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EDIG > SEC Filings for EDIG > Form 10-Q on 12-Feb-2014All Recent SEC Filings

Show all filings for E DIGITAL CORP

Form 10-Q for E DIGITAL CORP


12-Feb-2014

Quarterly Report


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

THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW. SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2013.

Cautionary Note on Forward Looking Statements

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

General

We are a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. We are developing and marketing an intellectual property portfolio including (a) licensing and enforcing our Flash-R portfolio of patents related to the use of flash memory in portable devices, and (b) developing new licenseable intellectual property related to context and interpersonal awareness systems ("Nunchi" technology), data distribution and other technologies. We also market our eVU mobile entertainment system and services for the travel industry.

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

We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against targeted parties that we believe are infringing our patents. We commenced legal enforcement actions in 2007 and since September 2012, the law firm of Handal and Associates has been handling our patent enforcement matters on a partial contingent fee basis.

Currently, we have active lawsuits filed against parties believed to infringe patents covering the use of our flash memory technologies. In October and November 2012 we commenced enforcement action with respect to our patent portfolio by filing complaints in the U.S. District Court for the Southern District of California, asserting that products made and sold by the defendant companies infringe our U.S. patents. We filed additional complaints from December 2012 through December 2013, and subsequently entered into license and settlement agreements with multiple defendants, won a stipulated judgment against one defendant, and dismissed one defendant without prejudice.

On June 28, 2011, the United States District Court for the District of Colorado issued an Opinion and Order Regarding Claim Construction following a January 28, 2011 Markman hearing (a proceeding under U.S. patent law where both sides present to the Court their arguments on how they believe patent terms should be construed). The Opinion construed claim terms in United States Patent 5,491,774 (the '774 patent") one of the Company's Flash-R patents, more narrowly than we had proposed. This Markman ruling could negatively affect future licensing prospects with respect to the '774 patent.

In September 2012 we announced that the United States Patent and Trademark Office (USPTO) had completed the reexamination of the '774 and our. U.S. Patent No. 5,742,737 (the '737). While we were required to supplement one claim of the '737 patent and modify certain claims of the '774 patent, we believe the reexam process reaffirmed important patent claims as we continue our Flash-R patent portfolio monetization activities.

In June 2013, the defendants of the current string of Flash-R enforcement litigation filed a joint motion asking the U.S. District Court for the Southern District of California to prevent the Company from relitigating the meaning of certain terms of the Company's U.S. Patent No. '774 and U.S. Patent No. 5,839,108 ("the '108 patent"). In August 2013, a judge ruled in favor of the defendants for application of the doctrine of collateral estoppel, resulting in the adoption of the meaning of certain terms of the '774 as defined by the judge in the Company's 2010 Colorado litigation. In October 2013, the Company filed an appeal to the Federal Circuit Court of Appeals, formally challenging the ruling. The ruling could adversely impact the Company's efforts to establish patent infringement of certain claims by certain defendants of the '774 patent and the '108 patent. We believe the ruling has no impact on the Company's assertions of patent infringement against the defendants under the '737 and U.S. Patent No. 5,842,170.

While we expect to file future complaints against additional companies and license additional companies, there can be no assurance of the timing or amounts of any related license revenue. We also are developing new intellectual property for possible licensing in the areas of context and interpersonal awareness and advanced data security technologies.

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

Overall Performance and Trends

We focused significant efforts on developing, licensing and enforcing our patent portfolio during the first nine months of fiscal 2014 and during the fiscal years ended March 31, 2013 and 2012. While we have settled and licensed with more than 35 defendants since 2007 to date, there is a reluctance of patent infringers to negotiate and ultimately take a patent license without at least the threat of legal action. However, the majority of patent infringement contentions settle out of court, with such settlements to date being based, we believe, on the strength of our patent claims and the validity and persuasive evidence and clarity that our patents are being infringed. Although we believe we have been successful in early licensing by demonstrating the strength, validity and clarity of our patent claims, future events including court rulings and patent reexamination results could have a significant positive or negative impact on future licensing activity. The 2011 Markman ruling and the 2013 collateral estoppel ruling could negatively affect licensing efforts and future licensing prospects.

Our eVU IFE business remained slow during the first nine months of fiscal 2014. We are unable to predict future sales levels in this market as orders have been and are expected to continue to be sporadic from both existing and new customers because of increased competition from personal devices and airline economics.

Management faces challenges for the remainder of fiscal 2014 to execute our plan to increase Flash-R patent portfolio license fees and monetize our our Nunchi and microSignet technologies. The failure to obtain additional patent license revenues or eVU orders or delays of orders or production delays could have a material adverse impact on our operations. Our patent licensing business is subject to significant uncertainties as to the timing and amount of future license revenues, if any. We may also face unanticipated technical or manufacturing obstacles and face warranty and other risks in our business.

For the nine months ended December 31, 2013 we recognized net income before income taxes of $232,244 compared to a net loss before income taxes of $1,102,682 for the comparable period of the prior fiscal year. Our revenues were $1,837,554 for the first nine months of fiscal 2014 including $1,654,225 of patent license revenue. This compares to revenues of $336,567 for the prior year's first nine months with $2,000 of patent license revenue reported. We reported increased operating expenses totaling $1,605,310 in the nine months ended December 31, 2013 compared to $1,439,249 in the comparable period prior primarily due to increased patent-related legal costs.

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

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements located in Item 1 of Part I, "Financial Statements," and in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report of Form 10-K for the year ended March 31, 2013. The preparation of these financial statements prepared in accordance with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including but not limited to those related to revenue recognition, bad debts, inventory valuation, intangible assets, financing operations, stock-based compensation, fair values, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

revenue recognition;

stock-based compensation expense;

income taxes; and

Inventory reserve

Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. There were no significant changes or modification of our critical accounting policies and estimates involving management valuation adjustments affecting our results for the nine months ended December 31, 2013. For further information on our critical accounting policies, refer to Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended March 31, 2013.

Results of Operations



Three months ended December 31, 2013 compared to the three months ended December
31, 2012



                                    Three Months Ended December 31,
                            2013                          2012
                                           % of                         % of                  Change
                           Dollars        Revenue       Dollars        Revenue         Dollars          %
Revenues:
Products and services         58,867             5 %       79,072           100 %        (20,205 )        (26 %)
Patent licensing           1,227,500            95 %            -             0 %      1,227,500            0 %
                           1,286,367           100 %       79,072           100 %      1,207,295         1527 %
Operating costs and
expenses:
Cost of revenues:
Products and services         83,925             7 %       72,721            92 %         11,204           15 %
Patent licensing and
litigation costs             112,500             9 %       90,000           114 %         22,500           25 %
Contingent legal fees
and expenses                 119,004             9 %            -             0 %        119,004            0 %
Selling and
administrative               179,708            14 %      178,884           226 %            824            0 %
Research and
development                   77,436             6 %      131,161           166 %        (53,725 )        (41 %)
                             572,573            45 %      472,766           598 %         99,807           21 %
Operating income
(loss) before
provision for income
taxes                        713,794            55 %     (393,694 )        (498 %)     1,107,488         (281 %)

Income (Loss) Before Income Taxes

We reported a net income before income taxes of $713,794 for the three months ended December 31, 2013 compared to a net loss before income taxes of $393,694 for the comparable period of the prior year due to increased patent license settlements in the current year.

Revenues

Revenues increased during the most recent fiscal quarter (Q3 of fiscal 2014) compared to the same quarter of the prior fiscal year due to increased license arrangement activity. We experienced reduced product and service revenues due to no significant new customers or product sales and reduced service revenues from ongoing customers. Our product revenues have been sporadic in part as a result of industry economics including the rapid consumer adoption of portable devices resulting in reduced IFE activity. Our service revenues declined and vary depending on repair and content services provided to a changing customer mix. We expect product and service revenues to decline in future quarters due to no significant new customers or product sales and reduced service revenues from ongoing customers.

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

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

fluctuations in the number of agreements executed.

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

the effect of court and USPTO rulings and decisions;

fluctuations in the sales results or other royalty per unit activities of our licensees that impact the calculation of license fees due;

the timing of the receipt of periodic license fee payments and/or reports from licensees.

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

Operating Costs and Expenses

Operating costs and expenses include cost of revenues associated with products and services, and costs associated with our patent licensing and enforcement activities including contingent and non-contingent litigation costs and related enforcement support costs.For the three months ended December 31, 2013, operating costs and expenses increased by $99,807 compared to the same period in the prior year.

Patent licensing legal costs related to Flash-R portfolio enforcement were $112,500 at December 31, 2013 compared to $90,000 in the prior year's third quarter. The $22,500 increase is the result of patent-related consulting fees of $22,500 in the current period with no comparable expense in the same period in the prior year. Non-contingent licensing and litigation costs and related enforcement support costs may be incurred without any directly related revenues in a respective period. Generally contingent costs relate to revenues during a respective period but can vary depending on our share of certain costs and expenses. Prior to fiscal 2013 substantially all patent licensing cost of revenues consisted of contingent legal fees and costs. We reclassified $90,000 of operating expenses for the period ended December 31, 2012 to patent licensing and litigation costs to conform to the current year presentation. This reclassification had no effect on previously reported operating income, results of operations or accumulated deficit.

Contingent legal fees and expenses related to the Flash-R portfolio enforcement were $119,004 for the three months ended December 31, 2013 with no comparable expense for the same period in the prior year. The increase is primarily due to increased patent license settlement arrangements in the current period.

Cost of revenues associated with products and services increased from $72,721 in the prior year's third quarter to $83,925 in the current year. The increase of $11,204 is primarily due to an increase in reserve for inventory obsolescence in the current period of $18,373 as compared to an increase of $3,853 in the prior year's third quarter.

Selling and administrative costs for the three months ended December 31, 2013 were comparable to the same period in the year prior.

Research and related expenses decreased by $53,725 primarily due to $33,372 reduction in patent related legal and consulting fees, and a decrease of salaries and related benefits expenses in the current year of $19,403 as compared to the same period in the prior year. The prior year's third quarter included $1,196 for noncash stock-based compensation expense with no comparable expense in the current period. Research and related expenses can vary significantly from quarter to quarter based on the allocation of time spent by personnel who work on both revenue producing service and repair projects, on patent related costs and on internal research projects. Such expenses also vary based on decisions made regarding outside engineering and consulting.

Income Taxes

During the three months ended December 31, 2013, the Company recorded income tax expense of $15,000. During the same period of the prior year, the Company recorded a tax benefit of $59,200 reflecting an adjustment of state tax accruals related to a change in state tax apportionment factors.

Income (Loss)

The net income for the three months ended December 31, 2013 was $698,794 which included the income tax expense of $15,000. The net loss for the prior comparable third quarter was $334,494 which included the tax benefit of $59,200 reflecting an adjustment of state tax accruals related to a change in state tax apportionment factors.

Nine months ended December 31, 2013 compared to the nine months ended December 31, 2012

                                      Nine Months Ended December 31,
                            2013                           2012
                                           % of                           % of                  Change
                           Dollars        Revenue        Dollars         Revenue         Dollars          %
Revenues:
Product and services         183,329            10 %        334,567            99 %       (151,238 )        (45 %)
Patent licensing           1,654,225            90 %          2,000             1 %      1,652,225        82611 %
                           1,837,554           100 %        336,567           100 %      1,500,987          446 %
Operating costs and
expenses:
Products and services        254,522            14 %        265,846            79 %        (11,324 )         (4 %)
Patent licensing and
litigation costs             337,500            18 %        165,000            49 %        172,500          105 %
Contingent legal fees
and expenses                 148,897             8 %          3,490             1 %        145,407         4166 %
Selling and
administrative               625,935            34 %        558,785           166 %         67,150           12 %
Research and related         238,456            13 %        446,128           133 %       (207,672 )        (47 %)
                           1,605,310            87 %      1,439,249           428 %        166,061           12 %
Operating income
(loss) before
provision for income
taxes                        232,244            13 %     (1,102,682 )        (328 %)     1,334,926         (121 %)

Income (Loss) Before Income Taxes

The income before income taxes of $232,244 for the nine months ended December 31, 2013 resulted primarily from new license arrangements.

Revenues

Revenues increased during the most recent nine months compared to the same period of the prior fiscal year due to increase in patent license revenue from $2,000 to $1,654,225. We currently have one licensee reporting periodic royalties. One such payment was recognized in Q2 of the current year and one in Q2 of the prior year. All other royalties have been one-time fully paid up royalties. Service revenues vary depending on repair and content services provided to a changing customer mix. Since the introduction of the iPad and other tablet-style devices, as well as an abundance of portable entertainment content, eVU product sales activity has been slow and sporadic. Our product sales for the first nine months are not necessarily indicative of future orders. We had a no product order backlog at December 31, 2013. Our service agreements and terms vary with each customer and there is no assurance that our service revenues will continue at comparable levels for the balance of the fiscal year or in future periods.

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

Operating Expenses

Operating costs and expenses include cost of revenues associated with products and services, and costs associated with our patent licensing and enforcement activities including contingent and non-contingent litigation costs and related enforcement support costs.For the nine months ended December 31, 2013, operating costs and expenses increased by $166,061 compared to the same period in the prior year.

Patent licensing legal costs related to the Flash-R portfolio enforcement were $337,500 for the nine months ended December 31, 2013 compared to $165,000 for the same period in the prior year. The $172,500 increase is primarily due to a change in legal representation in September 2012. Non-contingent licensing and litigation costs and related enforcement support costs may be incurred without any directly related revenues in a respective period. Generally contingent costs relate to revenues during a respective period but can vary depending on our share of certain costs and expenses. Prior to fiscal 2013 substantially all patent licensing cost of revenues consisted of contingent legal fees and costs. We reclassified $165,000 of operating expenses for the nine months ended December 31, 2013 to patent licensing and litigation costs to conform to the current year presentation. This reclassification had no effect on previously reported operating income, results of operations or accumulated deficit.

Contingent legal fees and expenses related to the Flash-R portfolio enforcement were $148,897 for the nine months ended December 31, 2013 compared to $3,490 for the same period in the prior year. The $145,407 increase is primarily due to increased patent license settlement arrangements in the current period.

Selling and administrative costs for the nine months ended December 31, 2013 increased by $67,150 compared to the same period in the prior year, primarily due to current year annual meeting costs of $55,563 with no comparable expense in the same period of the prior year. The prior year included a $12,814 expense for noncash stock-based compensation expense with no comparable expense in the same period of the current year.

Research and related expenses decreased by $207,672 due primarily to a reduction of $152,296 of patent related costs due to the completion of the patent reexamination in the prior year, and a $52,568 reduction in staffing costs. Research and related expenses can vary significantly from quarter to quarter based on the allocation of time spent by personnel who work on both revenue producing service and repair projects, on patent related costs and on internal research projects. Such expenses also vary based on decisions made regarding outside engineering and consulting. Research and related expenses for the period ended December 31, 2012 included $3,588 of noncash stock-based compensation with no comparable expense in the same period of the current year.

Income (Loss)

The net income was $217,244 for the nine months ended December 31, 2013 which included the income tax expense of $15,000. The net loss for the prior comparable nine month period was $1,043,482 which included the tax benefit of $59,200 reflecting an adjustment of state tax accruals related to a change in state tax apportionment factors.

Liquidity and Capital Resources

At December 31, 2013, we had working capital of $1,944,173 compared to working capital of $1,658,759 at March 31, 2013. At December 31, 2013 we had cash on hand of $2,044,502.

Operating Activities

Cash provided by operating activities was $304,686 for the nine months ended December 31, 2013. Cash provided by operating activities included the net income of $217,244 increased by net non-cash expenses of $73,192. Major components also providing operating cash was a decrease of $23,775 in deposits and prepaid expenses and a decrease of $114,421 in accounts receivable. A major component reducing operating cash was a $143,265 decrease in accrued and other liabilities.

Cash used by operating activities was $1,075,047 for the nine months ended December 31, 2012. The usage was primarily the result of the net loss of $1,043,482. Major components also providing operating cash was a decrease of $50,682 in inventory and a decrease of $46,393 in accounts receivable. A major component reducing operating cash was a $104,776 decrease in accrued and other liabilities.

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

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

Investing Activities

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

Financing Activities

There were no cash financing activities during the three or nine months ended December 31, 2013.

Debt and Other Commitments

We currently have no debt outstanding other than trade payables and accruals. At December 31, 2013 we had no significant purchase commitments for product and components.

. . .

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