10-K 1 v187751_10k.htm Unassociated Document
 
  
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K

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

For the fiscal year ended March 31, 2010
Commission file number 0-20734

 
e.Digital Corporation
 (Exact name of registrant as specified in its charter)

Delaware
33-0591385
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
16770 West Bernardo Drive
San Diego, California 92127
(Address of principal executive offices) (Zip Code)

(858) 304-3016
(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:    None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company .  Seethe definitions of accelerated filer, large accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer ¨  Accelerated filer ¨  Non-accelerated filer   ¨   Smaller reporting company x

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

The aggregate market value of the issuer’s Common Stock held by non-affiliates of the registrant on September 30, 2009 was approximately $41,709,000 based on the closing price as reported on the NASD’s OTC Electronic Bulletin Board system.

As of June 1, 2010 there were 286,950,900shares of e.Digital Corporation Common Stock, par value $.001, outstanding.
 

 
TABLE OF CONTENTS
   
Page
PART I
     
ITEM 1.
Business
  3
ITEM 1A.
Risk Factors
 10
ITEM 1B.
Unresolved Staff Comments
 16
ITEM 2.
Properties
 16
ITEM 3.
Legal Proceedings
 17
ITEM 4.
Submission of Matters to a Vote of Security Holders
 17
     
PART II
     
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and
 
 
Issuer Purchases of Equity Securities
 17
ITEM 6.
Selected Consolidated Financial Data
 18
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 18
ITEM 7A.
Quantitative and Qualitative Disclosures about Market Risk
 27
ITEM 8.
Financial Statements and Supplementary Data
 27
ITEM 9.
Changes In and Disagreement With Accountants on Accounting and Financial Disclosure
 27
ITEM 9A(T).
Controls and Procedures
 27
ITEM 9B.
Other Information
 28
PART III
     
ITEM 10.
Directors, Executive Officers and Corporate Governance
 29
ITEM 11.
Executive Compensation
 30
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related
 
 
Stockholder Matters
 32
ITEM 13.
Certain Relationships and Related Transactions and Director Independence
 34
ITEM 14.
Principal Accounting Fees and Services
 34
     
PART IV
     
ITEM 15.
Exhibits, Financial Statement Schedules
 35
     
 
Signatures
 39
     
 
Financial Statements
F-1

FORWARD-LOOKING STATEMENTS

IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND THE COMPANY DESIRES TO TAKE ADVANTAGE OF THE “SAFE HARBOR” PROVISIONS THEREOF. THEREFORE, THE COMPANY IS INCLUDING THIS STATEMENT FOR THE EXPRESS PURPOSE OF AVAILING ITSELF OF THE PROTECTIONS OF SUCH SAFE HARBOR WITH RESPECT TO ALL OF SUCH FORWARD-LOOKING STATEMENTS. THE FORWARD-LOOKING STATEMENTS IN THIS REPORT REFLECT THE COMPANY’S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED 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 RISK FACTORS DESCRIBED BELOW AND NOT TO PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, WHICH SPEAK ONLY AS OF THE DATE HEREOF. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE HEREOF.
 

 
PART I
ITEM 1. BUSINESS

Overview
e.Digital Corporation (the “Company) is a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. We market our eVU® mobile entertainment system for the travel and recreational industries and licenseand enforce our Flash-R™ portfolio of flash memory patents for use in portable devices produced by electronic product manufacturers.

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

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

We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against targeted partiesthat we believeare infringing our patents. The international law firm of Duane Morris LLP is handling our patent enforcement matters on a contingent fee basis. During the period commencing September 2007 through March 2008, we filed complaints against eight electronic product manufacturers and subsequently licensed and settled the litigation with seven of the manufacturers and suspended the complaint against one defendant that filed for bankruptcy. In November 2009 we filed an additional patent infringement complaint against nineteen companies and we have subsequently licensed and settled with three companies. While we expect to file future complaints against additional companies and license additional companies there can be no assurance of the timing or amounts of any related license revenue.

Our Company, then known as Norris Communications, was incorporated in the Province of British Columbia, Canada on February 11, 1988 and on November 22, 1994 changed its domicile to the Yukon Territory, Canada. On August 30, 1996, we filed articles of continuance to change our jurisdiction to the State of Wyoming, then on September 4, 1996, reincorporated in the State of Delaware. On January 13, 1999, the stockholders approved a name change to e.Digital Corporation. Our principal executive offices and primary operating facilities are located at 16770 West Bernardo Drive, 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.

Background on Technical Innovations
We have a record of pioneering technical innovations and achievements in developing portable electronic products including products developed under contract for major OEM (original equipment manufacturer) customers. These innovations and achievements include:

 
·
1990 – Released the first commercial ear telephone with an earpiece that located both the speaker and the microphone in the ear without feedback. (This was the first product in what ultimately became today’s line of Jabra hands-free communication products.)

 
·
1993 – Developed the first portable digital player/recorder with removable flash memory. Resulted in five U.S. patents on the use of flash memory in portable devices.

 
·
1996 – Developed the first high-speed download device to store digital voice recordings on a personal computer in compressed format.

 
·
1998 – Developed the first multi-codec (including MP3) portable digital music player.

 
·
1999 – Delivered an integrated digital voice recorder and computer docking station system for medical transcription of voice and data for Lanier Healthcare, LLC.

 
·
2002 – Developed the first voice controlled MP3 player using our VoiceNav speech navigation system.
 
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·
2002 – Bang & Olufsen introduced a branded digital audio player (BeoSound 2) developed by us pursuant to a license agreement.

 
·
2003 – Designed, developed and delivered wireless MP3 headsets employing our MicroOS™ operating system to Hewlett-Packard for use at Disneyworld in Orlando, Florida.

 
·
2003 – Licensed our digital audio platform to a multi-billion dollar Asian OEM for branding to Gateway Computers.

 
·
2003 – Developed the first hard drive-based Hollywood studio-approved portable inflight entertainment (“IFE”) device.

 
·
2006 – Introduced eVU, a next generation dedicated mobile entertainment device with 12+ hours of playback, wireless capability and proprietary content encryption approved by major studios.

 
·
2007 – Introduced eVU-ER, an improved dedicated portable IFE player featuring a new power management technology providing an industry-leading 20+ hours of continuous video playback from a single battery. eVU is available in either a 7" or 8" high resolution LCD screen with 160 GB to 200 GB of rugged and reliable storage.

 
·
2009 –Added new features to eVU including an advanced touch screen interface.

These technical achievements and our base of technology allow us to rapidly develop or customize electronic products for our own account or for others.

eVU Mobile Entertainment System
Our eVU is a portable audio/video player designed to securely play encrypted content for the travel, leisure, healthcare and other markets. The primary use of eVU is in the inflight entertainment (IFE) market. We are a leading producer of dedicated portable IFE products delivering over 13,000 units since 2003 for airline use. Our eVU model features sharp images on a 7” or 8” high resolution LCD screen, a 160 GB (Gigabytes) to 200 GB of rugged and reliable storage, high audio fidelity, dual stereo headphone jacks, optional embedded credit card reader/processor, optional touch screen capabilities, a full feature graphical user interface, patent-pending hardware security technology, and 20 hours of high resolution video playback on a single battery charge. We also have the capability to add features and customize the product for target markets or select customers.

We market and sell our eVU portable mobile entertainment device to corporate customers directly and through VARs. Generally each batch sale includes logo customization on the device (for example an airline logo) and an initial content integration with a customized graphical user interface (“GUI”) (for example the airline logo appearing on startup, then a listing of content for selection by the end user). While marketing and sales of eVUs is currently targeted primarily to the airline industry, we believe it has applications in the healthcare, military, and other travel and leisure markets.

We have developed and sell accessory products to our customers and VARs allowing them to operate a mobile entertainment business. These accessories include e.Digital Battery Charging Stations to charge and recondition batteries and e.Digital Content Loading Stations to upload graphical interfaces and content to multiple players at one time. Customers also may order spare batteries depending on their requirements.

We also earn revenues from the provision of content integration, GUI customization, warranty and technical support and related services to our customers and VARs. We also offer extended maintenance and refurbishment services for customers. We periodically integrate customer content with our proprietary GUI software to produce a master content file (containing content and the customized GUI interface) for rapid uploading to multiple players. Our GUI allows ease of use and can accommodate multiple languages. Our tested and Hollywood studio approved encryption methods protect content from being pirated. These services allow protected content on eVU players to be periodically updated through e.Digital Content Loading Stations by our customers or VARs or others on their behalf.
 
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Technology
Our eVU products are based on our DVAP (Digital Video/Audio Platform) technology. Our DVAP technology accommodates various third party video compression encoded material, proprietary security measures and allows for many other customizable options. Key elements include:

MicroOS
Our proprietary MicroOS operating system serves as the software foundation for our DVAP Platform. 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, efficient and dynamic, responding to a variety of user interfaces. MicroOS managesthe user interface functions, battery and power control, the volume and equalizer functions, the LCD drivers and interfaces, decodesprocesses 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 efficiently manages multiple functions within a single device, utilizing less power, space and operating capacity than many alternative solutions.

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 was employed in our prior MP3 player products and in our current eVU products. Our latest eVU product incorporates an implementation of this family of technology and has been tested and approved by major Hollywood movie studios. We currently have a U.S. patent pending on our data security technology.

Flash-R Patent Portfolio Licensing and Enforcement
We believe we have an important portfolio of patents (Flash-R patent portfolio) related to the use of flash memory in portable devices and we are actively engaged in a strategy to monetize our patent portfolio through licensing and enforcement. In June 2006 we engaged an intellectual property consultant to investigate, document and develop the portfolio and to liaison with outside legal counsel. We, and our advisors, have performed due diligence on our patents and we believe we have strong intellectual property rights that can be licensed. Under U.S. law, an inventor or patent owner has the right to exclude others from making, selling or using their patented invention. Unfortunately, in the majority of cases, infringers are generally unwilling, at least initially, to negotiate or pay reasonable royalties for their unauthorized use of third-party patents and will typically fight any allegations of patent infringement. Inventors and/or patent holders without sufficient financial or expert technical resources to bring legal action may lack credibility in dealing with unwilling licensees and as a result, are often ignored.

As a result of the common reluctance of patent infringers to negotiate and ultimately take a patent license for the use of third-party patented technologies without at least the threat of legal action, patent licensing and enforcement often begins with the filing of patent enforcement litigation. However, the majority of patent infringement contentions settle out of court, based on the strength of the patent claims, validity, and persuasive evidence and clarity that the patent is being infringed. In March 2007 we selected and engaged the international law firm Duane Morris LLP to handle certain patent enforcement matters on a contingent fee basis. In October 2007 we announced that our Company had commenced enforcement action with respect to our patent portfolio. During the period from September 2008 through March 31, 2010 we licensed our patent portfolio to ten licensees. We anticipate bringing additional patent enforcement actions in the current fiscal year.

We execute patent licensing arrangements with users of our patented technologies through willing licensing negotiations and through the negotiation of license and settlement arrangements in connection with the filing of patent infringement litigation. We also discuss licenses without the filing of patent infringement litigation and may enter into some future licenses with licensees without the filing of a specific patent infringement action against such licensee.

Some license agreements include nonexclusive cross licenses and our policy is to value these only if directly used in operations. To date we have not valued any cross licenses received as they were considered part of the licensee’s overall license and settlement strategy and are not currently used in our products.

Our Flash-R patent portfolio covers certain aspects of the use of flash memory, addressing today's large and growing portable electronic products market. In 1993, we unveiled and began marketing the first digital voice recorder with removable flash memory, powered by MicroOS. In 1996, we produced and began marketing the first digital voice recorder interface for downloading and managing voice recordings on the personal computer. The Flash-R portfolio is protected through the years 2014 – 2016 and includes the following U.S. patents:
 
5

 
 
§
US5491774: Handheld record and playback device with flash memory
 
§
US5742737: Method for recording voice messages on flash memory in a hand held recorder
 
§
US5787445: Operating system including improved file management for use in devices utilizing flash memory as main memory
 
§
US5839108: Flash memory file system in a handheld record and playback device
 
§
US5842170: Method for editing in hand held recorder

Although most fees, costs and expenses of the litigation are covered under our contingent fee arrangement with Duane Morris, we incur support and related expenses for this litigation. In addition to support from our management team, we currently have one outside consultant assigned to assist, monitor and support Duane Morris in our intellectual property litigation and licensing activities.

Markets and Customers for Our Products and Patent Portfolio

Mobile Entertainment
Our focus is on our closed secure system offering high content protection in multiple use environments. We also see future opportunities to develop devices to meet the emerging need for digital downloads and portability.

Digital video players and related content are increasing in popularity with consumers especially with the emerging and growing use of digital downloads and portability championed by increasingly sophisticated portable consumer devices. While there may be future opportunities to develop portable consumer devices, our focus is on our closed secure system offering high content protection in multiple use environments such as IFE. We believe the consumer device markets are extremely competitive and subject to rapid technology changes making participation expensive and subject to significant risk. We believe there are applications for closed systems such as our eVU in broad aspects of the travel and leisure, medical, educational, government and military markets and that these are growing markets.

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 a published industry 2007 survey, airlines worldwide spent approximately $1.45 billion on IFE hardware.

Because the costs to retrofit an aircraft with IFE equipment can be prohibitive, we developed our alternative IFE system. Our portable IFE player is smaller than a typical laptop computer and has a high-quality color screen, stereo headphones and long battery life unattainable by computer based devices. Although passengers may rent or purchase portable DVD players from outside entities or bring their own portable device onboard, we created the first hard drive based portable video player that can be rentedto passengers by the airline. We believe this type of system is attractive to airlines and other travel-related entities because of its revenue potential, variety of content, long battery life, content security and inexpensive implementation.

According to individual airline reports accumulated in April 2010, the top 10 worldwide passenger airlineshadabout 4,700 aircraft many that we believe are not equipped with IFE systems. There are approximately 1,500 airlines worldwide representing a substantial market for portable IFE devices. Some of our eVU customers include Lufthansa, Air France, Malaysia Airlines, Alitalia, as well as small short-haul low cost carriers seeking to provide entertainment to their customers.

According to the American Hospital Directory there are over 6,000 hospitals and many outpatient and other medical facilities in the U.S. that provide a market opportunity for a portable secure device.We believe the travel and leisure market also provides a significant market opportunity. This includes over 120 cruise ships operating internationally and over 40,000 hotels with under 150 rooms with many that do not offer in-room movies. Rail, bus, ferries and other modes of transportation also represent markets for eVU.We also believe there may be a market for eVU devices in the military on aircraft carriers and in other settings where personnel have down time and seek entertainment from a robust device with wide content variety without DVDs or tape.

Flash-R Portfolio Licensing
We use the services of an intellectual property consultant to assist us in investigating and evaluating prospective licensees of our Flash-R patent portfolio and documenting possible current and past infringement. Our initial focus is on manufacturers of portable devices employing removable flash memory although we do not believe our portfolio is limited to this market segment. While we have identified a large number of products and companies that we believe are using our patented technology, this is an ongoing process as new products and companies are identified from our research. To date we have filed patent infringement litigation and sought licenses from 26 companies with 10 agreeing to license terms during the discovery stage of related litigation.We believe we are building a track record of demonstrating the strength, validity and clarity of our patent claims and that we can build a growing licensing business from our patent portfolio. The timing of future litigation or licensing is subject to many factors some not within our control.
 
6

 
Our Business Strategy
We are leveraging and building on a leadership position in the portable IFE market to market our eVU device to airlines and expand eVU distribution to the healthcare, military, and other travel and leisure markets. Our objective is to have our products play a significant role in the IFE and other related markets. We intend to expand our business by obtaining new IFE airline customers and customers in the healthcare, military, and other travel and leisure industries. We intend to use both direct and VAR sales domestically and internationally to grow our business.

We intend to continue to monetize our portfolio of patents related to the use of flash memory in portable devices. We expect to bring additional patent enforcement actions in the current fiscal year. We consult with advisors and legal counsel regarding our litigation and licensing strategy including decisions on the timing of various actions, target companies, jurisdiction of litigation, and other matters. There can be no assurance we can generate additional future revenues from this activity.

Manufacturing
We have developed a turnkey domestic manufacturing relationship with a qualified contract electronic manufacturer for our eVU product and additional relationships for important eVU accessories. We believe we can continue to deliver product timely to future customers. We expect a majority of any fiscal 2011 (year ending March 31, 2011) eVU purchases to be manufactured by this contract manufacturer. The loss of our manufacturers or the disruption in supply from manufacturers or in the supply of components by suppliers could have a material adverse effect on our financial condition, results of operations and cash flows.

In fiscal 2010 (year ended March 31, 2010) we purchased primary components from various suppliers with three suppliersaccounting for 44% of total purchases for the fiscal year (2009 one supplier accounted for 76% of total purchases). Our manufacturers purchase major electronic components from a limited number of suppliers.

Marketing, Sales and Distribution
Marketing and sales are performed primarily by our President and Chief Executive Officer, outside sales representatives, and various technical personnel who are involved in the sales process. Our initial focus has been on international and regional airlines directly and through a VAR.

A VAR offers the ability to provide entertainment (movie, television, music, informational, and/or educational content), supply, content refreshment and logistic services (recharging and maintenance) and related services for customers not able or willing to provide such services. In May 2006 we entered into a VAR agreement with London-based Mezzo Movies Ltd. providing them exclusive rights to certain customers in the low-cost short-haul airline market primarily in Europe. Although the agreement and associated exclusive rights have expired, we are continuing to provide products and services to Mezzo as a VAR customer.

We seek to add additional VARs, agents or joint venture partners in the airline and in our other target markets to expand our distribution. For some customers we may be required to add new support service capacity such as typically provided by our larger customers or VARs.

We market our product and 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. We employ marketing materials to supplement custom marketing presentations to key prospects. We also employ limited and selected advertising in targeted industry publications.

We rely on a combination of management, our intellectual property consultant and legal counsel in approaching licensees regarding our Flash-R portfolio and in identifying new target licensees. We have been and may in the future be approached by companies seeking licenses as awareness of our patent portfolio becomes better known throughout the electronic industry.
 
7

 
Customer Concentration and Backlog
Revenues from two licensees each accounted for more than 10% of revenues for the year ended March 31, 2010 (2009 – five licenses each accounted for more than 10% of revenues). These licensees paid a one-time fee and accordingly do not provide ongoing or future revenues. Historically, our product revenues have relied on a few major customers. There is no assurance we will obtain any revenues from existing customers in fiscal 2011. We are seeking to expand our eVU customer base and reduce reliance on a few customers in future periods. We also seek to license new targeted companies that we believe infringe our patent portfolio.

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, 2010 was $265,000 and at March 31, 2009 was $164,000. Our order backlog does not necessarily indicate future sales trends. Backlog orders are subject to modification, cancellation or rescheduling by our customers. Future shipments may also be delayed due to production delays, component shortages and other production and delivery related issues.

Research and Development Costs
For the years ended March 31, 2010 and 2009, we spent $482,866and $518,649, respectively, on research and development. We anticipate that we will continue to devote substantial resources to research and development activities.

Intellectual Property
We have five issued U.S. patents covering our MicroOS file management software and certain technology related to the use of flash memory in portable digital devices. 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 has been used in our products and has 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 pursuing trademark applications with the U.S. Patent and Trademark Office and also have filed certain U.S. 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 also filefor trade name and trademark protection when appropriate. We are the owner of U.S. federally registered trademarks including e.Digital®, eVU®, VoiceNav®, Music Explorer®, Odyssey®,Smart Solutions for a Digital World®, as registered trade names.We intend to make every reasonable effort to protect our proprietary rights to make it difficult for competitors to market equivalent competing products without being required to conduct the same lengthy testing and development conducted by us and not to use any of our innovative and novel solutions to overcome the many technical obstacles involved in developing portable devices using flash memory and other portable storage formats.

Competition
Many large manufacturers currently market various forms of component or handheld digital video players, including Apple, Panasonic, Sony, Samsung, Hitachi, RCA, Audiovox, Philips, Daewoo, General Electric, Toshiba and many others. Other manufacturers may announce products in the future.
 
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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 or rental outfits and custom portable IFE hardware specifically targeted for airline use. We compete with digEcor, a former customer that offers a competing product; The IMS Company, with their Fujitsu-based PEA (personal entertainment appliance) product; Panasonic Avionics portable IFE product; and products supplied by French consumer electronics manufacturer, Archos. European producers AIRVOD Entertainment Systems and Bluebox Avionics advertise portable IFE products that may become competitive to eVU. Other electronic companies have or have announced products and may become more active in the portable IFE market. The airline industry may also continue to opt for embedded IFE systems offered by Panasonic, Thales and others. 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 a portable 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.

While we do not compete with others on licensing or specific patents, we compete generally for the attention and for funds from prospective licensees many of which are approached frequently regarding licenses and/or are sued for patent infringement both with and without merit. Regardless of the merits of any infringement claim many companies find it more economical, especially in the early stage of litigation, to defend the litigation rather than license. As our current litigation proceeds, assuming we have success in establishing the merits of our claims, we believe our competitive position regarding the attention and funds from prospective licensees will improve. However long-term licensing success may be dependent upon prevailing in the current litigation or new litigation to judgment and possible appeal. Technological advances could also render the use of our patented methods obsolete prior to expiration of the term of our patents thus reducing amounts of future infringement. There can be no assurance that we will generate any new licensing or settlement revenue in the future.

We believe our existing know-how, contracts, patents, copyrights, trade secrets and potential future patents and copyrights, will be significant in enabling us to compete successfully in the field of portable digital entertainment products and systems and our licensing activities.

Seasonality
Our current business is not seasonal.

Employees
As of June 1, 2010, we employed approximately twelve full-time employees and one part-time employee of whom twowere in production and testing, seven were in research, development and engineering, four were in sales, general and administrative. None of our employees are represented by a labor union, and we are not aware of any current efforts to unionize the employees. Management considers the relationship between the Company and its employees to be good.

We also engage consultants or lease engineering personnel on a temporary basis from time to time and use other outside consultants for various services.

Environmental Compliance and Government Regulation
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.

Portable electronic devices must comply with various regulations related to electronics and radiated emissions. Devices for operation on aircraft must comply with additional emission regulations. RTCA, Inc., a global organization comprised of industry and government representatives, develops standards to assure the safety and reliability of all Airborne Electronics (Avionics). Manufacturers of aircraft electronic equipment selling their products in the United States, Europe, and around the globe must meet RTCA requirements, including RTCA/DO-160D. Our eVU is DO-160D-certified for conducted and radiated emissions. DO-160D is the standard procedures and environmental test criteria for testing airborne equipment for the entire spectrum of aircraft from light general aviation aircraft and helicopters through large commercial jets. eVU is also U.S. FCC and European CE compliant.
 
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In Europe, we are subject to the European Union’s (“EU”) Directive on the Restriction of Use of Certain Hazardous Substances in Electrical and Electronics Equipment (“RoHS”). This directive restricts the placement into the EU market of electrical and electronic equipment containing certain hazardous materials, including lead, mercury, cadmium and chromium. We are also subject to the EU’s Waste Electrical and Electronic Equipment Directive (“WEEE”), which regulates the collective, recovery and recycling of waste from certain electronic products.

Available Information
We file with the Securities and Exchange Commission (“SEC”) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, proxy statements and registration statements. The public may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may also obtain information from the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding issuers, including us, that file electronically.

Our Internet website address is http://www.edigital.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (“the Exchange Act”) are available free of charge through our Company’s website as soon as reasonably practical after those reports are electronically filed with, or furnished to, the SEC. In addition, copies of the written charters for the committees of our board of directors, our Code of Conduct, Corporate Governance, Communication and Whistleblower policies are also available on this website under the About Us and Management links. We will provide any person, without charge, a copy of our charters, codes and/or policies upon written request to Investor Relations, e.Digital Corporation, 16770 West Bernardo Drive, San Diego, California 92127. We may post amendments or waivers of our charters, codes, or policies, if any, on our website. This website address is intended to be an inactive textual reference only, and none of the information contained on our website is part of this report or is incorporated in this report by reference.

ITEM 1A. 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. Except for a profit in fiscal 2009, historically we have incurred significant losses and negative cash flow from operations and we have an accumulated deficit of $80.0 million at March 31, 2010. Our profitability in fiscal 2009 resulted from one-time patent licensing revenues and there is no assurance of future licensing revenues from new licensees. Accordingly, we could continue to incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability. Failure to achieve or maintain profitability will likely negatively impact the value of our securities. Our ability to continue as a going concern is in doubt and is dependent upon achieving a profitable level of operations and if necessary obtaining additional financing.
 
10

 
Disruptions in Financial Markets Could Continue to Adversely Affect our Business - As has been widely reported, financial markets in the United States, Europe and Asia have experienced extreme disruption in the past two years, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. Governments have taken unprecedented actions intended to address extreme market conditions that include severely restricted credit and declines in real estate and other asset values. While we believe these conditions have adversely impacted our customers and our business, it has not impaired our ability to operate our business. There can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies, which can then lead to challenges in the operation of our business. These economic developments affect businesses such as ours in a number of ways. The tightening of credit in financial markets adversely affects the ability of airline customers to finance purchases and operations and could result in a decrease in orders and spending for our products as well as create supplier disruptions. Economic and political developments have reduced travel and recreational spending and we believe adversely affected demand by airlines and others for our products and services. Financial difficulties of electronics manufacturers could also delay or reduce the likelihood of future patent licenses. We are unable to predict the likely duration and severity of the current disruption in financial markets and adverse economic conditions and the effects they will have on our business and financial condition.

We Expect Our Operating Results to Fluctuate Significantly- Our quarterly and annual operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation is a result of a variety of factors, including the following:

 
·
Unpredictable demand and required pricing to secure customers for our products andservices
 
·
Uncertainty regarding the timing and amount of any future patent licensing revenues
 
·
Market acceptance of our products by our customers and their end users
 
·
Uncertainties with respect to future customer product orders, their timing and the margins to be received, if any
 
·
Fluctuations in product costs and operating costs
 
·
Changes in research and development costs
 
·
Changes in general economic conditions
 
·
Risks and costs of warranty claims
 
·
Changes in technology
 
·
Short product lifecycles and possible obsolescence of inventory and materials

We do not Anticipate Paying Dividends. We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain any future earnings to fund the development and growth of our business. An investment in our common stock, therefore, may be more suitable for an investor that is seeking capital appreciation rather than current yield and, as a consequence, may be more speculative. Accordingly, investors should not purchase our common stock with an expectation of receiving regular dividends.

Risks Related to Product 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 that 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 our 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 product revenues has been derived primarily from a limited number of customers. The failure to receive orders for and produce products or a further decline in the economic prospects of the airline industry or our customers or the products we may produce for sale may have a material adverse effect on our operations. The airline industry is continuing to face a variety of economic challenges that may adversely affect the prospects for new orders of portable IFE systems and adversely affecting future operating results.

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 on our 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.
 
11

 
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 OneContract Manufacturer and a Limited Number of Suppliers and Our Business Will Be Harmed By Any Interruption of Supply or Failure of Performance. We rely on one contract manufacturer for our eVU product. We depend on our contract manufacturer to (i) allocate sufficient capacity to our manufacturing needs, (ii) produce acceptable quality products at agreed pricing and (iii) deliver on a timely basis. We also rely on limited number of suppliers for eVU accessory products. If a manufacturer is unable to satisfy our requirements, our business, financial condition and operating results may be materially and adversely affected. Any failure in performance by our manufacturers 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.

If We Lose Key Personnel or Are Unable to Attract and Retain Additional Highly Skilled Personnel Required For the Expansion of Our Activities Our Business Will Suffer. Our future success depends to a significant extent on the continued service of our key technical, sales and senior management personnel and their ability to execute our strategy. The loss of the services of any of our senior level management, or certain other key employees or our intellectual property consultant may harm our business. Our future success also depends on our ability to attract, retain and motivate highly skilled employees and consultants. Competition for employees in our industry is intense. We may be unable to retain our key employees or to attract, assimilate and retain other highly qualified employees in the future. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications.

Because Some of Our Management are Part-Time and Have Certain Conflicts of Interest, Our Business Could Be Harmed. Our Senior Vice President, Robert Putnam, also performs investor relations for LRAD Corporation. As a result of his involvement with LRAD 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 LRAD Corporation could overlap or conflict.

Risks Related to our Patent Licensing and Enforcement Strategy

We Face Uncertain Revenue Prospects from our Patent Enforcement Strategy.We have only recently recognized revenue from entering into licenses for our portfolio of flash memory patents and technologies. Our portfolio has not been tested in court and there is no assurance we can prevail in any current or future patent litigation. The licensing demand for our patent portfolio is subject to fluctuation based upon the rate at which target infringers agree to pay royalties or settle future enforcement actions, if any. There can be no assurance of future revenues from our strategy of enforcing our flash memory patent portfolio.Due to the nature of our licensing business and uncertainties regarding the amount and timing of the receipt of future license fees, if any, frompotential infringers, stemming primarily from uncertainties regarding the outcome of enforcement actions, rates of adoption of ourpatented technologies, the growth rates of our prospective licensees and other factors, our revenues may vary significantly in the future, which could make our business difficult to manage, adversely affect our business and operating results, causeour quarterly and annual results to be below market expectations and adversely affect the market price of our common stock.
 
12

 
Our Fee Arrangement with Patent Enforcement Counsel Subjects Us to Certain Risks and Substantial Costs and Fees Could Limit Our Net Proceeds From Any Successful Patent Enforcement Actions.Our agreement for legal services and a contingent fee arrangement with Duane Morris LLP provides that Duane Morris is our exclusive legal counsel in connection with the assertion of our flash memory related patents against infringers (“Patent Enforcement Matters’). Duane Morris is advancing certain costs and expenses including travel expenses, court costs and expert fees. We have agreed to pay Duane Morris a fee equal to 40% of any license or litigation recovery related to Patent Enforcement Matters, after recovery of expenses, and 50% of recovery if appeal is necessary. We are not in control of the timing, costs and fees, which could be substantial and could limit our share of proceeds, if any, from future patent enforcement actions. There can be no assurance Duane Morris will diligently and timely pursue patent enforcement actions on our behalf. In the event we are acquired or sold or we elect to sell the covered patents or upon certain other corporate events or in the event we terminate the agreement with Duane Morris for any reason, then Duane Morris shall be entitled to collect accrued costs and a fee equal to three times overall time and expenses and a fee of 15% of a good faith estimate of the overall value of the covered patents. We have provided Duane Morris a lien and a security interest in the covered patents to secure this obligation. Should any of the aforementioned events occur, the fees and costs owed to Duane Morris could be substantial and limit our revenues.

New Legislation, Regulations or Rules Related to Enforcing Patents Could Significantly Decrease Our Prospect for Revenue and Increase the Time and Costs Associated with Patent Enforcement. If new legislation, regulations or rules are implemented either by Congress, the United States Patent and Trademark Office, or the courts that impact the patent application process, the patent enforcement process or the rights of patent holders, these changes could negatively affect our revenue prospects and increase the costs of enforcement. For example, new rules regarding the burden of proof in patent enforcement actions could significantly increase the cost of our enforcement actions, and any new standards or limitations on liability for patent infringement could negatively impact revenue derived from such enforcement actions. While we are not aware that any such changes are likely to occur in the foreseeable future that impact our current patents, we cannot assure that such changes will not occur.

Should Litigation Be Required to Enforce Our Patents, Trial Judges and Juries Often Find It Difficult to Understand Complex Patent Enforcement Litigation, and as a Result, We May Need to Appeal Adverse Decisions By Lower Courts In Order to Successfully Enforce Our Patents. It is difficult to predict the outcome of patent enforcement litigation at the trial level. It is often difficult for juries and trial judges to understand complex, patented technologies, and as a result, there is a higher rate of successful appeals in patent enforcement litigation than more standard business litigation. Such appeals are expensive and time consuming, resulting in increased costs and delayed revenue. Although we intend to diligently pursue enforcement litigation if necessary to monetize our patents, we cannot predict with significant reliability the decisions made by juries and trial courts.

Federal Courts are Becoming More Crowded, and as a Result, Patent Enforcement Litigation is Taking Longer. Any patent enforcement actions we may be required to take to monetize our patents will most likely be prosecuted in federal court. Federal trial courts that hear patent enforcement actions also hear other cases that may take priority over any actions we may take. As a result, it is difficult to predict the length of time it will take to complete any enforcement actions.

As Patent Enforcement Litigation Becomes More Prevalent, It May Become More Difficult for Us to Voluntarily License Our Patents. We believe that the more prevalent patent enforcement actions become, the more difficult it will be for us to voluntarily license our patents to major electronic firms. As a result, we may need to increase the number of our patent enforcement actions to cause infringing companies to license our patents or pay damages for lost royalties. This may increase the risks associated with an investment in our Company.

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.
 
13

 
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. We are also subject to regulations for portable electronic devices in various countries and for the emissions of such devices in aircraft. Failure to comply with these many regulations could harm our business or require us to repurchase products from customers.

Compliance With Current And Future Environmental Regulations May Be Costly, Which Could Impact Our Future Earnings. We are subject to environmental and other regulations due to our production and marketing of products in certain states and countries. We also face increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the materials composition of our products, including the restrictions on lead and certain other substances in electronics that apply to specified electronics products put on the market in the European Union as of July 1, 2006 (Restriction of Hazardous Substances in Electrical and Electronic Equipment Directive (EU RoHS)). The European Union has also finalized the Waste Electrical and Electronic Equipment Directive (WEEE), which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. Other countries, such as the United States, China and Japan, have enacted or may enact laws or regulations similar to the EU RoHS or WEEE Legislation. These and other environmental regulations may require us to reengineer certain of our existing products to comply with environmental regulations.

We May Incur Liability from Our Requirement to Indemnify Certain Customers Regarding Litigation and Certain Intellectual Property Matters. Our contracts with major airlines are subject to future performance by us and product warranties and intellectual property indemnifications including certain remedies, ranging from modification to product substitution or refund. Should our products be deemed to infringe on the intellectual property of others the costs of modification, substitution or refund could be material and could harm our business and adversely impact our operations.

Our Internal Control Over Financial Reporting Is Not Adequate and May Result In Financial Statements That AreIncomplete or Subject To Restatement. Section 404 of the Sarbanes Oxley Act of 2002 requires significant procedures and review processes of our system of internal controls. Section 404 requires that we evaluate and report on our system of internal control over financial reporting in connection with this Annual Report on Form 10-K. In addition, our independent registered public accounting firm will be required to report on our internal controls over financial reporting for the year ending March 31, 2011. The additional costs associated with this process may be significant.
 
14

 
After documenting and testing our system, we have identified a material weakness in our accounting and financialfunctions due to a lack of oversight by an independent audit committee. As a result, our internal control over financial reporting is not effective. As a result of our internal control over financial reporting being ineffective, investors could lose confidence in our financial reports, and our stock price might be adversely affected. In addition, remedying this or any future material weaknesses that we or our independent registered public accounting firm might identify, could require us to incur significant costs and expend significant time and management resources. We cannot assure you that any of the measures we might implement to remedy any such deficiencies would effectively mitigate or remedy such deficiencies.

Risks Related to Trading in Our Common Stock

Sales of Common Stock Issuable on the Exercise of Outstanding Convertible Preferred Stock, Warrantsand Options, May Depress the Price of Our Common Stock.As of March 31, 2010, we had preferred stock outstanding convertible into 5,983,700 shares of our common stock, outstanding warrants to purchase 7,500,000 shares of our common stock and outstanding options granted to our employees, directors and consultants to purchase 4,965,500 shares of our common stock. The exercise prices for the options and warrants range from $0.10 to $0.23per share. In the future we may issue additional convertible securities, options and warrants. The issuance of shares of common stock issuable upon the exercise of outstanding or future convertible securities, options or warrants could cause substantial dilution to holders of common stock, and the sale of those shares in the market could cause the market price of our common stock to decline. The potential dilution from these shares could negatively affect the terms on which we could obtain any future equity financing.

Investing in a Technology Stock (Such as Ours) May Involve Greater Risk Than Other Investments Due to Market Conditions, Stock Price Volatility and Other Factors. The trading price of our common stock has been subject to significant fluctuations to date, and will likely be subject to wide fluctuations in the future due to:

 
·
Quarter-to-quarter variations in operating results
 
·
Announcements of technological innovations by us, our customers or competitors
 
·
New products or significant design achievements by us or our competitors
 
·
General conditions in the markets for the our products or in the electronics industry
 
·
The price and availability of products and components
 
·
Changes in operating factors including delays of shipments, orders or cancellations
 
·
General financial market conditions
 
·
Market conditions for technology stocks
 
·
Litigation or changes in operating results or estimates by analysts or others
 
·
Or other events or factors

In addition, potential dilutive effects of future sales of shares of common stock by stockholders and by the Company and subsequent sale of common stock by the holders of warrants and options could have an adverse effect on the market price of our shares.

We do not endorse and accept any responsibility for the estimates or recommendations issued by stock research analysts or others from time to time or comments on any electronic chat boards. The public stock markets in general, and technology stocks in particular, have experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many high technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock in the future.

Low-Price Stocks and Stocks Traded on the OTC Electronic Bulletin Board are Subject to Special Regulations and may have Increased Risk.Our shares of common stock are traded on the OTC Electronic Bulletin Board, an electronic, screen-based trading system operated by the National Association of Securities Dealers, Inc. (“NASD”). Securities traded on the OTC Electronic Bulletin Board are, for the most part, thinly traded and are subject to special regulations not imposed on securities listed or traded on the NASDAQ system or on a national securities exchange. As a result, an investor may find it difficult to dispose of, or to obtain accurate quotations as to the price of, our common stock. Sales of substantial amounts of our outstanding common stock in the public market could materially adversely affect the market price of our common stock. To date, the price of our common stock has been extremely volatile with the sale price fluctuating from a low of $0.10 to a high of $0.225 in the last fiscal year. In addition, our common stock is subject to Rules 15g-1-15g-6 promulgated under the Exchange Act that imposes additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally, a person with assets in excess of $1,000,000 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 Securities and Exchange 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 Securities and Exchange 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.
 
15


Important Factors Related to Forward-Looking Statements and Associated Risks.  This prospectus contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and we intend that such forward-looking statements be subject to the safe harbors created thereby.  These forward-looking statements include our plans and objectives of management for future operations, including plans and objectives relating to the products and our future economic performance.  The forward-looking statements included herein are based upon current expectations that involve a number of risks and uncertainties.  These forward-looking statements are based upon assumptions that 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 both from product sales and licensing 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. UNRESOLVED STAFF COMMENTS
None

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 a current aggregate monthly payment of $6,344 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.

 
16

 

ITEM 3. LEGAL PROCEEDINGS

Business Litigation
On November 13, 2009 we entered into a settlement agreement ending certain litigation with digEcor, Inc. (digEcor) agreeing to waive any right to appeal prior Court’s rulings and orders in favor of the Company and the Company withdrawing its applications for costs of suit. The agreement also reduced and settled the judgment (related to batteries) to $60,000 from $80,000 that we had previously accrued resulting in $20,000 of other income. The agreement included standard mutual release of claims and covenants not to sue.

Intellectual Property Litigation
In September 2007 and March 2008, we filed complaints against eight electronic product manufacturers in the U.S. District Court for the Eastern District of Texas asserting that products made by the companies infringefour of our U.S. patents covering the use of flash memory technology. These patents are part of our Flash-R patent portfolio. By September 30, 2009 we had licensed and settled the litigationwith seven of the manufacturers and suspended the complaint against one defendant in bankruptcy.

In November 2009 we filed an additional patent infringement complaint in the United States DistrictCourt for the District of Colorado against nineteen companies that manufacture devices using flash memory. ByMarch 31, 2010 we had licensed and settled the litigation with three of the defendants.

Although most fees, costs and expenses of intellectual property litigation are covered under our arrangement with Duane Morris LLP as described above, we may incur support and related expenses forthis litigation that may become material.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information
Our common stock trades in the over-the-counter market on the 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.

   
Low
   
High
 
Fiscal year ended March 31, 2009
           
First quarter
  $ 0.08     $ 0.16  
Second quarter
  $ 0.08     $ 0.18  
Third quarter
  $ 0.08     $ 0.16  
Fourth quarter
  $ 0.10     $ 0.20  
                 
Fiscal year ended March 31, 2010
               
First quarter
  $ 0.10     $ 0.17  
Second quarter
  $ 0.10     $ 0.16  
Third quarter
  $ 0.15     $ 0.215  
Fourth quarter
  $ 0.124     $ 0.155  

Holders
At June 1, 2010 there were 286,950,900 shares of common stock outstanding and approximately 2,854 stockholders of record.
 
17

 
Dividends
We have never paid any dividends to our common stockholders. Future cash dividends or special payments of cash, stock or other distributions, if any, will be dependent upon our earnings, financial condition and other relevant factors.  The Board of Directors does not intend to pay or declare any dividends on our common stock in the foreseeable future, but instead intends to have the Company retain all earnings, if any, for use in the business.

Equity Compensation Plan Information
The following table sets forth information as of March 31, 2010, with respect to compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance, aggregated as follows:

Plan Category
 
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
(a)
   
Weighted-average exercise
       price of outstanding       
options, warrants and
rights
(b)
   
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
 
Equity compensation plans approved by security holders
    4,715,500     $ 0.14       4,910,000  
Equity compensation plans not approved by security holders (1)
    250,000     $ 0.16       -0-  
Total
    4,965,500     $ 0.15       4,910,000  

(1) consists of 250,000 shares of common stock granted to a consultant vesting on a performance basis with an exercise price of $0.16 per share.

Recent Sales of Unregistered Securities
Nounregistered securities were issued during the fiscal year that were not previously reported in a Quarterly Report on Form 10-Q or Current Report on Form 8-K.

Issuer Purchases of Equity Securities
Not applicable.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

Not applicable.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto and includes forward-looking statements with respect to the Company’s future financial performance.  Actual results may differ materially from those currently anticipated and from historical results depending upon a variety of factors, including those described elsewhere in this Annual Report and under the sub-heading, “Risk Factors - Important Factors Related to Forward-Looking Statements and Associated Risks.”

General
We are a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. We market our eVU mobile entertainment system for the travel and recreational industries and licenseand enforce our Flash-R portfolio of flash memory patents for use in portable devices produced by electronic product manufacturers.

 
18

 

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

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

We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against targeted parties that we believe are infringing our patents. The international law firm of Duane Morris LLP is handling our patent enforcement matters on a contingent fee basis. During the period commencing September 2007 through March 2008, we filed complaints against eight electronic product manufacturers and subsequently licensed and settled the litigation with seven of the manufacturers and suspended the complaint against one defendant that filed for bankruptcy. In November 2009 we filed an additional patent infringement complaint against nineteen companies and we have subsequently licensed and settled with three companies. While we expect to file future complaints against additional companies and license additional companies there can be no assurance of the timing or amounts of any related license revenue.

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

Overall Performance and Trends
We focused significant efforts on developing, licensing and enforcing our patent portfolio in the fiscal years ended March 31, 2010 and 2009. We successfully completed our first round of enforcement litigation in September 2009 when we licensed the last of the remaining original defendants. In November 2009 we filed additional enforcement actions against nineteen defendants, licensed our first customer from the second round in December 2009 and by March 31, 2010 had licensed a total of three licensees from the second round. There is a reluctance of patent infringers to negotiate and ultimately take a patent license without at least the threat of legal action. However, the majority of patent infringement contentions settle out of court, based on the strength of the patent claims, validity, and persuasive evidence and clarity that the patent is being infringed. We believe we are building a track record of demonstrating the strength, validity and clarity of our patent claims and that we can result in significant future revenues from our patent portfolio.

Our eVU IFE business remained slow during both fiscal 2010 and 2009 primarily due to airline economics. While we are seeing increased activity and an increased backlog at March 31, 2010 from recent orders, we are unable to predict future sales levels in this market as orders are sporadic from both existing and new customers. We continue to pursue business in the airline and other markets for our eVU product line.

While we reported a profit for the fiscal year ended March 31, 2009 (fiscal 2009), in prior years and in the year just completed (fiscal 2010) we have incurred losses and negative cash flow from operations. We expect to incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability. Our ability to continue as a going concern is in doubt and is dependent upon achieving a profitable level of operations and if necessary obtaining additional financing.

For the year ended March 31, 2010:

 
·
We recognized a net lossof $809,420 compared to net income of $2,933,986 for fiscal 2009. The difference in results was primarily attributable to lower license revenues due to the timing and amount of individual license agreements.

 
·
Our revenues were $2.6 million in fiscal 2010 compared to $11.1 million in fiscal 2009. During fiscal 2009 we licensed six companies out of our first round of litigation. We filed our second round of litigation in November 2009 and licensed one last company from the first round and three companies from the second round. As a result of the timing of such license agreements our licensing revenues in fiscal 2010 were $1.6 million compared to $10.1 million in fiscal 2009. eVU product and service revenues were $954,000 in fiscal 2010 compared to $940,000 in fiscal 2009.

 
19

 

 
·
Our gross profit for the year ended March 31, 2010 was $1.3 million or 51% of revenues compared to $6.5 million or 59% of revenues for the comparable prior year as a result of the reduced licensing revenue.

 
·
Operating expenses were $2.2 million for fiscal 2010 reduced from the $2.8 million infiscal 2009primarily as a result of reduced legal fees from the favorable conclusion of litigation with a former customer in November 2009.

Management faces challenges in fiscal 2011 to execute its plan to grow product and service revenues andincrease Flash-R patent portfolio license fees.The failure to obtain additional patent license revenues or eVU orders or delays of orders or production delays could have a material adverse impact on our operations. Our patent licensing business is subject to significant uncertainties as to the timing and amount of future license revenues, if any. We may also face unanticipated technical or manufacturing obstacles and face warranty and other risks in our business.

Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our estimates, including but not limited to those related to revenue recognition, bad debts, inventory valuation, intangible assets, financing operations, warranty obligations, stock-based compensation, fair values, derivatives, income taxes, contingencies and litigation.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

We believe that, of the significant accounting policies discussed in Note 2 to our consolidated financial statements, the following accounting policies require our most difficult, subjective or complex judgments:

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

We discuss below the critical accounting assumptions, judgments and estimates associated with these policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. For further information on our critical accounting policies, refer to Note 2 to the consolidated financial statements included herein.

Revenue Recognition
As described below, significant management judgments must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of revenue recognized or deferred for any period, if management made different judgments.

We recognize revenue in accordance with ASC Topic 605, Revenue Recognition. Revenue is recognized when (i) persuasive evidence of an arrangement exists, (ii) all obligations have been substantially performed pursuant to the terms of the license agreement, (iii) amounts are fixed or determinable and (iv) collectibility of amounts is reasonably assured.

We make estimates and judgments when determining whether the collectibility of product, service or license fees receivable from customers is reasonably assured. We assess the collectibility of our receivables based on a number of factors, including past transaction history and the credit-worthiness of customers. Management estimates regarding collectibility impact the actual revenues recognized each period and the timing of the recognition of revenues. Our assumptions and judgments regarding future collectibility could differ from actual events, thus materially impacting our financial position and results of operations.
 
20

 
Certain license agreements provide for the payment of contractually determined paid-up license fees in consideration for the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by our patented technologies. Generally, the execution of these license agreements also provide for the release of the licensee from certain past and future claims, and the dismissal of any pending litigation. Pursuant to the terms of these agreements, we have no further obligation with respect to the grant of the non-exclusive retroactive and future license and related releases, including no express or implied obligation to maintain or upgrade the technology, or provide future support or services. Generally, the agreements provide for the grant of the license and releases upon execution of the agreement. As such, the earnings process is generally complete upon the execution of the agreement, and as a result, revenue is recognized upon execution of the agreement, when collectibility is reasonably assured, and all other revenue recognition criteria have been met. While most licenses contain similar standard provisions, management must evaluate each agreement and make judgments to assure that substantial delivery of contract elements has occurred, whether any significant ongoing obligations exist subsequent to contract execution, whether amounts due are collectible and the appropriate period or periods, in which, or during which, respectively, the completion of the earning process occurs. Depending on the magnitude of specific license agreements, if different judgments, assumptions and estimates are made regarding contracts executed in any specific period, our periodic financial results may be materially affected.

In fiscal 2010 we entered into our first licenses providing for future royalties based on future licensee activities. Licensees that pay license fees on a periodic basis are required to report to us actual activity after the activity takes place. The amount of license fees due under these license agreements each period cannot be reasonably estimated by management. Consequently, we will recognize revenue from these licensing agreements on a lag basis as royalties are reported provided amounts are fixed or determinable and collectibility is reasonably assured. The lag method allows for the receipt of licensee royalty reports prior to the recognition of revenue.Differences between amounts recognized and amounts that could subsequently be audited or reported as anadjustment to those amountswill be recognized in the period such adjustment is determined as a change in accounting estimate.

Some license agreements include nonexclusive cross licenses and our policy is to value these only if directly used in operations. To date the we have not valued any cross licenses received as they were considered part of the licensee’s overall license and settlement strategy and are not used in our products. However we must evaluate each license with cross license rights to determine what is being cross licensed and if it is used in our products and this requires management to make judgments that affect our operations.

Stock-Based Compensation
ASC Topic 718, “Compensation – Stock Compensation,” or ASC 718, sets forth the accounting requirements for“stock-based” compensation payments to employees, non-employee directors and consultants and requires all stock based-payments to be recognized as expense in the statement of operations. The compensation cost for all stock-based awards is measured at the grant date, based on the fair value of the award (determined using a Black-Scholes option pricing model), and is recognized as an expense over the requisite service period (generally the vesting period of the equity award). Determining the fair value of stock-based awards at the grant date requires significant estimates and judgments, including estimating the market price volatility of our common stock, future employee stock option exercise behavior and requisite service periods. Due to our limited exercise history we applied the simplified method prescribed by SEC Staff Accounting Bulletin 110, Share-Based Payment: Certain Assumptions Used in Valuation Methods - Expected Term, to estimate expected life.

Options or stock awards issued to non-employees who are not directors are recorded at their estimated fair value at the measurement date and are periodically revalued as the options vest and are recognized as expense over the related service period on a graded vesting method. Stock options issued to consultants with performance conditions are measured and recognized when the performance is complete.

ASC Topic 718 requires stock-based compensation expense to be recorded only for those awards expected to vest using an estimated pre-vesting forfeiture rate. As such, ASC Topic 718 requires us to estimate pre-vesting option forfeitures at thetime of grant and reflect the impact of estimated pre-vesting option forfeitures on compensation expense recognized. Estimates ofpre-vesting forfeitures must be periodically revised in subsequent periods if actual forfeitures differ from those estimates. Weconsider several factors in connection with our estimate of pre-vesting forfeitures including types of awards, employee class, andhistorical pre-vesting forfeiture data. The estimation of stock awards that will ultimately vest requires judgment, and to the extentthat actual results differ from our estimates, such amounts will be recorded as cumulative adjustments in the period the estimatesare revised. If actual results differ significantly from these estimates, stock-based compensation expense and our results ofoperations could be materially impacted.

Refer to Notes 2 and 10 to our consolidated financial statements included in this report for moreinformation.

Derivative Instruments and Preferred Stock
We value derivative instruments in accordance with the interpretative guidance of ASC 815-40, Derivatives and Hedging – Contracts in Entity’s Own Equity related to the classification and measurement of warrants and instruments with embedded conversion features. We make certain assumptions and estimates to value our derivative liabilities. Factors affecting these liabilities and values include changes in the stock price and other assumptions.

 
21

 

We accounted for preferred stock issued in fiscal 2009 that was subject to provisions for redemption outside of our control as mezzanine equity in accordance with ASC 480Distinguishing Liabilities from Equity and recorded the values net of discounts for warrant values and beneficial conversion features. These securities were recorded at fair value at the date of issue and related discounts are being accreted over the term of the securities. The securities were reclassified to permanent equity when the provisions for redemption were terminated. We accounted for the related warrants as a derivative instrument as defined in ASC 815 and treated the warrants as a liability due to the lack of sufficient authorized shares of common stock. Upon the authorization and reservation of shares of common stock for exercise of the warrants we determined the warrants were no longer a derivative liability and we reclassified the value at that date to paid-in capital.  We also determined that the termination of certain warrant redemption rights was an effective modification of the warrant term and calculated the fair value of the warrants immediately prior to the modification compared to the value immediately after the modification and recorded the difference in warrant value in other finance expenses. These matters required us to make significant assumptions and estimates about stock volatility, stock prices and other assumptions.

Income Taxes
In preparing our consolidated financial statements, we estimate our income taxes in each of the countries inwhich we operate. While we believe we operate only in the United States, certain licensees have withheld taxes on license payments in foreign countries. During fiscal 2009 we determined that it was unlikely we could recover a refund of foreign taxes withheld and that we could only use the foreign taxes as a future credit against U.S. taxes. However in fiscal 2010 we obtained a refund of $264,000 of foreign taxes. An additional $206,250 of foreign taxes were withheld in fiscal 2010 and due to regulatory changes in the foreign jurisdiction we believe it unlikely we can obtain a refund of these taxes withheld and that they may only be used as a foreign tax credit. These matters regarding foreign taxes requires us to make judgments and estimates based on various assumptions and these affect our reported operations.

Our determination of income tax expense or benefit requires estimates including an assessment of the current tax expense and the effects of temporary differences resulting from the different treatment of transactions fortax and financial accounting purposes. These differences result in deferred tax assets and liabilities, which are included inour consolidated balance sheet. The Company accounts for deferred income taxes utilizing an asset and liability method,whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between thefinancial statements and the tax bases of assets and liabilities, as measured by current enacted tax rates. Deferred tax assetsare reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will notbe realized. We evaluate the realizability of our deferred tax assets by assessing our valuation allowance and by adjustingthe amount of such allowance, if necessary. At March 31, 2010, we had net deferred tax assets primarily resulting fromtemporary differences between the book and tax bases of assets and liabilities, and loss and credit carry forwards. Wecontinue to provide a 100% valuation allowance our deferred tax assets based on an assessment of the likelihood of theirrealization. In reaching our conclusion, we evaluated certain relevant criteria including deferred tax liabilities that can beused to offset deferred tax assets, estimates of future taxable income of appropriate character within the carry-forwardperiod available under the tax laws, and tax planning strategies. Our judgments regarding future taxable income maychange due to market conditions, changes in U.S. or international tax laws, our business and results ofoperations, and other factors. These changes, if any, may require material adjustments to these deferred tax assets,resulting either in a tax benefit, if it is estimated that future taxable income is likely, or a reduction in the value of thedeferred tax assets, if it is determined that their value is impaired, resulting in a reduction in net income or an increase innet loss in the period when such determinations are made.

Our income tax provision is based on calculations and assumptions that will be subject to examination by the taxing authorities in the jurisdictions in which we operate. Should the actual results differ from our estimates, we would have to adjust the income tax provision in the period in which the facts and circumstances that give rise to the revision become known. Tax law and rate changes are reflected in the income tax provision in the period in which such changes are enacted.

Other
We do not have off-balance sheet transactions, arrangements or obligations.  Inflation has not had any significant impact on our business.

Recently Issued Accounting Standards
See Note 2 to our consolidated financial statements included herein for a description of significant recent accounting standards.Other accounting standards have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date and are not expected to have a material impact on our consolidated financial statements upon adoption.

 
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Results of Operations

Year ended March 31, 2010 Compared to Year ended March 31, 2009

   
Year Ended March 31,
             
   
2010
         
2009
                   
         
% of
         
% of
   
Change
 
   
Dollars
   
Revenue
   
Dollars
   
Revenue
   
Dollars
   
%
 
Revenues:
                                   
Products
    204,735       8 %     362,079       3 %     (157,344 )     (43 )%
Services
    749,134       29 %     578,303       5 %     170,831       30 %
Patent license
    1,600,000       63 %     10,115,350       91 %     (8,515,350 )     (84 )%
      2,553,869       100 %     11,055,732       100 %     (8,501,863 )     (77 )%
Gross Profit:
                                               
Product gross profit (loss)
    (94,343 )     (4 )%     43,407       0 %     (137,750 )     (317 )%
Service gross profit
    421,352       16 %     369,281       3 %     52,071       14 %
Patent license
    985,085       39 %     6,131,263       55 %     (5,146,178 )     (84 )%
      1,312,094       51 %     6,543,951       59 %     (5,231,857 )     (80 )%
Operating Expenses:
                                               
Selling and administrative
    1,707,814       67 %     2,325,359       21 %     (617,545 )     (27 )%
Research and related
    482,866       19 %     518,649       5 %     (35,783 )     (7 )%
      2,190,680       86 %     2,844,008       26 %     (653,328 )     (23 )%
Other expenses
    13,916       1 %     (344,457 )     (3 )%     358,373       (104 )%
                                                 
Income (loss) before provision for income taxes
    (864,670 )     (34 )%     3,355,486       30 %     (4,220,156 )     (126 )%

Income (loss) before provision for income taxes
The loss before income tax benefit in fiscal 2010 resulted from reduced patent license revenues. The income in the prior year was the result of significant license revenues and related margins as discussed below. Since patent license revenues to date have been one-time with each licensee, they are non-recurring and accordingly there is no assurance of any future patent license revenues. We cannot predict future license revenue from new license agreements providing for periodic future payments tied to licensee activity.

Revenues
Revenues for the year ended March 31, 2010 included $1,600,000 of one-time non-recurring patent license revenue and $953,869 of eVU product and service revenues. Our product revenues declined in part as a result of airline industry economics resulting in reduced IFE activity. While our backlog shows an increase in recent activity, this business is expected to continue to be sporadic in future quarters.Our service revenues increased as a result of both increased content related services from year over year increases in aggregate customers and from increased repair and maintenance revenues as prior year customers are using products no longer under warranty.

Revenues for the year ended March 31, 2009 included $10,115,350 of one-time non-recurring patent license revenue and $940,382 of eVU product and service revenues. We have not yet recognized any periodic reported revenue from license agreements providing for future royalties. In the prior year we entered into six licenses and in the current year a total of four licenses. License fee revenues recognized fluctuate significantly from period to period primarily based on the following factors:
 
·
the dollar amount of agreements executed each period, which is primarily driven by the magnitude of infringement associated with a specific licensee;
 
·
the specific terms and conditions of agreements executed each period and the periods of infringement contemplated by the respective payments; and
 
·
fluctuations in the number of agreements executed.

 
23

 

In the future the following additional factors could also impact revenue variability:
 
·
fluctuations in the sales results or other royalty per unit activities of our licensees that impact the calculation oflicense fees due;
 
·
the timing of the receipt of periodic license fee payments and/or reports from licensees.

Prior year licenses included larger companies with greater magnitude of infringement.

eVU product sales activity has been slow during the last two years due to airline industry economics and industry credit concerns resulting in airlines curtailing expansion and new projects. We had backlog at March 31, 2010 of $265,000 compared to $164,000 at prior year end with the increase reflecting recent new orders. We are pursuing new eVU business and targeting new patent licensees but our results will continue to be dependent on the timing and quantity of eVU orders and the timing and amount of future patent licensing arrangements, if any. While our service revenues increased in the last year, future levels depend on the number of customers that continue to utilize our product for IFE. Loss of customers for which we provide content or maintenance and service revenue, generally without long-term agreements, would negatively impact future service revenues.

Gross Profit
Gross profit for fiscal 2010 was $1,312,094 or 51% of revenues.  The gross profit on product and service revenues was 34% and the gross profit on patent licensing fees was 62% of license revenues. Gross profit for fiscal 2009 was $6,543,951 or 59% of revenues.  The gross profit on product and service revenues was 44% and the gross profit on patent licensing fees was 61% of license revenues. The reduction in product and service gross profit in the current year was impacted by a $65,459 market adjustment to reduce inventory values to the lower-of-cost or market primarily due to competitive conditions in the IFE industry affecting planned future pricing on certain products.License revenue costs of revenues consists primarily of contingency legal and other direct costs associated with patent licensing.Gross profit margins are highly dependent on revenue mix, prices charged, volume of orders, contingency patent legal fees and costs.Management does not believe historical gross profits percentages can be relied on as an indicator of results from future revenues.

Operating Expenses
Selling and administrative costs decreased by $617,545 from fiscal 2009 to fiscal 2010. This included a $533,000 reduction in legal fees primarily related to the favorable resolution of customer litigation in November 2009. Salaries and benefits decreased $205,000 primarily due to a reduction in senior management personnel in January 2009 and other staffing reductions due to reduced eVU activity. Professional fees increased by $71,000 primarily as a result of fees paid to foreign tax experts that assisted in obtaining refunds ofwithheld foreign income taxes. Noncash stock-based compensation costs increased $81,000 to $129,625 primarily due to the immediate vesting of option grants made in fiscal 2010.

Research and related expenditures were comparable for the two years. Stock-based compensation expenses were $26,703 in fiscal 2010 and $26,620 in fiscal 2009. We expect future research and development costs to be comparable to the most recent year due to current staffing levels and projects. Should we elect to develop significant new products or major revisions to our existing products we may require increased internal and external research and development costs.

Other Income (Expenses)
Net other expenses were $344,457 for the year ended March 31, 2009andincluded $163,559 of interest expense including $80,300 of non-cash interest from the amortization of debt discount and $181,157 of non-cash warrant and other finance related expenses. Due to reduced debt balances our interest expense in fiscal 2010 was only $17,099 and we recognized $31,015 of other income including a $20,000 gain from reduction of amounts owed related to litigation.

Benefit (Provision) for Income Taxes
The provision for income taxes for the year ended March 31, 2009 of $421,500 consisted of foreign taxes withheld and paid of $264,000 on license revenues and $157,500 accrued for California state taxes. The deferred tax expense of $868,000 was offset by a benefit related to the decrease of the deferred tax asset valuation allowance. The Company generated a tax liability in the state of California due to recent legislation suspendingNOL carryforwards for the 2008 and 2009 tax years. The state tax liability of $157,500 was after a reduction of 50% from the use of allowable R&Dcredits generated in prior years.

During the year ended March 31, 2010 we obtained a refund of the $264,000 of foreign taxes paid in the prior year that we previously judged was not probable of recovery. We paid $206,250 of foreign taxes related to license revenues and due to tax law changes we do not believe it probable that this amount can be recovered other than as applied as a foreign tax credit. The deferred tax benefit of $256,000 was offset by change in the valuation allowance.

 
24

 

Income (Loss) Attributable to Common Stockholders
The loss attributable to common stockholders for the year ended March 31, 2010 included the net loss after tax benefit of $809,420 increased by accrued and deemed dividends on convertible preferred stock of $175,139 or a net loss attributable to common stockholders of $984,559. The income attributable to common stockholders for the year ended March 31, 2009 included the net income after taxes of $2,933,986 reduced by accrued and deemed dividends on convertible preferred stock of $130,320 or a net income attributable to common stockholders of $2,803,666.

Liquidity and Capital Resources

   
2009
   
2010
   
2009 to 2010
variance in $'s
   
2009 to 2010
variance in %'s
 
   
(in thousands, except percentages)
 
Working capital
  $ 3,277     $ 2,966     $ (311 )     (9.5 )%
Cash and cash equivalents
  $ 3,814     $ 2,819     $ (995 )     (26 )%
Total assets
  $ 4,478     $ 3,334     $ (1,144 )     (26 )%

   
2009
   
2010
   
2009 to 2010
variance in $'s
   
2009 to 2010
variance in %'s
 
Net cash provided by (used in)
 
(in thousands, except percentages)
 
 Operating activities
  $ 2,837     $ (944 )   $ (3,781 )     (133 )%
 Investing activities
  $ (4 )   $ (3 )   $ 1       25 %
 Financing activities
  $ 859     $ (48 )   $ (907 )     (106 )%

At March 31, 2010, we had working capital of $3.0 million compared to a working capital deficit of $3.3 million for the prior year. We had $109,000 and $94,000 of working capital invested in accounts receivable at March 31, 2010 and 2009, respectively. Our terms to customers vary but we often require payment prior to shipment of product and any such payments are recorded as deposits. We expect certain airline customers to demand commercial terms such as 30 or 60 days in the future and this could increase our need for working capital. Patent license payments are normally due at signing of the license or within 30-45 days.

Operating Activities
For the year ended March 31, 2010, net cash decreased by $995,000. Cash used by operating activities was $944,000. Cash used by operating activities included the net loss of $809,000reduced by net non-cash expenses of $267,000. Major components also providing operating cash was a decrease of $105,000 in inventory and an increase of $61,000 in deferred revenue due to increased paid orders not yet delivered at March 31, 2010. Major components using operating cash included a $151,000 decrease in accounts payable and a $341,000 decrease in accrued liabilities primarily resulting from decreases in litigation related accruals due to favorable resolution of such litigation and a reduction in state taxes payable due to losses in the current year versus income in the prior year.

For the year ended March 31, 2009, net cash increased by $3.69 million. Cash provided by operating activities was $2.84 million. Cash provided by operating activities included income of $2.93 million increased by net non-cash expenses of $294,000. Major components also providing operating cash was a decrease of $81,000 in accounts receivable and an increase of $226,000 in accrued liabilities. Major components using operating cash included a $28,000 increase in inventory and a $583,000 decrease in accounts payable.

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

Financing Activities
For the year ended March 31, 2010, we used $47,865 of cash to make the final convertible term note payment in November 2009. We made $350,000 of additional payments for the seven prior months in shares of common stock issuing 2,705,515 restricted shares. A total of $212,083 of preferred stock and accumulated dividends was converted to common stock during the year through the issuance of 2,120,821 shares of common stock.

 
25

 

For the year ended March 31, 2009, cash provided by financing activities was $859,000. This included $660,000 from the sale of common stock during the year to Fusion Capital Fund II, LLC (“Fusion”) and $700,000 cash from the sale of preferred stock. We paid off our secured note balance of $450,000 and made term principal payments of $51,000. During the prior year we obtained $960,000 from the sale of common stock to Fusion, obtained $226,000 from exercises of warrants and options and made secured note payments of $300,000.

We currently have no sources of financing funding other than the potential exercise of options and warrants which generally will be dependent on higher stock prices and thus substantial uncertainty.

Debt and Other Commitments
As described above we paid off our convertible term debt during fiscal 2010 and have no debt other than normal trade payables and accruals outstanding. We have no credit lines or access or commitments for any future debt financing.

At March 31, 2010 we were committed to approximately $224,000 as purchase commitments for product and components as a result of preparing to build to our backlog of orders of $265,000 at March 31, 2010. These purchase commitments are generally subject to modification as to timing, quantities and scheduling and in certain instances may be cancelable without penalty.

We are also committed for our office lease as more fully described in Note 12 to our consolidated financial statements.

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

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

Cash Requirements
Other than cash on hand and accounts receivable, we have no material unused sources of liquidity at this time.  Based on our cash position at March 31, 2010 and current planned expenditures and level of operationwe believe we have sufficient capital resources for the next twelve months. Actual results could differ significantly from management plans. We believe we may be able to obtain additional funds from future patent licensing and eVU product sales and services but the timing of licenses and shipments and the amount and quantities of shipments, orders and reorders are subject to many factors and risks, many outside our control.

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

Selected Quarterly Financial Information
The following table sets forth unaudited income statement data for each of our Company’s last eight quarters. The unaudited quarterly financial information as restated 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.Our quarterly operating results have varied significantly in the past and are expected to vary significantly in the future.

 
26

 

Quarter ended
 
6/30/2009
   
9/30/2009
   
12/31/2009
   
3/31/2010
   
FY 2010
 
Revenues
  $ 223,030     $ 1,512,267     $ 284,170     $ 534,402     $ 2,553,869  
Gross profit
    102,052       936,644       104,352       169,046       1,312,094  
Income (loss) for the period
    (569,076 )     348,386       (315,285 )     (273,445 )     (809,420 )
Operating profit (loss)
    (554,201 )     559,154       (584,411 )     (299,128 )     (878,586 )
Income (loss) attributable to common shareholders
    (611,889 )     292,498       (360,672 )     (304,496 )     (984,559 )
Basic and diluted earnings (loss) per common share
  $ (0.00 )   $ 0.00     $ (0.00 )   $ (0.00 )   $ (0.00 )
Weighted average shares outstanding (basic)
    282,507,374       284,407,839       286,625,653       281,298,128       286,950,900  

Quarter ended
 
6/30/2008
   
9/30/2008
   
12/31/2008
   
3/31/2009
   
FY 2009
 
Revenues
  $ 377,727     $ 1,774,430     $ 3,906,033     $ 4,997,542     $ 11,055,732  
Gross profit
    114,057       1,157,107       2,286,550       2,986,237       6,543,951  
Income (loss) for the period
    (669,207 )     (28,833 )     1,547,795       2,084,231       2,933,986  
Operating profit (loss)
    (571,489 )     400,511       1,597,631       2,273,290       3,699,943  
Income (loss) attributable to common shareholders
    (670,618 )     (72,116 )     1,504,511       2,041,889       2,803,666  
Basic and diluted earnings (loss) per common share
  $ (0.00 )   $ (0.00 )   $ 0.01     $ 0.01     $ 0.01  
Weighted average shares outstanding (basic)
    274,497,647       277,082,261       279,143,996       281,298,128       277,997,077  

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Consolidated Financial Statements of the Company required to be included in this Item 8 are incorporated herein by reference and are set forth in a separate section of this report following Item 15 and the Signature Page (page 40) commencing on Page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 9A(T). CONTROLS & PROCEDURES
Attached as exhibits to this Form 10-K are certifications of our President (“Principal Executive Officer” or “PEO”) and Interim Chief Accounting Officer (“Principal Financial Officer” or “PFO”) that are required in accordance with Rule 13a-14 of the Exchange Act. This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications.

Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls (as defined in Rule 13a-15(e) of the Exchange Act) and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our PEO and PFO, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives.

At the conclusion of the period ended March 31, 2010, we carried out an evaluation, under the supervision and with the participation of our management, including the PEO and PFO, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the PEO and PFO concluded that our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, were not effective at the reasonable assurance level due to the existence of a material weakness in our internal control over financial reporting, discussed below.

 
27

 

Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for our Company. We maintain internal control over financial reporting designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Internal control over financial reposting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of e.Digital; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with authorizations of management and directors of e.Digital; and (iii) provide reasonable assurance regarding prevention and timely detection of unauthorized acquisition, use, or disposition of e.Digital’s assets that could have a material effect on the financial statements.

Management conducted an assessment of the effectiveness of our internal control over financial reporting as of March 31, 2010 using criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). This assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment. Management’s assessment is supported by testing and monitoring performed by certain of our finance and accounting personnel of the operational effectiveness of our internal control.

Based on this assessment, management identified a material weakness in our internal control over financial reporting: the lack of independent oversight by an audit committee of independent members of the Board of Directors.  In light of this material weakness management concluded that our internal control over financial reporting needs improvement and was not effective. Due to our small size and limited resources it is difficult to attract qualified independent directors and qualified audit committee members. Management has concluded that with certain management oversight controls that are in place, the risks associated with the lack of independent audit committee oversight is not sufficient to justify the costs of adding additional directors and independent audit committee members at this time. Management will periodically reevaluate this situation. If we secure sufficient capital or improve our operating results it is our intention to change the composition and/or size of the Board of Directors with emphasis on recruiting qualified independent audit committee members.

This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

Inherent Limitations on Effectiveness of Controls
Our management, including the PEO and PFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions of deterioration in the degree of compliance with policies or procedures.

Changes In Internal Control Over Financial Reporting
No change in our internal controls over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None
 
28


PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

Directors and Executive Officers
The following table sets forth the name and position of each of our directors and executive officers at June 1, 2010:

Name
 
Age
 
Positions
 
Director Since
Alfred H. Falk
 
55
 
President, Chief Executive Officer and Director
 
January 2009
Robert Putnam
 
51
 
Senior Vice President, Corporate Secretary, Interim Chief Accounting Officer and Director
 
1995
Allen Cocumelli
 
60
 
Chairman* and Director
 
1999
Renee Warden
 
46
 
Director
 
2005
Eric M. Polis
 
39
 
Director
 
October 2008

* Allen Cocumelli as Chairman of our Board of Directors, is technically considered as an executive officer under our bylaws. However, we do not believe that he meets the definition of an “executive officer” under Rule 16a-1(f) of the Securities Exchange Act of 1934 in that he does not perform any policy-making functions for our Company, nor is he compensated for this position.

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.

Alfred H. Falk – Mr. Falk was promoted and appointed as President and Chief Executive Officer of the Company by the Board of Directors on January 20, 2009.  Mr. Falk had been the Company’s vice president of corporate development since July 2004. He formerly served as president and a member of the Board of the company from January 1997 (and from July 1998 as chief executive officer) until July 2004. From March 1995 to January 1997, he served as vice president of corporate development and vice president of OEM and international sales. Prior to joining the company, Falk worked for Resources Internationale as director of U.S. sales from 1993 to 1995. From 1988 to 1993, he was the manager of OEM sales and technology licensing for Personal Computer Products, Inc. From 1978 to 1988, he held several management positions at DH Technology.

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 also served as Secretary of from March 1998 until December 2001.  He served as a Director of LRAD Corporation (“LRAD”) 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 director of investor relations of LRAD.  He also served as Secretary/Treasurer of Patriot Scientific (“Patriot”) from 1989 to 2000 and from 1989 to March 1998 was a Director of Patriot.  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 Chairman of the Board in October 2008. Mr. Columelli also previously served as Chairman of the Board from April 2000 to November 2002. Mr. Cocumelli has been Secretary and General Counsel of SimpleNet, Inc. since 2004. Prior thereto, Mr. Cocumelli was a Director of Website Services at Yahoo! Inc. from 2000 to 2004. Prior to joining Yahoo! Inc., Mr. Cocumelli was General Counsel of Simplenet Network Communications Inc. from 1996 and Chief Operating Officer of Simplenet Network Communications Inc. from November 1997 until 1999. Prior to joining Simplenet Network Communications Inc., 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 has been Financial Manager for Verifone since July 2009. Previously, Ms. Warden was Director of Accounting for Revolution Money, Inc. from April 2007 to July 2009. Prior to its acquisition by Crown Castles in April 2007, Ms. Warden was Manager Special Projects/SOX for Global Signal, Inc. Prior to joining Global Signal, Inc. Ms. Warden was Vice President and Controller for Kintera, Inc. from May 2005 to May 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.

 
29

 

Eric M. Polis - Mr. Polis has been Secretary, Treasurer and a Director of ASI Technology Corporation, a publicly traded specialty finance company, since July 2000. He has been employed as an asset manager for privately-held Davric Corporation since 1997. Mr. Polis is also a private investor and serves on the board of several Las Vegas non-profit organizations. He obtained a B.S. in Business Administration from the University of Arizona in 1993.

Code of Business Conduct and Ethics
We have adopted a Code of Conduct Policy applicable to all our employees, including our principal executive officer, principal financial officer and principal accounting officer. We will provide any person, without charge, a copy of our Code of Conduct Policy upon written request to Investor Relations, e.Digital Corporation, 16770 West Bernardo Drive, San Diego, California 92127. We also post on our website a copy of or Code of Conduct Policy at www.edigital.com.

Section 16(a) Beneficial Ownership Reporting Compliance
Based solely on a review of copies of such reports furnished to our Company and representation that no other reports were required during the fiscal year ended March 31, 2010, we believe that all persons subject to the reporting requirements pursuant to Section 16(a) filed the required reports on a timely basis with the Securities and Exchange Commission.

Stockholder Recommendations for Director Nominations
We have no nominating committee of the Board of Directors and no formal procedure for director nominations. Accordingly, there has been no change in the procedures by which security holders may recommend nominees to our board of directors since our last shareholders meeting in November 2009.

Audit Committee and Audit Committee Financial Expert
We have a separately designated standing Audit Committee, currently consisting of Ms. Warden and Mr. Putnam. Ms. Warden has been designated as the “Audit Committee Financial Expert,” as defined by Regulation S-K, although as a paid accounting consultant to the Company she is not an “independent” director, as defined under the NASDAQ Stock Market rules and Rule 10A-3 of the Securities Exchange Act of 1934. Likewise Mr. Putnam, as an executive officer is not independent.

ITEM 11. EXECUTIVE COMPENSATION.

Summary Compensation Table

                   
Option
   
All Other
       
       
Salary (1)
   
Bonus
   
Awards (2)
   
Compensation
   
Total
 
Name and Principal Position
 
Year
 
($)
   
($)
   
($)
   
($)
   
($)
 
                                   
Alfred H. Falk, President and
 
2010
  $ 155,000       -     $ 33,273       -     $ 188,273  
Chief Executive Officer (PEO)
 
2009
  $ 155,000       -     $ 0       -     $ 155,000  
                                             
Robert Putnam, Senior Vice
 
2010
  $ 85,000       -     $ 16,637       -     $ 101,637  
President, Secretary and Interim
 
2009
  $ 85,000       -     $ 0       -     $ 85,000  
Chief Accounting Officer (PEO) (3)
                                           

(1)
Represents actual cash compensation.
(2)
The value listed in the above table represents the fair value of the options granted during the year and valuedunder ASC 718. Fair value is calculated as of the grant date using a Black-Scholes option-pricing model. The determination of the fair value of share-based payment awards made on the date of grant is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. Our assumptions in determining fair value are described in our audited consolidated financial statements for the year ended March 31, 2010, included herein.
(3)
Mr. Putnam provides part-time services to our company.  See “Certain Transactions – Conflicts of Interest.”

 
30

 

Outstanding Equity Awards at Fiscal Year-End

Name
 
Number of
Securities
Underlying
Unexercised
Options
Exercisable
   
Number of
Securities
Underlying
Unexercised
Options
Unexercisable
   
Equity
Incentive
Plan
Awards: 
Number of
Securities
Underlying
Unexercised
Unearned
Options
   
Option
Exercise
Price
 
Option Expiration
Date
 
Alfred H. Falk
    500,000       -       -     $ 0.155  
12/8/13
 
                                     
Robert Putnam
    250,000       -       -     $ 0.155  
12/8/13
 

Employment Agreements, Termination of Employment and Change in Control Arrangements

Mr. Putnam and Mr. Falk have no employment letter or agreement.

Director Compensation
Our directors are reimbursed for reasonable out-of-pocket expenses incurred in attending meetings of the board of directors and committee meetings. Employee directors do not receive any cash compensation for services as directors and have not received any equity compensation grants designated for such services. In addition, members of the board of directors who are not employees receive equity compensation grants as consideration for board and committee service from time to time. There is no established policy as to frequency or amount of equity compensation grants for non-employee directors.

The following table sets forth the compensation paid to our non-employee directors in 2010.

Name
 
Fee Earned or
Paid in Cash
   
Option
Awards (1)
   
All Other
Compensation
   
Total
 
Allen Cocumelli(2)
        $ 16,637           $ 16,637  
Renee Warden (3)
        $ 16,637           $ 16,637  
Eric M. Polis (4)
        $ 16,637           $ 16,637  

(1)
The value listed in the above table represents the fair value of options on 250,000 shares granted to each person during the year and valued under ASC 718. Fair value is calculated as of the grant date using a Black-Scholes option-pricing model. The determination of the fair value of share-based payment awards made on the date of grant is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. Our assumptions in determining fair value are described in our audited consolidated financial statements for the year ended March 31, 2010, included in our Annual Report on Form 10-K.
(2)
At March 31, 2010 Mr. Cocumelli had option awards outstanding exercisable into 500,000 shares of common stock that were vested and exercisable.
(3)
During fiscal 2010 Ms. Warden provided accounting services unrelated to her role as a director or audit committee member and earned compensation of $2,625 not included above. At March 31, 2010 Ms. Warden had option awards outstanding exercisable into 500,000 shares of common stockof that were vested and exercisable.
(4)
At March 31, 2010 Mr. Polis had option awards outstanding exercisable into 550,000 shares of common stockof which 475,000 were vested and exercisable.

Compensation Committee Interlocks and Insider Participation
The Compensation Committee of ourCompany’s Board of Directors was formed in June 2000 and is currently comprised of Directors, Allen Cocumelli and Eric Polis. None of these individuals was at any time during the fiscal year 2010, or at any time, an employee or officer of the Company.  No executive officer of the 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 ourCompany’s Board of Directors or Compensation Committee.

 
31

 

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 June 1, 2010, with respect to (i) each stockholder known by us to be beneficial owners of more than 5% of our outstanding Common Stock, (ii) each of the current directors and nominees for election as directors, (iii) each of the executive officers named in the Summary Compensation Table below and (iv) all current directors, nominees and executive officers as a group (five persons).  Other than as set forth below, we are not aware of any other stockholder who may be deemed to be a beneficial owner of more than 5% of our company’s Common Stock.

Name and Address
 
Amount and Nature of
   
Percent
 
Title
 
 of Beneficial Owner
 
Beneficial Ownership
   
of Class
 
of Class
 
Alfred H. Falk
    1,493,850
(1)
    *  
Common
 
16770 West Bernardo Drive
                   
San Diego, CA 92127
                   
                     
Robert Putnam
    5,088,911
(2)
    1.8
Common
 
16770 West Bernardo Drive
                   
San Diego, CA 92127
                   
                     
Allen Cocumelli
    501,000
(3)
    *  
Common
 
16770 West Bernardo Drive
                   
San Diego, CA 92127
                   
                     
Eric M. Polis
    4,307,119
(4)
    1.5 %
Common
 
980 American Pacific Drive, #111
                   
Henderson, NV 89014
                   
                     
Renee Warden
    500,000
(5)
    *  
Common
 
16770 West Bernardo Drive
                   
San Diego, CA 92127
                   
                     
Jerry E. Polis
    20,661,411
(6)
    7.2 %
Common
 
980 American Pacific Drive, #111
                   
Henderson, NV 89014
                   
                     
All officers, directors and nominees as a group (5 persons)
    11,890,880
(7)
    4.1 %
Common
 

 
 
(1)
Includes 550 shares held by son to which Mr. Falk disclaims beneficial ownership. Includes options and warrants exercisable within 60 days to purchase 500,000 shares.
 
(2)
Includes options and warrants exercisable within 60 days to purchase 1,250,000 shares and preferred stock convertible into 1,100,411 shares.
 
(3)
Includes options exercisable within 60 days to purchase 500,000 shares.
 
(4)
Includes options exercisable within 60 days to purchase 512,500 shares. Also includes (i) 2,307,421 shares of common stock held a Family Trust of which Mr. Polis is Trustee, (ii) 1,042,696 shares of common stock held by the Polis Family LLC of which Mr. Polis is a managing member, (iii) 133,000 shares of common stock held by The Polis Charitable Foundation of which Mr. Polis is an officer, (iv) 25,000 shares of common stock held in a personal IRA, (v) 107,922 shares of common stock held by ASI Capital Corporation of which Mr. Polis is Secretary and Treasurer, (vi) 138,580 shares of common stock held by ASI Technology Corporation of which Mr. Polis is Secretary and Treasurer, and (vii) 40,000 shares of common stock held as custodian for a minor child. Mr. Polis disclaims beneficial ownership of the shares held by the Polis Charitable Foundation and as custodian for the minor child and to the shares held by ASI Capital Corporation and its paretn ASI Technology Corporation except to the extent of his respective pecuniary interest.
 
(5)
Consists of options exercisable within 60 days to purchase 500,000 shares.

 
32

 

 
(6)
Ownership by Mr. Jerry E. Polis is based on information provided by the stockholder as of December 31, 2009. Includes (i) 11,894,003 shares of common stock held by the Jerry E. Polis Family Trust (“Family Trust”) of which Mr. Polis is Trustee, (ii) 6,857,610shares of common stock held by Davric Corporation (“Davric”) of which Mr. Polis is President and Director (iii) 1,042,696 shares of common stock held by the Polis Family LLC of which Mr. Polis is a managing member, (iv) 333,000 shares of common stock held by The Polis Charitable Foundation of which Mr. Polis is President, (v) 220,000 shares of common stock held by the Polis Museum of Fine Art of which Mr. Polis is trustee, (vi) 67,600 shares of common stock held in a personal IRA, (viii) 107,922 shares of common stock held by ASI Capital Corporation of which Mr. Polis is President and (ix) 138,580 shares of common stock held by ASI Technology Corporation of which Mr. Polis is President. Mr. Polis disclaims beneficial ownership of the shares held by the Polis Charitable Foundation and the Polis Museum of Fine Art and to the shares held by ASI Capital Corporation and ASI Technology Corporation except to the extent of his respective pecuniary interest.
 
(7)
Includes options and warrants exercisable within 60 days to purchase 3,262,500 shares and preferred stock convertible into 1,100,411shares.

*  Less than 1%

Series AA Preferred Stock

The following security ownership information is set forth as of June 1, 2010 with respect to certain persons or groups known to the Company to be beneficial owners of more than 5% of Series AA Preferred Stock.

Name and Address
 
Amount and Nature of
   
Percent
 
Title
 
of Beneficial Owner
 
Beneficial Ownership(1)
   
of Class
 
of Class
 
Robert Putnam
    10,000 (2)     18.2 %
Series AA
 
16770 West Bernardo Drive
               
Preferred Stock
 
San Diego, CA 92127
                   
                     
James A. Barnes
    15,000 (3)     27.3
Series AA
 
8617 Canyon View Dr.
               
Preferred Stock
 
Las Vegas, NV 89117
                   
                     
Norris Family 1997 Trust
    10,000 (4)     18.2 %
Series AA
 
16101 Blue Crystal Trail
               
Preferred Stock
 
Poway, CA 92064
                   
                     
James C. Zolin & Josephine Zolin
    5,000 (5)     9.1 %
Series AA
 
17108 Via De La Valle
               
Preferred Stock
 
Rancho Santa Fe, CA 92067
                   
                     
Victor Gabourel
    5,000 (6)     9.1 %
Series AA
 
11404 Cypress Woods Dr.
               
Preferred Stock
 
San Diego, CA 92131
                   
                     
Robert M. Kaplan
    5,000 (6)     9.1 %
Series AA
 
P.O. Box 2600
               
Preferred Stock
 
Sun Valley, ID 83353                    
 
 
(1)
Represents the number of shares of Series AA Preferred Stock held as of May 10, 2010. At such date an aggregate of 55,000 shares of Series AA Preferred Stock were issued and outstanding with each share having 100 votes per share.
 
(2)
Mr. Putnam is an officer and director of the Company and has sole voting and investment power with respect to the Series AA Preferred Stock.
 
(3)
Includes 5,000 shares held by Sunrise Capital, Inc., 5,000 shares held by Sunrise Management, Inc. Profit Sharing Plan and 5,000 shares held by Palermo Trust. Mr. Barnes is President of Sunrise Capital, Inc. and Trustee of Sunrise Management, Inc. Profit Sharing Plan and the Palermo Trust. Mr. Barnes shares investment and voting power with respect to the Series AA Preferred Stock with his spouse.
 
(4)
Voting and investment power with respect to the Series AA Preferred Stock is shared by Elwood G. Norris and Stephanie Norris.
 
(5)
The named owners are believed by the Company to share investment and voting power over the Series AA Preferred Stock.
 
(6)
The named owner is believed by the Company to have sole investment and voting power over the Series AA Preferred Stock.

 
33

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.

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 Director of Investor Relations of LRAD.  The possibility exists that this other relationship 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 Related Persons
On occasion we engage in certain related party transactions. Related parties include directors and executive officers and their immediate family members and certain security holders and their immediate family members. For purposes of this disclosure related party security holders include any beneficial owner of more than five percent of either our common or preferred shares. The following are related party transactions with respect to the two fiscal years ended March 31, 2009.

Mr. James A. Barnes, becamea related party in June 2008 when affiliated entities acquired greater than 5% of our Series AA preferred stock. During fiscal 2010, we incurred accounting, regulatory consulting services and cost reimbursements of $44,254 to Sunrise Capital, Inc., a company controlled by Mr. Barnes.

Jerry E. Polis and affiliated entities are considered as related parties through ownership of greater than 5% of our outstanding common stock.At April 1, 2009 we owed Davric Corporation (“Davric”) $387,234 on a 7.5% Convertible Term Note (“Term Note”). Stated monthly principal and interest payments were $50,000 and we could elect to make monthly installment payments either in cash or in shares of common stock. Subject to certain notice periods and other limitations, the balance of the Term Note was convertible by Davric at $0.30 per common share and we could call the Term Note for mandatory conversion if the closing sale price of our common stock was at least $0.40 per share for ten consecutive trading days. During fiscal 2010 we made $350,000 of principal and interest payments through the issuance of 2,705,515 restricted shares of common stock and made the finalpayment of $47,865 in cash in November 2009. At March 31, 2010 there was no debt balance outstanding. Total interest expense for the fiscal year was $10,631.

During fiscal 2010 we paid director and former executive officer Renee Warden an aggregate of $2,625 for accounting services unrelated to her role as a director or audit committee member.

On December 8, 2009, directors Allen Cocumelli, Renee Warden and Eric M. Polis were each granted an option on 250,000 common shares exercisable at $0.155 per share until December 8, 2013vesting at grant but subject other standard option plan conditions.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
 
The following table describes fees for professional audit services rendered by SingerLewak LLP, our principal accountant, for the audit of our annual financial statements for the years ended March 31, 2010 and March 31, 2009 and fees billed for other services rendered by SingerLewak LLPduring those periods. These amounts include fees paid to SingerLewak LLP.

 
34

 

Type of Fee
 
2010
   
2009
 
Audit Fees (1)
  $ 102,330     $
160,797
 
Audit Related Fees (2)
    -       -  
Tax Fees (3)
    -       -  
All Other Fees (4)
    -       -  
Total
  $ 102,330     $ 160,797  
 
1.           Audit Fees include the aggregate fees paid by us during the fiscal year indicated for professional services rendered by SingerLewak 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 SingerLewak LLPthat are reasonably related to the performance of the audit or review of our financial statements and not included in Audit Fees.

3.           Tax Fees include the aggregate fees paid by us during the fiscal year for professional services for tax compliance, tax advice and tax planning. No such fees were billed by SingerLewak LLPfor the respective periods.

4.           All Other Fees include the aggregate fees paid by us during the fiscal year indicated for products and services other than the services reported above. No such fees were billed by SingerLewak LLPfor the respective periods.

Audit Committee Pre-Approval Policies and Procedures
The Audit Committee on an annual basis reviews audit and non-audit services performed by the independent auditor. All audit and non-audit services are pre-approved by the Audit Committee, which considers, among other things, the possible effect of the performance of such services on the auditors’ independence. The Audit Committee has considered the role of SingerLewak LLPin providing services to us for the fiscal year ended March 31, 2010 and has concluded that such services are compatible with their independence as our company’s auditors. The Audit Committee has established its pre-approval policies and procedures, pursuant to which the Audit Committee approved the foregoing audit services provided by SingerLewak LLP in fiscal year 2010.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

The following documents are filed as part of this Annual Report on Form 10-K:

(a) Consolidated Financial Statements
See “Index to Consolidated Financial Statements” on page F-1.

 (b) Exhibits
Each exhibit marked with an asterisk is filed with this Annual Report on Form 10-K. Each exhibit not marked with an asterisk is incorporated by reference to the exhibit of the same number (unless otherwise indicated) previously filed by the Company as indicated below.

Exhibit
   
Number
 
Sequential Description
     
2.1
 
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.
 
 
35

 
 
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.
     
3.1.3
 
Certificate of Amendment of Certificate of Incorporation of e.Digital Corporation filed with the State of Delaware on September 18, 2008 and filed as Exhibit 3.1.3 to the Company’s Current Report on Form 8-K dated September 18, 2008.
     
3.1.4
 
Certificate of Amendment of Certificate of Incorporation of e.Digital Corporation filed with the State of Delaware on August 11, 2005 and filed as Exhibit 3.1.4 to the Company’s Current Report on Form 8-K dated September 18, 2008.
     
3.2
 
Bylaws of the Company, 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 Registration Statement on Form S-3 dated November 3, 2000.
     
3.6
 
Certificate of Designation of Preferences, Rights and Limitations of Series D preferred stock filed with the State of Delaware on December 23, 2002 and filed as Exhibit 3.6 to the Company’s Current Report on Form 8-K dated December 30, 2002.
     
3.7
 
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.
     
3.8
 
Certificate of Designation of Preferences, Rights and Limitations of Series EE preferred stock filed with the State of Delaware on November 19, 2004 and filed as Exhibit 3.7 to the Company’s Current Report on Form 8-K dated November 19, 2004.
     
3.9
 
Certificate of Designation of Preferences, Rights and Limitations of Series AA preferred stock filed with the State of Delaware on June 26, 2008 and filed as Exhibit 99.4 to the Company’s Current Report on Form 8-K dated July 1, 2008.
     
4.1
 
Form of Stock Purchase Warrant (Series EE Warrants) exercisable until November 2006 issued to seventeen accredited investors for an aggregate of 4,070,000 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 4.55 to the Company’s Current Report on Form 8-K dated November 19, 2004.
     
4.2
  
Form of 12% Subordinated Promissory Note and Warrant Purchase Agreement dated as of June 30, 2005 entered into with certain accredited investors in a maximum aggregate amount of $1,000,000 and filed as Exhibit 4.50 to the Company’s 2004 Form 10-K.
 
 
36

 
 
4.2.1
 
Form of First Amendment to 12% Subordinated Promissory Note dated as of June 30, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Payee) filed as Exhibit 4.51.1 to Form 8-K dated July 13, 2005.
     
4.2.2
 
Form of Second Amendment to 12% Subordinated Promissory Note dated as of October 25, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Payee) filed as Exhibit 4.50.2 to Form 8-K dated November 8, 2005.
     
4.2.3
 
Form of Amendment to 12% Subordinated Promissory Note and Warrant Purchase Agreement dated as of October 25, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Purchaser) filed as Exhibit 4.50.1 to Form 8-K dated November 8, 2005.
     
4.3
 
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 4.52 to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2004.
     
4.3.1
 
Form of First Amendment to Stock Purchase Warrant dated as of June 30, 2005 between the company and certain accredited investors (individual amendments differ only as to name of Holder) filed as Exhibit 4.51.2 to Form 8-K dated July 13, 2005.
     
4.4
 
Form of Restricted Common Stock Purchase Agreement, dated February 24, 2006 between the Company and certain accredited investors for purchase of 18,750,000 common shares (individual agreements differ only as to number of shares) and filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 27, 2006.
     
4.5
 
Form of Series “A” Warrant exercisable until February 28, 2009, issued February 24, 2006 to certain accredited investors for up to an aggregate of 4,687,500 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K dated February 27, 2006
     
4.6
 
Form of Series “B” Warrant exercisable until six months after the effectiveness of this Registration Statement or July 31, 2008 whichever is earlier, issued February 24, 2006 to certain accredited investors for up to an aggregate of 4,687,500 common shares (individual warrants differ only as to holder and number of shares) and filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K dated February 27, 2006.
     
4.7
 
Form of New Warrant issued to 29 investors in August and September 2006 for an aggregate of 2,331,572 common shares exercisable at $0.15 per share through August 31, 2009 filed as Exhibit 4.53 to Form 8-K dated August 28, 2006
     
4.8
 
Exchange Agreement between the Company and Davric Corporation dated December 1, 2006 filed as Exhibit 99.1 to Form 8-K dated December 12, 2006.
     
4.8.1
 
7.5% Convertible Subordinated Term Note issued by the Company to Davric Corporation dated December 1, 2006 filed as Exhibit 99.2 to Form 8-K dated December 12, 2006.
     
4.9
 
Common Stock Purchase Agreement, dated as of January 2, 2007, by and between e.Digital Corporation and Fusion Capital Fund II, LLC filed as Exhibit 10.1 to Form 8-K dated January 8, 2007.
     
4.10
 
Registration Rights Agreement, dated as of January 2, 2007, by and between e.Digital Corporation and Fusion Capital Fund II, LLC filed as Exhibit 10.2 to Form 8-K dated January 8, 2007.
     
4.11
 
Form of Convertible Preferred Stock Purchase Agreement between the Company and 12 investors for an aggregate of 75,000 Series AA Preferred Shares and Warrants (individual agreements differ only as to number of shares) dated June 27, 2008 filed as Exhibit 99.2 to Form 8-K dated July 1, 2008.
     
4.12
  
Form of Stock Purchase Warrant between the Company and 12 investors for an aggregate of 7,500,000 common shares (individual warrants differ only as to holder and number of shares) dated June 27, 2008 filed as Exhibit 99.3 to Form 8-K dated July 1, 2008.

 
37

 
 
10.1
 
Lease Agreement between the Company and LBA Industrial Fund – Holding Co. II, Inc. and Innsbruck Holdings, L.P. dated March 3, 2006 and filed as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2006.
     
10.2
 
Agreement for Legal Services and Contingent Fee Arrangement dated March 23, 2007 between the Company and Duane Morris LLP filed as Exhibit 99.1 to Form 8-K dated  March 28, 2007. (Portions of this Exhibit have been omitted and filed separately with the Securities and Exchange Commission as part of an application for confidential treatment pursuant to the Securities Exchange Act of 1934, as amended.)
     
10.3
 
Secured Promissory Note of the Company to ASI Capital Corporation dated March 23, 2007 filed as Exhibit 99.3 to Form 8-K dated March 28, 2007.
     
10.3.1
 
Loan Extension Agreement between the Company and ASI Capital Corporation dated as of September 28, 2007 and previously filed as Exhibit 99.1 to Form 8-K dated October 15, 2007.
     
10.3.2
 
Secured Promissory Note of the Company to ASI Technology Corporation dated December 23, 2007 filed as Exhibit 99.1 to Form 8-K dated January 4, 2008.
     
10.3.3
 
Loan Extension Agreement between the Company and ASI Technology Corporation dated as of June 30, 2008 and previously filed as Exhibit 99.1 to Form 8-K dated July 1, 2008.
     
10.3.4
 
Loan Extension Agreement between the Company and ASI Technology Corporation dated as of December 31, 2008 and previously filed as Exhibit 99.1 to Form 8-K dated January 5, 2009.
     
10.4
 
Security Agreement between the Company and its subsidiary and ASI Capital Corporation dated March 23, 2007 filed as Exhibit 99.4 to Form 8-K dated March 28, 2007.
     
10.4.1
 
Security Agreement between the Company and its subsidiary and ASI Technology Corporation dated December 23, 2007 filed as Exhibit 99.2 to Form 8-K dated January 4, 2008.
     
10.5
 
Stock Option Plan adopted by the Company on September 29, 1994 ("1994 Plan"), filed as Exhibit 10.10 to the Company's 1995 Form10-KSB.
     
10.5.1
 
First Amendment to Stock Option Plan adopted by the Company onJanuary 26, 1996 and filed previously as Exhibit 10.14.1 to theCompany's Annual Report on Form 10-KSB dated March 31, 1998.
     
10.5.2
 
Second Amendment to Stock Option Plan adopted by the Company onSeptember 3, 1997 and filed previously as Exhibit 10.14.2 to theCompany's Annual Report on Form 10-KSB dated March 31, 1998.
     
10.5.3
 
Third Amendment to Stock Option Plan adopted by the Company on November 9, 2000 and filed previously as Exhibit B to the Company's Annual Report on Schedule 14A dated September 22, 2000.
     
10.6
 
2005 Equity-Based Compensation Plan, filed as Exhibit B to the to the Company's July 12, 2005 Definitive Proxy Statement.
     
10.6.1
 
Form of Incentive Stock Option Agreement under the 2005 Equity-Based Compensation Plan and filed previously as Exhibit 10.6.1 to the Company’s Annual Report on Form 10-K dated March 31, 2007.
     
10.6.2
 
Form of Nonstatutory Stock Option Agreement under the 2005 Equity-Based Compensation Plan and filed previously as Exhibit 10.6.2 to the Company’s Annual Report on Form 10-K dated March 31, 2007.
     
21.1
 
Subsidiary of e.Digital Corporation. Incorporated by reference to Exhibit 21.1 on Form 10-K for the year ended March 31, 2009, dated June 16, 2009.
     
23.1
  
Consent of SingerLewak LLP, Independent Registered Public Accounting Firm.*

 
38

 
 
31.1
 
 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk, Principal 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 Alfred H. Falk, Principal Executive Officer and Robert Putnam, Principal Accounting Officer.*

*
Filed concurrently herewith.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

e.Digital Corporation
 
By: 
/s/   ALFRED H. FALK
 
   President and Chief Executive Officer

Date:  June 10, 2010

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Name
 
Position
 
Date
         
         
/s/ ALFRED H. FALK
 
President and Chief Executive Officer
 
June 10, 2010
Alfred H. Falk
 
(Principal Executive Officer)
   
         
/s/ ALLEN COCUMELLI
 
Chairman of the Board and Director
 
June 10, 2010
Allen Cocumelli
       
         
/s/ ROBERT PUTNAM
 
Senior Vice President and Director
 
June 10, 2010
     Robert Putnam
 
Interim Chief Accounting Officer and
   
   
Secretary (Principal Financial and Accounting Officer)
   
         
/s/ ERIC M. POLIS
 
Director
 
June 10, 2010
Eric M. Polis
       
         
/s/ RENEE WARDEN
 
Director
 
June 10, 2010
     Renee Warden
  
 
  
 
 
 
39

 

INDEX TO FINANCIAL STATEMENTS
   
Page
     
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND SUBSIDIARY
   
     
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
F-2
     
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2010 AND 2009
 
F-3
     
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED MARCH 31, 2010 AND 2009
 
F-4
     
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED MARCH 31, 2010 AND 2009
 
F-5
     
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MARCH 31, 2010 AND 2009
 
F-6
     
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  
F-7 to F-25
 
 
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
e.Digital Corporation
San Diego, CA

We have audited the accompanying consolidated balance sheets of e.Digital Corporation and subsidiary (the “Company”) as of March 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the two years in the period ended March 31, 2010.  These consolidated financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of March 31, 2010 and 2009, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2010 in conformity with U.S. generally accepted accounting principles.

We were not engaged to examine management's assertion about the effectiveness of the Company's internal control over financial reporting as of March 31, 2010 included in the accompanying Management’s Report on Internal Control Over Financial Reporting and, accordingly, we do not express an opinion thereon.

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 historically suffered recurring losses from operations and has a substantial accumulated deficit.  This raises substantial doubt about the Company’s ability to continue as a going concern.  Management’s plan in regard to these matters are also described in Note 1.  The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ SingerLewak LLP

Los Angeles, CA
June 10, 2010

 
F-2

 


CONSOLIDATED BALANCE SHEETS
[See Note 1 - Nature of Operations and Basis of Presentation]

   
As of March 31
 
   
2010
   
2009
 
   
$
   
$
 
ASSETS
           
Current
           
Cash and cash equivalents
    2,818,727       3,813,990  
Accounts receivable
    108,749       93,771  
Inventory
    347,078       517,163  
Deposits and prepaid expenses
    59,072       26,108  
Total current assets
    3,333,626       4,451,032  
Property, equipment and intangibles, net of accumulated depreciation and amortization of $184,382 and $165,449, respectively
    11,090       26,638  
Total assets
    3,344,716       4,477,670  
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current
               
Accounts payable, trade
    51,997       202,900  
Accrued and other liabilities
    315,948       589,814  
Convertible term note, net of $-0- and $6,141 of debt discount
    -       381,093  
Total current liabilities
    367,945       1,173,807  
Deferred revenue - long term
    -       24,000  
Total liabilities
    367,945       1,197,807  
                 
Commitments and Contingencies
               
                 
Stockholders' equity
               
Preferred stock, $0.001 par value; 5,000,000 shares authorized
               
Series AA Convertible Preferred stock, $0.001 par value, 100,000
               
shares designated: 55,000 and 75,000 issued and outstanding, respectively
               
Liquidation preference of $598,370 and $778,459, respectively
    573,830       610,774  
Common stock, $0.001 par value, authorized 350,000,000,
               
286,950,900 and 282,124,564 shares issued and outstanding, respectively
    286,951       282,125  
Additional paid-in capital
    82,073,012       81,534,566  
Accumulated deficit
    (79,957,022 )     (79,147,602 )
Total stockholders' equity
    2,976,771       3,279,863  
                 
Total liabilities and stockholders' equity
    3,344,716       4,477,670  

See accompanying notes to consolidated financial statements

 
F-3

 


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

   
For the year ended
 
   
March 31
 
   
2010
   
2009
 
  
 
$
   
$
 
Revenues:
           
Products
    204,735       362,079  
Services
    749,134       578,303  
Patent license
    1,600,000       10,115,350  
      2,553,869       11,055,732  
                 
Cost of revenues:
               
Products