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EX-31.2 - E DIGITAL CORPv165804_ex31-2.htm
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EX-32.1 - E DIGITAL CORPv165804_ex32-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

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. Empl. Ident. No.)
incorporation or organization)
   

16770 West Bernardo Drive, San Diego, California
92127
(Address of principal executive offices)
(Zip Code)

(858) 304-3016
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   ¨ Yes   ¨ No  (not required)

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

As of November 9, 2009 a total of 286,950,900 shares of the Registrant’s Common Stock, par value $0.001, were issued and outstanding.


 
 

 
 
e.DIGITAL CORPORATION

INDEX

 
Page
PART I. FINANCIAL INFORMATION
 
   
Item 1. Financial Statements (unaudited):
 
   
Condensed Consolidated Balance Sheets as of September 30, 2009 and March 31, 2009
3
   
Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2009 and 2008
4
   
Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2009 and 2008
5
   
Notes to Interim Consolidated Financial Statements
6
   
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
17
   
Item 4. Controls and Procedures
23
   
   
PART II. OTHER INFORMATION
 
   
Item 1.
Legal Proceedings
24
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
24
Item 3.
Defaults Upon Senior Securities
25
Item 4.
Submission of Matters to a Vote of Security Holders
25
Item 5.
Other Information
25
Item 6.
Exhibits
25
   
SIGNATURES
26

 
2

 

Part I. Financial Information
Item 1. Financial Statements:
e.Digital Corporation and subsidiary
CONSOLIDATED BALANCE SHEETS

   
September 30,
       
   
2009
   
March 31,
 
   
(Unaudited)
   
2009
 
   
$
   
$
 
ASSETS
           
Current
           
Cash and cash equivalents
    2,616,717       3,813,990  
Accounts receivable
    1,436,713       93,771  
Inventory
    507,994       517,163  
Deposits and prepaid expenses
    24,755       26,108  
Total current assets
    4,586,179       4,451,032  
Property, equipment and intangibles, net of accumulated depreciation
               
and amortization of $174,851 and $165,449, respectively
    17,236       26,638  
Total assets
    4,603,415       4,477,670  
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current
               
Accounts payable, trade
    187,693       202,900  
Accrued and other liabilities
    941,324       589,814  
Current maturity of convertible term note, net of $358 and $6,141 of debt discount
    96,899       381,093  
Total current liabilities
    1,225,916       1,173,807  
Deferred revenue - long term
    -       24,000  
Total long-term liabilities
    -       24,000  
Total liabilities
    1,225,916       1,197,807  
                 
Commitments and Contingencies
               
                 
Stockholders' equity
               
Preferred stock, $0.001 par value; 5,000,000 shares authorized
               
Series AA Convertible Preferred stock, $0.001 par value, 100,000
               
shares designated: 65,000 and 75,000 issued and outstanding, respectively
               
Liquidation preference of $690,959 and $778,459, respectively
    603,954       610,774  
Common stock, $0.001 par value, authorized 350,000,000,
               
285,588,372 and 282,124,564 shares issued and outstanding, respectively
    285,588       282,125  
Additional paid-in capital
    81,856,249       81,534,566  
Accumulated deficit
    (79,368,292 )     (79,147,602 )
Total stockholders' equity
    3,377,499       3,279,863  
                 
Total liabilities and stockholders' equity
    4,603,415       4,477,670  

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,
 
   
2009
   
2008
   
2009
   
2008
 
 
 
$
   
$
   
$
   
$
 
Revenues:
                               
Products
    43,440       1,683       57,515       235,981  
Services
    218,827       172,747       427,782       316,176  
Patent license
    1,250,000       1,600,000       1,250,000       1,600,000  
Total revenues
    1,512,267       1,774,430       1,735,297       2,152,157  
                                 
Cost of revenues:
                               
Products
    27,789       13,975       76,793       207,459  
Services
    104,834       42,022       176,808       112,208  
Patent license
    443,000       561,326       443,000       561,326  
Total cost of revenues
    575,623       617,323       696,601       880,993  
Gross profit
    936,644       1,157,107       1,038,696       1,271,164  
                                 
Operating expenses:
                               
Selling and administrative
    250,741       627,497       827,413       1,166,392  
Research and related expenditures
    126,749       129,099       206,330       275,750  
Total operating expenses
    377,490       756,596       1,033,743       1,442,142  
                                 
Operating income (loss)
    559,154       400,511       4,953       (170,978 )
                                 
Other income (expense):
                               
Interest and other income
    -       678       -       5,733  
Interest expense
    (5,787 )     (42,114 )     (15,834 )     (90,708 )
Warrant and finance (expense) income
    1,269       (123,908 )     (3,559 )     (178,087 )
Other expense
    (4,518 )     (165,344 )     (19,393 )     (263,062 )
                                 
Income (loss) before provision for income taxes
    554,636       235,167       (14,440 )     (434,040 )
Provision for income taxes
    (206,250 )     (264,000 )     (206,250 )     (264,000 )
Income (loss) for the period
    348,386       (28,833 )     (220,690 )     (698,040 )
Accrued and deemed dividends on preferred stock
    (55,888 )     (43,283 )     (98,701 )     (44,694 )
Income (loss) attributable to common stockholders
    292,498       (72,116 )     (319,391 )     (742,734 )
Income (loss) per common share - basic and diluted
    0.00       (0.00 )     (0.00 )     (0.00 )
                                 
Weighted average common shares outstanding
                               
  Basic
    284,407,839       277,082,261       283,462,799       275,797,016  
  Diluted
    286,048,464       277,082,261       283,462,799       275,797,016  

See notes to interim consolidated financial statements

 
4

 
 
e.Digital Corporation and subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS
[See Note 1 - Nature of Operations and Basis of Presentation]

   
For the six months ended
 
   
September 30
 
   
2009
   
2008
 
 
 
$
   
$
 
OPERATING ACTIVITIES
               
Loss for the period
    (220,690 )     (698,040 )
Adjustments to reconcile loss to net cash used in operating activities:
               
Depreciation and amortization
    9,402       8,228  
Accretion related to promissory notes
    5,783       23,180  
Warrant modification and warrant derivative revaluation
    -       174,667  
Interest paid with common stock
    10,023       22,477  
Warranty provision
    8,466       (35,600 )
Stock-based compensation
    18,326       32,257  
Changes in assets and liabilities:
               
Accounts receivable, trade
    (1,342,942 )     (1,584,784 )
Inventories
    9,169       (62,324 )
Prepaid expenses and other
    1,353       (3,935 )
Accounts payable, trade
    (15,207 )     794,356  
Accrued and other liabilities
    306,470       (53,353 )
Accrued employee benefits
    (5,934 )     (18,543 )
Customer deposits
    -       54,900  
Accrued income taxes
    48,750       264,000  
Warranty reserve
    (17,262 )     (39,663 )
Deferred revenue
    (12,980 )     (27,000 )
Cash used in operating activities
    (1,197,273 )     (1,149,177 )
                 
FINANCING ACTIVITIES
               
Proceeds from sale of common stock
    -       500,000  
Proceeds from sale of preferred stock
    -       700,000  
Payment on convertible term note
    -       (25,599 )
Payments on secured promissory note
    -       (50,000 )
Proceeds from unsecured promissory note
    -       40,000  
Cash provided by financing activities
    -       1,164,401  
Net increase (decrease) in cash and cash equivalents
    (1,197,273 )     15,224  
Cash and cash equivalents, beginning of period
    3,813,990       122,116  
Cash and cash equivalents, end of period
    2,616,717       137,340  
                 
Supplemental disclosures of cash flow information:
               
Cash paid for interest
    28       45,051  
Cash paid for taxes
    160,000       -  
Supplemental schedule of noncash investing and financing activities:
         
Common stock issued on conversion of preferred stock
    105,521       -  
Accounts payable exchanged for preferred stock
    -       50,000  
Accrued and deemed dividends on preferred stock
    98,701       44,694  
Term note payments paid in common stock
    300,000       120,000  
Financing fees paid in common stock
    -       9,800  
Warrant derivative liability reclassified to equity
    -       132,315  

See accompanying notes to consolidated financial statements

 
5

 

1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
e.Digital Corporation is a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. The Company has innovated a proprietary secure digital video/audio technology platform ("DVAP") and markets the eVU™ mobile entertainment device for the travel and recreational industries. The Company also obtains revenue from licensing its Flash-R™ portfolio of patents related to the use of flash memory in portable devices.

Unaudited Interim Financial Statements
These unaudited consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. These interim consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments considered necessary for a fair statement of the Company's financial position at September 30, 2009, and the results of its operations and cash flows for the periods presented, consisting only of normal and recurring adjustments. All significant intercompany transactions have been eliminated in consolidation. Operating results for the three and six months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2010. For further information, refer to the Company's consolidated financial statements and footnotes thereto for the year ended March 31, 2009 filed on Form 10-K.

Going Concern
Until the fiscal year ended March 31, 2009 (fiscal 2009), the Company incurred significant losses and negative cash flow from operations and has an accumulated deficit of $79,368,292 at September 30, 2009. The Company’s profitability for the prior year resulted from one-time patent licensing revenues and there is no assurance of future licensing revenues from new licensees. Accordingly, the Company could continue to incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability. Until the Company can demonstrate sustained profitability its ability to continue as a going concern is in doubt and may be dependent upon obtaining additional financing in the future. These consolidated financial statements do not give effect to any adjustments that 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.

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

2. RECENT ACCOUNTING PRONOUNCEMENTS
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the three and six months ended September 30, 2009, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2009, that are of significance, or potential significance to the Company.

Adopted Accounting Pronouncements
Effective July 1, 2009, the Company adopted The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (ASC 105). This standard establishes only two levels of U.S. generally accepted accounting principles (GAAP), authoritative and nonauthoritative. The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification” or “ASC”) became the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification became nonauthoritative. The Company began using the new guidelines and numbering system prescribed by the Codification when referring to GAAP in the second quarter of fiscal 2010. As the Codification was not intended to change or alter existing GAAP, it did not have any impact on the Company’s consolidated financial statements.

 
6

 

Effective April 1, 2009, the Company adopted three accounting standard updates that were intended to provide additional application guidance and enhanced disclosures regarding fair value measurements and impairments of securities established in ASC 820, Fair Value Measurements and Disclosures. They also provide additional guidelines for estimating fair value in accordance with fair value accounting. The first update, as codified in ASC 820-10-65, provides additional guidelines for estimating fair value in accordance with fair value accounting. The second accounting update, as codified in ASC 320-10-65, changes accounting requirements for other-than-temporary-impairment for debt securities by replacing the current requirement that a holder have the positive intent and ability to hold an impaired security to recovery in order to conclude an impairment was temporary with a requirement that an entity conclude it does not intend to sell an impaired security and it will not be required to sell the security before the recovery of its amortized cost basis. The third accounting update, as codified in ASC 825-10-65, increases the frequency of fair value disclosures. These updates were effective for fiscal years and interim periods ended after June 15, 2009. The adoption of these accounting updates did not have any impact on the Company’s consolidated financial statements.

In February 2008, the FASB issued an accounting standard update that delayed the effective date of fair value measurements accounting for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2010. These include goodwill and other non-amortizable intangible assets. The Company adopted this accounting standard update effective April 1, 2009. The adoption of this update to non-financial assets and liabilities, as codified in ASC 820-10, did not have any impact on the Company’s consolidated financial statements.

Effective April 1, 2009, the Company adopted a new accounting standard for subsequent events, as codified in ASC 855-10. The update modifies the names of the two types of subsequent events either as recognized subsequent events (previously referred to in practice as Type I subsequent events) or non-recognized subsequent events (previously referred to in practice as Type II subsequent events). In addition, the standard modifies the definition of subsequent events to refer to events or transactions that occur after the balance sheet date, but before the financial statements are issued (for public entities) or available to be issued (for nonpublic entities). It also requires the disclosure of the date through which subsequent events have been evaluated. The update did not result in significant changes in the practice of subsequent event disclosures, and therefore the adoption did not have any impact on the Company’s consolidated financial statements.

Effective April 1, 2009, the Company adopted a new accounting standard update regarding business combinations. As codified under ASC 805 the update requires the acquisition method to be applied to all transactions and other events in which an entity obtains control over one or more other businesses, requires the acquirer to recognize the fair value of all assets and liabilities acquired, even if less than one hundred percent ownership is acquired, and establishes the acquisition date fair value as measurement date for all assets and liabilities assumed. For the Company, this accounting update was effective on a prospective basis for all business combinations for which the acquisition date is on or after April 1, 2009. Since the Company is not contemplating any business combinations it does not presently expect any impact of adoption on its consolidated financial statements.

ASC 810, Consolidation (“ASC 810”), ASC 810-10-65, Transition and Open Effective Date Information (“ASC 810-10-65”) establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated financial statements. ASC 810-10-65 is effective for our fiscal years beginning after December 15, 2008. The provisions of are applied prospectively upon adoption except for the presentation and disclosure requirements that are applied retrospectively. The Company has no non-controlling interests and accordingly the adoption on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

ASC 815, Derivatives and Hedging (“ASC 815”) and ASC 815-10-65, Transition and Open Effective Date Information (“ASC 815-10-65”) includes a requirement for enhanced disclosures about an entity’s derivative and hedging activities. ASC 815 is effective prospectively for fiscal years beginning after November 15, 2008. The Company currently has no derivatives or hedging activities and the adoption on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

ASC 808, Collaborative Arrangements provides guidance for income statement presentation, classification, and disclosures related to collaborative arrangements. The arrangements generally provide that the collaborators will share, based on contractually defined calculations, the profits or losses from the associated activities. Periodically, the collaborators share financial information related to product revenues generated (if any) and costs incurred that may trigger a sharing payment for the combined profits or losses. The guidance requires collaborators in such an arrangement to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable GAAP or, in the absence of other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. ASC 808 is effective for collaborative arrangements in place at the beginning of the annual period beginning after December 15, 2008. The Company does not have any such collaborative arrangements and the adoption of ASC 808 on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

 
7

 
 
In June 2008, the FASB issued ASC 850-15-5, Evaluating Whether an Instrument Involving a Contingency Is Considered Indexed to an Entity's Own Stock.  ASC 850-15-5 requires entities to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock by assessing the instrument’s contingent exercise provisions and settlement provisions.  Instruments not indexed to their own stock fail to meet the first part of the scope exception in ASC 815-10-15-74(a), and should be classified as a liability and marked-to-market.  The statement is effective for fiscal years beginning after December 15, 2008 and is to be applied to outstanding instruments upon adoption with the cumulative effect of the change in accounting principle recognized as an adjustment to the opening balance of retained earnings.  The Company evaluated its various convertible securities and determined that no change in accounting was required related to this pronouncement at April 1, 2009 or for the period ended September 30, 2009.

New Accounting Pronouncements
In September 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (ASU 2009-13). It updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21). The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The Company is currently assessing the future impact of this new accounting update to its consolidated financial statements.

3. INCOME (LOSS) PER SHARE
Basic earnings (loss) per common share is computed by dividing income (loss) attributable to common shareholders by the weighted-average number of shares of common stock outstanding during the period. The income attributable to common stockholders was reduced by and the loss to common stockholders increased by accrued and deemed dividends on preferred stock during the three and six months ended September 30, 2009 of $55,888 and $98,701, respectively (three and six months ended September 30, 2008 by $43,283 and $44,694, respectively). Diluted earnings per common share is computed by dividing income (loss) attributable to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding convertible preferred stock, stock options, warrants and convertible debt. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.

The following table sets forth the computation of basic and diluted earnings per share:

 
8

 

   
Three Months Ended
   
Six Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Basic
                       
Income (loss) attributable to common stockholders
  $ 292,498     $ (72,116 )   $ (319,391 )   $ (742,734 )
Weighted average common shares outstanding (basic)
    284,407,839       277,082,261       283,462,799       275,797,016  
Basic income (loss) per common share
  $ 0.00     $ (0.00 )   $ (0.00 )   $ (0.00 )
                                 
Diluted
                               
Income (loss) attributable to common stockholders
  $ 292,498     $ (72,116 )   $ (319,391 )   $ (742,734 )
Plus:
                               
Accrued and deemed dividends on preferred stock (1)
    -       -       -       -  
Income (loss) for diluted
  $ 292,498     $ (72,116 )   $ (319,391 )   $ (742,734 )
Common and potential common shares:
                               
Weighted average common shares outstanding
    284,407,839       277,082,261       283,462,799       275,797,016  
Assumed exercise of options and warrants
    1,640,625       -       -       -  
Common and potential common shares (1)
    286,048,464       277,082,261       283,462,799       275,797,016  
Diluted income (loss) per common share
  $ 0.00     $ (0.00 )   $ (0.00 )   $ (0.00 )
                                 
Potentially dilutive securities outstanding at period end excluded from diluted computation as they were antidilutive
    14,269,281       29,911,984       21,769,281       29,911,984  

(1) The convertible preferred stock and convertible term note were antidilutive for the respective periods.
 
4. INVENTORIES
 
Inventories are stated at the lower of cost, which approximates actual costs on a first in, first out cost basis, or market.
Inventories consisted of the following:
 
   
September 30,
   
March 31,
 
   
2009
   
2009
 
   
$
   
$
 
Raw materials
    133,591       140,544  
Work in process
    27,514       28,335  
Finished goods
    346,889       348,284  
      507,994       517,163  
 
5. STOCK-BASED COMPENSATION COSTS
 
The Company accounts for stock-based compensation under the provisions of ASC 718, Share-Based Payment and ASC 505-50, Equity-Based Payments to Non-Employees. ASC 718 requires measurement of all employee stock-based awards using a fair-value method and recording of related compensation expense in the consolidated financial statements over the requisite service period. Further, as required under ASC 718, the Company estimates forfeitures for stock-based awards that are not expected to vest. The Company recorded stock-based compensation in its consolidated statements of operations for the relevant periods as follows:

 
9

 

   
Three Months Ended
   
Six Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
$
   
$
   
$
   
$
 
Research and development
    1,037       -       1,037       -  
Selling and administrative
    5,544       17,536       17,289       32,257  
Total stock-based compensation expense
    6,581       17,536       18,326       32,257  

As of September 30, 2009 total estimated compensation cost of stock options granted but not yet vested was $45,802 and is expected to be recognized over the weighted average period of 1.5 years.

The following table sets forth the weighted-average key assumptions and fair value results for stock options granted during the six-month periods ended September 30, 2009 and 2008 (annualized percentages).

   
Six Months Ended
 
   
September 30,
 
   
2009
   
2008
 
Volatility
    71 %     71 %
Risk-free interest rate
    1.45 %     2.5 %
Forfeiture rate
    0.0 %     0.0 %
Dividend yield
    0.0 %     0.0 %
Expected life in years
    2.5       3.5  
Weighted-average fair value of options granted
  $ 0.05     $ 0.05  

The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the common stock over the period commensurate with the expected life of the options. The Company has a small number or option grants and limited exercise history and accordingly has for all new option grants applied the simplified method prescribed by SEC Staff Accounting Bulletin 110 to estimate expected life (computed as vesting term plus contractual term divided by two). The expected forfeiture rate is estimated based on historical experience for each option group. 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.

See Note 8 for further information on outstanding stock options.

6. WARRANTY RESERVE

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

   
Three Months Ended
   
Six Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
$
   
$
   
$
   
$
 
Beginning balance
    16,138       103,222       14,155       109,138  
Warranty provision
    (3,406 )     (45,680 )     8,466       (35,600 )
Warranty deductions
    (7,373 )     (23,667 )     (17,262 )     (39,663 )
Ending balance
    5,359       33,875       5,359       33,875  

 
10

 

7. PROMISSORY NOTE
The Company has the option, subject to certain limitations, to elect to make monthly $50,000 installment payments on the 7.5% Convertible Subordinated Term Note either in cash or in shares of common stock (“Monthly Installment Shares”). Monthly Installment Shares are valued at the arithmetic average of the closing prices for the last five trading days of the applicable month without discount. Payments must be paid in cash if the computed average price is less than $0.10 per share. During the six months ended September 30, 2009 the Company made the six monthly installment payments aggregating $300,000 through the issuance of 2,408,603 shares of common stock. Subsequent to September 30, 2009 the Company made the October 2009 note payment through the issuance of 296,912 shares of common stock.

8. STOCKHOLDERS’ EQUITY
The following table summarizes stockholders’ equity transactions during the six-month period ended September 30, 2009:

   
Preferred stock
   
Common stock
   
Additional
   
Accumulated
       
   
Amount
   
Shares
   
Amount
   
paid-in capital
   
deficit
   
Total
 
Balance, March 31, 2009
    610,774       282,124,564       282,125       81,534,566       (79,147,602 )     3,279,863  
Dividends on Series AA preferred stock
    18,020       -       -       (18,020 )     -       -  
Accretion of discount on Series AA preferred
                                               
  stock
    80,681       -       -       (80,681 )     -       -  
Conversion of Series AA preferred stock
    (105,521 )     1,055,205       1,055       104,466       -       -  
Shares issued for term debt payments
    -       2,408,603       2,408       297,592       -       300,000  
Stock-based compensation
    -       -       -       18,326       -       18,326  
Loss and comprehensive loss
    -       -       -       -       (220,690 )     (220,690 )
Balance, September 30, 2009
    603,954       285,588,372       285,588       81,856,249       (79,368,292 )     3,377,499  

Options
The following table summarizes stock option activity for the period:

         
Weighted average
   
Aggregate
 
   
Shares
   
exercise price
   
Intrinsic Value
 
   
#
   
$
   
$
 
Outstanding March 31, 2009
    8,050,500       0.16        
  Granted     500,000       0.11        
  Exercised     -                
  Canceled/expired     (1,515,000 )     0.22        
Outstanding September 30, 2009
    7,035,500       0.14       82,750  
Exercisable at September 30, 2009
    5,352,165       0.15       36,167  

(1)
Options outstanding are exercisable at prices ranging from $0.11 to $0.23 and expire over the period from 2010 to 2013.
(2)
Aggregate intrinsic value is based on the closing price of our common stock on September 30, 2009 of $0.15 and excludes the impact of options that were not in-the-money.

Share warrants
The following table summarizes information on warrant activity during the six months ended September 30, 2009:

 
11

 


   
Number
   
Average Purchase
Price Per Share $
 
Shares purchasable under outstanding warrants at March 31, 2009
    9,831,572       0.11  
Stock purchase warrants exercised
    -          
Stock purchase warrants expired
    (2,331,572 )     0.15  
Shares purchasable under outstanding warrants at September 30, 2009
    7,500,000       0.10  

The Company has outstanding share warrants as of September 30, 2009, as follows:
 
   
Number of
   
Exercise Price
       
Description
 
Common Shares
   
Per Share $
   
Expiration Date
 
                   
Warrants
    7,500,000       0.10     June 30, 2011  

9. PREFERRED STOCK
On June 27, 2008 the Company issued 75,000 shares of 5% Series AA Convertible Preferred Stock (the “Series AA Stock”) with a stated value of $10 per share. Dividends of 5% per annum are payable in shares of common stock or at the Company’s election additional shares of Series AA Stock or under certain circumstances in cash. The Series AA Stock has voting rights of ten votes per share and a liquidation preference equal to $10.00 per share plus accrued and unpaid dividends. The stated value plus accrued dividends on Series AA Stock is convertible into common stock at $0.10 per common share with automatic conversion on June 30, 2010 subject to certain limitations. The Company may call the Series AA Stock for conversion if the common stock market price is at least $0.25 per share for ten consecutive trading days.

The income attributable to common stockholders was reduced by and the loss to common stockholders increased by accrued and deemed dividends on preferred stock during the three and six months ended September 30, 2009 of $55,888 and $98,701, respectively (three and six months ended September 30, 2008 by $43,283 and $44,694, respectively).

During the six months ended September 30, 2009 the Company issued 1,055,205 shares of common stock upon the conversion of 10,000 shares of Series AA Stock and accordingly 65,000 shares of Series AA Stock were outstanding at September 30, 2009. Subsequent to September 30, 2009 the Company issued 1,065,616 shares of common stock upon the conversion of 10,000 shares of Series AA Stock.

10. FAIR VALUE MEASUREMENTS
The carrying amounts of cash and cash equivalents, accounts receivables, accounts payable, accrued liabilities and convertible term debt approximate their fair values due to the short-term maturities of these instruments.

On April 1, 2008, the Company adopted ASC 820, Fair Value Measurements and Disclosures that defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.

ASC 820 establishes a three-level valuation hierarchy of valuation techniques that is based on observable and unobservable inputs. Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The first two inputs are considered observable and the last unobservable, that may be used to measure fair value and include the following:
Level 1 - 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 for similar assets or liabilities; quoted prices 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 the 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.

 
12

 

As of September 30, 2009, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis, including its cash and cash equivalents. The fair value of these assets and liabilities was determined using the following inputs in accordance with ASC 820 at September 30, 2009:

   
Fair Value Measurement as of September 30, 2009
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Description
 
$
   
$
   
$
   
$
 
Cash and cash equivalents (1)
    2,616,717       2,616,717       -       -  

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

11. SEGMENT INFORMATION
ASC 280 Segment Reporting provides annual and interim reporting standards for an enterprise’s business segments and related disclosures about its products, services, geographical areas and major customers. The Company has two operating segments: (1) products and services and (2) patent licensing. Products and services consist of sales of the Company’s electronic eVU mobile entertainment device and related content services and patent licensing consists of intellectual property revenues from the Flash-R patent portfolio.
 
Accounting policies for each of the operating segments are the same as on a consolidated basis.
 
Our reportable segment information for the three and six months ended September 30, 2009 and 2008 is as follows:

   
For the three months ended
   
For the six months ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
$
   
$
   
$
   
$
 
REVENUES:
                       
Products and services
    262,267       174,430       485,297       552,157  
Patent licensing
    1,250,000       1,600,000       1,250,000       1,600,000  
Total revenue
    1,512,267       1,774,430       1,735,297       2,152,157  
                                 
GROSS PROFIT:
                               
Products and services
    129,644       118,433       231,696       232,490  
Patent licensing
    807,000       1,038,674       807,000       1,038,674  
Total gross profit
    936,644       1,157,107       1,038,696       1,271,164  
                                 
RECONCILIATION:
                               
Total segment gross profit
    936,644       1,157,107       1,038,696       1,271,164  
Operating expenses
    (377,490 )     (756,596 )     (1,033,743 )     (1,442,142 )
Other expense
    (4,518 )     (165,344 )     (19,393 )     (263,062 )
Income (loss) before income taxes
    554,636       235,167       (14,440 )     (434,040 )

 
13

 
 
The Company does not have significant assets employed in the patent license segment and does not track capital expenditures or assets by reportable segment. Consequently it is not practical to show this information.

Revenue by geographic region is determined based on the location of the Company’s direct customers or distributors for product sales and services. Patent license revenue is considered United States revenue as payments are for licenses for United States operations irrespective of the location of the licensee’s home domicile.

   
For the three months ended
 
For the six months ended
 
   
September 30,
 
September 30,
 
   
2009
 
2008
 
2009
 
2008
 
   
$
 
$
 
$
 
$
 
United States
    1,250,000       1,600,000       1,250,000       1,600,000  
International
    262,267       174,430       485,297       552,157  
Total revenue
    1,512,267       1,774,430       1,735,297       2,152,157  

Sales to two customers comprised 72% and 12% of revenue for the six months ended September 30, 2009. Sales to two customers comprised 74% and 10% of revenue for the six months ended September 30, 2008. Accounts receivable from one customer comprised 87% of net accounts receivable at September 30, 2009 and one customer accounted for 91% of net accounts receivable at September 30, 2008.

12. COMMITMENTS AND CONTINGENCIES

Legal Matters

Business Litigation
In May 2006, the Company announced that a complaint had been filed against it and certain of its officers and employees by digEcor, Inc. (“digEcor”) in the Third Judicial District Court of Utah, County of Salt Lake (the “Court”). In January 2007, March 2009 and April 2009 the Court ruled on certain motions of the parties substantially limiting the issues for trial and each party voluntarily dismissed additional claims and specific defendants.  In its rulings, the Court dismissed digEcor's unjust enrichment, fraud, negligent misrepresentation, tortious interference, non-competition, punitive damage and certain unfair competition claims. The bulk of the bench trial related to digEcor’s claims for breaches of three contracts and associated damages, and one claim for injunctive relief was completed in May 2009 followed by the parties filing Proposed Findings of Fact and Conclusions of Law and final arguments in July 2009.
 
On September 14, 2009, the Company announced that the Court ruled in favor of the Company by dismissing all remaining claims with prejudice and ordering that digEcor recover no damages or injunctive relief. Specifically, the Court dismissed digEcor's claims for breach of a November 2005 Purchase Order between the parties, breach of a digital rights management (“DRM”) Agreement, and breach of an October 22, 2002 Product Agreement. All claims were dismissed "with prejudice and on the merits." The Court also declined to grant digEcor any injunctive relief in connection with the DRM-related claim.  The Court’s ruling and prior rulings may be subject to future appeal by either party.
 
At September 30, 2009 the Company had an accrual of $80,000 related to a deposit for batteries made by digEcor.
 
On November 13, 2009 the Company entered into a settlement agreement ending the digEcor litigation with digEcor agreeing to waive any right to appeal the Court’s rulings and orders in favor of the Company and the Company withdrawing its applications for costs of suit. The agreement also reduced and settled the judgment (related to batteries) to $60,000. The agreement included standard mutual release of claims and covenants not to sue.
 
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 currently in bankruptcy.

Subsequent to September 30, 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.

 
14

 

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. 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 September 30, 2009 the Company had outstanding unfilled purchase orders and was committed to a contract manufacturer and component suppliers for approximately $106,000 of future deliveries.

Facility Lease
In March 2006 the Company entered into a sixty-two month lease, commencing June 1, 2006, for approximately 4,800 square feet with an aggregate payment of $6,159 per month excluding utilities and costs. The aggregate payments adjust annually with maximum aggregate payments totaling $6,535 in the fifty-first through the sixty-second month. Future lease commitments aggregated $141,850 at September 30, 2009.

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 September 30, 2009 had substantially all of its cash and cash equivalents at one financial institution in a non-interest bearing account. Effective October 14, 2008, Federal Deposit Insurance Corporation deposit insurance was changed to provide full deposit insurance coverage for non-interest bearing deposit transaction accounts through December 31, 2009.

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 currently relies on one legal firm to represent it in patent licensing matters.

13. INCOME TAXES
During the quarter ended September 30, 2009 the Company provided a tax provision of $206,250 representing foreign taxes for which a credit (a deferred tax asset) may be allowable against future United States taxes subject to certain limitations. At September 30, 2009, the Company had deferred tax assets associated with federal net operating losses (“NOLs”), related state NOLs, foreign tax credits and certain Federal and California research and development tax credits but recorded a corresponding full valuation allowance as it is more likely than not that some portion or all of the deferred tax assets will not be realized. In spite of state NOLs the Company may be subject to California state taxes during fiscal 2010 if it generates sufficient taxable income due to the California suspension of the net operating loss (“NOL”) carryforwards for the 2008 and 2009 tax years.

 
15

 

When, and if, the Company can sustain consistent profitability, and management determines that it is likely it will be able to utilize the net operating losses and/or tax credits prior to their expiration, then the valuation allowance can be reduced or eliminated.

14. SUBSEQUENT EVENTS
 
The subsequent events have been evaluated through November 16, 2009, which was the date the Financial Statements were issued (see notes 7, 9 and 12).

 
16

 

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, 2009.

Cautionary Note on Forward Looking Statements

In addition to the other information in this report, the factors listed below should be considered in evaluating our business and prospects.  This report contains a number of forward-looking statements that reflect our current views with respect to future events and financial performance.  These forward-looking statements are subject to certain risks and uncertainties, including those discussed below and elsewhere herein, that could cause actual results to differ materially from historical results or those anticipated.  In this report, the words “anticipates,” “believes,” “expects,” “intends,” “future” and similar expressions identify forward-looking statements.  Readers are cautioned to consider the specific factors described below and not to place undue reliance on the forward-looking statements contained herein, which speak only as of the date hereof.  We undertake no obligation to publicly revise these forward-looking statements, to reflect events or circumstances that may arise after the date hereof.

General
We are a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name.  We have innovated a proprietary secure digital video/audio technology platform (“DVAP”) and market our eVU™ mobile entertainment device for the travel and recreational industries. We also own and are licensing our Flash-R™ portfolio of patents related to the use of flash memory in portable devices.

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

We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against targeted parties who we believe may be infringing our patents. The international law firm of Duane Morris LLP is handling our patent enforcement matters on a contingent fee basis. In September 2007 and March 2008 we filed a first tranche of patent infringement litigation against eight defendants. In September 2008 we recorded our first patent license revenue and by September 30, 2009 we had licensed and settled the litigation with seven of the defendants and suspended the complaint against one defendant currently in bankruptcy. Subsequent to September 30, 2009 we filed a new patent infringement complaint against nineteen additional companies that manufacture devices using flash memory.

We believe the successful licensing of all seven active manufacturers from our first round of patent enforcement actions evidences strength of our fundamental intellectual property. And while we expect additional patent license revenues from the manufacturers in the new complaint and from others in future periods there can be no assurance of the timing or amounts of any related license revenue. A number of factors, many outside our control, affect the amount of each licensing arrangement and the timing of when parties elect to license our intellectual property. These factors include the number and nature of infringing products, estimates of past and future infringement, importance of the infringing technology to the total product, the legal environment surrounding a particular case, estimates of the cost, time and complexity of litigation through trial and possible appeals as well as other factors.

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 any new business activity, including unforeseeable expenses, delays and complications. Accordingly, there is no guarantee that we can or will report operating profits in future periods.

 
17

 

Overall Performance and Trends
Until the fiscal year ended March 31, 2009 (fiscal 2009), we incurred significant losses and negative cash flow from operations. Our fiscal 2009 profitability resulted from one-time patent licensing revenues and there is no assurance of future licensing revenues from new licensees. Accordingly, we could incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability. Our ability to continue as a going concern is in doubt and is dependent upon achieving a profitable level of operations and if necessary obtaining additional financing.

eVU sales activity has been slow due to airline industry economics and industry credit concerns resulting in airlines curtailing expansion and new projects. We are aggressively pursuing new business but our results will be dependent on the timing and quantity of eVU orders and any future patent licenses. We seek to expand and diversify our customer base both in the in-flight entertainment ("IFE") space and other markets. 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.

For the six months ended September 30, 2009 we recognized a net loss before income taxes of $14,440 compared to a net loss before income taxes of $434,040 for the comparable period of the prior fiscal year. Our revenues were $1.74 million for the first six months of fiscal 2010 compared to $2.15 million for the prior year’s first six months. In the prior year’s second quarter we recognized our first patent license revenue of $1.6 million and in our most recent second quarter we recognized $1.25 million of patent license revenue. We are in the early stages of licensing our patents and while we expect additional patent licenses in future periods there can be no assurance of the timing or amounts of any such license revenue. We reported reduced operating expenses of $1,033,743 in the six months ended September 30, 2009 compared to $1,442,142 in the comparable period prior primarily due to reduced staffing and reduced legal fees.

We expect our operating costs to be lower for the balance of fiscal 2010 compared to the prior year. Our monthly cash operating costs average approximately $150,000 per month, excluding litigation costs that should now decline substantially due to the favorable conclusion of business litigation (see Part II – Item 1 – Legal Proceedings below). 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.

Critical Accounting Policies
We have identified a number of accounting policies as critical to our business operations and the understanding of our results of operations. These are described in our consolidated financial statements located in Item 1 of Part I, “Financial Statements,” and in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report of Form 10-K for the year ended March 31, 2009. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations when such policies affect our reported and expected financial results.

The methods, estimates and judgments we use in applying our accounting policies, in conformity with generally accepted accounting principles in the United States, have a significant impact on the results we report in our financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The estimates affect the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

 
18

 

Results of Operations

Three months ended September 30, 2009 compared to the three months ended September 30, 2008
   
Three Months Ended September 30,
             
   
2009
         
2008
                   
         
% of
         
% of
   
Change
 
   
Dollars
   
Revenue
   
Dollars
   
Revenue
   
Dollars
   
%
 
Revenues:
                                   
Products
    43,440       3 %     1,683       0 %     41,757       2481 %
Services
    218,827       14 %     172,747       10 %     46,080       27 %
Patent license
    1,250,000       83 %     1,600,000       90 %     (350,000 )     (22 )%
      1,512,267       100 %     1,774,430       100 %     (262,163 )     (15 )%
Gross Profit:
                                               
Product gross profit
    15,651       1 %     (12,292 )     (1 )%     27,943       (227 )%
Service gross profit
    113,993       8 %     130,725       7 %     (16,732 )     (13 )%
Patent license
    807,000       53 %     1,038,674       59 %     (231,674 )     (22 )%
      936,644       62 %     1,157,107       65 %     (220,463 )     (19 )%
Operating Expenses:
                                               
Selling and administrative
    250,741       17 %     627,497       35 %     (376,756 )     (60 )%
Research and related
    126,749       8 %     129,099       8 %     (2,350 )     (2 )%
      377,490       25 %     756,596       43 %     (379,106 )     (50 )%
Other expenses
    (4,518 )     (0 )%     (165,344 )     (9 )%     160,826       (97 )%
Income before provision for income taxes
    554,636       37 %     235,167       13 %     319,469       136 %

Income before provision for income taxes
We reported income before income taxes of $554,636 for the three months ended September 30, 2009 compared to net income before income taxes of $235,167 for the comparable period of the prior year. The $319,469 improvement was the result of reduced operating and other expenses that more than offset a slight decline in revenues and related gross profit.

Revenues
Revenues of $1,512,267 in the second quarter of fiscal 2010 compared to $1,774,430 for the comparable prior period. Our most recent quarter’s revenues included $1,250,000 of one-time non-recurring patent license revenue compared to $1,600,000 in the prior comparable quarter. Our most recent quarter’s revenues also included $43,440 of eVU product and $218,827 of service revenues. We recently filed a complaint against nineteen additional electronic manufacturers, and while we expect additional patent licenses from these and other companies in future periods, there can be no assurance of the timing or amounts of any future license revenue. Recent eVU product sales activity has been slow due to airline industry economics and industry credit concerns resulting in airlines curtailing expansion and new projects. Our service revenues have grown as result of prior year customer additions but as service arrangements and terms vary with each customer there is no assurance in the current airline environment that our service revenues will continue at comparable levels for the balance of the fiscal year. We are pursuing new business but our results will continue to be dependent on the timing and quantity of eVU orders and the timing and amount of any patent licensing arrangements.

Gross Profit
Gross profit for the second quarter of fiscal 2010 was $936,644 or 62% of revenues.  The gross profit for the prior year’s second quarter was $1,157,107 or 65% of revenues. Gross profit margins are highly dependent on revenue mix, prices charged, volume of orders, and for patent licensing the amounts of contingency legal fees and costs.

 
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Operating Expenses
Selling and administrative costs for the three months ended September 30, 2009, were $250,741 compared to $627,497 for the second quarter of the prior year. The significant $376,756 decrease included $42,700 of reduced staffing costs due to fewer personnel, a $72,000 reduction in shareholder related costs due do the timing of this year's annual meeting scheduled in the third quarter of the current year rather than the second quarter and $265,500 of reduced professional fees primarily due to reduced business litigation costs and the effect of a $100,000 reversal of a legal accrual related to such litigation as a result of the favorable litigation outcome. While we expect to incur costs related to our annual shareholder meeting in the third quarter of this fiscal year, we do not expect them to be as high as the prior year’s second quarter costs primarily due to reduced mailing costs. We expect professional fees in the third and fourth quarter to be less than the prior year due to the conclusion of the business litigation.

Research and related expenditures for the three months ended September 30, 2009 were comparable to the prior year’s second quarter.

Other Income (Expenses)
Net other expenses of $4,518 for the second quarter of fiscal 2010 included $5,787 of noncash interest expense offset by a foreign exchange gain of $1,269. Net other expenses for the second quarter of the prior year of $165,344 included a non-cash financing expense of $177,125 related to a charge for warrant modification, a non-cash $53,217 gain from warrant derivative revaluation reduced by $42,114 of interest expense including $15,471 of non-cash interest.

Provision for Income Taxes
Income tax expense of $206,250 consists of foreign taxes payable on patent license revenue.

Income Attributable to Common Stockholders
The income attributable to common stockholders for the most recent second quarter included the net income after taxes of $348,386 reduced by accrued and deemed dividends on Series AA Stock of $55,888 for a net income attributable to common stockholders of $292,498. The net loss after tax for the prior comparable second quarter was $28,833 increased by accrued and deemed dividends of $43,283 for a net loss attributable to common stockholders of $72,116.

Six months ended September 30, 2009 compared to the six months ended September 30, 2008

   
Six Months Ended September 30,
             
   
2009
         
2008
                   
         
% of
         
% of
   
Change
 
   
Dollars
   
Revenue
   
Dollars
   
Revenue
   
Dollars
   
%
 
Revenues:
                                   
Product revenues
    57,515       3 %     235,981       11 %     (178,466 )     (76 )%
Service revenues
    427,782       25 %     316,176       15 %     111,606       35 %
Patent license
    1,250,000       72 %     1,600,000       74 %     (350,000 )     (22 )%
      1,735,297       100 %     2,152,157       100 %     (416,860 )     (19 )%
Gross Profit:
                                               
Product gross profit
    (19,278 )     (1 )%     28,522       1 %     (47,800 )     (168 )%
Service gross profit
    250,974       14 %     203,968       10 %     47,006       23 %
Patent license gross profit
    807,000       47 %     1,038,674       48 %     (231,674 )     (22 )%
      1,038,696       60 %     1,271,164       59 %     (232,468 )     (18 )%
Operating Expenses:
                                               
Selling and administrative
    827,413       48 %     1,166,392       54 %     (338,979 )     (29 )%
Research and related
    206,330       12 %     275,750       13 %     (69,420 )     (25 )%
      1,033,743       60 %     1,442,142       67 %     (408,399 )     (28 )%
Other income (expenses)
    (19,393 )     (1 )%     (263,062 )     (12 )%     243,669       (93 )%
Loss before income taxes
    (14,440 )     (1 )%     (434,040 )     (20 )%     419,600       (97 )%

 
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Loss before income taxes
We showed a loss before income taxes of $14,440 for the six months ended September 30, 2009 compared to a loss before income taxes of $434,040 for the comparable period of the prior year. The $419,600 improvement was primarily attributable to reduced operating and other expenses.
 
Revenues
Revenues of $1,735,297 for the first six months of fiscal 2009 compared to $2,152,157 for the same period of the prior year. The 19% reduction in revenues included reduced product revenues and patent license revenues and increased service revenues. Fiscal 2010 six-month revenues included eVU products and service revenue of $485,297 and patent license revenue of $1,250,000. We recently filed a complaint against nineteen additional electronic manufacturers, and while we expect additional patent licenses from these and other companies in future periods, there can be no assurance of the timing or amounts of any future license revenue. Recent eVU product sales activity has been slow due to airline industry economics and industry credit concerns resulting in airlines curtailing expansion and new projects. Our service revenues have grown as result of prior year customer additions but as service arrangements and terms vary with each customer there is no assurance in the current airline environment that our service revenues will continue at comparable levels for the balance of the fiscal year. We are pursuing new business but our results will continue to be dependent on the timing and quantity of eVU orders and the timing and amount of any patent licensing arrangements.

Gross Profit
Gross profit for the first six months of fiscal 2010 was $1,038,696 or 60% of revenues. The gross profit for the prior year’s first six months was $1,271,164 or 59% of revenues. The amount and percentage of gross profit margins are highly dependent on revenue mix, prices charged, volume of orders and costs.

Operating Expenses
Selling and administrative costs for the six months ended September 30, 2009, were $827,413 compared to $1,166,392 for the first six months of fiscal 2008. The $338,979 decrease included $119,000 of reduced staffing costs due to fewer personnel, a $72,000 reduction in shareholder related costs due do the timing of this year's annual meeting scheduled for the third quarter rather than the second quarter and $105,000 of reduced professional fees primarily due to reduced business litigation costs and a $100,000 reversal of a legal accrual related to such litigation as a result of the favorable litigation outcome. While we expect to incur costs related to our annual shareholder meeting in the third quarter of this fiscal year, we do not expect them to be as high as the prior year’s second quarter costs primarily due to reduced mailing costs.

Research and related expenditures for the six months ended September 30, 2009 were $206,330, compared to $275,750 for the six months ended September 30, 2008. The decrease included $31,000 primarily from reduced staffing and $38,000 from reduced outside engineering services due to reduced internally funded research projects.

Other Income (Expenses)
Net other expenses of $19,393 for the six months ended September 30, 2009 included interest expense of $15,834 (including $15,806 of noncash interest expense) and foreign exchange loss of $1,059. Net other expense was $263,062 for the six months ended September 30, 2008 included a non-cash financing expense of $177,125 related to a charge for warrant modification and $90,708 of interest expense including $43,815 of non-cash interest.

Provision for Income Taxes
Income tax expense of $206,250 consists of foreign taxes payable on patent license revenue.

Loss Attributable to Common Stockholders
The loss attributable to common stockholders for the six months ended September 30, 2009 included the loss after taxes of $220,690 reduced by accrued and deemed dividends on Series AA Stock of $98,701 or a net loss of $319,391.  The loss attributable to common stockholders for the prior comparable six months included the loss after taxes of $698,040 reduced by accrued and deemed dividends on convertible preferred stock of $44,694 or a net loss of $742,734.

Liquidity and Capital Resources
At September 30, 2009, we had working capital of $3,360,263 compared to a working capital of $3,277,225 at March 31, 2009. At September 30, 2009 we had cash on hand of $2,616,717.

 
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Operating Activities
Cash used in operating activities was $1,197,273 for the six months ended September 30, 2009. Cash used in operating activities included the net loss of $220,690 reduced by net non-cash expenses of $52,000. Major components also providing operating cash was an increase of $48,750 in accrued foreign income taxes and $306,470 in accrued and other liabilities that included a $408,000 increase in accrued legal and professional fees offset by a $100,000 reduction in an accrual for litigation. Major components using operating cash included an increase of $1,342,942 in accounts receivable.

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

Cash used in operating activities during the six months ended September 30, 2008 was $1,149,177 resulting from the $698,040 net loss reduced by net non-cash expenses of $225,209. Major components providing operating cash was an increase of $794,356 in accounts payable and $264,000 in accrued income taxes payable. Major components using operating cash included an increase of $1,584,784 in accounts receivable.

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

Investing Activities
The Company’s efforts are primarily on operations and currently we have no significant investing capital needs. We have no commitments requiring investment capital.

Financing Activities
For the six months ended September 30, 2009 we had no financing activities. For the six months ended September 30, 2008, cash provided by financing activities was $1,164,401. This included $500,000 from the sale of common stock and $700,000 cash from the sale of Series AA Stock. We reduced our secured note balance by $50,000, reduced our term note balance by $25,599 and obtained $40,000 in July 2008 from a new one-year note.

Debt and Other Commitments
We currently have unsecured convertible term debt with a principal amount of $97,258. Our plans are to make future principal and interest payments with shares of common stock, subject to maintaining the $0.10 minimum share price and other covenants of the term loan. Aggregate principal and interest payments due to mature in November 2009 are $98,165 with the October payment of $50,000 paid in shares of common stock rather than cash.

At September 30, 2009 we were committed to approximately $106,000 as purchase commitments for product and components. These orders 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 our interim consolidated financial statements.

Our legal firm Duane Morris is handling Patent Enforcement Matters and certain related appeals on our Flash-R patent portfolio on a contingent fee basis. Duane Morris also has agreed to advance certain costs and expenses including travel expenses, court costs and expert fees. We have agreed to pay Duane Morris a fee equal to 40% of any license or litigation recovery related to Patent Enforcement Matters, after recovery of expenses, and 50% of recovery if appeal is necessary.

In the event we are acquired or sold or elect to sell the covered patents or upon certain other corporate events or in the event we terminate the agreement for any reason, then Duane Morris shall be entitled to collect accrued costs and a fee equal to three times overall time and expenses accrued in connection with the agreement and a fee of 15% of a good faith estimate of the overall value of the covered patents. Duane Morris has a lien and a security interest in the covered patents to secure its obligations under the agreement.

 
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Cash Requirements
Other than cash on hand and accounts receivable, we have no material unused sources of liquidity at this time.  Based on our cash position at September 30, 2009 and (a) current planned expenditures and level of operation, and (b) no cash debt service (assuming convertible term debt payments are made in shares of common stock) 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.

Since we have not demonstrated sustainable profitability, our company’s ability to continue as a going concern is in doubt and is dependent upon achieving sustained profitability and if necessary obtaining additional financing. We currently have no plans, arrangements or understandings regarding any acquisitions.

Item 4. Controls and Procedures
Based on an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of September 30, 2009, our President and CEO (“Principal Executive Officer” or “PEO”) and Interim Chief Accounting Officer (“Principal Financial Officer” or “PFO”) have concluded that our disclosure controls and procedures were not effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms.

In connection with the preparation of our annual financial statements, our management performed an assessment of the effectiveness of internal control over financial reporting as of March 31, 2009. Management's assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls. Based on this evaluation, management determined that, as of March 31, 2009, there was a material weakness in our internal control over financial reporting: the lack of independent oversight by an audit committee of independent members of the Board of Directors. In light of this material weakness, management concluded that, as of March 31, 2009, we did not maintain effective internal control over financial reporting. As defined by the Public Company Accounting Oversight Board Auditing Standard No. 5, a material weakness is a deficiency or a combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has concluded that with certain management oversight controls that are in place, the risks associated with the lack of independent audit committee oversight is not sufficient to justify the costs of adding additional directors and independent audit committee members at this time. Management will periodically reevaluate this situation. If we secure sufficient capital or sustain our improved operating results it is our intention to change the composition and/or size of the Board of Directors with emphasis on recruiting qualified independent audit committee members.

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the relationship between the benefit of desired controls and procedures and the cost of implementing new controls and procedures.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in our internal controls over financial reporting that could significantly affect internal controls over financial reporting during the quarter ended September 30, 2009.

 
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PART II.     OTHER INFORMATION

Item 1. Legal Proceedings

Business Litigation
In May 2006, we announced that a complaint had been filed against us and certain of our officers and employees by digEcor, Inc. (“digEcor”) in the Third Judicial District Court of Utah, County of Salt Lake (the “Court”). In January 2007, March 2009 and April 2009 the Court ruled on certain motions of the parties substantially limiting the issues for trial and each party voluntarily dismissed additional claims and specific defendants.  In its rulings, the Court dismissed digEcor's unjust enrichment, fraud, negligent misrepresentation, tortious interference, non-competition, punitive damage and certain unfair competition claims. The bulk of the bench trial related to digEcor’s claims for breaches of three contracts and associated damages, and one claim for injunctive relief was completed in May 2009 followed by the parties filing Proposed Findings of Fact and Conclusions of Law and final arguments in July 2009.
 
On September 14, 2009, we announced that the Court ruled in our favor by dismissing all remaining claims with prejudice and ordering that digEcor recover no damages or injunctive relief. Specifically, the Court dismissed digEcor's claims for breach of a November 2005 Purchase Order between the parties, breach of a DRM Agreement, and breach of an October 22, 2002 Product Agreement. All claims were dismissed "with prejudice and on the merits." The Court also declined to grant digEcor any injunctive relief in connection with the DRM-related claim.  The Court’s ruling and prior rulings may be subject to future appeal by either party.
 
At September 30, 2009 we had an accrual of $80,000 related to a deposit for batteries made by digEcor.
 
On November 13, 2009 we entered into a settlement agreement ending the digEcor litigation with digEcor agreeing to waive any right to appeal the Court’s rulings and orders in our favor and our withdrawing applications for costs of suit. The agreement also reduced and settled the judgment (related to batteries) to $60,000. The agreement included standard mutual release of claims and covenants not to sue.
 
Intellectual Property Litigation
In September 2007 and March 2008, we filed complaints against eight electronic product manufacturers in the U.S. District Court for the Eastern District of Texas asserting that products made by the companies infringe four of our U.S. patents covering the use of flash memory technology. These patents are part of our Flash-R patent portfolio. By September 30, 2009 we had licensed and settled the litigation with seven of the manufacturers and suspended the complaint against one defendant currently in bankruptcy.

Subsequent to September 30, 2009 we 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.

Although most fees, costs and expenses of the litigation are covered under our arrangement with Duane Morris LLP, we may incur support and related expenses for this litigation that may become material.

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
(a)
The following common shares were issued during the fiscal quarter and not previously reported in a Quarterly Report on Form 10-Q or Current Report on Form 8-K:

 
·
On July 31, 2009 the Company issued 458,715 shares of common stock to Davric Corporation in consideration of a $50,000 monthly payment on its 7.5% term note. The shares were sold upon the exemption provided by Section 4(2) under the Securities Act of 1933, no commissions were paid and a restrictive legend was placed on the shares issued.

 
·
On August 5, 2009 the Company issued 1,055,205 shares of common stock upon the conversion of 10,000 shares of Series AA Stock sold for $100,000 cash on June 27, 2008. The shares issued on exchange were issued without restrictive legend in reliance on Rule 144(d).

 
·
On August 31, 2009 the Company issued 431,034 shares of common stock to Davric Corporation in consideration of a $50,000 monthly payment on its 7.5% term note. The shares were sold upon the exemption provided by Section 4(2) under the Securities Act of 1933, no commissions were paid and a restrictive legend was placed on the shares issued.

 
24

 

 
·
On September 30, 2009 the Company issued 322,580 shares of common stock to Davric Corporation in consideration of a $50,000 monthly payment on its 7.5% term note. The shares were sold upon the exemption provided by Section 4(2) under the Securities Act of 1933, no commissions were paid and a restrictive legend was placed on the shares issued.

 
(b)
NONE
 
(c)
NONE

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
Exhibit 31.1 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk, President and CEO (Principal Executive Officer).

Exhibit 31.2 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Robert Putnam, Interim Accounting Officer (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 Alfred H. Falk, President and CEO (Principal Executive Officer) and Robert Putnam, Interim Accounting Officer (Principal Accounting Officer).

 
25

 

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 16, 2009
By:
/s/ ROBERT PUTNAM
   
Robert Putnam, Interim Chief Accounting Officer
   
(Principal Accounting and Financial Officer
   
and duly authorized to sign on behalf of the Registrant)
 
26