ITEM 1. BUSINESS
Overview
e.Digital Corporation is a holding company that operates through a wholly-owned California subsidiary of the same name and is incorporated under the laws of Delaware. We provide engineering services, product reference designs and technology platforms to customers focusing on the digital video/audio and player/recorder markets. We have innovated a proprietary secure digital video/audio technology platform ("DVAP") that can be applied to produce complex consumer electronic products. In 2003 our DVAP was applied to an in-flight entertainment ("IFE") device, the digEplayer(TM), for one customer. To date, we have delivered over 8,000 digEplayers for airline use.
In December 2005 we announced our latest proprietary DVAP device, the eVU(TM) mobile entertainment device. The rugged eVU features sharp images on a 7" high resolution LCD screen, a 40 GB hard drive, high audio fidelity, dual stereo headphone jacks, embedded credit card reader/processor, touch screen capabilities, full feature graphical user interface, patent-pending hardware security technology, and 10 hours of high resolution video playback on a single battery charge. We also have the capability to add features and customize the product for select customers.
We were incorporated in the Province of British Columbia, Canada as Norris Communications Corp. on February 11, 1988 and on November 22, 1994 changed our 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, stockholders approved a name change to e.Digital Corporation. Our principal executive offices and primary operating facilities are located at 16770 West Bernardo Road, San Diego, California 92127 and our telephone number is (858) 304-3016. Our Internet site is located at www.edigital.com. Information contained in our Internet site is not part of this Annual Report.
Technology and Services
While we continue to offer engineering services, product reference designs and technology platforms, our primary strategy for future quarters is to produce branded eVU devices for customer orders. eVU is targeted at business opportunities for secure hard drive-based closed system video products loaded with desirable movie, television, music, informational, and educational content, rented or provided to customers. We have commenced eVU demonstration deliveries and are preparing pilot trials for select target customers. We are focused on U.S. and international companies in the healthcare, military, and travel and leisure industries who desire to brand and market eVU to consumers at their facilities. We have developed logistic and secure content solutions to enable customers to rapidly deploy, operate and maintain eVUs for target customers. In addition to offering eVUs for sale we expect to provide eVU solutions on a periodic payment program.
Our revenue has been, and is expected to be, derived from a combination of sale of products to customers when we arrange for turnkey production, fees from licensing, engineering services, manufacturing services, warranty services, industrial design services, technical support services and unit royalty payments.
When developers of electronic products lack the experience or resources to work with portable storage media or to do their own design work, our design services help perform component and product design. We offer design services in areas such as circuit design, the design and incorporation of custom digital signal processing solutions, wireless communication, computer and Internet connectivity and product design. We have expertise in embedded systems, digital and analog integrated circuit design, wireless, multimedia, Internet and computer connectivity, DSP customization, flash memory interface and related fields.
In addition to design, our engineers can perform product development and engineering services aimed to convert designs into functional reference designs, prototypes and/or end products. The engineering services we offer include custom hardware and firmware (an instruction set programmed into a chip which determines the product's functionality and user interface), software development, technology platform development and product design.
We also arrange for manufacturing services including factory hand-off and development of test procedures. The manufacturing services we provide range from startup through order fulfillment services and post production quality and warranty services.
Our business customers license or purchase our product reference designs or our technology platforms to embed in or integrate with their product design allowing them to accelerate the product development process.
MicroOS(TM)
Our proprietary MicroOS(TM) operating system serves as the foundation for our DVAP, digital audio and wireless technology platforms. MicroOS was originally developed by us for use in digital voice recorder technology, but because of its inherent flexibility, has grown and been adapted to support audio and video storage and playback and wireless utilities. MicroOS is compact and dynamic, responding to a variety of user interfaces. MicroOS manages the volume and equalizer functions, the LCD drivers and interfaces, decodes a wide variety of audio and video files, interacts with a variety of digital rights management schemes and supports today's most popular media storage formats including hard disk drives, compact and embedded flash and others.
MicroOS manages multiple functions within a single device, utilizing less power, space and operating capacity than many alternative solutions. The life cycle of consumer electronics products is very short and continues to accelerate. With MicroOS we believe we are able to complete new product design and development projects faster and more economical than many competitors. The use of MicroOS shortens the development cycle and MicroOS' flexibility provides the same lead time benefits to subsequent generations of each MicroOS based product.
Digital Video/Audio Technology Platform
We have designed and developed a digital dideo/audio technology platform based on our proprietary MicroOS core. Our DVAP accommodates various third party video compression encoded material, proprietary security measures and allows for other customizable options. The DVAP supports screen sizes from 2.5 to 10.4" and is capable of achieving better than DVD quality video. The 7" version was first released in 2003 for use on commercial airline flights as an in flight entertainment (IFE) device.
Our first commercial release of our DVAP was accomplished through business customer Airline Protective Systems ("APS") branding and distribution of the digEplayer 5500(TM) IFE product to Alaska Airlines. The first units were provided to Alaska Airlines passengers in October 2003. In 2004, we received follow-on orders for commercial quantities of IFE units. The units are loaded with content by APS from partners such as 20th Century Fox, DreamWorks SKG, Warner Brothers and DMX. The large 7" screen delivers better than DVD quality video - a key competitive factor to others evaluating opportunities in the market.
digEcor ((formerly, APS) a division of Wencor West, Inc.) has marketed the digEplayer to airlines worldwide and other companies within the travel and leisure industry. We are actively in pursuit of other companies seeking personal video platforms for their own branding purposes. We believe there are opportunities for new and next generation applications of our DVAP.
Our proprietary DVAP is flexible and we believe we can address markets beyond IFE with products customized for niche customers for travel and leisure, medical, education, government and military use. We modified our DVAP technology to incorporate the latest LCD screen, media storage, video processing, battery and other components to address specific needs of the IFE, medical and travel and leisure segments of the market. The resulting product is our eVU(TM) mobile entertainment device.
Content Protection Technology
We have designed and developed a family of proprietary hardware and software encryption, digital rights management (DRM), key management and data obscuration technology for content protection. This technology has been employed in our prior MP3 player products and in our current DVAP products. Our latest product eVU incorporates an implementation of this family of technology. Elements of this technology have been incorporated into the digEplayer via license and have been tested and approved by major Hollywood movie studios. We currently have a U.S. patent application pending for security technology and a provisional U.S. patent application for our family of security technology.
Wireless Technology
We have experience in developing wireless solutions for business customers and our DVAP has applications for wireless technology. Wireless communications between devices and hosts will benefit consumers' abilities to manage and procure content. We are also integrating 802.11(Wi-Fi) technology as an option for our DVAP. We have a separate Wireless Technology Platform that can also be applied to other electronic products. We expect to support and integrate other, new wireless technologies into our DVAP or our wireless technology platform, including WiMax, UWB (ultra wide band) and others.
Recent Developments
In November 2005, in the normal course of our business, we placed a purchase order for 1,250 digEplayers with a contract manufacturer, Maycom Co., Ltd. ("Maycom"). Maycom was paid progress payments with final payments made in full for the order by e.Digital and directly by our customer, digEcor ("digEcor") in March, 2006.
In March 2006 we announced that we had became aware of information indicating that Maycom may be unwilling or unable to complete the November 2005 purchase order for product intended for delivery to digEcor. In May 2006, we announced that a complaint had been filed against our company and certain of our officers and employees by digEcor in the Third Judicial District Court of Utah, County of Salt Lake. The complaint alleges breaches of contract, unjust enrichment, breaches of good faith and fair dealing, fraud, negligent misrepresentation, and interference with prospective economic relations. digEcor is seeking, among other things, an injunction to prevent us from selling or licensing certain digital rights management technology and "from engaging in any competition with digEcor until after 2009." digEcor is also seeking "actual damages" of $793,750 and "consequential damages...not less than an additional $1,000,000." We believe this action is related to the purchase order we placed in the normal course of our business on November 11, 2005 for 1,250 digEplayers with contract manufacturer, Maycom. Maycom was paid progress payments with final payments made in full for the order by e.Digital and directly by, digEcor in March 2006. Maycom has fulfilled orders for digEplayers since 2003, and has fulfilled orders for other products manufactured for us and our customers since 2000. We expect Maycom to fulfill their obligation under the purchase order and we have initiated legal remedies to compel its performance. We have received recent verbal and written assurances from Maycom that they intend to perform under the purchase order. We believe there are alternative suppliers that may be able to complete the order if Maycom is unable to do so. We are also evaluating if any third parties have interfered with our business relationship with Maycom.
We are unable to determine at this time the impact this complaint and matter may have on our financial position or results of operations if Maycom does not timely fulfill its obligation to us and we are unable to deliver product to our customer, digEcor, in a timely manner. We have not recognized any revenue or costs related to products associated with this order, as we only recognize revenues and associated costs when products are delivered to and accepted by our customer. We had approximately $600,000 in deposits to Maycom as a current asset and approximately $790,000 of deposits from digEcor as a current liability related to the digEplayers associated with this order. Our deposits with Maycom are considered as impaired at March 31, 2006 and we could be obligated to digEcor for their deposits to us if product is not delivered. We intend to seek restitution from Maycom for any damages we may incur from this matter and the digEcor complaint. Maycom is not involved in the design, tooling or production of our proprietary eVU mobile entertainment product.
Industry Background
We design and market digital technology product platforms employing portable storage media, with the major categories being digital video recorder/players, digital music recorder/players and related mobile devices. We also have experience developing digital automotive technology platforms and a wireless technology platforms.
Digital Video Recorder/Players
Digital video players including DVD (digital video disc) players are increasing in popularity with consumers. According to the Consumer Electronics Association, DVD content is a $12 billion/year market.
Video compression formats such as MPEG-4 and DivX allow the compression and transmission of digital video files over the Internet. They also allow consumers to download and store on their personal computer's hard drive full-length, two-hour, motion picture files in as little as 500 MB of storage space. These movies can then be viewed by consumers on a computer monitor or a personal video recorder/player.
There is also a developing market for streaming delivery of video content on the Internet. Corporations or video production companies may use streaming video to deliver information and entertainment to users. DivXNetworks, Inc., the creator and provider of the DivX video compression format, reports that over 80 million users have downloaded their video playback software. This illustrates the demand for high-quality video in manageable file sizes. The users of DivX compression format have been limited to viewing DivX motion picture content on their computer monitors. We believe there will be growing demand for a system including portable hardware that will allow consumers to select and download movies over the Internet in compressed digital form, then download them to a portable player capable of feeding the video and audio signals through a home entertainment system or built-in viewing screen and speakers.
We believe there are applications for our DVAP platform and related products in broad aspects of the travel and leisure, medical, education, government and military markets and that these are growing markets.
In Flight Entertainment
IFE encompasses music, news, television programming, and motion pictures presented through audio/video systems typically embedded into an aircraft. Certain airlines are also beginning to incorporate satellite programming and/or wireless Internet access for their passengers through extensive built-in hardware in certain aircraft on certain routes. According to the Wall Street Journal, airlines worldwide spend approximately $2 billion a year on entertainment.
Because the costs to retrofit an aircraft with IFE equipment can be prohibitive, we have developed an alternative portable IFE system. Our portable IFE player, based upon our DVAP, is smaller than a typical laptop computer and has a high-quality color screen and stereo headphones. Although passengers may rent or purchase portable DVD players from outside entities, we created the first portable video players rented to passengers by airlines. We believe this type of system is attractive to airlines and other travel-related entities because of its revenue potential, variety of content, and inexpensive implementation.
Portable Storage Market
There are two major categories of portable storage media: solid state and miniature rotating disks including hard disk drives. We have designed our technology to work with a wide variety of portable storage media. Our product applications support a variety of storage media with capacities ranging from 16 Megabytes ("MB") to 80 Gigabytes ("GB") in portable storage formats widely available from various vendors.
We believe these portable storage formats are complicated to use and generally require a sophisticated interface and file system. A file system is a software driver used to make portable memory components more closely emulate a traditional disk drive and allow an understood mechanism for rapidly storing and retrieving data with the minimal overhead allowed in a portable device. Portable storage formats may also require the use of sophisticated power management systems to maximize battery life in portable devices, and additionally may require robust software interfaces with personal computing platforms for consumers' ease of use in exchanging data files (consisting of music, pictures, movies, voice recordings, text documents, spreadsheets, or other data) with their personal computers.
Our MicroOS operating system for storage management and experience in a variety of portable products are key factors in marketing our services and solutions to business customers. We also believe we have an import portfolio of patents for licensing related to the portable storage market.
Our Business Strategy
We are currently focusing development, sales, marketing, and support efforts chiefly on platform and product development opportunities for customers in the portable digital entertainment device markets. Our objective is to have our DVAP products play a major role in the IFE and other related markets.
In addition to offering our eVU product and custom variations of this DVAP product to customers, we also are available to provide customers a total solution from product design through development, manufacturing, delivery, and support. We actively seek licensing, private label, and business customer opportunities in the digital video and audio processing markets. Our efforts include:
1. Expanding our business by developing custom products for customers - We seek to expand our business through sales and marketing targeted at obtaining additional product development opportunities with existing customers and new business customers.
2. Developing brand name recognition with business customers - This strategy is being pursued through participation in industry alliances, trade show participation, professional articles and attaching our name along with customer products to the greatest extent possible.
3. Expanding the technology base through continued enhancements of our technologies and application - We develop in-house proprietary designs, products, features or technologies that may be private labeled or licensed to one or more business customers. Our engineering team continues to enhance and update MicroOS(TM) and related technology. We also devote resources to expanding our technology to new applications. In addition to supporting music, voice, and video processing, we believe our technology may have applications in a wide range of products.
4. Leverage strategic industry relationships - We have established and maintain important strategic industry relationships and associations with a number of related companies. We seek to leverage these relationships to offer better technology integration and solutions to our business customers and to maximize subtle but valuable marketing and co-promotion opportunities.
Customers
Our revenues result from the sale of products, product royalties, fees from engineering services, order fulfillment, technical support services, warranty services and/or design services. In some cases, we rely on outside subcontractors to perform services including manufacturing, testing and certification, industrial design, and assembly.
We expect our revenues in fiscal 2007 to come primarily from new customers of our eVU product. We currently have revenue-producing contracts or revenue-producing licensing and marketing arrangements with the following customers:
APS/Wencor (now known as digEcor), - We licensed elements of our DVAP technology to digEcor and customized it for use in a branded portable IFE device known as the digEplayer 5500(TM) for Alaska Airlines. This portable IFE product has been marketed and sold to other airlines by digEcor. We have provided product to APS/Wencor pursuant to license and supply agreement. There is no assurance we will obtain any future revenues from APS/Wencor due to the disputes and litigation described elsewhere herein. See Item 1. Business - "Recent Developments."
Bang & Olufsen - We licensed technology to Bang & Olufsen for use in their branded digital audio player products. The first product developed under our licensing agreement (the BeoSound 2 portable MP3 player) reached the retail market in June 2002. Bang & Olufsen sells their branded products, including the BeoSound 2, through exclusive retail stores worldwide.
Other Customers We offer developers of electronic products a portfolio of services within the broad categories of design services, development services, manufacturing services, and customer service. We seek and have discussions with a variety of prospective customers on new electronic products. We also make improvements to our existing DVAP and other technologies using our own resources to attract new customers. Our revenue has been, and is expected to be, derived from a combination of fees from licensing, engineering services, manufacturing services, warranty services, industrial design services, technical support services and unit royalty payments.
Strategic Relationships & Associations
Companies with related but not competing technologies have agreed to license our technologies and/or designs. To varying degrees, these strategic partners promote and market our work with their own. They may, from time to time, refer customers to us. With these strategic partners, we may collaborate on projects where both partners could benefit.
We also rely on certain partners and/or vendors for their contributions to our product designs and we may purchase or license components or technologies from them. These partners may also promote or display our products or designs at industry trade shows or in their advertising. We believe these partners add value to our services and help generate industry goodwill that can result in increased business.
Manufacturing and Distribution
We have nonexclusive relationships with manufacturers with facilities in Asia and the United States. These manufacturers either have performed in the past or are qualified to perform manufacturing, assembly, and related services for our customers and licensees. We have expertise in developing, performing and overseeing manufacturing processes. We offer technology transfer, manufacturing supervision, documentation, and quality control services to our customers.
We purchase our primary components from two manufacturers accounting for 74% and 13% of total purchases for fiscal year 2006. For fiscal 2005 one manufacturer accounted for 92% of total purchases and for fiscal 2004 purchases from two manufacturers accounted for 19% and 14%. These manufacturers purchase major electronic components from a limited number of suppliers.
In November 2005, in the normal course of our business, we placed a purchase order for 1,250 digEplayers with our contract manufacturer, Maycom. Maycom was paid progress payments with final payments made in full for the order by e.Digital and directly by our customer, digEcor in March, 2006. In March 2006 we announced that we had became aware of information indicating that Maycom may be unwilling or unable to complete the November 2005 purchase order for product intended for delivery to digEcor. We are working to resolve this material supply interruption and the significant impact it has on our operations. See discussions related to this issue and digEcor elsewhere in this Annual Report. See Item 1. Business - "Recent Developments."
We have developed a domestic manufacturing source for our eVU product and believe we can deliver product timely to future customers. The loss of a manufacturer or the disruption in supply from the manufacturer or in the supply of components by their suppliers has had and could have in the future a material adverse effect on our financial condition, results of operations and cash flows.
Marketing and Sales
Business customers' technology marketing and sales are performed internally, primarily by our Vice President of Business Development and our President/Chief Technical Officer and various technical personnel who are involved in the sales process. Targeted customers include digital video device developers and users, major electronic product manufacturers, PC manufacturers and automotive audio/video manufacturers.
We primarily market our services through our strategic and industry relationships and technical articles in trade and business journals. We also participate in industry trade shows, either directly or in conjunction with customers and/or strategic partners. In the last twelve months we have devoted significant resources to creating enhanced marketing materials that supplement custom marketing presentations to key prospects. We may in the future employ limited and selected advertising in targeted industry publications.
Sales to one major customer comprised approximately 94% of revenues in fiscal year 2006 [2005- one customer comprised 96%] and [2004 - three customers comprised 36%, 26% and 11%]. Historically, our revenues have relied on a few major customers. There is no assurance we will obtain any revenues from this customer in fiscal 2007. The loss of any customer could have a material adverse effect on our financial condition, results of operations and cash flows.
Our backlog fluctuates due to the timing of large orders and other factors. Our products are manufactured with lead times of generally less than three months. Our backlog at March 31, 2006 was nil (excluding the uncompleted digeCor order described herein), at March 31, 2005 was $0.6 million and 2004 was nil. Accordingly, the amount of order backlog does not indicate future sales trends.
Research and Development Costs
For the years ended March 31, 2006, 2005 and 2004, we spent $1,337,568, $1,515,238 and $1,531,177, respectively, on research and development. We anticipate that we will continue to devote substantial resources to research and development activities. In fiscal 2006, 2005 and 2004, approximately nil, $122,613 and $292,607 of total research and development revenue was recognized from the company's research and development contracts. The related costs were included in cost of services.
Intellectual Property
We have five issued U.S. patents covering our MicroOS file management software and certain technology related to portable digital devices incorporating flash memory. Our software is also protected by copyrights. We rely primarily on a combination of patents, copyright and trade secret protection together with licensing arrangements and nondisclosure and confidentiality agreements to establish and protect our proprietary rights.
We have designed and developed proprietary hardware encryption technology for content protection. This technology, in various forms, has been used in the digEplayer and eVU products and certain implementations have been tested and approved by major Hollywood movie studios. We currently have a patent application pending with the U.S. Patent Office for this technology.
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 are currently pursuing trademark applications with the U.S. Patent and Trademark Office and also have filed certain U.S. and international patent applications, we do not know whether any of these applications will result in the issuance of patents or trademarks, 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 have also filed a number of trademark applications with the U.S. Patent and Trademark Office. We have received notification of allowance from the United States Patent Office for use of e.Digital(TM), MicroOS(TM), Smart Solutions for a Digital World (Service Mark), VoiceNav(R), Music Explorer(R), MXP(TM), Flashback(R), Hold That Thought(R), Fumble Free(R) and SoundClip(R) 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 and other portable storage formats.
Competition
Many electronic firms and prospective business customers have in-house design and development teams. There are also a large number of electronic engineering and development firms in the U.S. and worldwide that offer design, development and manufacturing services competitive to the services we offer. Many of these firms have larger staffs and greater financial resources than we do.
Many large manufacturers currently market various forms of component or handheld digital video players, including Panasonic, Sony, Samsung, Hitachi, RCA, Audiovox, Philips, Daewoo, General Electric, and Toshiba. Other manufacturers may announce products in the future. Although we are early adopters of the DivX video compression technology, there can be no assurance that other manufacturers will not create and introduce competing products also incorporating this or comparable video compression technology.
Competition in the IFE industry comes from portable DVD hardware manufactured by companies such as Sony, Samsung, Panasonic, or Audiovox, who may sell such products to travelers or airlines. Innovative Media Solutions (IMS) offers a portable PC laptop-based IFE product used on several airlines. The airline industry may also continue to opt for embedded IFE systems. Motion picture studios or others could contract competing hardware developers to create new portable products for the IFE industry. Although our system was designed as an IFE device and has unique features and the support of content providers, there can be no assurance that other manufacturers will not create and introduce new competing portable IFE products.
Barriers to entry by new competitors are not significant and new competitors in consumer electronics are continually commencing operations. The technology of electronics and electronic components, features and capabilities is also rapidly changing, in many cases causing rapid obsolescence of existing products and technologies.
We believe we have developed a leading low-level real time operating system and comprehensive file management system capable of customization for individual customer requirements. Other companies offering file management systems include M-Systems Flash Disk Pioneers Ltd., Intel Corporation, Digital5 Inc., PortalPlayer Inc., I/O Magic, and Datalight Inc. In addition to licensing file management systems, some companies develop their own file management systems for a particular product, either in total or by adapting from one of the competitive vendors. While this self-development is common in simple memory management devices, we offer a system attractive for more complex applications. Our technology will compete with other solutions; however, we will focus on markets requiring advanced features and a robust file management system. Although we were successful in competing against other systems in our selection by Bang & Olufsen, APS, and others, there is no assurance we can continue to compete against other providers of digital recording solutions, many of whom have substantially greater resources.
Our technology focuses on digital applications. Accordingly, competition for our technology includes analog tape solutions, traditional dictation equipment, and traditional CD or DVD recording and playback equipment. Our business customers and we therefore, compete with a wide range of consumer and business product suppliers producing a wide variety of products and solutions. The electronics product market is highly competitive with many large international companies competing for the consumer and business markets.
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 in the field of portable digital entertainment products and systems.
Seasonality
Although our business is not seasonal in the traditional sense, production is usually lower in the first quarter of the calendar year as foreign manufacturing plants typically are closed for a period from shortly before the year-end holiday season until early February.
Executive Officers
Alex Diaz - Mr. Diaz joined the Board in July 2002 and was appointed Chairman in November 2002. Mr. Diaz is Executive Vice President of Califormula Radio Group in San Diego, where he oversees the wide area network (WAN) linking audio, production studios, and transmitter sites, all of which he designed. He also established a Web presence for several of Califormula's San Diego radio stations, including Jammin' Z90, Radio Latina, and classical music station XLNC1. Before joining Califormula, Mr. Diaz worked at Radio Computing Services in New York. Mr. Diaz holds bachelor's degrees in mathematics and computer science from the University of California in San Diego.
William Blakeley -Mr. Blakeley was appointed President and Chief Technical Officer in November 2005. Mr. Blakeley has served as a Principal Systems Engineer and Manager for Northrop Grumman Radio Systems since August 2002. Mr. Blakeley also served as an independent consultant (program management) for two venture backed start ups from January 2002 until August 2002. He also served as Vice President of Engineering for Aegis Broadband Inc. from January 1999 until January 2002. He has also served as President of SDCOMM Technologies, Inc. from 1997 to 1999. From 1988 to 1997, Mr. Blakeley held various management positions with Scientific Atlanta, Inc. Mr. Blakeley obtained a Bachelor of Science degree in Applied Mathematics from San Diego State University in 1983 and a Master of Science degree in electrical engineering from San Diego State University in 1988.
Robert Putnam - Mr. Putnam was appointed Senior Vice President in April 1993. He was appointed a Director of the company in 1995. In May 2005, Mr. Putnam assumed the additional responsibilities of Interim Chief Accounting Officer and Corporate Secretary. Mr. Putnam served as Secretary of the company from March 1998 until December 2001. He served as a Director of American Technology Corporation ("ATC") from 1984 to September 1997 and served as Secretary/Treasurer until February 1994, President and Chief Executive Officer from February 1994 to September 1997 and currently serves as Vice President, Investor Relations of ATC. He also served as Secretary/Treasurer of Patriot Scientific from 1989 until December 2000 and was a director from 1989 to March 1998. Mr. Putnam obtained a B.A. degree in mass communications/advertising from Brigham Young University in 1983. Mr. Putnam devotes only part-time services to the company, approximately twenty hours per week.
Employees
As of June 16, 2006, we employed approximately fifteen full-time employees and one part-time employee of whom three were in production and testing, eight were in research, development and engineering, three were in sales, general and administrative and two are executive officers. 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
e.Digital Corporation's Internet website address is 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 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 Securities and Exchange Commission.
Environmental Compliance
Our operations are subject to various foreign, federal, state and local regulatory requirements relating to environmental, waste management, health and safety matters and there can be no assurance that material costs and liabilities will not be incurred or that past or future operations will not result in exposure or injury or claims of injury by employees or the public. Some risk of costs and liabilities related to these matters are inherent in our business, as with many similar businesses. Management believes its business is operated in substantial compliance with applicable environmental, waste management, health and safety regulations, the violation of which could have a material adverse effect on our operations. In the event of violation, these requirements provide for civil and criminal fines, injunctions and other sanctions and, in certain instances, allow third parties to sue to enforce compliance. In addition, new, modified or more stringent requirements or enforcement policies could be adopted which could adversely affect our operations.
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 a History of Losses and May Incur Future Losses. We have incurred significant operating losses in prior fiscal years and as of the fiscal year ended and March 31, 2006 we had an accumulated deficit of $77.2 million. We had losses of approximately $3.1 million, $2.4 million and $2.5 million in fiscal years 2006, 2005 and 2004, respectively. To date, we have not achieved profitability and given the level of operating expenditures and the uncertainty of revenues and margins, we will continue to incur losses and negative cash flows in future periods. The failure to obtain sufficient revenues and margins to support operating expenses could harm our business.
We do not Anticipate Paying Dividends. We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain any future earnings to fund the development and growth of our business. An investment in our common stock, therefore, may be more suitable for an investor that is seeking capital appreciation rather than current yield and, as a consequence, may be more speculative. Accordingly, investors should not purchase our common stock with an expectation of receiving regular dividends.
We Expect Our Operating Results to Fluctuate Significantly - Our quarterly and annual operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation is a result of a variety of factors, including the following:
o Unpredictable demand and pricing for our contract development services o Market acceptance of our business customers' products by end users o Uncertainties with respect to future customer product orders, their timing and the margins to be received, if any o Fluctuations in operating costs o Changes in research and development costs o Changes in general economic conditions o Changes in technology o Short product lifecycles
We May Experience Product Delays, Cost Overruns and Errors Which Could Adversely Affect our Operating Performance and Ability to Remain Competitive. We have experienced development delays and cost overruns associated with contract development services in the past. We may experience additional delays and cost overruns on current projects or future projects. Future delays and cost overruns could adversely affect our financial results and could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements. Our technology, the results of our contract services and the products produced for our customers could contain errors that could cause delays, order cancellations, contract terminations, adverse publicity, reduced market acceptance of products, or lawsuits by our customers or others who have acquired our products, including customers branded products.
We Need to Obtain Additional Financing to Continue Operating our Business. We believe that cash on hand and proceeds from existing development and production contracts and product sales, are not sufficient to meet cash requirements for the next twelve months. We anticipate the need to raise additional funds to:
o Finance working capital requirements o Pay for increased operating expenses or shortfalls in anticipated revenues o Fund increases in research and development costs o Develop new technology, products or services o Respond to competitive pressures o Support strategic and industry relationships o Fund the production and marketing of our products and services
We cannot assure you that such additional financing will be available on terms favorable to us, or at all. If adequate funds are not available to us then we may not be able to continue operations or take advantage of opportunities. If we raise additional funds through the sale of equity, including common stock, the percentage ownership of our stockholders will be reduced.
Unless We Obtain Adequate Financing and Increase Our Revenues We May Be Unable to Continue as a Going Concern. We have experienced substantial reduction in cash, projected revenues and increased costs that adversely affected our results of operations and cash flows. Our company has suffered recurring losses from operations. This factor, in combination with (i) reliance upon debt and new equity financing to fund the continuing, losses from operations and cash flow deficits, (ii) material net losses and cash flow deficits from operations during fiscal year 2006, fiscal year 2005 and in prior years and (iii) the possibility that we may be unable to meet our debts as they come due, raise substantial doubt about our ability to continue as a going concern. Our company's ability to continue as a going concern is dependent upon our ability to obtain adequate financing and achieve a level of revenues, adequate to support our capital and operating requirements, as to which no assurance can be given. In the event we are unable to continue as a going concern, we may elect or be required to seek protection from our creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. To date, management has not considered this alternative, nor does management view it as a likely occurrence. Our auditors have included in their report an explanatory paragraph describing conditions that raise substantial doubt about our ability to continue as a going concern.
Risks Related to Sales, Marketing and Competition
We May Be Unable to Successfully Compete in the Electronic Products Market Which is Highly Competitive and Subject to Rapid Technological Change. We compete in the market for electronics products which is intensely competitive and subject to rapid technological change. The market is also impacted by evolving industry standards, rapid price changes and rapid product obsolescence. Our competitors include a number of large foreign companies with U.S. operations and a number of domestic companies, many of which have substantially greater financial, marketing, personnel and other resources. Our current competitors or new market entrants could introduce new or enhanced technologies or products with features that render the company's technology or products obsolete or less marketable, or could develop means of producing competitive products at a lower cost. Our ability to compete successfully will depend in large measure on our ability to maintain our capabilities in connection with upgrading products and quality control procedures and to adapt to technological changes and advances in the industry. Competition could result in price reductions, reduced margins, and loss of contracts, any of which could harm our business. There can be no assurance that we will be able to keep pace with the technological demands of the marketplace or successfully enhance our products or develop new products that are compatible with the products of the electronics industry.
We Rely on a Limited Number of Customers for Revenue. Historically, a substantial portion of our revenues has been derived primarily from a limited number of customers. One customer, APS/Wencor (now known as digEcor), accounted for approximately 94% of revenues for the year ended March 31, 2006. The failure to receive orders for and produce products or a decline in the economic prospects of our customers or the products we may produce for sale may have a material adverse effect on our operations. In May 2006, the company and certain of its officers were sued by digEcor. We are unable to determine at this time the impact this litigation and matter may have on our financial position or results of operations. See Item 1. Business - "Recent Developments."
If We Are Unsuccessful in Achieving Market Acceptance of Our Products, It Could Harm Our Business. Sales and marketing strategy contemplates sales of developed products to the electronics and computer software market by our customers. The failure of our customers to penetrate their projected markets would have a material adverse effect upon our operations and prospects. Market acceptance of our products and those of our customers will depend in part upon our ability to demonstrate and maintain the advantages of our technology over competing products.
We Have Limited Marketing Capabilities and Resources Which Makes It Difficult For Us to Create Awareness of and Demand for Our Products and Technology. We have limited marketing capabilities and resources and are primarily dependent upon in-house executives for the marketing of our products, as well as our licensing business. Selling products and attracting new business customers requires ongoing marketing and sales efforts and expenditure of funds to create awareness of and demand for our technology. We cannot assure that our marketing efforts will be successful or result in future development contracts or other revenues.
The Success of Our Business Depends on Emerging Markets and New Products. In order for demand for our technology, services and products to grow, the markets for portable digital devices, such as digital recorders and digital video/music players and other portable consumer devices, must develop and grow. If sales for these products do not grow, our revenues could decline. To remain competitive, we intend to develop new applications for our technology and develop new technology and products. If new applications or target markets fail to develop, or if our technology, services and products are not accepted by the market, our business, financial condition and results of operations could suffer.
Development of New or Improved Products, Processes or Technologies May Render Our Technology Obsolete and Hurt Our Business. The electronics, contract manufacturing and computer software markets are characterized by extensive research and development and rapid technological change resulting in very short product life cycles. Development of new or improved products, processes or technologies may render our technology and developed products obsolete or less competitive. We will be required to devote substantial efforts and financial resources to enhance our existing products and methods of manufacture and to develop new products and methods. There can be no assurance we will succeed with these efforts. Moreover, there can be no assurance that other products will not be developed which may render our technology and products obsolete.
Risks Related to Operations
We Depend On a Limited Number of Contract Manufacturers and Suppliers and Our Business Has Been and Will Be Harmed By Any Interruption of Supply or Failure of Performance. We rely on two suppliers for manufacturing our in-flight entertainment, eVU and MedeViewer products. We depend on our contract manufacturers to (i) allocate sufficient capacity to our manufacturing needs, (ii) produce acceptable quality products at agreed pricing and (iii) deliver on a timely basis. If a manufacturer is unable to satisfy these requirements, our business, financial condition and operating results may be materially and adversely affected. Any failure in performance by our manufacturer for any reason could have a material adverse affect on our business. Production and pricing by such manufacturer is subject to the risk of price fluctuations and periodic shortages of components. We have no supply agreements with component suppliers and, accordingly, we are dependent on the future ability of our manufacturer to purchase components. Failure or delay by suppliers in supplying necessary components could adversely affect our ability to deliver products on a timely and competitive basis in the future. Failure to deliver by one supplier has had a significant impact on our operations. See Item 1. Business - "Recent Developments."
If We Lose Key Personnel or Are Unable to Attract and Retain Additional Highly Skilled Personnel Required For the Expansion of Our Activities Our Business Will Suffer. Our future success depends to a significant extent on the continued service of our key technical, sales and senior management personnel and their ability to execute our strategy. The loss of the services of any of our senior level management, or certain other key employees, may harm our business. Our future success also depends on our ability to attract, retain and motivate highly skilled employees. Competition for employees in our industry is intense. We may be unable to retain our key employees or to attract, assimilate and retain other highly qualified employees in the future. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications.
Because Some of Our Management are Part-Time and Have Certain Conflicts of Interest, Our Business Could Be Harmed. Our Vice President, Robert Putnam, is also investor relations of American Technology Corporation. As a result of his involvement with American Technology Corporation, Mr. Putnam has in the past, and is expected in the future to devote a substantial portion of his time to other endeavors and only part-time services to e.Digital. Certain conflicts of interest now exist and will continue to exist between e.Digital and Mr. Putnam due to the fact that he has other employment or business interests to which he devotes some attention and he is expected to continue to do so. It is conceivable that the respective areas of interest of e.Digital and American Technology Corporation could overlap or conflict.
Risks Related to Intellectual Property and Government Regulation
Failing to Protect Our Proprietary Rights to Our Technology Could Harm Our Ability to Compete, as well as Our Results of Our Operations. Our success and ability to compete substantially depends on our internally developed software, technologies and trademarks, which we protect through a combination of patent, copyright, trade secret and trademark laws. Patent applications or trademark registrations may not be approved. Even when they are approved, our patents or trademarks may be successfully challenged by others or invalidated. If our trademark registrations are not approved because third parties own such trademarks, our use of these trademarks would be restricted unless we enter into arrangements with the third-party owners, which may not be possible on commercially reasonable terms or at all. We generally enter into confidentiality or license agreements with our employees, consultants and strategic and industry partners, and generally control access to and distribution of our software, technologies, documentation and other proprietary information. Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, parties may attempt to disclose, obtain or use our solutions or technologies. The steps we have taken may not prevent misappropriation of our solutions or technologies, particularly in foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States. We have licensed, and we may license in the future, certain proprietary rights to third parties. While we attempt to ensure that our business partners maintain the quality of our brand, they may take actions that could impair the value of our proprietary rights or our reputation. In addition, these business partners may not take the same steps we have taken to prevent misappropriation of our solutions or technologies.
We May Face Intellectual Property Infringement Claims That May Be Difficult to Defend and Costly to Resolve, Which Could Harm Our Business. Although we do not believe we infringe the proprietary rights of any third parties, we cannot assure you that third parties will not assert such claims against us in the future or that such claims will not be successful. We could incur substantial costs and diversion of management resources to defend any claims relating to proprietary rights, which could harm our business. In addition, we are obligated under certain agreements to indemnify the other party for claims that we infringe on the proprietary rights of third parties. If we are required to indemnify parties under these agreements, our business could be harmed. If someone asserts a claim relating to proprietary technology or information against us, we may seek licenses to this intellectual property. We may not be able to obtain licenses on commercially reasonable terms, or at all. The failure to obtain the necessary licenses or other rights may harm our business.
Risks Related To Government Regulation, Content And Intellectual Property Government Regulation May Subject Us to Liability and Require Us to Change The Way We Do Business. Our business is subject to rapidly changing laws and regulations. Although our operations are currently based in California, the United States government and the governments of other states and foreign countries have attempted to regulate activities on the Internet. Evolving areas of law that are relevant to our business include privacy law, copyright law, proposed encryption laws, content regulation and import/export regulations. Because of this rapidly evolving and uncertain regulatory environment, we cannot predict how these laws and regulations might affect our business. In addition, these uncertainties make it difficult to ensure compliance with the laws and regulations governing the Internet. These laws and regulations could harm us by subjecting us to liability or forcing us to change how we do business.
Risks Related to Trading in Our Common Stock
Investing in a Technology Stock (Such as Ours) May Involve Greater Risk Than Other Investments Due to Market Conditions, Stock Price Volatility and Other Factors. The trading price of our common stock has been subject to significant fluctuations to date, and will likely be subject to wide fluctuations in the future due to:
o Quarter-to-quarter variations in operating results o Announcements of technological innovations by us, our customers or competitors o New products or significant design achievements by us or our competitors o General conditions in the markets for the our products or in the electronics industry o The price and availability of products and components o Changes in operating factors including delays of shipments, orders or cancellations o General financial market conditions o Market conditions for technology stocks o Litigation or changes in operating results or estimates by analysts or others o Or other events or factors
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 OTC Electronic Bulletin Board, an electronic, screen-based trading system operated by the National Association of Securities Dealers, Inc. ("NASD"). Securities traded on the OTC Electronic Bulletin Board are, for the most part, thinly traded and are subject to special regulations not imposed on securities listed or traded on the NASDAQ system or on a national securities exchange. As a result, an investor may find it difficult to dispose of, or to obtain accurate quotations as to the price of, our common stock. Sales of substantial amounts of our outstanding common stock in the public market could materially adversely affect the market price of our common stock. To date, the price of our common stock has been extremely volatile with the sale price fluctuating from an intra-day low of $0.07 to a high of $0.22 in the last twelve months. In addition, our common stock is subject to Rules 15g-1-15g-6 promulgated under the Securities Exchange Act of 1934 that imposes additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally, a person with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with his or her spouse). For transactions covered by this rule, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell the Company's securities and may affect the ability of investors to sell their securities in the secondary market. The Commission has also adopted regulations which define a "penny stock" to be any equity security that has a market price (as defined) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the regulations require the delivery, prior to the transaction, of a disclosure schedule prepared by the Commission relating to the penny stock market. The broker-dealer must also disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock in the account and information on the limited market in penny stocks.
Important Factors Related to Forward-Looking Statements and Associated Risks. This Annual Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934 and we intend that such forward-looking statements be subject to the safe harbors created thereby. These forward-looking statements include our plans and objectives of management for future operations, including plans and objectives relating to the products and our future economic performance. The forward-looking statements included herein are based upon current expectations that involve a number of risks and uncertainties. These forward-looking statements are based upon assumptions that we will design, manufacture, market and ship new products on a timely basis, that competitive conditions within the computer and electronic markets will not change materially or adversely, that the computer and electronic markets will continue to experience growth, that demand for the our products will increase, that we will obtain and/or retain existing development partners and key management personnel, that future inventory risks due to shifts in market demand will be minimized, that our forecasts will accurately anticipate market demand and that there will be no 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 March 2006, we entered into a sixty-two month lease, commencing June 1, 2006, for approximately 4,800 square feet at 16770 West Bernardo Drive, San Diego, California with an aggregate payment of $5,805 excluding utilities and costs. The aggregate payments adjust annually with maximum aggregate payments totaling $6,535 in the fifty-first through the sixty-second month.
We believe this facility is adequate to meet our needs for the next twelve months given current plans. However should we expand our operations, we may be required to obtain additional space or alternative space. We believe there is adequate availability of office space in the general vicinity to meet our future needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On May 12, 2006, we became aware of a complaint filed on May 4, 2006 against our company and certain of our officers and employees by digEcor in the Third Judicial District Court of Utah, County of Salt Lake. The complaint was sent to our registered agent in Delaware on May 5, 2006 and received by them on May 8, 2006. Our registered agent sent the complaint to our corporate offices by regular mail on May 9, 2006 and we subsequently received the complaint which alleges breaches of contract, unjust enrichment, breaches of good faith and fair dealing, fraud, negligent misrepresentation, and interference with prospective economic relations. digEcor is seeking, among other things, an injunction to prevent us from selling or licensing certain digital rights management (DRM) technology "to any other party besides digEcor" and "from engaging in any competition with digEcor until after 2009." digEcor is also seeking "actual damages" of $793,750 and "consequential damages . . . not less than an additional $1,000,000." We believe this action is related to the purchase order we placed in the normal course of our business on November 11, 2005 for 1250 digEplayers with our contract manufacturer, Maycom. Maycom was paid progress payments with final payments made in full for the order by e.Digital, and directly by digEcor, in March 2006.
Maycom has fulfilled orders for digEplayers since 2003, and has fulfilled orders for other products manufactured for us and our customers since 2000. On March 20, 2006 we became aware of information indicating that Maycom may be unwilling or unable to complete the purchase order for product intended for delivery to digEcor. We are also aware that an agent of digEcor made an onsite inspection of order progress at Maycom's factory in January 2006 prior to final progress payments being made and that digEcor has had direct verbal and e-mail contact with Maycom.
We expect Maycom to fulfill its obligation under the purchase order and we have initiated legal remedies in Korea to compel its performance. We have received recent verbal and e-mail assurances from Maycom that they intend to perform under the purchase order. We believe there are alternative suppliers that may be able to complete the order if Maycom is unable to do so. We continue to investigate if any third parties have interfered with our business relationship with Maycom.
We are unable to determine at this time the impact this complaint and matter may have on our financial position or results of operations if Maycom does not timely fulfill its obligation to us and we are unable to deliver product to digEcor in a timely manner. We have not recognized any revenue or costs related to products associated with this order, as we only recognize revenues and associated costs when products are delivered to and accepted by our customers. We had approximately $600,000 in deposits to Maycom as a current asset and approximately $790,000 of deposits from digEcor as a current liability related to the digEplayers associated with this order. Our deposits with Maycom are considered impaired at March 31, 2006 and we could be obligated to digEcor for their deposits to us if product is not delivered. We intend to seek restitution from Maycom for any damages we may incur from this matter and the digEcor complaint.
We intend to vigorously defend against the claims made in the complaint. We are also considering other appropriate legal action which may include the filing of a cross complaint.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Our common stock trades in the over-the-counter market on the OTC Electronic Bulletin Board. The following table sets forth, for the periods indicated, the high and low closing bid prices for our common stock, as reported by the National Quotation Bureau, for the quarters presented. Bid prices represent inter-dealer quotations without adjustment for markups, markdowns, and commissions.
Fiscal year ended March 31, 2005 First quarter $0.32 $0.22 Second quarter $0.27 $0.16 Third quarter $0.43 $0.19 Fourth quarter $0.34 $0.18
Fiscal year ended March 31, 2006 First quarter $0.22 $0.15 Second quarter $0.16 $0.10 Third quarter $0.11 $0.07 Fourth quarter $0.17 $0.07
At May 26, 2006 there were 200,431,000 shares of common stock outstanding and approximately 2,893 stockholders of record.
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.
Recent Sales of Unregistered Securities
On February 24, 2006, we entered into a Restricted Common Stock Purchase Agreement with a group of twenty-seven accredited investors pursuant to which we issued and sold 18,750,000 shares of our common stock at a purchase price of $0.08 per share, for an aggregate amount of $1,500,000. In connection with such financing, we also issued "A" warrants to purchase 4,687,500 shares of common stock with an exercise price of $0.10 per share, that are exercisable until February 28, 2009, and "B" warrants to purchase 4,687,500 shares of common stock with an exercise price of $0.09 per share, that are exercisable until six months after this registration statement becomes effective. The February 2006 private placement of common stock and warrants triggered anti-dilution provisions of certain of our outstanding securities. The exercise price on warrants exercisable for 4,070,000 shares of common stock adjusted from $0.50 per share to $0.08 per share, the exercise price on warrants exercisable for 2,112,500 shares of common stock adjusted from $0.19 per share to $0.08 per share, the conversion price on $1,500,000 of our 12% Subordinated Promissory Notes adjusted from $0.19 per share to $0.08 per share and the conversion price of the stated value and accumulated dividends on outstanding shares of Series D and Series EE convertible preferred stock adjusted from $0.19 per common share to $0.08 per common share. We had 110,000 shares (stated value of $10 per preferred share) of Series D convertible preferred stock and 4,330 shares (stated value of $100 per preferred share) of Series EE convertible preferred stock outstanding at the time of the antidilution adjustment.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
(1) For information pertaining to the calculation of basic earnings (loss) per common shares, see Note 2 to the Consolidated Financial Statements elsewhere in this report.
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 that operates through our wholly-owned California subsidiary of the same name and is incorporated under the laws of Delaware. We provide engineering services, product reference designs and technology platforms to customers focusing on the digital video/audio and player/recorder markets. We have innovated a proprietary secure digital video/audio technology platform ("DVAP") that can be applied to produce complex consumer electronic products. In 2003 our DVAP was applied to an in-flight entertainment ("IFE") device, the digEplayer, for one customer. To date, we have delivered over 8,000 digEplayers for airline use.
In December 2005 we announced our latest proprietary DVAP device, the eVU(TM) mobile entertainment device. The rugged eVU features sharp images on a 7" high resolution LCD screen, a 40 GB hard drive, high audio fidelity, dual stereo headphone jacks, embedded credit card reader/processor, touch screen capabilities, full feature graphical user interface, patent-pending hardware security technology, and 10 hours of high resolution video playback on a single battery charge. We also have the capability to add features and customize the product for select customers.
While we continue to offer engineering services, product reference designs and technology platforms, our primary strategy for future quarters is to produce branded eVU devices for customer orders. eVU is targeted at business opportunities for secure hard drive-based closed system video products loaded with desirable movie, television, music, informational, and educational content, rented or provided to customers. We have commenced eVU demonstration deliveries and are preparing pilot trials for select target customers. We are focused on U.S. and international companies in the healthcare, military, and travel and leisure industries who desire to brand and market eVU to consumers at their facilities. We have developed logistic and secure content solutions to enable customers to rapidly deploy, operate and maintain eVUs for target customers. In addition to offering eVUs for sale we expect to provide eVU solutions on a periodic payment program.
We have relationships with manufacturers with facilities in the United States, China and Korea. We have expertise in developing, performing and overseeing manufacturing processes. From time to time, we apply our technology and expertise in providing manufacturing supervision, documentation, and quality control services to products for our business customers.
Services offered include custom hardware, firmware (an instruction set programmed into a chip which determines the product's functionality and user interface), software development, technology platform development, product design, manufacturing services, fulfillment services, warranty services, and licensing of our patented file management system. Our revenues may result from the sale of products, product royalties, fees from engineering services, industrial order fulfillment, technical support services, warranty services and/or design services. In some cases, we rely on outside subcontractors to perform services including manufacturing, testing and certification, industrial design, and assembly.
Overall Performance
We have experienced substantial reduction in cash, projected revenues and increased costs that adversely affect our current results of operations and liquidity. We incurred significant operating losses and negative cash flow in each of the last three fiscal years and these losses have been material. We incurred an operating loss of $2.5 million, $2.0 million and $2.3 million in fiscal year 2006, 2005 and 2004, respectively, and have an accumulated deficit of $77,172,095 at March 31, 2006. At March 31, 2006, we had a working capital deficit of $2,516,367.
Our operating plans require additional funds which may take the form of debt or equity financings. There can be no assurance that any additional funds will be available to our company on satisfactory terms and conditions, if at all. Our company's ability to continue as a going concern is in substantial doubt and is dependent upon achieving a profitable level of operations and, if necessary, obtaining additional financing.
Management of our company has undertaken steps as part of a plan to improve operations with the goal of sustaining our operations for the next twelve months and beyond. These steps include (a) controlling overhead and expenses; (b) expanding sales and marketing to business customers and markets and (c) raising, if necessary, additional capital and/or obtaining third party financing.
For the year ended March 31, 2006:
o Our revenues were $3.3 million, a 24% a decrease from total revenues of $4.3 million for fiscal 2005. Sales to one customer accounted for 94% of our revenues and our results have been highly dependent on the timing and quantity of digEplayer orders by this customer and its airline customers. At March 31, 2006 we had approximately $1.2 million of orders in production for this customer but delivery by our contractor is behind schedule and not assured. There can be no assurance of future orders from this customer and cancellations or delays of existing orders could have a material impact on our operations.
o We recorded a gross profit of $114,000 compared to a gross profit of $997,000 for fiscal 2005. Gross profit decreased due to a $603,750 impairment charge for deposits made to a contract manufacturer that may not be recoverable offset by a $115,139 reduction of previous supplier accruals no longer deemed payable. Gross profit also decreased due to the mix of devices, batteries and other accessories and the lower sales volume.
o Operating expenses were $2.7 million a decrease from $3.0 million for fiscal 2005 due primarily to reduced personnel and legal costs in the current period.
o Other income and expenses were a net expense of $565,000 consisting primarily of interest expense of $573,500 including non-cash interest of $301,000 related to amortization of warrants issued with debt.
o Our net loss increased to $3.1 million from $2.4 million for the prior year ended 2005 and the net loss available to common stockholders after non-cash deemed and imputed dividends on preferred stock increased to $5.3 million from $3.7 million for the year ended March 31, 2005.
Our monthly cash operating costs have been on average $150,000 and $180,000 per month for the periods ending March 31, 2006 and 2005, respectively. However, we may increase expenditure levels in future periods to support and expand our revenue opportunities and continue advanced product and technology research and development. The introduction of the eVU will also require additional expenditures, the amount and timing not currently estimable by management. Accordingly, our losses are expected to continue until such time as we are able to realize revenues and margins sufficient to cover our costs of operations. We may also face unanticipated technical or manufacturing obstacles and face warranty and other risks in our business. See "Risk Factors."
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to product returns, bad debts, inventory valuation, intangible assets, financing operations, warranty obligations, estimated costs to complete research contracts and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
We recognize license revenue and product revenue upon shipment of a product to the customer, FOB destination or FOB shipping point depending on the specific contract term, if a signed contract exists, the fee is fixed and determinable, collection of resulting receivables is probable and there are no resulting obligations. With most of our consumer electronics retailers, we do not meet the criteria for revenue recognition upon shipment and therefore only recognize the revenue as the product is sold through our customer to the ultimate end-user. Research and development contract revenues on short-term projects or service revenue is recognized once the services or product has been delivered, the fee is fixed and determinable, collection of the resulting receivable is probable and there are no resulting obligations. If all of the service or product has been delivered and there is one element that is perfunctory to the services or product that has not been delivered, revenue will be recognized evenly over the remaining term of the undelivered element. Research and development contract revenue on long-term projects is recognized on the percentage of completion method. Funds received in advance of meeting the criteria for revenue recognition are deferred and are recorded as revenue as they are earned. If the costs we incur on a contract are expected to exceed the anticipated revenue we will record the loss in the period in which the facts that give rise to the revision becomes known.
We record estimated reductions to revenue for anticipated product returns, discounts offered to our customers and volume-based incentives. If market conditions were to decline, we may take actions to increase the discounts offered for future sales which will result in an incremental reduction of revenue at the time the discounts are offered.
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We also review deposits with manufacturers and others for impairment and at March 31, 2006 considered $604,000 of deposits as impaired and recorded a corresponding expense.
We value derivative instruments in accordance with the interpretative guidance of FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities", EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock", Accounting Principles Board Opinion No. 14 "Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants", EITF 98-5 "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios", and EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" and associated pronouncements relate to the classification and measurement of warrants and instruments with embedded conversion features. We must make certain assumptions and estimates to value our derivative liabilities. Factors affecting these liabilities and values include changes in our stock price and other assumptions.
We have provided a full valuation reserve related to our substantial deferred tax assets. In the future, if sufficient evidence of our ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, we may be required to reduce our valuation allowances, resulting in income tax benefits in our consolidated statement of operations. We evaluate the realizability of the deferred tax assets and assess the need for valuation allowance quarterly. The utilization of the net operating loss carryforwards could be substantially limited due to restrictions imposed under federal and state laws upon a change in ownership.
Under our bylaws, we have agreed to indemnify our officers and directors for certain events. We also enter into certain indemnification agreements in the normal course of our business. We have no liabilities recorded for such indemnities.
We are currently involved in certain legal proceedings. For any legal proceedings we are involved in, we estimate the range of liability relating to pending litigation, where the amount and range of loss can be estimated. We record our best estimate of a loss when a loss is considered probable. As additional information becomes available, we assess the potential liability related to pending litigation and will revise estimates. At March 31, 2006 we had no litigation loss accrual however we considered $603,750 of deposits to a contract manufacturer as impaired and recorded additional cost of revenue expense related thereto.
We do not have off-balance sheet transactions, arrangements or obligations.
Results of Operations Year ended March 31, 2006, 2005 and 2004
Revenues:
The following table sets forth selected data from the statement of operations for the Company for the fiscal year ended March 31, 2004, 2005 and 2006, respectively.
Total Revenues: For the year ended March 31, 2006, we reported total revenue of $3.3 million, a 24% decrease from total revenues of $4.3 million for the comparable year. Product revenue for the year ended March 31, 2006 was $3.2 million, a decrease of 21% from product revenues of $4.0 million for the comparable year. The decrease in product revenue in fiscal year 2006 relates to the delay in production of a 1250 unit digEplayer order. We have $603,750 as a prepayment to a manufacturer for an order of units to be shipped at a time yet to be determined. Based on current conditions of this manufacturer and this order and the potential that the manufacturer will not fulfill its obligation, we have recorded an impairment against the prepayment as additional cost of revenue.
For the year ended March 31, 2005, we reported total revenue of $4.3 million, a 24% increase from total revenues of $3.4 million for fiscal 2004. Product revenue for the year ended March 31, 2005 was $4.0 million, an increase of 49% from product revenues of $2.7 million for fiscal 2004. The increase in product revenues in fiscal year 2005 resulted from the increase in airline orders for the digEplayer through APS/Wencor customers
Service Revenue: Our development arrangements are designed to produce limited current revenues while creating proprietary products to be sold to customers or to be produced under long-term license or royalty arrangements. Service revenues for the year ended March 31, 2006 decreased by 70% to $76,000 from $250,000 for the comparable year. The decrease resulted primarily from our not obtaining additional service contracts or payments on existing agreements.
Service revenues were $250,000 and $731,000 for the fiscal years 2005 and 2004 respectively. The decrease of 66% in service revenues was primarily attributed to the fulfillment of OEM contracts. We had recorded for nonrecurring engineering ("NRE") contracts (contracts involving the payment of one-time engineering fees in association with a particular project an aggregate of unearned revenue $20,000 and $176,000 at March 31, 2006 and 2005 respectively.
Cost of Revenues:
Gross Margin: For the year ended March 31, 2006, we reported a $114,000 or 14% gross profit as compared to a 23% gross profit for the comparable year. For fiscal year 2006, costs of revenues consisted of $2.6 million of product costs and $5,000 of contract service cost consisting primarily from the engineering expenses recognized and being funded in part by our customers. Cost of revenues also included a $603,750 impairment charge for deposits made to a contract manufacturer that may not be recoverable offset by a $115,139 reduction of previous supplier accruals no longer deemed payable for a net of $488,611 that was charged in the last fiscal quarter.
For the year ended March 31, 2005 we reported a $997,000 or 23% gross profit as compared to a gross profit of $689,000 for the year ended March 31, 2004. The increase in the gross profit percentage is due to improved margins on products delivered to customers and termination of our low or negative margin on e.Digital branded products. Gross profit percentage is highly dependent on sales, price, volume, purchasing costs and overhead allocations. Gross margins may vary significantly from period to period.
Operating Expenses:
Total operating expenses (consisting of selling and administrative expenses and research and related expenditures) were $2.7 million, $3.0 million and $3.0 million for fiscal year 2006, 2005 and 2004, respectively.
Selling, General and Administrative: For the year ended March 31, 2006, selling and administrative costs were $1.3 million compared to $1.5 million for the comparable year. The $199,000 decrease in selling and administrative costs resulted from the decrease of $148,000 in personnel and related costs due to the reduction in headcount, a reduction of $161,000 in legal and professional fees offset by an increase of $110,000 relating to the annual shareholders meeting. We anticipate selling and administrative expenses to be constant as we are focused more on business customer opportunities and de-emphasize selling and marketing our branded product.
Selling and administrative costs were $1.5 million for the year ended March 31, 2005 compared to $1.5 million for the comparable year. The $31,000 increase in selling and administrative costs resulted from the increase in legal fees in connection with the Fujitsu Ten arbitration and settlement offset by decreases in facilities expenditures and shareholders' related costs. We anticipate selling and administrative expenses to be constant as we are focused more on business customer opportunities and de-emphasize selling and marketing our branded product.
Research and Development expenses: For the year ended March 31, 2006, research and development expenditures were $1.3 million as compared to year ended March 31, 2005 of $1.5 million. The decrease of $177,000 resulted from a decrease of $121,000 in personnel and related costs due to the reduction in headcount, a decrease of $60,000 in consulting and independent contract labor offset by an increase of $24,000 in materials and supplies associated with the development of the eVU product.
For the year ended March 31, 2005, research and development expenditures were $1.5 million, the same level as the $1.5 million for the year ended March 31, 2004.
Research and development costs are subject to significant quarterly variations depending on the use of outside services, the assignment of engineers to development projects and the availability of financial resources.
We reported an operating loss of $2.5 million, $2.0 million, and $2.3 million for the year ended March 31, 2006, 2005 and 2004, respectively. The increase in operating loss in fiscal 2006 compared to fiscal 2005 resulted from the reduced gross margin caused primarily by the impairment of deposits offset in part by reduced overall operating expenses. The decrease in operating loss in fiscal year 2005 compared to fiscal year 2004 resulted from the improved gross margins in combination with comparable operating expenses. We believe, but we cannot guarantee, that our strategy of investing in development of our digital video/audio technology platform with supply or royalty provisions will provide positive margins in future periods. The timing and amount of product sales and the recognition of contract service revenues impact our operating losses. Accordingly, there is uncertainty about future operating results and the results for the year ended March 31, 2006 are not necessarily reflective of operating results for future periods.
We reported interest expense of $574,000, $384,000 and $122,000 for the years ended March 31, 2006, 2005 and 2004, respectively. The interest expense in 2006 consisted of interest on the 12% and 15% Promissory Notes and the non-cash amortization expense associated with warrants and warrant repricing. The interest expense in 2005 consisted of interest on the 12% and 15 % Promissory Notes. The interest expense in 2004 consisted of interest on the 15% Promissory Note.
We reported a loss of $3.1 million, $2.4 million and $2.5 million in fiscal year 2006, 2005 and 2004, respectively.
The net loss available to common stockholders for fiscal year 2006 was increased in computing loss per share by accrued dividends of $162,000 on the Series D and EE stock and $2.0 million in additional expense associated with repricing of conversion prices of the preferred stock resulting from the February 2006 common stock sale. The net loss available to common stockholders for fiscal year 2005 was increased in computing loss per share by accrued dividends of $226,000 on the Series D and EE stock and $1.1 million for the beneficial conversion attributed to the issuance of the Series EE stock.
Liquidity and Capital Resources
At March 31, 2006, we had a working capital deficit of $2.5 million compared to a working capital deficit of $1.5 million for the comparable year. We had $3,000 and $53,000 of working capital invested in accounts receivable at March 31, 2006 and 2005, respectively. We have prepayment terms with our manufacturer and for our customer for the digEplayer product. Our customer is required to pay in advance for production of these units in three (3) installments with the last payment paid at time of shipment. These payments are recorded as a customer deposit until revenue can be recognized. We have the same payment obligation with our manufacturer requiring (3) installment payments of which are recorded as a prepaid until product has been shipped to the customer. These payments are evaluated periodically for impairment. Therefore, the company does not have any accounts receivable or inventory with respect to such product.
For the year ended March 31, 2006, net cash decreased by $230,530. Cash used in operating activities was $2,327,130. The major components using cash were a loss of $3,106,681 reduced by $112,500 of accrued interest and accretion relating to the unsecured promissory note, $63,494 of depreciation and amortization, $300,665 for the amortization of interest on warrants repriced in connection with a restricted common stock sale and a $603,750 impairment charge on a deposit with a supplier. Cash used in operating activities was also impacted by an increase of $23,850 in accrued liabilities, an $86,500 increase in customer deposits and a decrease of $50,171 in accounts receivable. The major changes in assets and liabilities using operating cash was a $130,064 increase for prepaid and deposits, a decrease of $53,830 in deferred revenue, a $17,334 decrease in accrued employee benefits and a decrease of $135,016 in accounts payable.
At March 31, 2006, we had cash on hand of $1,058,723. For the year ended March 31, 2006, cash provided by financing activities was $2,096,600. During the fiscal year ended March 31, 2006, we obtained a total of $1,500,000 from the issuance of common stock, $500,000 from the issuance of 12% Convertible Subordinated Promissory Notes and $118,000 from exercise of warrants. During the fiscal year ended March 31, 2006, we repaid $21,400 of the 15% Unsecured Note.
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, 2006 assuming (a) continuation of existing business customer arrangement, and (b) current planned expenditures and level of operation, we believe we will require approximately $1.0 million of additional capital resources for the next twelve months plus amounts required to make payments on the 15% Unsecured Notes in the approximate principal amount of $900,000 and 12% Convertible Subordinated Promissory Notes for $1,500,000. In the past we have rescheduled the maturity dates of certain debt obligations but there can be no assurance we will be able to reschedule any debt in the future. Some of these required resources could come from improved operations. However actual results could differ significantly from management plans. The actual future margins to be realized, if any, and the timing of shipments and the realization of royalties are subject to many factors and risks, many outside our control.
We have experienced substantial reduction in cash, projected revenues and increased costs that adversely affect our current result of operations and liquidity. Our operating plans require additional funds which may take the form of debt or equity financings. There can be no assurance that any additional funds will be available. Our company's ability to continue as a going concern is in substantial doubt and is dependent upon achieving a profitable level of operations and, if necessary, obtaining additional financing.
We are actively seeking equity and/or debt financing and intend to use proceeds from equity sales for working capital and to repay the 12% and 15% Unsecured Notes. If we are unable to secure sufficient financing, we will attempt to renegotiate the terms of this note with the lender. There can be no guarantee that we will be able to raise additional equity and/or renegotiate the terms of the note with the lender. If we are able to renegotiate the terms of the note we may be unable to determine what terms the lender may demand.
We require additional capital to finance future developments and improvements to our technology. Should additional funds not be available, we may be required to curtail or scale back staffing or operations. Failure to obtain additional financings will have a material adverse affect on our company. Potential sources of such funds include exercise of outstanding warrants and options, or debt financing or additional equity offerings. However, there is no guarantee that warrants and options will be exercised or that debt or equity financing will be available when needed. Any future financing may be dilutive to existing stockholders.
As of March 31, 2006, our contractual obligations and commercial commitments are summarized below:
1 Includes two 15% unsecured notes and accrued interest as of March 31, 2006, both notes mature on June 30, 2006. 2 Office sublease agreement
Future Commitments and Financial Resources
We have an accrued lease liability of $515,000 that arose in the normal course of business for equipment delivered to the company. This amount is approximately nine years old. The accrued lease liability reflects management's best estimate of amounts due for matters in dispute. Settlement of this liability may either be more or less than the amount recorded in the audited consolidated financial statements and accordingly may be subject to measurement uncertainty in the near term.
In the future, if our operations increase significantly, we may require additional funds. We also may require additional capital to finance future developments, acquisitions or expansion of facilities. We currently have no plans, arrangements or understandings regarding any acquisitions.
In March 2006, we entered into a new sixty-two month lease, commencing June 1, 2006, for approximately 4,800 square feet at a new location in the San Diego area with an aggregate payment of $5,805 excluding utilities and costs. The aggregate payments adjust annually with maximum aggregate payments totaling $6,535 in the fifty-first through the sixty-second month.
Selected Quarterly Financial Information
The following table sets forth unaudited income statement data for each of our last eight quarters. This unaudited quarterly financial information has been prepared on the same basis as the annual information presented elsewhere in the Form 10-K and, in the opinion of management, reflects all adjustments (consisting of normal recurring entries) necessary for a fair presentation of the information presented. The operating results for any quarter are not necessarily indicative of results for any future period.
Inflation
Inflation has not had any significant impact on our business.
New Accounting Pronouncements
As discussed in the notes to the consolidated financial statements, the implementation of new accounting pronouncements is not expected to have a material effect on our consolidated financial statements.
Certain Factors That May Affect Our Business, Future Results and Financial Condition
In addition to the other information in this Annual Report on Form 10-K, the factors listed below should be considered in evaluating our business and prospects. This Annual Report contains a number of forward-looking statements which 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.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our investment in cash and cash equivalents and our debt of $2,515,954, consisting of accrued interest and the 15% Promissory Notes and 12% Promissory Notes. We do not use derivative financial instruments in our investment portfolio and due to the nature of our investments, do not expect our operating results or cash flows to be significantly affected by potential changes in interest rates. At March 31, 2006, the market value of these investments, which were all classified as cash and cash equivalents and certificate of deposit, and debt approximated cost.
Foreign Currency Exchange Rate Risk
We invoice our customers in U.S. dollars for all products and purchase our products from our suppliers in U.S. dollars. To date the foreign currency exchange risk has not been material. We have not entered into hedging transactions or activities.
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 and commence on Page immediately following page 37.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS & PROCEDURES
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Interim Chief Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We carried out an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Interim Chief Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2006, the end of the period covered by this report. Based on that evaluation and remedial measures instituted during the year for the material weakness described below, our Chief Executive Officer and Interim Chief Accounting Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of March 31, 2006.
Identification of Material Weakness and Remedial Measures
In connection with the closing of our general ledger and the preparation of our Form 10-Q for the quarter ended December 31, 2005 we determined that our consolidated financial statements included in the Quarterly Report for the quarterly period ended September 30, 2005 reflected an error made in accruing liabilities for direct shipments of product to a customer. Management has determined that the error was the result of a control deficiency with the Company's procedures in correctly reconciling customer prepayments, customer invoices, inventory, cost of sales and accrued liabilities. Management also believed that the lack of a full-time chief accounting officer contributed to this deficiency. Management believes this control deficiency constituted a material weakness. A material weakness is a control deficiency, or a combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In response to this error, we restated our consolidated financial statements for the quarterly period ended December 31, 2005. As a result of this finding, our Audit Committee has authorized and directed management to implement actions to address this deficiency and to enhance the reliability and effectiveness of our control procedures. As a result, we have established a policy for accounting staff to follow to make sure the proper reconciliations of accounts is completed each reporting period and that vendor payables and accruals are properly matched and recorded with direct customer shipments.
Changes in Internal Control over Financial Reporting
Other than as summarized above, there have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the year ended March 31, 2006 that materially affected, or are 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 ANDEXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to each director, executive officer and key employee of e.Digital Corporation, as follows:
Name Age Position - ---- --- --------
Alex Diaz 41 Chairman of the Board and Director William Blakeley 50 President and Chief Technical Officer Robert Putnam 47 Senior Vice President, Interim Chief Accounting Officer, Secretary and Director Allen Cocumelli 53 Director Renee Warden 42 Director
Biographical Information
Alex Diaz - Mr. Diaz joined the Board in July 2002 and was appointed Chairman in November 2002. Mr. Diaz is Executive Vice President of Califormula Radio Group in San Diego, where he oversees the wide area network (WAN) linking audio, production studios, and transmitter sites, all of which he designed. He also established a Web presence for several of Califormula's San Diego radio stations, including Jammin' Z90, Radio Latina, and classical music station XLNC1. Before joining Califormula, Mr. Diaz worked at Radio Computing Services in New York. Mr. Diaz holds bachelor's degrees in mathematics and computer science from the University of California in San Diego.
William Blakeley -Mr. Blakely was appointed President and Chief Technical Officer in November 2005. Mr. Blakeley has served as a Principal Systems Engineer and Manager for Northrop Grumman Radio Systems since August 2002. Mr. Blakeley also served as an independent consultant (program management) for two venture backed start ups from January 2002 until August 2002. He also served as Vice President of Engineering for Aegis Broadband Inc. from January 1999 until January 2002. He has also served as President of SDCOMM Technologies, Inc. from 1997 to 1999. From 1988 to 1997, Mr. Blakeley held various management positions with Scientific Atlanta, Inc. Mr. Blakeley obtained a Bachelor of Science degree in Applied Mathematics from San Diego State University in 1983 and a Master of Science degree in electrical engineering from San Diego State University in 1988.
Robert Putnam - Mr. Putnam was appointed Senior Vice President in April 1993. He was appointed a Director of e.Digital Corporation in 1995. In May 2005, Mr. Putnam assumed the additional responsibilities of Interim Chief Accounting Officer and Corporate Secretary. Mr. Putnam served as Secretary of e.Digital Corporation from March 1998 until December 2001. He served as a Director of American Technology Corporation ("ATC") from 1984 to September 1997 and served as Secretary/Treasurer until February 1994, President and Chief Executive Officer from February 1994 to September 1997 and currently serves as investor relations of ATC. He also served as Secretary/Treasurer of Patriot Scientific from 1989 until December 2000 and was a director from 1989 to March 1998. Mr. Putnam obtained a B.A. degree in mass communications/advertising from Brigham Young University in 1983. Mr. Putnam devotes only part-time services to the company, approximately twenty hours per week.
Allen Cocumelli - Mr. Cocumelli was appointed to the Board of Directors on August 25, 1999 and served as Chairman of the Board from April 2000 until November 2002. Mr. Cocumelli has been General Counsel of Simple Network Communications Inc. ("Simplenet") since 1996 and Chief Operating Officer of Simplenet since November 1997. Prior to joining Simplenet, Mr. Cocumelli was in the private practice of law. From 1978 to 1986 Mr. Cocumelli served as a manager in the Components Manufacturing Group and as Director of Corporate Training and Development at Intel. Mr. Cocumelli obtained a B.S. degree in Industrial Psychology from the University of California, Los Angeles in 1972 and a J.D. from Thomas Jefferson University in 1991. Mr. Cocumelli is a member of the California Bar Association.
Renee Warden - Ms. Warden was appointed to the Board of Directors on August 4, 2005. Ms. Warden has been the Manager of Special Projects for Global Signal Services, LLC based in Florida since June 2006. Previously, Ms. Warden held the position of Vice President and Controller for Kintera, Inc. from May 2005 to June 2006. Prior to joining Kintera, Inc., Ms. Warden was an executive officer of e.Digital Corporation. Ms. Warden joined e.Digital Corporation in 1991 as Accounting Manager. In 1997 Ms. Warden was appointed Controller and Corporate Secretary for e.Digital Corporation and in 2003 was promoted to Chief Accounting Officer and Secretary until May 2005. From 1993 to 2003 Ms. Warden also held the positions of Chief Accounting Officer, Secretary and Director of Human Resources for ATC. Ms. Warden obtained a B.S. degree in business accounting from the University of Phoenix in 1999.
Board of Directors - Overview
The Company's bylaws state that the Board of Directors shall consist of not less than four nor more than seven members. The specific number of Board members within this range is established by the Board of Directors and is currently set at five. The terms of all directors will expire at the next annual meeting of our company's stockholders, or when their successors are elected and qualified. Directors are elected each year, and all directors serve one-year terms. Officers serve at the pleasure of the Board of Directors. There are no arrangements or understandings between our company and any other person pursuant to which he was or is to be selected as a director, executive officer or nominee. There are no other persons whose activities are material or are expected to be material to our company's affairs.
The Board of Directors met five times during fiscal 2006 and acted by unanimous written consent four times. During such fiscal year, each Board member attended 100% of the meetings of the Board held during the period for which he was a director.
Board of Directors - Committees
The Company has an Audit Committee and a Compensation Committee.
Audit Committee. The Audit Committee, currently consisting of Ms. Warden and Messrs. Diaz and Putnam, reviews the audit and control functions of e.Digital Corporation, e.Digital Corporation's accounting principles, policies and practices and financial reporting, the scope of the audit conducted by our company's auditors, the fees and all non-audit services of the independent auditors and the independent auditors' opinion and letter of comment to management and management's response thereto. The Audit Committee was designated on June 7, 2000 and held four meetings during the fiscal year ended March 31, 2006.
Compensation Committee. The Compensation Committee is currently comprised of two non-employee Board members, Allen Cocumelli and Alex Diaz. The Compensation Committee reviews and recommends to the Board the salaries, bonuses and prerequisites of our company's executive officers. The Compensation Committee also reviews and recommends to the Board any new compensation or retirement plans and administers such plans. No executive officer of our company serves as a member of the board of directors or compensation committee of any other entity that has one or more executive officers serving as a member of our company's Board of Directors or Compensation Committee. The Compensation Committee held one meeting during the fiscal year ended March 31, 2006.
Board of Directors - Audit Committee Financial Expert
The Company has a standing Audit Committee that includes the following three members of the Board of Directors: Renee Warden, Alex Diaz and Robert Putnam. Ms. Warden has been designated as the "Audit Committee Financial Expert," as defined by Regulation S-K, although as a former executive officer of the company she is not or an "independent" director, as defined under the NASDAQ National Stock Market rules and Rule 10A-3 of the Securities Exchange Act of 1934.
Board of Directors - Compensation
Stock Options - Directors have received in the past and may receive in the future stock options pursuant to our company's stock option plans.
Standard Compensation - Our company has no other arrangements to pay any direct or indirect remuneration to any of our directors in their capacity as directors other than in the form of reimbursement of expenses for attending directors' or committee meetings.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth for the years ended March 31, 2006, 2005 and 2004, the cash compensation of Mr. William Blakeley, current President and Chief Technical Officer, Mr. Atul Anandpura,, former President and Chief Executive Officer and Mr. Alfred H. Falk, former President and Chief Executive Officer (collectively, the "Named Executive Officers"). No other persons served as Executive Officer of e.Digital Corporation during the fiscal year ended March 31, 2006 and received total compensation in excess of $100,000.
(1) Auto allowance. (2) Mr. Anandpura resigned as President and Chief Executive Officer and as a director effective October 26, 2005. (3) Mr. Falk resigned as President and Chief Executive Officer and as a director effective July 1, 2004. Mr. Falk continues to be employed by our company as Vice President of Business Development.
Option Grants
Shown below is further information on grants of stock options to the Named Executive Officers reflected in the Summary Compensation Table shown above.
(1) Mr. Falk resigned as President and Chief Executive Officer and as a director effective July 1, 2004. Mr. Falk continues to be employed by our company as Vice President of Business Development. (2) These options vest 33% upon grant and quarterly thereafter over two years. (3) These options vest 25% annually commencing on March 31 2006.
Aggregated Option Exercises and Fiscal Year-end Values
The following table provides information on exercised and unexercised options of the Named Executive Officers at March 31, 2006:
Fiscal Year-End Option Values
(1) Based on the last sale price at the close of business on March 31, 2006 of $0.15.
The Company has not awarded stock appreciation rights to any of its employees and has no long-term incentive plans, as that term is defined in Securities and Exchange Commission regulations. The Company has no defined benefit or actuarial plans covering any person.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information as of March 31, 2006, with respect to compensation plans (including individual compensation arrangements) under which equity securities of e.Digital Corporation are authorized for issuance, aggregated as follows:
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Common Stock
The following security ownership information is set forth, as of March 31, 2006, with respect to certain persons or groups known to e.Digital Corporation to be beneficial owners of more than 5% of our company's outstanding common stock and with respect to each director of the Company, each of the executive officers named in the Summary Compensation Table currently employed by e.Digital Corporation, and all current directors, nominees and executive officers as a group (five persons). Other than as set forth below, e.Digital Corporation is not aware of any other person who may be deemed to be a beneficial owner of more than 5% of our company's common stock.
(1) Includes options and warrants exercisable within 60 days to purchase 1,020,833 shares. (2) Includes options and warrants exercisable within 60 days to purchase 479,167 shares and 625,000 shares issuable upon conversion of convertible debt. (3) Includes options exercisable within 60 days to purchase 575,000 shares. (4) Includes options exercisable within 60 days to purchase 475,000 shares. (5) Includes options exercisable within 60 days to purchase 350,000 shares. (6) Includes options and warrants exercisable within 60 days to purchase 2,900,000 shares and 625,000 shares issuable upon conversion of convertible debt. Excludes unvested options to purchase 2,250,000 shares.
- ---------------------------- * Less than 1%
Series D Preferred Stock
The following security ownership information is set forth as of March 31, 2006, with respect to certain persons or groups known to e.Digital Corporation to be beneficial owners of more than 5% of Series D Preferred Stock.
- --------------
(1) Represents number of shares of Series D Preferred Stock, held as of March 31, 2006. At such date an aggregate of 96,000 shares of Series D Preferred Stock were issued and outstanding convertible into an aggregate of 16,679,014 shares of common stock subject to a 4.999% conversion limitation. (2) Jerry E. Polis is Trustee and believed by our company to have sole voting and investment power with respect to the Series D Preferred Stock held. (3) Eric Polis is believed by our company to have sole voting and investment power with respect to the Series D Preferred Stock held. (4) James A. Barnes is Trustee and believed by our company to share voting and investment power with his spouse respect to the Series D Preferred Stock held.
Series EE Preferred Stock
The following security ownership information is set forth as of March 31, 2006, with respect to certain persons or groups known to e.Digital Corporation to be beneficial owners of more than 5% of Series EE Preferred Stock.
- --------------
(1) Represents number of shares of Series EE Preferred Stock, held as of March 31, 2006. At such date an aggregate of 2,500 shares of Series EE Preferred Stock were issued and outstanding convertible into an aggregate of 3,466,781 shares of common stock. (2) DKR LP is registered investment advisor with the Securities and Exchange Commission and as such, is the investment manager to Basso Multi-Strategy Holding Fund, Ltd. DKR LP has retained Basso to act as the portfolio manager to the fund. As such DKR LP and Basso have shares dispositive and voting power over the securities. Howard Fischer is president of Basso and is named as authorized signatory. (3) DKR LP is registered investment advisor with the Securities and Exchange Commission and as such, is the investment manager to Basso Multi-Strategy Holding Fund, Ltd. DKR LP has retained Basso to act as the portfolio manager to the fund. As such DKR LP and Basso have shares dispositive and voting power over the securities. Howard Fischer is president of Basso and is named as authorized signatory.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Conflicts of Interest. Certain conflicts of interest now exist and will continue to exist between e.Digital Corporation and its officers and directors due to the fact that they have other employment or business interests to which they devote some attention and they are expected to continue to do so. We have not established policies or procedures for the resolution of current or potential conflicts of interest between our company and its management or management-affiliated entities. There can be no assurance that members of management will resolve all conflicts of interest in our company's favor. The officers and directors are accountable to our company as fiduciaries, which means that they are legally obligated to exercise good faith and integrity in handling our company's affairs. Failure by them to conduct our company's business in its best interests may result in liability to them.
Officer and director Robert Putnam also acts as Vice President, Investor Relations of ATC. The possibility exists that these other relationships could affect Mr. Putnam's independence as a director and/or officer of e.Digital Corporation. Mr. Putnam is obligated to perform his duties in good faith and to act in the best interest of our company and its stockholders, and any failure on his part to do so may constitute a breach of his fiduciary duties and expose such person to damages and other liability under applicable law. While the directors and officers are excluded from liability for certain actions, there is no assurance that Mr. Putnam would be excluded from liability or indemnified if he breached his loyalty to our company.
Transactions with Management. None.
Employment Agreements
All employees of e.Digital Corporation, including executive officers, are employees at-will.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table describes fees for professional audit services rendered by Singer Lewak Greenbaum & Goldstein LLP, our principal accountant, for the audit of our annual financial statements for the years ended March 31, 2006 and March 31, 2005 and fees billed for other services rendered by Singer Lewak Greenbaum & Goldstein LLP during those periods. These amounts include fees paid to Singer Lewak Greenbaum & Goldstein LLP.
Type of Fee 2006 2005 - ----------- ---- -------- Audit Fees (1) $ $90,507 Audit Related Fees (2) 17,695 Tax Fees (3) - - All Other Fees (4) - - ---- -------- Total $ $108,202 ==== ========
1. Audit Fees include the aggregate fees paid by us during the fiscal year indicated for professional services rendered by Singer Lewak Greenbaum & Goldstein LLP for the audit of our annual financial statements and review of financial statements included in our Forms 10-Q.
2. Audit Related Fees include the aggregate fees paid by us during the fiscal year indicated for assurance and related services by Singer Lewak Greenbaum & Goldstein LLP that are reasonably related to the performance of the audit or review of our financial statements and not included in Audit Fees. Also included in Audit Related Fees are fees for accounting advice.
3. Tax Fees include the aggregate fees paid by us during the fiscal year for services provided by Singer Lewak Greenbaum & Goldstein LLP with respect to tax compliance, tax advice and tax planning.
4. All Other Fees include the aggregate fees paid by us during the fiscal year indicated for products and services provided by Singer Lewak Greenbaum & Goldstein LLP, other than the services reported above.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) 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 Number Description of Exhibit - ------ ---------------------- 2.6 Plan of Reorganization and Agreement of Merger, dated July 1996 and filed as Exhibit A to the Company's July 3, 1996 Proxy Statement.
3.1 Certificate 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.
3.1.1 Certificate 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.
3.1.2 Certificate 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.
3.2 Bylaws of Norris Communications, Inc., filed as Exhibit C to the Company's July 3, 1996 Proxy Statement.
3.3 Certificate 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.
3.4 Certificate 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.
3.5 Certificate 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 Form S-3, dated November 3, 2000.
3.6 Certificate 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
4.3 Form of Warrant Agreement dated June 7, 1996 for an aggregate of $3,805,900 issued to a total of twelve investors and filed as an Exhibit to the Company's Current Report on Form 8-K dated April 5, 1996.
4.3.1 Form of Amendment No. 1 to Common Stock Warrant between the Company and three Warrant Holders holding an aggregate of $1,154,409 face value of warrants granted in July and August 1996 (Each Amendment is identical except for the dates and the name of the Warrant Holder), filed as Exhibit 4.11.1 to the Company's Form 8-K, dated September 10, 1997.
4.4 Warrant Agreement for 401,924 shares of Common Stock between the Company and Klein Investment Group, L.P. (formerly known as Iacocca Capital Partners, L.P.) dated August 7, 1996 and filed previously as an Exhibit to the Company's Current Report on Form 8-K dated August 29, 1996.
4.4.1 First Amendment to Common Stock Warrant (increasing warrants to 801,924), Termination of January 7, 1997 Letter Agreement and Amendment to Consulting Agreement dated September 29, 1997 between the Company and Klein Investment Group, L.P., filed as Exhibit 4.12.1 to the Company's Form 10-QSB for the quarter ended September 30, 1997.
4.6 Form of Series 98A 12% Convertible Promissory Note with Limited Guaranty ("Notes") due May 15, 1999 between the Company and 6 investors for an aggregate of $1,000,000 (individual notes vary as to date, amount and payee) and filed previously as Exhibit 4.6 to the Company's Annual Report on Form 10-KSB dated March 31, 1998.
4.7 Stock Purchase Warrant dated June 3, 1998 for 571,429 Common Shares between the Company and Renwick Corporate Finance, Inc. and filed previously as Exhibit 4.7 to the Company's Annual Report on Form 10-KSB dated March 31, 1998.
4.8 Form of Stock Purchase Warrant dated June 12, 1998 entered into between the Company and Elwood G. Norris and Robert Putnam for an aggregate of 2,000,000 shares (1,500,000 shares as to Mr. Norris and 500,000 shares as to Mr. Putnam) and filed previously as Exhibit 4.8 to the Company's Annual Report on Form 10-KSB dated March 31, 1998.
4.9 Form of 15% Promissory Note due December 31, 1999 for an aggregate of $500,000 issued to three investors and filed previously as Exhibit 4.9 to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 31, 1998.
4.10 Form of Warrant Exercisable into an aggregate of 5,000,000 shares of Common Stock at $0.10 per share until June 30, 2000 issued to three investors and filed previously as Exhibit 4.10 to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 31, 1998.
4.11 Stock Purchase Warrant for 33,750 Common Shares between the Company and Cruttenden & Co., Inc. dated July 15,1994 and filed as Exhibit 4.3 to the Company's 1995 Form 10-KSB.
4.12 Stock Purchase Warrant for 300,000 Common Shares between the Company and CVD Financial Corporation dated July 15, 1994 and filed as Exhibit 4.4 to the Company's 1995 Form 10-KSB.
4.12.1 First Amendment to Stock Purchase Warrant for 300,000 Common Shares between the Company and CVD Financial Corporation dated November 14, 1994 and filed as Exhibit 4.4.1 to the Company's 1995 Form 10-KSB.
4.12.2 Second Amendment to Stock Purchase Warrant (for 300,000 shares) between the Company and CVD Financial Corporation dated August 1, 1995 and filed as Exhibit 10.5.5 to the Company's Form 8-K dated October 27, 1995.
4.13 Stock Purchase Warrant for 150,000 Common Shares between the Company and CVD Financial Corporation dated July 15, 1994 and filed as Exhibit 4.5 to the Company's 1995 Form 10-KSB.
4.13.1 First Amendment to Stock Purchase Warrant for 150,000 Common Shares between the Company and CVD Financial Corporation dated November 14, 1994 and filed as Exhibit 4.5.1 to the Company's 1995 Form 10-KSB.
4.13.2 Second Amendment to Stock Purchase Warrant (for 150,000 shares) between the Company and CVD Financial Corporation dated August 1, 1995 and filed as Exhibit 10.5.4 to the Company's Form 8-K dated October 27, 1995.
4.14 Warrant Agreement for 82,100 Common Shares between the Company and Comdisco, Inc. dated as of August 15, 1994 and filed as Exhibit 4.6 to the Company's 1995 Form 10-KSB.
4.15 Warrant Agreement No. 1 for 106,986 Common Shares between the Company and Pennsylvania Merchant Group Ltd. dated March 1, 1995 and filed as Exhibit 4.7 to the Company's 1995 Form 10-KSB.
4.15.1 Warrant Agreement No. 2 for 87,300 Common Shares between the Company and Pennsylvania Merchant Group Ltd. dated March 17, 1995 and filed as Exhibit 4.7.1 to the Company's 1995 Form 10-KSB.
4.15.2 Warrant Agreement No. 3 for 714 Common Shares between the Company and Pennsylvania Merchant Group Ltd. dated March 20, 1995 and filed as Exhibit 4.7.2 to the Company's 1995 Form 10-KSB.
4.15.3 First Amendments to Warrant Agreements No. 1, 2 and 3 between the Company and Pennsylvania Merchant Group Ltd. dated as of September 29, 1997 (amended to 45,570 shares), filed as Exhibit 4.7.3 to the Company's Form 10-QSB for the quarter ended September 30, 1997.
4.16 First Amendment to Warrant Agreement between the Company and First Bermuda Securities Ltd. dated as of September 30, 1997 (27,500 shares), filed as Exhibit 4.10.1 to the Company's Form 10-QSB for the quarter ended September 30, 1997.
4.17 Placement Agent's Warrant Agreement between Auerbach, Pollack & Richardson, Inc. and the Company, filed as Exhibit 10.17 to the Company's Form 8-K dated November 13, 1995.
4.17.1 Warrant Certificate Issued to Auerbach, Pollak & Richardson, Inc. and filed as Exhibit 10.18 to the Company's Form 8-K dated November 13, 1995 and filed previously as an Exhibit to the Company's Current Report on Form 8-K, dated November 13, 1995.
4.17.2 Release and Termination of Right of First Refusal and Amendment to Warrant between the Company and Auerbach, Pollak & Richardson, Inc. dated May 13, 1996 and filed previously as an Exhibit to the Company's Annual Report on Form 10-KSB for the fiscal year ended March 31, 1996.
4.17.3 Form of Amendment to Warrant Certificate and Warrant Agreement between the Company and Auerbach, Pollack & Richardson, Inc. and six individual assignees (identical amendments except as to the number of shares (total of 128,067 shares) and the name of holder) dated as of September 30, 1997, filed as Exhibit 10.18.2 to the Company's Form 10-QSB for the quarter ended September 30, 1997.
4.18 Warrant Agreement for 150,000 Common Shares between the Company and Higham, McConnell & Dunning dated October 10, 1996 and filed previously as an Exhibit to Registration Statement No. 333-13779.
4.18.1 Amendment No. 1 to Stock Purchase Warrant Agreement between the Company and Higham, McConnell & Dunning dated September 30, 1997, filed as Exhibit to the Company's Form 10-QSB for the quarter ended September 30, 1997.
4.18.2 Amendment No. 2 to Stock Purchase Warrant Agreement between the Company and Higham, McConnell & Dunning dated May 27, 1999, filed previously on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.19 Warrant Agreement for 500,000 shares dated January 15, 1999 between the Company and Sunrise Capital, Inc., filed previously on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.20 Form of Warrant Agreement for an aggregate of 2,907,142 shares (as of March 31, 1999) issued at various dates between the Company and six investors, filed previously on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.21 Form of Warrant Agreement for an aggregate of 1,117,857 shares (as of March 31, 1999) dated March 1999 between the Company and four investors., filed previously on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.22 Warrant Agreement for 125,000 shares dated October 15, 1998 between the Company and Renwick Corporate Finance, Inc., filed previously on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.23 Warrant Agreement for 100,000 shares dated January 15, 1999 between the Company and Pomerado Properties., filed previously on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.24 Warrant Agreement for 195,000 shares dated June 24, 1999 between the Company and JNC Opportunity Fund Limited, filed previously on the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.25 Warrant Agreement for 137,615 shares dated June 24, 1999 between the Company and Jesup & Lamont Securities Corporation and filed as Exhibit 3.4 to the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.26 Convertible Preferred Stock Purchase Agreement between the Company and JNC Opportunity Fund Limited dated June 24, 1999 and filed as Exhibit 3.4 to the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.27 Registration Rights Agreement between the Company and JNC Opportunity Fund Limited dated June 24, 1999 and filed as Exhibit 3.4 to the Company's Annual Report on Form 10-KSB dated March 31, 1999.
4.28 Warrant Agreement for an aggregate of 230,946 shares dated October 5,2000 between the Company and the Series C preferred stockholders filed as Exhibit 4.3 on Form S-3, dated November 3, 2000.
4.29 Warrant Agreement for 138,568 shares dated October 5, 2000 between the Company and Jesup and Lamont Securities Corporation filed as Exhibit 4.4 on Form S-3, dated November 3, 2000.
4.30 Convertible Preferred Stock Purchase Agreement between the Company and the Series C preferred stockholders dated October 5, 2000 and filed as Exhibit 4.5 on Form S-3, dated November 3, 2000.
4.31 Registration Rights Agreement between the Company and the Series C preferred stockholders dated October 5, 2000 and filed as Exhibit 4.6 on Form S-3, dated November 3, 2000.
4.32 Form of 12% Secured Promissory Note due December 31, 2002 aggregating $1,000,000 entered into with seven accredited investors (individual notes differ only as to holder and amount) and filed as Exhibit 4.32 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.
4.33 Form of Security Agreement, dated September 28, 2001 by the Company in favor of seven accredited investors and filed as Exhibit 4.33 to the Company's Annual Report on Form 10-K dated June 28, 2002.
4.34 Form of Stock Purchase Warrant exercisable until September 30, 2006 issued to seven accredited investors for an aggregate of 750,000 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 4.32 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001.
4.35 Form of 5% Secured Promissory Note due April 18, 2002 in the amount of $1,200,000 entered into with Immanuel Kant International Limited and filed as Exhibit 4.9 to the Company's Registration Statement on Form S-3 dated April 23, 2002.
4.36 Form of Security Agreement, dated January 18, 2002 by the Company in favor of Immanuel Kant International Limited and filed as Exhibit 4.10 to the Company's Registration Statement on Form S-3 dated April 23, 2002.
4.37 Form of Intellectual Property Security Agreement, dated January 18, 2002 by the Company in favor of Immanuel Kant International Limited and filed as Exhibit 4.11 to the Company's Registration Statement on Form S-3 dated April 23, 2002.
4.38 Form of Amendment No. 1 to 5% Secured Promissory Note due April 18, 2002 in the amount to $1,200,000 entered into on April 17, 2002 with Immanuel Kant International Limited and filed as Exhibit 4.12 to the Company's Registration Statement on Form S-3 dated April 23, 2002.
4.38.1 Form of Amendment No. 2 to 5% Secured Promissory Note due April 18, 2002 in the amount to $1,200,000 entered into on April 29, 2002 with Immanuel Kant International Limited and filed as Exhibit 4.38.1 to the Company's Annual Report on Form 10-K dated June 28, 2002
4.39 Form of 24% Unsecured Promissory Notes aggregating $1,050,000 entered into with three accredited investors (individual notes differ only as to amount) and filed as Exhibit 4.39 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002
4.40 Form of 15% Unsecured Promissory Notes due February 11, 2002 in the amount of $750,000 entered into with Davric Corporation and filed as Exhibit 4.40 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.
4.40.1 First Amendment to 15% Promissory Note due February 11, 2002 filed as Exhibit 4.40.1 to the Company's form 8-k dated December 30, 2002.
4.41 Form of Asset Transfer Agreement, dated July 26, 2002 by and between the Company and Bryan Jones and Russell Clark and filed as Exhibit 4.13 to the Company's Registration Statement on Form S-3 dated April 23, 2002.
4.42 Certificate of Designation of Preferences, Rights and Limitations of Series D Preferred Stock filed as Exhibit 3.6 to the Company's Form 8-k dated December 30, 2002.
4.43 Form of Conversion Agreement entered into with five holders of the Company's 12% Promissory Notes due December 31, 2002 and three holders of the Company's 24% Promissory Notes due December 31, 2002 filed as Exhibit 4.41 to the Company's Form 8-k dated December 30, 2002.
4.44 Form of 24% Unsecured Note to Alex Diaz dated March 17, 2003 and filed as Exhibit to the Company's Form 10K dated June 26, 2003.
4.45 Form of 24% Unsecured Promissory Note due June 30, 2004 aggregating $200,000 entered into with three accredited investors (individual notes differ only as to amount) and filed as Exhibit to the Company's Form 10K dated June 26, 2003.
4.46 Form of Series A Warrant Agreement for an aggregate of 1,712,333 shares (dated November 19, 2003) between the Company and the Series E preferred stockholders (individual warrants differ only as to holder and number of shares) and previously filed as exhibit 4.8 on the Company's Form S-3 dated December 22, 2003.
4.47 Form of Series B Warrant Agreement for an aggregate of 856,166 shares (dated November 19 2003) between the Company and the Series E preferred stockholders (individual warrants differ only as to holder and number of shares) and previously filed as exhibit 4.9 on the Company's Form S-3 dated December 22, 2003.
4.48 Registration Rights Agreement between the Company and the Series E preferred stockholders dated November 19, 2003 and filed as Exhibit 4.47 to the Company's Current Report on Form 8-K dated November 21, 2003.
4.49 Convertible Preferred Stock Purchase Agreement between the Company and the Series E preferred stockholders dated November 19, 2003 and filed as Exhibit 4.46 to the Company's Current Report on Form 8-K dated November 21, 2003.
4.50 Form of 12% Subordinated Promissory Note and Warrant Purchase Agreement entered into with certain accredited investors in a maximum aggregate amount of $1,000,000 and filed as Exhibit 4.4.6 to the Company's 2004 Form 10-K.
4.51 Form of 12% Subordinated Promissory Note due on July 1, 2005 between the Company and certain accredited investors (individual notes differ only as to amount) and filed as Exhibit 4.4.7 to the Company's 2004 Form 10-K.
4.52 Form 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 4.4.8 to the Company's 2004 Form 10-K.
10.1 Amended Sublease Agreement between Smith Industries and Aerospace and the Company dated January 1, 2004 and filed as Exhibit 99.1 to the Company's 2004 Form 10-K.
10.2 Lease Agreement between the Company and LBA Industrial Fund - Holding Co. II, Inc. and Innsbruck Holdings, L.P. dated March 3, 2006.*
21.1 List of subsidiaries.*
23 Consents of Experts and Counsel 23.1 Singer Lewak Greenbaum & Goldstein, LLP *
31 Certifications *
31.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by William Blakeley, Chief Executive Officer.
31.2 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Robert Putnam, Principal Accounting Officer.
32.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by William Blakeley, Chief Executive Officer and Robert Putnam, Principal Accounting Officer. - ---------------------------
* Filed concurrently herewith.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
e.Digital Corporation
By: /s/ WILLIAM BLAKELEY ------------------------------------- President and Chief Technical Officer
Date: June 29, 2006
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
- ----------------------------- Page ----
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND SUBSIDIARY
REPORT OF SINGER LEWAK GREENBAUM & GOLDSTEIN LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2006 AND 2005
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED MARCH 31, 2006, 2005 AND 2004
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT FOR THE YEARS ENDED MARCH 31, 2006, 2005 AND 2004
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MARCH 31, 2006, 2005 AND 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS to
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors e.Digital Corporation San Diego, CA
We have audited the consolidated balance sheets of e.Digital Corporation and subsidiary (the "Company") as of March 31, 2006 and 2005, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended March 31, 2006. 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 provided 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 the Company as of March 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2006, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations, and its total liabilities exceeds its total assets. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN, LLP - ------------------------------------------- SINGER LEWAK GREENBAUM & GOLDSTEIN, LLP
Santa Ana, CA June 28, 2006
e.Digital Corporation and subsidiary
CONSOLIDATED BALANCE SHEETS [See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS [See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY [See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS [See Note 1 - Nature of Operations and Basis of Presentation]
See accompanying notes
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
The consolidated financial statements have been prepared, by management, in accordance with accounting principles generally accepted in the United States on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future.
The Company has incurred significant losses and negative cash flow from operations in each of the last three years and has an accumulated deficit of $77,172,095 at March 31, 2006 [2005 - $71,954,029]. At March 31, 2006, the Company had a working capital deficiency of $2,516,367. Substantial portions of the losses are attributable to marketing costs of the Company's new technology and substantial expenditures on research and development of technologies. The Company's operating plans require additional funds that may take the form of debt or equity financings. There can be no assurance that any additional funds will be available. The Company's ability to continue as a going concern is in substantial doubt and is dependent upon achieving a profitable level of operations and obtaining additional financing.
Management of our company has undertaken steps as part of a plan to improve operations with the goal of sustaining our operations for the next twelve months and beyond. These steps include (a) controlling overhead and expenses; (b) expanding sales and marketing to new business customers and new markets and (c) raising additional capital and/or obtaining financing.
There can be no assurance the Company can successfully accomplish these steps and it is uncertain the Company will achieve a profitable level of operations and obtain additional financing. There can be no assurance that any additional financings will be available to the Company on satisfactory terms and conditions, if at all. In the event we are unable to continue as a going concern, we may elect or be required to seek protection from our creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. To date, management has not considered this alternative, nor does management view it as a likely occurrence.
These consolidated financial statements do not give effect to any adjustments which would be necessary should the Company be unable to continue as a going concern and therefore be required to realize its assets and discharge its liabilities in other than the normal course of business and at amounts different from those reflected in the accompanying consolidated financial statements.
2. 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 period. Actual results could differ from those estimates.
Fair value of financial instruments
The Company's financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable trade, other accounts payable and accrued liabilities, accrued lease liability, accrued employee benefits, preferred stock and unsecured promissory notes. Management has determined that the carrying value of cash and cash equivalent, accounts receivable, accounts payable trade and other accounts payable and accrued liabilities and accrued employee benefits approximate their fair value due to their short term nature. Management has determined that the carrying value of the preferred stock and unsecured promissory notes approximates its fair value based on discounted cash flows at market rates. The fair value of the accrued lease liability is not readily determinable as it has no fixed repayment terms.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
Translation of foreign currencies
Monetary assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the rate in effect at the balance sheet date. Other balance sheet items and revenues and expenses are translated into U.S. dollars at the rates prevailing on the respective transaction dates. Gains and losses on foreign currency transactions, which have not been material, are reflected in the consolidated statements of operations.
Loss per share
Basic loss per share is computed by dividing loss available to common stockholders by the weighted average number of common shares outstanding for the year. Diluted loss per share reflects the potential dilution of securities that could share in the loss of an entity. As at March 31, 2006, stock options, warrants and convertible preferred stock and notes exercisable into 64,049,961 [2005 - 28,255,962] [2004 - 19,727,293] shares of common stock were outstanding. These securities were not included in the computation of diluted loss per share because they are antidilutive, but they could potentially dilute earnings (loss) per share in future years.
The provisions of each of the Company's series D, E and EE of preferred stock provided for a 12%, 8% and 8% per annum accretion, respectively in the conversion value (similar to a dividend). These amounts increase the net loss available to common stockholders. Net loss available to common stockholders is computed as follows:
Guarantees and Indemnifications
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others -- an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34." The following is a summary of the Company's agreements that the Company has determined are within the scope of FIN No. 45:
The Company provides a one year limited warranty for most of its products. See "Warranty Liabilities."
Revenue recognition
The Company recognizes license revenue and product revenue upon shipment of a product to the customer, FOB destination or FOB shipping point depending on the specific contract term, if a signed contract exists, the fee is fixed and determinable, collection of resulting receivables is probable and there are no resulting obligations. Research and development contract revenues on short-term projects or service revenue is recognized once the services or product has been delivered, the fee is fixed and determinable, collection of the resulting receivable is probable and there are no resulting obligations. If all of the service or product has been delivered and there is one element that is perfunctory to the services or product that has not been delivered, revenue will be recognized evenly over the remaining term of the undelivered element.
Research and development contract revenue on long-term projects is recognized on the percentage of completion method. Funds received in advance of meeting the criteria for revenue recognition are deferred and are recorded as revenue as they are earned.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
Cash equivalents
Cash equivalents are highly liquid investments with insignificant interest rate risk and maturities of three months or less at the date of purchase and are recorded at cost, which approximates fair value. Cash equivalents consist principally of investments in short-term money market instruments.
Deposits and Prepaid Expenses
Deposits and prepaid expenses are recorded at amounts paid to suppliers or others. Amounts recorded are evaluated for impairment periodically and at March 31, 2006 a charge of $603,750 was expensed to cost of revenues to reflect impairment of deposits made to a contract manufacturer that has failed to timely deliver with no assurance of future performance.
Inventory
Inventory is recorded at the lower of cost and net realizable value. Cost is determined on a first-in, first-out basis.
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.
Intangible assets
Intangible assets include third party costs relating to obtaining patents, which are deferred when management is reasonably certain the patent will be granted. Such costs are amortized to operations over the life of the patent. If management determines that development of products to which patent costs relate is not reasonably certain, or that deferred patent costs exceed net recoverable value, such costs are charged to operations. Intangible assets also include website development costs incurred during the application development stage of the Company's website which have been capitalized and are amortized over a two year period on the straight-line method. All other patent and website related costs are charged to operations when incurred.
Advertising
Advertising costs are charged to expense as incurred. The Company expensed $104, $420 and $12,263 for the years ending March 31, 2006, 2005 and 2004, respectively.
Research and Development costs
Research and development costs are expensed as incurred.
Warranty Liability
The Company warrants its products to be free from defects in materials and workmanship for a period ranging up to one year from the date of purchase, depending on the product. The warranty is generally a limited warranty, and in some instances imposes certain shipping costs on the customer. The Company currently provides direct warranty service. 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. See Schedule II for additional information regarding warranties.
Interest Expense
Interest expense includes interest expense and non-cash amortization of debt discount.
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.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
Rental payments under operating leases are expensed as incurred.
Shipping and handling costs
Amounts paid by customers for shipping and handling are included in product revenues. Actual shipping and handling costs are included in product cost of revenues.
Income taxes
The Company follows the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect for the year in which the differences are expected to reverse.
Stock based compensation
Stock-Based Compensation - We currently account for stock-based employee compensation arrangements using the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, and Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 44, Accounting for Certain Transactions Involving Stock Compensation, and comply with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock-based Compensation - Transition and Disclosure. Under APB 25 and related interpretations, compensation is based on the difference, if any, on the date of the grant, between the fair value of our common stock and the exercise price.
Our accounting treatment of stock options will significantly change during 2007 due to our planned adoption of SFAS No. 123R (SFAS 123(R)), Share-Based Payment, which is effective for fiscal years beginning after June 15, 2005. See Recently Issued Accounting Pronouncements below.
The following table illustrates the effect on net income (loss) and net income (loss) per share if we had applied the fair value recognition provisions of SFAS No. 123 to employee stock benefits, including shares issued under the stock option plans and under our Employee Stock Purchase Plan (collectively "options"). For purposes of pro forma disclosures, the estimated fair value of the options is assumed to be amortized to expense over the options' vesting periods. Pro forma information follows:
The Fair value of options, used as a basis for the above pro forma disclosures, was estimated at the date of grant using the Black-Scholes option-pricing model. The option pricing assumptions include no expected dividends, 96 volatility in 2004, 72.6 volatility in 2005, and 87.38 volatility in 2006, expected life of the options of 2.5 years in 2004, 2005 and 2006 and a risk-free interest rate of 1.74% for 2004, 2.86% for 2005, and 4.95% for 2006.
Beginning with the quarter ending June 20, 2006, the Company will account for its stock-based compensation plans in accordance with SFAS Statement No. 123, "Accounting for Stock Based Compensation (revised)." See note 2.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
Comprehensive income
Comprehensive income 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, 2006, 2005 and 2004, there were no material differences between comprehensive income and net loss for the year.
Software development costs
The Company accounts for software development costs in accordance with Financial Accounting Standards Board ("FASB") Statement No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," under which certain software development costs incurred subsequent to the establishment of technological feasibility are capitalized and amortized over the estimated lives of the related products. Technological feasibility is established upon completion of a working model. Development costs incurred subsequent to the establishment of technological feasibility have not been significant, and all software development costs have been charged to research and related expenditures in the accompanying consolidated statements of operations.
Impairment of Long-Lived Assets
Long-lived assets and identifiable intangibles held for use are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of undiscounted expected future cash flows is less than the carrying amount of the asset or if changes in facts and circumstances indicate, an impairment loss is recognized and measured using the asset's fair value.
Segment information
The Company identifies its operating segments based on how management internally evaluates separate financial information (if available), business activities and management responsibility. The Company believes it operates in a single business segment, the development, manufacture and marketing of electronic products, offering engineering services to electronics companies to create portable digital devices that can link to personal computers and the Internet.
Common stock issued for services
The Company records compensation expense for common stock issued for services based on the estimated fair market value. Estimated fair market value is determined based on the quoted closing-bid stock price on the day of issuance.
Derivative Instruments
The Company values derivative instruments in accordance with the interpretative guidance of FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities", EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock", Accounting Principles Board Opinion No. 14 "Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants", EITF 98-5 "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios", and EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" and associated pronouncements related to the classification and measurement of warrants and instruments with embedded conversion features. The Company makes certain assumptions and estimates to value its derivative liabilities. Factors affecting these liabilities and values include changes in the stock price and other assumptions.
Reclassifications
Certain amounts included in the prior year financial statements have been reclassified to conform to the current year's presentation. These reclassifications have no affect on the reported net income.
Recent accounting pronouncements
In December 2004, the FASB issued SFAS 123(R), Share-Based Payment, which replaces SFAS 123 and supersedes APB Opinion No. 25. SFAS 123(R) requires that compensation costs relating to share-based payment transactions be recognized in financial statements. The pro forma disclosure previously permitted under SFAS 123 will no longer be an acceptable alternative to recognition of expenses in the financial statements. SFAS 123(R) is effective as of the beginning of the first reporting period that begins after June 15, 2005, with early adoption encouraged. We currently measure compensation costs related to share-based payments under APB 25, as allowed by SFAS 123, and provide disclosure in notes to financial statements as required by SFAS 123. We are required to adopt SFAS 123(R) starting in fiscal 2007. We expect the adoption of SFAS 123(R) will have a material adverse impact on our net income and net income per share. We are currently in the process of evaluating the extent of such impact. We have also not yet determined our method of adoption of FAS 123(R). Please see our disclosure under Footnote 1 to our Consolidated Financial Statements addressing stock-based compensation.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
During March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 107, guidance on SFAS No. 123 (revised 2004) SAB 107 was issued to assist preparers by simplifying some to the implementation challenges of SFAS No. 123 (revised 2004) while enhancing the information that investors receive. The Company will consider the guidance provided by SAB No. 107 as it implements SFAS 123 (revised 2004) during fiscal 2006.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs." SFAS No. 151 amends the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) under the guidance in ARB No. 43, Chapter 4, "Inventory Pricing." Paragraph 5 of ARB No. 43, Chapter 4, previously stated that ". . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be so abnormal as to require treatment as current period charges. . . ." This statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not expect the adoption of SFAS 151 to have a material effect on the Company's results of operations or financial condition.
In December 2004, the FASB issued FAS No. 153, "Exchange of Nonmonetary Assets", which is an amendment to APB Opinion No. 29. The guidance in APB Opinion No. 29, "Accounting for Nonmonetary Transactions", is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that opinion, however, included certain exceptions to that principle. This statement amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of FAS No. 153, effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005, or our fiscal year commencing on April 1, 2006, is not expected to have a material impact on our financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." FASB Statement of Accounting Standards (SFAS) 154 establishes new standards on accounting for changes in accounting principles. Pursuant to the new rules, all such changes must be accounted for by retrospective application to the financial statements of prior periods unless it is impracticable to do so. SFAS 154 completely replaces Accounting Principles Bulletin (APB) Opinion 20 and SFAS 3, though it carries forward the guidance in those pronouncements with respect to accounting for changes in estimates, changes in the reporting entity, and the correction of errors. The Statement is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, with early adoption permitted for changes and corrections made in years beginning after May 2005. Management does not expect adoption of SFAS No. 154 to have a material impact on the Company's financial statements.
In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47, "Accounting for Conditional Asset Retirement Obligations." FIN No. 47 clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, "Accounting for Asset Retirement Obligations," refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement. Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005 (December 31, 2005 for calendar-year companies). Retrospective application of interim financial information is permitted but is not required. Management does not expect the adoption of FIN 47 to have a material effect on the Company's results of operations or financial condition.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
In February 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) 155, "Accounting for Certain Hybrid Financial Instruments." SFAS 155 amends SFAS 133 to narrow the scope exception for interest-only and principal-only strips on debt instruments to include only such strips representing rights to receive a specified portion of the contractual interest or principal cash flows. SFAS 155 also amends SFAS 140 to allow qualifying special-purpose entities to hold a passive derivative financial instrument pertaining to beneficial interests that itself is a derivative financial instrument. Generally, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," requires that a derivative embedded in a host contract that does not meet the definition of a derivative be accounted for separately (referred to as bifurcation) under certain conditions. That general rule notwithstanding, SFAS No. 133 (prior to amendments made to it by SFAS No. 155) provides a broad exception for interest-only and principal-only strips initially resulting from the separation of rights to receive contractual cash flows of a financial instrument that itself does not contain an embedded derivative that would have been accounted for separately. SFAS 155 amends SFAS 133 to restrict the scope exception to strips that represent rights to receive only a portion of the contractual interest cash flows or of the contractual principal cash flows of a specific debt instrument. Prior to amendments made by SFAS 155, SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," permitted a qualifying special-purpose entity (SPE) to hold only passive derivative financial instruments pertaining to beneficial interests (other than another derivative financial instrument) issued or sold to parties other than the transferor. SFAS 155 amends SFAS 140 to allow a qualifying SPE to hold a derivative instrument pertaining to beneficial interests that itself is a derivative financial instrument. Management does not expect the adoption of SFAS 155 to have a material effect on the Company's results of operations or financial condition.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets," which provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This statement amends FASB Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," with respect to the accounting for separately recognized servicing assets and servicing liabilities. The statement (1) requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations; (2) requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable; (3) permits an entity to choose either the amortization method or the fair value method for subsequent measurement for each class of separately recognized servicing assets or servicing liabilities; (4) permits at initial adoption a one-time reclassification of available-for-sale securities to trading securities by an entity with recognized servicing rights, provided the securities reclassified offset the entity's exposure to changes in the fair value of the servicing assets or liabilities; and (5) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the balance sheet and additional disclosures for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities as of the beginning of an entity's fiscal year that begins after September 15, 2006, with earlier adoption permitted in certain circumstances. The statement also describes the manner in which it should be initially applied. Management does not expect the adoption of SFAS 156 to have a material effect on the Company's results of operations or financial condition.
3. CREDIT RISK
Financial instruments totaling $888,762 [2005 - $1,131,525] [2004 - $504,105] which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents, certificate of deposit, accounts receivable. The Company maintains cash and cash equivalents with three financial institutions. The Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses which, when realized, have been within the range of management's expectations.
Amounts owing from one customer comprise approximately 100% and 99% of accounts receivable at March 31, 2006 and 2005, respectively. Amounts owing from two major customers comprise approximately 69%, and 23%, respectively of accounts receivable at March 31, 2004.
4. MAJOR CUSTOMERS AND SUPPLIERS
The Company operates in one major line of business, the development, manufacture and marketing of electronic products. Sales to one major customer comprised approximately 94% of revenues respectively in fiscal 2006 [2005 - one customer comprised 94%] [2004 - three customers comprised 36%, 26% and 11%] The Company purchases its primary component from two distributors accounting for 74% ad 13% of total purchases for fiscal 2006. Purchases from one distributor accounted for 92% of total purchases for fiscal 2005. Purchases from two distributors accounted for 19% and 14% of total purchases for fiscal 2004. During the year ended March 31, 2004, management increased the provision for doubtful accounts by $36,019, and recorded no discount in the provision, and accordingly, the provision for doubtful accounts receivable at March 31, 2005 is $-0-. The provision for doubtful accounts receivable at March 31, 2006 is $-0-.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
6. STATEMENT OF CASH FLOWS
The Company had non-cash operating and financing activities and made cash payments as follows:
7. PROPERTY AND EQUIPMENT
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
8. INTANGIBLE ASSETS
9. PROMISSORY NOTES
15% Unsecured Promissory Note
On December 11, 2002, we issued a 15% Unsecured Promissory Note for cash proceeds of $750,000 from an unrelated corporation. On January 31, 2005, the 15% Unsecured Promissory Note was amended to extend the maturity date to September 30, 2006 when principal and interest will be payable. Accrued interest on the note at March 31, 2006 was $140,625. On January 31, 2005, we paid cash interest of $8,500 and issued to the noteholder a secondary 15% Unsecured Promissory Note for accrued interest of $150,000. The secondary 15% Unsecured Promissory Note will also mature on September 30, 2006. Principal and interest on the secondary 15% Unsecured Promissory Note is payable in monthly installments of $3,500 with the balance due at maturity.
12% Convertible Subordinated Promissory Notes
In June and July 2004, we sold $1,000,000 of unsecured 12% Subordinated Promissory Notes due July 1, 2005. The purchasers, in connection therewith, were granted warrants to purchase 2,000,000 shares of common stock at an exercise price of $0.25 per share, exercisable until December 31, 2007. The estimated fair market value of these warrants at issuance was $232,186 and was recorded as a deferred financing charge related to the 12% Subordinated Promissory Notes as a cost of issuing the warrants charged to Additional Paid in Capital. The deferred financing charge was amortized as a debt discount over the original term of the 12% Subordinated Promissory Notes. On June 30, 2005, the 12% Subordinated Promissory Notes and warrants were modified by extending the maturity date from July 1, 2005 to December 31, 2005 and by reducing the purchase price of each warrant share purchasable under the warrant from $0.25 to $0.19. Due to the modification of these warrants, our company recorded additional debt discount of $120,062 on the 12% Subordinated Promissory Notes.
In October 2005, the 12% Subordinated Promissory Notes were modified by extending the maturity date to December 31, 2006 and to increase the maximum allowable note amount from $1,000,000 to $1,500,000 and all $500,000 of additional notes were sold. Noteholders acquiring 12% Subordinated Promissory Notes on or after October 26, 2005 are entitled to receive a royalty equal to (i) the principal of the 12% Subordinated Promissory Note purchased divided by (ii) $500,000 (or the aggregate principal of the additional 12% Subordinated Promissory Notes sold) (the "Additional Notes") multiplied by (iii) Twenty Dollars ($20.00) for each entertainment device sold during the calendar years of 2006, 2007 and 2008. The outstanding 12% Subordinated Promissory Notes were also amended such that the principal amount was convertible at $0.19 per common share, subject to anti-dilution adjustments if our company makes certain issuances of stock at a lower price. On February 24, 2006, the conversion price on $1,500,000 of the 12% Subordinated Promissory Notes was adjusted from $0.19 per share to $0.08 per share. The exercise price of the warrants was further adjusted from $0.19 per share to $0.08. An additional debt discount of $1,225,590 was recorded to reflect the value of the reduced conversion price of the debt and the value of the warrants due to the new warrant exercise price and this amount is being amortized over the term of the notes.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
10. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. For financial statement purposes, a change in valuation allowance of $2,570,000 [2005 - $2,118,000] has been recognized to offset certain deferred tax assets for which realization is uncertain. Significant components of the Company's deferred tax liabilities and assets as of March 31 are as follows:
There is no net provision for income taxes in 2006, 2005 and 2004 as the Company incurred losses in those years.
A reconciliation between federal statutory income tax rates and the effective tax rate of the Company at March 31 is as follows:
The Company has U.S. federal net operating loss carryforwards available at March 31, 2006 of approximately $55,250,000 [2005 - $53,300,000] which will begin to expire in 2006. The Company has state net operating loss carryforwards of $17,600,000 [2005 - $16,400,000] which will begin to expire in 2006. 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.
11. CAPITAL STOCK
Authorized capital
The authorized capital of the Company consists of 300,000,000 common shares with a par value of $.001 per share and 5,000,000 preferred shares with a par value of $10.00 per share.
Common stock
The issued common stock of the Company consisted of 200,431,000, 170,493,385 and 160,527,868 common shares as of March 31, 2006, 2005 and 2004, respectively.
Stock options
The Company maintains two stock option plans. The 1992 Stock Option Plan is a non-qualified stock option plan, which entitles certain directors and key employees to purchase common shares of the Company. A maximum of 10% of outstanding common shares are authorized for grant under the Plan. Options are granted at a price not less than fair market value at the date of grant, and are subject to approval of the Board of Directors. The 1994 Stock Option Plan entitles certain directors, key employees and consultants of the Company to purchase common shares of the Company. The 1994 Plan covered a maximum aggregate of 14,000,000 shares, as amended and approved by stockholders on July 25, 1996, January 5, 1998 and November 9, 2000. The 1994 Plan provides for the granting of options that either qualify for treatment as incentive stock options or non-statutory stock options. The 1994 Plan expired on August 18, 2004.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
During 2006, 7,190,000 [2005 - 3,380,000] options were granted at exercise prices ranging from $0.09 to $0.145 [2005 - $0.22 to $0.28] per share. Options granted during 2005 and 2004 were under the 1994 Stock Option Plan. The following table summarizes stock option transactions:
The following table summarizes the number of options exercisable at March 31, 2006 and the weighted average exercise prices and remaining contractual lives of the options.
The options generally vest over a period of two to three years.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
Share warrants
The Company has outstanding share warrants as of March 31, 2006, granted in connection with private placements and convertible notes payable, entitling the holders to purchase one common share for each warrant held as follows (subject to certain future antidilution price protection):
(1) In connection with the issuance of the Series EE preferred stock in November 2004, the Company issued warrants with an exercise price of $0.50. The Company utilized the Black-Scholes Method in valuing the warrants, and calculated the relative fair value of the equity and the warrants. The Company calculated the historical volatility over a 52 week period to be 81.03%, risk free rate of 3.02% with a term of 3 years and recorded $1,100,611 as the beneficial conversion feature for the equity and attached warrants for the year ended March 31, 2006. (2) The warrants expire on the earlier of July 31, 2008 or six months after an effective registration statement.
In February 2006, the Company issued 4,687,500 of A warrants and 4,687,500 of B warrants in connection with a restricted common stock sale aggregating $1,500,000.
A summary of the status of outstanding stock purchase warrants outstanding as of March 31, 2004, 2005 and 2006 and the changes during the years then ended is presented below:
12. REDEEMABLE AND NON-REDEEMABLE PREFERRED STOCK
The Company is authorized to issue 5,000,000 shares of $0.001 par value preferred stock in one or more series from time to time by action of the Board of Directors.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
The following is a summary of the terms of the preferred stock series outstanding during the two fiscal years ended March 31, 2006 and 2005, respectively.
On December 30, 2002, the Company issued 205,000 shares of 12% Series D non-redeemable convertible preferred stock (the "Series D stock") with a stated value of $10 per share. The Series D stock was issued pursuant to a conversion agreement with all of the noteholders of the Company's $1,000,000 SP Notes and $1,050,000 Unsecured Notes. The conversion price was reduced to $0.19 pursuant to anti-dilution protection given to the preferred stockholders triggered by the sale of $129,000 of shares of Common Stock in January 2003 and to $0.08 per share by the sale of $1,500,000 of common stock in February 2006. In connection with the repricing to $0.08, the Company recorded an additional deemed dividend of $1,522,400 to reflect the new beneficial conversion price.
On November 19, 2003, the Company issued 12,770 shares of 8% Series E Convertible Redeemable Preferred Stock (the "Series E Stock") with a stated value of $100 per share for gross proceeds of $1,277,000. The Series E Stock was redeemable in certain instances at the Company's option eighteen month upon the occurrence of certain triggering events including, without limitations, a lapse of a registration statement for ten non-consecutive trading days and certain other events. The redemption price upon such election following a triggering event was the greater of (a) 110% of the stated value or (b) the product of the number of preferred shares multiplied by the closing market price multiplied by the stated value per share divided by the then conversion price per share.
The Company also issued to the purchasers of the Series E Stock, Series A Warrants to purchase 1,712,333 shares of Common Stock at $0.60 per share exercisable until May 18, 2004 and Series B Warrants to purchase 856,166 shares of Common Stock at $1.00 per share exercisable until November 18, 2005. The Company utilized the Black Scholes Method in valuing the Series A and B Warrants, and calculated the relative fair value of the Series E Stock and Series A and B Warrants. The effective conversion price of the Series E Stock was then determined by the Company based on the relative fair value of the stock. Utilizing the calculated intrinsic value of the Series E Stock, the Company calculated a beneficial conversion charge in the amount of $693,615, which was recorded in the loss attributed to common shareholders in the accompanying financial statements for fiscal 2004. All Series E Stock was converted as of March 31, 2006.
In connection with the Series E Stock financings, the Company incurred as finder's fee for $7,250 in cash and, in connection therewith, issued to such finder a 9,666 Series A and 4,833 Series B warrant with an aggregate fair market value of $2,755.
On November 30, 2004, the Company issued 18,500 shares of 8% Series EE Convertible Preferred Stock (the "Series EE Stock") at a per share price of $100 for an aggregate amount of $1,850,000. The Series EE Stock is redeemable in certain instances at the Company's option eighteen month upon the occurrence of certain triggering events including, without limitations, a lapse of a registration statement for ten non-consecutive trading days and certain other events. The redemption price upon such election following a triggering event is the greater of (a) 110% of the stated value or (b) the product of the number of preferred shares multiplied by the closing market price multiplied by the stated value per share divided by the then conversion price per share.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
The Company also issued to the Investors, warrants to purchase 3,700,000 shares of common stock at $0.50 per share until November 30, 2007. The Company utilized the Black Scholes Method in valuing the warrants, and calculated the relative fair value of the Series EE Stock and warrants. The effective conversion price of the Series EE Stock was then determined by the Company based on the relative fair value of the stock. The beneficial conversion feature was calculated, based on EITF 98-5 as modified by EITF 00-27, as a "convertible instrument containing fixed terms that change". Utilizing the calculated intrinsic value of the Series EE Stock, the Company calculated a beneficial conversion charge in the amount of $1,100,611, which was recorded in the loss attributed to common stockholders in the accompanying financial statements. As a result of a reset of the conversion price of the Series EE Stock in February 2006 to $0.08 per common share, the Company recorded an additional deemed dividend of $1,522,400 to reflect the new beneficial conversion price.
The Company incurred placement agent fees of approximately $129,000 in cash and, in connection therewith, issued to such placement agent 370,000 warrants. The estimated fair market value of these warrants at issuance was $38,935 and has been recorded as offering cost related to the issuance of the Series EE Stock.
As of March 31, 2006, the Series D and EE Stock would have been convertible into 16,679,014 and 3,466,781 shares of Common Stock, respectively.
The following table summarizes values assigned as deemed dividends for the value of the warrants and the beneficial conversion feature on each preferred stock issuance during the last three fiscal years.
(1) Additional values for deemed dividends associated with a reset of the conversion price from $0.19 per common share to $0.08 per common share.
13. COMMITMENTS AND CONTINGENCIES
The Company may become involved in certain legal proceedings and claims which arise in the normal course of business. As of March 31, 2006, the Company did not have any significant litigation outstanding, and management does not expect any matters to have a material impact on the Company's liquidity or the financial statements taken as a whole. Subsequent to March 31, 2006 litigation was filed against the Company. See Note 14.
The Company depends on its contract manufacturer to (i) allocate sufficient capacity to our manufacturing needs, (ii) produce acceptable quality products at agreed pricing and (iii) deliver on a timely basis. If a manufacturer is unable to satisfy these requirements, the Company's business, financial condition and operating results may be materially and adversely affected. Any failure in performance by either of these manufacturers for any reason could have a material adverse affect on the Company's business. Production and pricing by each such manufacturer is subject to the risk of price fluctuations and periodic shortages of components. The Company does not have supply agreements with component suppliers and, accordingly, it is dependent on the future ability of its manufacturers to purchase components. Failure or delay by suppliers in supplying necessary components could adversely affect the Company's ability to deliver products on a timely and competitive basis in the future.
E.DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006
Facility lease
On July 11, 1997, the Company entered into a three-year joint lease agreement with American Technology Corporation, for property located in San Diego, California. In September 2000, the Company amended the three-year lease to become an independent lessee and acquired an additional 1,500 square feet of improved research and development space. The amended lease agreement expires on July 31, 2003. From August 2002 until December 2003 the aggregate monthly lease payments was $16,606. In January 2004, the Company amended the lease to reduce the occupied office space to 7,500 square feet with an aggregate monthly lease payment of $9,290 inclusive of utilities and costs and expiring on July 31, 2006. In March 2006 the Company entered into a new sixty-two month lease, commencing June 1, 2006, for approximately 4,800 square feet with an aggregate payment of $5,805 excluding utilities and costs. The aggregate payments adjust annually with maximum aggregate payments totaling $6,535 in the fifty-first through the sixty-second month.
Office rent expense recorded by the Company for the year ended March 31, 2006, was $102,194 [2005 - $111,480] and [2004- $155,375].
The total operating lease obligations under the lease for office space is $381,484 of which the Company's minimum commitment is as follows:
2007 $ 58,056 2008 71,061 2009 73,192 2010 75,388 2011 77,650 2012 26,137 --------- $ 381,484 =========
14. SUBSEQUENT EVENT
On May 12, 2006, the Company became aware of a complaint filed on May 4, 2006 against it and certain of officers and employees by digEcor, Inc., ("digEcor") in the Third Judicial District Court of Utah, County of Salt Lake. The complaint alleges breaches of contract, unjust enrichment, breaches of good faith and fair dealing, fraud, negligent misrepresentation, and interference with prospective economic relations. digEcor is seeking, among other things, an injunction to prevent the Company from selling or licensing certain digital rights management (DRM) technology "to any other party besides digEcor" and "from engaging in any competition with digEcor until after 2009." digEcor is also seeking "actual damages" of $793,750 and "consequential damages...not less than an additional $1,000,000." The Company believes this action is related to the purchase order placed in the normal course of business on November 11, 2005 for 1,250 digEplayers(TM) with contract manufacturer, Maycom Co., Ltd. ("Maycom"). Maycom was paid progress payments with final payments made in full for the order by the Company, and directly by digEcor, in March 2006. Maycom has failed to timely deliver the order resulting in this complaint.
The Company is unable to determine at this time the impact this complaint and matter may have on its financial position or results of operations if Maycom does not timely fulfill its obligation and the Company is unable to deliver product to digEcor in a timely manner. The Company has not recognized any revenue or costs related to products associated with this order. The Company intends to seek restitution from Maycom for any damages it may incur from this matter and the digEcor complaint though recovery is not assured. At March 31, 2006 the Company recorded an impairment charge of $603,750 to expense as cost of revenues the value of deposits made to Maycom that have become impaired as a result of Maycom's nonperformance.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors e.Digital Corporation San Diego, CA
Our audits of the consolidated financial statements referred to in our report dated June 28, 2006 (included elsewhere in this Annual Report on Form 10-K) also included the financial statement schedules of e.Digital Corporation (the "Company"), listed in Item 15(a) of this Form 10-K. These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits of the consolidated financial statements.
In our opinion, the financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Our report covering the basic financial statements indicates that there is substantial doubt as to the Company's ability to continue as a going concern, the outcome of which cannot presently be determined and that the financial statements do not include any adjustments, that might result from the outcome of this uncertainty.
/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN, LLP
Santa Ana, CA June 28, 2006
e.Digital Corporation Schedule II - Valuation and Qualifying Accounts
ALLOWANCE FOR DOUBTFUL ACCOUNTS
RESERVE FOR OBSOLESCENCE
WARRANTY RESERVE