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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

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 incorporation or organization)   (I.R.S. Empl. Ident. No.)

 

  16870 West Bernardo Drive, Suite 120, San Diego, California   92127
  (Address of principal executive offices)   (Zip Code)

 

(858) 304-3016

(Registrant’s telephone number, including area code)

 

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 T   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 T   NO £

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large Accelerated Filer £ Accelerated filer £
  Non-accelerated filer    £ (Do not check if a smaller reporting company) Smaller reporting company T

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES £   NO T

 

As of November 1, 2013 a total of 293,186,908 shares of the Registrant’s Common Stock, par value $0.001, were issued and outstanding.

 

 

 

 
 

e.DIGITAL CORPORATION

 

 

INDEX

 

      Page
PART I. FINANCIAL INFORMATION  
       
  Item 1. Financial Statements (unaudited): 3
       
    Condensed Consolidated Balance Sheets as of September 30, 2013 and March 31, 2013 3
       
    Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2013 and 2012 4
       
    Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2013 and 2012 5
       
    Notes to Interim Condensed Consolidated Financial Statements 6
       
  Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
       
  Item 4. Controls and Procedures 18
       
PART II. OTHER INFORMATION  
       
  Item 1. Legal Proceedings 18
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19
       
  Item 3. Defaults Upon Senior Securities 19
       
  Item 4. Mine Safety Disclosures 19
       
  Item 5. Other Information 19
       
  Item 6. Exhibits 19
       
SIGNATURES 20

 

 

 

2
 

Part I. Financial Information

Item 1. Financial Statements:

e.Digital Corporation and subsidiary

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   September 30,     
   2013   March 31, 
   (Unaudited)   2013 
   $   $ 
ASSETS          
Current          
Cash and cash equivalents   1,355,698    1,741,439 
Accounts receivable   59,125    175,930 
Inventory   13,044    21,199 
Deposits and prepaid expenses   67,537    60,325 
Total current assets   1,495,404    1,998,893 
Inventory, long-term   63,319    104,031 
Property, equipment and intangibles, net of accumulated depreciation and amortization of $170,957 and $168,768, respectively   10,740    12,929 
Total assets   1,569,463    2,115,853 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current          
Accounts payable, trade   78,596    67,297 
Accrued and other liabilities   194,052    272,837 
Total current liabilities   272,648    340,134 
           
Commitments and Contingencies          
           
Stockholders' equity          
Preferred stock, $0.001 par value; 5,000,000 shares authorized None issued and outstanding        
Common stock, $0.001 par value, authorized 350,000,000, 293,186,908 shares issued and outstanding each period   293,187    293,187 
Additional paid-in capital   82,813,635    82,810,989 
Accumulated deficit   (81,810,007)   

(81,328,457

Total stockholders' equity   1,296,815    1,775,719 
           
Total liabilities and stockholders' equity   1,569,463    2,115,853 

 

 

See notes to interim condensed consolidated financial statements

 

 

3
 

 

e.Digital Corporation and subsidiary

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

   For the three months ended   For the six months ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   $    $    $    $ 
Revenues:                    
Products and services   67,004    122,949    124,462    255,495 
Patent license   34,725    2,000    426,725    2,000 
    101,729    124,949    551,187    257,495 
                     
Operating costs and expenses:                    
Cost of revenues:                    
Products and services   62,587    99,348    170,597    193,125 
Patent licensing and litigation costs   112,500    52,500    225,000    75,000 
Contingent legal fees and expenses   14,765    800    29,893    3,490 
Selling and administrative   243,840    179,442    446,227    379,901 
Research and related expenditures   78,150    168,864    161,020    314,967 
Total operating costs and expenses   511,842    500,954    1,032,737    966,483 
                     
Operating loss before provision for income taxes   (410,113)   (376,005)   (481,550)   (708,988)
Income tax benefit (expense)                
Loss for the period   (410,113)   (376,005)   (481,550)   (708,988)
Loss per common share - basic and diluted   (0.00)   (0.00)   (0.00)   (0.00)
                     
Weighted average common shares outstanding
Basic and diluted
   293,186,908    293,003,158    293,186,908    293,003,158 

 

 

See notes to interim condensed consolidated financial statements

 

 

4
 

 

e.Digital Corporation and subsidiary

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For the six months ended 
   September 30, 
   2013   2012 
OPERATING ACTIVITIES  $   $ 
Loss for period   (481,550)   (708,988)
Adjustments to reconcile loss to net cash used in operating activities:          
Depreciation and amortization   2,189    2,741 
Inventory market and reserve adjustment   48,552    22,731 
Warranty provision   353    1,378 
Stock-based compensation   2,646    10,546 
Changes in assets and liabilities:          
Accounts receivable   116,805    46,239 
Inventory   315    16,140 
Deposits and prepaid expenses   (7,212)   21,674 
Accounts payable, trade   11,300    31,690 
Accrued and other liabilities   (79,139)   (23,108)
Cash used in operating activities   (385,741)   (578,957)
Net decrease in cash and cash equivalents   (385,741)   (578,957)
Cash and cash equivalents, beginning of period   1,741,439    3,125,349 
Cash and cash equivalents, end of period   1,355,698    2,546,392 

 

 

See notes to interim condensed consolidated financial statements

 

 

5
 

 

 

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 is developing and marketing an intellectual property portfolio including licensing and enforcing its Flash-R™ portfolio of patents related to the use of flash memory in portable devices. We are also developing new licenseable intellectual property related to context and interpersonal awareness systems (“Nunchi” technology), data distribution and other technologies. The Company also markets the eVU® mobile entertainment system for the travel industry.

 

Unaudited Interim Financial Statements

These unaudited condensed consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These interim condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments considered necessary for a fair statement of the Company's financial position at September 30, 2013, and the results of its operations and cash flows for the periods presented, consisting only of normal and recurring adjustments. All significant intercompany transactions have been eliminated in consolidation. Operating results for the three and six months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2014. For further information, refer to the Company's consolidated financial statements and footnotes thereto for the year ended March 31, 2013 filed on Form 10-K.

 

Estimates

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

 

2. RECENT ACCOUNTING PRONOUNCEMENTS

 

There have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended September 30, 2013 that are of significance, or potential significance to the Company’s financial statements.

 

3. LOSS PER SHARE

 

Basic loss per common share is computed by dividing loss for the period by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed by dividing 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 included outstanding stock options and warrants. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. These securities were not included in the computation of diluted loss per share for the periods because they are antidilutive, but they could potentially dilute earnings per share in future periods. 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. For the periods presented potential dilutive securities were not included in the computation of diluted loss per share because they had no effect or were antidilutive, but they could potentially dilute earnings per share in future periods. There was no difference in basic and diluted loss per share or basic and diluted weighted average shares outstanding for the periods presented.

 

6
 

 

4. INVENTORIES

 

Inventory is recorded at the lower of cost or net realizable value. The cost of substantially all the Company’s inventory is determined by the weighted average cost method. We also have finished goods that we have determined to be slow-moving and have classified this portion of inventory as a long-term asset. Inventories consisted of the following:

 

   September 30,   March 31, 
   2013   2013 
   $   $ 
Raw materials   35,890    39,249 
Work in process   13,669    13,669 
Finished goods   38,067    79,635 
    87,626    132,553 
Reserve for obsolescence   (11,263)   (7,323)
    76,363    125,230 
Less current portion   13,044    21,199 
Inventory, long term   63,319    104,031 

 

The foregoing is net of an aggregate lower-of-cost-or-market inventory adjustment of $128,762 at September 30, 2013 and $84,150 at March 31, 2013, respectively. The Company made a lower of cost or market adjustment during the six months ended September 30, 2013 of $44,612 to reflect decreased product demand.

 

5. STOCK-BASED COMPENSATION COSTS

 

The Company accounts for stock-based compensation under the provisions of ASC 718, Share-Based Payment and ASC 505-50, Equity-Based Payments to Non-Employees. ASC 718 requires measurement of all employee stock-based awards using a fair-value method and recording of related compensation expense in the consolidated financial statements over the requisite service period. Further, as required under ASC 718, the Company estimates forfeitures for stock-based awards that are not expected to vest. The Company recorded stock-based compensation in its consolidated statements of operations for the relevant periods as follows:

 

   Three Months Ended   Six Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
Research and development       1,196    849    2,392 
Selling and administrative       4,265    1,797    8,154 
Total stock-based compensation expense       5,461    2,646    10,546 

 

As of September 30, 2013 all stock options granted were fully vested.

 

No stock options were granted during the three or six-month periods ended September 30, 2013 and 2012.

 

See Note 7 for further information on outstanding stock options.

 

7
 

 

6. WARRANTY RESERVE

 

Details of the estimated warranty liability included in accrued and other liabilities are as follows:

 

   Three Months Ended   Six Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
Beginning balance   448    633    657    1,093 
Warranty provision   (30)   1,064    353    1,378 
Warranty usage   (180)   (1,329)   (772)   (2,103)
Ending balance   238    368    238    368 

 

7. STOCKHOLDERS’ EQUITY

 

The following table summarizes stockholders’ equity transactions during the six-month period ended September 30, 2013:

 

   Common stock   Additional   Accumulated   Total stockholders' 
   Shares   Amount   paid-in capital   deficit   equity 
       $   $   $   $ 
Balance, April 1, 2013   293,186,908    293,187    82,810,989    (81,328,457)   1,775,719 
Stock-based compensation           2,646         2,646 
Loss for the period               (481,550)   (481,550)
Balance, September 30, 2013   293,186,908    293,187    82,813,635    (81,810,007)   1,296,815 

 

Options

The following table summarizes stock option activity for the period:

 

 

       Weighted average   Aggregate 
   Shares   exercise price   Intrinsic Value 
   #   $   $ 
Outstanding April 1, 2013   7,145,000    0.09      
Granted              
Exercised              
Canceled/expired   (1,300,000)         
Outstanding September 30, 2013   5,845,000    0.09   $70,694 
Exercisable at September 30, 2013   5,845,000    0.09   $70,694 

 

(1)Options outstanding are exercisable at prices ranging from $0.02 to $0.155 and expire over the period from 2013 to 2015.
(2)Aggregate intrinsic value is based on the closing price of our common stock on September 30, 2013 of $0.0631 and excludes the impact of options that were not in-the-money.

 

Share warrants

No warrants were outstanding at September 30, 2013 and September 30, 2012.

 

8. FAIR VALUE MEASUREMENTS

 

Cash and cash equivalents are measured at fair value in the Company’s consolidated financial statements. Accounts receivable are financial assets with carrying values that approximate fair value due to the short-term nature of these assets. Accounts payable and accrued and other liabilities are financial liabilities with carrying values that approximate 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 and Disclosures (“ASC 820”) which established a fair value hierarchy that requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instruments categorization within the hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

The Company’s cash and cash equivalents are valued using unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs under ASC 820).

 

8
 

 

9. SEGMENT INFORMATION

 

ASC 280 Segment Reporting provides annual and interim reporting standards for an enterprise’s business segments and related disclosures about its products, services, geographical areas and major customers. The Company has two operating segments: (1) products and services and (2) patent licensing. Products and services consist of sales of the Company’s electronic eVU mobile entertainment device and related content and support services and patent licensing consists of intellectual property revenues from the Flash-R™ patent portfolio.

 

Accounting policies for each of the operating segments are the same as on a consolidated basis.

 

Reportable segment information for the three and six months ended September 30, 2013 and 2012 is as follows:

 

    For the three months ended
September 30,
    For the six months ended
September 30,
 
    

2013

$

    

2012

$

    

2013

$

    

2012

$

 
SEGMENT REVENUES:                   
Products and services   67,004    122,949    124,462    255,495 
Patent licensing   34,725    2,000    426,725    2,000 
Total revenue   101,729    124,949    551,187    257,495 
                     
SEGMENT COST OF REVENUES:                    
Products and services   62,587    99,348    170,597    193,125 
Patent licensing and litigation costs   112,500    52,500    225,000    75,000 
Contingent legal fees   14,765    800    29,893    3,490 
Total cost of revenues   189,852    152,648    425,490    271,615 
                     
RECONCILIATION:                    
Segment income (loss) before corporate costs   (88,123)   (27,699)   125,697    (14,120)
Other corporate operating costs   321,990    348,306    607,247    694,868 
Operating (loss) before provision for income taxes   (410,113)   (376,005)   (481,550)   (708,988)

 

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 practicable 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 home domicile.

 

   For the three months ended   For the six months ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   $   $   $   $ 
United States   34,725    2,000    426,725    2,000 
International   67,004    122,949    124,462    255,495 
Total revenue   101,729    124,949    551,187    257,495 

 

9
 

 

Revenues from five licensees comprised 18%, 15%, 15%, 10% and 10% of revenue for the six months ended September 30, 2013, with no other licensee or customer accounting for more than 10% of revenues. Revenues from five licensees comprised 33%, 22%, 12%, 10% and 10% of revenue for the six months ended September 30, 2012, with no other customer accounting for more than 10% of revenues. Accounts receivable from three customers comprised 44%, 40% and 12% of net accounts receivable at September 30, 2013. Accounts receivable from two customers comprised 48%, 22% of net accounts receivable at September 30, 2012.

 

10. COMMITMENTS AND CONTINGENCIES

 

Legal Matters

 

The Company engages in litigation from time to time as part of its Flash-R™ portfolio licensing and enforcement activities.

 

In September 2012 the Company terminated the legal representation of Duane Morris LLP related to Flash-R™ patent enforcement activities. The Company remains obligated to pay contingency fees up to 40% on certain future royalty payments from previous matters.

 

In September 2012 the Company engaged Handal and Associates (“Handal”) to provide intellectual property (“IP”) legal services in connection with licensing and prosecuting claims of infringement of the Company’s flash memory patent portfolio (“Patent Enforcement Matters”). Pursuant to a partial contingent fee arrangement, the Company is paying a monthly retainer fee of $30,000 to Handal creditable against future contingency recoveries. Handal has agreed to advance related expenses excluding experts and prior art search firms. The Company has agreed to pay Handal a fee equal to 33% of any license fee or settlement related to Patent Enforcement Matters, less prior retainers and expenses, and 40% if litigation is required and successful. The Company may terminate the representation at any time but would be obligated to pay fees and advances.

 

The Company is required in the normal course of business to engage in litigation to enforce its patents and patent rights. In October 2012 the Company commenced enforcement action with respect to its patent portfolio and currently has multiple complaints filed in the U.S. District Court for the Southern District of California, asserting that products made and sold by defendant companies infringe the Company’s U.S. patents covering the use of flash memory technologies. As a result of its enforcement actions, it is possible that the Company could become subject to claims, counterclaims, legal actions or court sanctions in the future. No material such actions or matters are currently pending against the Company.

 

Facility Lease

In January 2012, the Company entered into a sixty-two month facility lease for its corporate office location, commencing May 1, 2012, for approximately 3,253 square feet at 16870 West Bernardo Drive, Suite 120, San Diego, California. The aggregate monthly payment is $5,693 excluding utilities and costs. The aggregate payments adjust annually with maximum payments increasing to $7,157 in the forty-ninth through sixty-second months. Future lease commitments at September 30, 2013 total $298,137. The Company recognizes rent expense by the straight-line method over the lease term. As of September 30, 2013, deferred rent totaled $30,983.

 

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 cash equivalents and trade receivables. The Company maintains cash and cash equivalent accounts with Federal Deposit Insurance Corporation (“FDIC”) insured financial institutions. Certain of the Company’s accounts are each insured up to $250,000 by the FDIC. The Company’s exposure for amounts in excess of FDIC insured limits at September 30, 2013 was approximately $1.1 million. The Company has not experienced any losses in such accounts. 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 customers comprising the Company’s customer base and their geographic dispersion. The Company has not incurred any significant credit related losses.

 

The Company relies on one third-party contract manufacturer to produce its eVU mobile 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.

 

10
 

 

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.

 

The Company provides a one-year limited warranty for most of its products.

 

Employee Benefit – 401K Plan

In September 2012, the Company adopted a defined contribution plan (401(k)) covering its employees. Matching contributions are made on behalf of all participants, according to the Safe Harbor provision. The Company matches 100% (dollar for dollar) on deferrals of up to 4% of employee compensation deferred. As of September 30, 2013, the Company made matching contributions totaling $7,869.

 

11. INCOME TAXES

There is no provision for income taxes for the six months ended September 30, 2013 and 2012 as the Company currently estimates its effective tax rate to be zero due to uncertainty of income in future interim quarters of the current year and due to net operating loss carryforwards.

 

At September 30, 2013, the Company had deferred tax assets associated with federal net operating losses (“NOLs”), related state NOLs, foreign tax credits and certain Federal and California research and development tax credits, but recorded a corresponding full valuation allowance as it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

The Company records a liability for uncertain tax positions when it is probable that a loss has been incurred and the amount can be reasonably estimated.  At September 30, 2013, the Company has no liabilities for uncertain tax positions. 

 

 

 

 

11
 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

THE FOLLOWING DISCUSSION 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 BELOW. SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2013.

 

Cautionary Note on Forward Looking Statements

In addition to the other information in this report, the factors listed below should be considered in evaluating our business and prospects. This 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.

 

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 are developing and marketing an intellectual property portfolio including licensing and enforcing our Flash-R™ portfolio of patents related to the use of flash memory in portable devices. We also market our eVU® mobile entertainment system for the travel industry.

 

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 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.

 

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. Since September 2012, the law firm of Handal and Associates has been handling our patent enforcement matters on a partial contingent fee basis.

 

Currently, we have active lawsuits filed against parties believed to infringe patents covering the use of our flash memory technologies. In October and November 2012 we commenced enforcement action with respect to our patent portfolio by filing complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe our U.S. patents. We filed additional complaints from December 2012 through April 2013, and subsequently entered into license and settlement agreements with multiple defendants, won a stipulated judgment against one defendant, and dismissed one defendant without prejudice.

 

On June 28, 2011, the United States District Court for the District of Colorado issued an Opinion and Order Regarding Claim Construction following a January 28, 2011 Markman hearing (a proceeding under U.S. patent law where both sides present to the Court their arguments on how they believe patent terms should be construed). The Opinion construed claim terms in United States Patent 5,491,774 (the ‘774 patent”) one of the Company’s Flash-R patents, more narrowly than we had proposed. This Markman ruling could negatively affect future licensing prospects with respect to the ‘774 patent.

 

In September 2012 we announced that the United States Patent and Trademark Office (USPTO) had completed the reexamination of the ‘774 and our. U.S. Patent No. 5,742,737 (the ‘737). While we were required to supplement one claim of the ‘737 patent and modify certain claims of the ‘774 patent, we believe the reexam process reaffirmed important patent claims as we continue our Flash-R™ patent portfolio monetization activities.

 

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In June 2013, the defendants of the current string of Flash-R™ enforcement litigation filed a joint motion asking the U.S. District Court for the Southern District of California to prevent the Company from relitigating the meaning of certain terms of the Company’s U.S. Patent No. ‘774 and U.S. Patent No. 5,839,108 (“the ‘108 patent”). In August 2013, a judge ruled in favor of the defendants for application of the collateral estoppels doctrine, resulting in the adoption of the meaning of certain terms of the ‘774 as defined by the judge in the Company’s 2010 Colorado litigation. In October 2013, the Company filed an appeal to the Federal Circuit Court of Appeals, formally challenging the ruling. The ruling could adversely impact the Company’s efforts to establish patent infringement of certain claims by certain defendants of the ‘774 patent and the ‘108 patent. We believe the ruling has no impact on the Company’s assertions of patent infringement against the defendants under the ‘737 and U.S. Patent No. 5,842,170.

 

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. We also are developing new intellectual property for possible licensing in the areas of context and interpersonal awareness technologies.

 

Our business is high risk in nature. There can be no assurance we can achieve sufficient eVU or patent license revenues to attain 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 during the first six months of fiscal 2014 and during the fiscal years ended March 31, 2013 and 2012. While we have settled and licensed with more than 25 defendants to date, 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, with such settlements to date being based, we believe, on the strength of our patent claims and the validity and persuasive evidence and clarity that our patents are being infringed. Although we believe we have been successful in early licensing by demonstrating the strength, validity and clarity of our patent claims, future events including court rulings and patent reexamination results could have a significant positive or negative impact on future licensing activity. The 2011 Markman ruling and the 2013 collateral estoppel ruling could negatively affect licensing efforts and future licensing prospects.

 

Our eVU in flight entertainment (“IFE”) business remained slow during the first six months. We are unable to predict future sales levels in this market as orders have been and are expected to continue to be sporadic from both existing and new customers because of increased competition from personal devices and airline economics

 

Management faces challenges for the remainder of fiscal 2014 to execute our plan to increase Flash-R patent portfolio license fees and monetize our Nunchi technology. 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.

 

For the six months ended September 30, 2013 we recognized a net loss of $481,550 compared to a net loss of $708,988 for the comparable period of the prior fiscal year. Our revenues were $551,187 for the first six months of fiscal 2014 including $426,725 of patent license revenue. This compares to revenues of $257,495 for the prior year’s first six months including $2,000 of patent license revenue. We reported increased operating expenses totaling $1,032,737 in the six months ended September 30, 2013 compared to $966,483 for the same period of the prior year. The increase of $66,254 is attributed primarily to annual meeting costs of $55,349 in the current period with no comparable expense in the same period of the prior year.

 

Our cash operating costs average approximately $135,000 per month. However, we may increase expenditure levels in future periods to support and expand our revenue opportunities and continue advanced product and technology research and development. Our quarterly results are highly dependent on the timing and amount of licensing fees and accordingly quarterly results can vary dramatically from period to period. As a result of this and other factors, past results and expenditure levels may not be indicative of future quarters. We expect to incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability.

 

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Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements located in Item 1 of Part I, “Financial Statements,” and in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended March 31, 2013. The preparation of these financial statements prepared in accordance with accounting principles generally accepted in the United States 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, stock-based compensation, fair values, 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 our consolidated financial statements, the following accounting policies require our most difficult, subjective or complex judgments:

 

  · revenue recognition;
  · stock-based compensation expense;
  · income taxes; and
  · inventory reserve

 

Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. There were no significant changes or modification of our critical accounting policies and estimates involving management valuation adjustments affecting our results for the six months ended September 30, 2013. For further information on our critical accounting policies, refer to Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended March 31, 2013.

 

Results of Operations

 

Three months ended September 30, 2013 compared to the three months ended September 30, 2012

 

   Three Months Ended September 30,         
   2013   % of   2012   % of   Change 
   Dollars   Revenue   Dollars   Revenue   Dollars   % 
Revenues:                              
Products and services   67,004    66%    122,949    98%    (55,945)   (46%)
Patent licensing   34,725    34%    2,000    2%    32,725    1636% 
    101,729    100%    124,949    100%    (23,220)   (19%)
Operating costs and expenses:                              
Cost of revenues:                              
Products and services   62,587    61%    99,348    80%    (36,761)   (37%)
Patent licensing and litigation costs   112,500    111%    52,500    42%    60,000    114% 
Contingent legal fees and expenses   14,765    14%    800    1%    13,965    1746% 
Selling and administrative   243,840    240%    179,442    144%    64,398    36% 
Research and development   78,150    77%    168,864    135%    (90,714)   (54%)
    511,842    503%    500,954    401%    10,888    2% 
Operating (loss) before provision for income taxes   (410,113)   (403%)   (376,005)   (301%)   (34,108)   9% 

 

Loss Before Income Taxes

We reported a net loss before income taxes of $410,113 for the three months ended September 30, 2013 compared to a net loss before income taxes of $376,005 for the comparable period of the prior year due primarily to reduced product and services revenue in the current year.

 

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Revenues

Revenues decreased during the most recent fiscal quarter (second quarter of fiscal 2014) compared to the same quarter of the prior fiscal year as the result of reduced product and service sales activity due to no significant new customers or product sales and reduced service revenues from ongoing customers. Our product revenues have been sporadic in part as a result of industry economics including the rapid consumer adoption of portable devices resulting in reduced IFE activity. Our service revenues declined and vary depending on repair and content services provided to a changing customer mix. We expect product and service revenues to decline in future quarters due to no significant new customers or product sales and reduced service revenues from ongoing customers.

 

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.

 

In the future the following additional factors could also impact revenue variability:

  · the effect of court and USPTO rulings and decisions;
  · fluctuations in the sales results or other royalty per unit activities of our licensees that impact the calculation of license fees due;
  · the timing of the receipt of periodic license fee payments and/or reports from licensees.

 

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.

 

Operating Costs and expenses

Operating costs and expenses include cost of revenues associated with products and services, and costs associated with our patent licensing and enforcement activities including contingent and non-contingent litigation costs and related enforcement support costs. For the three months ended September 30, 2013, operating costs and expenses increased by $10,888 compared to the same period in the prior year.

 

Patent licensing legal costs related to Flash-R portfolio enforcement were $112,500 at September 30, 2013 compared to $52,500 in the prior year’s second quarter. The $60,000 increase is the result of non-contingent legal fees of $90,000 in the current period as compared to $30,000 in the same period in the prior year due to a change in legal representation. Non-contingent licensing and litigation costs and related enforcement support costs may be incurred without any directly related revenues in a respective period. Generally contingent costs relate to revenues during a respective period but can vary depending on our share of certain costs and expenses. Prior to fiscal 2013 substantially all patent licensing cost of revenues consisted of contingent legal fees and costs. We reclassified $52,500 of operating expenses for the period ended September 30, 2012 to patent licensing and litigation costs to conform to the current year presentation. This reclassification had no effect on previously reported operating income, results of operations or accumulated deficit.

 

Cost of revenues associated with products and services decreased from $99,348 in the prior year’s second quarter to $62,587 in the current year. The $36,761 decrease is primarily due to a lower-of-cost-or-market adjustment to inventory in the prior period of $18,691 with no comparable expense in the current year, and a decrease of salaries expense in the current year of $10,965 as compared to the same period of the prior year.

 

Selling and administrative costs for the three months ended September 30, 2013 increased by $64,398 compared to the same period in the year prior. The current period included $55,349 for annual meeting costs with no comparable expense in the same period of the prior year comparable period. The prior year’s second quarter included $4,265 for noncash stock-based compensation expense with no comparable expense in the current period.

 

Research and related expenses decreased by $90,714 primarily due to $53,209 reduction in legal fees related to the patent reexamination completed in the prior year, $17,345 reduction in other patent related legal fees, and a decrease of salaries and related benefits expenses in the current year of $19,738 as compared to the same period in the prior year. The prior year’s second quarter included $1,196 for noncash stock-based compensation expense with no comparable expense in the current period. Research and related expenses can vary significantly from quarter to quarter based on the allocation of time spent by personnel who work on both revenue producing service and repair projects, on patent related costs and on internal research projects. Such expenses also vary based on decisions made regarding outside engineering and consulting.

 

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Six months ended September 30, 2013 compared to the six months ended September 30, 2012

 

   Six Months Ended September 30,         
   2013   % of   2012   % of   Change 
   Dollars   Revenue   Dollars   Revenue   Dollars   % 
Revenues:                              
Product and services   124,462    23%    255,495    99%    (131,033)   (51%)
Patent licensing   426,725    77%    2,000    1%    424,725    21236% 
    551,187    100%    257,495    100%    293,692    114% 
Operating costs and expenses:                              
Products and services   170,597    31%    193,125    75%    (22,528)   (12%)
Patent licensing and litigation costs   225,000    41%    75,000    29%    150,000    200% 
Contingent legal fees and expenses   29,893    5%    3,490    1%    26,403    757% 
Selling and administrative   446,227    81%    379,901    148%    66,326    17% 
Research and related   161,020    29%    314,967    122%    (153,947)   (49%)
    1,032,737    187%    966,483    375%    66,254    7% 
Operating (loss) before provision for income taxes   (481,550)   (87%)   (708,988)   (275%)   227,438    (32%)

 

Loss Before Income Taxes

The loss before income taxes of $481,550 for the six months ended September 30, 2013 resulted primarily from increased patent licensing and litigation costs and reduced revenue from products and services.

 

Revenues

Revenues increased during the most recent six months compared to the same period of the prior fiscal year due to the increase in patent license revenue from $2,000 to $426,725. We currently have one licensee reporting periodic royalties. One such payment was recognized in the quarter ended September 30, 2013 and one in the same period of the prior year. All other royalties have been one-time fully paid up royalties. Service revenues vary depending on repair and content services provided to a changing customer mix. eVU product sales activity have been slow and sporadic due to airline industry economics including rapid consumer adoption of portable devices, with airlines curtailing expansion and new projects. Our product sales for the first six months are not necessarily indicative of future orders and we had no significant product backlog at September 30, 2013. Our service agreements and terms vary with each customer and there is no assurance in the current airline environment that our service revenues will continue at comparable levels for the balance of the fiscal year or in future periods.

 

While we expect additional patent licenses in future periods, there can be no assurance of the timing or amounts of future license revenues. We are pursuing new eVU and other technology business but our results will continue to be dependent on the timing and quantity of eVU orders and timing and amount of any patent licensing arrangements.

 

Operating Costs and expenses

Operating costs and expenses include cost of revenues associated with products and services, and costs associated with our patent licensing and enforcement activities including contingent and non-contingent litigation costs and related enforcement support costs. For the six months ended September 30, 2013, operating costs and expenses increased by $66,254 compared to the same period in the prior year.

 

Patent licensing legal costs related to the Flash-R portfolio enforcement were $225,000 for the six months ended September 30, 2013 compared to $75,000 for the same period in the prior year. The $150,000 increase is primarily due to a change in legal representation in September 2012. Non-contingent licensing and litigation costs and related enforcement support costs may be incurred without any directly related revenues in a respective period. Generally contingent costs relate to revenues during a respective period but can vary depending on our share of certain costs and expenses. Prior to fiscal 2013 substantially all patent licensing cost of revenues consisted of contingent legal fees and costs. We reclassified $75,000 of operating expenses for the six months ended September 30, 2012 to patent licensing and litigation costs to conform to the current year presentation. This reclassification had no effect on previously reported operating income, results of operations or accumulated deficit.

 

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Selling and administrative costs for the six months ended September 30, 2013 increased by $66,326 compared to the same period in the year prior. The current period included $55,349 for annual meeting costs with no comparable expense in the same period of the prior year.

 

Research and related expenses decreased by $153,947 due primarily to $118,924 of decreased patent related costs and $33,165 of decreased salaries and related benefits expense. Research and related expenses can vary significantly from quarter to quarter based on the allocation of time spent by personnel who work on both revenue producing service and repair projects, on patent related costs and on internal research projects. Such expenses also vary based on decisions made regarding outside engineering and consulting.

 

Liquidity and Capital Resources

At September 30, 2013, we had working capital of $1,222,756 compared to working capital of $1,658,759 at March 31, 2013. At September 30, 2013 we had cash on hand of $1,355,698.

 

Operating Activities

Cash used by operating activities was $385,741 for the six months ended September 30, 2013. Cash used by operating activities included the net loss of $481,550 decreased by net non-cash expenses of $53,740. Major components providing operating cash were a decrease of $116,805 in accounts receivable, a decrease of $48,867 in inventory including lower-of-cost or market and reserve adjustments of $48,552, and an increase of $11,300 in accounts payable. A major component reducing operating cash was a decrease of $79,139 in accrued and other liabilities.

 

Cash used by operating activities was $578,957 for the six months ended September 30, 2012. Cash used by operating activities included the net loss of $708,988 decreased by net non-cash expenses of $14,665. Major components providing operating cash were a decrease of $46,239 in accounts receivable, a decrease of $38,871 in inventory including a lower-of cost or market adjustment of $18,691, and an increase of $31,690 in accounts payable. A major component reducing operating cash was a decrease of $23,108 in accrued and other liabilities.

 

Our terms to customers vary but we often require payment prior to shipment of product and any such payments are recorded as deposits. Patent license payments are normally due at signing of the license or within 30-45 days of settlement or end of royalty reporting period.

 

Individual working capital components can change dramatically from period to period due to timing of licensing, sales and shipments and corresponding receivable, inventory and payable balances. Accordingly operating cash requirements vary significantly from period to period.

 

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

There were no cash financing activities during the six months ended September 30, 2013 and 2012.

 

Debt and Other Commitments

We currently have no debt outstanding other than trade payables and accruals. At September 30, 2013 we had no significant purchase commitments for product and components.

 

We have future lease commitments on our current facility as more fully described in our accompanying interim condensed consolidated financial statements.

 

Our legal firm, Handal and Associates, provides IP legal services in connection with licensing and prosecuting claims of infringement of our flash memory patent portfolio. Pursuant to a partial contingent fee arrangement, we are paying a monthly retainer fee of $30,000 to Handal creditable against future contingency recoveries. Handal has agreed to advance related expenses excluding experts and prior art search firms. We have agreed to pay Handal a fee equal to 33% of any license fee or settlement related to Patent Enforcement Matters, less prior retainers and expenses, and 40% if litigation is required and successful. We may terminate the representation at any time but would be obligated to pay fees and advances.

 

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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 September 30, 2013 and current planned expenditures and level of operation, we 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.

 

Item 4. Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the relationship between the benefit of desired controls and procedures and the cost of implementing new controls and procedures.

 

We carried out an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2013, the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There have been no changes in our internal control over financial reporting during our fiscal quarter ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Our process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies which may be identified during this process.

 

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Company engages in litigation from time to time as part of its Flash-R™ portfolio licensing and enforcement activities. In October and November 2012 the Company commenced enforcement action with respect to its patent portfolio by filing complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe the Company’s U.S. patents covering the use of flash memory technologies. The Company filed additional complaints from December 2012 through April 2013, and subsequently entered into license and settlement agreements with multiple defendants, won a stipulated judgment against one defendant, and dismissed one defendant without prejudice.

 

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

(a)NONE
(b)NONE
(c)NONE

 

Item 3. Defaults Upon Senior Securities

 

NONE

 

Item 4. Mine Safety Disclosures

 

NONE

 

Item 5. Other Information

 

(a) NONE

(b) NONE

 

Item 6. Exhibits

 

Exhibit 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, President and CEO (Principal Executive Officer).

 

Exhibit 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 MarDee Haring-Layton (Chief Financial Officer).

 

Exhibit 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, President and CEO (Principal Executive Officer) and MarDee Haring-Layton (Chief Financial Officer).

 

  Extensible Business Reporting Language (XBRL) Exhibits*
   
101.INS XBRL Instance Document*
101.SCH XBRL Taxonomy Extension Schema Document*
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB XBRL Taxonomy Extension Labels Linkbase Document*
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document*

 

*Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files in Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

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SIGNATURES

 

Pursuant to the requirements 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  
    Alfred H. Falk, President and Chief Executive Officer  
       

 

  By: /s/ MARDEE HARING-LAYTON  
    MarDee Haring-Layton, Chief Financial Officer  

 

Date:   November 13, 2013

 

 

 

 

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