PINX:EDIG E Digital Corporation Annual Report 10-K Filing - 3/31/2012

Effective Date 3/31/2012

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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, 2012

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)

 

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)

 

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).   

[ X ] Yes   [ ] No

 

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

 

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the 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, 2011 was approximately $10,673,000 based on the closing price as reported on the NASD’s OTC Electronic Bulletin Board system.

 

As of June 7, 2012 there were 293,003,158 shares of e.Digital Corporation Common Stock, par value $.001, outstanding.

 
 

 

TABLE OF CONTENTS

    Page
   PART I  
ITEM 1. Business 3
ITEM 1A. Risk Factors 11
ITEM 1B. Unresolved Staff Comments 17
ITEM 2. Properties 18
ITEM 3. Legal Proceedings 19
ITEM 4. Not Applicable 19
     
PART II   
     
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 19
ITEM 6. Selected Consolidated Financial Data 20
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk 28
ITEM 8. Financial Statements and Supplementary Data 28
ITEM 9. Changes in and Disagreement With Accountants on Accounting and Financial Disclosure 28
ITEM 9A. Controls and Procedures 28
ITEM 9B. Other Information 29
PART III   
     
ITEM 10. Directors, Executive Officers and Corporate Governance 30
ITEM 11. Executive Compensation 32
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related  
  Stockholder Matters 34
ITEM 13. Certain Relationships and Related Transactions and Director Independence 35
ITEM 14. Principal Accounting Fees and Services 36
     
PART IV   
     
ITEM 15. Exhibits, Financial Statement Schedules 36
     
  Signatures 40
     
  Financial Statements F-1

 

FORWARD-LOOKING STATEMENTS

 

IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND THE COMPANY DESIRES TO TAKE ADVANTAGE OF THE “SAFE HARBOR” PROVISIONS THEREOF. THEREFORE, THE COMPANY IS INCLUDING THIS STATEMENT FOR THE EXPRESS PURPOSE OF AVAILING ITSELF OF THE PROTECTIONS OF SUCH SAFE HARBOR WITH RESPECT TO ALL OF SUCH FORWARD-LOOKING STATEMENTS. THE FORWARD-LOOKING STATEMENTS IN THIS REPORT REFLECT THE COMPANY’S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED HEREIN, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM HISTORICAL RESULTS OR THOSE ANTICIPATED. IN THIS REPORT, THE WORDS “ANTICIPATES,” “BELIEVES,” “EXPECTS,” “INTENDS,” “FUTURE” AND SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED TO CONSIDER THE SPECIFIC RISK FACTORS DESCRIBED BELOW AND NOT TO PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, WHICH SPEAK ONLY AS OF THE DATE HEREOF. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE HEREOF.

 

 
 

PART I

ITEM 1. 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 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, content integration 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 U.S. and international companies for use in the airline and other travel 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 some of 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 twelve companies, suspended the complaint against one defendant and dismissed with prejudice the six remaining defendants. 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 communication networks and digital data distribution.

 

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 16870 West Bernardo Drive, Suite 120, 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.)

  • 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.

  • 1998 – Developed the first multi-codec (including MP3) portable digital music player.

  • 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.

  • 2002 – Bang & Olufsen introduced a branded digital audio player (BeoSound 2) developed by us pursuant to a license agreement.

  • 2003 – Designed, developed and delivered wireless MP3 headsets employing our MicroOS™ operating system to Hewlett-Packard for use at Disneyworld in Orlando, Florida.

  • 2003 – Licensed our digital audio platform to a multi-billion dollar Asian OEM for branding to Gateway Computers.

  • 2003 – Developed the first hard drive-based Hollywood studio-approved portable inflight entertainment (“IFE”) device.

  • 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.

  • 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.

  • 2009 –Added new features to eVU including an advanced touch screen interface.

  • 2010- 2011- Filed seven new patents in the areas of communication networks and digital data distribution.

eVU Mobile Entertainment System

Our eVU is a portable audio/video player designed to securely play encrypted content primarily for the airline and other travel 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 plus hours of high resolution video playback on a single battery charge. We also have the capability to add features and customize the product for select customers.

 

We market and sell our eVU portable mobile entertainment device to corporate airline 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).

 

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.

 

 

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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 manages the user interface functions, battery and power control, the volume and equalizer functions, the LCD interfaces, processes a wide variety of audio and video formats and manages the decoding process. It interacts with a variety of digital rights management schemes and supports today’s most popular media storage formats including hard disk drives and embedded and removable flash memories. 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 data security systems including encryption, decryption, digital rights management (“DRM”) and key management technologies 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.

 

Other Technology

We continue to focus on adding to our intellectual property portfolio. During fiscal years 2011 and 2012, we filed seven new patents related to new technologies in the areas of communication networks and digital data distribution. These efforts are in the early stage of development and our intent is to license or seek strategic relationships for these technologies. We continue to also seek technologies to leverage our DVAP technology. There can be no assurance we can exploit any new innovations in future periods.

 

Intellectual Property Portfolio Licensing and Enforcement

While we are adding new intellectual property, 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 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 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 in the United States District Court for the District of Colorado (the “Court”) against nineteen companies that manufacture devices using flash memory. On June 28, 2011, the Court 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. As of December 2011 we had licensed and settled with 12 defendants, realizing gross license fees aggregating approximately $3.6 million, suspended the complaint against one defendant, and dismissed with prejudice the remaining six defendants, thereby ending the Colorado patent litigation case. Additionally, in October 2011 we entered into a Flash-R licensing agreement with a manufacturing company outside of the above litigation rounds. While we continue to evaluate future licensing and enforcement actions, the Order and the Statement, described above, could negatively affect future licensing prospects.

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In related enforcement developments, during the fiscal year 2011, the United States Patent and Trademark Office (“USPTO”) granted a Request for Ex Parte Reexamination of our U.S. Patent No. ‘774, related to a handheld record and playback device with flash memory, and U.S. Patent No. 5,742,737 (the ‘737 patent) related to a method for recording voice messages on flash memory in a hand held recorder.  During the reexamination process, we amended certain claim elements affecting the reissue of the ‘774 patent, which were approved by the USPTO. The review of the ‘737 patent resulted in a rejection of one claim, however we intend to submit supplemental clarifying information which we believe should allow the USPTO to determine that the patent claim, as written, was properly allowed. These outcomes and actions can assist us in defending certain challenges to the validity of our patents. The timing of the USPTO’s completion of the reexamination of the ‘737 patent is uncertain. We believe that the USPTO should complete the reexamination process of the subject patents in 2012. However, there can be no assurance of final determinations and the impact on future licensing activity is uncertain.

 

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. We anticipate bringing additional patent enforcement actions in the future.

 

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 began marketing the first digital voice recorder with removable flash memory, powered by MicroOS. In 1996, we produced and marketed the first digital voice recorder interface for downloading and managing voice recordings on the personal computer. The Flash-R patent portfolio is protected through the years 2014 – 2016 and includes the following U.S. patents:

 

  • 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 Flash-R property litigation and licensing activities. We are also seeking to license or enter into strategic relationships related to our communication networks and digital data distribution technologies.

 

Markets and Customers for Our Products and Intellectual Property Portfolio

 

Mobile Entertainment

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.

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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.

 

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 rented to 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.

 

Intellectual Portfolio Licensing

We use the services of an intellectual property consultant to assist us in investigating and evaluating prospective licensees and strategic partners for our intellectual property portfolio. With respect to our Flash-R patent portfolio this has included documenting possible current and past infringement. Our initial Flash-R portfolio 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 27 companies with 19 agreeing to license terms during the discovery stage of related litigation. With respect to our communication networks technologies, we are demonstrating these technologies to prospective licensees and strategic partners. We believe we are building a track record of demonstrating the strength, validity and clarity of our patent claims and the value of our other intellectual property and we believe that we can build a growing licensing business from our intellectual property portfolio. The timing of future litigation or licensing is subject to many factors, some of which are not within our control.

 

Our Business Strategy

We are leveraging and building on a leadership position in the portable IFE market to market our eVU device to airlines. We intend to continue to market our business by obtaining new IFE airline customers directly and through VAR sales domestically and internationally.

 

We are commercializing our Flash-R patent portfolio through licensing and have pursued enforcement by litigating against targeted parties that we believe are infringing our patents. We expect to bring additional patent enforcement actions in fiscal year 2013. 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.

 

We are expanding our intellectual property portfolio. In fiscal 2011 and 2012 we filed seven new U.S. patent applications for technologies related to communication networks and digital data distribution and may file additional patent applications in the future related to these or other technologies. Our strategy is to select and prioritize new technologies and when deemed appropriate to develop functional systems employing one or more technologies. Currently we have no plans to introduce new products but seek strategic partners or licensees for commercialization of products and services, based on our technologies.

 

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 2013 (year ending March 31, 2013) 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 2012 (year ended March 31, 2012) we purchased primary components from various suppliers with two suppliers accounting for 55% of total purchases for the fiscal year (2011 four suppliers accounted for 63% of total purchases). Our contract manufacturers also purchase major electronic components from a limited number of suppliers.

 

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Marketing, Sales and Distribution

Marketing and sales are performed primarily by our President and Chief Executive Officer and various technical personnel who are involved in the sales process.  Our 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.

 

Customer Concentration and Backlog

Revenues from four licensees accounted for more than 10% of revenues for the year ended March 31, 2012 (2011 – one licenses and three customers 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 2013. 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. We had no backlog of orders at March 31, 2012, and had $8,800 in backlog at March 31, 2011. 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, 2012 and 2011, we spent $672,913 and $473,298, 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. During fiscal 2011 and 2012 we filed seven new U.S. patent applications for technology related to communication networks and digital data distribution. 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. We may file additional patent applications in the future related to these or other technologies.

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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 have filed certain U.S. patent applications, we do not know whether any of these applications will result in the issuance of patents, 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 file for 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.

 

Competition in the IFE industry comes from portable entertainment devices manufactured by companies such as Sony, Samsung, Apple, 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. The IFE industry has also been impacted by the rapid consumer adoption of portable devices.

 

We compete with companies offering portable IFE products such as digEcor and Panasonic Avionics.; The IMS Company, with their tablet style product; and products supplied by Apple and Samsung, sold through value added resellers. European producers AIRVOD Entertainment Ltd. and Bluebox Avionics advertise, market and sell portable IFE products that are 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. Long-term licensing success may be dependent upon prevailing in 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 and license our intellectual property.

 

Seasonality

Our current business is not seasonal.

 

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Executive Officers

The current executive officers of e.Digital Corporation and their ages and business experience are set forth below.

 

Alfred H. Falk - age 57, 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.

 

MarDee Haring-Layton – age 36, was appointed Chief Financial Officer of the Company by the Board of Directors on December 5, 2011. Ms. Haring-Layton had been with the Company, on a part-time consulting basis, since July 2010. Previously, she was employed as a consultant with Resources Global Professionals, a multinational professional services firm, from 2007 to 2011. From 2005 to 2006, she was the Corporate Audit Manager at Royale Energy, Inc. Prior to Royale Energy, Ms. Haring-Layton was employed by Charlotte Russe, Inc. as Systems Control and Reporting Manager and Deloitte & Touche, LLP as an audit professional. Ms. Haring-Layton holds a B.S. in Business Administration from San Diego State University.

 

Eric M. Polis - age 41, was appointed a Director in October 2008 and Secretary in December 2010. He has been employed as an asset manager for privately-held Davric Corporation since 1997. He was Secretary, Treasurer and a Director of ASI Technology Corporation, a publicly traded specialty finance company, from July 2000 to May 2010. 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.

 

Employees

As of March 31, 2012, we employed approximately eight full-time employees and one part-time employee, of whom three were in production and testing, two were in research, development and engineering, and 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-160E. Our eVU is DO-160E-certified for conducted and radiated emissions. DO-160E 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.

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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, 16870 West Bernardo Drive, Suite 120, 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 and fiscal 2012, 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, 2012. Our profitability in fiscal years 2009 and 2012 was the result of 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.

 

If We Encounter Unforeseen Difficulties and Cannot Obtain and Required Additional Funding on Favorable Terms, Our Business May Suffer. Our consolidated cash and cash equivalents on hand totaled $3.1 million at March 31, 2012. To date, we have relied primarily upon the sale of equity securities, product and service revenues and payments from licensees to generate the funds needed to finance our operations. If we incur losses in future periods or we encounter unforeseen difficulties in the future, including difficulties arising as a result of the outside influences identified below, we may deplete our capital resources more rapidly than anticipated. As a result, we may be required to obtain additional financing in the future through debt or equity financings or otherwise. If we are required to raise additional capital in the future, such additional financing may not be available on favorable terms, if at all, or may be dilutive to our existing stockholders. If we fail to obtain additional capital as and when needed, such failure could have a material adverse impact on our business, results of operations and financial condition.

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General Economic Conditions May Reduce Our Revenues and Harm Our Business. Our business is exposed to adverse changes in general economic conditions and financial markets in the United States, Europe and Asia. Because use of our products is entertainment-oriented and generally discretionary, the current slowdown or a further decline in U.S. and

foreign economic growth could adversely affect consumer confidence, disposable income and spending. As a result, sales of our products to customers and the use by consumers may not grow as rapidly as in prior periods or may decrease, which could adversely affect our future revenues.

 

We Expect Our Operating Results to Fluctuate Significantly. Our quarterly and annual operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation is a result of a variety of factors, including the following:

 

  • Unpredictable demand and required pricing to secure customers for our products and services
  • Uncertainty regarding the timing and amount of any future patent licensing revenues
  • Market acceptance of our products by our customers and their end users
  • Uncertainties with respect to future customer product orders, their timing and the margins to be received, if any
  • Fluctuations in product costs and operating costs
  • Changes in research and development costs
  • Changes in general economic conditions
  • Risks and costs of warranty claims
  • Changes in technology
  • Short product lifecycles and the possibility of excessive or obsolete inventory and materials

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 or solutions at a lower cost. Our ability to compete successfully will depend in large measure on our ability to adapt to technological changes and advances in the industry. Competition could result in price reductions, reduced margins, and loss of customers, 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. Moreover, there can be no assurance that other products or solutions will not render our technology and products obsolete.

 

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 products or a further decline in the economic prospects of our airline customers may have a material adverse effect on our operations. The airline industry is continuing to face a variety of economic and other challenges including the rapid consumer adoption of portable devices 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.

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Risks Related to Operations

 

We Depend On One Contract 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.

 

Risks Related to our Patent Licensing and Enforcement Strategy

 

We Face Uncertain Revenue Prospects from our Patent Enforcement Strategy. Our portfolio has not been tested in court and there is no assurance we can prevail in any current or future patent litigation. On June 28, 2011, the United States District Court for the District of Colorado issued an Opinion and Order Regarding Claim Construction following the 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 ‘774, one of the Company’s Flash-R patents, more narrowly than proposed by the Company. The Markman ruling could negatively affect future licensing prospects and future rulings from reexamination of certain Flash-R patent claims by the USPTO could have a significant positive or negative impact on future licensing activity in 2013 and beyond. 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-R 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, from potential infringers, stemming primarily from uncertainties regarding the outcome of enforcement actions, rates of adoption of our patented 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, cause our quarterly and annual results to be below market expectations and adversely affect the market price of our common stock.

 

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.

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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.

 

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.

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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.

 

Risks Related to Trading in Our Common Stock

 

Our Disclosure Controls and Procedures May Not Prevent or Detect All Acts of Fraud. Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to management and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our management expects that our disclosure controls and procedures and internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, they cannot provide absolute assurance that all control issues and instances of fraud, if any, within our company have been prevented or 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. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by an unauthorized override of the controls. The design of any systems of controls also is based in part upon certain assumptions about the likelihood of future events, and we cannot assure that any design will succeed in achieving its stated goals under all potential future conditions. Accordingly, because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.

 

Failure to Maintain an Effective System of Internal Control Over Financial Reporting Could Harm Stockholder and Business Confidence In Our Financial Reporting, Our Ability to Obtain Financing and Other Aspects of Our Business. Maintaining an effective system of internal control over financial reporting is necessary for us to provide reliable financial reports. Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC require us to include in our Form 10-K a report by management regarding the effectiveness of our internal control over financial reporting. The report includes, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of the respective fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. While our management has concluded that we did not have any material weaknesses as of March 31, 2012, material weaknesses have been identified in prior years and it is possible that material weaknesses will be identified in the future. In addition, components of our internal control over financial reporting may require improvement from time to time. If management is unable to assert that our internal control over financial reporting is effective in any future period, investors may lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on its stock price.

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Evolving Regulation of Corporate Governance and Public Disclosure May Result In Additional Expenses and Continuing Uncertainty. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, conversion to International Financial Reporting Standards, XBRL interactive SEC filings, and new SEC regulations are creating uncertainty for public companies. We continually evaluate and monitor developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. These new or changed laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices.

 

We are committed to maintaining high standards of corporate governance and public disclosure. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and we may be harmed.

 

Sales of Common Stock Issuable on the Exercise of Outstanding Warrants and Options May Depress the Price of Our Common Stock. As of March 31, 2012, we had no outstanding common stock warrants. In the future we may issue additional convertible securities, options and warrants. The issuance of shares of common stock issuable upon the exercise of 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.

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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 $0.019 to a high of $0.10 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, excluding the value of such person’s primary residence, 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 SEC 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 SEC relating to the penny stock market. The broker-dealer must also disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer’s presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock in the account and information on the limited market in penny stocks.

 

Important Factors Related to Forward-Looking Statements and Associated Risks. This prospectus contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the 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

 

17
 

 

 

ITEM 2. PROPERTIES

 

In January 2012, the Company entered into a new 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 $4,880 excluding utilities and costs. The aggregate payments adjust annually with maximum payments totaling $7,157 in the forty-ninth through sixty-second months. Future lease commitments at March 31, 2012 total $368,080.

 

The facility lease for 4,800 square feet at 16770 West Bernardo Drive, San Diego, California, with aggregate monthly payment of $6,534 excluding utilities and costs, terminated April 30, 2012.

 

18
 

 

ITEM 3. LEGAL PROCEEDINGS

 

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, 2012 the Company had licensed and settled the litigation with twelve of the defendants, suspended the complaint against one defendant, and dismissed with prejudice the remaining six defendants, thereby ending the Colorado patent litigation case.

 

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.

 

ITEM 4. NOT APPLICABLE

 

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, 2012      
    First quarter $0.035   $0.10
    Second quarter $0.031   $0.054
    Third quarter $0.019   $0.035
    Fourth quarter $0.026   $0.050
           
  Fiscal year ended March 31, 2011      
    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, 2012 there were 293,003,158 shares of common stock outstanding and approximately 2,839 stockholders of record.

 

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.

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Equity Compensation Plan Information

The following table sets forth information as of March 31, 2012, 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   7,355,000   $0.09    2,270,500 
Equity compensation plans not approved by security holders   -0-    —      -0- 
                
Total   7,355,000   $0.09    2,270,500 

 

Recent Sales of Unregistered Securities

No unregistered 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 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.

 

Our strategy is to market our eVU products and services to U.S. and international companies for use in the airline and other travel industries. We employ direct sales and sales through VARs (value added resellers) that provide marketing, logistic and/or content services to corporate customers.

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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 twelve companies, suspended the complaint against one defendant, and dismissed with prejudice the remaining six defendants, thereby ending the Colorado patent litigation case.

 

Two of our patents are in the process of being reexamined by the United States Patent and Trademark Office. Favorable determination from the reexaminations could bolster our licensing and unfavorable determinations could adversely affect our ability to monetize our patent portfolio.

 

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 communication networks and digital data distribution.

 

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, 2012 and 2011. We have successfully completed two rounds of enforcement litigation and by March 31, 2012 had licensed a total of nineteen licensees. 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 2012 and 2011 primarily due to increased competition and airline economics. We are unable to predict future sales levels in this market as orders have been are expected to continue to be 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, 2012 (fiscal 2012), in prior years we have historically 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.

 

For the year ended March 31, 2012:

 

  • We recognized a net income of $1,195,072 compared to net loss of $1,083,211 for fiscal 2011. The difference in results was primarily attributable to higher license revenues and margins due to the timing and amount of individual license agreements.

  • Our revenues were $4.7 million in fiscal 2012 compared to $1.3 million in fiscal 2011. During fiscal 2011 we licensed one company from the November 2009 (second) round of litigation. During fiscal 2012 we licensed eight companies from the second round of litigation and licensed an additional company outside of the litigation. As a result of the timing of such license agreements, our licensing revenues in fiscal 2012 were $4.1 million compared to $0.2 million in fiscal 2011. eVU product and service revenues were $626,772 in fiscal 2012 compared to $1,065,000 in fiscal 2011.

  • Our gross profit for the year ended March 31, 2012 was $2.9 million or 62% of revenues compared to $0.5 million or 39% of revenues for the comparable prior year as a result of the increased licensing revenue.

  • Operating expenses were $1.6 million for fiscal 2012 increased slightly from the $1.59 million in fiscal 2011 primarily as a result of increased legal and professional fees related to the patent reexamination.

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Management faces challenges in fiscal 2013 to execute its plan to grow product and service revenues and increase Flash-R patent portfolio license fees. On June 28, 2011, the United States District Court for the District of Colorado issued an Opinion and Order Regarding Claim Construction following the 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 “774”, one of the Company’s Flash-R patents, more narrowly than proposed by the Company. The Markman ruling could negatively affect future licensing prospects and future rulings from reexamination of certain Flash-R patent claims by the USPTO and could have a significant positive or negative impact on future licensing activity in 2013 and beyond. 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; and
  • income taxes.

We discuss below the critical accounting assumptions, judgments and estimates associated with these policies. Historically other than our estimate of foreign tax expense incurred in fiscal 2009 and recovered in fiscal 2011 as discussed below, 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) collectability of amounts is reasonably assured.

 

We make estimates and judgments when determining whether the collectability of product, service or license fees receivable from customers is reasonably assured. We assess the collectability of our receivables based on a number of factors, including past transaction history and the credit-worthiness of customers. Management estimates regarding collectability impact the actual revenues recognized each period and the timing of the recognition of revenues. Our assumptions and judgments regarding future collectability could differ from actual events, thus materially impacting our financial position and results of operations.

22
 

 

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 collectability 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 collectability 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 an adjustment to those amounts will 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 the time of grant and reflect the impact of estimated pre-vesting option forfeitures on compensation expense recognized. Estimates of pre-vesting forfeitures must be periodically revised in subsequent periods if actual forfeitures differ from those estimates. We consider several factors in connection with our estimate of pre-vesting forfeitures including types of awards, employee class, and historical pre-vesting forfeiture data. The estimation of stock awards that will ultimately vest requires judgment, and to the extent that actual results differ from our estimates, such amounts will be recorded as cumulative adjustments in the period the estimates are revised. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

 

Refer to Notes 2 and 10 to our consolidated financial statements included in this report for more information.

 

23
 

Income Taxes

In preparing our consolidated financial statements, we estimate our income taxes in each of the countries in which 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 2012 a total of $57,025 of foreign taxes was withheld and we determined that it was unlikely we can recover a refund of such foreign taxes withheld and that we can only use the foreign taxes as a future credit against U.S. taxes. Matters regarding foreign taxes require 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 for tax and financial accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our 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 the financial statements and the tax bases of assets and liabilities, as measured by current enacted tax rates. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. We evaluate the realizability of our deferred tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary. At March 31, 2012, we had net deferred tax assets primarily resulting from temporary differences between the book and tax bases of assets and liabilities, and loss and credit carry forwards. We continue to provide a 100% valuation allowance our deferred tax assets based on an assessment of the likelihood of their realization. In reaching our conclusion, we evaluated certain relevant criteria including deferred tax liabilities that can be used to offset deferred tax assets, estimates of future taxable income of appropriate character within the carry-forward period available under the tax laws, and tax planning strategies. Our judgments regarding future taxable income may change due to market conditions, changes in U.S. or international tax laws, our business and results of operations, 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 the deferred tax assets, if it is determined that their value is impaired, resulting in a reduction in net income or an increase in net 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.

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Results of Operations

 

Year ended March 31, 2012 Compared to Year ended March 31, 2011

 

    Year Ended March 31,         
    2012         2011                
         % of         % of    Change
    Dollars    Revenue    Dollars    Revenue    Dollars    % 
Revenues:                              
Products   162,844    3%   431,056    33%   (268,212)   (62%)
Services   463,928    10%   633,565    49%   (169,637)   (27%)
Patent license   4,100,379    87%   231,042    18%   3,869,337    1675%
    4,727,151    100%   1,295,663    100%   3,431,488    265%
Gross Profit:                              
Product gross profit   10,518    0%   93,514    7%   (82,996)   (89%)
Service gross profit   160,859    3%   292,460    23%   (131,601)   (45%)
Patent license   2,778,077    59%   120,000    9%   2,658,077    2215%
    2,949,454    62%   505,974    39%   2,443,480    483%
Operating Expenses:                              
Selling and administrative   964,444    20%   1,119,366    86%   (154,922)   (14%)
Research and related   672,913    14%   473,298    37%   199,615    42%
    1,637,357    35%   1,592,664    123%   44,693    3%
Operating income (loss) before provision for income taxes   1,312,097    28%   (1,086,690)   (84%)   2,398,787    (221%)

  

Income (Loss) before provision for income taxes

The operating income before provision for taxes in fiscal 2012 resulted from increased patent licensing revenues. The loss before income tax benefit in fiscal 2011 resulted from limited patent license revenues and insufficient overall margins to support operating costs. Since a significant majority of patent license revenues in fiscal 2012 and 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.

 

Revenues

Revenues for the year ended March 31, 2012 included $4,082,500 of one-time non-recurring patent license revenue, $17,879 of royalty-based patent license revenues and $626,772 of eVU product and service revenues. 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.

 

Revenues for the year ended March 31, 2011 included $200,000 of one-time non-recurring patent license revenue, $31,042 of royalty-based patent license revenues and $1,064,621 of eVU product and service revenues.

 

In the prior year we entered into one license and in the current year a total of eight 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.

25
 

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 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.

 

eVU product sales activity has been slow during the last few years due to airline industry economics and the rapid consumer adoption of portable devices resulting in airlines curtailing new projects. We had no product backlog at March 31, 2012 compared to $8,800 at the prior year-end. Our product sales for the fiscal 2012 are not necessarily indicative of future orders. Our service arrangements 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 in future periods. 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 2012 was $2,949,454 or 62% of revenues. The gross profit margin on product and service revenues was 27% and the gross profit on patent licensing fees was 68% of license revenues. Gross profit for fiscal 2011 was $505,974 or 39% of revenues. The gross profit margin on product and service revenues was 36% and the gross profit on patent licensing fees was 52% of license revenues. 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 $154,922 from fiscal 2011 to fiscal 2012. The decrease is due to reduced current year expense for noncash stock-based compensation of $12,681 compared to $126,298 for the prior year, reduced selling and administrative expenses including $191,000 in reduced salaries due to a reduction in staffing, offset by increased shareholder costs of $60,000 for the annual shareholder meeting held during the fiscal year, with no comparable expenses incurred in the prior fiscal year.

 

Research and related expenditures increased by $199,615 from fiscal 2011 to fiscal 2012, primarily due to the increase in professional fees of $258,023 in relation to patent reexamination cases, offset by reduced stock-based compensation expenses of $7,486 in fiscal 2012 compared to $42,372 in fiscal 2011. 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

Net other income was $0 for the year ended March 31, 2012. In fiscal 2011 we recognized $41,408 of other income as the result of vendor settlements.

 

Income Taxes

We had a tax expense of $117,025 for the current period compared to the prior year income tax benefit of $3,479 from state refunds.

 

Income (loss) Attributable to Common Stockholders

The income attributable to common stockholders for the year ended March 31, 2012 included the net income of $1,195,072. The loss attributable to common stockholders for the year ended March 31, 2011 included the net loss of $1,083,211 increased by accrued and deemed dividends on convertible preferred stock of $31,396 or a net loss attributable to common stockholders of $1,114,607. No preferred stock remains outstanding.

26
 

 

 

Liquidity and Capital Resources

 

   2011  2012  2011 to 2012 variance in $'s  2011 to 2012 variance in %'s
    (in thousands, except percentages) 
Working capital  $2,013   $3,209   $1,196    59%
Cash and cash equivalents  $1,806   $3,125   $1,319    73%
Total assets  $2,197   $3,539   $1,342    61%

 

   2011  2012  2011 to 2012 variance in $'s  2011 to 2012 variance in %'s
Net cash provided by (used in)  (in thousands, except percentages)
Operating activities  $(1,007)  $1,336   $2,343    232%
Investing activities  $(5)  $(16)  $(11)   (220%)
Financing activities  $-0-   $-0-   $-0-    —   

 

At March 31, 2012, we had working capital of $3.2 million compared to working capital of $2.0 million for the prior year. We had $168,000 and $98,000 of working capital invested in accounts receivable at March 31, 2012 and 2011, respectively. Our terms to customers vary but at times we may 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, 2012, net cash increased by $1,319,000. Cash provided by operating activities was $1,336,000. Cash provided by operating activities included the net income of $1,195,012 increased by net non-cash expenses of $139,000. Major components providing operating cash were increases in accounts payable of $75,000 and accrued and other liabilities of $60,000, and a reduction of inventory of $70,000. Major components using operating cash included a $70,000 increase in accounts receivable.

 

For the year ended March 31, 2011, net cash decreased by $1,013,000. Cash used by operating activities was $1,007,000. Cash used by operating activities included the net loss of $1,083,000 reduced by net non-cash expenses of $150,000. Major components also providing operating cash was a decrease of $91,000 in inventory. Major components using operating cash included a $176,000 decrease in accrued liabilities primarily resulting from a decrease in deferred revenue.

 

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

We had no investing activity transactions during the years ended March 31, 2012 and 2011.

 

We currently have no sources of financing funding other than the potential exercise of options which generally will be dependent on higher stock prices and thus substantial uncertainty.

 

Debt and Other Commitments

We 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, 2012 we were committed to approximately $5,000 of purchase commitments for product and components. 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.

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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.

 

The costs of the USPTO reexamination of certain claims of the Flash-R patents is not covered under our arrangement with Duane Morris and we have engaged separate counsel and will be required to pay such costs.

 

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, 2012 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.

 

We currently have no plans, arrangements or understandings regarding any acquisitions.

 

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 set forth in a separate section of this report following Item 15 and the Signature Page commencing on Page F-1.

 

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

 

There have been no disagreements or any reportable events requiring disclosure under Item 304(b) of Regulation S-K.

 

ITEM 9A. CONTROLS & PROCEDURES

We are required to maintain disclosure controls and procedures designed to ensure that material information related to us, including our consolidated subsidiaries, is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.

 

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 Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management, which, by their nature, can provide only reasonable assurance regarding management’s control objectives. In designing and evaluating the 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 is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

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At the conclusion of the period ended March 31, 2012, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, were effective at a reasonable assurance level.

 

Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2012 based on the guidelines established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Our internal control over financial reporting includes policies and procedures that provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles in the United States. Based on this evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of March 31, 2012.

This annual report does not include an attestation report of the company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s independent registered public accounting firm pursuant to rules of the SEC that permit the company to provide only management’s report in this annual report.

 

Inherent Limitations on Effectiveness of Controls

 

Our management 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

 

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PART III

 

Certain information required by this Part III is omitted from this Annual Report as we intend to file our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders (the “Proxy Statement”) pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after the end of the fiscal year covered by this Annual Report, and certain information included in the Proxy Statement is incorporated herein by reference.

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

 

Directors and Executive Officers

 

Set forth below is information concerning our executive officers and directors as of June 1, 2012:

 

Name Age Positions Director Since
Alfred H. Falk 57 President, Chief Executive Officer and Director January 2009
MarDee Haring-Layton 36 Chief Financial Officer  
Allen Cocumelli 61 Chairman* and Director 1999
Renee Warden 48 Director 2005
Eric M. Polis 41 Director 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 – was promoted and appointed as President and Chief Executive Officer of the Company by the Board of Directors on January 20, 2009 when he was also appointed as a Director.  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, Mr. 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. Mr. Falk’s extensive business experience and background, prior sales experience, and his long service with the Company including as Chief Executive Officer since 2009, qualifies him to serve on our Board.

 

MarDee Haring-Layton – was appointed Chief Financial Officer of the Company by the Board of Directors on December 5, 2011. She has been with the Company, on a part-time consulting basis, since July 2010. Previously, she was employed as a consultant with Resources Global Professionals, a multinational professional services firm, from 2007 to 2011. From 2005 to 2006, she was the Corporate Audit Manager at Royale Energy, Inc. Prior to Royale Energy, Ms. Haring-Layton was employed by Charlotte Russe, Inc. as Systems Control and Reporting Manager and Deloitte & Touche, LLP as an audit professional. Ms. Haring-Layton holds a B.S. in Business Administration from San Diego State University.

 

Eric M. Polis - was appointed a Director in October 2008 and Secretary in December 2010. He has been employed as an asset manager for privately-held Davric Corporation since 1997. He was Secretary, Treasurer and a Director of ASI Technology Corporation, a publicly traded specialty finance company, from July 2000 to May 2010. 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. Mr. Polis’ prior public company executive experience and broad general investment and business experience qualify him to serve on our Board.

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Allen Cocumelli – was appointed Chairman of the Board in October 2008. He 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. And since 1995 he has had a part-time solely owned law practice. Prior thereto, he 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. He previously served as a manager in the Components Manufacturing Group and as Director of Corporate Training and Development at Intel. Mr. Cocumelli obtained a B.A. degree in Industrial Psychology from the University of California, Los Angeles and a J.D. from the Thomas Jefferson School of Law. Mr. Cocumelli is a member of the California Bar Association. The Board believes that Mr. Cocumelli’s technology experience and legal background will continue to be valuable as the Company pursues its patent enforcement and licensing strategy.

 

Renee Warden – Ms. Warden served as a Financial Manager for Verifone from July 2009 to June 2011. 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 American Technology Corporation. Ms. Warden obtained a B.S. degree in Business Accounting from the University of Phoenix in 1999. Ms. Warden’s broad financial and accounting experience positions her well to serve as a director and to fill the critical role of Audit Committee “financial expert.”

 

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, 16870 West Bernardo Drive, Suite 120, 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, 2012, 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 September 2011.

 

Audit Committee and Audit Committee Financial Expert

The Audit Committee, currently consisting of Ms. Warden and Mr. Cocumelli, assists our Board of Directors in discharging its responsibilities to oversee the integrity of our financial statements, our compliance with legal and regulatory requirements and the independent auditor’s qualifications and independence. It reviews the audit and control functions of the Company, the Company’s accounting principles, policies and practices and financial reporting, the scope of the audit conducted by our Company’s auditors, the fees and all non-audit services of the independent auditors and the independent auditors’ opinion and letter of comment to management and management’s response thereto. The Audit Committee is governed by a written charter adopted in 2000. The Audit Committee held four meetings during the fiscal year ended March 31, 2012.

 

Our Board of Directors has determined that each member of the Audit Committee is able to read and understand fundamental financial statements, including our Company’s balance sheet, income statement and cash flow statement. Our Board of Directors has also determined that Ms. Warden qualifies as an “audit committee financial expert,” as defined in applicable Securities Exchange Commission rules. The Board has determined that the Ms. Warden meets the audit committee member independence requirements applicable Securities Exchange Commission rules for exchange listed companies, Mr. Cocumelli, while determined to be an independent director, would not meet the audit committee member independence requirements for audit committee members due to his consulting with the company on legal matters (see Item 11 – Director Compensation). 

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ITEM 11. EXECUTIVE COMPENSATION.

 

Compensation of our Named Executive Officers

 

We have identified Alfred H. Falk and MarDee Haring-Layton as our named executive officers. 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. Mr. Polis serves as corporate Secretary, an executive officer position, but is not compensated for this role and is not considered an employee. He is considered a non-employee director (see “Director Compensation” below).

 

Summary Compensation Table

 

Name and Principal Position

Fiscal Year

Salary(1) Bonus

Option Awards (2)

All Other Compensation

Total

Alfred H. Falk, President and
Chief Executive Officer (PEO)

 

2012

2011

 

$185,500

$171,129

 

$-0-

$-0-

 

$4,098

$19,291

 

$-0-

$-0-

 

$189,598

$190,420

 

MarDee Haring-Layton

Chief Financial Officer (PFO) (3)

 

2012

2011

$88,562

$17,659

$-0-

$-0-

$2,391

$2,044

$-0-

$-0-

$90,953

$19,703

               

(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 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, 2012, included herein.
(3)Ms. Haring-Layton was paid on a consulting basis with compensation at $65 per hour with a minimum commitment of 24 hours per week through December 5, 2011 when she was appointed as Chief Financial Officer.

 

We do not have any annuity, retirement, pension or deferred compensation plan or other arrangements for our executive officers or any employees. No named executive officer received any form of non-cash compensation from us in the fiscal year ended March 31, 2012, or currently receives any such compensation. No named executive officer received a restricted stock award, a stock appreciation right or a long-term incentive plan payout in the fiscal year ended March 31, 2012.

 

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   75,000 225,000 (1) - $0.022 11/29/15
  500,000 - - $0.155 12/8/13
  500,000 - - $0.09 6/30/14
           
MarDee Haring-Layton 25,000 75,000 (1) - $0.027 11/29/15
  12,500 37,500 (1) - $0.022 12/5/15
  10,000 10,000 (1) - $0.10 12/22/14
  10,000 10,000 (1) - $0.11 1/26/15

(1)These options vest 25% every six months after grant.

32
 

Option Exercises and Stock Vested Table

There were no options exercised by the Named Executive Officers during fiscal 2012. There are no pension benefits for any Named Executive Officer.

 

Potential Payments Upon Termination, Death, Disability, or Retirement

We have no executive employee contracts at this time. Every officer and employee is an at will employee.

 

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 2012.

 

Name

Fee Earned or Paid in Cash

Option

Awards (1)

All Other Compensation

Total

Allen Cocumelli (2) $500 $3,415 -- $3,915
Renee Warden (2) $500 $3,415 -- $3,915
Eric M. Polis (2) $500 $3,415 -- $3,915

 

(1)The value listed in the above table represents the fair value of options on 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, 2012, included in our Annual Report on Form 10-K.
(2)Each listed director was granted a five-year option on 250,000 shares during the year exercisable at $0.022 per share and vesting 25% on grant and 25% each six months.

 

During fiscal 2012 the Company paid the Law Office of Allen Cocumelli, owned by director Allen Cocumelli a total of $60,000 to provide legal and consulting advice to management primarily related to managing outside legal work including patent enforcement matters. The Company has retained the Law Office of Allen Cocumelli through January 2012 at the rate of $5,000 per month for future services but the arrangement is cancellable on 30-day notice.

 

Compensation Committee Interlocks and Insider Participation

The Compensation Committee, currently comprised of two non-employee Board members, Allen Cocumelli and Eric M. Polis (appointed as Secretary on December 20, 2010 an uncompensated non-employee officer position), assists our Board of Directors in discharging its responsibilities in respect of compensation of our executive officers and directors. It reviews and recommends to the Board the salaries, bonuses and perquisites of our Company’s executive officers. The Compensation Committee also reviews and recommends to the Board any new compensation or retirement plans and administers such plans. No executive officer of our 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 our Company’s Board of Directors or Compensation Committee. The Compensation Committee held one meeting during the fiscal year ended March 31, 2012.

 

Our Compensation Committee has not adopted a formal charter. The Compensation Committee performs the following functions regarding compensation for the named executive officers (“ NEOs”):

 

·Review and approve our Company’s goals relating to Principal Executive Officer (“PEO”) compensation.
·Evaluate the PEO’s performance in light of the goals.
·Make recommendations to the board regarding compensation to be paid to any other NEOs.
·Annually review, for all NEOs, annual base salary, bonus, long-term incentives, employment-related agreements and special benefits.

 

33
 

The Committee’s compensation policies are particularly designed to align executive officer and senior management salaries and bonus compensation to the individual’s performance in the short-term and to emphasize compensation from equity, primarily employee stock options, for long-term incentives.

 

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, 2012, 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 named executive officers reflected in the Summary Compensation Table below and (iv) all current directors, nominees and executive officers as a group (five persons). Beneficial ownership is determined under the rules of the SEC and generally includes voting or investment power over securities. 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 of Beneficial Owner   Amount and Nature of Beneficial Ownership(1)  Percent
of Class
  Title of Class
Alfred H. Falk   2,143,850 (1)  *  Common
16870 West Bernardo Drive, Suite 120         
San Diego, CA 92127         
          
Allen Cocumelli   776,000 (2)  *  Common
16870 West Bernardo Drive, Suite 120         
San Diego, CA 92127         
          
Renee Warden   675,000 (3)  *  Common
16870 West Bernardo Drive, Suite 120         
San Diego, CA 92127         
          
Eric M. Polis   4,273,117 (4)  1.5%  Common
980 American Pacific Drive, #111         
Henderson, NV 89014         
          
MarDee Haring-Layton   100,000 (5)  *  Common
16870 West Bernardo Drive, Suite 120         
San Diego, CA 92127         
          
All officers, directors and nominees         
   as a group (5 persons)   7,967,967 (6)  2.7%  Common

 

(1)Includes 550 shares held by son to which Mr. Falk disclaims beneficial ownership. Includes options exercisable to purchase 1,150,000 shares.
(2)Includes options exercisable to purchase 775,000 shares.
(3)Consists of options exercisable.
(4)Includes options exercisable to purchase 725,000 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, and (v) 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 except to the extent of his respective pecuniary interest.
(5)Includes options exercisable and options exercisable within 60 days to purchase 100,000 shares.
(6)Includes options exercisable and options exercisable within 60 days to purchase 3,425,000 shares.

____________________________

* Less than 1%

 

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.

 

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, 2012.

 

Mr. James A. Barnes, became a related party in June 2008 when affiliated entities acquired greater than 5% of our Series AA preferred stock and ceased being a related party in June 2010 when such stock was converted to common stock. We incurred accounting, regulatory consulting services and cost reimbursements of $36,789 to Sunrise Capital, Inc., a company controlled by Mr. Barnes during fiscal 2012 ($38,137 in fiscal 2011).

 

On December 8, 2009, directors Allen Cocumelli, Renee Warden and Eric M. Polis were each granted options to acquire 250,000 shares of common stock exercisable at $0.155 per share until December 8, 2013, vesting at grant but subject other standard option plan conditions.

 

On June 30, 2010, directors Allen Cocumelli (as to 400,000), Renee Warden (as to 300,000) and Eric M. Polis (as to 50,000) were each granted options to acquire shares of common stock exercisable at $0.09 per share until June 30, 2014, vesting at grant but subject other standard option plan conditions.

 

On November 29, 2011, directors Allen Cocumelli, Renee Warden and Eric M. Polis were each granted options to acquire 250,000 shares of common stock exercisable at $0.022 per share until November 29, 2015, vesting 25% at grant and 25% each six months and subject other standard option plan conditions.

 

During the fiscal year ended March 31, 2012 there were no other (and there are no currently proposed) transactions in which the amount involved exceeded the lesser of $120,000 or 1% of the average of total assets at year end for the last two completed fiscal years to which we were (or are to be) a participant and in which any executive officer, director, nominee for director, 5% beneficial owner of our common stock or other series of voting stock or member of the immediate family of any of the foregoing persons had (or will have) a direct or indirect material interest.

 

Director Independence

For a director to be considered “independent,” the Board must affirmatively determine that the director has no material relationship with the Company (directly or as a partner, stockholder or officer of an organization that has a relationship with the Company). In each case, the Board considers all relevant facts and circumstances. We consider Allen Cocumelli and Renee Warden as independent.

 

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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, 2012 and March 31, 2011 and fees billed for other services rendered by SingerLewak LLP during those periods. These amounts include fees paid to SingerLewak LLP.

 

Type of Fee  2012  2011
Audit Fees (1)  $90,000   $90,000 
Audit Related Fees (2)  $4,035   $3,780 
Tax Fees (3)        
All Other Fees (4)        
Total  $94,035   $93,780 

 

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 LLP that 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 LLP for 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 LLP for 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 LLP in providing services to us for the fiscal year ended March 31, 2012 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 2012.

 

 

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.

36
 

Sequential Description

Exhibit

Number

2.1Plan of Reorganization and Agreement of Merger, dated July 1996 and filed as Exhibit A to the Company’s July 3, 1996 Proxy Statement.

 

3.1Certificate of Incorporation of Norris Communications, Inc. (as amended through May 28, 1996) and filed as Exhibit B to the Company’s July 3, 1996 Proxy Statement.

 

3.1.1Certificate 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.

 

3.1.2Certificate 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.

 

3.1.3Certificate 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.
3.1.4Certificate 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.

 

3.2Bylaws of the Company, filed as Exhibit C to the Company’s July 3, 1996 Proxy Statement.

 

3.3Certificate 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.

 

3.4Certificate 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.

 

3.5Certificate 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.

 

3.6Certificate 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.

 

3.7Certificate 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.

 

3.8Certificate 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.

 

37
 
3.9Certificate 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.

 

4.1Form 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.

 

4.2Form 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.

 

4.2.1Form 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.

 

4.2.2Form 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.

 

4.2.3Form 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.

 

4.3Form 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.

 

4.3.1Form 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.

 

4.4Form 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.

 

4.5Form 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

 

4.6Form 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.

 

4.7Form 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

 

4.8Exchange Agreement between the Company and Davric Corporation dated December 1, 2006 filed as Exhibit 99.1 to Form 8-K dated December 12, 2006.

 

4.8.17.5% 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.

 

4.9Common 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.

38
 

 

4.10Registration 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.

 

4.11Form 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.

 

4.12Form 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.

 

10.1Lease 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.

 

10.1.2Second Amendment to Lease Agreement executed on May 31, 2011 between the Company and LBA/Met Partners II – COMPANY II, LLC.

 

10.2Agreement 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.)

 

10.3Secured 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.

 

10.3.1Loan 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.

 

10.3.2Secured 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.

 

10.3.3Loan 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.

 

10.3.4Loan 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.

 

10.4Security 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.

 

10.4.1Security 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.

 

10.52005 Equity-Based Compensation Plan, filed as Exhibit B to the to the Company's July 12, 2005 Definitive Proxy Statement.

 

10.5.1Form 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.

 

10.5.2Form 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.

 

10.7Separation Agreement and General Release, dated as of December 15, 2010, between e.Digital Corporation and Robert Putnam and filed previously as Exhibit 99.1 to Form 8-K dated December 17, 2010.

39
 

 

10.8Joint Statement in Response to June 28, 2011 Order Regarding Claim Construction as filed with the United States District Court for the District of Colorado on July 28, 2011 and filed previously as Exhibit 99.1 to Form 8-K dated July 28, 2011.

 

10.9Lease Agreement between the Company and BOI-Rancho Bernardo Bluffs Trust executed on January 20, 2012 filed previously as Exhibit 99.1 to Form 8-K dated January 20, 2012.

 

21.1Subsidiary 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.

 

23.1Consent of SingerLewak LLP, Independent Registered Public Accounting Firm.*

 

31.1Certification 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.*

 

31.2Certification 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.*

 

32.1Certification 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 MarDee Haring-Layton, Chief Financial 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 21, 2012

 

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 21, 2012
Alfred H. Falk   (Principal Executive Officer)    
         
/s/ ALLEN COCUMELLI   Chairman of the Board and Director   June 21, 2012
Allen Cocumelli        
         
/s/ MARDEE HARING-LAYTON   Chief Financial Officer   June 21, 2012
MarDee Haring-Layton   (Principal Accounting Officer)    
         
/s/ ERIC M. POLIS   Secretary and Director   June 21, 2012
Eric M. Polis        
         
/s/ RENEE WARDEN   Director   June 21, 2012
Renee Warden        

 

40
 

  

 

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, 2012 AND 2011 F-3
   
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED  
MARCH 31, 2012 AND 2011 F-4
   
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS  
ENDED MARCH 31, 2012 AND 2011 F-5
   
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED  
MARCH 31, 2012 AND 2011 F-6
   
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-7 to F-21

 

 

 

F-1
 

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 (collectively the “Company”) as of March 31, 2012 and 2011, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. These 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. The Company is not required to have, nor were we engaged to perform an audit, of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 e.Digital Corporation and subsidiary as of March 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

 

/s/ SingerLewak LLP

 

Los Angeles, CA

June 21, 2012

 

F-2
 

e.Digital Corporation and subsidiary

 

CONSOLIDATED BALANCE SHEETS

[See Note 1 - Nature of Operations and Basis of Presentation]

 

 

   As of March 31
   2012  2011
   $  $
ASSETS          
Current          
Cash and cash equivalents   3,125,349    1,805,894 
Accounts receivable   168,018    98,152 
Inventory   98,136    256,458 
Deposits and prepaid expenses   40,132    30,327 
Total current assets   3,431,635    2,190,831 
Inventory, long-term   88,663    —   
Property, equipment and intangibles, net of accumulated depreciation and amortization of $194,461 and $184,382, respectively   18,276    6,506 
Total assets   3,538,574    2,197,337 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current          
Accounts payable, trade   99,949    24,466 
Accrued expenses and other liabilities   211,014    153,013 
Total current liabilities   310,963    177,479 
           
Commitments and Contingencies          
           
Stockholders' equity          
Preferred stock, $0.001 par value; 5,000,000 shares authorized none issued or outstanding          
Common stock, $0.001 par value, authorized 350,000,000, 293,003,158 issued and outstanding each period   293,003    293,003 
Additional paid-in capital   82,779,769    82,767,088 
Accumulated deficit   (79,845,161)   (81,040,233)
Total stockholders' equity   3,227,611    2,019,858 
           
Total liabilities and stockholders' equity   3,538,574    2,197,337 

 

See accompanying notes to consolidated financial statements 

F-3
 

 

e.Digital Corporation and subsidiary

 

CONSOLIDATED STATEMENTS OF OPERATIONS

[See Note 1 - Nature of Operations and Basis of Presentation]

 

   For the year ended
   March 31
   2012  2011
Revenues:   $    $ 
Products   162,844    431,056 
Services   463,928    633,565 
Patent license   4,100,379    231,042 
    4,727,151    1,295,663 
           
Cost of revenues:          
Products   152,326    337,542 
Services   303,069    341,105 
Patent license   1,322,302    111,042 
    1,777,697    789,689 
Gross profit   2,949,454    505,974 
           
Operating expenses:          
Selling and administrative   964,444    1,119,366 
Research and related expenditures   672,913    473,298 
Total operating expenses   1,637,357    1,592,664 
           
Net income (loss) before provision for income taxes   1,312,097    (1,086,690)
(Provision for) benefit from income taxes   (117,025)   3,479 
Net income (loss) and comprehensive income (loss)   1,195,072    (1,083,211)
Accrued and deemed dividends on preferred stock   —      (31,396)
Income (loss) attributable to common stockholders   1,195,072    (1,114,607)
Income (loss) per common share - basic and diluted  $0.00   ($0.00)
           
Weighted average common shares outstanding          
Basic   293,003,158    291,494,239 
Diluted   293,334,860    291,494,239 

 

 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] 

 

   Preferred stock  Common stock  Additional
paid-in
  Accumulated  Total stockholders'
   Amount  Shares  Amount  capital  deficit  equity
   $     $  $  $  $
Balance, March 31, 2010  573,830   286,950,900    286,951    82,073,012    (79,957,022)   2,976,771 
Dividends on Series AA preferred stock  6,856   —      —      (6,856)   —      —   
Accretion of discount on Series AA preferred stock  24,540   —      —      (24,540)   —      —   
Conversion of Series AA preferred stock  (605,226)   6,052,258    6,052    599,174    —      —   
Stock-based compensation     —      —      126,298         126,298 
Net loss and comprehensive loss     —      —      —      (1,083,211)   (1,083,211)
Balance, March 31, 2011     293,003,158    293,003    82,767,088    (81,040,233)   2,019,858 
Stock-based compensation     —      —      12,681         12,681 
Net income and comprehensive income     —      —      —      1,195,072    1,195,072 
Balance, March 31, 2012     293,003,158    293,003    82,779,769    (79,845,161)   3,227,611 

 

 See accompanying notes to consolidated financial statements 

F-5
 

 

e.Digital Corporation and subsidiary

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 [See Note 1 - Nature of Operations and Basis of Presentation] 

 

   For the year ended
   March 31,
   2012  2011
OPERATING ACTIVITIES  $  $
Net income (loss) for the period   1,195,072    (1,083,211)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   4,291    10,079 
Bad debt expense   —      740 
Warranty provision   (3,435)   12,680 
Stock-based compensation   12,681    126,298 
Changes in assets and liabilities:          
Accounts receivable   (69,866)   9,857 
Inventory   69,659    90,620 
Deposits and prepaid expenses   (9,805)   28,745 
Accounts payable, trade   75,483    (27,531)
Accrued and other liabilities   61,436    (175,615)
Cash provided by (used in) operating activities   1,335,516    (1,007,338)
           
INVESTING ACTIVITIES          
Purchase of property and equipment   (16,061)   (5,495)
Cash used in investing activities   (16,061)   (5,495)
           
Net increase (decrease) in cash and cash equivalents   1,319,455    (1,012,833)
Cash and cash equivalents, beginning of period   1,805,894    2,818,727 
Cash and cash equivalents, end of period   3,125,349    1,805,894 

 

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, 2012

 

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. The Company also markets the eVU™ mobile entertainment system for the travel industry.

 

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 reporting periods. Some of the estimates needed to be made by management include the allowance for doubtful accounts, valuation of inventory, estimated useful lives of property and equipment and intangible assets, warranty reserve, valuation of equity instruments associated with share-based compensation and for services rendered and the valuation allowance for the Company’s deferred tax asset. Actual results could materially differ from these 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 10.

 

F-7
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

Fair Value of Financial Instruments

Cash and cash equivalents are measured at fair value in the Company’s 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, deferred revenue 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 Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (“ASC 820”) that 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 instrument’s categorization within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. ASC 820 establishes three levels of inputs that may be used to measure fair 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 assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be 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 or liabilities.

 

The Company’s financial assets measured at fair value on a recurring basis at March 31, 2012 are as follows:

 

   Fair Value Measurement as of March 31, 2012
    Total    Level 1    Level 2    Level 3 
Description   $    $    $    $ 
Cash and cash equivalents (1)   3,125,349    3,125,349    —      —   

 

(1)Included in cash and cash equivalents on the accompanying consolidated balance sheet.

 

Income (Loss) per Share

Basic 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. The loss attributable to common stockholder was increased by accrued and deemed dividends on preferred stock during the year ended March 31, 2011 of $31,396. 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 and warrants. 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.

 

At March 31, 2012, stock options exercisable into 7,355,000 shares of common stock were outstanding (2011– options and warrants exercisable into 13,522,500 shares of common stock were outstanding). These securities had an immaterial effect on diluted income per share and there was no difference between basic and diluted income per share for the year ended March 31, 2012. Dilutive securities were not included in the computation of diluted loss per share for the year ended March 31, 2011 because they are antidilutive. Dilutive securities could potentially dilute earnings (loss) per share in future years.

 

The following table presents the calculation of basic and diluted net income (loss) per share:

 

Years Ended  March 31, 2012  March 31, 2011
Net income (loss)  $1,195,072   $(1,114,607)
           
Weighted-average shares—basic   293,003,158    291,494,239 
Effect of dilutive potential common shares   331,702    —   
           
Weighted-average shares—diluted   293,334,860    291,494,239 
           
Net income per share—basic  $0.00   $(0.00)
           
Net income per share—diluted  $0.00   $(0.00)

 

Employee equity share options, granted by the Company are treated as potential common shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of in-the-money options. The dilutive effect of such equity awards is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are collectively assumed to be used to repurchase shares.

 

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 at March 31, 2012 had substantially all of its cash and cash equivalents at one financial institution in a non-interest bearing account, which pursuant to current rules is insured in full by the Federal Deposit Insurance Corporation through December 31, 2012. 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.

F-8
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

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.

 

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.

 

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) collectability 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.

F-9
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

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 collectability 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, Leases and 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.

 

Until fiscal 2010 all patent licenses provided for a contractually determined one time fully paid up license in consideration 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 collectability 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.

F-10
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

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 are included 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. The cost of substantially all our inventory is determined by the weighted average cost method. 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 11 for purchase commitments.

 

We also maintain a substantial number of finished goods that we have determined to be slow-moving and have classified this portion of inventory as a long-term asset.

 

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 $-0- and $7,446 for the years ending March 31, 2012 and 2011, 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.

F-11
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

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.

 

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, 2012, the Company had not recorded any provisions for accrued interest and penalties related to uncertain tax positions.

 

The tax years 2007 through 2011 remain open under the statute 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 1994.

 

Stock-based Compensation

The Company has adopted stock plans as summarized in Note 9. 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.

F-12
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

The Company recorded $12,681 and $126,298 of stock-based compensation expense for the years ended March 31, 2012 and 2011, respectively. The amounts of stock-based compensation expense are classified in the consolidated statements of operations as follows:

 

Year Ended March 31, 2012 2011  
    $ $  
  Research and development 7,486 42,372  
  Selling and administrative 5,195 83,926  
  Total stock-based compensation expense 12,681 126,298  

 

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 Income (Loss)

Comprehensive income (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, 2012 and 2011, there were no material differences between comprehensive income (loss) and net income (loss) for the respective years.

 

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).

 

New Accounting Pronouncements

In April 2011, the FASB issued ASU No. 2011-17—Revenue Recognition—Milestone Method (Topic 605), which provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize consideration that is contingent upon achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. The amendments in this Update are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2011. The adoption of the amendments in this update did not have any significant impact on the Company’s financial position and results of operations.

 

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement providing additional guidance on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance of ASU 2011-04 is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning with the Company’s fiscal 2013 year. The Company does not expect the adoption of this update will have a material effect on its financial statements.

 

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income providing guidance regarding the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new standard also requires presentation of adjustments for items that are reclassified from other comprehensive income to net income in the statement where the components of net income and the components of other comprehensive income are presented. The updated guidance of ASU 2011-05 is effective on a retrospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning with the Company’s fiscal 2013 year. The Company does not expect the adoption of this update will have a material effect on its financial statements.

F-13
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

In September 2011, the FASB issued Accounting Standards Update ("ASU") 2011-08,  Intangibles - Goodwill and Other which allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill  impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. ASU 2011-08 will be effective for the Company in fiscal 2013, with early adoption permitted. The Company does not expect the adoption of this update will have a material effect on its financial statements.

 

There have been no other recent accounting pronouncements or changes in accounting pronouncements during the year ended March 31, 2012, or subsequently thereto, that the Company believes are of potential significance to its financial statements.

 

 

3. STATEMENT OF CASH FLOWS

The Company had non-cash financing activities and made cash payments as follows:

 

Year Ended March 31, 2012 2011  
    $ $  
Non-cash financing activities:      
  Common stock issued on conversion of preferred stock               -       605,226  
  Accrued and deemed dividends on preferred stock               -         31,396  
Cash payments during year for:      
  Income taxes - net      57,825                  -  

  

 

4. INVENTORIES

Inventories consist of the following:

 

March 31, 2012 2011  
    $ $  
  Raw materials 55,430 70,835  
  Work in process 15,410 19,027  
  Finished goods 115,959 166,596  
    186,799 256,458  
  Less current portion 98,136 256,458  
  Inventory, long-term 88,663 -  

 

 

The foregoing is net of an aggregate lower-of-cost-or-market inventory adjustment of $65,459 at March 31, 2012 and 2011.

 

 

5. PROPERTY, EQUIPMENT AND INTANGIBLES

Property and equipment consisted of the following:

 

Year Ended March 31, 2012     2011  
    $     $  
  Computer hardware and software   52,100         53,294  
  Furniture and equipment   34,658        26,499  
  Machinery and equipment    75,219       75,406  
  Leasehold improvements       -    1,639  
  Tooling    19,720   19,720  
       181,697          176,558  
  Accumulated depreciation and amortization   (163,421      (170,052
        18,276         6,506  

F-14
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

Intangible assets consisted of the following:

 

Year Ended March 31, 2012     2011  
    $     $  
  Patents and licenses       24,409          24,409  
  Accumulated amortization      (24,409        (24,409
           -                 -    

 

 

6. ACCRUED LIABILITIES

Accrued liabilities consisted of the following:

 

March 31,  2012  2011
   $  $
Payroll and related   75,913    65,140 
Income taxes   59,200    —   
Deferred revenue   24,438    —   
Warranty reserve   1,093    4,589 
Accrued professional fees   50,370    81,010 
Deferred rent   —      2,274 
    211,014    153,013 

  

Details of the estimated warranty liability are as follows:

 

Year Ended March 31,  2012  2011
   $  $
Beginning balance   4,589    5,262 
Warranty provision   (3,435)   12,680 
Warranty deductions   (61)   (13,353)
Ending balance   1,093    4,589 

 

 

7. INCOME TAXES

Details of the income tax provision (benefit) for the years ended March 31, 2012 and 2011 are as follows:

 

Year ended March 31,  2012  2011
   $  $
Current tax expense (benefit)   117,025    (3,479)
Deferred tax expense (benefit)   518,000    (432,000)
Change in valuation allowance   (518,000)   432,000 
Income tax provision (benefit)   117,025    (3,479)

 

 

F-15
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

Details of tax provision (benefit) are as follows:

 

Year ended March 31, 2012 2011    
      $ $    
  Current tax expense (benefit):        
    Federal expense (benefit)     -        -      
    State expense (benefit) 60,000 (3,479  
    Foreign tax expense (benefit)  57,025    -      
    117,025 (3,479 )  

 

The Company paid $57,025 of foreign taxes during the year ended March 31, 2012.

 

The Company has U.S. federal NOL carryforwards available at March 31, 2012 of approximately $22,000,000 (2011 - $24,000,000) that will begin to expire in 2012. The Company has state net operating loss carryforwards of $18,000,000 (2011 - $19,400,000) 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.

 

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 1996, 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 2011 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 credits along 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, 2012 and 2011 are shown below. A valuation allowance of $10,705,000 and $11,223,000 was established at March 31, 2012 and 2011 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.

 

F-16
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

March 31, 2012     2011  
      $     $  
  Deferred tax assets:          
    Net operating loss carryforwards     9,511,000        10,120,000  
    Foreign tax credit      263,000          206,000  
    Research tax credit     1,557,000         1,617,000  
    Stock-based compensation       65,000             76,000  
    Accruals and other      87,000           76,000  
            11,483,000        12,095,000  
               
  Deferred tax liabilities:          
    Depreciation and amortization        (27,000        (27,000
    State taxes      (751,000        (845,000
            (778,000        (872,000
  Deferred tax assets     10,705,000         11,223,000  
  Valuation allowance for deferred tax assets     (10,705,000       (11,223,000
  Net deferred taxes             -              -    

 

 

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, 2012 and 2011 is as follows:

 

Year ended March 31, 2012     2011  
      $     $  
  Income taxes (benefit) computed at federal statutory rate    459,000     (380,000
  Foreign taxes      57,025               -    
  Foreign tax credit    (57,025            -    
  Permanent book-tax differences     2,025     25,000  
  State income tax expense (benefit), net of federal effect   76,000        (62,479
  True-ups and operating loss expirations, net   98,000         (18,000
  Change in valuation allowance     (518,000      432,000  
  Income tax provision (benefit)  117,025        (3,479

 

8. 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 293,003,158 common shares as of March 31, 2012 and 2011.

 

Preferred Stock

On June 27, 2008 the Company issued for aggregate proceeds of $750,000 a total of 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 were paid in shares of common stock. The Series AA Stock had 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 was convertible into common stock at $0.10 per common share with automatic conversion on June 30, 2011 subject to certain limitations. 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”).

F-17
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

The proceeds of $750,000 were allocated between the fair value of the Series AA Stock with the value of the Series AA Warrants treated as a discount to the Series AA Stock. A total of $24,540 of discount was accreted in 2011 as a deemed dividend. During the year ended March 31, 2011 the Company issued 6,052,258 shares of common stock upon the automatic conversion of the balance of 55,000 shares of Series AA Stock. No shares of Series AA Stock were outstanding.

 

Share Warrants

A summary of warrant activity during the years ended March 31, 2012 and 2011 is presented below:

 

   Number  Average Purchase  Price Per Share $
Shares purchasable under outstanding warrants at March 31, 2011   7,500,000    0.10 
Stock purchase warrants expired   (7,500,000 )   0.10  
Shares purchasable under outstanding warrants at March 31, 2012    —      0.00 

 

The Company has no outstanding share warrants as of March 31, 2012.

 

9. 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, 2012 there were options outstanding on 7,355,000 common shares pursuant to the 2005 Plan with options on 2,270,500 shares available for future grant under the 2005 Plan plus any future forfeitures or cancellations from the 2005 Plan options currently outstanding.

 

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, 2012 and 2011 (annualized percentages):

 

   Year Ended March 31,
   2012  2011
Volatility   114%   77.5%
Risk-free interest rate   0.28%   0.71%
Forfeiture rate   1.0%   1.0%
Dividend yield   0.0%   0.0%
Expected life in years   2.4    2.5 
Weighted-average fair value of options granted  $0.014   $0.04 

 

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 of 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 at 0.0% 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.

F-18
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

Since the Company has a net operating loss carryforward as of March 31, 2012, no excess tax benefit for the tax deductions related to stock-based awards was recognized for the year ended March 31, 2012. Additionally, no incremental tax benefits were recognized from stock options exercised during the year ended March 31, 2012 or 2011 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, 2012 total estimated compensation cost of options granted but not yet vested was approximately $19,851 and is expected to be recognized over the weighted average period of 1.1 years.

 

Stock Option Summary Information

The following table summarizes stock option transactions:

 

      Weighted average  Aggregate
   Shares  exercise price  Intrinsic Value
   #  $  $
Outstanding March 31, 2010   4,965,500    0.15      
Fiscal 2011               
Granted   2,985,000    0.09      
Exercised   —             
Canceled/expired   (1,928,000)   0.15      
Outstanding March 31, 2011   6,022,500    0.15    9,975 
Exercisable at March 31, 2011   4,959,580    0.12    9,975 
Fiscal 2012               
Granted   1,845,000    0.02      
Exercised   —             
Canceled/expired   (512,500)   0.18      
Outstanding March 31, 2012   7,355,000    0.09    32,575 
Exercisable at March 31, 2012   5,787,500    0.11    8,447 

 

 

The following table summarizes the number of options exercisable at March 31, 2012 and the weighted average exercise prices and remaining contractual lives of the options.

 

Range of exercise prices Number outstanding
at March
31, 2012
Number
exercisable at March 31, 2012
Weighted
Average exercise
price
Weighted
average
remaining contractual
life
Weighted
average
Exercise
price of
options
exercisable at
March 31, 2012
$ # # $ Years $
$0.022-$0.03 1,845,000 491,250 0.022 3.7 0.023
$0.09-$0.115 4,260,000 4,046,250 0.10 2 0.10
$0.155 1,250,000 1,250,000 0.155 1.7 0.155

 

 

10. 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-19
 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

Reportable segment information for the years ended March 31, 2012 and 2011 is as follows:

Year Ended March 31,  2012
$
  2011
$
REVENUES:          
Products and services   626,772    1,064,621 
Patent licensing   4,100,379    231,042 
Total revenue   4,727,151    1,295,663 
           
GROSS PROFIT:          
Products and services   171,377    385,974 
Patent licensing   2,778,077    120,000 
Total gross profit   2,949,454    505,974 
           
RECONCILIATION:          
Total segment gross profit   2,949,454    505,974 
Operating expenses   (1,637,357)   (1,592,664)
Other income   —      —   
Income (loss) before provision for income taxes   1,312,097    (1,086,690)

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 there is no disclosure of 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,  2012
$
  2011
$
United States   4,100,379    231,042 
International   626,772    1,064,621 
Total revenue   4,727,151    1,295,663 

 

Revenues from four licensees (21%, 21%, 22% and 10%) each accounted for more than 10% of revenues for the year ended March 31, 2012. Revenues from one licensee and three customers each accounted for more than 10% of revenues for the year ended March 31, 2011. Accounts receivable from three parties comprised 45%, 22% and 14% of net accounts receivable at March 31, 2012. Accounts receivable from two parties comprised 36% and 18% of net accounts receivable at March 31, 2011.

 

11. COMMITMENTS AND CONTINGENCIES

 

Legal Matters

 

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.

F-20
 

 

e.Digital Corporation

Notes to Consolidated Financial Statements

March 31, 2012

 

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, 2012 the Company had licensed and settled the litigation with twelve of the defendants, suspended the claim against one defendant, and dismissed with prejudice the remaining six defendants, thereby ending the Colorado patent litigation case.

 

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 with Duane Morris LLP. The agreement provides that Duane Morris is the Company’s legal counsel in connection with the assertion of the Company’s flash memory related patents against infringers (“Patent Enforcement Matters’).

 

Duane Morris has agreed to handle the Company’s Patent Enforcement Matters and certain related appeals on a contingent 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 or litigation recovery related to Patent Enforcement Matters, after recovery of expenses, and 50% of recovery if appeal is necessary.

 

In the event the Company is acquired or sold or elects to sell the covered patents or upon certain other corporate events or in the event the Company terminates 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. Any such corporate event or termination fee will only be recorded if and when such applicable event becomes probable. The Company has provided Duane Morris a lien and a security interest in the covered patents to secure its obligations under the agreement.

 

Contract Manufacturers and Suppliers

At March 31, 2012 the Company had outstanding unfilled purchase orders and was committed to a contract manufacturer and component suppliers for approximately $5,000 of future deliveries with such amounts generally subject to modification or rescheduling in the normal course of business.

 

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 $4,879.50 excluding utilities and costs. The aggregate payments adjust annually with maximum payments increasing to $7,156.60 in the forty-ninth through sixty-second months. Future lease commitments at March 31, 2012 total $368,080.

 

The facility lease for 4,800 square feet at 16770 West Bernardo Drive, San Diego, California, with one remaining monthly payment at March 31, 2012 of $6,534 excluding utilities and costs, terminated April 30, 2012.

 

12. SUBSEQUENT EVENTS

 

See subsequent event disclosure included in Note 11 related to the facility lease.

 

 

F-21

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