ITEM 1. BUSINESS
Overview
e.Digital Corporation (referred to as “e.Digital”, the “Company”, “we”, “our” or “us”) is a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. The Company is developing and marketing an intellectual property portfolio including (a) licensing and enforcing its Flash-R™ portfolio of patents related to the use of flash memory in portable devices, and (b) developing new licensable intellectual property related to context and interpersonal awareness systems (“Nunchi” technology), advanced data security technologies (“microSignet” technology) and other technologies.
We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against targeted parties that we believe are infringing our patents. We commenced legal enforcement actions in 2007 and since September 2012, the law firm of Handal and Associates has been handling our patent enforcement matters on a partial contingent fee basis.
Currently, we have active enforcement lawsuits filed against parties believed to infringe patents covering the use of our flash memory technologies. In fiscal 2013 we commenced enforcement action with respect to our patent portfolio by filing complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe our U.S. patents. During fiscal years 2013 through 2015, we commenced enforcement action with respect to our patent portfolios and have filed a total of 82 complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe our U.S. patents. As of June 4, 2015, 60 defendants had agreed to license and settlement terms during the course of related enforcement litigation.
While we expect to file future complaints against additional companies and license additional companies, there can be no assurance of the timing or amounts of any related license revenue. We have developed and continue to develop new intellectual property for licensing in the areas of context and interpersonal awareness (Nunchi), advanced data security technologies (microSignet) and other technologies.
During the third quarter of fiscal 2015 we ceased providing eVU® mobile entertainment services to our travel industry customers, with the sole exception of one remaining contract to be completed by September 2015.
Our principal executive offices and primary operating facilities are located at 16870 West Bernardo Drive, Suite 120, San Diego, California 92127 and our telephone number is (858) 304-3016. Our Internet site is located at www.edigital.com. Information contained on our Internet site is not part of this annual report.
Our Company, then known as Norris Communications, was incorporated in the Province of British Columbia, Canada on February 11, 1988 and on November 22, 1994 changed its domicile to the Yukon Territory, Canada. On August 30, 1996, we filed articles of continuance to change our jurisdiction to the State of Wyoming, then on September 4, 1996, reincorporated in the State of Delaware. On January 13, 1999, the stockholders approved a name change to e.Digital Corporation.
History of Technical Innovations
We have a record of pioneering technical innovations and achievements in developing portable electronic products and other innovative technologies. These innovations and achievements include:
Invented the technology of combined microphone and speaker earpieces without feedback. (This was the first product in what ultimately became today’s line of Jabra hands-free communication products.)
Developed the first portable digital player/recorder with removable flash memory, resulting in five U.S. patents on the use of flash memory in portable devices.
Developed the first high-speed download device to store digital voice recordings on a personal computer in compressed format.
Developed the first multi-codec (including MP3) portable digital music player.
Delivered an integrated digital voice recorder and computer docking station system for medical transcription of voice and data for Lanier Healthcare, LLC.
Developed the first voice controlled MP3 player using our VoiceNav® speech navigation system. Bang & Olufsen introduced a branded digital audio player (BeoSound 2) developed by us pursuant to a license agreement.
Designed, developed and delivered wireless MP3 headsets employing our MicroOS™ operating system to Hewlett-Packard for use at Disneyworld in Orlando, Florida. Licensed our digital audio platform to a multi-billion dollar Asian OEM for branding to Gateway Computers. Developed the first hard drive-based Hollywood studio-approved portable inflight entertainment (“IFE”) device.
Introduced eVU, a next generation dedicated mobile entertainment device with 12+ hours of playback, wireless capability and proprietary content encryption approved by major studios.
Introduced eVU-ER, an improved dedicated portable IFE player featuring a new power management technology providing an industry-leading 20+ hours of continuous video playback from a single battery. eVU is available in either a 7" or 8" high resolution LCD screen with 160 GB to 200 GB of rugged and reliable storage.
Added new features to eVU including an advanced touch screen interface.
2010 - 2013 Developed new technology in the areas of context and interpersonal awareness, cloud technology, information security, user authentication and digital data distribution.
2012 - 2013 Granted six patents for context and interpersonal awareness systems technologies, Nunchi.
Granted first patent related to advanced data security, microSignet.
Granted additional patent for context and interpersonal awareness systems technologies, Nunchi.
We have accumulated a body of proprietary technology some covered by patents, both issued and pending, along with other technology protected by trade secrets and copyrights.
Technologies
Flash-R™ Technology
Our Flash-R patent portfolio covers certain aspects of the use of flash memory, addressing today's large and growing portable electronic products market. In 1993, we began marketing the first digital voice recorder with removable flash memory. In 1996, we produced and marketed the first digital voice recorder interface for downloading and managing voice recordings on the personal computer.
Three of our Flash-R U.S. patents expired in 2014 and two more expire in 2016. Under applicable law, we have six years from the date that a putative infringer is on notice of its infringement of the patents. Accordingly, if we put an infringer on notice of infringement by filing a lawsuit, and that infringer did not have notice of infringement prior to receiving the lawsuit, our damages would be limited to the period commencing from the date of service of the lawsuit and would end on the expiration of the patents at issue. If we take action immediately following the patent termination date, the damage amount may extend to the full six years of prior use but only if the infringer is on notice of infringement. At expiration, a patent becomes public domain. As a result, we have no cause of action against any party that first has notice of infringement after a patent's expiration. As to those that may have notice of infringement before expiration, the six year look-back period declines on a daily basis. No action may be brought, however, six years after a patent's expiration.
Certain aspects of our Flash-R patent portfolio are protected through March of 2016 and include the following U.S. patents:
· US5787445:Operating system including improved file management for use in devices utilizing flash memory as main memory (expires March 7, 2016)
· US5839108:Flash memory file system in a handheld record and playback device (expires March 7, 2016)
We believe our Flash-R patent portfolio covers certain fundamental technology related to many consumer electronics products that utilize flash memory including cell phones, digital cameras, camcorders, PDAs and other popular devices.
Nunchi Technology® - - Context and Interpersonal Awareness Systems
Our Nunchi patent portfolio covers certain aspects of advanced context awareness, addressing emerging products, services and revenue models. Our Nunchi technology includes a patent portfolio of seven U.S. patents (below):
· US8306514:System and Method for Managing Mobile Communications (expires 2030)
· US8311522:System and Method for Managing Mobile Communications (expires 2030)
· US8311523:System and Method for Managing Mobile Communications (expires 2030)
· US8311524:System and Method for Managing Mobile Communications (expires 2030)
· US8315618:System and Method for Managing Mobile Communications (expires 2030)
· US8315619:System and Method for Managing Mobile Communications (expires 2030)
· US9002331:System and Method for Managing Mobile Communications (expires 2030)
Other related continuation applications of some of the issued patents are currently pending and we evaluate additional developments for new applications as we further develop this technology.
microSignet™- Data security technology based on defects in semi-conductors
Our microSignet patent (and pending continuation) covers applications reliant on securing data, derived from physical characteristics of semiconductors. The following U.S. patent has issued:
· US8572440:System and Method for Managing Information Stored in Semi-Conductors (expires 2030)
We believe our portfolios cover important aspects of integrating cloud-based servers, existing communication networks and relational databases and data security, to both understand and anticipate the needs of people.
Other Technology
We continue to focus on adding to our intellectual property portfolio. There can be no assurance we can exploit any new innovations in future periods.
Intellectual Property Portfolio Licensing and Enforcement
While we are adding new intellectual property, we believe we have an important portfolio of patents (Flash-R technology, Nunchi technology and microSignet) and we are actively engaged in a strategy to monetize our patent portfolio through licensing and enforcement.
In June 2006 we engaged an intellectual property consultant to investigate, document and develop the Flash-R portfolio and to liaison with outside legal counsel. We, and our advisors, have performed due diligence on our patents and we believe we have strong licensable intellectual property rights. Under U.S. law, an inventor or patent owner has the right to exclude others from making, selling or using their patented invention. Unfortunately, in the majority of cases, infringers are generally unwilling, at least initially, to negotiate or pay reasonable royalties for their unauthorized use of third-party patents and will typically fight any allegations of patent infringement. Inventors and/or patent holders without sufficient financial or expert technical resources to bring legal action may lack credibility in dealing with unwilling licensees and as a result, are often ignored.
As a result of the common reluctance of patent infringers to negotiate and ultimately take a patent license for the use of third-party patented technologies without at least the threat of legal action, patent licensing and enforcement often begins with the filing of patent enforcement litigation. However, the majority of patent infringement contentions settle out of court based on the strength of the patent claims, validity, and persuasive evidence and clarity that the patent is being infringed.
We execute patent licensing arrangements with users of our patented technologies through willing licensing negotiations and through the negotiation of license and settlement arrangements in connection with the filing of patent infringement litigation. We also discuss licenses without the filing of patent infringement litigation and may enter into some future licenses with licensees without the filing of a specific patent infringement action against such licensee. We anticipate bringing additional patent enforcement actions in the future.
Some license agreements include nonexclusive cross licenses and our policy is to value these only if directly used in operations. To date we have not valued any cross licenses received as they were considered part of the licensee’s overall license and settlement strategy and are not currently used in our products.
Licensing and Patent Enforcement Activities
We are commercializing our patent portfolios through licensing and we are aggressively pursuing enforcement by litigating against targeted parties that we believe are infringing our patents. We commenced legal enforcement actions in 2007 and since September 2012, the law firm of Handal and Associates has been handling our patent enforcement matters on a partial contingent fee basis.
Beginning in fiscal 2013 we commenced new rounds of enforcement actions with respect to our patent portfolios by filing complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe our U.S. patents. Currently, we have active lawsuits filed against parties believed to infringe patents covering the use of our Flash-R and Nunchi technologies.
Flash-R Technology Enforcement and Licensing Progress - In November 2014, our appeal to the Federal Circuit Court of Appeals regarding application of the doctrine of collateral estoppel as to our U.S. Patent No. 5,839,108 (“the ‘108 patent”) was successful. The Court upheld the lower court’s application of collateral estoppel to U.S. Patent No. 5,491,774 (“the ‘774”), which has now expired. In December 2014 the United States District Court for the Southern District of California ruled favorably regarding our claim construction of the ‘108 patent. As a result we entered into license and settlement agreements with additional defendants. In January and February 2015 we filed additional enforcement actions against multiple defendants.
Nunchi Technology Enforcement - We commenced legal action with regard to our Nunchi portfolio of patents in July 2014. We currently have two active complaints in the U.S. District Court for the Northern District of California and one active complaint in the U.S. District Court for the Southern District of California.
MicroSignet Technology - We are seeking to license our MicroSignet technology and to date have not commenced any legal actions but may do so in the future.
While we expect to file future complaints against additional companies and license additional companies, there can be no assurance of the timing or amounts of any related license revenue. We continue to develop additional intellectual property in the areas of context and interpersonal awareness systems as well as explore new technologies for possible development or licensing.
Technology Licensing and Enforcement Strategy
We are expanding our intellectual property portfolio. We were granted six patents related to context and interpersonal awareness systems by the United States Patent and Trademark Office (USPTO) in fiscal 2013, and one in fiscal 2015 Additionally, in fiscal 2013 we filed three new U.S. patent continuation applications for technologies related to our Nunchi context and interpersonal awareness systems, and may file additional patent applications in the future related to these or other technologies. Our strategy is to select and prioritize new technologies and when deemed appropriate, to develop functional systems employing one or more technologies. Currently we have no plans to introduce new products but seek strategic partners or licensees for commercialization of products and services, based on our technologies.
We use the services of officers, employees and our legal firm, Handal and Associates, to assist us in investigating and evaluating prospective licensees and strategic partners for our intellectual property. While we have identified a large number of products and companies that we believe are using our technologies, this is an ongoing process as new products and companies are identified from our research. To date we have filed patent infringement litigation and sought licenses from 109 companies and related distributors with 78 agreeing to license terms as of June 4, 2015.
We believe we are building a track record of demonstrating the strength, validity and clarity of our various patent claims and the value of our intellectual property and we believe that we can build a growing licensing business from our intellectual property portfolios. The timing of future litigation or licensing is subject to many factors, some of which are not within our control.
eVU Mobile Entertainment System Business
Our eVU IFE business continued to decline in the fiscal year ended March 31, 2014 (fiscal 2014) and thereafter, primarily due to increased competition from personal devices. During the third quarter of fiscal 2015, we ceased marketing eVU products and accessories, but continue to provide service to one customer through the term of an existing contract ending in September 2015.
Customer Concentration
Revenue from one licensee accounted for 16% of revenues for the year ended March 31, 2015 (2014 - one licensee accounted for 11% of revenues). We seek to license new targeted companies that we believe infringe our patent portfolio.
Research and Development Costs
For the years ended March 31, 2015 and 2014 we spent $366,637 and $354,720, respectively, on research and development. We anticipate that we will continue to devote substantial resources to research and development activities.
Intellectual Property
We have two issued U.S. patents covering the use of flash memory in portable digital devices. We have seven issued U.S. patents covering technology related to our Nunchi context and interpersonal awareness systems. We have one issued U.S. patent covering our advanced data security technology, microSignet. We have designed and developed proprietary hardware encryption technology for content protection. This technology has been used in our products and has been tested and approved by major Hollywood movie studios.
We rely primarily on a combination of patents, copyright and trade secret protection together with licensing arrangements and nondisclosure and confidentiality agreements to establish and protect our proprietary rights. We may file additional patent applications in the future related to these or other technologies.
The patent position of any item for which we have filed a patent application is uncertain and may involve complex legal and factual issues. Although we have filed certain U.S. patent applications, we do not know whether any of these applications will result in the issuance of patents, or, for any patents already issued or issued in the future, whether they will provide significant proprietary protection or will be circumvented or invalidated. Additionally, since an issued patent does not guarantee the right to practice the claimed invention, there can be no assurance others will not obtain patents that we would need to license or design around in order to practice our patented technologies, or that licenses that might be required would be available on reasonable terms. Further there can be no assurance that any unpatented manufacture, use, or sale of our technology or products will not infringe on patents or proprietary rights of others. We have made reasonable efforts in the design and development of our products not to infringe on other known patents.
We also rely on trade secret laws for protection of our intellectual property, but there can be no assurance others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology, or that we can protect our rights to unpatented trade secrets.
We also file for trade name and trademark protection when appropriate. We are the owner of U.S. federally registered trademarks including e.Digital®, eVU®, VoiceNav®, Music Explorer®, Odyssey®, Smart Solutions for a Digital World®, and Nunchi® as registered trade names. We intend to make every reasonable effort to protect our proprietary rights to make it difficult for competitors to market equivalent competing products without being required to conduct the same lengthy testing and development conducted by us and not to use any of our innovative and novel solutions to overcome the many technical obstacles involved in developing portable devices using flash memory and other portable storage formats.
Competition
While we do not compete with others on licensing our specific patents, we compete generally for the attention and for funds from prospective licensees many of which are approached frequently regarding licenses and/or are sued for patent infringement both with and without merit. Regardless of the merits of any infringement claim many companies find it more economical, especially in the early stage of litigation, to defend the litigation rather than license. Long-term licensing success may be dependent upon our ability to prevail in new litigation matters and possibly upon appeal. Technological advances could also render the use of our patented methods obsolete prior to expiration of the term of our patents thus reducing amounts of future infringement. There can be no assurance that we will generate any new licensing or settlement revenue in the future.
We believe our existing know-how, contracts, patents, copyrights, trade secrets and potential future patents and copyrights, will be significant in enabling us to compete successfully and license our intellectual property.
Seasonality
Our current business is not seasonal.
Executive Officers and Employees
The current three executive officers of e.Digital Corporation are Alfred H. Falk, President and Chief Executive Officer; MarDee Haring-Layton, Chief Financial Officer; and Eric M. Polis, Secretary.
As of March 31, 2015, we employed approximately five full-time employees, of whom one was in production and testing, one in research, development and engineering, and three were in sales, general and administrative. None of our employees are represented by a labor union, and we are not aware of any current efforts to unionize the employees. Management considers the relationship between the Company and its employees to be good.
We also engage consultants or lease engineering personnel on a temporary basis from time to time and use other outside consultants for various services.
Available Information
We file with the Securities and Exchange Commission (“SEC”) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, proxy statements and registration statements. The public may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may also obtain information from the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding issuers, including us, that file electronically.
Our Internet website address is http://www.edigital.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are available free of charge through our Company’s website as soon as reasonably practical after those reports are electronically filed with, or furnished to, the SEC. In addition, copies of the written charters for the committees of our board of directors, our Code of Conduct, Corporate Governance, Communication and Whistleblower policies are also available on this website under the About Us and Management links. We will provide any person, without charge, a copy of our charters, codes and/or policies upon written request to Investor Relations, e.Digital Corporation, 16870 West Bernardo Drive, Suite 120, San Diego, California 92127. We may post amendments or waivers of our charters, codes, or policies, if any, on our website. This website address is intended to be an inactive textual reference only, and none of the information contained on our website is part of this report or is incorporated in this report by reference.
ITEM 1A.
ITEM 1A. RISK FACTORS
Cautionary Note on Forward Looking Statements
In addition to the other information in this annual report the factors listed below should be considered in evaluating our business and prospects. This annual report contains a number of forward-looking statements that reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those discussed below and elsewhere herein, that could cause actual results to differ materially from historical results or those anticipated. In this report, the words “anticipates,” “believes,” “expects,” “intends,” “future” and similar expressions identify forward-looking statements. Readers are cautioned to consider the specific factors described below and not to place undue reliance on the forward-looking statements contained herein, which speak only as of the date hereof. We undertake no obligation to publicly revise these forward-looking statements, to reflect events or circumstances that may arise after the date hereof.
Financial Risks
We Have Not Achieved Consistent Profitability and May Incur Future Losses. Our profits have not been consistent as revenues vary significantly between periods as a result of license activity. Historically we have incurred significant losses and negative cash flow from operations and we have an accumulated deficit of $81.5 million at March 31, 2015. Profitable years, including fiscal 2014, have been the result of one-time patent licensing revenues and there is no assurance of future licensing revenues from new licensees. Accordingly, we could continue to incur losses in the future until service and/or licensing revenues are sufficient to sustain continued profitability. Failure to achieve or maintain profitability will likely negatively impact the value of our securities.
If We Encounter Unforeseen Difficulties and Cannot Obtain any Required Additional Funding on Favorable Terms, Our Business May Suffer. Our consolidated cash and cash equivalents on hand totaled $1.95 million at March 31, 2015. In recent periods we have relied primarily on service revenues and payments from licensees to generate the funds needed to finance our operations. If we incur losses in future periods or we encounter unforeseen difficulties in the future, including difficulties arising as a result of the outside influences identified below, we may deplete our capital resources. As a result, we may be required to obtain additional financing in the future through debt or equity financings or otherwise. If we are required to raise additional capital in the future, such additional financing may not be available on favorable terms, if at all, or may be dilutive to our existing stockholders. If we fail to obtain additional capital as and when needed, such failure could have a material adverse impact on our business, results of operations and financial condition.
We Expect Our Operating Results to Fluctuate Significantly. Our quarterly and annual operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation is a result of a variety of factors, including the following:
·Uncertainty regarding the timing and amount of any future patent licensing revenues
·Changes in research and development costs
·Changes in general economic conditions
·Changes in technology
We do not Anticipate Paying Dividends. We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain any future earnings to fund the development and growth of our business. An investment in our common stock, therefore, may be more suitable for an investor that is seeking capital appreciation rather than current yield and, as a consequence, may be more speculative. Accordingly, investors should not purchase our common stock with an expectation of receiving regular dividends.
Risks Related to our Patent Licensing and Enforcement Strategy
We Face Uncertain Revenue Prospects from our Patent Enforcement Strategy. Our portfolio has not been thoroughly tested in court and there is no assurance we can prevail in any current or future patent litigation. Future court rulings or rulings from any reexamination of patent claims by the USPTO could have a significant positive or negative impact on future licensing activity. The licensing demand for our patent portfolio is subject to fluctuation based upon the rate at which target infringers agree to pay royalties or settle future enforcement actions, if any. There can be no assurance of future revenues from our strategy of enforcing our patent portfolio. Due to the nature of our licensing business and uncertainties regarding the amount and timing of the receipt of future license fees, if any, from potential infringers, stemming primarily from uncertainties regarding the outcome of enforcement actions, rates of adoption of our patented technologies, the growth rates of our prospective licensees and other factors, our revenues may vary significantly in the future, which could make our business difficult to manage, adversely affect our business and operating results, cause our quarterly and annual results to be below market expectations and adversely affect the market price of our common stock.
Our Fee Arrangement with Patent Enforcement Counsel Subjects Us to Certain Risks and Substantial Costs and Fees and Could Limit Our Net Proceeds From Any Successful Patent Enforcement Actions. Our agreement for legal services and partial contingent fee arrangement with Handal and Associates provides that Handal is our legal counsel in connection with the assertion of our flash memory related patents, Nunchi patents and microSignet patents against infringers. Handal is advancing certain costs and expenses including travel expenses and court costs. We have agreed to pay Handal a monthly retainer fee of $30,000 and a fee ranging from 33-40% of any license or litigation recovery related to patent enforcement matters, less prior retainers and expenses. We are not in control of the timing, costs and fees, which could be substantial and we could be required to pay substantial litigation support costs without any recovery. Costs and fees paid by Handal could also limit our share of proceeds, if any, from future patent enforcement actions. There can be no assurance Handal will diligently and timely pursue patent enforcement actions on our behalf.
We May Not Be Successful in Marketing or Licensing our Nunchi or Other Technologies. We are marketing our Nunchi technology with patent enforcement assistance from our legal firm, Handal & Associates. There can be no assurance we can be successful in monetizing this or any other technologies.
New Legislation, Regulations or Rules Related to Obtaining or Enforcing Patents Could Make Our Patent Enforcement More Difficult, Significantly Increase Our Operating Costs and Decrease Our Revenues. If new legislation, regulations or rules are implemented by Congress, the USPTO or the courts that impact the patent application process, the patent enforcement process or the rights of patent holders, such changes could negatively affect our business by making our patent enforcement efforts more difficult, costly and decrease opportunities for future revenues. Recently, United States patent laws were amended with the enactment of the Leahy-Smith America Invents Act, or the America Invents Act, which took effect on March 16, 2013. The America Invents Act includes a number of significant changes to U.S. patent law. In general, the legislation attempts to address issues surrounding the enforceability of patents and the increase in patent litigation by, among other things, establishing new procedures for patent litigation. For example, the America Invents Act changes the way that parties may be joined in patent infringement actions, increasing the likelihood that such actions will need to be brought against individual allegedly-infringing parties by their respective individual actions or activities. In addition, the America Invents Act enacted a new inter-partes review process at the USPTO which can be, and often is, used by defendants, and other individuals and entities, to separately challenge the validity of any patent. At this time, it is not clear what, if any, overall impact the America Invents Act will have on the operation of our enforcement business. However, the America Invents Act and its implementation could increase the uncertainties and costs surrounding the enforcement of our patented technologies, which could have a material adverse effect on our business and financial condition.
The U.S. Department of Justice, or the DOJ, has conducted reviews of the patent system to evaluate the impact of patent assertion entities on industries in which those patents relate. It is possible that the findings and recommendations of the DOJ could impact the ability to effectively license and enforce standards-essential patents and could increase the uncertainties and costs surrounding the enforcement of any such patented technologies. Also, in 2014, the Federal Trade Commission, or FTC, initiated a study under Section 6(b) of the Federal Trade Commission Act to evaluate the patent assertion practice and market impact of Patent Assertion Entities, or PAEs. It is expected that the results of the PAE study by the FTC will be provided to Congress and other agencies, such as the DOJ, who could take action, including legislative proposals, based on the results of the study.
Finally, new rules regarding the burden of proof in patent enforcement actions could significantly increase the cost of our enforcement actions, and new standards or limitations on liability for patent infringement could negatively impact our revenue derived from such enforcement actions. In addition, recent federal court decisions have lowered the threshold for obtaining attorneys’ fees in patent infringement cases and increased the level of deference given to a district court’s fee-shifting determination. These decisions may make it easier for district courts to shift a prevailing party’s attorneys' fees to a non-prevailing party if the district court believes that the case was weak or conducted in an abusive manner. As a result, defendants in patent infringement actions may elect not to settle because these decisions make it much easier for defendants to get attorneys’ fees.
Should Litigation Be Required to Enforce Our Patents, Trial Judges and Juries Often Find It Difficult to Understand Complex Patent Enforcement Litigation, and as a Result, We May Need to Appeal Adverse Decisions By Lower Courts In Order to Successfully Enforce Our Patents. It is difficult to predict the outcome of patent enforcement litigation at the trial level. It is often difficult for juries and trial judges to understand complex, patented technologies, and as a result, there is a higher rate of successful appeals in patent enforcement litigation than more standard business litigation. Such appeals are expensive and time consuming, resulting in increased costs and delayed revenue. Although we intend to diligently pursue enforcement litigation if necessary to monetize our patents, we cannot predict with significant reliability the decisions made by juries and trial courts.
Federal Courts are Becoming More Crowded, and as a Result, Patent Enforcement Litigation is Taking Longer. Any patent enforcement actions we may be required to take to monetize our patents will most likely be prosecuted in federal court. Federal trial courts that hear patent enforcement actions also hear other cases that may take priority over any actions we may take. As a result, it is difficult to predict the length of time it will take to complete any enforcement actions.
As Patent Enforcement Litigation Becomes More Prevalent, It May Become More Difficult for Us to Voluntarily License Our Patents. We believe that the more prevalent patent enforcement actions become, the more difficult it will be for us to voluntarily license our patents to major technology firms as they may increasingly become more reluctant to settle and license. As a result, we may need to increase the number of our patent enforcement actions and/or expend additional resources on enforcement actions to cause infringing companies to license our patents or pay damages for lost royalties. This may increase the risks associated with an investment in our Company.
In Connection With Patent Enforcement Actions That We May Conduct, a Court May Rule That We Have Violated Certain Statutory, Regulatory, Federal, Local or Governing Rules or Standards, Which May Expose Us To Certain Material Liabilities. In connection with any of our patent enforcement actions, it is possible that a defendant may request and/or a court may rule that we have violated statutory authority, regulatory authority, federal rules, local court rules, or governing standards relating to the substantive or procedural aspects of such enforcement actions. In such event, a court may issue monetary sanctions against us or award attorney’s fees and/or expenses to a defendant(s), which could be material, and if we are required to pay such monetary sanctions, attorneys’ fees and/or expenses, such payment could materially harm our operating results and our financial position.
Our Flash-R Patents Have Limited Time Available for Enforcement Prior to Expiration. Three of the five patents in the Flash-R portfolio expired in 2014. The two remaining patents will expire in March 2016, and we will therefore have limited time to collect license fees for future infringement and may also be limited in enforcing past infringement beyond certain periods and these limitations may make enforcement more difficult and limit any recoveries and therefore increase the risks associated with an investment in our Company.
Risks Related to Operations
If We Lose Key Personnel or Are Unable to Attract and Retain Additional Highly Skilled Personnel Required For the Expansion of Our Activities Our Business Will Suffer. Our future success depends to a significant extent on the continued service of our key technical, sales and senior management personnel and their ability to execute our strategy. The loss of the services of any of our senior level management, or certain other key employees or our intellectual property consultant may harm our business. Our future success also depends on our ability to attract, retain and motivate highly skilled employees and consultants. Competition for employees in our industry is intense. We may be unable to retain our key employees or to attract, assimilate and retain other highly qualified employees in the future. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications.
We Rely on a Limited Number of Customers for Revenue. Historically, a substantial portion of our product, service and licensing revenues has been derived primarily from a limited number of customers. The failure to receive future revenues from new licensees could have a material adverse effect on our operations.
Risks Related to Intellectual Property and Government Regulation
Failing to Protect Our Proprietary Rights to Our Technology Could Harm Our Ability to Compete, as well as Our Results of Our Operations. Our success and ability to compete substantially depends on our internally developed software, technologies and trademarks, which we protect through a combination of patent, copyright, trade secret and trademark laws. Patent applications or trademark registrations may not be approved. Even when they are approved, our patents or trademarks may be successfully challenged by others or invalidated. If our trademark registrations are not approved because third parties own such trademarks, our use of these trademarks would be restricted unless we enter into arrangements with the third-party owners, which may not be possible on commercially reasonable terms or at all. We generally enter into confidentiality or license agreements with our employees, consultants and strategic and industry partners, and generally control access to and distribution of our software, technologies, documentation and other proprietary information. Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, parties may attempt to disclose, obtain or use our solutions or technologies. The steps we have taken may not prevent misappropriation of our solutions or technologies, particularly in foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States. We have licensed, and we may license in the future, certain proprietary rights to third parties. While we attempt to ensure that our business partners maintain the quality of our brand, they may take actions that could impair the value of our proprietary rights or our reputation. In addition, these business partners may not take the same steps we have taken to prevent misappropriation of our solutions or technologies.
We May Face Intellectual Property Infringement Claims That May Be Difficult to Defend and Costly to Resolve, Which Could Harm Our Business. Although we do not believe we infringe the proprietary rights of any third parties, we cannot assure you that third parties will not assert such claims against us in the future or that such claims will not be successful. We could incur substantial costs and diversion of management resources to defend any claims relating to proprietary rights, which could harm our business. In addition, we are obligated under certain agreements to indemnify the other party for claims that we infringe on the proprietary rights of third parties. If we are required to indemnify parties under these agreements, our business could be harmed. If someone asserts a claim relating to proprietary technology or information against us, we may seek licenses to this intellectual property. We may not be able to obtain licenses on commercially reasonable terms, or at all. The failure to obtain the necessary licenses or other rights may harm our business.
Risks Related to Government Regulation, Content and Intellectual Property Government Regulation May Subject Us to Liability and Require Us to Change the Way We Do Business. Our business is subject to rapidly changing laws and regulations. Although our operations are currently based in California, the United States government and the governments of other states and foreign countries have attempted to regulate activities on the Internet. Evolving areas of law that are relevant to our business include privacy law, copyright law, proposed encryption laws, content regulation and import/export regulations. Because of this rapidly evolving and uncertain regulatory environment, we cannot predict how these laws and regulations might affect our business. In addition, these uncertainties make it difficult to ensure compliance with the laws and regulations governing the Internet. These laws and regulations could harm us by subjecting us to liability or forcing us to change how we do business.
Risks Related to Trading in Our Common Stock
Our Disclosure Controls and Procedures May Not Prevent or Detect All Acts of Fraud. Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to management and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our management expects that our disclosure controls and procedures and internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, they cannot provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been prevented or detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by an unauthorized override of the controls. The design of any systems of controls also is based in part upon certain assumptions about the likelihood of future events, and we cannot assure that any design will succeed in achieving its stated goals under all potential future conditions. Accordingly, because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.
Failure to Maintain an Effective System of Internal Control Over Financial Reporting Could Harm Stockholder and Business Confidence In Our Financial Reporting, Our Ability to Obtain Financing and Other Aspects of Our Business. Maintaining an effective system of internal control over financial reporting is necessary for us to provide reliable financial reports. Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC require us to include in our Form 10-K a report by management regarding the effectiveness of our internal control over financial reporting. The report includes, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of the respective fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. While our management has concluded that we did not have any material weaknesses as of March 31, 2015, material weaknesses have been identified in prior years and it is possible that material weaknesses will be identified in the future. In addition, components of our internal control over financial reporting may require improvement from time to time. If management is unable to assert that our internal control over financial reporting is effective in any future period, investors may lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on the Company’s stock price.
Evolving Regulation of Corporate Governance and Public Disclosure May Result In Additional Expenses and Continuing Uncertainty. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, conversion to International Financial Reporting Standards, XBRL interactive SEC filings, and new SEC regulations are creating uncertainty for public companies. We continually evaluate and monitor developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. These new or changed laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices.
We are committed to maintaining high standards of corporate governance and public disclosure. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and we may be harmed.
Investing in a Technology Stock (Such as Ours) May Involve Greater Risk Than Other Investments Due to Market Conditions, Stock Price Volatility and Other Factors. The trading price of our common stock has been subject to significant fluctuations to date, and will likely be subject to wide fluctuations in the future due to:
·Quarter-to-quarter variations in operating results
·Announcements of technological innovations by us, our customers or competitors
·New innovations or achievements by us or our competitors
·The legal and regulatory environment for patent enforcement actions
·General financial market conditions
·Market conditions for technology stocks
·Litigation or changes in operating results or estimates by analysts or others
·Other events or factors
In addition, potential dilutive effects of future sales of shares of common stock by stockholders and by the Company and subsequent sale of common stock by the holders of options could have an adverse effect on the market price of our shares.
We do not endorse and accept any responsibility for the estimates or recommendations issued by stock research analysts or others from time to time or comments on any electronic chat boards. The public stock markets in general, and technology stocks in particular, have experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many high technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock in the future.
Low-Price Stocks and Stocks Traded on the OTC Electronic Bulletin Board are Subject to Special Regulations and may have Increased Risk. Our shares of common stock are traded on the OTCQB Marketplace, an electronic, screen-based trading system operated by OTC Markets Group. Securities traded on the OTCQB are, for the most part, thinly traded and are subject to special regulations not imposed on securities listed or traded on the NASDAQ system or on a national securities exchange. As a result, an investor may find it difficult to dispose of, or to obtain accurate quotations as to the price of, our common stock. Sales of substantial amounts of our outstanding common stock in the public market could materially adversely affect the market price of our common stock. To date, the price of our common stock has been extremely volatile with the sale price fluctuating from a low of $0.030 to a high of $0.1385 in the last fiscal year. In addition, our common stock is subject to Rules 15g-1-15g-6 promulgated under the Exchange Act that imposes additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally, a person with assets in excess of $1,000,000, excluding the value of such person’s primary residence, or annual income exceeding $200,000 or $300,000 together with his or her spouse). For transactions covered by this rule, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell the Company’s securities and may affect the ability of investors to sell their securities in the secondary market. The SEC has also adopted regulations which define a “penny stock” to be any equity security that has a market price (as defined) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the regulations require the delivery, prior to the transaction, of a disclosure schedule prepared by the SEC relating to the penny stock market. The broker-dealer must also disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer’s presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock in the account and information on the limited market in penny stocks.
Important Factors Related to Forward-Looking Statements and Associated Risks. This prospectus contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and we intend that such forward-looking statements be subject to the safe harbors created thereby. These forward-looking statements include our plans and objectives of management for future operations, including plans and objectives relating to the products and our future economic performance. The forward-looking statements included herein are based upon current expectations that involve a number of risks and uncertainties. These forward-looking statements are based upon assumptions that competitive conditions within the computer and technology markets will not change materially or adversely, that the computer and technology markets will continue to experience growth, that demand for our technologies will increase, that we will obtain and/or retain existing development partners and key management personnel, that our forecasts will accurately anticipate market demand and that there will be no material adverse change in our operations or business. Assumptions relating to the foregoing involve judgments with respect, among other things, to future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated in forward-looking information will be realized. In addition, as disclosed above, our business and operations are subject to substantial risks which increase the uncertainty inherent in such forward-looking statements. Any of the other factors disclosed above could cause our net sales or net income (or loss), or our growth in net sales or net income (or loss), to differ materially from prior results. Growth in absolute amounts of costs of sales and selling and administrative expenses or the occurrence of extraordinary events could cause actual results to vary materially from the results contemplated in the forward-looking statements. Budgeting and other management decisions are subjective in many respects and thus susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our marketing, capital expenditure or other budgets, which may in turn affect our results of operations. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
In January 2012, we entered into a sixty-two month facility lease for our corporate office location, commencing May 1, 2012, for approximately 3,253 square feet at 16870 West Bernardo Drive, Suite 120, San Diego, California. The aggregate monthly payment is $5,693 excluding utilities and costs. The aggregate payments adjust annually with maximum payments totaling $7,157 in the forty-ninth through sixty-second months. Future lease commitments at March 31, 2015 total $188,511.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company engages in litigation from time to time as part of our patent portfolio licensing and enforcement activities. In fiscal 2013 we commenced new enforcement actions with respect to our Flash-R patent portfolio by filing complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe our U.S. patents. In November 2014, our appeal to the Federal Circuit Court of Appeals regarding application of the doctrine of collateral estoppel as to our U.S. Patent No. 5,839,108 (“the ‘108 patent”) was successful. The Court upheld the lower court’s application of collateral estoppel to U.S. Patent No. 5,491,774 (“the ‘774”), which has now expired. In December 2014 the United States District Court for the Southern District of California ruled favorably regarding our claim construction of the ‘108 patent. As a result, in December 2014 and January 2015, we entered into license and settlement agreements with additional defendants. In January 2015 we filed additional enforcement actions against multiple defendants. As of June 4, 2015, 61 defendants had agreed to license and settlement terms during the course of related enforcement litigation.
We commenced legal action with regards to our Nunchi portfolio of patents in July 2014 and we currently have two active complaints in the U.S. District Court for the Northern District of California and one active complaint in the U.S. District Court for the Southern District of California.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock trades in the over-the-counter market on the OTCQB Marketplace. The following table sets forth, for the periods indicated, the high and low closing bid prices for our common stock, as reported by the OTC Markets Group, for the quarters presented. Bid prices represent inter-dealer quotations without adjustment for markups, markdowns, and commissions.
Holders
At June 10, 2015 there were 293,428,330 shares of common stock outstanding and approximately 2,835 stockholders of record.
Dividends
We have never paid any dividends to our common stockholders. Future cash dividends or special payments of cash, stock or other distributions, if any, will be dependent upon our earnings, financial condition and other relevant factors. The Board of Directors does not intend to pay or declare any dividends on our common stock in the foreseeable future, but instead intends to have the Company retain all earnings, if any, for use in the business.
Equity Compensation Plan Information
The following table sets forth information as of March 31, 2015, with respect to compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance, aggregated as follows:
Recent Sales of Unregistered Securities
No unregistered securities were issued during the fiscal year that were not previously reported in a Quarterly Report on Form 10-Q or Current Report on Form 8-K.
Issuer Purchases of Equity Securities
Not applicable.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto and includes forward-looking statements with respect to the Company’s future financial performance. Actual results may differ materially from those currently anticipated and from historical results depending upon a variety of factors, including those described elsewhere in this Annual Report and under the sub-heading, “Risk Factors - Important Factors Related to Forward-Looking Statements and Associated Risks.”
General
We are a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. We are developing and marketing an intellectual property portfolio including (a) licensing and enforcing our Flash-R™ portfolio of patents related to the use of flash memory in portable devices, and (b) developing new licensable intellectual property related to context and interpersonal awareness systems (“Nunchi” technology), advanced data security technologies (“microSignet” technology) and other technologies.
With the inception of patent license revenue in fiscal 2009, the Company determined that it has two operating segments: (1) patent licensing and and (2) products and services. Patent licensing consists of intellectual property revenues from the Flash-R patent portfolio and products and services consist of sales of the Company’s electronic eVU mobile entertainment device and related content services. During the third quarter of fiscal 2015 we ceased marketing eVU products and accessories but continue to provide service to one customer through the term of an existing contract ending September 2015.
We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against targeted parties that we believe are infringing our patents. Since September 2012, the law firm of Handal and Associates has been handling our patent enforcement matters on a partial contingent fee basis.
Currently, we have active lawsuits filed against parties believed to infringe patents covering the use of our flash memory technologies. In fiscal 2013 through fiscal 2015 we commenced enforcement action with respect to our patent portfolio by filing complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe our U.S. patents. We subsequently entered into license and settlement agreements with multiple defendants, won a stipulated judgment against one defendant, and dismissed one defendant without prejudice.
While we expect to file future complaints against additional companies and license additional companies, there can be no assurance of the timing or amounts of any related license revenue. We also are developing new intellectual property for possible licensing in the areas of context and interpersonal awareness systems and in July 2014 we commended enforcement actions in the U.S. District Court for the Northern District of California and in the U.S. District Court for the Southern District of California.
Our business is high risk in nature. There can be no assurance we can achieve sufficient patent license or other revenues to sustain profitability. We continue to be subject to the risks normally associated with introducing new products, services and technologies, including unforeseeable expenses, delays and complications. Accordingly, there is no guarantee that we can or will report operating profits in future periods.
Overall Performance and Trends
We focused significant efforts on developing, licensing and enforcing our patent portfolio in the fiscal years ended March 31, 2015 and 2014. We have successfully completed enforcement litigation and are in the process of additional enforcement actions. There is a reluctance of patent infringers to negotiate and ultimately take a patent license without at least the threat of legal action. However, the majority of patent infringement contentions settle out of court, based on the strength of the patent claims, validity, and persuasive evidence and clarity that the patent is being infringed. We believe we are building a track record of demonstrating the strength, validity and clarity of our patent claims that can result in significant future revenues from our patent portfolio.
Our eVU IFE business continued to decline in the fiscal year ended March 31, 2015 (fiscal 2015). During the third quarter of fiscal 2015 we ceased marketing eVU products and accessories, but we plan to service one remaining customer through the term of the existing contract in September 2015.
Revenues and profits have been sporadic in prior years and we have incurred significant historical losses and negative cash flow from operations. We expect to incur losses in the future until licensing or other revenues are sufficient to sustain continued profitability.
For the year ended March 31, 2015:
·We recognized a net loss of $235,153 compared to net income of $56,084 for fiscal 2014. The difference in results was primarily attributable to increased contingent legal fees and expenses.
·Our revenues of $2,235,803 in fiscal 2015 were comparable to fiscal 2014 revenues of $2,280,758. During fiscal 2015 we had 29 new license agreements as compared to 22 new license agreements in fiscal 2014. As a result of the timing of such license agreements, our licensing revenues in fiscal 2015 totaled $2,079,534 compared to $2,045,385 in fiscal 2014. eVU product and service revenues were $156,269 in fiscal 2015 compared to $235,373 in fiscal 2014.
·Operating expenses were $2.69 million for fiscal 2015 an increase from $2.19 million in fiscal 2014 primarily as a result of increased contingent legal fees and expenses related to the patent license litigation.
Management faces challenges in fiscal 2016 to obtain Flash-R patent portfolio license fees as the patent portfolio expires and monetize our Nunchi and microSignet technologies. The failure to obtain additional patent license revenues 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.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including but not limited to those related to revenue recognition, inventory valuation, financing operations, stock-based compensation, fair values, derivatives, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe that, of the significant accounting policies discussed in Note 2 to our consolidated financial statements, the following accounting policies require our most difficult, subjective or complex judgments:
·revenue recognition;
·stock-based compensation expense;
·income taxes; and
·inventory reserve
We discuss below the critical accounting assumptions, judgments and estimates associated with these policies. Historically other than our estimate of foreign tax expense incurred in fiscal 2009 and recovered in fiscal years 2011 and 2015 as discussed below, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. For further information on our critical accounting policies, refer to Note 2 to the consolidated financial statements included herein.
Revenue Recognition
As described below, significant management judgments must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of revenue recognized or deferred for any period, if management made different judgments.
We recognize revenue in accordance with ASC Topic 605, Revenue Recognition. Revenue is recognized when (i) persuasive evidence of an arrangement exists, (ii) all obligations have been substantially performed pursuant to the terms of the license agreement, (iii) amounts are fixed or determinable and (iv) collectability of amounts is reasonably assured.
We make estimates and judgments when determining whether the collectability of product, service or license fees receivable from customers is reasonably assured. We assess the collectability of our receivables based on a number of factors, including past transaction history and the credit-worthiness of customers. Management estimates regarding collectability impact the actual revenues recognized each period and the timing of the recognition of revenues. Our assumptions and judgments regarding future collectability could differ from actual events, thus materially impacting our financial position and results of operations.
Certain license agreements provide for the payment of contractually determined paid-up license fees in consideration for the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by our patented technologies. Generally, the execution of these license agreements also provide for the release of the licensee from certain past and future claims, and the dismissal of any pending litigation. Pursuant to the terms of these agreements, we have no further obligation with respect to the grant of the non-exclusive retroactive and future license and related releases, including no express or implied obligation to maintain or upgrade the technology, or provide future support or services. Generally, the agreements provide for the grant of the license and releases upon execution of the agreement. As such, the earnings process is generally complete upon the execution of the agreement, and as a result, revenue is recognized upon execution of the agreement, when collectability is reasonably assured, and all other revenue recognition criteria have been met. While most licenses contain similar standard provisions, management must evaluate each agreement and make judgments to assure that substantial delivery of contract elements has occurred, whether any significant ongoing obligations exist subsequent to contract execution, whether amounts due are collectible and the appropriate period or periods, in which, or during which, respectively, the completion of the earning process occurs. Depending on the magnitude of specific license agreements, if different judgments, assumptions and estimates are made regarding contracts executed in any specific period, our periodic financial results may be materially affected.
In fiscal 2010 we entered into our first licenses providing for future royalties based on future licensee activities. Licensees that pay license fees on a periodic basis are required to report to us actual activity after the activity takes place. The amount of license fees due under these license agreements each period cannot be reasonably estimated by management. Consequently, we will recognize revenue from these licensing agreements on a lag basis as royalties are reported provided amounts are fixed or determinable and collectability is reasonably assured. The lag method allows for the receipt of licensee royalty reports prior to the recognition of revenue. Differences between amounts recognized and amounts that could subsequently be audited or reported as an adjustment to those amounts will be recognized in the period such adjustment is determined as a change in accounting estimate.
Some license agreements include nonexclusive cross licenses and our policy is to value these only if directly used in operations. To date the we have not valued any cross licenses received as they were considered part of the licensee’s overall license and settlement strategy and are not used in our products. However we must evaluate each license with cross license rights to determine what is being cross licensed and if it is used in our products and this requires management to make judgments that affect our operations.
Stock-Based Compensation
ASC Topic 718, “Compensation - Stock Compensation,” or ASC 718, sets forth the accounting requirements for “stock-based” compensation payments to employees, non-employee directors and consultants and requires all stock based-payments to be recognized as expense in the statement of operations. The compensation cost for all stock-based awards is measured at the grant date, based on the fair value of the award (determined using a Black-Scholes option pricing model), and is recognized as an expense over the requisite service period (generally the vesting period of the equity award). Determining the fair value of stock-based awards at the grant date requires significant estimates and judgments, including estimating the market price volatility of our common stock, future employee stock option exercise behavior and requisite service periods. Due to our limited exercise history we applied the simplified method prescribed by SEC Staff Accounting Bulletin 110, Share-Based Payment: Certain Assumptions Used in Valuation Methods - Expected Term, to estimate expected life.
Options or stock awards issued to non-employees who are not directors are recorded at their estimated fair value at the measurement date and are periodically revalued as the options vest and are recognized as expense over the related service period on a graded vesting method. Stock options issued to consultants with performance conditions are measured and recognized when the performance is complete.
ASC Topic 718 requires stock-based compensation expense to be recorded only for those awards expected to vest using an estimated pre-vesting forfeiture rate. As such, ASC Topic 718 requires us to estimate pre-vesting option forfeitures at the time of grant and reflect the impact of estimated pre-vesting option forfeitures on compensation expense recognized. Estimates of pre-vesting forfeitures must be periodically revised in subsequent periods if actual forfeitures differ from those estimates. We consider several factors in connection with our estimate of pre-vesting forfeitures including types of awards, employee class, and historical pre-vesting forfeiture data. The estimation of stock awards that will ultimately vest requires judgment, and to the extent that actual results differ from our estimates, such amounts will be recorded as cumulative adjustments in the period the estimates are revised. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.
ASC 718 also provides that any corporate income tax benefit realized upon exercise or vesting of an award in excess of that previously recognized in earnings (referred to as a “windfall tax benefit”) will be presented in the Consolidated Statements of Cash Flows as a financing (rather than as operating) cash flow. Realized windfall tax benefits are credited to paid-in capital. Realized shortfall tax benefits (amounts which are less than that previously recognized in earnings) are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense.
Refer to Notes 2 and 8 to our consolidated financial statements included in this annual report for more information.
Income Taxes
In preparing our consolidated financial statements, we estimate our income taxes in each of the countries in which we operate. While we believe we operate only in the United States, certain licensees have withheld taxes on license payments in foreign countries. During fiscal 2015 a total of $36,362 of foreign taxes was withheld and we determined that it was unlikely we can recover a refund of such foreign taxes withheld and that we can only use the foreign taxes as a future credit against U.S. taxes. Matters regarding foreign taxes require us to make judgments and estimates based on various assumptions and these affect our reported operations.
Our determination of income tax expense or benefit requires estimates including an assessment of the current tax expense and the effects of temporary differences resulting from the different treatment of transactions for tax and financial accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. The Company accounts for deferred income taxes utilizing an asset and liability method, whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the financial statements and the tax bases of assets and liabilities, as measured by current enacted tax rates. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. We evaluate the realizability of our deferred tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary. At March 31, 2015, we had net deferred tax assets primarily resulting from temporary differences between the book and tax bases of assets and liabilities, and loss and credit carry forwards. We continue to provide a 100% valuation allowance our deferred tax assets based on an assessment of the likelihood of their realization. In reaching our conclusion, we evaluated certain relevant criteria including deferred tax liabilities that can be used to offset deferred tax assets, estimates of future taxable income of appropriate character within the carry-forward period available under the tax laws, and tax planning strategies. Our judgments regarding future taxable income may change due to market conditions, changes in U.S. or international tax laws, our business and results of operations, and other factors. These changes, if any, may require material adjustments to these deferred tax assets, resulting either in a tax benefit, if it is estimated that future taxable income is likely, or a reduction in the value of the deferred tax assets, if it is determined that their value is impaired, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made.
Our income tax provision is based on calculations and assumptions that will be subject to examination by the taxing authorities in the jurisdictions in which we operate. Should the actual results differ from our estimates, we would have to adjust the income tax provision in the period in which the facts and circumstances that give rise to the revision become known. Tax law and rate changes are reflected in the income tax provision in the period in which such changes are enacted. As of March 31, 2015 and 2014, we had no material uncertain tax positions and uncertain tax positions have had no impact on our consolidated financial condition or results of operations or cash flows.
Inventory Reserve
In preparing our financial statements we periodically review inventory for impairments to recognize when the expected benefit is less than carrying value and to reserve for inventory that is obsolete. We ceased offering new eVU systems and accordingly fully reserved for related remaining inventory during fiscal 2015 reporting no net inventory balances at March 31, 2015.
Other
We do not have off-balance sheet transactions, arrangements or obligations. Inflation has not had any significant impact on our business.
Recently Issued Accounting Standards
See Note 2 to our consolidated financial statements included herein for a description of significant recent accounting standards. Other accounting standards have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date and are not expected to have a material impact on our consolidated financial statements upon adoption.
Results of Operations
Year ended March 31, 2015 Compared to Year ended March 31,
Operating income (loss) before other income, provision for or benefit from income taxes
The operating loss before income tax benefit in fiscal 2015 resulted from increased expenses related to patent licensing revenues. The operating income before income tax benefit in fiscal 2014 resulted from patent license revenues. Since a significant majority of patent license revenues to date have been one-time with each licensee, they are non-recurring and accordingly there is no assurance of any future patent license revenues.
Revenues
Revenues for the year ended March 31, 2015 included $2,077,000 of one-time non recurring patent license revenues, $2,534 of royalty-based patent license revenues and $156,269 of eVU service revenues. Our service revenues declined as we provided repair and content services to a declining customer base.
During the third quarter of fiscal 2015 we ceased marketing eVU products and accessories but continued to provide services to one existing customer under a contract to be completed by September 2015. We expect nominal revenues and costs in fiscal 2016 from eVU services.
Revenues for the year ended March 31, 2014 included $2,038,750 of one-time non recurring patent license revenues, $6,635 of royalty-based patent license revenues and $235,373 of eVU product and service revenues.
In the current year we entered into a total of 29 licenses, and in the prior year there were 22 new licenses. License fee revenues recognized fluctuate significantly from period to period primarily based on the following factors:
·the dollar amount of agreements executed each period, which is primarily driven by the magnitude of infringement associated with a specific licensee;
·the specific terms and conditions of agreements executed each period and the periods of infringement contemplated by the respective payments; and
·fluctuations in the number of agreements executed.
In the future the following additional factors could also impact revenue variability:
·fluctuations in the sales results or other royalty per unit activities of our licensees that impact the calculation of license fees due;
·the timing of the receipt of periodic license fee payments and/or reports from licensees.
We are targeting new patent licensees but our results will continue to be dependent on the timing and amount of future patent licensing arrangements, if any.
Operating Expenses
Operating costs and expenses include cost of revenues associated with products and services and costs associated with our patent licensing and enforcement activities. Product and service costs vary depending on the related revenues and were 154% and 131% of related revenues for the fiscal years ended March 31, 2015 and 2014, respectively. Our results have varied depending on the amount of revenues and margins on various arrangements along with variances in the costs required to perform related services.
Patent licensing and litigation costs of revenues include the costs and expenses incurred in connection with our licensing and enforcement activities, including contingent and non-contingent litigation costs and related enforcement support costs. Non-contingent licensing and litigation costs and related enforcement support costs may be incurred without any directly related revenues in a respective period. Generally contingent costs relate to revenues during a respective period but can vary depending on our share of certain costs and expenses.
Selling and administrative costs increased by $76,109 from fiscal 2014 to fiscal 2015. The increase is primarily due to stock compensation expense of $71,715 in the current period, an increase from $22,428 in the same period of the prior year, a $113,960 increase in legal fees, $120,235 of which related specifically to the recovery of foreign taxes from 2009, offset by a decrease of $55,563 fiscal 2014 shareholder meeting with no comparable expense in the fiscal 2015, and decreased consulting fees of $41,591 in the current year versus $95,240 in the same period of the prior year
Research and related expenditures increased by $11,917 from fiscal 2014 to fiscal 2015. We expect future research and development costs to be comparable to the most recent year due to current staffing levels and projects. Should we elect to develop significant new technologies or products we may require increased internal and external research and development costs.
Income Taxes
We had a tax benefit of $169,888 in the current period, resulting from the recovery of $206,250 of foreign taxes paid in fiscal 2010, less foreign taxes paid in fiscal 2015 of $36,362.
Income (loss)
The net loss for the year ended March 31, 2015 was $235,153. The net income for the year ended March 31, 2014 was $56,084.
Liquidity and Capital Resources
At March 31, 2015, we had working capital of $1.71 million compared to working capital of $1.81 million for the prior year. We had $11,218 and $238,623 of working capital invested in accounts receivable at March 31, 2015 and 2014, respectively. Patent license payments are normally due at signing of the license or within 30-45 days. We currently have no credit lines or debt arrangements to provide working capital other than from cash as generated from operations.
Operating Activities
For the year ended March 31, 2015, net cash increased by $165,118. Cash provided by operating activities was $164,018. Cash provided by operating activities included the net loss of $235,153 decreased by net non-cash expenses of $144,621. A major component using operating cash was a $73,810 decrease in accrued and other liabilities.
For the year ended March 31, 2014, net cash increased by $46,424. Cash provided by operating activities was $48,718. Cash provided by operating activities included the net income of $56,084 increased by net non-cash expenses of $100,067. Major components using operating cash included a $62,693 increase in accounts receivable and a $44,188 decrease in accounts payable and accrued liabilities
Investing Activities
We did not invest in equipment in fiscal 2015. The Company’s efforts are primarily on operations and currently we have no significant investing capital needs. We have no commitments requiring investment capital.
Financing Activities
We received $1,100 of proceeds from stock option exercises in fiscal 2015 and $3,111 during the year ended March 31, 2014.
We currently have no sources of financing funding other than the potential exercise of options that generally will be dependent on higher stock prices and thus additional exercises are uncertain.
Debt and Other Commitments
We have no debt other than normal trade payables and accruals outstanding. We have no credit lines or access or commitments for any future debt financing.
We are committed for our office lease as more fully described in Note 10 to our consolidated financial statements.
Our legal firm, Handal and Associates, provides intellectual property legal services in connection with licensing and prosecuting claims of infringement of our flash memory andNunchi patent portfolios. 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 ranging from 33-40% of any license fee or settlement related to patent enforcement matters, less prior retainers and expenses. 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 March 31, 2015 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 other operations but the timing thereof is subject to many factors and risks, many outside our control. Our operating plans may require additional funds in future periods and should additional funds not be available, we may be required to curtail or scale back operations. Potential sources of such funds include exercise of outstanding options, or debt financing or new equity offerings. However, there is no assurance that options will be exercised or that debt or equity financing will be available if and when needed. Any future financing may be dilutive to existing stockholders.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company required to be included in this Item 8 are set forth in a separate section of this report following Item 15 and the Signature Page commencing on Page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no disagreements or any reportable events requiring disclosure under Item 304(b) of Regulation S-K.
ITEM 9A.
ITEM 9A. CONTROLS & PROCEDURES
We are required to maintain disclosure controls and procedures designed to ensure that material information related to us, including our consolidated subsidiaries, is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls (as defined in Rule 13a-15(e) of the Exchange Act) and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management, which, by their nature, can provide only reasonable assurance regarding management’s control objectives. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
At the conclusion of the period ended March 31, 2015, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, were effective at a reasonable assurance level.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2015 based on the guidelines established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) 2013. Our internal control over financial reporting includes policies and procedures that provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles in the United States. Based on this evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of March 31, 2015.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this annual report.
Inherent Limitations on Effectiveness of Controls
Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Changes in Internal Control Over Financial Reporting
No change in our internal controls over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Except as provided below, in accordance with General Instruction G(3) to Form 10-K, certain information required by this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than July 21, 2015.
Code of Business Conduct and Ethics
We have adopted a Code of Conduct Policy applicable to all our employees, including our principal executive officer, principal financial officer and principal accounting officer. We will provide any person, without charge, a copy of our Code of Conduct Policy upon written request to Investor Relations, e.Digital Corporation, 16870 West Bernardo Drive, Suite 120, San Diego, California 92127. We also post on our website a copy of or Code of Conduct Policy at www.edigital.com.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
In accordance with General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than July 21, 2015.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
In accordance with General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than July 21, 2015.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
In accordance with General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than July 21, 2015.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
In accordance with General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than July 21, 2015.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this Annual Report on Form 10-K:
(a) Consolidated Financial Statements
See “Index to Consolidated Financial Statements” on page.
(b) Exhibits
Each exhibit marked with an asterisk is filed with this Annual Report on Form 10-K. Each exhibit not marked with an asterisk is incorporated by reference to the exhibit of the same number (unless otherwise indicated) previously filed by the Company as indicated below.
Exhibit
NumberSequential Description
2.1Plan of Reorganization and Agreement of Merger, dated July 1996 and filed as Exhibit A to the Company’s July 3, 1996 Proxy Statement.
3.1Certificate of Incorporation of Norris Communications, Inc. (as amended through May 28, 1996) and filed as Exhibit B to the Company’s July 3, 1996 Proxy Statement.
3.1.1Certificate of Amendment of Certificate of Incorporation of Norris Communications, Inc. filed with the State of Delaware on January 14, 1998 and filed as Exhibit 3.1.1 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended December 31, 1997.
3.1.2Certificate of Amendment of Certificate of Incorporation of Norris Communications Inc. filed with the State of Delaware on January 13, 1999 and filed as Exhibit 3.1.2 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended December 31, 1998.
3.1.3Certificate of Amendment of Certificate of Incorporation of e.Digital Corporation filed with the State of Delaware on September 18, 2008 and filed as Exhibit 3.1.3 to the Company’s Current Report on Form 8-K dated September 18, 2008.
3.1.4Certificate of Amendment of Certificate of Incorporation of e.Digital Corporation filed with the State of Delaware on August 11, 2005 and filed as Exhibit 3.1.4 to the Company’s Current Report on Form 8-K dated September 18, 2008.
3.2Bylaws of the Company, filed as Exhibit C to the Company’s July 3, 1996 Proxy Statement.
3.3Certificate of Designation of Preferences, Rights and Limitations of Series A Redeemable Convertible Preferred Stock filed with the State of Delaware on September 19, 1997 and filed as Exhibit 3.3 to the Company’s Current Report on Form 8-K dated October 3, 1997.
3.4Certificate of Designation of Preferences, Rights and Limitations of Series B Redeemable Convertible Preferred Stock filed with the State of Delaware on June 24, 1999, and filed as Exhibit 3.4 to the Company’s Annual Report on Form 10-KSB dated March 31, 1999.
3.5Certificate of Designation of Preferences, Rights and Limitations of Series C Redeemable Convertible Preferred Stock filed with the State of Delaware on October 4, 2000 and filed as Exhibit 3.5 to the Company’s Registration Statement on Form S-3 dated November 3, 2000.
3.6Certificate of Designation of Preferences, Rights and Limitations of Series D preferred stock filed with the State of Delaware on December 23, 2002 and filed as Exhibit 3.6 to the Company’s Current Report on Form 8-K dated December 30, 2002.
3.7Certificate of Designation of Preferences, Rights and Limitations of Series E preferred stock filed with the State of Delaware on November 19, 2003 and filed as Exhibit 3.7 to the Company’s Current Report on Form 8-K dated November 21, 2003.
3.8Certificate of Designation of Preferences, Rights and Limitations of Series EE preferred stock filed with the State of Delaware on November 19, 2004 and filed as Exhibit 3.7 to the Company’s Current Report on Form 8-K dated November 19, 2004.
3.9Certificate of Designation of Preferences, Rights and Limitations of Series AA preferred stock filed with the State of Delaware on June 26, 2008 and filed as Exhibit 99.4 to the Company’s Current Report on Form 8-K dated July 1, 2008.
4.1Form of Stock Purchase Warrant (Series EE Warrants) exercisable until November 2006 issued to seventeen accredited investors for an aggregate of 4,070,000 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 4.55 to the Company’s Current Report on Form 8-K dated November 19, 2004.
4.2Form of 12% Subordinated Promissory Note and Warrant Purchase Agreement dated as of June 30, 2005 entered into with certain accredited investors in a maximum aggregate amount of $1,000,000 and filed as Exhibit 4.50 to the Company’s 2004 Form 10-K.
4.2.1Form of First Amendment to 12% Subordinated Promissory Note dated as of June 30, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Payee) filed as Exhibit 4.51.1 to Form 8-K dated July 13, 2005.
4.2.2Form of Second Amendment to 12% Subordinated Promissory Note dated as of October 25, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Payee) filed as Exhibit 4.50.2 to Form 8-K dated November 8, 2005.
4.2.3Form of Amendment to 12% Subordinated Promissory Note and Warrant Purchase Agreement dated as of October 25, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Purchaser) filed as Exhibit 4.50.1 to Form 8-K dated November 8, 2005.
4.3Form of Stock Purchase Warrant exercisable until June 30, 2007 issued to certain accredited investors for up to an aggregate of 2,000,000 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 4.52 to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2004.
4.3.1Form of First Amendment to Stock Purchase Warrant dated as of June 30, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Holder) filed as Exhibit 4.51.2 to Form 8-K dated July 13, 2005.
4.4Form of Restricted Common Stock Purchase Agreement, dated February 24, 2006 between the Company and certain accredited investors for purchase of 18,750,000 common shares (individual agreements differ only as to number of shares) and filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 27, 2006.
4.5Form of Series “A” Warrant exercisable until February 28, 2009, issued February 24, 2006 to certain accredited investors for up to an aggregate of 4,687,500 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K dated February 27, 2006
4.6Form of Series “B” Warrant exercisable until six months after the effectiveness of this Registration Statement or July 31, 2008 whichever is earlier, issued February 24, 2006 to certain accredited investors for up to an aggregate of 4,687,500 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K dated February 27, 2006.
4.7Form of New Warrant issued to 29 investors in August and September 2006 for an aggregate of 2,331,572 common shares exercisable at $0.15 per share through August 31, 2009 filed as Exhibit 4.53 to Form 8-K dated August 28, 2006
4.8Exchange Agreement between the Company and Davric Corporation dated December 1, 2006 filed as Exhibit 99.1 to Form 8-K dated December 12, 2006.
4.8.17.5% Convertible Subordinated Term Note issued by the Company to Davric Corporation dated December 1, 2006 filed as Exhibit 99.2 to Form 8-K dated December 12, 2006.
4.9Common Stock Purchase Agreement, dated as of January 2, 2007, by and between e.Digital Corporation and Fusion Capital Fund II, LLC filed as Exhibit 10.1 to Form 8-K dated January 8, 2007.
4.10Registration Rights Agreement, dated as of January 2, 2007, by and between e.Digital Corporation and Fusion Capital Fund II, LLC filed as Exhibit 10.2 to Form 8-K dated January 8, 2007.
4.11Form of Convertible Preferred Stock Purchase Agreement between the Company and 12 investors for an aggregate of 75,000 Series AA Preferred Shares and Warrants (individual agreements differ only as to number of shares) dated June 27, 2008 filed as Exhibit 99.2 to Form 8-K dated July 1, 2008.
4.12Form of Stock Purchase Warrant between the Company and 12 investors for an aggregate of 7,500,000 common shares (individual warrants differ only as to holder and number of shares) dated June 27, 2008 filed as Exhibit 99.3 to Form 8-K dated July 1, 2008.
10.1Lease Agreement between the Company and LBA Industrial Fund - Holding Co. II, Inc. and Innsbruck Holdings, L.P. dated March 3, 2006 and filed as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2006.
10.1.2Second Amendment to Lease Agreement executed on May 31, 2011 between the Company and LBA/Met Partners II - COMPANY II, LLC.
10.2Agreement for Legal Services and Contingent Fee Arrangement dated March 23, 2007 between the Company and Duane Morris LLP filed as Exhibit 99.1 to Form 8-K dated March 28, 2007. (Portions of this Exhibit have been omitted and filed separately with the Securities and Exchange Commission as part of an application for confidential treatment pursuant to the Securities Exchange Act of 1934, as amended.)
10.3+2005 Equity-Based Compensation Plan, filed as Exhibit B to the to the Company's July 12, 2005 Definitive Proxy Statement.
10.3.1+Form of Incentive Stock Option Agreement under the 2005 Equity-Based Compensation Plan and filed previously as Exhibit 10.6.1 to the Company’s Annual Report on Form 10-K dated March 31, 2007.
10.3.2+Form of Nonstatutory Stock Option Agreement under the 2005 Equity-Based Compensation Plan and filed previously as Exhibit 10.6.2 to the Company’s Annual Report on Form 10-K dated March 31, 2007.
10.6Joint Statement in Response to June 28, 2011 Order Regarding Claim Construction as filed with the United States District Court for the District of Colorado on July 28, 2011 and filed previously as Exhibit 99.1 to Form 8-K dated July 28, 2011.
10.7Lease Agreement between the Company and BOI-Rancho Bernardo Bluffs Trust executed on January 20, 2012 filed previously as Exhibit 99.1 to Form 8-K dated January 20, 2012.
10.8Termination of Agreement dated September 11, 2012, between the Company and Duane Morris LLP filed previously as Exhibit 99.2 to Form 8-K dated September 17, 2012.
10.9Agreement for Legal Services and Contingent Fee Arrangement dated September 14, 2012 between the Company and Handal and Associates filed previously as Exhibit 99.1 to Form 8-K dated September 17, 2012.
* Filed concurrently herewith.
+ Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name Position Date
/s/ ALFRED H. FALK President and Chief Executive Officer June 25, 2015
Alfred H. Falk (Principal Executive Officer)
/s/ ALLEN COCUMELLI Chairman of the Board and Director June 25, 2015
Allen Cocumelli
/s/ MARDEE HARING-LAYTON Chief Financial Officer June 25, 2015
MarDee Haring-Layton (Principal Accounting Officer)
/s/ ERIC M. POLIS Secretary and Director June 25, 2015
Eric M. Polis
/s/ RENEE WARDEN Director June 25, 2015
Renee Warden
Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
e.Digital Corporation and Subsidiary
San Diego, California
We have audited the accompanying consolidated balance sheets of e.Digital Corporation and subsidiary (collectively, the “Company”) as of March 31, 2015 and 2014, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of e.Digital Corporation and subsidiary as of March 31, 2015 and 2014, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ SingerLewak LLP
Los Angeles, CA
June 25, 2015
e.Digital Corporation and subsidiary
CONSOLIDATED BALANCE SHEETS
[See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes to consolidated financial statements
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
[See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes to consolidated financial statements
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
[See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes to consolidated financial statements
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
[See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes to consolidated financial statements
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
e.Digital Corporation is a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. The Company is developing and marketing an intellectual property portfolio including (a) licensing and enforcing its Flash-R™ portfolio of patents related to the use of flash memory in portable devices, and (b) developing new licenseable intellectual property related to context and interpersonal awareness systems (“Nunchi” technology), advanced data security technologies (“microSignet” technology) and other technologies.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies used in the preparation of these consolidated financial statements:
Principles of Consolidation
These consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, e.Digital Corporation (a company incorporated in the State of California). All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Some of the estimates needed to be made by management include the allowance for doubtful accounts, valuation of inventory, estimated useful lives of property and equipment and intangible assets, warranty reserve, valuation of equity instruments associated with share-based compensation and for services rendered and the valuation allowance for the Company’s deferred tax asset. Actual results could materially differ from these estimates.
Segment Information
With the inception of patent license revenue in fiscal 2009, the Company determined that it has two operating segments: (1) patent licensing and (2) products and services. Patent licensing consists of intellectual property revenues from the Flash-R patent portfolio and products and services consist of sales of the Company’s electronic eVU mobile entertainment device and related content services. During the third quarter of fiscal 2015 the Company ceased marketing eVU products and accessories but continues to provide services to one customer under an existing contract. The Company plans to terminate providing eVU services after existing contract terms are complete by September 2015. Segment information and related disclosures about the Company’s products, services, geographical areas and major customers is contained in Note 9.
Fair Value of Financial Instruments
U.S. generally accepted accounting principles define fair value as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date, and also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available. The three-level hierarchy of valuation techniques established to measure fair value, is defined as follows:
·Level 1: inputs are unadjusted quoted prices in active markets for identical assets or liabilities.
·Level 2: inputs other than level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of assets or liabilities.
·Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
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.
The Company’s financial assets measured at fair value on a recurring basis at March 31, 2015 are as follows:
(1)Included in cash and cash equivalents on the accompanying consolidated balance sheet.
Income (Loss) per Share
Basic income (loss) per common share is computed by dividing income (loss) by the weighted-average number of shares of common stock outstanding during the period. Diluted income (loss) per common share is computed by dividing income (loss) 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 consist of stock options.
The following table presents the calculation of basic and diluted net income (loss) per share:
Employee equity share options, granted by the Company are treated as potential common shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of in-the-money options. Certain options were excluded in the computation of diluted income per share for the years ended March 31, 2015 and 2014 because the assumed proceeds exceeded the average market value of the Company’s common stock. The dilutive effect of such equity awards is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are collectively assumed to be used to repurchase shares. Dilutive securities could potentially dilute earnings (loss) per share in future years.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
Concentration of Credit Risk and Sources of Supply
Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents and trade receivables. The Company maintains cash and cash equivalent accounts with Federal Deposit Insurance Corporation (“FDIC”) insured financial institutions. Certain of the Company’s accounts are each insured up to $250,000 by the FDIC. The Company’s exposure for amounts in excess of FDIC insured limits at March 31, 2015 was approximately $1.7 million. The Company has not experienced any losses in such accounts. The Company does not believe that it is subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships. The Company performs periodic evaluations of the relative credit standing of these financial institutions. The Company has not experienced any significant losses on its cash equivalents.
Concentrations of credit risk with respect to trade accounts receivable are limited due to the number and nature of customers comprising the Company’s customer base and their geographic dispersion. The Company has not incurred any significant credit related losses.
The Company relies on one 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.
Revenue Recognition
The Company recognizes revenue in accordance with ASC Topic 605, Revenue Recognition. Revenue is recognized when (i) persuasive evidence of an arrangement exists, (ii) all obligations have been substantially performed pursuant to the terms of the license agreement, (iii) amounts are fixed or determinable and (iv) collectability of amounts is reasonably assured. The Company’s segments have the following revenue recognition policies:
Patent Licensing and Enforcement
The Company’s patent licensing operations include the licensing and enforcement of its patented technologies. These activities include the negotiation of licensing arrangements with users of patented technologies to realize a fair and reasonable license fee for all applicable periods (periods prior to and subsequent to the execution of the license agreement). In most instances to date, the Company has initiated patent litigation against infringers who are otherwise unwilling to engage in licensing negotiations, or in cases where a disagreement exists regarding whether or not infringement exists.
Revenues generated from license agreements are recognized in the period earned, provided that amounts are fixed or determinable and collectability is reasonably assured. The Company applies the guidance of SEC Staff Accounting Bulletin Topic 13.A.3(f), Nonrefundable Up-Front Fees, to its patent license and settlement agreements using the specific performance method analogous to the sale of an asset in such literature as ASC 840, Leases and ASC 926-605, Entertainment - Films, Revenue Recognition. At the time the Company enters into a contract and provides the customer with the licensed technology the Company has performed all of its obligations under contract, the rights to the Company’s technology have been transferred and no significant performance obligations remain. The Company’s licenses are perpetual in nature, extending until the expiration of the related patents. The execution of license agreements also provides for the release of the licensee from certain claims, the dismissal of any pending litigation and covenants not to sue. Pursuant to the terms of these agreements, the Company has no further obligation with respect to the grant of the license and related releases, including no express or implied obligation to maintain or upgrade the technology, or provide future support or services.
Most of the Company’s patent licenses have provided for a contractually determined one time fully paid up license in consideration for the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by patented technologies owned by the Company. The Company also has license agreements providing for future royalties based on future licensee activities. Licensees that pay license fees on a periodic basis generally report actual activity after the activity takes place. The amount of license fees due under these license agreements each period cannot be reasonably estimated by management. Consequently, the Company recognizes revenue from these licensing agreements on a lag basis as royalties are reported provided amounts are fixed or determinable and collectability is reasonably assured. The lag method allows for the receipt of licensee royalty reports prior to the recognition of revenue.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
The Company considers its licensing and enforcement activities as one unit of accounting under ASC 605-25, Multiple-Element Arrangements as the delivered items do not have value to customers on a stand alone basis, there are no undelivered elements and there is no general right of return relative to the license. Under ASC 605-25, the appropriate recognition of revenue is determined for the combined deliverables as a single unit of accounting and revenue is recognized upon delivery of the final elements, including the license for past and future use and the release. Also due to the fact that the settlement element and license element for past and future use are the major business activities of the Company’s licensing segment, the Company does not present these two elements as different revenue streams in its consolidated statement of operations. The Company does not expect to provide licenses that do not provide some form of settlement or release.
The Company evaluates each new license agreement for revenue recognition in accordance with the above criteria and applicable literature.
The Company values nonexclusive cross licenses received only if directly used in operations. To date the Company has not valued any cross licenses received as they were considered part of the customer’s overall license and settlement strategy and are not used in the Company’s products.
Products and Services
The Company recognizes product revenue upon shipment of a product to the customer, FOB shipping point, or upon acceptance by the customer depending on the specific contract terms, if a signed contract exists, the fee is fixed and determinable, collection of resulting receivables is probable and there are no resulting obligations. Service revenue is recognized once the services have been delivered, the fee is fixed and determinable, collection of the resulting receivable is probable and there are no resulting obligations. If all of the service or product has been delivered and there is one element that is more than perfunctory to the services or product that has not been delivered, revenue will be deferred and recognized evenly over the remaining term of the undelivered element.
Service revenues may include revenue from coding, encrypting and integrating content for periodic uploading to hardware players. Revenue is recognized upon acceptance of the content master file by the customer if the fee is fixed and determinable, collection of the resulting receivables is probable and there are no resulting obligations.
Revenue from separately priced extended warranty or product replacement arrangements is deferred and recognized to income on a straight-line basis over the contract period. The Company evaluates these arrangements to determine if there are excess costs greater than future revenues to be recorded as a loss.
Funds received in advance of meeting the criteria for revenue recognition are deferred and are recorded as revenue as they are earned. Any amounts related to periods beyond twelve months are considered long-term deferred revenue.
Costs of Revenues
Patent licensing and litigation costs of revenues include the costs and expenses incurred in connection with the Company’s licensing and enforcement activities, consisting mostly of non-contingent litigation costs and related enforcement support costs. Contingent legal fees and expenses are expensed in the period that the related revenues are recognized however legal fees and costs advanced or required to be paid in the event no recoveries are obtained are expensed as incurred and included in patent licensing and litigation costs in the consolidated statement of operations.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
Prepaid Expenses
Prepaid expenses are recorded at amounts paid to suppliers or others. Amounts recorded are evaluated for impairment each reporting period.
Shipping and Handling Costs and Sales Taxes
Amounts paid by customers for shipping and handling and for sales taxes are included in product revenues. Actual shipping and handling costs and sales taxes are included in product cost of revenues.
Inventory
Inventory is recorded at the lower of cost and net realizable value. The cost of substantially all Company inventory is determined by the weighted average cost method. Carrying value of inventory is periodically reviewed and impairments, if any, are recognized when the expected benefit is less than carrying value. The Company’s policy is to reserve for inventory that is obsolete or determined to be slow-moving and classifies any slow moving portion of inventory as a long-term asset. The Company has ceased offering new eVU systems and accordingly has fully reserved inventory at March 31, 2015. The Company is providing eVU content services to one customer through the term of existing contract in September 2015.
Property and Equipment
Property and equipment are recorded at cost. Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the related assets, ranging from 3 to 7 years or, in the case of leasehold improvements, over the lesser of the useful life of the related asset or the lease term. When assets are sold or retired, the cost and accumulated depreciation are removed from the respective accounts and any gain or loss on the disposition is credited or charged to income. Maintenance and repair costs are charged to operations when incurred. The Company reviews the carrying amount of fixed assets whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable in accordance with ASC 360-10-35, Impairment or Disposal of Long-Lived Assets.
Intangible Assets
Intangible assets are recorded at cost, less accumulated amortization. These costs are capitalized and amortized on a straight-line basis over the estimated periods benefited by the asset. The Company assesses the recoverability of any affected long-lived assets in accordance with ASC 350-30-35-14 by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows.
Research and Development Costs
Research and development costs are expensed as incurred.
Warranty Liability
The Company warrants its products to be free from defects in materials and workmanship for a period ranging up to one year from the date of purchase, depending on the product. The warranty is generally a limited warranty, and in some instances imposes certain shipping costs on the customer. The Company currently provides warranty service directly and through subcontractors. Some agreements with customers require certain quantities of product be made available for use as warranty replacements. International market warranties are generally similar to the U.S. market.
The Company establishes a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. Factors affecting warranty reserve levels include the number of units sold and anticipated cost of warranty repairs and anticipated rates of warranty claims. The Company evaluates the adequacy of the provision for warranty costs each reporting period.
Leases
Leases entered into are classified as either capital or operating leases. Leases, which substantially transfer all benefits and risks of ownership of property to the Company, are accounted for as capital leases. At the time a capital lease is entered into, an asset is recorded together with its related long-term obligation to reflect the purchase and financing. Rental payments under operating leases are expensed as incurred.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
Deferred Rent
For the Company’s operating facility lease, rent expense is recognized on a straight-line basis over the term of the lease and accordingly, the difference between cash rent payments and the recognition of rent expense is recorded as a deferred rent liability.
Income Taxes
The Company accounts for income taxes using the asset and liability method, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance related to deferred tax assets is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company provides a full valuation reserve related to its net deferred tax assets. In the future, if sufficient evidence of an ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, the Company may be required to reduce the valuation allowances, resulting in income tax benefits in the consolidated statement of operations. The Company evaluates the realizability of the deferred tax assets and assesses the need for valuation allowance quarterly. The utilization of the net operating loss carry forwards could be substantially limited due to restrictions imposed under federal and state laws upon a change in ownership. The Company has experienced various ownership changes as a result of past financings and could experience future ownership changes.
Upon the adoption of accounting for uncertainty in income taxes, as of April 1, 2007 the Company recognized no adjustment for uncertain tax provisions and the total amount of unrecognized tax benefits as of April 1, 2007 was $-0-. At the adoption date of April 1, 2007, deferred tax assets were fully reserved by a valuation allowance to reduce the deferred tax assets to zero, the amount that more likely than not is expected to be realized.
The Company recognizes interest and penalties related to uncertain tax positions as part of the provision for income taxes. As of March 31, 2015, the Company had not recorded any provisions for accrued interest and penalties related to uncertain tax positions.
The tax years 2010 through 2014 remain open under the statute of limitations to examination by the major tax jurisdictions to which the Company is subject. However, due to net operating loss carryforwards (“NOL”) from prior periods, the Internal Revenue Service (IRS) could potentially review the losses related to NOL-generating years back to 1995.
Stock-based Compensation
The Company has adopted stock plans as summarized in Note 8. The Company measures all employee stock-based compensation awards in accordance with ASC 718 and records such expense in the consolidated financial statements over the requisite service period. The Company records the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award-the requisite service period (usually the vesting period). Options or stock awards issued to non-employees who are not directors of the Company are recorded at their estimated fair value at the measurement date and are periodically revalued as the options vest and are recognized as expense over the related service period on a graded vesting method. Stock options issued to consultants with performance conditions are measured and recognized when the performance is complete.
The Company recorded $87,499 and $28,540 of stock-based compensation expense for the years ended March 31, 2015 and 2014, respectively. The amounts of stock-based compensation expense are classified in the consolidated statements of operations as follows:
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
While certain research and development personnel costs are allocated to cost of revenues for proportionate time spent on product and content services, the amounts of related stock-based compensation costs are not considered significant.
ASC 718 also provides that any corporate income tax benefit realized upon exercise or vesting of an award in excess of that previously recognized in earnings (referred to as a “windfall tax benefit”) will be presented in the Consolidated Statements of Cash Flows as a financing (rather than as operating) cash flow. Realized windfall tax benefits are credited to paid-in capital. Realized shortfall tax benefits (amounts which are less than that previously recognized in earnings) are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. For the years ended March 31, 2015 and 2014, there were no differences between comprehensive income (loss) and net income (loss) for the respective years.
New Accounting Pronouncements
In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. Under the new guidance, a discontinued operation is defined as a disposal of a component or group of components that is disposed of or is classified as held for sale and “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The new standard applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. The amendment is effective for annual reporting periods beginning after December 15, 2014 and interim periods within those annual periods. The Company is currently evaluating the new standard.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The new guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The amendment is effective for annual reporting periods beginning after December 15, 2016 and interim periods within those annual periods. The Company is currently evaluating the new standard.
In June 2014, the FASB issued ASU No. 2014-12, Compensation - Stock Compensation: Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period. The guidance requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. The guidance will be effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. The Company is currently evaluating the impact of this guidance, if any, on its financial statements.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements Going Concern (Subtopic 205-40) - Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern. This ASU requires management to assess an entity's ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the ASU (1) provides a definition of the term substantial doubt, (2) requires an evaluation every reporting period including interim periods, (3) provides principles for considering the mitigating effect of management's plans, (4) requires certain disclosures when substantial doubt is alleviated as a result of consideration of management's plans, (5) requires an express statement and other disclosures when substantial doubt is not alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). This standard is effective for the fiscal years ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The Company is currently evaluating the new guidance to determine the impact it will have on its consolidated financial statements.
Other Accounting Standards Updates not effective until after March 31, 2015 are not expected to have a material effect on the Company’s financial position or results of operations.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
3. INVENTORIES
Inventories consist of the following:
The foregoing is net of an aggregate lower-of-cost-or-market inventory adjustment of $70,858 and $81,609 at March 31, 2015 and 2014, respectively. The Company has ceased offering new eVU systems and accordingly has fully reserved inventory at March 31, 2015.
4. PROPERTY, EQUIPMENT AND INTANGIBLES
Property and equipment consisted of the following:
Intangible assets consisted of the following:
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
5. ACCRUED AND OTHER LIABILITIES
Accrued liabilities consisted of the following:
Details of the estimated warranty liability are as follows:
6. INCOME TAXES
Details of the income tax provision (benefit) for the years ended March 31, 2015 and 2014 are as follows:
Details of tax provision (benefit) are as follows:
The Company recorded a tax benefit of $169,888 consisting of prior year foreign tax recoveries of $206,250 less current year foreign taxes paid of $36,362.
The Company has U.S. federal NOL carryforwards available at March 31, 2015 of approximately $24,000,000 (2014 - $24,000,000) that will begin to expire in 2021. The Company has state net operating loss carryforwards of $11,300,000 (2014 - $12,600,000) that will begin to expire in 2015. The difference between federal and state net operating loss carryforwards is due to certain percentage limitations of California loss carryforwards and to expired California carryforwards. Certain foreign taxes paid create a foreign tax credit carryover that will be available to offset federal tax expense in future years, subject to certain limitations. The foreign tax credit carryover expires beginning in 2021.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
Utilization of the NOL and any R&D credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code (“IRC”) of 1986 and similar state provisions, due to changes in ownership of the Company that have occurred previously or that could occur in the future. Since the date of currently available NOLs from fiscal 1996, the Company has raised capital through the issuance of capital stock using multiple types of securities on multiple occasions which, the Company believes, caused multiple ownership changes as defined by Section 382. The Company performed a 382 analysis to assess whether ownership changes occurred which would limit the Company’s utilization of its NOLs and any R&D credits carryforwards. Based on this analysis, the Company determined that no ownership changes have occurred since March 31, 2000. Accordingly, NOL carryforwards generated during the 2001 through 2015 fiscal years, are generally not subject to Section 382 limitations and the Company will be able to utilize such NOLs and any R&D carryforwards provided it generates sufficient future earnings. Future ownership changes may limit the Company’s ability to fully utilize these tax benefits. Accordingly, the Company has recorded the deferred tax assets associated with such federal NOLs, related state NOLs, and R&D tax credits along with a corresponding valuation allowance.
During the year ended March 31, 2010 the Company completed a study of prior year R&D credits and updated its related unrecognized tax benefits. Due to the existence of the valuation allowance, this change and future changes in the Company’s unrecognized tax benefits will not impact its effective tax rate.
Significant components of the Company’s deferred tax assets as of March 31, 2015 and 2014 are shown below. A valuation allowance of $10,529,000 and $10,601,000 was established at March 31, 2015 and 2014 respectively, to offset the net deferred tax assets as realization is uncertain. When and if the Company can sustain consistent profitability and management determines that it is more likely than not that the Company will be able to utilize the deferred tax assets prior to their expiration, the valuation allowance may be reduced or eliminated.
At March 31, 2014, deferred tax assets do not include excess or windfall tax benefits from stock-based compensation of approximately $1,700. Equity will be increased by $1,700 if and when such deferred tax assets are ultimately realized. The Company uses ASC 740 ordering when determining when excess tax benefits have been realized. There was no comparable tax benefits for March 31, 2015.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
The difference between the provision for income taxes (benefit) and the amount computed by applying the U.S. federal income tax rate for the years ended March 31, 2015 and 2014 is as follows:
7. CAPITAL STOCK
Authorized Capital
The authorized capital of the Company consists of 350,000,000 common shares with a par value of $.001 per share and 5,000,000 preferred shares with a par value of $10.00 per share. The issued common stock of the Company consisted of 293,378,330 and 293,328,330 common shares as of March 31, 2015 and 2014, respectively. The Company had no shares of preferred stock outstanding at March 31, 2015 or 2014.
8. BENEFIT PLANS AND STOCK-BASED COMPENSATION
Stock Plan and Awards
The Company has stock options outstanding under its 2005 Equity-Based Compensation Plan covering a maximum of 10,000,000 common shares. The Company may grant incentive options, nonstatutory options, stock appreciation rights or restricted stock awards to employees, directors or consultants until July 28, 2015. At March 31, 2015 there were options outstanding on 5,948,578 common shares pursuant to the 2005 Plan with options on 3,301,750 shares available for future grant under the 2005 Plan plus any future forfeitures or cancellations from the 2005 Plan options currently outstanding.
Stock-Based Compensation
The grant-date fair value of employee share options and similar instruments is estimated using a Black-Scholes option-pricing model. The following table sets forth the weighted-average key assumptions and fair value results for stock options granted during the years ended March 31, 2015 and 2014.
The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the common stock over the period commensurate with the expected life of the options. The Company has a small number of option grants and limited exercise history and accordingly has for all new option grants applied the simplified method prescribed by SEC Staff Accounting Bulletin 110, Share-Based Payment: Certain Assumptions Used in Valuation Methods - Expected Term, to estimate expected life (computed as vesting term plus contractual term divided by two). The expected forfeiture rate is estimated based on historical experience and is assumed at 0.0% for nonemployees and certain long-term employees and 5.0% for other employees. For the purpose of this analysis, the weighted-average of 0.0% forfeiture rate was used because of classification of employees and nonemployees granted options during the year. 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.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
Since the Company has a net operating loss carryforward as of March 31, 2015, no excess tax benefit for the tax deductions related to stock-based awards was recognized for the year ended March 31, 2015. Additionally, no incremental tax benefits were recognized from stock options exercised during the year ended March 31, 2015 or 2014 that would have resulted in a reclassification to reduce net cash provided by operating activities with an offsetting increase in net cash provided by financing activities.
As of March 31, 2015 total estimated compensation cost of options granted but not yet vested was approximately $135,500 and is expected to be recognized over the weighted average period of 1.3 years.
Stock Option Summary Information
The following table summarizes stock option transactions:
The following table summarizes the number of options exercisable at March 31, 2015 and the weighted average exercise prices and remaining contractual lives of the options.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
9. SEGMENT INFORMATION
The Company has two operating segments: (1) patent licensing and and (2) products and services. Patent licensing consists of intellectual property revenues from the Flash-R patent portfolio and products and services consist of sales of the Company’s electronic eVU mobile entertainment device and related content services. During the third quarter of fiscal 2015 the Company ceased marketing eVU products and accessories but continues to provide services to one customer under an existing contract. The Company plans to terminate providing eVU services after the existing contract terms are complete in September 2015.
Reportable segment information for the years ended March 31, 2015 and 2014 is as follows:
The Company does not have significant assets employed in the patent license segment and does not track capital expenditures, assets, research or selling and administrative costs by reportable segment. Consequently there is no disclosure of this information.
Revenue by geographic region is determined based on the location of the Company’s direct customers or distributors for product sales and services. Patent license revenue is considered United States revenue as payments are for licenses for United States operations irrespective of the location of the licensee’s or licensee’s parent home domicile.
Revenues from one licensee (16%) accounted for more than 10% of revenues for the year ended March 31, 2015. Revenues from one licensee (11%) accounted for more than 10% of revenues for the year ended March 31, 2014. Accounts receivable from three parties comprised 46%, 35% and 19% of net accounts receivable at March 31, 2015. Accounts receivable from three parties comprised 42%, 33% and 11% of net accounts receivable at March 31, 2014.
e.Digital Corporation
Notes to Consolidated Financial Statements
March 31, 2015
10. COMMITMENTS AND CONTINGENCIES
Legal Matters
Intellectual Property Litigation
In fiscal years 2013 through 2015 the Company commenced new rounds of enforcement action with respect to its patent portfolio and as of June 4, 2015, has active a total of 16 complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe the Company’s U.S. patents covering the use of Flash-R portfolio.
The Company commenced legal action with regards to its Nunchi portfolio of patents in July 2014 and currently has two active complaints in the U.S. District Court for the Northern District of California and one in the U.S. District Court for the Southern District of California.
Commitment Related to Intellectual Property Legal Services
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 . 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 ranging from 33-40% of any license fee or settlement related to patent enforcement matters, less prior retainers and expenses. The Company may terminate the representation at any time but would be obligated to pay fees and advances.
Facility Lease
In January 2012, the Company entered into a sixty-two month facility lease for its corporate office location, commencing May 1, 2012, for approximately 3,253 square feet at 16870 West Bernardo Drive, Suite 120, San Diego, California. The aggregate monthly payment is $5,693 excluding utilities and costs. The aggregate payments adjust annually with maximum payments totaling $7,157 in the forty-ninth through sixty-second months. Future lease commitments at March 31, 2015 total $188,511. The Company recognizes rent expense by the straight-line method over the lease term. As of March 31, 2015, deferred rent totaled $28,218.
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 March 31, 2015, the Company made matching contributions totaling $13,805.