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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2012

 

Commission File Number 0-20734

logo_bw_500dpi.jpg

e.Digital Corporation

(Exact name of registrant as specified in its charter)

 

Delaware   33-0591385
(State or other jurisdiction of incorporation or organization)  

(I.R.S. Empl. Ident. No.) 

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

 

(858) 304-3016

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

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

 

As of November 6, 2012 a total of 293,003,158 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, 2012 and March 31, 2012 3
       
    Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2012 and 2011 4
       
    Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2012 and 2011 5
       
    Notes to Interim Condensed Consolidated Financial Statements 6
       
  Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
       
  Item 4. Controls and Procedures 18
       
PART II. OTHER INFORMATION
       
  Item 1. Legal Proceedings 19
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19
  Item 3. Defaults Upon Senior Securities 19
  Item 4. (Removed and Reserved) 19
  Item 5. Other Information 19
  Item 6. Exhibits 19
       
SIGNATURES 20

 

2
 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

e.Digital Corporation and subsidiary

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   September 30,     
   2012   March 31, 
   (Unaudited)   2012 
   $   $ 
ASSETS          
Current          
Cash and cash equivalents   2,546,392    3,125,349 
Accounts receivable   121,779    168,018 
Inventory   41,456    98,136 
Deposits and prepaid expenses   18,458    40,132 
Total current assets   2,728,085    3,431,635 
Inventory, long-term   106,472    88,663 
Property, equipment and intangibles, net of accumulated depreciation and amortization of $190,571 and $187,830, respectively   15,535    18,276 
Total assets   2,850,092    3,538,574 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current          
Accounts payable, trade   131,639    99,949 
Accrued and other liabilities   189,284    211,014 
Total current liabilities   320,923    310,963 
           
Commitments and Contingencies          
           
Stockholders' equity          
Preferred stock, $0.001 par value; 5,000,000 shares authorized, none issued and outstanding        
Common stock, $0.001 par value, authorized 350,000,000, 293,003,158  shares issued and outstanding each period   293,003    293,003 
Additional paid-in capital   82,790,315    82,779,769 
Accumulated deficit   (80,554,149)   (79,845,161)
Total stockholders' equity   2,529,169    3,227,611 
           
Total liabilities and stockholders' equity   2,850,092    3,538,574 

 

 

See notes to interim condensed consolidated financial statements

 

3
 

 

e.Digital Corporation and subsidiary

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

   For the three months ended   For the six months ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
  $   $   $   $ 
Revenues:                
Products   7,849    21,250    10,602    60,257 
Services   115,100    116,903    244,893    234,711 
Patent license   2,000    904,338    2,000    2,929,338 
    124,949    1,042,491    257,495    3,224,306 
                     
Cost of revenues:                    
Products   19,780    24,514    23,112    61,676 
Services   79,568    77,342    170,013    141,422 
Patent license   800    341,670    3,490    1,252,874 
    100,148    443,526    196,615    1,455,972 
Gross profit   24,801    598,965    60,880    1,768,334 
                     
Operating expenses:                    
Selling and administrative   231,942    230,774    454,901    479,621 
Research and related expenditures   168,864    103,736    314,967    293,021 
Total operating expenses   400,806    334,510    769,868    772,642 
                     
Operating income (loss) before provision for income taxes   (376,005)   264,455    (708,988)   995,692 
Income tax provision       (101,025)       (101,025)
Income (loss) for the period   (376,005)   163,430    (708,988)   894,667 
Income (loss) per common share - basic and diluted   (0.00)   0.00    (0.00)   0.00 
                     
Weighted average common shares outstanding                    
Basic and diluted   293,003,158    293,003,158    293,003,158    293,003,158 

 

 

See notes to interim condensed consolidated financial statements

 

4
 

 

e.Digital Corporation and subsidiary

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

   For the six months ended 
   September 30, 
   2012   2011 
  $   $ 
OPERATING ACTIVITIES          
Income (loss) for period   (708,988)   894,667 
Adjustments to reconcile income (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   2,741    2,318 
Warranty provision   1,378    (2,604)
Stock-based compensation   10,546    6,224 
Changes in assets and liabilities:          
Accounts receivable   46,239    (3,326)
Inventory   38,871    39,963 
Deposits and prepaid expenses   21,674    (5,588)
Accounts payable, trade   31,690    205,891 
Accrued and other liabilities   (23,108)   88,321 
Cash provided by (used in) operating activities   (578,957)   1,225,866 
Net increase (decrease) in cash and cash equivalents   (578,957)   1,225,866 
Cash and cash equivalents, beginning of period   3,125,349    1,805,894 
Cash and cash equivalents, end of period   2,546,392    3,031,760 

 

 

See notes to interim condensed consolidated financial statements

 

5
 

  

1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION

 

e.Digital Corporation is a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. The Company markets the eVU™ mobile entertainment system for the travel industry and licenses and enforces its Flash-R™ portfolio of patents related to the use of flash memory in portable devices.

 

Unaudited Interim Financial Statements

These unaudited condensed consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These interim condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments considered necessary for a fair statement of the Company's financial position at September 30, 2012, 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 six months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2013. For further information, refer to the Company's consolidated financial statements and footnotes thereto for the year ended March 31, 2012 filed on Form 10-K.

 

Estimates

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

 

2. RECENT ACCOUNTING PRONOUNCEMENTS

 

There have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended September 30, 2012 that are of significance, or potential significance to the Company’s 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. Diluted earnings per common share is computed by dividing loss attributable to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities included outstanding stock options and warrants. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. These securities were not included in the computation of diluted loss per share for the periods because they are antidilutive, but they could potentially dilute earnings per share in future periods. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities. For the periods presented potential dilutive securities were not included in the computation of diluted earnings (loss) per share because they had no effect or were antidilutive, but they could potentially dilute earnings per share in future periods. There was no difference in basic and diluted earnings (loss) per share or basic and diluted weighted average shares outstanding for the periods presented.

 

6
 

 

4. INVENTORIES

 

Inventory is recorded at the lower of cost or net realizable value. The cost of substantially all the Company’s inventory is determined by the weighted average cost method.

 

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

 

Inventories consisted of the following:

 

   September 30,   March 31, 
   2012   2012 
   $   $ 
Raw materials   55,414    55,430 
Work in process   15,346    15,410 
Finished goods   81,208    115,959 
    151,968    186,799 
Reserve for obsolescence   (4,040)    
    147,928    186,799 
Less current portion   41,456    98,136 
Inventory, long term   106,472    88,663 

  

The foregoing is net of an aggregate lower-of-cost-or-market inventory adjustment of $84,150 at September 30, 2012, which includes a current period adjustment of $18,691,and $65,459 at March 31, 2012, respectively.

 

5. STOCK-BASED COMPENSATION COSTS

 

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

  

   Three Months Ended   Six Months Ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
Research and development   1,196    2,174    2,392    5,865 
Selling and administrative   4,265    326    8,154    359 
Total stock-based compensation expense   5,461    2,500    10,546    6,224 

   

As of September 30, 2012 total estimated compensation cost of stock options granted but not yet vested was $11,143 and is expected to be recognized over the weighted average period of 0.7 years.

 

No stock options were granted during the three or six-month periods ended September 30, 2012 and 2011.

 

See Note 7 for further information on outstanding stock options.

 

7
 

 

6. WARRANTY RESERVE

 

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

 

   Three Months Ended   Six Months Ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
Beginning balance   633    3,205    1,093    4,589 
Warranty provision   1,064    (1,271)   1,378    (2,604)
Warranty usage   (1,329)       (2,103)   (51)
Ending balance   368    1,934    368    1,934 

  

7. STOCKHOLDERS’ EQUITY

 

The following table summarizes stockholders’ equity transactions during the six-month period ended September 30, 2012:

 

   Common stock   Additional   Accumulated   Total stockholders' 
   Shares   Amount   paid-in capital   deficit   equity 
        $   $   $   $ 
Balance, April 1, 2012   293,003,158    293,003    82,779,769    (79,845,161)   3,227,611 
Stock-based compensation           10,546        10,546 
Loss for the period               (708,988)   (708,988)
Balance, September 30, 2012   293,003,158    293,003    82,790,315    (80,554,149)   2,529,169 

  

Options

The following table summarizes stock option activity for the period:

 

        Weighted average   Aggregate
    Shares   exercise price   Intrinsic Value
    #   $   $
Outstanding April 1, 2012 7,355,000   0.09    
  Granted                       -           
  Exercised                       -          
  Canceled/expired                       -      -    
Outstanding September 30, 2012 7,355,000   0.09   $            87,740
Exercisable at September 30, 2012 6,405,000   0.10   $            44,670

  

(1)Options outstanding are exercisable at prices ranging from $0.02 to $0.155 and expire over the period from 2013 to 2015.
(2)Aggregate intrinsic value is based on the closing price of our common stock on September 30, 2012 of $0.07 and excludes the impact of options that were not in-the-money.

 

Share warrants

No warrants were outstanding at September 30, 2012 and September 30, 2011.

 

8. FAIR VALUE MEASUREMENTS

 

Cash and cash equivalents are measured at fair value in the Company’s consolidated financial statements. Accounts receivable are financial assets with carrying values that approximate fair value due to the short-term nature of these assets. Accounts payable and accrued and other liabilities are financial liabilities with carrying values that approximate fair value due to the short-term nature of these liabilities. Effective April 1, 2008 the Company adopted and follows ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) which established a fair value hierarchy that requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instruments categorization within the hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

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

 

8
 

 

9. SEGMENT INFORMATION

 

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

 

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

 

Reportable segment information for the three and six months ended September 30, 2012 and 2011 is as follows:

  

   For the three months ended   For the six months ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
REVENUES:                    
Products and services   122,949    138,153    255,495    294,968 
Patent licensing   2,000    904,338    2,000    2,929,338 
Total revenue   124,949    1,042,491    257,495    3,224,306 
                     
GROSS PROFIT:                    
Products and services gross profit   23,601    36,297    62,370    91,870 
Patent licensing gross profit (loss)   1,200    562,668    (1,490)   1,676,464 
Total gross profit   24,801    598,965    60,880    1,768,334 
                     
RECONCILIATION:                    
Total segment gross profit   24,801    598,965    60,880    1,768,334 
Operating expenses   (400,806)   (334,510)   (769,868)   (772,642)
Income (loss) before income taxes   (376,005)   264,455    (708,988)   995,692 

 

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

 

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

 

   For the three months ended   For the six months ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
   $   $   $   $ 
United States   2,000    904,338    2,000    2,929,338 
International   122,949    138,153    255,495    294,968 
Total revenue   124,949    1,042,491    257,495    3,224,306 

 

Revenues from five customers comprised 33%, 22%, 12%, 10% and 10% of revenue for the six months ended September 30, 2012, with no other licensee or customer accounting for more than 10% of revenues. Revenues from three licensees comprised 32%, 31% and 15% of revenue for the six months ended September 30, 2011, with no other customer accounting for more than 10% of revenues. Accounts receivable from two customers comprised 48% and 22% of net accounts receivable at September 30, 2012. Accounts receivable from three customers comprised 28%, 25% and 22% of net accounts receivable at September 30, 2011.

 

9
 

 

10. COMMITMENTS AND CONTINGENCIES

 

Legal Matters

 

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

 

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

 

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

 

In October and November 2012 the Company commenced enforcement action with respect to its patent portfolio by filing complaints against Diasonic Technology, Co Ltd., Yamaha Corporation, Yamaha Corporation of America, Korg, Inc., and Korg USA, SanDisk Corporation, Philips Electronics North America Corporation and Grundig Intermedia GmbH (Grundig), in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe the Company’s U.S. patents covering the use of flash memory technologies.

 

Facility Lease

In January 2012, the Company entered into a sixty-two month facility lease for its corporate office location, commencing May 1, 2012, for approximately 3,253 square feet at 16870 West Bernardo Drive, Suite 120, San Diego, California. The aggregate monthly payment is $4,879 excluding utilities and costs. The aggregate payments adjust annually with maximum payments increasing to $7,157 in the forty-ninth through sixty-second months. Future lease commitments at September 30, 2012 total $355,881. The Company recognizes rent expense by the straight-line method over the lease term. As of September 30, 2012, deferred rent totaled $17,485.

 

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, 2012 had substantially all of its cash and cash equivalents at one financial institution in a non-interest bearing account, which pursuant to current rules is insured in full by the Federal Deposit Insurance Corporation through December 31, 2012. The Company does not believe that it is subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships. The Company performs periodic evaluations of the relative credit standing of these financial institutions. The Company has not experienced any significant losses on its cash equivalents.

 

Concentrations of credit risk with respect to trade accounts receivable are limited due to the number and nature of customers comprising the Company’s customer base and their geographic dispersion. The Company has not incurred any significant credit related losses.

 

The Company relies on one third-party contract manufacturer to produce its eVU mobile entertainment product and generally relies on single suppliers for batteries, charging stations and other components. The Company also relies on one legal firm to represent it in patent licensing and enforcement matters.

 

Guarantees and Indemnifications

The Company enters into standard indemnification agreements in the ordinary course of business. Some of the Company’s product sales and services agreements include a limited indemnification provision for claims from third parties relating to the Company’s intellectual property. Such indemnification provisions are accounted for in accordance with ASC 450, Contingencies. The indemnification is generally limited to the amount paid by the customer. To date, there have been no claims under such indemnification provisions.

 

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

 

10
 

 

Employee Benefit – 401K Plan

In September 2012, the Company adopted a defined contribution plan (401(k)) covering its employees. Matching contributions are made on behalf of all participants, according to the Safe Harbor provision. The Company matches 100% (dollar for dollar) on deferrals of up to 4% of employee compensation deferred. As of September 30, 2012, the Company made matching contributions totaling $750.

 

11. INCOME TAXES

 

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

 

At September 30, 2012, the Company had deferred tax assets associated with federal net operating losses (“NOLs”), related state NOLs, foreign tax credits and certain Federal and California research and development tax credits, but recorded a corresponding full valuation allowance as it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

The Company records a liability for uncertain tax positions when it is probable that a loss has been incurred and the amount can be reasonably estimated.  At September 30, 2012, the Company has no liabilities for uncertain tax positions. 

 

 

11
 

 

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

 

THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW. SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2012.

 

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 market our eVU mobile entertainment system for the travel industry and license and enforce our Flash-R™ portfolio of flash memory patents for use in portable devices produced by electronic product manufacturers. We also seek to expand our licensable intellectual property portfolio and in fiscal 2011 and 2012, filed seven new U.S. patent applications for technologies related to communication networks and digital data distribution. In November 2012, four of these patents were granted by the United States Patent and Trademark Office (USPTO), and we have received Issue Notification for two additional patents.

 

With the inception of patent license revenue in September 2008, we determined that we have two operating segments: (1) products and services and (2) patent licensing and enforcement. Our products and services revenue is derived from the sale of eVU products and accessories to customers, warranty and technical support services and content integration fees and related services. Our patent licensing and enforcement revenue consists of intellectual property revenues from our Flash-R™ patent portfolio.

 

Our strategy is to continue to market our eVU products and services to U.S. and international companies for use in the airline and other travel industries. We employ direct sales and also 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 aggressively pursue enforcement by litigating against targeted parties that we believe are infringing our patents. The law firm of Handal and Associates is handling our patent enforcement matters on a partial contingent fee basis. To date we have completed two rounds of patent infringement litigation and sought licenses from a total of 27 companies with 19 agreeing to license and settlement terms during the discovery stage of related litigation.

 

In September 2012 we announced that the United States Patent and Trademark Office (USPTO) had completed the reexamination of our U.S. Patent Nos. 5,491,774 (the ‘774) and 5,742,737 (the ‘737). While we were required to supplement one claim of the ‘737 patent and modify certain claims of the ‘774 patent, we believe the reexam process reaffirmed important patent claims as we continue our Flash-R™ patent portfolio monetization activities.

 

In October and November 2012 the Company commenced enforcement action with respect to its patent portfolio by filing complaints against Diasonic Technology, Co Ltd., Yamaha Corporation, Yamaha Corporation of America, Korg, Inc., and Korg USA, SanDisk Corporation, Philips Electronics North America Corporation and Grundig Intermedia GmbH (Grundig), in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe the Company’s U.S. patents covering the use of flash memory technologies.

 

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We expect to file future complaints against additional companies and license additional companies. There can be no assurance of the timing or amounts of any related license revenue. We also are developing new intellectual property for possible licensing in the areas of communication networks and digital data distribution.

 

Our business is high risk in nature. There can be no assurance we can achieve sufficient eVU or patent license revenues to sustain profitability. We continue to be subject to the risks normally associated with introducing new products, services and technologies, including unforeseeable expenses, delays and complications. Accordingly, there is no guarantee that we can or will report operating profits in future periods.

 

Overall Performance and Trends

We focused significant efforts on developing, licensing and enforcing our patent portfolio during the first six months of fiscal 2013 and during the fiscal years ended March 31, 2012 and 2011. While we have settled and licensed with a total of nineteen defendants to date, there is a reluctance of patent infringers to negotiate and ultimately take a patent license without at least the threat of legal action. However, the majority of patent infringement contentions settle out of court, based on the strength of the patent claims, validity, and persuasive evidence and clarity that the patent is being infringed. Although we believe we have been successful in early licensing by demonstrating the strength, validity and clarity of our patent claims, prior court rulings and future events including new court rulings and new patent reexaminations could have a significant positive or negative impact on future licensing activity.

 

Our eVU IFE business remained slow during the first six months primarily due to increased competition, rapid consumer adoption of portable devices and airline economics. We are unable to predict future sales levels in this market as orders have been and are expected to continue to be sporadic from both existing and new customers. We continue to pursue business in the airline and other markets for our eVU product line.

 

Management faces challenges for the remainder of fiscal 2013 to execute its plan; promote its eVU business, license new intellectual property currently in development, and obtain Flash-R™ patent portfolio license fees. The failure to obtain additional patent license revenues or eVU orders or delays of orders or production delays could have a material adverse impact on our operations. Our patent licensing business is subject to significant uncertainties as to the timing and amount of future license revenues, if any. We may also face unanticipated technical or manufacturing obstacles and face warranty and other risks in our business.

 

For the six months ended September 30, 2012 we recognized a net loss before income taxes of $708,988 compared to net income before income taxes of $995,692 for the comparable period of the prior fiscal year. Our revenues were $257,495 for the first six months of fiscal 2013 including $2,000 of patent license revenue. This compares to revenues of $3,224,306 for the prior year’s first six months including $2,929,338 of patent license revenue. We reported operating expenses totaling $769,868 in the six months ended September 30, 2012 which is comparable to the amount reported in the same period of the prior year of $772,642.

 

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

 

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements located in Item 1 of Part I, “Financial Statements,” and in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report of Form 10-K for the year ended March 31, 2012. The preparation of these financial statements prepared in accordance with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates, including but not limited to those related to revenue recognition, bad debts, inventory valuation, intangible assets, financing operations, stock-based compensation, fair values, income taxes, contingencies and litigation.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

 

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We believe that, of the significant accounting policies discussed in our consolidated financial statements, the following accounting policies require our most difficult, subjective or complex judgments:

 

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

 

Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. There were no significant changes or modification of our critical accounting policies and estimates involving management valuation adjustments affecting our results for the six months ended September 30, 2012. For further information on our critical accounting policies, refer to Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended March 31, 2012.

 

Results of Operations

 

Three months ended September 30, 2012 compared to the three months ended September 30, 2011

 

   Three Months Ended September 30,         
   2012       2011             
       % of       % of   Change 
   Dollars   Revenue   Dollars   Revenue   Dollars   % 
Revenues:                              
Products   7,849    6%   21,250    2%   (13,401)   (63%)
Services   115,100    92%   116,903    11%   (1,803)   (2%)
Patent license   2,000    2%   904,338    87%   (902,338)   (100%)
    124,949    100%   1,042,491    100%   (917,542)   (88%)
Gross Profit:                              
Product (loss)   (11,931)   (10%)   (3,264)   (0%)   (8,667)   266%
Service gross profit   35,532    29%   39,561    4%   (4,029)   (10%)
Patent license gross profit   1,200    1%   562,668    54%   (561,468)   (100%)
    24,801    20%   598,965    57%   (574,164)   (96%)
Operating Expenses:                              
Selling and administrative   231,942    186%   230,774    22%   1,168    1%
Research and related   168,864    135%   103,736    10%   65,128    63%
    400,806    321%   334,510    32%   66,296    20%
Income (loss) before income taxes   (376,005)   (301%)   264,455    25%   (640,460)   (242%)

 

Income (Loss) Before Income Taxes

We reported a net loss before income taxes of $376,005 for the three months ended September 30, 2012 compared to a net income before income taxes of $264,455 for the comparable period of the prior year due primarily to reduced patent license settlements in the current year.

 

Revenues

Revenues decreased during the most recent fiscal quarter (Q2 of fiscal 2013) compared to the same quarter of the prior fiscal year due to reduced license arrangement activity. We experienced reduced product and service revenues due to no significant new customers or product sales and reduced service revenues from ongoing customers. Our product revenues have been sporadic in part as a result of industry economics including the rapid consumer adoption of portable devices resulting in reduced IFE activity. Our service revenues declined and vary depending on repair and content services provided to a changing customer mix.

 

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License fee revenues recognized fluctuate significantly from period to period primarily based on the following factors:

·the dollar amount of agreements executed each period, which is primarily driven by the magnitude of infringement associated with a specific licensee;
·the specific terms and conditions of agreements executed each period and the periods of infringement contemplated by the respective payments; and
·fluctuations in the number of agreements executed.

 

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

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

 

We are pursuing new eVU business and targeting new patent licensees but our results will continue to be dependent on the timing and quantity of eVU orders and the timing and amount of future patent licensing arrangements, if any.

 

Gross Profit

Gross profit for the second quarter of fiscal 2013 was $24,801 or 20% of revenues, and was negatively impacted by an $18,691 lower-of-cost-or-market adjustment to inventory. The gross profit on product and service revenues was 19% of related revenues and the gross profit on patent licensing fees was 60% of license revenues. The gross profit for the prior year’s second quarter was $598,965 or 57% of revenues. Gross profit margins are highly dependent on revenue mix, prices charged, volume of orders, and for periods with patent licensing revenues the amounts of contingency legal fees and costs.

 

Operating Expenses

Selling and administrative costs for the three months ended September 30, 2012 declined by $1,168 compared to the same period in the year prior. The current period included a $4,265 expense for noncash stock-based compensation expense compared to $326 for the prior year’s second quarter. Current period selling and administrative expenses included $23,102 of increased staffing costs, offset by lack of current year annual meeting costs of $18,690, reduced professional fees of $3,198 and reduced rent and related expenses of $9,341.

 

Research and related expenses in the most recent quarter included $1,196 of noncash stock-based compensation costs compared to $2,174 in the prior year’s second quarter. Research and related expenses increased by $65,128 due primarily to $54,202 of increased patent related costs. Research and related expenses can vary significantly from quarter to quarter based on the allocation of time spent by personnel who work on both revenue producing service and repair projects, on patent related costs and on internal research projects. Such expenses also vary based on decisions made regarding outside engineering and consulting.

 

Income Taxes

There was no income tax expense or benefit in the current period. Income tax expense for the three months ended September 30, 2011 was $101,025 consisting of $57,025 foreign tax expense and $44,000 as a provision for California state taxes.

 

Income (Loss)

The net loss for the three months ended September 30, 2012 was $376,005. The net income for the prior comparable second quarter was $163,430.

 

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Six months ended September 30, 2012 compared to the six months ended September 30, 2011

 

   Six Months Ended September 30,         
   2012       2011             
       % of       % of   Change 
   Dollars   Revenue   Dollars   Revenue   Dollars   % 
Revenues:                              
Product revenues   10,602    4%   60,257    2%   (49,655)   (82%)
Service revenues   244,893    95%   234,711    7%   10,182    4%
Patent license   2,000    1%   2,929,338    91%   (2,927,338)   (100%)
    257,495    100%   3,224,306    100%   (2,966,811)   (92%)
Gross Profit:                              
Product (loss)   (12,510)   (5%)   (1,419)   0%   (11,091)   782%
Service gross profit   74,880    29%   93,289    3%   (18,409)   (20%)
Patent license gross profit (loss)   (1,490)   0%   1,676,464    52%   (1,677,954)   (100%)
    60,880    24%   1,768,334    55%   (1,707,454)   (97%)
Operating Expenses:                              
Selling and administrative   454,901    177%   479,621    15%   (24,720)   (5%)
Research and related   314,967    122%   293,021    9%   21,946    7%
    769,868    299%   772,642    24%   (2,774)   (0%)
Income (loss) before income taxes   (708,988)   (275%)   995,692    31%   (1,704,680)   (171%)

  

Income (Loss) Before Income Taxes

The loss before income taxes of $708,988 for the six months ended September 30, 2012 resulted primarily from no new license arrangements.

 

Revenues

Revenues decreased during the most recent six months compared to the same period of the prior fiscal year due to the decrease in patent license revenue from $2,929,338 to $2,000. We currently have one licensee reporting periodic royalties. One such payment was recognized in Q2 of the current year and one in the same period of the prior year. All other royalties have been one-time fully paid up royalties. Service revenues vary depending on repair and content services provided to a changing customer mix. eVU product sales activity have been slow and sporadic due to airline industry economics including rapid consumer adoption of portable devices, with airlines curtailing expansion and new projects. Our product sales for the first six months are not necessarily indicative of future orders and we had no significant product backlog at September 30, 2012. Our service agreements and terms vary with each customer and there is no assurance in the current airline environment that our service revenues will continue at comparable levels for the balance of the fiscal year or in future periods.

 

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

 

Gross Profit

Gross profit for the six months ended September 30, 2012 was $60,880 or 24% of revenues, and was negatively impacted by an $18,691 lower-of-cost-or-market adjustment to inventory. The gross profit for the prior year’s first six months was $1,768,334 or 55% of revenues. Gross profit margins are highly dependent on revenue mix, prices charged, volume of orders, and for periods with significant patent licensing revenues the amounts of contingency legal fees and costs.

 

Operating Expenses

Selling and administrative costs for the six months ended September 30, 2012 declined by $24,720 compared to the same period in the year prior. The current period included an $8,154 expense for noncash stock-based compensation expense compared to $359 for the prior year’s first six months. Current period selling and administrative expenses included $53,483 of increased staffing costs, offset by lack of current year annual meeting costs of $60,281, reduced professional fees of $19,769 and reduced rent and related expenses of $13,315.

 

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Research and related expenses in the most recent six months included $2,392 of noncash stock-based compensation costs compared to $5,865 for the same period in the prior year. Research and related expenses increased by $21,946 due primarily to $13,924 of increased patent related costs and increased salaries expense of $11,569. Research and related expenses can vary significantly from quarter to quarter based on the allocation of time spent by personnel who work on both revenue producing service and repair projects, on patent related costs and on internal research projects. Such expenses also vary based on decisions made regarding outside engineering and consulting.

 

Income (Loss)

The net loss was $708,988 for the six months ended September 30, 2012. The net income for the prior comparable six month period was $894,667.

 

Liquidity and Capital Resources

At September 30, 2012, we had working capital of $2,407,162 compared to working capital of $3,120,672 at March 31, 2012. At September 30, 2012 we had cash on hand of $2,546,392.

 

Operating Activities

Cash used by operating activities was $578,957 for the six months ended September 30, 2012. Cash used by operating activities included the net loss of $708,988 decreased by net non-cash expenses of $14,665. Major components providing operating cash were a decrease of $46,239 in accounts receivable, a decrease of $38,871 in inventory including lower-of-cost or market adjustments of $18,691, and an increase of $31,690 in accounts payable. A major component reducing operating cash was a decrease of $21,730 in accrued and other liabilities.

 

Cash provided by operating activities was $1,225,866 for the six months ended September 30, 2011. The provision was primarily the result of the net income of $894,667.

 

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

 

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

 

Investing Activities

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

 

Financing Activities

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

 

Debt and Other Commitments

We currently have no debt outstanding other than trade payables and accruals. At September 30, 2012 we had no significant purchase commitments for product and components.

 

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

 

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

 

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, 2012 and current planned expenditures and level of operation, we believe we have sufficient capital resources for the next twelve months. Actual results could differ significantly from management plans. We believe we may be able to obtain additional funds from future patent licensing and eVU product sales and services but the timing of licenses and shipments and the amount and quantities of shipments, orders and reorders are subject to many factors and risks, many outside our control.

 

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Item 4. Controls and Procedures

 

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

 

We carried out an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2012, the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms.

  

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There have been no changes in our internal control over financial reporting during our fiscal quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Our process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies which may be identified during this process.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Intellectual Property Litigation

The Company engages in litigation from time to time as part of its Flash-R™ portfolio licensing and enforcement activities. In October and November 2012 the Company commenced enforcement action with respect to its patent portfolio by filing complaints against Diasonic Technology, Co Ltd., Yamaha Corporation, Yamaha Corporation of America, Korg, Inc., and Korg USA, SanDisk Corporation, Philips Electronics North America Corporation and Grundig Intermedia GmbH (Grundig), in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe the Company’s U.S. patents covering the use of flash memory technologies.

  

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

 

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

 

Item 3. Defaults Upon Senior Securities

 

NONE

 

Item 4. (Removed and Reserved)

 

Item 5. Other Information

 

(a) NONE

(b) NONE

 

Item 6. Exhibits

 

Exhibit 31.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk, President and CEO (Principal Executive Officer).
   
Exhibit 31.2 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by MarDee Haring-Layton (Chief Financial Officer).
   
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk, President and CEO (Principal Executive Officer) and MarDee Haring-Layton (Chief Financial Officer).
   
  Extensible Business Reporting Language (XBRL) Exhibits
   
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Labels Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

  

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

  e.DIGITAL CORPORATION
     
  By: /s/ ALFRED H. FALK
    Alfred H. Falk, President and Chief Executive Officer
     
  By: /s/ MARDEE HARING-LAYTON
    MarDee Haring-Layton, Chief Financial Officer

 

Date: November 13, 2012

 

 

 

 

 

 

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