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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
Commission File Number 0-20734
e.Digital Corporation
(Exact name of registrant as specified in its charter)
Delaware 33-0865123
(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
13114 Evening Creek Drive South, San Diego, California 92128
- ------------------------------------------------------ -----
(Address of principal executive offices) (Zip Code)
(858) 679-1504
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES |_| NO|X|
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date:
Common Stock, par value $0.001 165,610,545
- ------------------------------ -------------------------------
(Class) (Outstanding at November 5, 2004)
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e.DIGITAL CORPORATION
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 2004 and
and March 31, 2004 3
Consolidated Statements of Operations for the three and six
months ended September 30, 2004 and 2003 4
Consolidated Statements of Cash Flows for the six
months ended September 30, 2004 and 2003 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure about Market Risk 22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Unregistered Sales of Equity Securities and use of Proceeds 22
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES 24
2
E.DIGITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, MARCH 31,
2004 2004
(Unaudited) (Audited)
$ $
--------------------------
ASSETS
CURRENT
Cash and cash equivalents 419,174 467,954
Accounts receivable, trade, less allowance of $118,087 and $174,255
for doubtful accounts, respectively 71,835 36,151
Inventory net of allowance for obsolete inventory of $0 and $4,600 respectively -- 5,009
Deposits and prepaid expenses 174,309 29,085
--------------------------
TOTAL CURRENT ASSETS 665,318 538,199
--------------------------
Property and equipment, net of accumulated depreciation of
$465,551 and $398,760, respectively 147,452 158,638
--------------------------
TOTAL ASSETS 812,770 696,837
==========================
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT
Accounts payable, trade 519,228 385,453
Other accounts payable and accrued liabilities 33,289 70,852
Accrued lease liability 515,000 515,002
Accrued employee benefits 120,018 185,737
Dividends 288,651 246,798
Deferred revenue 119,448 107,056
Customer deposit 217,874 --
Convertible subordinated promissory notes, less $174,139 and $0 for
amortization of warrants, respectively 825,861 --
Unsecured promissory notes, short term 946,875 123,405
--------------------------
TOTAL CURRENT LIABILITIES 3,586,244 1,634,303
--------------------------
Deferred revenue 40,773 69,387
Unsecured promissory note -- 767,220
--------------------------
TOTAL LIABILITIES 3,627,017 2,470,910
--------------------------
COMMITMENTS AND CONTINGENCIES
Stockholders' deficit
Preferred stock, $0.001 par value; 5,000,000 shares authorized
Series D Convertible Preferred stock 250,000 shares designated:140,000 and 145,000
issued and outstanding, respectively. Liquidation preference
of $1,696,333 and $1,670,883, respectively 1,400,000 1,450,000
Series E Convertible and Redeemable Preferred stock 15,000 shares designated:
700 and 8,768 issued and outstanding, respectively. Liquidation preference
of $74,978 and $902,715 respectively 55,250 862,050
Common stock, $0.001 par value, authorized 200,000,000,
164,885,301 and 160,527,868 shares outstanding, respectively 164,886 160,528
Additional paid-in capital 65,460,217 64,316,408
Dividends (288,651) (246,798)
Accumulated deficit (69,605,949) (68,316,261)
--------------------------
TOTAL STOCKHOLDERS' DEFICIT (2,814,246) (1,774,073)
--------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT 812,770 696,837
==========================
See notes to interim consolidated financial statements
3
E.DIGITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
$ $ $ $
-----------------------------------------------------------
Revenues:
Products 1,953,787 1,036,071 2,015,235 2,047,042
Services 74,697 61,844 106,413 204,864
-----------------------------------------------------------
2,028,485 1,097,915 2,121,648 2,251,906
-----------------------------------------------------------
COST OF REVENUES:
Products 1,613,831 893,729 1,631,556 1,863,701
Services 47,617 68,684 54,417 181,845
-----------------------------------------------------------
1,661,448 962,413 1,685,973 2,045,546
-----------------------------------------------------------
Gross profit (loss) 367,037 135,502 435,675 206,360
-----------------------------------------------------------
OPERATING EXPENSES:
Selling and administrative 398,675 385,101 744,916 764,527
Research and related expenditures 362,237 476,140 789,152 676,805
-----------------------------------------------------------
Total operating expenses 760,912 861,241 1,534,068 1,441,332
-----------------------------------------------------------
Operating loss (393,875) (725,739) (1,098,393) (1,234,972)
-----------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest expense (116,514) (28,273) (146,693) (63,438)
Loss on disposal of asset -- -- -- (36,714)
Other income (expenses) -- -- (1,800) --
-----------------------------------------------------------
Other income (expense) (116,514) (28,273) (148,493) (100,152)
-----------------------------------------------------------
NET LOSS (510,389) (754,012) (1,246,886) (1,335,124)
Accrued dividends on the Series D and E Preferred stock (37,198) (61,500) (84,655) (123,000)
-----------------------------------------------------------
LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS (547,587) (815,512) (1,331,541) (1,458,124)
===========================================================
LOSS PER COMMON SHARE - BASIC AND DILUTED (0.00) (0.01) (0.01) (0.01)
===========================================================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 164,386,736 154,882,753 163,250,768 151,993,493
===========================================================
See notes to interim consolidated financial statements
4
E.DIGITAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED
SEPTEMBER 30
2004 2003
OPERATING ACTIVITIES $ $
---------- ----------
Net Loss (1,246,886) (1,335,125)
Adjustments to reconcile loss to net cash used in operating activities:
Depreciation and amortization 23,641 51,341
Accrued interest and accretion relating to secured promissory notes 56,250 28,126
Amortization of interest on warrants issued in connection with the
12% convertible subordinated promissory notes 58,047 --
Stock issued to vendor 11,729 49,263
Loss on disposal of asset -- 36,713
Changes in assets and liabilities:
Accounts receivable, trade (35,684) 45,467
Inventory 5,009 113,696
Prepaid expenses and other (145,225) 18,663
Deferred contract charges -- 39,965
Accounts payable, trade 133,775 2,695
Other accounts payable and accrued liabilities (37,565) (90,389)
Customer deposit 217,874 --
Accrued employee benefits (65,719) (53,594)
Deferred revenue (16,222) 384,840
---------- ----------
Cash used in operating activities (1,040,975) (708,339)
---------- ----------
INVESTING ACTIVITIES
Purchase of property and equipment (12,455) (75,152)
Increase in restricted cash -- (190,000)
---------- ----------
Cash used in investing activities (12,455) (265,152)
---------- ----------
FINANCING ACTIVITIES
Proceeds from issuance of Shares -- 933,500
Proceeds from 12% Convertible Subordinated Promissory Notes 1,000,000 --
Proceeds from 24% Unsecured Note -- 69,300
Proceeds from 24% Unsecured Promissory Notes -- 200,000
Payment on 24% Unsecured Note -- (104,757)
Proceeds from exercise of stock options 4,650 122,025
Proceeds from exercise of warrants -- 50,000
------------------------
Cash provided by financing activities 1,004,650 1,270,068
------------------------
Net increase (decrease) in cash and cash equivalents (48,780) 296,577
---------- ----------
Cash and cash equivalents, beginning of period 467,954 83,906
---------- ----------
Cash and cash equivalents, end of period 419,174 380,483
========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH INFORMATION: Cash paid during the period for:
Interest 31,147 --
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Deemed dividends on Series D & E preferred stock 84,655 123,000
See notes to interim consolidated financial statements
5
E.DIGITAL CORPORATION AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2004
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
e.Digital Corporation, (the "Company") is incorporated under the laws of
Delaware. The Company offers engineering services, as well as complete reference
designs and technology platforms with a focus on digital video/audio and
player/recorders.
The accompanying unaudited interim consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiary of the same name, based
in San Diego, California. The unaudited interim consolidated financial
statements have been prepared, by management, in accordance with accounting
principles generally accepted in the United States for interim financial
information and in the opinion of management reflect all adjustments, which
consist of normal and recurring adjustments, necessary to present fairly the
financial position and results of operations and cash flows of the Company.
The Company has incurred significant losses and negative cash flow from
operations in each of the last three years and has an accumulated deficit of
$69,605,949 at September 30, 2004. At September 30, 2004, the Company had a
working capital deficiency of $2,920,926. Substantial portions of the losses are
attributable to marketing costs of the Company's new technologies and products
and substantial expenditures on research and development of technologies. The
Company's operating plans may require additional funds that may take the form of
debt or equity financings. There can be no assurance that any additional funds
will be available. The Company's ability to continue as a going concern is in
substantial doubt and is dependent upon achieving a profitable level of
operations and obtaining additional financing.
Management of the Company has undertaken steps as part of a plan to improve
operations with the goal of sustaining Company operations for the next twelve
months and beyond. These steps include (a) delivering digital products produced
under contract for customers (b) expanding sales and marketing to additional
customers and markets; (c) controlling overhead and expenses; and (d) raising
additional capital and/or financing. There can be no assurance the Company can
successfully accomplish these steps and it is uncertain the Company will achieve
a profitable level of operations in the future or without additional financing.
There can be no assurance that any additional financings, if required, will be
available to the Company on satisfactory terms and conditions, if at all. In the
event the Company fails to achieve profitable operations and is unable to
continue as a going concern, it may elect or be required to seek protection from
its creditors by filing a voluntary petition in bankruptcy or may be subject to
an involuntary petition in bankruptcy. To date, management has not considered
this alternative, nor does management view it as a likely occurrence.
These consolidated financial statements do not give effect to any adjustments
which would be necessary should the Company be unable to continue as a going
concern and therefore be required to realize its assets and discharge its
liabilities in other than the normal course of business and at amounts different
from those reflected in the accompanying consolidated financial statements.
2. LOSS PER SHARE
The Company's losses for the periods presented cause the inclusion of potential
common stock ("Common Stock") instruments outstanding to be antidilutive and,
therefore, the Company is not required to present a diluted loss per common
share. Stock options, warrants and convertible preferred stock exercisable into
19,740,553 shares of Common Stock were outstanding as at September 30, 2004.
These securities were not included in the computation of diluted loss per share
because they are antidilutive, but they could potentially dilute earnings per
share in future periods.
The loss available to Common Stockholders was increased during the three and six
months ended September 30, 2004 by accrued dividends of $37,198 and $84,655,
respectively. The loss available to Common Stockholders is computed as follows:
6
E.DIGITAL CORPORATION AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2004
For the three months ended For the six months ended
September 30, September 30,
2004 2003 2004 2003
--------------------------------------------------------------
Net Loss
$ (510,389) $ (754,012) $(1,246,886) $(1,335,124)
Dividends on Series D and E preferred
stock (37,198) (61,500) (84,655) (123,000)
--------------------------------------------------------------
Loss available to common stockholders $ (547,587) $ (815,512) $(1,331,541) $(1,458,124)
--------------------------------------------------------------
3. STOCK BASED COMPENSATION
The Company has a stock-based employee and non-employee compensation plan. The
Company accounts for stock-based employee and non-employee compensation
arrangements using the intrinsic value method in accordance with the provisions
of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25") and complies with the disclosure provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Under APB No. 25, compensation expense is based
on the difference, if any, on the date of the grant, between the fair value of
the Company's stock and the exercise price. The Company accounts for stock
issued to non-employees in accordance with the provisions of SFAS No. 123 and
Emerging Issues Task Force No. 96-18 "Accounting for Equity Instruments with
Variable Terms That Are Issued for Consideration Other Than Employee Services
Under FASB Statement No. 123."
The fair value of options, used as a basis for the above pro forma disclosures,
was estimated at the date of grant using the Black-Scholes option-pricing model.
The option pricing assumptions include a dividend yield of 0% expected
volatility of 0.70 a risk free interest rate of 2.86% and an expected life of
2.5 years. The following table summarizes the weighted average fair value of the
stock options granted during the periods:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Net loss as reported $ (510,389) $ (754,012) $(1,246,886) $(1,335,124)
Add: Total stock-based employee compensation recorded -- -- -- --
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all
awards 63,853 -- 132,220 278,574
----------- ----------- ----------- -----------
Pro forma net loss $ (574,242) $ (754,012) $(1,379,106) $(1,613,698)
----------- ----------- ----------- -----------
Earnings per share:
Basic and Diluted - as reported $ (0.00) $ (0.01)$ (0.01) $ (0.01)
Basic and Diluted - pro forma $ (0.00) $ (0.01)$ (0.01) $ (0.01)
4. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS No. 149 amends and clarifies accounting and reporting for
derivative instruments and hedging activities under SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective
for derivative instruments and hedging activities entered into or modified after
June 30, 2003, except for certain forward purchase and sale securities. For
these forward purchase and sale securities, SFAS No. 149 is effective for both
new and existing securities after June 30, 2003. Management does not expect
adoption of SFAS No. 149 to have a material impact on the Company's statements
of earnings, financial position, or cash flows.
In December 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities," an interpretation of Accounting Research Bulletin
No. 51, "Consolidated Financial Statements." This pronouncement requires the
consolidation of variable interest entities, as defined, and is effective
immediately for variable interest entities created after January 31, 2003, and
for variable interest entities in which an enterprise obtains an interest after
that date. The Company does not have any variable interest entities, and
therefore, this interpretation is not expected to have a material impact on the
Company's financial statements.
7
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. SFAS No. 150 will be effective for financial instruments entered
into or modified after May 31, 2003 and otherwise will be effective at the
beginning of the first interim period beginning after June 15, 2003. Management
does not expect adoption of SFAS No. 150 to have a material impact on the
Company's statements of earnings, financial position, or cash flows.
5. PROMISSORY NOTES
September 20, 2004 March 31, 2004
- --------------------------------------------------------------------------------
15% Unsecured Promissory Note $ 750,000 $ 750,000
12% Convertible Subordinated
Promissory Note 1,000,000
Accrued interest on notes 196,875 140,625
Less amortization of warrants (174,139) --
Less current portion (1,772,736) (123,405)
- --------------------------------------------------------------------------------
Long term $ -- $ 767,220
- --------------------------------------------------------------------------------
15% Unsecured Promissory Note On December 11, 2002, the Company issued a 15%
Unsecured Promissory Note ("15% Unsecured Note") for gross cash proceeds of
$750,000 to an individual. The 15% Unsecured Note, under the original term, was
scheduled to mature on February 11, 2004 and payable $50,000 each month, with a
final payment of $35,801 on February 11, 2004. The Company entered into a
forbearance agreement with the investor through and including December 31, 2002.
On December 30, 2002, the Company issued 133,223 shares of Common Stock in
consideration for all accrued and unpaid interest of $196,875. On December 23,
2002, the holder of the 15% Unsecured Note agreed to (i) extend the maturity
date of the 15% Unsecured Note from February 11, 2004 to May 31, 2005; (ii)
reduce the monthly payments from $50,000 to $7,500 through December 31, 2003,
representing the monthly interest on the 15% Unsecured Note and (iii) $50,000
payments each month, beginning January 31, 2004. On January 14, 2004, the holder
of the 15% Unsecured Note agreed to postpone principal and interest payments on
the note until December 31, 2004.
12% Convertible Subordinated Promissory Notes
On July 2, 2004, the Company closed a $1,000,000 offering of Unsecured 12%
Convertible Subordinated Promissory Notes due July 1, 2005 ("12% CSP Notes").
The 12% CSP Notes were sold in two phases, with $660,000 of the 12% CSP Notes
being issued and sold on June 25, 2004 and the remaining $340,000 of 12% SP
Notes being issued and sold on July 2, 2004. In total, the Company received
aggregate cash proceeds of $1,000,000 from the sale of the 12% CSP Notes. The
purchasers, in connection therewith, were granted warrants to purchase 2,000,000
shares of Common Stock at an exercise price of $0.25 per share, exercisable
until June 30, 2007 (collectively, the "Warrants"). In the event the Company
shall offer shares of its capital stock the Noteholder shall have the right and
option, at any time prior to the maturity date, subject to and upon compliance
with the provisions hereof and the terms and provisions of the equity offering
documents to convert the unpaid principal amount of the note, the prepayment
fee, if any, and any accrued and unpaid interest into shares of capital stock
being offered. The conversion price shall be equal to the offering price of the
capital stock in effect at the time of conversion.
6. STOCKHOLDERS' EQUITY
The following table summarizes stockholders' equity transactions during the
six-month period ended September 30, 2004:
Additional Preferred Accumulated
paid-in
Shares Amount Capital Dividends stock deficit
- -------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2004 160,527,868 $160,528 $64,316,408 $(246,798) $2,312,050$(68,316,261)
Shares issued upon exercise of stock options 30,000 30 4,620 - - -
Shares sold by vendor from prior year
issuance - - 11,729 - - -
8
Additional Preferred Accumulated
paid-in
Shares Amount Capital Dividends stock deficit
- -------------------------------------------------------------------------------------------------------------------------
Value assigned to warrants issued in
connection with
12% Convertible Subordinated Promissory
Note - - 232,186 - - -
Shares issued for conversion of E 4,016,178 4,017 836,452 33,669 (806,800) (33,669)
Shares issued for conversion of D 311,255 311 58,822 9,133 (50,000) (9,133)
Dividends on Series D & E Preferred stock - - - (84,655) - -
Loss for the Period - - - - - (1,246,886)
- -------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 2004 164,885,301 $164,886 $65,460,217 $(288,651) $1,455,250$(69,605,949)
- -------------------------------------------------------------------------------------------------------------------------
7. WARRANTS AND OPTIONS
At September 30, 2004 warrants were outstanding and exercisable into the
following shares of Common Stock:
Number of Exercise Price
Description Common Shares Per Share $ Expiration Date
- ---------------------------------------------------------------------------------------------------------------------------
Warrant(1) 46,189 0.19 October 5, 2005
Warrant 856,166 1.00 November 18, 2005
Warrant(1) 550,000 0.19 September 30,2006
Warrant(2) 2,000,000 0.25 June 30, 2007
- ---------------------------------------------------------------------------------------------------------------------------
Total 3,452,355
- ---------------------------------------------------------------------------------------------------------------------------
(1) The Warrants are subject to certain adjustments if the Company
issues shares lower than $0.19.
(2) In connection with the issuance of 12% CSP Notes the Company issued
2,000,000 warrants with an exercise price of $0.25. The estimated
fair market value of these warrants at issuance was $232,186 and has
been recorded as a deferred financing charge related to the 12% SP
Notes as a cost of issuing the warrants charged to Additional Paid
in Capital. The deferred financing charge is being amortized over
the term of the 12% CSP Notes.
Subsequent to September 30, 2004, 87,500 warrants were exercised using the net
issuance provision into 44,872 shares of Common Stock.
The following table summarizes stock option activity for the period:
Weighted average
Shares exercise price
# $
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding March 31, 2004 4,141,665 0.7993
Granted 3,380,000 0.2250
Canceled/expired (438,332) 2.5269
Exercised (30,000) 0.2250
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding September 30, 2004 7,053,333 0.3262
- ---------------------------------------------------------------------------------------------------------------------------
Exercisable at September 30, 2004 3,710,158 0.5933
- ---------------------------------------------------------------------------------------------------------------------------
Options outstanding are exercisable at prices ranging from $0.0875 to $2.6875
and expire over the period from 2004 to 2009 with an average life of 3.58 years.
The 1994 stock option plan expired on August 15, 2004. A new employee stock
option plan will be presented to the shareholders for approval at the next
company annual shareholders meeting.
8. PREFERRED STOCK
Convertible Non-Redeemable Series D
On December 30, 2002, the Company issued 205,000 shares of 12% Series D
non-redeemable convertible preferred stock (the "Series D Stock") with a stated
value of $10 per share. The Series D Stock was issued pursuant to a conversion
agreement with all of the noteholders of the Company's $1,000,000 Subordinated
Promissory Notes and $1,050,000 Unsecured Notes. Dividends of 12% per annum are
payable, with certain exceptions, either in cash or in shares of Common Stock at
the Company's election. The conversion price for each share of Series D Stock is
$0.19 subject to certain adjustments if the Company issues shares at prices
lower than $0.19. As of September 30, 2004 the 140,000 shares of the Series D
Stock would have been convertible into 8,928,070 shares Common Stock. The Series
D stock shall be subject to automatic conversion on December 31, 2007.
Subsequent to September 30, 2004, 5,000 Series D stock has been converted into
321,404 shares of Common Stock.
9
Convertible Redeemable Series E
On November 19, 2003, the Company issued 12,770 shares of 8% Series E
Convertible Redeemable Preferred Stock (the "Series E Stock") with a stated
value of $100 per share. Dividends of 8% per annum are payable, with certain
exceptions, either in cash or in shares of Common Stock at the election of the
Company. The stated dollar amount of Series E Stock, is convertible into fully
paid and nonassessable shares of Common Stock at a conversion price $0.45 per
share which was fixed for the first 90 days following the original issue date,
and commencing 90 days following the original issue date, the conversion price
was equal to the lower of (i) $0.45 and (ii) 85% of the average of the volume
weighted average price per share during the ten consecutive trading days
immediately preceding the conversion date. The Series E Stock shall be subject
to automatic conversion on November 19, 2005 subject to certain conditions. As
of September 30, 2004 the 700 shares of the Series E stock would have been
convertible into 394,295 shares Common Stock. Subsequent to September 30, 2004,
700 Series E stock has been converted into 358,968 shares of Common Stock.
The Series E Stock is redeemable in certain instances at the Company's option of
certain triggering events including, without limitations, a lapse of a
registration statement for ten non-consecutive trading days and certain other
events. The redemption price upon such election following a triggering event is
the greater of (a) 110% of the stated value or (b) the product of the number of
preferred shares multiplied by the closing market price multiplied by the stated
value per share divided by the then conversion price per share.
9. INVENTORY
Inventory is recorded at the lower of cost and net realizable value. Cost is
determined on a first-in, first out basis. Effectively on July 1, 2004, the
Company had ceased providing customer support, accessories or repairs for its
discontinued line of consumer products. The Company has written off all
remaining accessories for its branded products in inventory.
September 30, 2004 March 31, 2004
$ $
- -------------------------------------------------------------------------------------------------------------------------
Finished goods -- --
Raw materials -- $9,609
- -------------------------------------------------------------------------------------------------------------------------
Reserve obsolete -- 4,600
- -------------------------------------------------------------------------------------------------------------------------
-- $5,009
- -------------------------------------------------------------------------------------------------------------------------
10. COMMITMENTS AND CONTINGENCIES
The Company relies on Asian contract manufacturing partners for the manufacture
of its products. The Company depends on this and other contract manufacturers to
(i) allocate sufficient capacity to the Company's manufacturing needs, (ii)
produce acceptable quality products at agreed pricing and (iii) deliver on a
timely basis. If a manufacturer is unable to satisfy these requirements, the
Company's business, financial condition and operating results may be materially
and adversely affected. Any failure in performance by this manufacturer for any
reason could have a material adverse affect on the Company's business.
Production and pricing by each such manufacturer is subject to the risk of price
fluctuations and periodic shortages of components. The Company does not have
supply agreements with component suppliers and, accordingly, it is dependent on
the future ability of its manufacturers to purchase components. Failure or delay
by suppliers in supplying necessary components could adversely affect the
Company's ability to deliver products on a timely and competitive basis in the
future.
Approximately $515,000 of the accrued lease liability arose in the normal course
of business for equipment delivered to the Company and was recorded at amounts
reflected on the invoices and other documentation received from the third party
vendor. This amount is approximately eight years old. The amount owing to the
vendor may still be due but as the Company has had no contact with the vendor,
the amount may not require payment. Accordingly, the accrued lease liability
reflects management's best estimate of amounts due for matters in dispute.
Settlement of this liability may be either more or less than the amount recorded
in the consolidated financial statements and accordingly may be subject to
measurement uncertainty in the near term.
10
In September 2000, we entered into a three-year sublease agreement which expired
on July 31, 2003. From the date of expiration until December 2003, the Company
leased the property on a month-to-month basis. On January 1, 2004, the Company
amended the lease for approximately 7,750 square feet with an aggregate monthly
payment of $9,291 inclusive of utilities and costs expiring on July 31, 2006.
11. CREDIT RISK
Amounts owing from one customer comprise 98% of accounts receivable at September
30, 2004. Amounts owing from two major customers comprise approximately 69% and
23%, respectively of accounts receivable at March 31, 2004.
12. MAJOR CUSTOMERS AND SUPPLIERS
The Company operates in one major line of business, the development, manufacture
and marketing of electronic products. Sales to one customer comprised 97% of
revenue for the six months ended September 30, 3004. Sales to two major
customers comprise 72% of revenue for the six months ended September 30, 2003.
13. COMPARATIVE FIGURES
Certain of the comparative figures have been restated to conform with the
current period's presentation.
14. INCOME TAX
The Company has U.S. federal net operating loss carryforwards available at March
31, 2004 of approximately $51,000,000 which will begin to expire in 2006. The
Company has state net operating loss carryforwards of $16,000,000 which will
expire beginning in 2004. The difference between federal and state net operating
loss carryforwards is due to the 50% limitation of California loss carryforwards
and to expiring California carryforwards.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE
COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW AND UNDER THE SUB-HEADING,
"BUSINESS RISKS." SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED MARCH 31, 2004.
General
e.Digital Corporation is a holding company that operates through a wholly-owned
California subsidiary of the same name and is incorporated under the laws of
Delaware. The Company offers engineering services, as well as complete reference
designs and technology platforms with a focus on digital video and
player/recorders.
We offer our engineering services and technologies to business customers with a
focus on developing digital video, music, and voice players/recorders with
potential wireless capabilities using the latest in digital storage media (a
device used to store data) and technology. Our business customers license or
purchase our products or our technology to embed in their own products. We offer
complete reference designs (working, full-featured designs sometimes implemented
as prototypes that can be customized to a customers' preferred look and feel or
branded and sold as they are, according to the customer's wishes) and technology
platforms (basic working technology that can be developed into a finished
consumer product, or incorporated into an existing consumer product design) for
private labeling. We may sometimes integrate our unique or proprietary features
and/or technology into new products for their product lines. We focus our
marketing efforts on business customers in various digital processing markets
including digital image and video/audio and other electronic product markets.
We have relationships with manufacturers with facilities in the United States,
China and Korea. We have expertise in developing, performing and overseeing
manufacturing processes. We apply our technology and expertise in providing
manufacturing supervision, documentation, and quality control services to
products for our business customers.
Services offered include custom hardware, firmware (an instruction set
programmed into a chip which determines the product's functionality and user
interface), software development, technology platform development, product
design, manufacturing services, fulfillment services, warranty services, and
licensing of our patented file management systems. Our revenues may result from
the sale of products, product royalties, fees from engineering services,
industrial order fulfillment, technical support services, warranty services
and/or design services. In some cases, we rely on outside subcontractors to
perform services including manufacturing, testing and certification, industrial
design, and assembly.
We incurred operating losses in each of the last three fiscal years and these
losses have been material. We incurred operating losses of $3.5 million, $6.7
million and $5.8 million in fiscal year 2004, 2003 and 2002, respectively. At
September 30, 2004, we had a working capital deficit of $2.9 million. Our
current monthly operating costs level is approximately $215,000 per month.
However, we may increase expenditure levels in future periods to support and
expand our revenue opportunities and continue advanced product and technology
research and development. Accordingly, our losses are expected to continue until
such time as we are able to realize supply, licensing, royalty, sales, and
development revenues sufficient to cover the fixed costs of operations. We
continue to be subject to the risks normally associated with any new business
activity, including unforeseeable expenses, delays and complications.
Accordingly, there is no guarantee that we can or will report operating profits
in the future.
Since March 31, 2003, we have experienced substantial reduction in cash,
projected revenues and increased costs that adversely affect our current results
of operations and liquidity. Our operating plans require additional funds which
may take the form of debt or equity financings. There can be no assurance that
any additional funds will be available to our company on satisfactory terms and
conditions, if at all. Our Company's ability to continue as a going concern is
in substantial doubt and is dependent upon achieving a profitable level of
operations and, if necessary, obtaining additional financing.
Management of our Company has undertaken steps as part of a plan to improve
operations with the goal of sustaining our operations for the next twelve months
and beyond. These steps include (a) delivering digital products produced under
contract; (b) expanding sales and marketing to additional customers and markets;
(c) controlling overhead and expenses; and (d) raising additional capital and/or
financing. There can be no assurance the Company can successfully accomplish
these steps and it is uncertain the Company will achieve a profitable level of
operations in the future or without additional financing.
12
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to product returns, bad debts, inventory valuation, intangible assets,
financing operations, warranty obligations, estimated costs to complete research
contracts and contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
We recognize license revenue and product revenue upon shipment of a product to
the customer, FOB destination or FOB shipping point depending on the specific
contract term, if a signed contract exists, the fee is fixed and determinable,
collection of resulting receivables is probable and there are no resulting
obligations. With most of our consumer electronics retailers, we do not meet the
criteria for revenue recognition upon shipment and therefore only recognize the
revenue as the product is sold through our customer to the ultimate end-user.
Research and development contract revenues on short-term projects or service
revenue is recognized once the services or product has been delivered, the fee
is fixed and determinable, collection of the resulting receivable is probable
and there are no resulting obligations. If all of the service or product has
been delivered and there is one element that is perfunctory to the services or
product that has not been delivered, revenue will be recognized evenly over the
remaining term of the undelivered element. Research and development contract
revenue on long-term projects is recognized on the percentage of completion
method. Funds received in advance of meeting the criteria for revenue
recognition are deferred and are recorded as revenue as they are earned. If the
costs we incur on a contract are expected to exceed the anticipated revenue we
will record the loss in the period in which the facts that give rise to the
revision becomes known.
We record estimated reductions to revenue for anticipated product returns,
discounts offered to our customers and volume-based incentives. If market
conditions were to decline, we may take actions to increase the discounts
offered for future sales which will result in an incremental reduction of
revenue at the time the discounts are offered.
We maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
We have provided for a full valuation reserve related to our substantial
deferred tax assets. In the future, if sufficient evidence of our ability to
generate sufficient future taxable income in certain tax jurisdictions becomes
apparent, we may be required to reduce our valuation allowances, resulting in
income tax benefits in our consolidated statement of operations. We evaluate the
realizability of the deferred tax assets and assess the need for valuation
allowance quarterly. The utilization of the net operating loss carryforwards
could be substantially limited due to restrictions imposed under federal and
state laws upon a change in ownership.
Under our bylaws, we have agreed to indemnify our officers and directors for
certain events. We also enter into certain indemnification agreements in the
normal course of our business. The Company has no liabilities recorded for such
indemnities.
We do not have off-balance sheet arrangements, financings, or relationships with
unconsolidated entities or other persons, also known as "special purposes
entities" (SPEs).
13
Results of Operations
Six months ended September 30, 2004 compared to six months ended September 30,
2003
For the first six months ended September 30, 2004, we reported total revenues of
$2,121,648, a 6% decrease from total revenues of $2,251,906 for the first six
months of fiscal 2003. Product revenues for six months ending September 30, 2004
were $2,015,235, a 2% decrease from product revenues of $2,047,042 for the six
months ending September 30, 2003. We have received product purchase orders for
approximately $2.2 million, which is expected to ship in the third quarter of
fiscal 2005.
Service revenues for the first six months of fiscal 2004 were $106,413 compared
to $204,864 for the comparable period of the prior year. The timing and amount
of service revenues are dependent upon a limited number of projects. At
September 30, 2004 we had $160,221 of deferred revenue from development
contracts, which will be recognized based on the terms and conditions of each
agreement. We are increasing our focus on internally developed technology to be
offered to our customers in order to speed adoption of our technology and
enhance our future revenues.
For the six months ended September 30, 2004, we reported a gross profit of
$435,675 compared to a gross profit of $206,360 for the first six months of
fiscal 2003. Cost of sales for the six months ended September 30, 2004 consisted
of $1,631,556 of product costs and $54,417 of service costs, consisting mostly
of research and development labor being funded in part by our service
development agreements. Although we do not anticipate any significant future
contract losses, we cannot guarantee that we can maintain positive gross margins
in the future or with future customers. Gross profit as a percentage of revenue
increased from 9% to 21%, due primarily to the recurring orders of the in-flight
entertainment product line which provides for a higher margin than the prior
year's fulfillment of an order for Softeq. At the present time, warranty costs
are not significant.
Total operating expenses (consisting of research and related expenditures and
selling and administrative expenses) for the six months ended September 30, 2004
were $1,534,068, as compared to $1,441,332 for the six months ended September
30, 2003. Selling and administrative costs aggregated $744,916 for the first six
months of fiscal 2005 compared to $764,527 in the prior period. The $19,611
decrease in selling and administrative costs resulted primarily from a decrease
of $40,987 in depreciation and amortization expense and a decrease of $52,363 in
rent and other related costs offset by an increase of $81,112 in legal fees in
connection with the pending Eclipse arbitration. We anticipate quarterly selling
and administrative expenses to be constant as we are focused more on OEM
opportunities and de-emphasize selling and marketing our branded products.
Research and related expenditures for the six months ended September 30, 2004
were $789,152, as compared to $676,805, for the six months ended September 30,
2003. The $112,347 increase in research and development costs resulted from an
increase of $32,533 for consulting and other related services, an increase of
$65,691for engineering supplies and materials for pre-production and demo
prototypes and an increase of $8,112 for personnel and related costs. Research
and development costs are subject to significant quarterly variations depending
on the use of outside services, the assignment of engineers to development
projects and the availability of financial resources.
We reported an operating loss of $1,098,393 for the six months ended September
30, 2004 as compared to an operating loss of $1,234,972 for the six months ended
September 30, 2003. The decrease in operating loss consisted of the gross profit
for the six-month period offset by the increase of $92,736 in operating
expenses. We believe, but we cannot guarantee, that our strategy of investing in
digital video/audio platform developments with supply or royalty provisions will
provide positive margins in future periods. The timing and amount of product
sales and the recognition of contract service revenues impact our operating
losses. Accordingly, there is uncertainty about future operating results and the
results for the three months are not necessarily indicative of operating results
for future periods or the fiscal year.
We reported a loss for the first six months of the current fiscal year of
$1,246,886 as compared to a loss of $1,335,124 for the prior year's first six
months. For the six months ended September 30, 2004, we incurred interest
expense of $146,693 as compared to $63,438 for the comparable period in the
prior year.
The loss available to common stockholders for the six months ended September 30,
2004 and 2003 is $1,331,541 and $1,458,124, respectively. Included in the loss
available to common stockholders for the six months ending September 30, 2004
and 2003 is accrued dividends of $84,655 and $123,000, respectively on the
Series D and E stock.
14
Three months ended September 30, 2004 compared to three months ended September
30, 2003
For the three months ended September 30, 2004, we reported total revenues of
$2,028,485, an 85% increase from total revenues of $1,097,915 for the comparable
three-month period of fiscal 2003. Product revenues for the quarter ending
September 30, 2004 were $1,953,787, an 89% increase from product revenues of
$1,036,071 for the quarter ending September 30, 2003. The $917,716 increase in
product revenues resulted primarily from repeat orders of the in-flight
entertainment product line.
Service revenues for the three months ended September 30, 2004 were $74,697
compared to $61,844 for the comparable period of the prior year. The timing and
amount of service revenues is dependent upon a limited number of projects. At
September 30, 2004 we had $160,221 of deferred revenue from development
contracts that will be recognized based on the terms and conditions of each
agreement.
For the three months ended September 30, 2004, we reported a gross profit of
$367,037 compared to a gross profit of $135,502 for the three months of fiscal
2004. Cost of sales for the three months ended September 30, 2004 consisted of
$1,613,831 of product costs and $47,617 of service costs, consisting mostly of
research and development labor funded in part by OEM development agreements.
Although we do not anticipate any significant future contract losses, we cannot
guarantee that we can maintain positive gross margins in the future or with
future customers. Gross profit as a percentage of revenue improved from 12% to
18%. In addition, in the quarter ended September 30, 2003, we incurred the
write-down of inventory by $355,508 related to slow moving and obsolete products
and certain APL Direct Logistics' costs.
Total operating expenses (consisting of research and related expenditures and
selling and administrative expenses) for the three months ended September 30,
2004, were $760,912, as compared to $861,241 for the three months ended
September 30, 2003. Selling and administrative costs aggregated $398,675 for the
three months of fiscal 2004 compared to $385,101 in the prior period. The
$13,574 increase in selling and administrative costs resulted primarily from the
following: a decrease of $21,118 in depreciation and amortization expense, an
decrease of $26,191 in bad debt expense and a $25,702 decrease in rent, a
$12,620 decrease for insurances and taxes, and a $11,681 decrease for
professional services offset by an increase of $68,597 in legal expense in
relation to the arbitration and an increase of $47,539 in personnel and related
costs due to an increase in health and other related insurance premiums.
Research and related expenditures for the three months ended September 30, 2004
were $362,237, as compared to $476,140 for the three months ended September 30,
2003. The decrease of $113,903 in Research and Development costs resulted from
the manner in which the company was allocating its engineering labor to cost of
goods for customer contracts that are now being recognized on a percentage of
completion basis. Research and development costs are subject to significant
quarterly variations depending on the use of outside services, the assignment of
engineers to development projects, reimbursement by customer contracts and the
availability of financial resources.
We reported an operating loss of $393,875 for the three months ended September
30, 2004, as compared to an operating loss of $725,739 for the three months
ended September 30, 2003. The decrease in operating loss resulted primarily from
the gross profit for the three months ended September 30, 2004 as well as a
decrease of $100,329 in operating expenses. We believe, but we cannot guarantee,
that our strategy of investing in our video/audio technology platform
developments with supply or royalty provisions. The timing and amount of product
sales and the recognition of contract service revenues impact our operating
losses. Accordingly, there is uncertainty about future operating results and the
results for the three months are not necessarily indicative of operating results
for future periods or the fiscal year.
We reported an increase in interest expense of $116,514 for the three months
ended September 30, 2004 versus $28,273 and the comparable period of 2004 due to
the issuance on or about July 2, 2004, of the 12% SP Notes and amortization of
the warrants.
We reported a loss on disposal of assets of $36,713 for the three months ended
September 30, 2003 due to the shutdown of our wedig.com music site.
15
We reported a loss for the three months of the current fiscal year of $510,389
as compared to a loss of $754,012 for the prior year's three months.
The loss attributable to common stockholders for the three months ended
September 30, 2004 and 2003 was $547,587 and $815,512, respectively. Included in
the loss available to common stockholders for the period ending September 30,
2004 were accrued dividends of $28,273 on the Series D and E stock issued.
Liquidity and Capital Resources
At September 30, 2004, we had working capital deficit of $2,920,926 compared to
a working capital deficit of $1,096,104 at March 31, 2004. We had $nil of
working capital invested in inventory at September 30, 2004. Cash used in
operating activities for the six month period ended September 30, 2004 was
$1,040,975 resulting primarily from the $1,246,886 loss for the period, a
decrease of $16,222 in deferred revenue, a decrease of $37,565 in other accounts
payable and accrued liabilities offset by an increase of $133,775 in accounts
payable, an increase of $145,225 in prepaid expenses and other, an increase of
$217,874 in customer deposits and an increase of $35,684 in accounts receivable.
During the six months ended September 30, 2004, the Company purchased $12,455 in
property and equipment. For the six months ended September 30, 2004, cash
provided by financing activities was $1,004,650 resulting primarily from
$1,000,000 proceeds from issuance of the 12% Convertible Subordinated Promissory
Notes. For the six months ended September 30, 2004, net cash and cash
equivalents decreased by $48,780.
At September 30, 2004, we had net accounts receivable of $71,835 as compared to
$36,151 at March 31, 2004. This represented approximately 30 days of revenues.
Receivables can vary dramatically due to the timing of product shipments and
contract arrangements on development agreements.
On July 2, 2004, the Company closed a $1,000,000 offering of Unsecured 12%
Convertible Subordinated Promissory Notes due July 1, 2005 and the Company
received aggregate cash proceeds of $1,000,000.
At September 30, 2004, we had cash and cash equivalents of $419,174. Other than
cash and cash equivalents and accounts receivable, we have no material unused
sources of liquidity at this time. We have no material commitments for capital
expenditures or resources. Based on our cash position assuming (a) continuation
of existing business customer arrangements, and (b) currently planned
expenditures and level of operation, we believe we will require approximately
$1,500,000 of additional funds for the next twelve months of operations plus
amounts required to make payments on the 15% Unsecured Note in the approximate
amount of $946,875 and 12% CSP notes for $1,000,000. However, actual results
could differ significantly from management plans. We believe we may be able to
obtain additional funds from future product margins from business customer
product sales but actual future margins to be realized, if any, and the timing
of shipments and the amount and quantities of shipments, orders and reorders are
subject to many factors and risks, many outside our control. We have a
forbearance agreement on the $750,000 principal and accrued interest on the 15%
Unsecured Note and the timing and schedule of amounts due thereafter are not
currently known. Accordingly we may need to seek equity or debt financing in the
next twelve months for working capital if product margins are insufficient and
we may need to seek equity or debt financing for payments of the 15% Unsecured
Note (or renegotiate terms thereon) and other obligations reflected on our
balance sheet.
There can be no guarantee that we will be able to raise additional equity or
debt financing, if required, and/or renegotiate the terms of debts as they
arise. We may also require additional capital to finance future developments and
improvements to our technologies or develop new technologies.
Should additional funds not be available, we may be required to curtail or scale
back staffing or operations. Failure to obtain additional financings will have a
material adverse affect on our company. Potential sources of such funds include
exercise of outstanding warrants and options, or debt financing or additional
equity offerings. However, there is no guarantee that warrants and options will
be exercised or that debt or equity financing will be available when needed. Any
future financing may be dilutive to existing stockholders.
Future Commitments and Financial Resources
We have an accrued lease liability of $515,000 that arose in the normal course
of business for equipment delivered to the Company. This amount is approximately
eight years old. The accrued lease liability reflects management's best estimate
of amounts due for matters in dispute. Settlement of this liability may either
be more or less than the amount recorded in the audited consolidated financial
statements and accordingly may be subject to measurement uncertainty in the near
term.
16
In the future, if our operations increase significantly, we may require
additional funds. We also may require additional capital to finance future
developments, acquisitions or expansion of facilities. We currently have no
plans, arrangements or understandings regarding any acquisitions.
In September 2000, we entered into a three-year sublease agreement, which
expired on July 31, 2003. From the date of expiration until December 2003, the
Company leased the property on a month-to-month basis. On January 1, 2004, the
Company amended the lease for approximately 7,750 square feet with an aggregate
monthly payment of $9,291 inclusive of utilities and costs expiring on July 31,
2006.
Certain Factors That May Affect Our Business, Future Results and Financial
Condition In addition to the other information in this Form 10-Q, the factors
listed below should be considered in evaluating our business and prospects. This
Form 10-Q 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. We have incurred
significant operating losses in prior fiscal years and at September 30, 2004 had
an accumulated deficit of $69.6 million. We had losses of approximately $3.5
million, $6.7 million and $5.8 million in fiscal 2004, 2003 and 2002,
respectively. To date, we have not achieved profitability and given the level of
operating expenditures and the uncertainty of revenues and margins, we will
continue to incur losses and negative cash flows in future periods. The failure
to obtain sufficient revenues and margins to support operating expenses could
harm our business.
We do not Anticipate Paying Dividends. We have never paid any cash dividends on
our Common Stock and do not anticipate paying any cash dividends in the
foreseeable future. We currently intend to retain any future earnings to fund
the development and growth of our business. An investment in our Common Stock,
therefore, may be more suitable for an investor that is seeking capital
appreciation rather than current yield and, as a consequence, may be more
speculative. Accordingly, investors should not purchase our Common Stock with an
expectation of receiving regular dividends.
We Expect Our Operating Results To Fluctuate Significantly - Our quarterly and
annual operating results have fluctuated significantly in the past and we expect
that they will continue to fluctuate in the future. This fluctuation is a result
of a variety of factors, including the following:
o Unpredictable demand and pricing for our contract development
services
o Market acceptance of our business customers' products by end users
o Uncertainties with respect to future customer product orders, their
timing and the margins to be received, if any
o Fluctuations in operating costs
o Changes in research and development costs
o Changes in general economic conditions
o Changes in technology
o Short product lifecycles
We May Experience Product Delays, Cost Overruns and Errors Which Could Adversely
Affect our Operating Performance and Ability to Remain Competitive. We have
experienced development delays and cost overruns associated with contract
development services in the past. We may experience additional delays and cost
overruns on current projects or future projects. Future delays and cost overruns
could adversely affect our financial results and could affect our ability to
respond to technological changes, evolving industry standards, competitive
developments or customer requirements. Our technology, the results of our
contract services and the products produced for business customers could contain
errors that could cause delays, order cancellations, contract terminations,
adverse publicity, reduced market acceptance of products, or lawsuits by our
customers or others who have acquired our products, including customer's
products.
17
We May Need to Obtain Additional Financing to Continue Operating our Business.
We believe that with cash on hand and proceeds from existing development and
production contracts and product sales, we have sufficient proceeds to meet cash
requirements for the next six months. However, we may need to raise additional
funds to:
o Finance unanticipated working capital requirements
o Pay for increased operating expenses or shortfalls in anticipated
revenues
o Fund increases in research and development costs
o Develop new technology, products or services
o Respond to competitive pressures
o Support strategic and industry relationships
o Fund the marketing of our products and services
In the event additional funds are required, we cannot assure you that such
additional financing will be available on terms favorable to us, or at all. If
adequate funds are not available to us then we may not be able to continue
operations or take advantage of opportunities. If we raise additional funds
through the sale of equity, the sale of Common Stock hereunder, the percentage
ownership of our stockholders will be reduced.
Unless We Obtain Adequate Financing and Increase Our Revenues We May Be Unable
to Continue as a Going Concern. We have experienced substantial reduction is
cash, projected revenues and increased costs that adversely affected our results
of operations and cash flows. Our Company has suffered recurring losses from
operations. This factor, in combination with (i) reliance upon debt and new
equity financing to fund the continuing, losses from operations and cash flow
deficits, (ii) material net losses and cash flow deficits from operations during
fiscal 2004, fiscal 2003 and prior years and (iii) the possibility that we may
be unable to meet our debts as they come due, raise substantial doubt about our
ability to continue as a going concern. Our Company's ability to continue as a
going concern is dependent upon our ability to obtain adequate financing and
achieve a level of revenues, adequate to support our capital and operating
requirements, as to which no assurance can be given. In the event we are unable
to continue as a going concern, we may elect or be required to seek protection
from our creditors by filing a voluntary petition in bankruptcy or may be
subject to an involuntary petition in bankruptcy. To date, management has not
considered this alternative, nor does management view it as a likely occurrence.
Our auditors have included in their report an explanatory paragraph describing
conditions that raise substantial doubt about our ability to continue as a going
concern.
Risks Related to Sales, Marketing and Competition
We May Be Unable to Successfully Compete in the Electronic Products Market Which
is Highly Competitive and Subject to Rapid Technological Change. We compete in
the market for electronics products which is intensely competitive and subject
to rapid technological change. The market is also impacted by evolving industry
standards, rapid price changes and rapid product obsolescence. Our competitors
include a number of large foreign companies with U.S. operations and a number of
domestic companies, many of which have substantially greater financial,
marketing, personnel and other resources. Our current competitors or new market
entrants could introduce new or enhanced technologies or products with features
that render the Company's technology or products obsolete or less marketable, or
could develop means of producing competitive products at a lower cost. Our
ability to compete successfully will depend in large measure on our ability to
maintain our capabilities in connection with upgrading products and quality
control procedures and to adapt to technological changes and advances in the
industry. Competition could result in price reductions, reduced margins, and
loss of contracts, any of which could harm our business. There can be no
assurance that we will be able to keep pace with the technological demands of
the marketplace or successfully enhance our products or develop new products
that are compatible with the products of the electronics industry.
We Rely on a Limited Number of Customers for Revenue. Historically, a
substantial portion of our revenues has been derived primarily from a limited
number of customers. For the six months ended September 30, 2004 and 2003, one
customer accounted for approximately 97% of revenue and two customers accounted
for 72% of revenues, respectively. The failure to receive orders for and produce
products or a decline in the economic prospects of our customers or the products
we may produce for sale may have a material adverse effect on our operations.
18
If We Are Unsuccessful in Achieving Market Acceptance of Our Products, It Could
Harm Our Business. Sales and marketing strategy contemplates sales of developed
products to the electronics and computer software market, by e.Digital or its
customers. The failure of our Company or its customers to penetrate their
projected markets would have a material adverse effect upon our operations and
prospects. Market acceptance of our products and those of our customers will
depend in part upon our ability to demonstrate and maintain the advantages of
our technology over competing products.
We Have Limited Marketing Capabilities and Resources Which Makes It Difficult
For Us To Create Awareness of and Demand for Our Products and Technology. We
have limited marketing capabilities and resources and are primarily dependent
upon in-house executives for the marketing of our technology platforms, 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.
The Success of Our Business Depends on Emerging Markets and New Products. In
order for demand for our technology, services and products to grow, the markets
for portable digital devices, such as digital recorders and digital video
players and other portable consumer devices, must develop and grow. If sales for
these products do not grow, our revenues could decline. To remain competitive,
we intend to develop new applications for our technology and develop new
technology and products. If new applications or target markets fail to develop,
or if our technology, services and products are not accepted by the market, our
business, financial condition and results of operations could suffer.
Development of New or Improved Products, Processes or Technologies May Render
Our Technology Obsolete and Hurt Our Business. The electronics, contract
manufacturing and computer software markets are characterized by extensive
research and development and rapid technological change resulting in very short
product life cycles. Development of new or improved products, processes or
technologies may render our technology and developed products obsolete or less
competitive. We will be required to devote substantial efforts and financial
resources to enhance our existing products and methods of manufacture and to
develop new products and methods. There can be no assurance we will succeed with
these efforts. Moreover, there can be no assurance that other products will not
be developed which may render our technology and products obsolete.
Risks Related to Operations
We Depend On a Limited Number of Contract Manufacturers and Suppliers and Our
Business Will Be Harmed By Any Interruption of Supply or Failure of Performance.
We rely on one supplier for manufacturing our 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. If a manufacturer is unable to satisfy these requirements, our
business, financial condition and operating results may be materially and
adversely affected. Any failure in performance by this manufacturer for any
reason could have a material adverse affect on our business. Production and
pricing by the 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, may harm our business. Our
future success also depends on our ability to attract, retain and motivate
highly skilled employees. Competition for employees in our industry is intense.
We may be unable to retain our key employees or to attract, assimilate and
retain other highly qualified employees in the future. We have from time to time
in the past experienced, and we expect to continue to experience in the future,
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications.
Because Some of Our Management are Part-Time and Have Certain Conflicts of
Interest, Our Business Could Be Harmed. Our Vice President, Robert Putnam, is
also a Vice President, Investor Relations of American Technology Corporation. As
a result of his involvement with American Technology Corporation, Mr. Putnam has
in the past, and is expected in the future to devote a substantial portion of
his time to other endeavors and only part-time services to e.Digital. Certain
conflicts of interest now exist and will continue to exist between e.Digital and
Mr. Putnam due to the fact that he has other employment or business interests to
which he devotes some attention and he is expected to continue to do so. It is
conceivable that the respective areas of interest of e.Digital and American
Technology Corporation could overlap or conflict.
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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.
Risks Related To Government Regulation, Content And Intellectual Property
Government Regulation May Subject Us to Liability and Require Us To Change The
Way We Do Business. Our business is subject to rapidly changing laws and
regulations. Although our operations are currently based in California, the
United States government and the governments of other states and foreign
countries have attempted to regulate activities on the Internet. Evolving areas
of law that are relevant to our business include privacy law, copyright law,
proposed encryption laws, content regulation and import/export regulations.
Because of this rapidly evolving and uncertain regulatory environment, we cannot
predict how these laws and regulations might affect our business. In addition,
these uncertainties make it difficult to ensure compliance with the laws and
regulations governing the Internet. These laws and regulations could harm us by
subjecting us to liability or forcing us to change how we do business.
Risks Related to Trading in Our Common Stock
Investing in a Technology Stock (Such as Ours) May Involve Greater Risk Than
Other Investments Due to Market Conditions, Stock Price Volatility and Other
Factors. The trading price of our Common Stock has been subject to significant
fluctuations to date, and will likely be subject to wide fluctuations in the
future due to:
o Quarter-to-quarter variations in operating results
o Announcements of technological innovations by us, our customers or
competitors
o New products or significant design achievements by us or our
competitors
o General conditions in the markets for the our products or in the
electronics and IFE industry
o The price and availability of products and components
o Changes in operating factors including delays of shipments, orders
or cancellations
o General financial market conditions
o Market conditions for technology stocks
o Litigation or changes in operating results or estimates by analysts
or others
o Or other events or factors
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We do not endorse or accept any responsibility for the estimates or
recommendations issued by stock research analysts or others from time to time or
comments on any electronic chat boards. The public stock markets in general, and
technology stocks in particular, have experienced extreme price and trading
volume volatility. This volatility has significantly affected the market prices
of securities of many high technology companies for reasons frequently unrelated
to the operating performance of the specific companies. These broad market
fluctuations may adversely affect the market price of our Common Stock in the
future.
Low-Price Stocks and Stocks Traded on the OTC Electronic Bulletin Board are
Subject to Special Regulations and may have Increased Risk. Our shares of Common
Stock are traded on the OTC Electronic Bulletin Board, an electronic,
screen-based trading system operated by the National Association of Securities
Dealers, Inc. ("NASD"). Securities traded on the OTC Electronic Bulletin Board
are, for the most part, thinly traded and are subject to special regulations not
imposed on securities listed or traded on the NASDAQ system or on a national
securities exchange. As a result, an investor may find it difficult to dispose
of, or to obtain accurate quotations as to the price of, our Common Stock. Sales
of substantial amounts of our outstanding Common Stock in the public market
could materially adversely affect the market price of our Common Stock. To date,
the price of our Common Stock has been extremely volatile with the sale price
fluctuating from a low of $0.12 to a high of $0.63 in the last twelve months. In
addition, our Common Stock is subject to Rules 15g-1-15g-6 promulgated under the
Securities Exchange Act of 1934 that imposes additional sales practice
requirements on broker-dealers who sell such securities to persons other than
established customers and accredited investors (generally, a person with assets
in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
with his or her spouse). For transactions covered by this rule, the
broker-dealer must make a special suitability determination for the purchaser
and have received the purchaser's written consent to the transaction prior to
sale. Consequently, the rule may affect the ability of broker-dealers to sell
the Company's securities and may affect the ability of investors to sell their
securities in the secondary market. The Commission has also adopted regulations
which define a "penny stock" to be any equity security that has a market price
(as defined) of less than $5.00 per share or an exercise price of less than
$5.00 per share, subject to certain exceptions. For any transaction involving a
penny stock, unless exempt, the regulations require the delivery, prior to the
transaction, of a disclosure schedule prepared by the Commission relating to the
penny stock market. The broker-dealer must also disclose the commissions payable
to both the broker-dealer and the registered representative, current quotations
for the securities and, if the broker-dealer is the sole market maker, the
broker-dealer must disclose this fact and the broker-dealer's presumed control
over the market. Finally, monthly statements must be sent disclosing recent
price information for the penny stock in the account and information on the
limited market in penny stocks.
Important Factors Related to Forward-Looking Statements and Associated Risks.
This prospectus contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act of 1934 and we intend that such forward-looking statements be subject to the
safe harbors created thereby. These forward-looking statements include our plans
and objectives of management for future operations, including plans and
objectives relating to the products and our future economic performance. The
forward-looking statements included herein are based upon current expectations
that involve a number of risks and uncertainties. These forward-looking
statements are based upon assumptions that we will design, manufacture, market
and ship new products on a timely basis, that competitive conditions within the
computer and electronic markets will not change materially or adversely, that
the computer and electronic markets will continue to experience growth, that
demand for the our products will increase, that we will obtain and/or retain
existing development partners and key management personnel, that future
inventory risks due to shifts in market demand will be minimized, that our
forecasts will accurately anticipate market demand and that there will be no
21
material adverse change in our operations or business. Assumptions relating to
the foregoing involve judgments with respect, among other things, to future
economic, competitive and market conditions and future business decisions, all
of which are difficult or impossible to predict accurately and many of which are
beyond our control. Although we believe that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could prove
inaccurate and, therefore, there can be no assurance that the results
contemplated in forward-looking information will be realized. In addition, as
disclosed above, our business and operations are subject to substantial risks
which increase the uncertainty inherent in such forward-looking statements. Any
of the other factors disclosed above could cause our net sales or net income (or
loss), or our growth in net sales or net income (or loss), to differ materially
from prior results. Growth in absolute amounts of costs of sales and selling and
administrative expenses or the occurrence of extraordinary events could cause
actual results to vary materially from the results contemplated in the
forward-looking statements. Budgeting and other management decisions are
subjective in many respects and thus susceptible to interpretations and periodic
revisions based on actual experience and business developments, the impact of
which may cause us to alter our marketing, capital expenditure or other budgets,
which may in turn affect our results of operations. In light of the significant
uncertainties inherent in the forward-looking information included herein, the
inclusion of such information should not be regarded as a representation by us
or any other person that our objectives or plans will be achieved.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Market risk represents the risk of loss that may impact our financial position,
results of operations or cash flows due to adverse changes in market prices,
including interest rate risk and other relevant market rate or price risks.
Our exposure to market risk for changes in interest rates relates primarily to
our investment in cash and cash equivalents of $419,174 and our debt of
$1,946,875, consisting of accrued interest, the 15% Unsecured Note and the 12%
Convertible Subordinated Promissory Note. We do not use derivative financial
instruments in our investment portfolio and due to the nature of our
investments, do not expect our operating results or cash flows to be
significantly affected by potential changes in interest rates. At September 30,
2004, the market value of these investments, which were all classified as cash
and cash equivalents and certificate of deposit, and debt approximated cost.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
The management of the Company, including the Chief Executive Officer and Chief
Accounting Officer, have conducted an evaluation of the effectiveness of the
Company's disclosure controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) as of a date within 45 days prior to the filing of this
Annual Report on Form 10-Q (the "Evaluation Date"). Based upon that evaluation,
the Chief Executive Officer and Chief Accounting Officer concluded that, as of
the Evaluation Date, the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company, including its consolidated subsidiaries, required to be included in the
Company's periodic SEC filings.
(b) Changes in internal controls.
Subsequent to the date of the evaluation, there have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls, nor were there any corrective actions required with
regard to significant deficiencies and material weaknesses.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved from time to time in routine litigation incidental to the
conduct of our business. Except as set forth below, there is currently no
material pending legal proceedings to which we are party or to which any of our
property is subject.
In March 2002, we entered into a Development and Manufacturing Agreement with
Eclipse by Fujitsu Ten ("Eclipse"), a car stereo company. Under the agreement,
e.Digital receives non-recurring engineering fees for design and development
services, as well as revenues for the manufacture and delivery of
Eclipse-branded audio products. In April 2004, we filed a demand for arbitration
against Eclipse for numerous breaches of the contract signed by Eclipse. These
breaches include cancellation of the initial non-cancelable order, breach of the
implied covenant of good faith and fair dealing, and misappropriation of our
intellectual property, confidential, proprietary and trade secret information.
As of the time of this filing, this issue remains pending. Arbitration has been
set for March 2005. There can be no certainty regarding the timing and outcome
of the Eclipse arbitration.
Item 2. Unregistered Sales of Equity Securities and use of Proceeds
(a) NONE
(b) NONE
(c) NONE
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Item 3. Defaults Upon Senior Securities
NONE
Item 4. Submission of Matters to a Vote of Security Holders
NONE
Item 5. Other Information
(a) NONE
(b) NONE
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 31.1 - Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Atul
Anandpura, Chief Executive Officer.
Exhibit 31.2 - Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Renee
Warden, Principal Accounting Officer.
Exhibit 32.1 - Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Atul
Anandpura, Chief Executive Officer and Renee Warden, Principal Accounting
Officer.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
e.DIGITAL CORPORATION
Date: November 15, 2004 By: /s/ RENEE WARDEN
----------------------------------------
Renee Warden, Chief Accounting Officer
(Principal Accounting and Financial
Officer and duly authorized to sign on
behalf of the Registrant)
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