057 | 1,157,107 | 2,286,550 | 2,986,237 | 6,543,951 | |||||||||||||||
Income
(loss) for the period
|
(669,207 | ) | (28,833 | ) | 1,547,795 | 2,084,231 | 2,933,986 | |||||||||||||
Operating
profit (loss)
|
(571,489 | ) | 400,511 | 1,597,631 | 2,273,290 | 3,699,943 | ||||||||||||||
Income
(loss) attributable to common shareholders
|
(670,618 | ) | (72,116 | ) | 1,504,511 | 2,041,889 | 2,803,666 | |||||||||||||
Basic
and diluted earnings (loss) per common share
|
$ | (0.00 | ) | $ | (0.00 | ) | $ | 0.01 | $ | 0.01 | $ | 0.01 | ||||||||
Weighted
average shares outstanding (basic)
|
274,497,647 | 277,082,261 | 279,143,996 | 281,298,128 | 277,997,077 |
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not
applicable.
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The
Consolidated Financial Statements of the Company required to be included in this
Item 8 are incorporated herein by reference and are set forth in a separate
section of this report following Item 15 and the Signature Page (page 40)
commencing on Page F-1.
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None
ITEM
9A(T). CONTROLS & PROCEDURES
Attached
as exhibits to this Form 10-K are certifications of our President (“Principal
Executive Officer” or “PEO”) and Interim Chief Accounting Officer (“Principal
Financial Officer” or “PFO”) that are required in accordance with Rule 13a-14 of
the Exchange Act. This “Controls and Procedures” section includes information
concerning the controls and controls evaluation referred to in the
certifications.
Evaluation
of Disclosure Controls and Procedures
We
maintain disclosure controls (as defined in Rule 13a-15(e) of the Exchange Act)
and procedures that are designed to ensure that information required to be
disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms, and
that such information is accumulated and communicated to our management,
including our PEO and PFO, as appropriate, to allow timely decisions regarding
required disclosure. Management necessarily applied its judgment in assessing
the costs and benefits of such controls and procedures, which, by their nature,
can provide only reasonable assurance regarding management’s control
objectives.
At the
conclusion of the period ended March 31, 2010, we carried out an evaluation,
under the supervision and with the participation of our management, including
the PEO and PFO, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based upon that evaluation, the PEO and PFO
concluded that our disclosure controls and procedures, as defined in Rule
13a-15(e) of the Exchange Act, were not effective at the reasonable assurance
level due to the existence of a material weakness in our internal control over
financial reporting, discussed below.
27
Management’s
Report on Internal Control Over Financial Reporting
Management
is responsible for establishing and maintaining adequate internal control over
financial reporting for our Company. We maintain internal control over financial
reporting designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles in the
United States of America. Internal control over financial reposting includes
those policies and procedures that (i) pertain to the maintenance of records
that in reasonable detail accurately and fairly reflect the transactions and
dispositions of the assets of e.Digital; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with authorizations of management and directors of
e.Digital; and (iii) provide reasonable assurance regarding prevention and
timely detection of unauthorized acquisition, use, or disposition of e.Digital’s
assets that could have a material effect on the financial
statements.
Management
conducted an assessment of the effectiveness of our internal control over
financial reporting as of March 31, 2010 using criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). This assessment included evaluation of
elements such as the design and operating effectiveness of key financial
reporting controls, process documentation, accounting policies, and our overall
control environment. Management’s assessment is supported by testing and
monitoring performed by certain of our finance and accounting personnel of the
operational effectiveness of our internal control.
Based on
this assessment, management identified a material weakness in our internal
control over financial reporting: the lack of independent oversight by an audit
committee of independent members of the Board of Directors. In light
of this material weakness management concluded that our internal control over
financial reporting needs improvement and was not effective. Due to our small
size and limited resources it is difficult to attract qualified independent
directors and qualified audit committee members. Management has concluded that
with certain management oversight controls that are in place, the risks
associated with the lack of independent audit committee oversight is not
sufficient to justify the costs of adding additional directors and independent
audit committee members at this time. Management will periodically reevaluate
this situation. If we secure sufficient capital or improve our operating results
it is our intention to change the composition and/or size of the Board of
Directors with emphasis on recruiting qualified independent audit committee
members.
This
annual report does not include an attestation report of our independent
registered public accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation by our independent
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit us to provide only management’s report in
this annual report.
Inherent
Limitations on Effectiveness of Controls
Our
management, including the PEO and PFO, does not expect that our disclosure
controls and procedures or our internal control over financial reporting will
prevent or detect all error and all fraud. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that
the control system’s objectives will be met. The design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Further, because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not
occur or that all control issues and instances of fraud, if any, within the
Company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur
because of simple error or mistake. Controls can also be circumvented by the
individual acts of some persons, by collusion of two or more people, or by
management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Projections of any evaluation of
controls effectiveness to future periods are subject to risks. Over time,
controls may become inadequate because of changes in conditions of deterioration
in the degree of compliance with policies or procedures.
Changes
In Internal Control Over Financial Reporting
No change
in our internal controls over financial reporting occurred during our last
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
ITEM
9B. OTHER INFORMATION
None
28
PART
III
ITEM
10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Directors
and Executive Officers
The
following table sets forth the name and position of each of our directors and
executive officers at June 1, 2010:
Name
|
Age
|
Positions
|
Director Since
|
|||
Alfred
H. Falk
|
55
|
President,
Chief Executive Officer and Director
|
January
2009
|
|||
Robert
Putnam
|
51
|
Senior
Vice President, Corporate Secretary, Interim Chief Accounting Officer and
Director
|
1995
|
|||
Allen
Cocumelli
|
60
|
Chairman*
and Director
|
1999
|
|||
Renee
Warden
|
46
|
Director
|
2005
|
|||
Eric
M. Polis
|
39
|
Director
|
October
2008
|
* Allen
Cocumelli as Chairman of our Board of Directors, is technically considered as an
executive officer under our bylaws. However, we do not believe that he meets the
definition of an “executive officer” under Rule 16a-1(f) of the Securities
Exchange Act of 1934 in that he does not perform any policy-making functions for
our Company, nor is he compensated for this position.
There are
no arrangements or understandings between our company and any other person
pursuant to which he was or is to be selected as a director, executive officer
or nominee.
Alfred H. Falk – Mr. Falk was
promoted and appointed as President and Chief Executive Officer of the Company
by the Board of Directors on January 20, 2009. Mr. Falk had been the
Company’s vice president of corporate development since July 2004. He formerly
served as president and a member of the Board of the company from January 1997
(and from July 1998 as chief executive officer) until July 2004. From March 1995
to January 1997, he served as vice president of corporate development and vice
president of OEM and international sales. Prior to joining the company, Falk
worked for Resources Internationale as director of U.S. sales from 1993 to 1995.
From 1988 to 1993, he was the manager of OEM sales and technology licensing for
Personal Computer Products, Inc. From 1978 to 1988, he held several management
positions at DH Technology.
Robert Putnam - Mr. Putnam was
appointed Senior Vice President in April 1993. He was appointed a
Director of e.Digital Corporation in 1995. In May 2005, Mr. Putnam
assumed the additional responsibilities of Interim Chief Accounting Officer and
Corporate Secretary. Mr. Putnam also served as Secretary of from
March 1998 until December 2001. He served as a Director of LRAD
Corporation (“LRAD”) 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 director of
investor relations of LRAD. He also served as Secretary/Treasurer of
Patriot Scientific (“Patriot”) from 1989 to 2000 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.
Allen Cocumelli – Mr.
Cocumelli was appointed Chairman of the Board in October 2008. Mr. Columelli
also previously served as Chairman of the Board from April 2000 to November
2002. Mr. Cocumelli has been Secretary and General Counsel of SimpleNet, Inc.
since 2004. Prior thereto, Mr. Cocumelli was a Director of Website Services at
Yahoo! Inc. from 2000 to 2004. Prior to joining Yahoo! Inc., Mr. Cocumelli was
General Counsel of Simplenet Network Communications Inc. from 1996 and Chief
Operating Officer of Simplenet Network Communications Inc. from November 1997
until 1999. Prior to joining Simplenet Network Communications Inc., 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.
Renee Warden –Ms. Warden has
been Financial Manager for Verifone since July 2009. Previously, Ms. Warden was
Director of Accounting for Revolution Money, Inc. from April 2007 to July 2009.
Prior to its acquisition by Crown Castles in April 2007, Ms. Warden was Manager
Special Projects/SOX for Global Signal, Inc. Prior to joining Global Signal,
Inc. Ms. Warden was Vice President and Controller for Kintera, Inc. from May
2005 to May 2006. Prior to joining Kintera, Inc., Ms. Warden was an executive
officer of e.Digital Corporation. Ms. Warden joined e.Digital Corporation in
1991 as Accounting Manager. In 1997 Ms. Warden was appointed Controller and
Corporate Secretary for e.Digital Corporation and in 2003 was promoted to Chief
Accounting Officer and Secretary until May 2005. From 1993 to 2003 Ms. Warden
also held the positions of Chief Accounting Officer, Secretary and Director of
Human Resources for ATC. Ms. Warden obtained a B.S. degree in business
accounting from the University of Phoenix in 1999.
29
Eric M. Polis - Mr. Polis has
been Secretary, Treasurer and a Director of ASI Technology Corporation, a
publicly traded specialty finance company, since July 2000. He has been employed
as an asset manager for privately-held Davric Corporation since 1997. Mr. Polis
is also a private investor and serves on the board of several Las Vegas
non-profit organizations. He obtained a B.S. in Business Administration from the
University of Arizona in 1993.
Code
of Business Conduct and Ethics
We have
adopted a Code of Conduct Policy applicable to all our employees, including our
principal executive officer, principal financial officer and principal
accounting officer. We will provide any person, without charge, a copy of our
Code of Conduct Policy upon written request to Investor Relations, e.Digital
Corporation, 16770 West Bernardo Drive, San Diego, California 92127. We also
post on our website a copy of or Code of Conduct Policy at
www.edigital.com.
Section
16(a) Beneficial Ownership Reporting Compliance
Based
solely on a review of copies of such reports furnished to our Company and
representation that no other reports were required during the fiscal year ended
March 31, 2010, we believe 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.
Stockholder
Recommendations for Director Nominations
We have
no nominating committee of the Board of Directors and no formal procedure for
director nominations. Accordingly, there has been no change in the procedures by
which security holders may recommend nominees to our board of directors since
our last shareholders meeting in November 2009.
Audit
Committee and Audit Committee Financial Expert
We have a
separately designated standing Audit Committee, currently consisting of Ms.
Warden and Mr. Putnam. Ms. Warden has been designated as the “Audit Committee
Financial Expert,” as defined by Regulation S-K, although as a paid accounting
consultant to the Company she is not an “independent” director, as defined under
the NASDAQ Stock Market rules and Rule 10A-3 of the Securities Exchange Act of
1934. Likewise Mr. Putnam, as an executive officer is not
independent.
ITEM
11. EXECUTIVE COMPENSATION.
Summary
Compensation Table
Option
|
All Other
|
|||||||||||||||||||||
Salary (1)
|
Bonus
|
Awards (2)
|
Compensation
|
Total
|
||||||||||||||||||
Name and Principal Position
|
Year
|
($)
|
($)
|
($)
|
($)
|
($)
|
||||||||||||||||
Alfred
H. Falk, President and
|
2010
|
$ | 155,000 | - | $ | 33,273 | - | $ | 188,273 | |||||||||||||
Chief
Executive Officer (PEO)
|
2009
|
$ | 155,000 | - | $ | 0 | - | $ | 155,000 | |||||||||||||
Robert
Putnam, Senior Vice
|
2010
|
$ | 85,000 | - | $ | 16,637 | - | $ | 101,637 | |||||||||||||
President,
Secretary and Interim
|
2009
|
$ | 85,000 | - | $ | 0 | - | $ | 85,000 | |||||||||||||
Chief
Accounting Officer (PEO) (3)
|
(1)
|
Represents
actual cash compensation.
|
(2)
|
The
value listed in the above table represents the fair value of the options
granted during the year and valuedunder ASC 718. Fair value is calculated
as of the grant date using a Black-Scholes option-pricing model. The
determination of the fair value of share-based payment awards made on the
date of grant is affected by our stock price as well as assumptions
regarding a number of complex and subjective variables. Our assumptions in
determining fair value are described in our audited consolidated financial
statements for the year ended March 31, 2010, included
herein.
|
(3)
|
Mr.
Putnam provides part-time services to our company. See “Certain Transactions –
Conflicts of Interest.”
|
30
Outstanding Equity Awards at Fiscal Year-End
Name
|
Number of
Securities
Underlying
Unexercised
Options
Exercisable
|
Number of
Securities
Underlying
Unexercised
Options
Unexercisable
|
Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
|
Option
Exercise
Price
|
Option Expiration
Date
|
|||||||||||||
Alfred
H. Falk
|
500,000 | - | - | $ | 0.155 |
12/8/13
|
||||||||||||
Robert
Putnam
|
250,000 | - | - | $ | 0.155 |
12/8/13
|
Employment
Agreements, Termination of Employment and Change in Control
Arrangements
Mr.
Putnam and Mr. Falk have no employment letter or agreement.
Director
Compensation
Our
directors are reimbursed for reasonable out-of-pocket expenses incurred in
attending meetings of the board of directors and committee meetings. Employee
directors do not receive any cash compensation for services as directors and
have not received any equity compensation grants designated for such services.
In addition, members of the board of directors who are not employees receive
equity compensation grants as consideration for board and committee service from
time to time. There is no established policy as to frequency or amount of equity
compensation grants for non-employee directors.
The
following table sets forth the compensation paid to our non-employee directors
in 2010.
Name
|
Fee Earned or
Paid in Cash
|
Option
Awards (1)
|
All Other
Compensation
|
Total
|
||||||||||||
Allen
Cocumelli(2)
|
— | $ | 16,637 | — | $ | 16,637 | ||||||||||
Renee
Warden
(3)
|
— | $ | 16,637 | — | $ | 16,637 | ||||||||||
Eric
M. Polis (4)
|
— | $ | 16,637 | — | $ | 16,637 |
(1)
|
The
value listed in the above table represents the fair value of options on
250,000 shares granted to each person during the year and valued under ASC
718. Fair value is calculated as of the grant date using a Black-Scholes
option-pricing model. The determination of the fair value of share-based
payment awards made on the date of grant is affected by our stock price as
well as assumptions regarding a number of complex and subjective
variables. Our assumptions in determining fair value are described in our
audited consolidated financial statements for the year ended March 31,
2010, included in our Annual Report on Form
10-K.
|
(2)
|
At
March 31, 2010 Mr. Cocumelli had option awards outstanding exercisable
into 500,000 shares of common stock that were vested and
exercisable.
|
(3)
|
During
fiscal 2010 Ms. Warden provided accounting services unrelated to her role
as a director or audit committee member and earned compensation of $2,625
not included above. At March 31, 2010 Ms. Warden had option awards
outstanding exercisable into 500,000 shares of common stockof that were
vested and exercisable.
|
(4)
|
At
March 31, 2010 Mr. Polis had option awards outstanding exercisable into
550,000 shares of common stockof which 475,000 were vested and
exercisable.
|
Compensation
Committee Interlocks and Insider Participation
The
Compensation Committee of ourCompany’s Board of Directors was formed in June
2000 and is currently comprised of Directors, Allen Cocumelli and Eric Polis.
None of these individuals was at any time during the fiscal year 2010, or at any
time, an employee or officer of the Company. No executive officer of
the Company serves as a member of the board of directors or compensation
committee of any other entity that has one or more executive officers serving as
a member of ourCompany’s Board of Directors or Compensation
Committee.
31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Common
Stock
The
following security ownership information is set forth, as of June 1, 2010, with
respect to (i) each stockholder known by us to be beneficial owners of more than
5% of our outstanding Common Stock, (ii) each of the current directors and
nominees for election as directors, (iii) each of the executive officers named
in the Summary Compensation Table below and (iv) all current directors, nominees
and executive officers as a group (five persons). Other than as set
forth below, we are not aware of any other stockholder who may be deemed to be a
beneficial owner of more than 5% of our company’s Common Stock.
Name and Address
|
Amount and Nature of
|
Percent
|
Title
|
|||||||
of Beneficial Owner
|
Beneficial Ownership
|
of Class
|
of Class
|
|||||||
Alfred
H. Falk
|
1,493,850 |
(1)
|
* |
Common
|
||||||
16770
West Bernardo Drive
|
||||||||||
San
Diego, CA 92127
|
||||||||||
Robert
Putnam
|
5,088,911 |
(2)
|
1.8 | % |
Common
|
|||||
16770
West Bernardo Drive
|
||||||||||
San
Diego, CA 92127
|
||||||||||
Allen
Cocumelli
|
501,000 |
(3)
|
* |
Common
|
||||||
16770
West Bernardo Drive
|
||||||||||
San
Diego, CA 92127
|
||||||||||
Eric
M. Polis
|
4,307,119 |
(4)
|
1.5 | % |
Common
|
|||||
980
American Pacific Drive, #111
|
||||||||||
Henderson,
NV 89014
|
||||||||||
Renee
Warden
|
500,000 |
(5)
|
* |
Common
|
||||||
16770
West Bernardo Drive
|
||||||||||
San
Diego, CA 92127
|
||||||||||
Jerry
E. Polis
|
20,661,411 |
(6)
|
7.2 | % |
Common
|
|||||
980
American Pacific Drive, #111
|
||||||||||
Henderson,
NV 89014
|
||||||||||
All
officers, directors and nominees as a group (5
persons)
|
11,890,880 |
(7)
|
4.1 | % |
Common
|
|
(1)
|
Includes
550 shares held by son to which Mr. Falk disclaims beneficial ownership.
Includes options and warrants exercisable within 60 days to purchase
500,000 shares.
|
|
(2)
|
Includes
options and warrants exercisable within 60 days to purchase 1,250,000
shares and preferred stock convertible into 1,100,411
shares.
|
|
(3)
|
Includes
options exercisable within 60 days to purchase 500,000
shares.
|
|
(4)
|
Includes
options exercisable within 60 days to purchase 512,500 shares. Also
includes (i) 2,307,421 shares of common stock held a Family Trust of which
Mr. Polis is Trustee, (ii) 1,042,696 shares of common stock held by the
Polis Family LLC of which Mr. Polis is a managing member, (iii) 133,000
shares of common stock held by The Polis Charitable Foundation of which
Mr. Polis is an officer, (iv) 25,000 shares of common stock held in a
personal IRA, (v) 107,922 shares of common stock held by ASI Capital
Corporation of which Mr. Polis is Secretary and Treasurer, (vi) 138,580
shares of common stock held by ASI Technology Corporation of which Mr.
Polis is Secretary and Treasurer, and (vii) 40,000 shares of common stock
held as custodian for a minor child. Mr. Polis disclaims beneficial
ownership of the shares held by the Polis Charitable Foundation and as
custodian for the minor child and to the shares held by ASI Capital
Corporation and its paretn ASI Technology Corporation except to the extent
of his respective pecuniary
interest.
|
|
(5)
|
Consists
of options exercisable within 60 days to purchase 500,000
shares.
|
32
|
(6)
|
Ownership
by Mr. Jerry E. Polis is based on information provided by the stockholder
as of December 31, 2009. Includes (i) 11,894,003 shares of common stock
held by the Jerry E. Polis Family Trust (“Family Trust”) of which Mr.
Polis is Trustee, (ii) 6,857,610shares of common stock held by Davric
Corporation (“Davric”) of which Mr. Polis is President and Director (iii)
1,042,696 shares of common stock held by the Polis Family LLC of which Mr.
Polis is a managing member, (iv) 333,000 shares of common stock held by
The Polis Charitable Foundation of which Mr. Polis is President, (v)
220,000 shares of common stock held by the Polis Museum of Fine Art of
which Mr. Polis is trustee, (vi) 67,600 shares of common stock held in a
personal IRA, (viii) 107,922 shares of common stock held by ASI Capital
Corporation of which Mr. Polis is President and (ix) 138,580 shares of
common stock held by ASI Technology Corporation of which Mr. Polis is
President. Mr. Polis disclaims beneficial ownership of the shares held by
the Polis Charitable Foundation and the Polis Museum of Fine Art and to
the shares held by ASI Capital Corporation and ASI Technology Corporation
except to the extent of his respective pecuniary
interest.
|
|
(7)
|
Includes
options and warrants exercisable within 60 days to purchase 3,262,500
shares and preferred stock convertible into
1,100,411shares.
|
* Less
than 1%
Series AA Preferred Stock
The
following security ownership information is set forth as of June 1, 2010 with
respect to certain persons or groups known to the Company to be beneficial
owners of more than 5% of Series AA Preferred Stock.
Name and Address
|
Amount and Nature of
|
Percent
|
Title
|
|||||||
of Beneficial Owner
|
Beneficial Ownership(1)
|
of Class
|
of Class
|
|||||||
Robert
Putnam
|
10,000 | (2) | 18.2 | % |
Series
AA
|
|||||
16770
West Bernardo Drive
|
Preferred
Stock
|
|||||||||
San
Diego, CA 92127
|
||||||||||
James
A. Barnes
|
15,000 | (3) | 27.3 | % |
Series
AA
|
|||||
8617
Canyon View Dr.
|
Preferred
Stock
|
|||||||||
Las
Vegas, NV 89117
|
||||||||||
Norris
Family 1997 Trust
|
10,000 | (4) | 18.2 | % |
Series
AA
|
|||||
16101
Blue Crystal Trail
|
Preferred
Stock
|
|||||||||
Poway,
CA 92064
|
||||||||||
James
C. Zolin & Josephine Zolin
|
5,000 | (5) | 9.1 | % |
Series
AA
|
|||||
17108
Via De La Valle
|
Preferred
Stock
|
|||||||||
Rancho
Santa Fe, CA 92067
|
||||||||||
Victor
Gabourel
|
5,000 | (6) | 9.1 | % |
Series
AA
|
|||||
11404
Cypress Woods Dr.
|
Preferred
Stock
|
|||||||||
San
Diego, CA 92131
|
||||||||||
Robert
M. Kaplan
|
5,000 | (6) | 9.1 | % |
Series
AA
|
|||||
P.O.
Box 2600
|
Preferred
Stock
|
|||||||||
Sun Valley, ID 83353 |
|
(1)
|
Represents the number of shares
of Series AA Preferred Stock held as of May 10, 2010. At such date an
aggregate of 55,000 shares of Series AA Preferred Stock were issued and
outstanding with each share having 100 votes per
share.
|
|
(2)
|
Mr. Putnam is an officer and
director of the Company and has sole voting and investment power with
respect to the Series AA Preferred
Stock.
|
|
(3)
|
Includes 5,000 shares held by
Sunrise Capital, Inc., 5,000 shares held by Sunrise Management, Inc.
Profit Sharing Plan and 5,000 shares held by Palermo Trust. Mr. Barnes is
President of Sunrise Capital, Inc. and Trustee of Sunrise Management, Inc.
Profit Sharing Plan and the Palermo Trust. Mr. Barnes shares investment
and voting power with respect to the Series AA Preferred Stock with his
spouse.
|
|
(4)
|
Voting and investment power with
respect to the Series AA Preferred Stock is shared by Elwood G. Norris and
Stephanie Norris.
|
|
(5)
|
The named owners are believed by
the Company to share investment and voting power over the Series AA
Preferred Stock.
|
|
(6)
|
The
named owner is believed by the Company to have sole investment and voting
power over the Series AA Preferred
Stock.
|
33
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
Conflicts
of Interest
Certain
conflicts of interest now exist and will continue to exist between e.Digital
Corporation and its officers and directors due to the fact that they have other
employment or business interests to which they devote some attention and they
are expected to continue to do so. We have not established policies
or procedures for the resolution of current or potential conflicts of interest
between our company and its management or management affiliated
entities. There can be no assurance that members of management will
resolve all conflicts of interest in our company’s favor. The
officers and directors are accountable to our company as fiduciaries, which
means that they are legally obligated to exercise good faith and integrity in
handling our company’s affairs. Failure by them to conduct our
company’s business in its best interests may result in liability to
them.
Officer
and director Robert Putnam also acts as Director of Investor Relations of
LRAD. The possibility exists that this other relationship could
affect Mr. Putnam’s independence as a director and/or officer of e.Digital
Corporation. Mr. Putnam is obligated to perform his duties in good
faith and to act in the best interest of our company and its stockholders, and
any failure on his part to do so may constitute a breach of his fiduciary duties
and expose such person to damages and other liability under applicable
law. While the directors and officers are excluded from liability for
certain actions, there is no assurance that Mr. Putnam would be excluded from
liability or indemnified if he breached his loyalty to our company.
Transactions
with Related Persons
On
occasion we engage in certain related party transactions. Related parties
include directors and executive officers and their immediate family members and
certain security holders and their immediate family members. For purposes of
this disclosure related party security holders include any beneficial owner of
more than five percent of either our common or preferred shares. The following
are related party transactions with respect to the two fiscal years ended March
31, 2009.
Mr. James
A. Barnes, becamea related party in June 2008 when affiliated entities acquired
greater than 5% of our Series AA preferred stock. During fiscal 2010, we
incurred accounting, regulatory consulting services and cost reimbursements of
$44,254 to Sunrise Capital, Inc., a company controlled by Mr.
Barnes.
Jerry E.
Polis and affiliated entities are considered as related parties through
ownership of greater than 5% of our outstanding common stock.At April 1, 2009 we
owed Davric Corporation (“Davric”) $387,234 on a 7.5% Convertible Term Note
(“Term Note”). Stated monthly principal and interest payments were $50,000 and
we could elect to make monthly installment payments either in cash or in shares
of common stock. Subject to certain notice periods and other limitations, the
balance of the Term Note was convertible by Davric at $0.30 per common share and
we could call the Term Note for mandatory conversion if the closing sale price
of our common stock was at least $0.40 per share for ten consecutive trading
days. During fiscal 2010 we made $350,000 of principal and interest payments
through the issuance of 2,705,515 restricted shares of common stock and made the
finalpayment of $47,865 in cash in November 2009. At March 31, 2010 there was no
debt balance outstanding. Total interest expense for the fiscal year was
$10,631.
During
fiscal 2010 we paid director and former executive officer Renee Warden an
aggregate of $2,625 for accounting services unrelated to her role as a director
or audit committee member.
On
December 8, 2009, directors Allen Cocumelli, Renee Warden and Eric M. Polis were
each granted an option on 250,000 common shares exercisable at $0.155 per share
until December 8, 2013vesting at grant but subject other standard option plan
conditions.
ITEM
14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The
following table describes fees for professional audit services rendered by
SingerLewak LLP, our principal accountant, for the audit of our annual financial
statements for the years ended March 31, 2010 and March 31, 2009 and fees billed
for other services rendered by SingerLewak LLPduring those periods. These
amounts include fees paid to SingerLewak LLP.
34
Type
of Fee
|
2010
|
2009
|
||||||
Audit
Fees (1)
|
$ | 102,330 | $ |
160,797
|
||||
Audit
Related Fees (2)
|
- | - | ||||||
Tax
Fees (3)
|
- | - | ||||||
All
Other Fees (4)
|
- | - | ||||||
Total
|
$ | 102,330 | $ | 160,797 |
1. Audit
Fees include the aggregate fees paid by us during the fiscal year indicated for
professional services rendered by SingerLewak 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 SingerLewak LLPthat are
reasonably related to the performance of the audit or review of our financial
statements and not included in Audit Fees.
3. Tax
Fees include the aggregate fees paid by us during the fiscal year for
professional services for tax compliance, tax advice and tax planning. No such
fees were billed by SingerLewak LLPfor the respective periods.
4. All
Other Fees include the aggregate fees paid by us during the fiscal year
indicated for products and services other than the services reported above. No
such fees were billed by SingerLewak LLPfor the respective periods.
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 SingerLewak LLPin providing services to us
for the fiscal year ended March 31, 2010 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
SingerLewak LLP in fiscal year 2010.
PART
IV
ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The
following documents are filed as part of this Annual Report on Form
10-K:
(a)
Consolidated Financial Statements
See
“Index to Consolidated Financial Statements” on page F-1.
(b)
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
|
Sequential Description
|
|
2.1
|
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.
|
35
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.
|
|
3.1.3
|
Certificate
of Amendment of Certificate of Incorporation of e.Digital Corporation
filed with the State of Delaware on September 18, 2008 and filed as
Exhibit 3.1.3 to the Company’s Current Report on Form 8-K dated September
18, 2008.
|
|
3.1.4
|
Certificate
of Amendment of Certificate of Incorporation of e.Digital Corporation
filed with the State of Delaware on August 11, 2005 and filed as Exhibit
3.1.4 to the Company’s Current Report on Form 8-K dated September 18,
2008.
|
|
3.2
|
Bylaws
of the Company, 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 Registration
Statement on Form S-3 dated November 3, 2000.
|
|
3.6
|
Certificate
of Designation of Preferences, Rights and Limitations of Series D
preferred stock filed with the State of Delaware on December 23, 2002 and
filed as Exhibit 3.6 to the Company’s Current Report on Form 8-K dated
December 30, 2002.
|
|
3.7
|
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.
|
|
3.8
|
Certificate
of Designation of Preferences, Rights and Limitations of Series EE
preferred stock filed with the State of Delaware on November 19, 2004 and
filed as Exhibit 3.7 to the Company’s Current Report on Form 8-K dated
November 19, 2004.
|
|
3.9
|
Certificate
of Designation of Preferences, Rights and Limitations of Series AA
preferred stock filed with the State of Delaware on June 26, 2008 and
filed as Exhibit 99.4 to the Company’s Current Report on Form 8-K dated
July 1, 2008.
|
|
4.1
|
Form
of Stock Purchase Warrant (Series EE Warrants) exercisable until November
2006 issued to seventeen accredited investors for an aggregate of
4,070,000 common shares (individual warrants differ only as to holder and
number of shares) and filed as Exhibit 4.55 to the Company’s Current
Report on Form 8-K dated November 19, 2004.
|
|
4.2
|
|
Form
of 12% Subordinated Promissory Note and Warrant Purchase Agreement dated
as of June 30, 2005 entered into with certain accredited investors in a
maximum aggregate amount of $1,000,000 and filed as Exhibit 4.50 to the
Company’s 2004 Form 10-K.
|
36
4.2.1
|
Form
of First Amendment to 12% Subordinated Promissory Note dated as of June
30, 2005 between the company and certain accredited investors (individual
amendments differ only as to name of Payee) filed as Exhibit 4.51.1 to
Form 8-K dated July 13, 2005.
|
|
4.2.2
|
Form
of Second Amendment to 12% Subordinated Promissory Note dated as of
October 25, 2005 between the company and certain accredited investors
(individual amendments differ only as to name of Payee) filed as Exhibit
4.50.2 to Form 8-K dated November 8, 2005.
|
|
4.2.3
|
Form
of Amendment to 12% Subordinated Promissory Note and Warrant Purchase
Agreement dated as of October 25, 2005 between the company and certain
accredited investors (individual amendments differ only as to name of
Purchaser) filed as Exhibit 4.50.1 to Form 8-K dated November 8,
2005.
|
|
4.3
|
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)
and filed as Exhibit 4.52 to the Company’s Annual Report on Form 10-K for
the fiscal year ended March 31, 2004.
|
|
4.3.1
|
Form
of First Amendment to Stock Purchase Warrant dated as of June 30, 2005
between the company and certain accredited investors (individual
amendments differ only as to name of Holder) filed as Exhibit 4.51.2 to
Form 8-K dated July 13, 2005.
|
|
4.4
|
Form
of Restricted Common Stock Purchase Agreement, dated February 24, 2006
between the Company and certain accredited investors for purchase of
18,750,000 common shares (individual agreements differ only as to number
of shares) and filed as Exhibit 10.1 to the Company’s Current Report on
Form 8-K dated February 27, 2006.
|
|
4.5
|
Form
of Series “A” Warrant exercisable until February 28, 2009, issued February
24, 2006 to certain accredited investors for up to an aggregate of
4,687,500 common shares (individual warrants differ only as to holder and
number of shares) and filed as Exhibit 10.2 to the Company’s Current
Report on Form 8-K dated February 27, 2006
|
|
4.6
|
Form
of Series “B” Warrant exercisable until six months after the effectiveness
of this Registration Statement or July 31, 2008 whichever is earlier,
issued February 24, 2006 to certain accredited investors for up to an
aggregate of 4,687,500 common shares (individual warrants differ only as
to holder and number of shares) and filed as Exhibit 10.3 to the Company’s
Current Report on Form 8-K dated February 27, 2006.
|
|
4.7
|
Form
of New Warrant issued to 29 investors in August and September 2006 for an
aggregate of 2,331,572 common shares exercisable at $0.15 per share
through August 31, 2009 filed as Exhibit 4.53 to Form 8-K dated August 28,
2006
|
|
4.8
|
Exchange
Agreement between the Company and Davric Corporation dated December 1,
2006 filed as Exhibit 99.1 to Form 8-K dated December 12,
2006.
|
|
4.8.1
|
7.5%
Convertible Subordinated Term Note issued by the Company to Davric
Corporation dated December 1, 2006 filed as Exhibit 99.2 to Form 8-K dated
December 12, 2006.
|
|
4.9
|
Common
Stock Purchase Agreement, dated as of January 2, 2007, by and between
e.Digital Corporation and Fusion Capital Fund II, LLC filed as Exhibit
10.1 to Form 8-K dated January 8, 2007.
|
|
4.10
|
Registration
Rights Agreement, dated as of January 2, 2007, by and between e.Digital
Corporation and Fusion Capital Fund II, LLC filed as Exhibit 10.2 to Form
8-K dated January 8, 2007.
|
|
4.11
|
Form
of Convertible Preferred Stock Purchase Agreement between the Company and
12 investors for an aggregate of 75,000 Series AA Preferred Shares and
Warrants (individual agreements differ only as to number of shares) dated
June 27, 2008 filed as Exhibit 99.2 to Form 8-K dated July 1,
2008.
|
|
4.12
|
|
Form
of Stock Purchase Warrant between the Company and 12 investors for an
aggregate of 7,500,000 common shares (individual warrants differ only as
to holder and number of shares) dated June 27, 2008 filed as Exhibit 99.3
to Form 8-K dated July 1, 2008.
|
37
10.1
|
Lease
Agreement between the Company and LBA Industrial Fund – Holding Co. II,
Inc. and Innsbruck Holdings, L.P. dated March 3, 2006 and filed as Exhibit
10.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended
March 31, 2006.
|
|
10.2
|
Agreement
for Legal Services and Contingent Fee Arrangement dated March 23, 2007
between the Company and Duane Morris LLP filed as Exhibit 99.1 to Form 8-K
dated March 28, 2007. (Portions of this Exhibit have been
omitted and filed separately with the Securities and Exchange Commission
as part of an application for confidential treatment pursuant to the
Securities Exchange Act of 1934, as amended.)
|
|
10.3
|
Secured
Promissory Note of the Company to ASI Capital Corporation dated March 23,
2007 filed as Exhibit 99.3 to Form 8-K dated March 28,
2007.
|
|
10.3.1
|
Loan
Extension Agreement between the Company and ASI Capital Corporation dated
as of September 28, 2007 and previously filed as Exhibit 99.1 to Form 8-K
dated October 15, 2007.
|
|
10.3.2
|
Secured
Promissory Note of the Company to ASI Technology Corporation dated
December 23, 2007 filed as Exhibit 99.1 to Form 8-K dated January 4,
2008.
|
|
10.3.3
|
Loan
Extension Agreement between the Company and ASI Technology Corporation
dated as of June 30, 2008 and previously filed as Exhibit 99.1 to Form 8-K
dated July 1, 2008.
|
|
10.3.4
|
Loan
Extension Agreement between the Company and ASI Technology Corporation
dated as of December 31, 2008 and previously filed as Exhibit 99.1 to Form
8-K dated January 5, 2009.
|
|
10.4
|
Security
Agreement between the Company and its subsidiary and ASI Capital
Corporation dated March 23, 2007 filed as Exhibit 99.4 to Form 8-K dated
March 28, 2007.
|
|
10.4.1
|
Security
Agreement between the Company and its subsidiary and ASI Technology
Corporation dated December 23, 2007 filed as Exhibit 99.2 to Form 8-K
dated January 4, 2008.
|
|
10.5
|
Stock
Option Plan adopted by the Company on September 29, 1994 ("1994 Plan"),
filed as Exhibit 10.10 to the Company's 1995
Form10-KSB.
|
|
10.5.1
|
First
Amendment to Stock Option Plan adopted by the Company onJanuary 26, 1996
and filed previously as Exhibit 10.14.1 to theCompany's Annual Report on
Form 10-KSB dated March 31, 1998.
|
|
10.5.2
|
Second
Amendment to Stock Option Plan adopted by the Company onSeptember 3, 1997
and filed previously as Exhibit 10.14.2 to theCompany's Annual Report on
Form 10-KSB dated March 31, 1998.
|
|
10.5.3
|
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.
|
|
10.6
|
2005
Equity-Based Compensation Plan, filed as Exhibit B to the to the Company's
July 12, 2005 Definitive Proxy Statement.
|
|
10.6.1
|
Form
of Incentive Stock Option Agreement under the 2005 Equity-Based
Compensation Plan and filed previously as Exhibit 10.6.1 to the Company’s
Annual Report on Form 10-K dated March 31, 2007.
|
|
10.6.2
|
Form
of Nonstatutory Stock Option Agreement under the 2005 Equity-Based
Compensation Plan and filed previously as Exhibit 10.6.2 to the Company’s
Annual Report on Form 10-K dated March 31, 2007.
|
|
21.1
|
Subsidiary
of e.Digital Corporation. Incorporated by reference to Exhibit 21.1 on
Form 10-K for the year ended March 31, 2009, dated June 16,
2009.
|
|
23.1
|
|
Consent
of SingerLewak LLP, Independent Registered Public Accounting
Firm.*
|
38
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, Principal
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 Robert Putnam, 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, Principal
Executive Officer and Robert Putnam, Principal Accounting
Officer.*
|
*
|
Filed
concurrently herewith.
|
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
e.Digital
Corporation
|
|
By:
|
/s/ ALFRED H.
FALK
|
President and Chief Executive
Officer
|
Date: June
10, 2010
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Name
|
Position
|
Date
|
||
/s/ ALFRED H. FALK
|
President
and Chief Executive Officer
|
June
10, 2010
|
||
Alfred
H. Falk
|
(Principal
Executive Officer)
|
|||
/s/ ALLEN COCUMELLI
|
Chairman
of the Board and Director
|
June
10, 2010
|
||
Allen
Cocumelli
|
||||
/s/ ROBERT PUTNAM
|
Senior
Vice President and Director
|
June
10, 2010
|
||
Robert Putnam
|
Interim
Chief Accounting Officer and
|
|||
Secretary
(Principal Financial and Accounting Officer)
|
||||
/s/ ERIC M. POLIS
|
Director
|
June
10, 2010
|
||
Eric
M. Polis
|
||||
/s/ RENEE WARDEN
|
Director
|
June
10, 2010
|
||
Renee Warden
|
|
|
|
39
INDEX TO FINANCIAL
STATEMENTS
Page
|
||
CONSOLIDATED
FINANCIAL STATEMENTS OF THE COMPANY AND SUBSIDIARY
|
||
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
|
F-2
|
|
CONSOLIDATED
BALANCE SHEETS AS OF MARCH 31, 2010 AND 2009
|
F-3
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED MARCH 31, 2010 AND
2009
|
F-4
|
|
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED MARCH 31, 2010 AND
2009
|
F-5
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MARCH 31, 2010 AND
2009
|
F-6
|
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
F-7 to F-25
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors
e.Digital
Corporation
San
Diego, CA
We have
audited the accompanying consolidated balance sheets of e.Digital Corporation
and subsidiary (the “Company”) as of March 31, 2010 and 2009, and the related
consolidated statements of operations, stockholders’ equity and cash flows for
each of the two years in the period ended March 31, 2010. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We
conducted our audits in accordance with 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 consolidated financial statements. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of March 31,
2010 and 2009, and the results of their operations and their cash flows for each
of the two years in the period ended March 31, 2010 in conformity with U.S.
generally accepted accounting principles.
We were
not engaged to examine management's assertion about the effectiveness of the
Company's internal control over financial reporting as of March 31, 2010
included in the accompanying Management’s Report on Internal Control Over
Financial Reporting and, accordingly, we do not express an opinion
thereon.
The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1
to the consolidated financial statements, the Company has historically suffered
recurring losses from operations and has a substantial accumulated
deficit. This raises substantial doubt about the Company’s ability to
continue as a going concern. Management’s plan in regard to these
matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
/s/
SingerLewak LLP
Los
Angeles, CA
June 10,
2010
F-2
CONSOLIDATED
BALANCE SHEETS
[See
Note 1 - Nature of Operations and Basis of Presentation]
As of March 31
|
||||||||
2010
|
2009
|
|||||||
$
|
$
|
|||||||
ASSETS
|
||||||||
Current
|
||||||||
Cash
and cash equivalents
|
2,818,727 | 3,813,990 | ||||||
Accounts
receivable
|
108,749 | 93,771 | ||||||
Inventory
|
347,078 | 517,163 | ||||||
Deposits
and prepaid expenses
|
59,072 | 26,108 | ||||||
Total
current assets
|
3,333,626 | 4,451,032 | ||||||
Property,
equipment and intangibles, net of accumulated depreciation and
amortization of $184,382 and $165,449, respectively
|
11,090 | 26,638 | ||||||
Total
assets
|
3,344,716 | 4,477,670 | ||||||
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
Current
|
||||||||
Accounts
payable, trade
|
51,997 | 202,900 | ||||||
Accrued
and other liabilities
|
315,948 | 589,814 | ||||||
Convertible
term note, net of $-0- and $6,141 of debt discount
|
- | 381,093 | ||||||
Total
current liabilities
|
367,945 | 1,173,807 | ||||||
Deferred
revenue - long term
|
- | 24,000 | ||||||
Total
liabilities
|
367,945 | 1,197,807 | ||||||
Commitments
and Contingencies
|
||||||||
Stockholders'
equity
|
||||||||
Preferred
stock, $0.001 par value; 5,000,000 shares authorized
|
||||||||
Series
AA Convertible Preferred stock, $0.001 par value, 100,000
|
||||||||
shares
designated: 55,000 and 75,000 issued and outstanding,
respectively
|
||||||||
Liquidation
preference of $598,370 and $778,459, respectively
|
573,830 | 610,774 | ||||||
Common
stock, $0.001 par value, authorized 350,000,000,
|
||||||||
286,950,900
and 282,124,564 shares issued and outstanding,
respectively
|
286,951 | 282,125 | ||||||
Additional
paid-in capital
|
82,073,012 | 81,534,566 | ||||||
Accumulated
deficit
|
(79,957,022 | ) | (79,147,602 | ) | ||||
Total
stockholders' equity
|
2,976,771 | 3,279,863 | ||||||
Total
liabilities and stockholders' equity
|
3,344,716 | 4,477,670 |
See
accompanying notes to consolidated financial statements
F-3
CONSOLIDATED
STATEMENTS OF OPERATIONS
[See
Note 1 - Nature of Operations and Basis of Presentation]
For
the year ended
|
||||||||
March 31
|
||||||||
2010
|
2009
|
|||||||
|
$
|
$
|
||||||
Revenues:
|
||||||||
Products
|
204,735 | 362,079 | ||||||
Services
|
749,134 | 578,303 | ||||||
Patent
license
|
1,600,000 | 10,115,350 | ||||||
2,553,869 | 11,055,732 | |||||||
Cost
of revenues:
|
||||||||
Products
|
299,078 | 318,672 | ||||||
Services
|
327,782 | 209,022 | ||||||
Patent
license
|
614,915 | 3,984,087 | ||||||
1,241,775 | 4,511,781 | |||||||
Gross
profit
|
1,312,094 | 6,543,951 | ||||||
Operating
expenses:
|
||||||||
Selling
and administrative
|
1,707,814 | 2,325,359 | ||||||
Research
and related expenditures
|
482,866 | 518,649 | ||||||
Total
operating expenses
|
2,190,680 | 2,844,008 | ||||||
Operating
income (loss)
|
(878,586 | ) | 3,699,943 | |||||
Other
income (expense):
|
||||||||
Interest
and other income
|
31,015 | 59 | ||||||
Interest
expense
|
(17,099 | ) | (163,359 | ) | ||||
Warrant
and other finance expenses
|
- | (181,157 | ) | |||||
Other
income (expense)
|
13,916 | (344,457 | ) | |||||
Income
(loss) before provision for income taxes
|
(864,670 | ) | 3,355,486 | |||||
Income
tax (provision) benefit
|
55,250 | (421,500 | ) | |||||
Income
(loss) for the period
|
(809,420 | ) | 2,933,986 | |||||
Accrued
and deemed dividends on preferred stock
|
(175,139 | ) | (130,320 | ) | ||||
Income
(loss) attributable to common stockholders
|
(984,559 | ) | 2,803,666 | |||||
Income
(loss) per common share - basic and diluted
|
$ | (0.00 | ) | $ | 0.01 | |||
Weighted
average common shares outstanding
|
||||||||
Basic
|
285,120,091 | 277,997,077 | ||||||
Diluted
|
285,120,091 | 279,143,600 |
See
accompanying notes to consolidated financial statements
F-4
e.Digital
Corporation and subsidiary
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
[See Note
1 – Nature of Operations and Basis of Presentation]
Total
|
||||||||||||||||||||||||
Preferred stock
|
Common stock
|
Additional
|
Accumulated
|
stockholders'
|
||||||||||||||||||||
Amount
|
Shares
|
Amount
|
paid-in capital
|
deficit
|
equity
|
|||||||||||||||||||
$
|
$
|
$
|
$
|
$
|
||||||||||||||||||||
Balance,
March 31, 2008
|
- | 272,494,867 | 272,495 | 80,103,769 | (82,081,588 | ) | (1,705,324 | ) | ||||||||||||||||
Sale
of Series AA preferred stock and warrants
|
||||||||||||||||||||||||
net
of $134,773 recorded as warrant liability
|
615,227 | - | - | - | - | 615,227 | ||||||||||||||||||
Record
$134,773 beneficial conversion
|
||||||||||||||||||||||||
related
to Series AA preferred stock
|
(134,773 | ) | - | - | 134,773 | - | - | |||||||||||||||||
Reclassification
of warrant liability to equity
|
- | - | - | 132,315 | - | 132,315 | ||||||||||||||||||
Value
assigned to modification of Seriess AA warrants
|
- | - | - | 177,125 | - | 177,125 | ||||||||||||||||||
Dividends
on Series AA preferred stock
|
28,459 | - | - | (28,459 | ) | - | - | |||||||||||||||||
Accretion
of discount on Series AA preferred stock
|
101,861 | - | - | (101,861 | ) | - | - | |||||||||||||||||
Shares
issued for term debt payments
|
- | 3,018,331 | 3,018 | 376,982 | - | 380,000 | ||||||||||||||||||
Shares
issued for debt financing fees
|
- | 108,921 | 109 | 11,691 | - | 11,800 | ||||||||||||||||||
Proceeds
from sale of common stock at an average price of $0.104 per
share
|
- | 6,345,549 | 6,346 | 653,654 | - | 660,000 | ||||||||||||||||||
Shares
issued on exercise of 325,000 options at $0.09 per share on a cashless
basis
|
- | 156,896 | 157 | (157 | ) | - | - | |||||||||||||||||
Stock-based
compensation
|
- | - | - | 74,734 | - | 74,734 | ||||||||||||||||||
Income
and comprehensive income
|
- | - | - | - | 2,933,986 | 2,933,986 | ||||||||||||||||||
Balance,
March 31, 2009
|
610,774 | 282,124,564 | 282,125 | 81,534,566 | (79,147,602 | ) | 3,279,863 | |||||||||||||||||
Dividends
on Series AA preferred stock
|
31,993 | - | - | (31,993 | ) | - | - | |||||||||||||||||
Accretion
of discount on Series AA preferred stock
|
143,146 | - | - | (143,146 | ) | - | - | |||||||||||||||||
Conversion
of Series AA preferred stock
|
(212,083 | ) | 2,120,821 | 2,121 | 209,962 | - | - | |||||||||||||||||
Shares
issued for term debt payments
|
- | 2,705,515 | 2,705 | 347,295 | - | 350,000 | ||||||||||||||||||
Stock-based
compensation
|
- | - | - | 156,328 | - | 156,328 | ||||||||||||||||||
Loss
and comprehensive loss
|
- | - | - | - | (809,420 | ) | (809,420 | ) | ||||||||||||||||
Balance,
March 31, 2010
|
573,830 | 286,950,900 | 286,951 | 82,073,012 | (79,957,022 | ) | 2,976,771 |
See
accompanying notes to consolidated financial statements
F-5
CONSOLIDATED
STATEMENTS OF CASH FLOWS
[See
Note 1 - Nature of Operations and Basis of Presentation]
For
the year ended
|
||||||||
March 31
|
||||||||
2010
|
2009
|
|||||||
|
$
|
$
|
||||||
OPERATING
ACTIVITIES
|
||||||||
Income
(loss) for the period
|
(809,420 | ) | 2,933,986 | |||||
Adjustments
to reconcile income (loss) to net cash provided by (used in) operating
activities:
|
||||||||
Depreciation
and amortization
|
18,933 | 17,532 | ||||||
Accretion
related to promissory notes
|
6,141 | 41,773 | ||||||
Warrant
modification and warrant derivative revaluation
|
- | 174,667 | ||||||
Inventory
market adjustment
|
65,459 | - | ||||||
Interest
paid with common stock
|
10,631 | 38,526 | ||||||
Warranty
provision
|
9,502 | (53,368 | ) | |||||
Stock-based
compensation
|
156,328 | 74,734 | ||||||
Changes
in assets and liabilities:
|
||||||||
Accounts
receivable
|
(14,978 | ) | 81,134 | |||||
Inventory
|
104,626 | (27,925 | ) | |||||
Deposits
and prepaid expenses
|
(32,964 | ) | 8,609 | |||||
Accounts
payable, trade
|
(150,903 | ) | (583,317 | ) | ||||
Accrued
and other liabilities
|
(307,368 | ) | 130,989 | |||||
Cash
provided by (used in) operating activities
|
(944,013 | ) | 2,837,340 | |||||
INVESTING
ACTIVITIES
|
||||||||
Purchase
of property and equipment
|
(3,385 | ) | (4,109 | ) | ||||
Cash
used in investing activities
|
(3,385 | ) | (4,109 | ) | ||||
FINANCING
ACTIVITIES
|
||||||||
Proceeds
from sale of common stock
|
- | 660,000 | ||||||
Proceeds
from sale of preferred stock
|
- | 700,000 | ||||||
Payments
on secured promissory note
|
- | (450,000 | ) | |||||
Payments
on convertible term note
|
(47,865 | ) | (51,357 | ) | ||||
Proceeds
from unsecured promissory note
|
- | 40,000 | ||||||
Payment
on unsecured promissory note
|
- | (40,000 | ) | |||||
Cash
provided by financing activities
|
(47,865 | ) | 858,643 | |||||
Net
increase (decrease) in cash and cash equivalents
|
(995,263 | ) | 3,691,874 | |||||
Cash
and cash equivalents, beginning of period
|
3,813,990 | 122,116 | ||||||
Cash
and cash equivalents, end of period
|
2,818,727 | 3,813,990 |
See
accompanying notes to consolidated financial statements including Note 3 for
additional information regarding non-cash financing activities and cash
payments
F-6
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
1.
NATURE OF OPERATIONS AND BASIS OF PRESENTATION
e.Digital
Corporation is a holding company incorporated under the laws of Delaware that
operates through a wholly-owned California subsidiary of the same name. The
Company markets the eVU™ mobile entertainment system for the travel and
recreational industries and licenses and enforcesits Flash-R™ portfolio of
patents related to the use of flash memory in portable devices.
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
and has an accumulated deficit of $79,957,022 at March 31, 2010. The Company’s
profitability in fiscal 2009 resulted from one-time patent licensing revenues
and there is no assurance of sufficient future licensing revenues from new
licensees to sustain operations. Accordingly, the Company may incur losses in
the future until product, service and/or licensing revenues are sufficient to
sustain continued profitability. The Company's ability to continue as a going
concern is in doubt and is dependent upon sustaininga profitable level of
operations and if necessary obtaining additional financing.
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.
Segment
Information
With the
inception of patent license revenue in fiscal 2009, the Company determined that
it has two operating segments: (1) products and services and (2) patent
licensing and enforcement. Products and services consist of sales of the
Company’s electronic eVU mobile entertainment device and related content
services and patent licensing and enforcement consists of intellectual property
revenues from the Flash-R patent portfolio. Segment information and related
disclosures about the Company’s products, services, geographical areas and major
customers is contained in Note 11.
F-7
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Fair
Value of Financial Instruments
Cash and
cash equivalents are measured at fair value in the company’sfinancial
statements. Accounts receivable are financial assets with carrying values that
approximate fair value due to theshort-term nature of these assets. Accounts
payable, deferred revenue and accrued and other liabilities are financial
liabilities with carrying values thatapproximate fair value due to the
short-term nature of these liabilities. Effective April 1, 2008 the Company
adopted and follows ASC 820, Fair Value Measurements
andDisclosures (“ASC 820”) which established a fair value hierarchy that
requires the company to maximize the use of observable inputs andminimize the
use of unobservable inputs when measuring fair value. A financial instruments
categorization within the hierarchy is based on thelowest level of input that is
significant to the fair value measurement. ASC 820 establishes three levels of
inputs that may be used to measurefair value:
|
·
|
Level
1: inputs are unadjusted quoted prices in active markets for identical
assets or liabilities.
|
|
·
|
Level
2: inputs other than level 1 that are observable, either directly or
indirectly, such as quoted prices in active markets for similar assetsand
liabilities, quoted prices for identical or similar assets or liabilities
in markets that are not active, or other inputs that are observable or
canbe corroborated by observable market data for substantially the full
term of assets or liabilities.
|
|
·
|
Level
3: unobservable inputs that are supported by little or no market activity
and that are significant to the fair value of the assets
orliabilities.
|
The
Company’s financial assets measured at fair value on a recurring basis at March
31, 2010 are as follows:
Fair Value Measurement as of March 31, 2010
|
||||||||||||||||
Total
|
Level 1
|
Level 2
|
Level 3
|
|||||||||||||
Description
|
$
|
$
|
$
|
$
|
||||||||||||
Cash
and cash equivalents (1)
|
2,818,727 | 2,818,727 | - | - |
|
(1)
|
Included
in cash and cash equivalents on the accompanying consolidated balance
sheet.
|
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 in other income (expense) for the
reporting period. To date foreign currency transactions are primarily undertaken
in European countries. Foreign currency gain for the year ended March 31, 2010
was $11,015 (2009 - loss of $1,805).
Income
(Loss) per Share
Basic
earnings (loss) per common share is computed by dividing income (loss)
attributable to common shareholders by the weighted-average number of shares of
common stock outstanding during the period. The income attributable to common
stockholders is reduced and the loss attributable to common stockholder is
increased by accrued and deemed dividends on preferred stock during the years
ended March 31, 2010 and 2009 of $175,139 and $130,320, respectively. Diluted
earnings per common share is computed by dividing income (loss) attributable to
common shareholders by the weighted-average number of shares of common stock
outstanding during the period increased to include the number of additional
shares of common stock that would have been outstanding if the potentially
dilutive securities had been issued. Potentially dilutive securities include
outstanding convertible preferred stock, stock options, warrants, and
convertible debt. The dilutive effect of potentially dilutive securities is
reflected in diluted earnings per share by application of the treasury stock
method. Under the treasury stock method, an increase in the fair market value of
the Company’s common stock can result in a greater dilutive effect from
potentially dilutive securities.
F-8
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
The
following table sets forth the computation of basic and diluted earnings per
share:
Year Ended March 31,
|
2010
|
2009
|
||||||
Basic
|
||||||||
Income
(loss) attributable to common stockholders
|
$ | (984,559 | ) | $ | 2,803,666 | |||
Weighted
average common shares outstanding (basic)
|
285,120,091 | 277,997,077 | ||||||
Basic
income (loss) per common share
|
$ | (0.00 | ) | $ | 0.01 | |||
Diluted
|
||||||||
Income
(loss) attributable to common stockholders
|
$ | (984,559 | ) | $ | 2,803,666 | |||
Plus:
|
||||||||
Accrued
and deemed dividends on preferred stock (1)
|
- | - | ||||||
Income
(loss) for diluted
|
$ | (984,559 | ) | $ | 2,803,666 | |||
Common
and potential common shares:
|
||||||||
Weighted
average common shares outstanding
|
285,120,091 | 277,997,077 | ||||||
Assumed
conversion of preferred stock (1)
|
- | - | ||||||
Assumed
exercise of options and warrants
|
- | 1,258,422 | ||||||
Common
and potential common shares
|
285,120,091 | 279,255,499 | ||||||
Diluted
income (loss) per common share
|
$ | (0.00 | ) | $ | 0.01 | |||
Potentially
dilutive securities outstanding at period end excluded from diluted
computation as they were antidilutive
|
18,449,200 | 19,364,976 |
(1) The
convertible preferred stock and convertible term note were antidilutive for the
respective periods.
Concentration
of Credit Risk and Sources of Supply
Financial instruments that
potentially subject the Company to concentration of credit risk consist
principally of cash and cashequivalents and trade receivables. The Company at
March 31, 2010 had substantially all of its cash and cash equivalents at one
financial institution in a non-interest bearing account in excess of
amounts insured by federal agencies. Effective October 14, 2008, FDIC
deposit insurance was changed to provide full deposit insurance coverage for
non-interest bearing deposit transaction accounts through December 31,
2009. This full coverage for non-interest bearing accounts was subsequently
extended through June 30, 2010. The Company does not
believe that it is subject to any unusual financial risk beyond the normal risk
associated with commercial banking relationships. The Company performs periodic
evaluations of the relative credit standing of these financial institutions. The
Company has not experienced any significant losses on its cash
equivalents.
Concentrations
of credit risk with respect to trade accounts receivable are limited due to the
number and nature of customerscomprising the Company’s customer base and their
geographic dispersion. The Company has not incurred any significant
creditrelated losses.
The
Company relies on one third-party contract manufacturer to produce its eVUmobile entertainment
product and generally relies on single suppliers for batteries, charging
stations and other components. The Company also relies on one legal firm to
represent it in patent licensing and enforcement matters.
Guarantees
and Indemnifications
The
Company enters into standard indemnification agreements in the ordinary course
of business. Some of the Company’s product sales and services agreements include
a limited indemnification provision for claims from third parties relating to
the Company’s intellectual property. Such indemnification provisions are
accounted for in accordance with ASC 450, Contingencies. The
indemnification is generally limited to the amount paid by the customer. To
date, there have been no claims under such indemnification
provisions.
F-9
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
The
Company provides a one-year limited warranty for most of its
products.
Revenue
Recognition
The
Company recognizes revenue in accordance with ASC Topic 605, Revenue
Recognition. Revenue is recognized when (i) persuasive evidence of
an arrangement exists, (ii) all obligations have been substantially performed
pursuant to the terms of the license agreement, (iii) amounts are fixed or
determinable and (iv) collectibility of amounts is reasonably assured. The
Company’s segments have the following revenue recognition policies:
Products
and Services
The
Company recognizes product revenue upon shipment of a product to the customer,
FOB shipping point, or upon acceptance by the customer depending on the specific
contract terms, if a signed contract exists, the fee is fixed and determinable,
collection of resulting receivables is probable and there are no resulting
obligations. 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 more than
perfunctory to the services or product that has not been delivered, revenue will
be deferred and recognized evenly over the remaining term of the undelivered
element.
Service
revenues may include revenue from coding, encrypting and integrating content for
periodic uploading to hardware players. Revenue is recognized upon acceptance of
the content master file by the customer if the fee is fixed and determinable,
collection of the resulting receivables is probable and there are no resulting
obligations.
In
accordance with Staff Accounting Bulletin (“SAB”) No. 104 Revenue Recognition (“SAB 104”) and
ASC 605-25,Multiple-Element
Arrangements, when an arrangement contains multiple elements with
standalone value, such as hardware and content or other services, revenue is
allocated based on the fair value of each element as evidenced by vendor
specific objective evidence. Such evidence consists primarily of pricing of
multiple elements as if sold as separate products or services. The Company
defers revenue for any undelivered elements, and recognizes revenue when the
product is delivered or over the period in which the service is performed, in
accordance with the Company’s revenue recognition policy for such element. If
the Company cannot objectively determine the fair value of any undelivered
element included in a multiple-element arrangement, revenue is deferred until
all elements are delivered and/or services have been performed, or until the
Company can objectively determine the fair value of all remaining undelivered
elements.
Revenue
from separately priced extended warranty or product replacement arrangements is
deferred and recognized to income on a straight-line basis over the contract
period. The Company evaluates these arrangements to determine if there are
excess costs greater than future revenues to be recorded as a loss.
Funds
received in advance of meeting the criteria for revenue recognition are deferred
and are recorded as revenue as they are earned. Any amounts related to periods
beyond twelve months are considered long-term deferred revenue.
Patent
Licensing and Enforcement
The
Company’s central patent licensing operations include the licensing and
enforcement of its patented technologies. These activities include the
negotiation of licensing arrangements with users of patented technologies to
realize a fair and reasonable license fee for all applicable periods (periods
prior to and subsequent to the execution of the license agreement). In most
instances, the Company must initiate patent litigation against infringers who
are otherwise unwilling to engage in technology licensing negotiations, or in
cases where a disagreement exists regarding whether or not infringement
exists.
Revenues
generated from license agreements are recognized in the period earned, provided
that amounts are fixed or determinable and collectibility is reasonably assured.
The Company applies the guidance of SEC Staff Accounting Bulletin Topic
13.A.3(f), Nonrefundable
Up-Front Fees, to its patent license and settlement agreements using the
specific performance method analogous to the sale of an asset in such literature
as ASC 840, Leasesand
ASC 926-605, Entertainment –
Films, Revenue Recognition.At the time the Company enters into a contract
and provides the customer with the licensed technology the Company has performed
all of its obligations under contract, the rights to the Company’s technology
have been transferred and no significant performance obligations remain. The
Company has no licenses that do not include settlement and covenants not to
sue.
F-10
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Until
fiscal 2010 all patent licenses provided for a contractually determined one time
fully paid up license inconsideration for the grant of a non-exclusive,
retroactive and future license to manufacture and/or sell products covered by
patented technologies owned by the Company.In December 2009 the Company entered
into its first license agreement providing for future royalties based on future
licensee activities. Licenses granted are perpetual in nature, extending until
the expiration of the related patents. The execution of license agreements
also provides for the release of the licensee from certain claims and the
dismissal of any pending litigation. Pursuant to the terms of these
agreements, the Company has no further obligation with respect to the grant of
the license and related releases, including no express or implied obligation to
maintain or upgrade the technology, or provide future support or
services. Licensees that pay license fees on a periodic basis generally
report actual activity after the activity takes place. The amount of license
fees due under these license agreements each period cannot be reasonably
estimated by management. Consequently, the Company recognizes revenue
from these licensing agreements on a lag basis as royalties are reported
provided amounts are fixed or determinable and collectibility is reasonably
assured. The lag method allows for the receipt of licensee royalty reports prior
to the recognition of revenue.
The Company considers its
licensing and enforcement activities as one unit of accounting under ASC 605-25,
Multiple-Element
Arrangements
as the delivered items do not have value to customers on a stand alone
basis,there are no undelivered elements and there is no general right of return
relative to the license.Under ASC 605-25, the appropriate recognition of
revenue is determined for the combined deliverables as a single unit of
accounting and revenue is recognized upon delivery of the final elements,
including the license for past and future use and the release. Also due to the
fact that the settlement element and license element for past and future use are
the major central business activities of the Company’s licensing segment, the
Company does not present these two elements as different revenue streams in its
consolidated statement of operations. The Company does not
expect to provide licenses that do not provide some form of settlement or
release.
The
Company evaluates each new license agreement for revenue recognition in
accordance with the above criteria and applicable literature.
The
Company values nonexclusive cross licenses received only if directly used in
operations. To date the Company has not valued any cross licenses received as
they were considered part of the customer’s overall license and settlement
strategy and are not used in the Company’s products.
Patent
license costs of revenues include contingency legal and other direct costs
associated with patent licensing and enforcement.
Deferred
Revenue, Deposits and Prepaid Expenses
Deferred
revenue and deposits relates primarily to prepaid extended warranty arrangements
and product sales or services paid but not delivered at period end. The Company
has certain customer arrangements providing for multiple year content services.
To the extent deferred services are to be provided beyond twelve months they are
treated as long-term. Prepaid expenses are recorded at amounts paid to suppliers
or others. Amounts recorded are evaluated for impairment each reporting
period.
Shipping
and Handling Costs and Sales Taxes
Amounts
paid by customers for shipping and handling and for sales taxes areincluded in
product revenues. Actual shipping and handling costs and sales taxes
are included in product cost of revenues.
Inventory
Inventory
is recorded at the lower of cost and net realizable value. Cost is determined on
a first-in, first-out basis. Carrying value of inventory is periodically
reviewed and impairments, if any, are recognized when the expected benefit is
less than carrying value.The Company writes its inventory down for estimated
obsolescence or lack of marketability equal to the difference between cost of
inventory and the net realizable value based upon assumptions about future
selling prices, demand, technology developments and market conditions.See Note
12 for purchase commitments.
F-11
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
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. The
Company reviews the carrying amount of fixed assets whenever events or changes
in circumstances indicate that the carrying amount of the assets may not be
recoverable in accordance with ASC 360-10-35, Impairment
or Disposal of Long-Lived Assets.
Intangible
Assets
Intangible
assets are recorded at cost, less accumulated amortization. These costs are
capitalized and amortized on a
straight-line
basis over the estimated periods benefited by the asset. The Company assesses
the recoverability of any affected long-lived assets in accordance with ASC
350-30-35-14 by determining whether the carrying value of such assets can be
recovered through undiscounted future operating cash flows.
Advertising
Advertising
costs are charged to expense as incurred. The Company expensed $9,259
and $10,031 for the years ending March 31, 2010 and 2009,
respectively.
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 warranty service directly and through subcontractors. Some
agreements with 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 Note 6 for
additional information regarding warranties.
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.
Income
Taxes
The
Company accounts for income taxes using the asset and liability method, the
objective of which is to establish deferred tax assets and liabilities for the
temporary differences between the amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carryforwards at
enacted tax rates expected to be in effect when such amounts are realized or
settled. A valuation allowance related to deferred tax assets is recorded when
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The Company provides a full valuation reserve related to
its net deferred tax assets. In the future, if sufficient evidence of an ability
to generate sufficient future taxable income in certain tax jurisdictions
becomes apparent, the Company may be required to reduce the valuation
allowances, resulting in income tax benefits in the consolidated statement of
operations. The Company evaluates the realizability of the deferred
tax assets and assesses the need for valuation allowance
quarterly. The utilization of the net operating loss carry forwards
could be substantially limited due to restrictions imposed under federal and
state laws upon a change in ownership.The Company has experienced various
ownership changes as a result of past financings and could experience future
ownership changes.
F-12
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Upon the
adoption of accounting for uncertainty in income taxes, as of April 1, 2007 the
Company recognized no adjustment for uncertain tax provisions and the total
amount of unrecognized tax benefits as of April 1, 2007 was $-0-. At
the adoption date of April 1, 2007, deferred tax assets were fully reserved by a
valuation allowance to reduce the deferred tax assets to zero, the amount that
more likely than not is expected to be realized.
The
Company recognizes interest and penalties related to uncertain tax positions as
part of the provision for income taxes. As of March 31, 2010, the Company had
not recorded any provisions for accrued interest and penalties related to
uncertain tax positions.
The tax
years 2005 through 2009 remain open under the statue of limitations to
examination by the major tax jurisdictions to which we are subject. However, due
to net operating loss carryforwards (“NOL”) from prior periods, the Internal
Revenue Service (IRS) could potentially review the losses related to
NOL-generating years back to 1993.
Stock-based
Compensation
The
Company has adopted stock plans as summarized in Note 10. The Company measures all
employee stock-based compensation awards using a fair-value method and recording
of such expense in the consolidated financial statements over the requisite
service period. The Company records the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award. That cost is recognized over the period during which an
employee is required to provide service in exchange for the award—the requisite
service period (usually the vesting period).Options or stock awards issued to
non-employees who are not directors of the Company are recorded at their
estimated fair value at the measurement date and are periodically revalued as
the options vest and are recognized as expense over the related service period
on a graded vesting method. Stock options issued to consultants with performance
conditions are measured and recognized when the performance is
complete.
The
Company recorded $156,328 and $74,734 of stock-based compensation expense for
the years ended March 31, 2010 and 2009, respectively. The amounts of
stock-based compensation expense are classified in the consolidated statements
of operations as follows:
Year
Ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Research
and development
|
26,703 | 26,620 | ||||||
Selling
and administrative
|
129,625 | 48,114 | ||||||
Total
stock-based compensation expense
|
156,328 | 74,734 |
While
certain research and development personnel costs are allocated to cost of
revenues for proportionate time spent on product and content services, the
amounts of related stock-based compensation costs are not considered
significant.
Comprehensive
Loss
Comprehensive
loss 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,
2010 and 2009, there were no material differences between comprehensive loss and
net loss for the year.
Common
Stock Issued for Services or Payments
The
Company records compensation expense for common stock issued for services or
financing fees based on the estimated fair market value. Estimated fair market
value is determined based on the quoted closing stock price on the day of
issuance or the market price defined in any underlying agreement as long as such
price closely approximates market price.
F-13
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Derivative
Instruments
The
Company values derivative instruments related to the classification and
measurement of warrants and equity instruments with embedded conversion features
in accordance with ASC 815-40, Derivatives and Hedging – Contracts
in Entity’s Own Equity. The Company makes certain assumptions and
estimates to value its derivative liabilities. Factors affecting these
liabilities and values include changes in the stock price and other
assumptions.
Reclassifications
Certain
amounts included in the prior year financial statements have been reclassified
to conform to the current year’s presentation. These reclassifications have no
affect on the reported net income (loss).
Recent
Accounting Pronouncements
Adopted Accounting
Pronouncements
Effective
July 1, 2009, the Company adopted The “FASB Accounting Standards
Codification” and the Hierarchy of Generally Accepted Accounting Principles
(ASC 105). This standard establishes only two levels of U.S. generally
accepted accounting
principles (“GAAP”), authoritative and nonauthoritative. The Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification” or “ASC”)
became the source of authoritative, nongovernmental GAAP, except for rules and
interpretive releases of the
SEC, which are sources of authoritative GAAP for SEC registrants. All
other non-grandfathered, non-SEC accounting literature not included in the
Codification became nonauthoritative. The Company began using the new guidelines
and numbering system
prescribed by the Codification when referring to GAAP in the second
quarter of fiscal 2010. As the Codification was not intended to change or alter existing
GAAP, it did not have any impact on the Company’s consolidated financial
statements.
Effective
April 1, 2009, the Company adopted three accounting standard updates that were
intended to provide additional application guidance and enhanced disclosures
regarding fair value measurements and impairments of securities established in
ASC 820, Fair Value
Measurements and Disclosures. They also provide additional guidelines for
estimating fair value in accordance with fair value accounting. The first
update, as codified in ASC 820-10-65, provides additional guidelines for
estimating fair value in accordance with fair value accounting. The second
accounting update, as codified in ASC 320-10-65, changes accounting requirements
for other-than-temporary-impairment for debt securities by replacing the current
requirement that a holder have the positive intent and ability to hold an
impaired security to recovery in order to conclude an impairment was temporary
with a requirement that an entity conclude it does not intend to sell an
impaired security and it will not be required to sell the security before the
recovery of its amortized cost basis. The third accounting update, as codified
in ASC 825-10-65, increases the frequency of fair value disclosures. These
updates were effective for fiscal years and interim periods ended after June 15,
2009. The adoption of these accounting updates did not have any impact on the
Company’s consolidated financial statements.
In
February 2008, the FASB issued an accounting standard update that delayed the
effective date of fair value measurements accounting for all non-financial
assets and non-financial liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually), until the beginning of the first quarter of fiscal 2010. These
include goodwill and other non-amortizable intangible assets. The Company
adopted this accounting standard update effective April 1, 2009 and elected not
to adopt the option available under ASC 825-10-10 to measure any of its other
eligible financial instruments or other items at fair value. Accordingly, the
Company continues to measure all of its assets and liabilities on the historical
cost basis of accounting except as required under generally accepted accounting
principles.
Effective
April 1, 2009 and as amended in February 2010, the Company adopted a new
accounting standard for subsequent events, as codified in ASC 855-10. The update
modifies the names of the two types of subsequent events either as recognized
subsequent events (previously referred to in practice as Type I subsequent
events) or non-recognized subsequent events (previously referred to in practice
as Type II subsequent events). In addition, the standard modifies the definition
of subsequent events to refer to events or transactions that occur after the
balance sheet date, but before the financial statements are issued (for public
entities) or available to be issued (for nonpublic entities). The update did not
result in significant changes in the practice of subsequent event disclosures,
and therefore the adoption did not have any impact on the Company’s consolidated
financial statements.
F-14
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Effective
April 1, 2009, the Company adopted a new accounting standard update regarding
business combinations. As codified under ASC 805 the update requires the
acquisition method to be applied to all transactions and other events in which
an entity obtains control over one or more other businesses, requires the
acquirer to recognize the fair value of all assets and liabilities acquired,
even if less than one hundred percent ownership is acquired, and establishes the
acquisition date fair value as measurement date for all assets and liabilities
assumed. For the Company, this accounting update was effective on a prospective
basis for all business combinations for which the acquisition date is on or
after April 1, 2009. Since the Company is not contemplating any business
combinations it does not presently expect any impact of adoption on its
consolidated financial statements.
ASC 810,
Consolidation (“ASC
810”), ASC 810-10-65, Transition and Open Effective Date
Information (“ASC 810-10-65”) establishes accounting and reporting
standards for the non-controlling interest in a subsidiary and for the
deconsolidation of a subsidiary. It clarifies that a non-controlling interest in
a subsidiary is an ownership interest in the consolidated financial statements.
ASC 810-10-65 is effective for our fiscal years beginning after December 15,
2008.The provisions of are applied prospectively upon adoption except for the
presentation and disclosure requirements that are applied retrospectively. The
Company has no non-controlling interests and accordingly the adoption on April
1, 2009 did not have a material impact on the Company’s consolidated financial
statements.
ASC 815,
Derivatives and Hedging
(“ASC 815”) and ASC 815-10-65, Transition and Open Effective Date
Information (“ASC 815-10-65”) includes a requirement for enhanced
disclosures about an entity’s derivative and hedging activities. ASC 815 is
effective prospectively for fiscal years beginning after November 15, 2008. The
Company currently has no derivatives or hedging activities and the adoption on
April 1, 2009 did not have a material impact on the Company’s consolidated
financial statements.
ASC
808, Collaborative
Arrangements provides guidance for income statement presentation,
classification, and disclosures related to collaborative arrangements. The
arrangements generally provide that the collaborators will share, based on
contractually defined calculations, the profits or losses from the associated
activities. Periodically, the collaborators share financial information related
to product revenues generated (if any) and costs incurred that may trigger a
sharing payment for the combined profits or losses. The guidance requires
collaborators in such an arrangement to present the result of activities for
which they act as the principal on a gross basis and report any payments
received from (made to) other collaborators based on other applicable GAAP or,
in the absence of other applicable GAAP, based on analogy to authoritative
accounting literature or a reasonable, rational, and consistently applied
accounting policy election. ASC 808 is effective for collaborative arrangements
in place at the beginning of the annual period beginning after December 15,
2008. The Company does not have any such collaborative arrangements and the
adoption of ASC 808 on April 1, 2009 did not have a material impact on the
Company’s consolidated financial statements.
F-15
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
New Accounting
Pronouncements
In
September 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-13,
Multiple-Deliverable Revenue
Arrangements—a consensus of the FASB Emerging Issues Task Force (ASU
2009-13). It updates the existing multiple-element revenue arrangements guidance
currently included under ASC 605-25, which originated primarily from the
guidance in EITF Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables (EITF 00-21). The revised guidance primarily provides two
significant changes: 1) eliminates the need for objective and reliable evidence
of the fair value for the undelivered element in order for a delivered item to
be treated as a separate unit of accounting, and 2) eliminates the residual
method to allocate the arrangement consideration. In addition, the guidance also
expands the disclosure requirements for revenue recognition. ASU 2009-13 will be
effective for the first annual reporting period beginning on or after June 15,
2010, with early adoption permitted provided that the revised guidance is
retroactively applied to the beginning of the year of adoption. The Company
believes this pronouncement is consistent with and will not change its revenue
recognition for patent licenses and will have no impact on its consolidated
financial statements.
3.
STATEMENT OF CASH FLOWS
The
Company had non-cash operating and financing activities and made cash payments
as follows:
Year
Ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Non-cash
financing activities:
|
||||||||
Common
stock issued on conversion of preferred stock
|
212,083 | - | ||||||
Accounts
payable exchanged for preferred stock
|
- | 50,000 | ||||||
Shares
issued for term debt payments
|
350,000 | 380,000 | ||||||
Shares
issued for financing fees
|
- | 11,800 | ||||||
Options
exercised on a cashless basis
|
- | 29,250 | ||||||
Options
granted for stock appreciation rights obligation
|
- | 26,620 | ||||||
Accrued
and deemed dividends on preferred stock
|
175,139 | 130,320 | ||||||
Warrant
derivative liability reclassified as equity
|
- | 132,315 | ||||||
Cash
payments during year for:
|
||||||||
Interest
|
327 | 83,059 | ||||||
Income
taxes - net
|
104,750 | 264,000 |
4.
INVENTORIES
Inventories
consist of the following:
March
31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Raw
materials
|
111,399 | 140,544 | ||||||
Work
in process
|
19,033 | 28,335 | ||||||
Finished
goods
|
216,646 | 348,284 | ||||||
347,078 | 517,163 |
The
foregoing is net of an aggregate lower-of-cost-or-market inventory adjustment of
$65,459 at March 31, 2010.
F-16
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
5.
PROPERTY, EQUIPMENT AND INTANGIBLES
Property
and equipment consisted of the following:
Year
Ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Computer
hardware and software
|
50,706 | 47,321 | ||||||
Furniture
and equipment
|
26,499 | 26,499 | ||||||
Machinery
and equipment
|
72,499 | 72,499 | ||||||
Leasehold
improvements
|
1,639 | 1,639 | ||||||
Tooling
|
19,720 | 19,720 | ||||||
171,063 | 167,678 | |||||||
Accumulated
depreciation and amortization
|
(159,973 | ) | (141,040 | ) | ||||
11,090 | 26,638 |
Intangible
assets consisted of the following:
Year
Ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Patents
and licenses
|
24,409 | 24,409 | ||||||
Accumulated
amortization
|
(24,409 | ) | (24,409 | ) | ||||
- | - |
6.
ACCRUED LIABILITIES
Accrued
liabilities consisted of the following:
March
31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Payroll
and related
|
103,607 | 112,727 | ||||||
Deferred
revenue
|
153,743 | 68,296 | ||||||
Customer
deposits
|
- | 80,000 | ||||||
Accrued
litigation
|
- | 100,000 | ||||||
Warranty
reserve
|
5,262 | 14,155 | ||||||
Accrued
state taxes
|
- | 157,500 | ||||||
Accrued
professional fees
|
45,000 | 45,000 | ||||||
Deferred
rent
|
8,336 | 12,136 | ||||||
315,948 | 589,814 |
F-17
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Details
of the estimated warranty liability are as follows:
Year
Ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Beginning
balance
|
14,155 | 109,138 | ||||||
Warranty
provision
|
9,502 | (53,368 | ) | |||||
Warranty
deductions
|
(18,395 | ) | (41,615 | ) | ||||
Ending
balance
|
5,262 | 14,155 |
7.
CONVERTIBLE TERM NOTE
On
December 12, 2006 the Company became obligated on a 7.5% Convertible
Subordinated Term Note (“Term Note”) in the original principal amount of
$970,752 with monthly principal and interest installments starting at $6,000 in
December 2006, increased to $15,000 in February 2007, increased to $30,000 in
December 2007 and to $50,000 in December 2008. The last installment of the note
was paid at maturity in November 2009. While outstanding the Term
Note was convertible, subject to certain limitations, at $0.30 per share of
common stock.
For the
year ended March 31, 2010 the Company made the final monthly payment totaling
$47,865 in cash and seven monthly payments aggregating $350,000 by issuing
2,705,515 shares of common stock. For the year ended March 31, 2009 the Company
made two monthly payments totaling $60,000 in cash and ten monthly payments
aggregating $380,000 by issuing 3,018,331 shares of common stock.
8.
INCOME TAXES
Details
of the income tax benefit (provision) for the years ended March 31, 2010 and
2009 are as follows:
Year
ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Current
tax benefit (expense)
|
55,250 | (421,500 | ) | |||||
Deferred
tax benefit (expense)
|
256,000 | (868,000 | ) | |||||
Change
in valuation allowance
|
(256,000 | ) | 868,000 | |||||
Income
tax benefit (provision)
|
55,250 | (421,500 | ) |
Details
of tax benefit (provision) are as follows:
Year
ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Current
tax benefit (expense):
|
||||||||
Federal
benefit (expense)
|
- | - | ||||||
State
expense
|
(2,500 | ) | (157,500 | ) | ||||
Foreign
benefit (expense)
|
57,750 | (264,000 | ) | |||||
55,250 | (421,500 | ) |
The
Company paid $206,250 of foreign taxes during the year ended March 31, 2010 and
received a refund of $264,000 of foreign taxes withheld and paid in the prior
year in connection with patent licensing agreements. In the year ended March 31,
2009 the Company also generated a tax liability to the state of California due
to the suspension of the net operating loss (“NOL”) carryforwards for the 2008
and 2009 tax years. The state tax liability of $157,500 was after a reduction of
50% from the use of allowable research and development (“R&D”)credits
generated in prior years.
The
Company has U.S. federal NOL carryforwards available at March 31, 2010 of
approximately $51,800,000 (2009 - $50,900,000) that will begin to expire in
2011. The Company has state net operating loss carryforwards of $18,500,000
(2009 - $18,600,000) that will begin to expire in 2012. The
difference between federal and state net operating loss carryforwards is due to
certain percentage limitations of California loss carryforwards and to expired
California carryforwards. The foreign taxes paid create a foreign tax credit
carryover that will be available to offset federal tax expense in future years,
subject to certain limitations. The foreign tax credit carryover
expires beginning in 2021.
F-18
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Utilization
of the NOL and any R&D credit carryforwards may be subject to a substantial
annual limitation under Section 382 of the Internal Revenue Code (“IRC”) of 1986
and similar state provisions, due to changes in ownership of the Company that
have occurred previously or that could occur in the future. These ownership
changes may limit the amount of NOL and R&D credit carryforwards that can be
utilized annually to offset future taxable income and tax, respectively. In
general, an ownership change, as defined by Section 382, results from
transactions increasing the ownership of certain shareholders or public groups
in the stock of a corporation by more than 50 percentage points over a
three-year period. Since the date of currently available NOLs from fiscal 1995,
the Company has raised capital through the issuance of capital stock using
multiple types of securities on multiple occasions which, the Company believes,
caused multiple ownership changes as defined by Section 382. The Company has
performed a 382 analysis to assess whether ownership changes have occurred which
would limit the Company’s utilization of its NOLs and any R&D credits
carryforwards. Based on this analysis, the Company determined that no ownership
changes have occurred since March 31, 2000. Accordingly, NOL carryforwards
generated during the 2001 through 2008 fiscal years, are generally not subject
to Section 382 limitations and the Company will be able
to utilize such NOLs and any R&D carryforwards provided it generates
sufficient future earnings. Future ownership changes may limit the
Company’s ability to fully utilize these tax benefits.Accordingly, the Company
has recorded the deferred tax assets associated with such federal NOLs, related
state NOLs, and R&D tax creditsalong with a corresponding valuation
allowance.
During
the year ended March 31, 2010 the Company completed a study of prior year
R&D credits and updated the related unrecognized tax benefits included in
the table below for each year. Due to the existence of the valuation allowance,
this change and future changes in the Company’s unrecognized tax benefits will
not impact its effective tax rate.
Significant
components of the Company’s deferred tax assets as of March 31, 2010 and 2009
are shown below. A valuation allowance of $10,791,000 and $10,535,000 was
established at March 31, 2010 and 2009 respectively, to offset the net deferred
tax assets as realization is uncertain. When and if the Company can sustain
consistent profitability and management determines that it is more likely than
not that the Company will be able to utilize the deferred tax assets prior to
their expiration, the valuation allowance may be reduced or
eliminated.
March
31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Deferred
tax assets:
|
||||||||
Net
operating loss carryforwards
|
9,623,000 | 9,252,000 | ||||||
Foreign
tax credit
|
206,000 | 264,000 | ||||||
Research
tax credit
|
1,573,000 | 1,573,000 | ||||||
Stock-based
compensation
|
88,000 | 65,000 | ||||||
Accruals
and other
|
151,000 | 150,000 | ||||||
11,641,000 | 11,304,000 | |||||||
Deferred
tax liabilities:
|
||||||||
Depreciation
and amortization
|
(35,000 | ) | (31,000 | ) | ||||
State
taxes
|
(815,000 | ) | (738,000 | ) | ||||
(850,000 | ) | (769,000 | ) | |||||
Deferred
tax assets
|
10,791,000 | 10,535,000 | ||||||
Valuation
allowance for deferred tax assets
|
(10,791,000 | ) | (10,535,000 | ) | ||||
Net
deferred taxes
|
- | - |
F-19
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
The
difference between the provision for income taxes (benefit) and the amount
computed by applying the U.S. federal income tax rate for the years ended March
31, 2010 and 2009 is as follows:
Year
ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
Income
taxes benefit (expense) computed at federal statutory
rate
|
302,500 | (1,174,000 | ) | |||||
Foreign
taxes (refund), net
|
57,750 | (264,000 | ) | |||||
Foreign
tax credit (reduction), net
|
(57,750 | ) | 264,000 | |||||
Permanent
book-tax differences
|
(33,250 | ) | (69,000 | ) | ||||
State
income tax (expense) benefit, net of federal effect
|
42,000 | (204,000 | ) | |||||
State
tax credit
|
- | 157,500 | ||||||
Change
in valuation allowance
|
(256,000 | ) | 868,000 | |||||
Income
tax benefit (provision)
|
55,250 | (421,500 | ) |
9.
CAPITAL STOCK
Authorized
Capital
The
authorized capital of the Company consists of 350,000,000 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 286,950,900 and 282,124,564
common shares as of March 31, 2010 and 2009, respectively.
Preferred
Stock
On June
27, 2008 the Company issued 75,000 shares of 5% Series AA Convertible Preferred
Stock (the “Series AA Stock”) with a stated value of $10 per share. Dividends of
5% per annum are payable in shares of common stock or at the Company’s election
additional shares of Series AA Stock or under certain circumstances in cash. The
Series AA Stock has voting rights of ten votes per share and a liquidation
preference equal to $10.00 per share plus accrued and unpaid dividends. The
stated value plus accrued dividends on Series AA Stock is convertible into
common stock at $0.10 per common share with automatic conversion on June 30,
2010 subject to certain limitations. The Company may call the Series AA Stock
for conversion if the common stock market price is at least $0.25 per share for
ten consecutive trading days.
The
Series AA Stock was issued for aggregate proceeds of $750,000 including $700,000
of cash and conversion of $50,000 of vendor debt. Purchasers were also issued
warrants to purchase an aggregate of 7,500,000 shares of common stock
exercisable at $0.10 per common share until June 30, 2011 (“Series AA
Warrants”). One officer/director purchased for $100,000 cash 10,000 shares of
Series AA Stock and was issued warrants to purchase 1,000,000 shares of common
stock on the same terms as unaffiliated investors.
At the
holder’s option the Series AA Stock and the Series AA Warrants were redeemable
for cash at June 30, 2009 should sufficient shares of common stock not be
authorized and reserved for conversion of all underlying shares by such date.
This redemption right was terminated effective September 17, 2008 with the
shareholders authorizing additional shares of common stock and the Board of
Directors reserving sufficient shares for future conversions of the Series AA
Stock and exercise of the Series AA Warrants.
F-20
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
The
proceeds of $750,000 were allocated between the fair value of the Series AA
Stock ($615,227) with the value of the Series AA Warrants ($134,773) treated as
a discount to the Series AA Stock. The Company determined the fair value of the
Series AA Warrants using the Black-Scholes option pricing model with the
following assumptions: no dividend yield; weighted average risk free rate of
2.93%; volatility of 60.6% and a term of one year. Further, the Company
calculated the intrinsic value of the beneficial conversion feature as $134,773.
The total discount to the Series AA Stock of $269,546, consisting of the value
of the Series AA Warrants and the amount of the beneficial conversion feature,
is being accreted as a deemed dividend over the term of the Series AA Stock. A
total of $143,146 of the discount was accreted as a deemed dividend for the year
ended March 31, 2010 (2009 - $101,861) by a charge to paid-in capital. The
stated 5% dividend also accrues to the carrying value of the Series AA Stock.
The deemed and stated dividends are also used in determining the net income
(loss) attributable to common stockholders for the respective
periods.
The
Company recorded a liability of $134,773 for the derivative value of the
warrants due to insufficient shares available for exercise. As a derivative
liability this amount was evaluated for reclassification and adjusted at each
reporting period based on the current market price. Upon the authorization and
reservation of shares of common stock for exercise of the warrants on September
17, 2008, the Company determined the warrants were no longer a derivative
liability. The value at that date of $132,315 was reclassified to paid-in
capital and a net non-cash gain of $2,458 was recorded. The Company also
determined that the termination of the warrant redemption rights was an
effective modification of the warrant term and calculated the fair value of the
warrants immediately prior to the modification compared to the value immediately
after the modification and recorded the difference in warrant value of $177,125.
The net of warrant adjustments of $174,667 is included in warrant and other
finance expenses.
During
the year ended March 31, 2010 the Company issued 2,120,821 shares of common
stock upon the conversion of 20,000 shares of Series AA Stock and accordingly
55,000 shares of Series AA Stock were outstanding at March 31,
2010.
Fusion
Capital Equity Purchase Agreement
On
January 2, 2007, the Company entered into an agreement with Fusion Capital Fund
II, LLC (“Fusion”) pursuant to which the Company had the right, subject to
certain conditions and limitations, to sell to Fusion common stock in specified
limited amounts and increments, at the Company’s election, over a two year
period that ended February 9, 2009 at prices determined based upon the market
price of the Company’s common stock.During the year ended March 31, 2009 prior
to termination of the agreement, the Company sold 6,345,549 common shares to
Fusion under the agreement for cash of $660,000.
Share
Warrants
A summary
of warrant activity during the years ended March 31, 2009 and 2010 is presented
below:
Number
|
Average Purchase
Price Per Share $
|
|||||||
Shares
purchasable under outstanding warrants at March 31, 2008
|
2,331,572 | 0.15 | ||||||
Stock
purchase warrants issued
|
7,500,000 | 0.10 | ||||||
Shares
purchasable under outstanding warrants at March 31, 2009
|
9,831,572 | 0.15 | ||||||
Stock
purchase warrants expired
|
(2,331,572 | ) | 0.15 | |||||
Shares
purchasable under outstanding warrants at March 31, 2010
|
7,500,000 | 0.10 |
The
Company has outstanding share warrants as of March 31, 2010, as
follows:
Number of
|
Exercise Price
|
||||||||||
Description
|
Common Shares
|
Per Share $
|
Expiration Date
|
||||||||
Warrants
|
7,500,000 | 0.10 |
June 30, 2011
|
F-21
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
10.
BENEFIT PLANS AND STOCK-BASED COMPENSATION
Stock Plan and
Awards
The
Company has stock options outstanding under its 2005 Equity-Based Compensation
Plan covering a maximum of 10,000,000 common shares. The Company may grant
incentive options, nonstatutory options, stock appreciation rights or restricted
stock awards to employees, directors or consultants until 2015. At March 31,
2010 there were options outstanding on 4,715,500 common shares pursuant to the
2005 Plan with options on 4,910,000 shares available for future grant under the
2005 Plan plus any future forfeitures or cancellations from the 2005 Plan
options currently outstanding.
The
Company has granted options outside the above plan as inducements to new
employees and for the continued service of key employees. At March 31, 2010
there were options outstanding on 250,000 common shares from grants outside the
stock option plan.
In March
2009 the Company authorized 425,000 options to former employees to replace
comparable stock-appreciation rights previously recorded as a $26,620 liability
with such amount included in paid-in capital and stock-based compensation
costs.
Stock-Based
Compensation
The
grant-date fair value of employee share options and similar instruments is
estimated using a Black-Scholes option-pricing model. The following table sets
forth the weighted-average key assumptions and fair value results for stock
options granted during the years ended March 31, 2010 and 2009 (annualized
percentages):
Year
Ended March 31,
|
||||||||
2010
|
2009
|
|||||||
Volatility
|
77 | % | 76 | % | ||||
Risk-free
interest rate
|
0.95 | % | 1.80 | % | ||||
Forfeiture
rate
|
1.0 | % | 0.0 | % | ||||
Dividend
yield
|
0.0 | % | 0.0 | % | ||||
Expected
life in years
|
2.2 | 2.9 | ||||||
Weighted-average
fair value of options granted
|
$ | 0.06 | $ | 0.06 |
The
dividend yield of zero is based on the fact that the Company has never paid cash
dividends and has no present intention to pay cash dividends. Expected
volatility is based on the historical volatility of the common stock over the
period commensurate with the expected life of the options. The Company has a
small number or option grants and limited exercise history and accordingly has
for all new option grants applied the simplified method prescribed by SEC Staff
Accounting Bulletin 110, Share-Based Payment: Certain
Assumptions Used in Valuation Methods - Expected Term,to estimate
expected life (computed as vesting term plus contractual term divided by two).
The expected forfeiture rate is estimated based on historical experience and is
assumed at0.0% for nonemployees and certain long-term employees and 5.0% for
other employees. Additional expense is recorded when the actual forfeiture rates
are lower than estimated and a recovery of prior expense will be recorded if the
actual forfeitures are higher than estimated.
Since the
Company has a net operating loss carryforward as of March 31, 2010, no excess
tax benefit for the tax deductions related to stock-based awards was recognized
for the year ended March 31, 2010. Additionally, no incremental tax benefits
were recognized from stock options exercised during the year ended March 31,
2010 or 2009 that would have resulted in a reclassification to reduce net cash
provided by operating activities with an offsetting increase in net cash
provided by financing activities.
As of
March 31, 2010 total estimated compensation cost of options granted but not yet
vested was approximately $28,500 and is expected to be recognized over the
weighted average period of 1.2 years.
F-22
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Stock
Option Summary Information
During
fiscal 2010, 2,330,000 options (2009 – 1,537,500 options) were granted at
exercise prices ranging from $0.11 to $0.15 (2009 - $0.11 to $0.22) per share.
The following table summarizes stock option transactions:
Weighted average
|
Aggregate
|
|||||||||||
Shares
|
exercise price
|
Intrinsic Value
|
||||||||||
#
|
$
|
$
|
||||||||||
Outstanding
March 31, 2008
|
10,897,167 | 0.17 | ||||||||||
Fiscal
2009
|
||||||||||||
Granted
|
1,537,500 | 0.13 | ||||||||||
Exercised
|
(325,000 | ) | 0.09 | |||||||||
Canceled/expired
|
(4,059,167 | ) | 0.14 | |||||||||
Outstanding
March 31, 2009
|
8,050,500 | 0.16 | 126,050 | |||||||||
Exercisable
at March 31, 2009
|
6,346,332 | 0.17 | 72,875 | |||||||||
Fiscal
2010
|
||||||||||||
Granted
|
2,330,000 | 0.15 | ||||||||||
Exercised
|
- | 0.09 | ||||||||||
Canceled/expired
|
(5,415,000 | ) | 0.17 | |||||||||
Outstanding
March 31, 2010
|
4,965,500 | 0.15 | 30,500 | |||||||||
Exercisable
at March 31, 2010
|
3,357,165 | 0.15 | 8,708 |
The
following table summarizes the number of options exercisable at March 31, 2010
and the weighted average exercise prices and remaining contractual lives of the
options.
Range of exercise
prices
|
Number
outstanding at
March 31, 2010
|
Number exercisable
at March 31, 2010
|
Weighted Average
exercise price
|
Weighted average
remaining
contractual life
|
Weighted average
Exercise price of
options exercisable
at March 31, 2010
|
||||||||||||||||
$
|
#
|
#
|
$
|
Years
|
$
|
||||||||||||||||
$0.11-$0.115 | 1,600,000 | 491,665 | 0.11 | 3.3 | 0.11 | ||||||||||||||||
$0.145-$0.16 | 2,730,000 | 2,230,000 | 0.16 | 2.6 | 0.15 | ||||||||||||||||
$0.185-$0.23 | 635,500 | 635,500 | 0.19 | 1.1 | 0.19 |
The
options generally vest over a period of two to three years. Options on 500,000
shares are subject to and vest based on future performance
conditions.
11.
SEGMENT INFORMATION
With the
inception of patent license revenue in fiscal 2009, the Company determined that
it has two operating segments: (1) products and services and (2) patent
licensing and enforcement. Products and services consist of sales of the
Company’s electronic eVU mobile entertainment device and related content
services and patent licensing and enforcement consists of intellectual
property revenues from the Flash-R patent portfolio.
F-23
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Reportable
segment information for the years ended March 31, 2010 and 2009 is as
follows:
Year
Ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
REVENUES:
|
||||||||
Products
and services
|
953,869 | 940,382 | ||||||
Patent
licensing
|
1,600,000 | 10,115,350 | ||||||
Total
revenue
|
2,553,869 | 11,055,732 | ||||||
GROSS
PROFIT:
|
||||||||
Products
and services
|
327,009 | 412,688 | ||||||
Patent
licensing
|
985,085 | 6,131,263 | ||||||
Total
gross profit
|
1,312,094 | 6,543,951 | ||||||
RECONCILIATION:
|
||||||||
Total
segment gross profit
|
1,312,094 | 6,543,951 | ||||||
Operating
expenses
|
(2,190,680 | ) | (2,844,008 | ) | ||||
Other
income (expense)
|
13,916 | (344,457 | ) | |||||
Income
(loss) before provision for income taxes
|
(864,670 | ) | 3,355,486 |
The
Company does not have significant assets employed in the patent license segment
and does not track capital expenditures or assets by reportable segment.
Consequently it is not practical to show this information.
Revenue
by geographic region is determined based on the location of the Company’s direct
customers or distributors for product sales and services. Patent license revenue
is considered United States revenue as payments are for licenses for United
States operations irrespective of the location of the licensee’s or licensee’s
parent home domicile.
Year
Ended March 31,
|
2010
|
2009
|
||||||
$
|
$
|
|||||||
United
States
|
1,676,600 | 10,115,350 | ||||||
International
|
877,269 | 940,382 | ||||||
Total
revenue
|
2,553,869 | 11,055,732 |
Revenues
from two licensees and one customer each accounted for more than 10% of revenues
for the year ended March 31, 2010. Revenues from five licensees each accounted
for more than 10% of revenues for the year ended March 31, 2009. Accounts
receivable from four parties comprised 28%, 21%, 18% and 15% of net accounts
receivable at March 31, 2010. Accounts receivable from threeparties comprised
44%, 19% and 11% of net accounts receivable at March 31, 2009.
12.
COMMITMENTS AND CONTINGENCIES
Legal
Matters
Business
Litigation
On
November 13, 2009 the Company entered into a settlement agreement ending certain
litigation with digEcor, Inc. (“digEcor”) agreeing to waive any
right to appeal prior Court’s rulings and orders in favor of the Company and the
Company withdrawing its applications for costs of suit. The agreement also
reduced and settled the judgment (related to batteries) to $60,000 from $80,000
that the Company had previously accrued resulting in $20,000 of other income.
The agreement included standard mutual release of claims and covenants not to
sue.
F-24
e.Digital
Corporation
Notes
to Consolidated Financial Statements
March
31, 2010
Intellectual Property
Litigation
In
September 2007 and March 2008, the Company filed complaints against eight
electronic product manufacturers in the U.S. District Court for the Eastern
District of Texas asserting that products made by the companies infringe four of
the Company's U.S. patents covering the use of flash memory technology. These
patents are part of the Company’s Flash-R patent portfolio. By September 30,
2009 the Company had licensed and settled the litigation with seven of the
manufacturers and suspended the complaint against one defendant in
bankruptcy.
In
November 2009 the Company filed an additional patent infringement complaint in
the United States District Court for the District of Colorado against
nineteen companies that manufacture devices using flash memory. By March
31, 2010 the Company had licensed and settled the litigation with three of the
defendants.
Although
most fees, costs and expenses of intellectual property litigation are covered
under the Company’s arrangement with Duane Morris LLP as described below, the
Company may incur support and related expenses for this litigation that may
become material.
Commitment Related to
Intellectual Property Legal Services
On March
23, 2007 the Company entered into an agreement for legal services and a
contingent fee arrangement withDuane Morris LLP. The agreement provides that
Duane Morris is the Company’s legal counsel inconnection with the assertion of
the Company’s flash memory related patents against infringers
(“PatentEnforcement Matters’).
Duane
Morris has agreed to handle the Company’s Patent Enforcement Matters and certain
related appeals on acontingent fee basis. Duane Morris also has agreed to
advance certain costs and expenses including travel expenses,court costs and
expert fees. The Company has agreed to pay Duane Morris a fee equal to 40% of
any license orlitigation recovery related to Patent Enforcement Matters, after
recovery of expenses, and 50% of recovery if appealis necessary.
In the
event the Company is acquired or sold or elects to sell the covered patents or
upon certain other corporateevents or in the event the Company terminates the
agreement for any reason, then Duane Morris shall be entitled tocollect accrued
costs and a fee equal to three times overall time and expenses (approximately
$690,000 at March 31, 2010) accrued in connection with theagreement and a fee of
15% of a good faith estimate of the overall value of the covered patents. Any
such corporate event or termination fee will only be recorded if and when such
applicable event becomes probable. The Company hasprovided Duane Morris a lien
and a security interest in the covered patents to secure its obligations under
theagreement.
Contract
Manufacturers and Suppliers
At March
31, 2010 the Company had outstanding unfilled purchase orders and was committed
to a contract manufacturer and component suppliers for approximately $224,000 of
future deliveries.
Facility
Lease
In March
2006 the Company entered into a sixty-two month lease, commencing June 1, 2006,
for approximately 4,800 square feet with an aggregate monthly payment currently
at $6,344 excluding utilities and costs. The aggregate payments adjust annually
with maximum aggregate payments totaling $6,534 in the fifty-first through the
sixty-second month. Future commitments aggregated $103,787 at March 31, 2010.
Office rent expense recorded by the Company for the year ended March 31, 2010
was $91,860 (2009 - $99,474).
13.
RELATED PARTY TRANSACTIONS
On
October 8, 2008 Eric M. Polis was appointed as a director of the Company. Mr.
Polis is Secretary, Treasurer and a director of ASI Technology Corporation
(“ASI”) the holder of an 18% Secured Promissory Note that was repaid in March
2009. The Company paid cash interest of $69,750 to ASI during the year ended
March 31, 2009.
See
additional related party disclosure in Note 9.
F-25