<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
Commission File Number 0-20734
e.DIGITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 33-0865123
------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Empl.
incorporation or organization) Ident. No.)
13114 Evening Creek Drive South, San Diego, California 92128
- ------------------------------------------------------ -----------
(Address of principal executive offices) (Zip Code)
(858) 679-1504
--------------
(Registrant's telephone number, including area code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [_]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Common Stock, par value $0.001 115,117,010
- ------------------------------ -----------
(Class) (Outstanding at November 8, 1999)
Transitional Small Business Disclosure Format (check one): YES [_] NO [X]
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<PAGE>
e.DIGITAL CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 1999 and
March 31, 1999 3
Consolidated Statements of Operations for the three and six
months ended September 30, 1999 and 1998 4
Consolidated Statements of Cash Flows for the six
months ended September 30, 1999 and 1998 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Changes in Securities 14
Item 3. Defaults Upon Senior Securities 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
</TABLE>
2
<PAGE>
Part I. Financial Information
Item 1. Financial Statements:
e.Digital Corporation and subsidiary
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, March 31,
1999 1999
$ $
----------- -----------
<S> <C> <C>
ASSETS
Current
Cash and cash equivalents 2,881,071 166,966
Accounts receivable, less allowance of doubtful
accounts of $nil and $953, respectively 146,195 60,793
Amounts receivable on research and development contracts 32,725 92,725
Inventory [note 5] 125,884 46,907
Prepaid expenses and other 16,088 8,961
----------- -----------
Total current assets 3,201,963 376,352
----------- -----------
Property and equipment, net of accumulated depreciation of
$229,913 and $213,342, respectively 114,063 72,675
Other intangible assets, net of accumulated amortization of
$13,832 and $12,611, respectively 10,577 11,798
----------- -----------
Total assets 3,326,603 460,825
=========== ===========
LIABILITIES, PREFERRED STOCKHOLDERS' EQUITY
AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current
Accounts payable, trade 584,654 597,953
Other accounts payable and accrued liabilities 603,745 711,033
15% Promissory notes payable, net of unamortized discount of
$27,497 and $82,499, respectively [note 6] 322,503 417,501
Current portion of term note payable - 28,020
----------- -----------
Total current liabilities 1,510,902 1,754,507
----------- -----------
Term note payable - 98,163
----------- -----------
Total liabilities 1,510,902 1,852,670
----------- -----------
Preferred stockholders' equity [note 7]
Series A, convertible voting preferred stock, $0.001 par value, redeemable at
$10 plus accrued and unpaid dividends at 8% cumulative,
100,000 shares authorized, 12,500 and 32,500 shares outstanding, respectively 13 33
Series B, 7% convertible, non-voting preferred stock, $0.001 par value,
redeemable in certain instances, 300 shares authorized,
300 and nil shares outstanding, respectively 300 -
Additional paid-in-capital 2,678,845 364,172
----------- -----------
Total preferred stockholders' equity 2,679,158 364,205
----------- -----------
Common stockholders' equity (deficiency) [note 8]
Common stock, $0.001 par value, authorized 200,000,000,
112,907,971 and 97,321,297 shares outstanding, respectively 112,908 97,321
Additional paid-in capital 37,729,106 35,126,914
Prepaid warrants - 261,047
Contributed surplus 1,592,316 1,592,316
Accumulated deficit (40,297,786) (38,833,648)
----------- -----------
Total common stockholders' equity (deficiency) (863,456) (1,756,050)
----------- -----------
Total liabilities, preferred stockholders' equity and common
stockholders' equity (deficiency) 3,326,603 460,825
=========== ===========
</TABLE>
See notes to interim consolidated financial statements.
3
<PAGE>
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
For the three months ended For the six months ended
September 30, September 30,
1999 1998 1999 1998
$ $ $ $
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues:
Products 125,215 51,399 140,277 73,895
Services 25,372 105,853 47,611 181,546
----------- ---------- ----------- ----------
150,587 157,252 187,888 255,441
----------- ---------- ----------- ----------
Cost of revenues:
Products 84,353 33,421 99,224 70,313
Services 70,430 184,214 85,137 267,092
----------- ---------- ----------- ----------
154,783 217,635 184,361 337,405
----------- ---------- ----------- ----------
Gross profit (loss) (4,196) (60,383) 3,527 (81,964)
----------- ---------- ----------- ----------
Operating expenses:
Selling and administrative 296,824 143,774 463,442 364,532
Research and related expenditures 331,654 146,641 546,376 292,489
----------- ---------- ----------- ----------
Total operating expenses 628,478 290,415 1,009,818 657,021
----------- ---------- ----------- ----------
Operating loss (632,674) (350,798) (1,006,291) (738,985)
----------- ---------- ----------- ----------
Other income (expense)
Interest income 25,570 4,600 26,417 5,507
Interest expense (17,390) (7,993) (38,463) (36,387)
Non-cash interest (27,500) (66,692) (55,001) (111,489)
Other - (36,316) (800) (40,383)
----------- ---------- ----------- ----------
Other income (expense) (19,320) (106,401) (67,847) (182,752)
----------- ---------- ----------- ----------
Loss and comprehensive loss for the period (651,994) (457,199) (1,074,138) (921,737)
----------- ---------- ----------- ----------
Loss and comprehensive loss available to
common stockholders' (note 4) (707,446) (472,697) (1,675,563) (956,081)
=========== ========== =========== ==========
Loss per common share - basic and diluted (0.01) (0.01) (0.02) (0.02)
=========== ========== =========== ==========
Weighted average common shares outstanding 112,015,904 60,706,795 110,960,680 59,575,141
=========== ========== =========== ==========
</TABLE>
See notes to interim consolidated financial statements.
4
<PAGE>
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
For the six months ended
September 30,
1999 1998
$ $
---------- ----------
<S> <C> <C>
OPERATING ACTIVITIES
Loss for the period (1,074,138) (921,737)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 17,792 28,366
Loss on disposal of property and equipment - 11,233
Professional services paid by issuance of common stock 108,635 30,000
Non-cash interest expense 55,001 111,489
Changes in assets and liabilities:
Accounts receivable (85,402) 34,567
Amounts receivable on research and development contracts 60,000 (45,731)
Inventory (78,977) 59,743
Prepaid expenses and other (7,127) 582
Accounts payable, trade (13,299) (129,132)
Other accounts payable and accrued liabilities (107,288) (33,515)
---------- ----------
Cash (used in) operating activities (1,124,803) (854,135)
---------- ----------
INVESTING ACTIVITIES
Purchase of property and equipment (57,959) (1,077)
Proceeds on disposal of property and equipment - 12,109
---------- ----------
Cash (used in) provided by investing activities (57,959) 11,032
---------- ----------
FINANCING ACTIVITIES
Repayments of term note payable (126,183) (23,565)
Proceeds from sale of Series B preferred stock 2,750,000 -
Proceeds from exercise of warrants 1,103,375 -
Proceeds from exercise of stock options 169,674 -
Proceeds from 12% convertible promissory notes - 1,000,000
---------- ----------
Cash provided by financing activities 3,896,867 976,435
---------- ----------
Net increase in cash 2,714,105 133,332
Cash and cash equivalents, beginning of period 166,966 62,370
---------- ----------
Cash and cash equivalents, end of period 2,881,071 195,702
========== ==========
Supplemental disclosures of cash information:
Cash paid during the period for:
Interest 38,463 36,387
Supplemental schedule of noncash investing and financing activities:
Professional services paid by issuance of common stock 108,635 30,000
Common stock issued on exercise of prepaid warrants 261,047 307,753
Common stock issued on conversion of Series A preferred stock 221,474 74,665
Warrants issued for services 275,000 -
Promissory note principal applied to warrant exercise 150,000 -
Deemed dividends on warrants 390,000 -
Deemed dividends on Series A and B preferred stock 61,424 34,344
</TABLE>
See notes to interim consolidated financial statements.
5
<PAGE>
E.DIGITAL CORPORATIONS AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1999
1. OPERATIONS
e.Digital Corporation, formerly Norris Communications, Inc. (the "Company"), was
incorporated in the Province of British Columbia, Canada on February 11, 1988
and on November 22, 1994, changed its domicile from British Columbia to the
Yukon Territory, Canada. The Company further changed its domicile to Wyoming on
August 30, 1997 and on September 4, 1997 reincorporated into Delaware. The
Company is engaged through its wholly-owned subsidiary in developing,
manufacturing and marketing advanced electronic products.
2. BASIS OF PRESENTATION
The accompanying interim consolidated financial statements include the accounts
of the Company and its wholly-owned subsidiary of the same name, based in San
Diego, California.
The interim consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the discharge of
liabilities in the normal course of business for the foreseeable future. The
Company has incurred significant losses and negative cash flow from operations
in each of the last three fiscal years and for the six month period ended
September 30, 1999 and has an accumulated deficit of $40,297,786 at September
30, 1999. The Company's operational plan involves focusing on licensing and
product development on a contract basis and for the Company's own account. The
Company's 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.
These interim consolidated financial statements do not give effect to any
adjustments which would be necessary should the Company be unable to continue as
a going concern and therefore be required to realize its assets and discharge
its liabilities in other than the normal course of business and at amounts
different from those reflected in the accompanying interim consolidated
financial statements.
These interim consolidated financial statements have been prepared in accordance
with accounting principles generally accepted for interim financial information
and the instructions to Form 10-QSB. They do not include all information and
footnotes required by generally accepted accounting principles for complete
financial statements. The interim consolidated financial statements and notes
thereto should be read in conjunction with the Company's audited consolidated
financial statements and notes thereto for the fiscal year ended March 31, 1999.
In the opinion of management, the interim consolidated financial statements
reflect all adjustments of a normal recurring nature necessary for a fair
statement of the results for interim periods. Operating results for the six
month period ended September 30, 1999 are not necessarily indicative of the
results that may be expected for the fiscal year ending March 31, 2000.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Investments
and Hedging Activities" ("SFAS No. 133") which establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
The statement also requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000.
The Company does not expect the adoption of SFAS No. 133 to have a material
effect on the Company's consolidated financial statements.
4. LOSS PER SHARE
The Company's losses for the periods presented cause the inclusion of potential
common stock instruments outstanding to be antidilutive and, therefore, in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share," the Company is not required to present a diluted earnings
(loss) per share. Stock options, warrants, convertible notes payable, and
convertible preferred stock exercisable into 17,164,666 shares of Common Stock
were outstanding as at September 30, 1999. These securities were not included in
the computation of diluted earnings (loss) per share because of the losses, but
could potentially dilute earnings (loss) per share in future periods.
6
<PAGE>
E.DIGITAL CORPORATIONS AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1999
The loss available to common stockholders was increased during the six months
ended September 30, 1999 by an imputed deemed dividend of $390,000 based on the
value of warrants issued in connection with 7% Series B Convertible Preferred
Stock (`Series B stock") (see note 7). The loss available to common stockholders
was reduced by a $150,000 deemed dividend computed from the discount provision
included in the Series B stock. The deemed dividends are not contractual
obligations on the part of the Company to pay such deemed dividends. The Series
A Preferred stock ("Series A stock") provides for a dividend of 8% per annum and
the Series B stock provides for a dividend of 7% per annum. The dividends for
the period ended September 30, 1999 were $61,424, which also increases the loss
available to common stockholders. The loss available to common stockholders' is
computed as follows:
<TABLE>
<CAPTION>
Six months ended September 30,
1999 1998
----------- -----------
<S> <C> <C>
Loss and comprehensive loss $(1,074,139) $ (921,737)
Imputed deemed dividend on warrants issued with Series B stock (390,000) -
Dividends on Series A and B stock (61,424) (34,344)
Series B stock dividends computed based on imputed discount at issuance (150,000) -
----------- -----------
Loss available to common stockholders $(1,675,563) $ (956,081)
=========== ===========
</TABLE>
5. INVENTORY
Inventory of raw material and finished goods is recorded at the lower of cost
and net realizable value. Cost is determined on a first-in, first-out basis.
Inventories consist of the following:
September 30, 1999 March 31, 1999
------------------ --------------
Raw material $116,084 $46,907
Finished goods 9,800 -
-------- --------
$125,884 $46,907
======== ========
6. PROMISSORY NOTES
Interest on the 15% unsecured, subordinated, promissory notes is payable
quarterly in cash and the notes are due December 31, 1999.
7. PREFERRED STOCK
Series A
- --------
The 12,500 shares of Series A stock outstanding at September 30, 1999 are
convertible into shares of Common Stock computed by dividing $10.00 plus accrued
and unpaid dividends at 8% per annum by $0.0875, subject to certain future
adjustments. At September 30, 1999, the Series A stock was convertible into
approximately 1.66 million shares of Common Stock. The Company is required to
redeem the Series A stock at $10.00 per share plus accrued and unpaid dividends
on September 1, 2000 and upon the occurrence of certain other events.
Series B
- --------
On June 25, 1999 the Company issued 300 shares of Series B stock for cash of
$10,000 per share and gross proceeds of $3,000,000. Dividends of 7% per annum
are payable, with certain exceptions, either in cash or in shares of Common
Stock at the election of the Company. The stated dollar amount of Series B
stock, is convertible into fully paid and nonassessable shares of Common Stock
of the Company at a conversion price which is the lower of (i) $2.00 per share
or (ii) a per share amount computed on each of two adjustment dates (30 and 60
days after registration of the underlying shares), but not less than $1.50 per
share except as may be subsequently modified as a consequence of certain
possible penalties and other adjustments. The conversion price on the two
adjustment dates is computed at a premium to the average of the three lowest of
the ten day closing bid market prices prior to and including each adjustment
date. The Series B stock shall be subject to automatic conversion on June 24,
2002 subject to certain conditions. At September 30, 1999, the Series B stock
was convertible into approximately 2.04 million shares of Common Stock.
Subsequent to September 30, 1999 a total of 200 shares of Series B stocks were
converted into 1,367,916 shares of common stock through November 8, 1999.
7
<PAGE>
E.DIGITAL CORPORATIONS AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1999
The Series B stock is redeemable in certain instances at the Company's option
and at the holder's election upon the occurrence of certain triggering events
including, without limitations, a lapse of a registration statement for ten non-
consecutive trading days and certain other events. The redemption price upon
such election following a triggering event is the greater of (a) 110% of the
stated value or (b) the product of the number of preferred shares multiplied by
the closing market price multiplied by the stated value per share divided by the
then conversion price per share. In addition, certain shares of Common Stock,
which are converted within 30 trading days of an event triggering redemption are
subject to repurchase. Because the redemption provisions are not entirely within
the control of the Company, the Series B stock is presented as preferred
stockholders' equity on the consolidated balance sheet.
The Company also issued to the purchaser of the Series B stock, warrants to
purchase 195,000 shares of Common Stock at $2.40 per share until June 24, 2004.
In connection with the Series B stock financing, the Company incurred placement
agent fees and legal and related costs of approximately $250,000 and issued a
warrant to purchase 137,615 shares of Common Stock at $3.27 per share until June
24, 2004 as a placement agent fee. The value assigned to the 137,615 warrants
issued as a placement fee was $275,000.
8. COMMON STOCKHOLDERS' EQUITY (DEFICIENCY)
The following table summarizes Common Stockholders' equity transactions during
the six month period ended September 30, 1999:
<TABLE>
<CAPTION>
Additional
paid-in Prepaid Contributed Accumulated
Shares Amount capital Warrants Surplus Deficit Total
---------- -------- ----------- --------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, March 31, 1999 97,321,297 $ 97,321 $35,126,914 $ 261,047 $1,592,316 $(38,833,648) $(1,756,050)
Stock issued on exercise of
prepaid warrants 4,493,335 4,493 256,554 (261,047) - - -
Stock issued on exercise of
stock options 1,928,944 1,929 167,743 - - - 169,672
Stock issued for services 84,639 85 108,550 - - - 108,635
Stock issued on exercise of
warrants 5,678,571 5,679 1,247,696 - - - 1,253,375
Stock issued for exercise of
cashless warrants 828,476 828 (828) - - - -
Stock issued on conversion of
20,000 shares of Series A
stock 2,572,709 2,573 218,901 - - - 221,474
Deemed dividend on 195,000
warrants issued with
Series B stock - - 390,000 - - (390,000) -
Value assigned to 137,615
warrants granted in
connection with issuance of
Series B stock - - 275,000 - - - 275,000
Dividends on Series A stock - - (5,040) - - - (5,040)
Dividends on Series B stock - - (56,384) - - - (56,384)
Net loss for the period - - - - - (1,074,138) (1,074,138)
----------- -------- ----------- --------- ---------- ------------ -----------
Balance, September 30, 1999 112,907,971 $112,908 $37,729,106 - $1,592,316 $(40,297,786) $ (863,456)
=========== ======== =========== ========= ========== ============ ===========
</TABLE>
8
<PAGE>
E.DIGITAL CORPORATIONS AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1999
9. WARRANTS AND OPTIONS
At September 30, 1999 warrants were outstanding/exercisable into the following
listed shares.
<TABLE>
<CAPTION>
Number of Exercise Price
Description Shares U.S.$ Expiration Date
- ----------- ---------- -------------- ---------------
<S> <C> <C> <C>
Warrants 20,570 0.25 February 2000
Warrants 25,000 0.25 March 2000
Warrants 400,000 0.10 January 2004
Warrants 3,500,000 0.10 June 2000
Warrants 27,500 0.25 March 2001
Warrants 125,000 0.0875 October 2001
Warrants 100,000 0.10 January 2002
Warrants 2,000,000 0.10 June 2003
Warrants 2,571,427 0.15 March 2002
Warrants 195,000 2.40 June 2004
Warrants 137,615 3.27 June 2004
--------- ------------- ---------------
Total 9,102,112
========= ============= ===============
</TABLE>
Subsequent to September 30, 1999 warrants on 932,141 shares were exercised for
cash proceeds of $136,391.
The following table summarizes stock option activity for the period:
<TABLE>
<CAPTION>
Number of Weighted Average
Shares Exercise Price
--------- ----------------
<S> <C> <C>
Outstanding at March 31, 1999 6,334,000 $0.1362
Granted - -
Exercised (1,928,944) $0.088
Expired (40,000) $3.65
Canceled - -
---------
Outstanding at September 30, 1999 4,365,056 $0.110
=========
Exercisable at September 30, 1999 3,382,556 $0.114
=========
</TABLE>
Options outstanding are exercisable at prices ranging from $0.0875 to $3.65 and
expire over the period from 2000 to 2004 with an average life of 3.95 years.
10. INCOME TAXES
The Company has not provided a tax provision for the current period, due to
current losses. As of March 31, 1999, the Company has U.S. net operating loss
carryforwards of approximately $29,945,000 and $14,787,000 for federal and state
taxes purposes, respectively, subject to certain limitations.
9
<PAGE>
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 AND UNDER THE SUB-HEADING,
"BUSINESS RISKS." SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB FOR THE
YEAR ENDED MARCH 31, 1999.
GENERAL
We provide innovative product designs and technologies for the rapidly growing
market for electronic devices using portable storage media. We employ our
patented MicroOS(TM) file management system as the intelligence targeted for
portable digital voice, music, audio, image, video and data recording devices
that interface with computers and the Internet. We anticipate that the majority
of our future revenues will be from licenses, royalty fees, and private label
agreements for products employing our MicroOS(TM) technology and from contract
development services for and sales to OEMs of custom digital products.
We commenced initial shipments in late June 1999 against approximately $3
million of production orders from Lanier Worldwide, Inc. ("Lanier"). These
shipments result from a January 1997 development and supply agreement (the
"Lanier Agreement"). Our initial order represents approximately five months of
orders for digital recording products targeted for the medical market. These
products are intended to be sold worldwide by Lanier's sales force. Our Lanier
contract provides for rolling six month forecasts of requirements and three
month rolling orders for future products.
During the quarter ended September 30, 1999 we were in production startup with
our contract manufacturer. We anticipate a significant increase in production in
the third fiscal quarter (ending December 31, 1999) for Lanier. We are scheduled
to ship in excess of $1 million worth of product to Lanier during the fiscal
third quarter. At September 30, 1999 our backlog of orders was $3.25 million
from Lanier. Anticipated shipments and our backlog are subject to change due to
a variety of factors many outside our control. Our customers may modify or
cancel orders and delay or change schedules. Shipments may also be delayed due
to production delays, component shortages and other production related issues.
In August 1998, we entered into a development agreement with Intel Corporation
("Intel") and we are designing and developing a digital voice recorder reference
design and prototypes. Under this agreement, Intel is paying us non-recurring
engineering fees for design and development of prototypes.
We are also supplying digital music player prototypes to Lucent Technologies and
performing other work to port Lucent's Enhanced Perceptual Audio Coder ("EPAC")
compression technology to a new Texas Instrument Digital Signal Processor
("DSP"). We are actively seeking to develop licensing, private label, and OEM
opportunities, which further will enable us to penetrate the digital recording
and playback market.
Our management is currently in discussions with OEM's interested in using our
Internet music player reference designs. We recently completed and demonstrated
a third generation secured portable internet music player employing Lucent's
EPAC digital compression technology. We intend to support various emerging
Digital Rights Management Systems ("DRMS") that support the Secure Digital Music
Initiative ("SDMI"). We have signed a non-exclusive license agreement to support
Liquid Audio Inc.'s SP3 DRMS and intend to support other emerging DRMS
developers. We are also currently in discussions with several popular DRMS
providers. There can be no assurance that we will support additional DRMS or
that OEM's will use our Internet music player reference designs.
We have incurred operating losses in each of the last three fiscal years and
these losses have been material. We incurred an operating loss of $2.6 million
in fiscal 1998 (including an inventory write-off of $1.3 million) and $1.8
million in fiscal 1999. Our current level of monthly cash operating costs is
approximately $180,000 per month compared to $120,000 per month for September
1998, with the growth attributed to increase expenditures in the development of
the digital music player and the addition of research and development personnel.
Moreover, we may increase expenditure levels in future periods to support our
digital music business and to support OEM customers. Accordingly, our losses are
expected to continue until such time as we are able to realize supply,
licensing, royalty and development revenues sufficient to cover our fixed costs
of operations. We continue to be subject to the risks normally associated with
any new business activity,
10
<PAGE>
including unforeseeable expenses, delays and complications. Accordingly, there
is no assurance we can or will report operating profits in the future.
We are focused on OEM licensing with respect to our MicroOS(TM) file management
system and contract development of private label and custom-designed products
for digital music applications, dictation systems, and computer peripherals and
telecommunication equipment. Revenue from licensing, royalties and development
services, and additional product supply arrangements, if any, are expected to be
subject to significant month to month variability resulting from the limited
market penetration and license activity to date, the timing and delays
associated with OEM new product introductions and the seasonal nature of demand
for consumer electronic products. Development and OEM contracts and product
orders may be delayed or terminated by customers and are subject to a number of
factors beyond the Company's control. The termination of the Lanier Agreement or
the lack of market success of the recently introduced digital recorder products
by Lanier would have a material adverse effect on our operations. The markets
for consumer electronic products are subject to rapidly changing customer tastes
and a high level of competition. Demand for our products is expected to be
influenced by OEM market success, technological developments and general
economic conditions. Because these factors can change rapidly, customer demand
for our technology can also shift quickly. We may not be able to respond to
technical developments by competitors because of the time required and risks
involved in the development or introduction of new or improved technology and
due to limited financial resources.
RESULTS OF OPERATIONS
For the first six months of fiscal 2000, we reported revenues of $187,888, a 26%
decrease from revenues of $255,441 for the first six months of fiscal 1999.
Product sales increased in the current period due to Lanier shipments while
service revenues decreased primarily due to a decline in Lanier development
services revenues. Three customers accounted for 95% of fiscal 1999's first six
months of revenues and three customers accounted for total revenue in the first
six months of fiscal 2000. The loss of a customer could have a material adverse
impact on our results of operations.
Revenue for the first six months of fiscal 2000 included product revenue of
$140,277 compared to $73,895 for the prior year's first six months. The increase
is due to Lanier product shipments. Product revenue generated a gross profit for
the six months ended September 30, 1999 and 1998 of 29% and 5%, respectively.
Our product shipments in fiscal 2000 consisted entirely of shipments as part of
our $3 million initial production order from Lanier. Product sales for the three
months ended September 30, 1999 increased 138% to $125,215 with a 33% gross
profit as compared to $51,399 with a 35% gross profit for the prior year's
second quarter.
Service revenues for the first six months of fiscal 2000 were $47,611 compared
to $181,546 for the comparable period of the prior year. Prior year service
revenue included $159,170 from the Lanier development contract. Second fiscal
2000 quarter service revenues were $25,372 compared to $105,853 for the prior
year's second quarter. The six month ended September 30, 1999 service revenue
included $17,611 and $30,000 recognized under the Intel and Lucent development
agreements, respectively.
For the six months ended September 30, 1999, we reported a gross profit of
$3,527 compared to a gross loss of $81,964 for the first six months of fiscal
1999. Cost of sales consisted of $99,224 of product costs and $85,137 of
contract services consisting mostly of research and development labor being
funded in part by the Lucent and Intel development agreements. Cost of sales for
the three months ended September 30, 1999 and 1998 were $154,783 and $217,635,
respectively. We are substantially completed on the Lanier development contract.
Although we do not anticipate any significant future contract losses, there can
be no assurance we can attain positive gross margins in the future or with
future customers. At the present time warranty reserves are not material and we
do not anticipate significant warranty costs in future periods. Our contract
supply agreement provides a twelve month manufacturing warranty.
Total operating expenses (consisting of research and related expenditures and
selling and administrative expenses) for the six months ended September 30,
1999, were $1,009,818, as compared to $657,021 for the six months ended
September 30, 1998. Selling and administrative costs aggregated $463,442 in the
first six months of fiscal 2000 compared to $364,532 in the prior period. The
$98,910 increase in selling and administrative costs resulted primarily from an
increase in legal expenses and related costs of $61,370; an increase in annual
meeting related costs of $28,630 due to a significant increase in the number of
shareholders; and an increase in personnel expenditures and associated costs of
$51,368 offset by the inclusion of a $55,000 non-recurring equity transaction
fee in the prior year's first quarter. Selling and administrative costs for the
three months ended September 30, 1999 were $296,824 compared to $143,774 for the
second quarter of the prior year. We anticipate selling and administrative
expenses to continue at higher levels than prior periods due to increased
11
<PAGE>
personnel costs. We hired a business development executive in October 1999 to
support an increase in prospective customers.
Research and related expenditures for the six months ended September 30, 1999
were $546,376, as compared to $292,489, for the six months ended September 30,
1998. The $253,887 increase in research and development costs resulted primarily
from an increase in consulting and engineering services of $25,716; an increase
in preproduction and other related costs of $67,130; and an increase in
engineering personnel and related costs of $134,330 resulting from a greater
percentage of in-house development compared to contract services. Research and
development for the three months ended September 30, 1999 and 1998 were $331,654
and $146,641, respectively. Research and development costs are subject to
significant quarterly variations depending on the use of outside services, the
assignment of engineers to development projects and the availability of
financial resources.
We reported an operating loss of $1,006,291 for the six months ended September
30, 1999, as compared to operating loss of $738,985 for the six months ended
September 30, 1998. The operating loss for the second quarter of fiscal 2000 was
$632,674 compared to $350,798 in the second quarter of the prior year. The
increase resulted primarily due to increased operating costs. We believe, but
there can be no assurance, that our strategy of investing in OEM developments
with supply or royalty provisions will provide positive margins in future
periods. The timing and amount of product sales and the recognition of contract
service revenues impact our operating losses. Accordingly, there is substantial
uncertainty about future operating results and the results for the first six
months are not necessarily indicative of operating results for future periods or
the fiscal year.
Our cash interest expense for the six months ended September 30, 1999 was
$38,464 comparable to $36,387 for the prior period.
We reported a loss for the first six months of the current fiscal year of
$1,074,139 compared to a loss of $921,737 for the prior year's first six months.
The loss available to common stockholders for the six months ended September 30,
1999 of $1,675,563 includes $390,000 of imputed dividends on the issuance of
warrants with the Series B stock, $61,424 of dividends and $150,000 related to
an imputed discount at issuance of the Series B stock.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, we had working capital of $1,691,061 compared to a
working capital deficit of $1,378,155 at March 31, 1999. We had $125,884 of
working capital invested in inventories at September 30, 1999. In June 1999, we
completed the sale of $3,000,000 of Series B 7% Convertible Preferred Stock.
The proceeds are being applied for continued operating capital.
For the six months ended September 30, 1999, net cash increased by $2,714,105.
Cash used in operating activities was $1,124,803. Major components using cash
were a net loss of $1,074,138 reduced by $17,792 of aggregate depreciation and
amortization, $108,635 for services paid by issuance of Common Stock and $55,001
of non-cash interest, or a use of cash of $892,710. The major change in assets
and liabilities providing cash from operating activities was a reduction in
amounts receivable on research and development contracts of $60,000. The major
changes in assets and liabilities using operating cash was an increase in
accounts receivable of $85,402, a reduction in accounts payable, trade of
$13,299 and a reduction in other accounts payable and accrued liabilities of
$107,288.
At September 30, 1999 we had cash on hand of approximately $2.88 million. Other
than cash on hand and accounts receivable, we have no material unused sources of
liquidity at this time. Based on our cash position assuming (a) continuation of
existing OEM development arrangements, (b) currently planned expenditures and
level of operation, (c) product sales against existing orders; we believe we
have sufficient capital resources for the next twelve months. However actual
results could differ significantly from management plans. The actual future
margins to be realized, if any, and the timing of shipments and the amount and
quantities of Lanier shipments, orders and reorders are subject to many factors
and risks, many outside our control.
Should additional funds be required and not be available, we may be required to
curtail or scale back staffing or operations. There can be no assurance that
additional funding in the future will be available or on what terms. Potential
sources of such
12
<PAGE>
funds include exercise of outstanding warrants and options, loans from
shareholders or other debt financing or additional equity offerings.
We may, from time to time, seek additional funds through lines of credit, public
or private debt or equity financing. We estimate we will require additional
capital to finance future developments and improvements to our technology. There
can be no assurances that additional capital will be available when needed. Any
future financings may also be dilutive to existing shareholders.
FUTURE COMMITMENTS AND FINANCIAL RESOURCES
We have recorded an obligation with a prior vendor providing for future payments
of approximately $515,000 from time to time based on agreed upon percentages of
future equity raised.
We have only recently commenced production on the Lanier products. We believe
our third party contract manufacturing arrangement minimizes the working capital
funds required for the production of Lanier orders. We are subject to the risk
that should this arrangement be modified or not produce the desired results,
that we would be required to supply substantial working capital for the
production of the Lanier orders. We rely on a third party manufacturer for
production of the Lanier products and are therefore subject to the substantial
risks associated with using a sole supplier.
Our plans for our MicroOS Audio(TM) technology are to continue to develop the
technology and seek OEM partnerships to exploit the technology. We may require
additional funds to continue development of this and other technologies and the
extent of such requirements is not presently determinable by management.
If, in the future, our operations increase significantly, we may require
additional funds. We might also require additional capital to finance future
developments, acquisitions or expansion of facilities. We currently have no
plans, arrangements or understandings regarding any acquisitions.
YEAR 2000 READINESS DISCLOSURE
We are aware of the issues associated with the programming code in existing
computer systems as the Year 2000 approaches. The "Year 2000" problem is
concerned with whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail. The Year 2000 problem is pervasive and complex as the computer operation
of virtually every company will be affected in some way which could lead to
business disruptions in the U.S. and internationally.
We have identified the following areas, which could be impacted by the Year 2000
issue. They are: Company designed and produced products; internally used systems
and software; products or services provided by key third parties; and the
inability of OEM customers and prospective customers to process business
transactions relating to revenue and product sales.
During the first calendar quarter ended March 31, 1999 we completed an initial
review of our internal systems. The review consisted of an evaluation of
significant internal hardware systems and major software application programs,
which are primarily, packaged third party "off-the-shelf" software programs. As
a result of this review we have identified certain systems which require further
review and probable upgrades to be Year 2000 ready, the costs of which are
included in our estimates outlined below. Our MicroOS(TM) technology does not
have any material Year 2000 problems.
We continue to assess the compliance of our major customers, suppliers and
vendors. We believe that third-party relationships upon which we rely represent
the greatest risk with respect to the Year 2000 issue, because we cannot
guarantee that third parties will be able to adequately assess and address their
Year 2000 compliance issues in a timely manner. We have tested the Lanier
products being produced and believe they are Year 2000 compliant. Our
manufacturing supplier has assured us in writing that it has no material Year
2000 issues and will be able to continue to produce product in their factory.
However, production is dependent upon outside part and component suppliers and
there can be no assurance that supply of critical components would not impede
production of products pursuant to Lanier orders. Failures of component
suppliers to the factory or failure at the factory would have a material adverse
effect on our operations.
As a consequence, we can give no assurances that issues related to Year 2000
will not have a material adverse effect on future results of operations or
financial condition.
13
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Total costs relating to the our compliance efforts, based on management's best
estimates range from $10,000 to $20,000 consisting primarily of obtaining,
installing and testing new computers and upgrades of third party "off-the-shelf"
software programs. During the second quarter ending September 30, 1999, we hired
an Information Systems ("IS") director to address all Year 2000 issues. To date
there have been no material direct out-of-pocket costs. Maintenance or
modification costs will be expensed as incurred, while the costs of new
computers or software will be capitalized and amortized over the respective
useful life.
Should we not be completely successful in mitigating internal and external Year
2000 risks, the likely worst case scenario could be a system failure causing
disruptions of operations, including, among other things, a temporary inability
to distribute products under the Lanier contract or to process transactions,
develop products, send invoices or engage in similar normal business activities
at our location or with vendors and suppliers. If we determine certain suppliers
are not Year 2000 compliant, we may have to arrange for alternative sources of
supply and the stockpiling of inventory in the fall of 1999 in preparation for
the Year 2000. We currently have no plans to stockpile inventory. However, we
cannot estimate at this time the cost or effect on our financial condition of
any stockpiling of inventory should we later determine this step is necessary.
We currently have no other contingency plans with respect to potential Year 2000
failures of our suppliers or customers and at the present time, after an initial
evaluation, do not intend to develop one other than continuing to work with
Eltech Electronics Technology, the contract manufacturer of our OEM products, to
mitigate the Lanier product Year 2000 exposure. If the above failures would
occur, depending upon their duration and severity, they could have a material
adverse effect on our business, results of operations and financial condition.
The information set forth above under this caption "Year 2000 Readiness
Disclosure" relates to our efforts to address the Year 2000 concerns regarding
our (a) operations, (b) products and technologies licensed or sold to third
parties and (c) major suppliers and customers. Such statements are intended as
Year 2000 Statements and Year 2000 Readiness Disclosures and are subject to the
"Year 2000 Information Readiness Act."
BUSINESS RISKS
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 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 and substantial business risk
factors described above and in the Company's Annual Report on Form 10-KSB for
the year ended March 31, 1999 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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in routine litigation incidental to the conduct of its business.
There are currently no material pending legal proceedings to which we are a
party or to which any of our property is subject.
ITEM 2. CHANGES IN SECURITIES
(a) NONE
(b) NONE
(c) NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
14
<PAGE>
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
NONE
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
e.DIGITAL CORPORATION AND SUBSIDIARY
Date: November 12, 1999 By: /s/ RENEE WARDEN
---------------
Renee Warden
Controller
(Principal Financial and Accounting
Officer and duly authorized to sign on
behalf of the Registrant)
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10-QSB AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 2,881,071
<SECURITIES> 0
<RECEIVABLES> 178,920
<ALLOWANCES> 0
<INVENTORY> 125,884
<CURRENT-ASSETS> 3,201,963
<PP&E> 343,976
<DEPRECIATION> 229,913
<TOTAL-ASSETS> 3,326,603
<CURRENT-LIABILITIES> 1,510,902
<BONDS> 0
2,679,158
0
<COMMON> 112,908
<OTHER-SE> (976,364)
<TOTAL-LIABILITY-AND-EQUITY> 3,326,603
<SALES> 140,277
<TOTAL-REVENUES> 187,888
<CGS> 99,224
<TOTAL-COSTS> 184,361
<OTHER-EXPENSES> 1,009,818
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 93,464
<INCOME-PRETAX> (1,074,138)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,074,138)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
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<NET-INCOME> (1,074,138)
<EPS-BASIC> (.02)
<EPS-DILUTED> 0
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