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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2000
Commission file number 0-20734
e.Digital Corporation
(Name of small business issuer in its charter)
Delaware 33-0591385
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
13114 Evening Creek Drive South
San Diego, California 92128
(858) 679-1504
(Address and telephone number of principal executive offices)
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)
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
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Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [ X ]
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State issuer's revenues for its most recent fiscal year. $489,962
The aggregate market value of the issuers Common Stock held by non-affiliates of
the registrant on June 16, 2000 was approximately $702,327,825 based on the
average of the closing bid and ask price of $5.5625 as reported on the NASD's
OTC electronic Bulletin Board system.
As of June 16, 2000 there were 126,261,182 shares of e.Digital Corporation
Common Stock, par value $.001, outstanding and 1,900 shares of Series A
Preferred Stock, par value $0.001 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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TABLE OF CONTENTS
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Page
PART I
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ITEM 1. Description of Business 2
ITEM 2. Description of Property 13
ITEM 3. Legal Proceedings 13
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters 14
ITEM 6. Management's Discussion and Analysis or Plan of Operation 14
ITEM 7. Financial Statements 22
ITEM 8. Changes In and Disagreement With Accountants on Accounting and Financial Disclosure 22
PART III
ITEM 9. Directors, Executive Officers, Promoters and Control Persons,
Compliance With Section 16(a) of the Exchange Act 22
ITEM 10. Executive Compensation 23
ITEM 11. Security Ownership of Certain Beneficial Owners and Management 25
ITEM 12. Certain Relationships and Related Transactions 25
ITEM 13. Exhibits and Reports on Form 8-K 26
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SIGNATURES
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. DESCRIPTION OF BUSINESS
General Overview
We offer an engineering partnership for leading electronics companies to create
portable digital devices that can link to PCs and the Internet. We market to
OEMs (Original Equipment Manufacturers) complete end-to-end solutions for
delivery and management of open and secure digital media with a focus on music
players/recorders and portable digital voice recorders. Services offered by us
range from the licensing of our patented MicroOS(TM) file management system to
custom software and hardware development, industrial design and manufacturing
services, often incorporating the OEM's unique or proprietary features and/or
technology. We focus our marketing efforts on OEMs in a range of digital
processing markets including dictation equipment, digital music, consumer
electronics, digital image and video and other portable product markets. Our
revenue will result from a combination of fees from licensing, engineering
services,manufacturing services, warranty services, industrial design services,
and unit royalty payments.
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Company
Our parent holding company, e.Digital Corporation, is a Delaware corporation
("e.Digital" or the "Company"). Our operations are conducted through a wholly
owned California subsidiary, also named e.Digital Corporation ("Subsidiary").
e.Digital was incorporated in the Province of British Columbia, Canada on
February 11, 1988 and on November 22, 1994 we changed our domicile to the Yukon
Territory, Canada. On August 30, 1996, we filed articles of continuance to
change our jurisdiction to the State of Wyoming, then on September 4, 1996,
reincorporated in the State of Delaware. On January 13, 1999, our shareholders
approved a name change from Norris Communications, Inc. to e.Digital
Corporation. The address of our principal executive office is 13114 Evening
Creek Drive South, San Diego, California 92128 and our telephone number is (858)
679-1504. Our primary operating facilities are located at that address. Our
Internet site is located at www.edig.com.
Recent Developments
We recently commenced delivery of digital dictation products that we developed
under contract for Lanier Worldwide, Inc. ("Lanier"). Shipments of the products,
known as "Cquence Mobile," are pursuant to our agreement with Lanier signed in
1997, and which expires at the end of December 2001. On April 27, 2000, Lanier
announced that it intends to sell its voice processing (dictation) business
which, we are informed, would include the Cquence Mobile line. Details of the
transaction, including the identity of the potential buyer or buyers and the
time frame for the transaction, are not known at this time. We do not know the
impact, if any, that any such transaction, if consummated, would have on future
orders under the Lanier agreement.
We recently developed a reference design for a portable, Internet music player.
In January 2000, we licensed our design and technology to Maycom Company, Ltd.
("Maycom"), a turnkey manufacturer of digital audio and radio communication
products. Maycom has announced its intentions to incorporate our technology into
a portable, Internet music player scheduled to be introduced to the consumer
market in summer 2000. In addition, Maycom has incorporated our technology into
a portable Internet music player design being marketed to third party OEM
customers and/or licensees by both Maycom and our marketing personnel. It is
anticipated that any such OEM products would be manufactured by Maycom.
In October 1999, we completed a purchase order from Lucent Technologies
("Lucent") to port Lucent's EPAC audio compression technology to a new Texas
Instrument digital signal processor ("DSP") chip.
We recently entered into a license agreement with InterTrust Technologies, the
MetaTrust Utility(TM), allowing us to incorporate their digital rights
management ("DRM") platform for embedded systems into our portable Internet
music player designs. We have also licensed IBM's DRM technology known as
EMMS(TM), and Microsoft's WMA(TM) (Windows Media Audio) which includes DRM
capabilities for optional inclusion in our portable Internet music player
designs. DRM technologies protect and manage rights and interests in digital
information.
We have entered into an agreement with RioPort, Inc. to integrate RioPort's
secure digital audio platform with our Internet music player designs. RioPort
will provide compatibility to our designs through its RioPort Audio Manager
software and other related software tools including the RioPort Media Device
Manager API (R)MDM, allowing consumers to easily transport digital audio content
from the Internet directly to portable devices that use our design.
We are also developing portable solutions for the emerging mobile enterprise
industry that is implementing voice and voice processing in corporate-wide
environments involving mobile, wireless, and/or desktop technology.
Industry Background
We design products employing portable storage media with the major categories
being digital recorders and related mobile devices and the rapidly emerging
Internet music market.
Portable Storage Market
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Our MicroOS(TM) technology serves as the intelligence for portable storage media
such as, Flash memory and IBM's Microdrive technology. The traditional data
storage market includes dynamic random access memory ("DRAM") as the main system
memory, static random access memory ("SRAM") as specialized and high speed
memory, hard disk drives for high capacity data storage and floppy disk drives
for low capacity removable data storage.
In recent years, digital processing has expanded beyond the boundaries of
desktop computer systems to include an array of electronic systems. These new
devices include hand-held data collection terminals, medical monitors, mobile
communication systems, highly portable computers, digital cameras, cellular
telephones, wireless base stations, network computers, digital audio and music
recorders and other electronic systems. These emerging applications have storage
requirements that are not well addressed by traditional storage solutions.
Important requirements include small form factor, high reliability, low power
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consumption and the capability to withstand high levels of shock and vibration
and extreme temperature fluctuations. In the late 1980s, a new memory
technology, known as Flash memory, was developed for these applications.
Flash memory-based products are solid-state devices. They are non-volatile,
meaning that no ongoing source of power is required in order for the products to
retain data indefinitely. Flash is noiseless, considerably lighter, more rugged
and consumes less power than older disk drive technology. A variety of form
factors have been developed using Flash memory including PC cards,
CompactFlash(TM) cards, Secure Digital(TM) Memory Cards, miniature cards, Memory
Sticks(TM), multimedia cards, smart media cards and others. Flash products are
produced by a large number of firms including Intel Corp., SanDisk Corporation,
AMD, Sony, M-Systems, Samsung, TDK, Toshiba and others. Industry estimates
indicate Flash card revenues amounted to $474 million in 1999 and the market is
projected to increase at a compound annual growth rate of more than 43 per cent
through 2003 according to International Data Corp. Late 1999 shortages of flash
cards are being addressed or have been addressed by major manufacturers opening
additional Flash memory factories and/or increasing production capacities at
existing manufacturing facilities.
A newer technology consistent with the very popular CompactFlash form factor is
IBM's new Microdrive technology designed to provide higher storage capacity for
portable devices. Microdrives are high capacity miniature one-inch hard disk
drives. IBM announced the availability of 340 MB Microdrives in early 2000.
We believe these portable storage formats are complicated to use and generally
require a sophisticated file system. A file system is a software driver which is
used to make portable memory components more closely emulate a disk drive and
allow an understood mechanism for rapidly storing and retrieving data with the
minimal overhead allowed in a portable device.
Our current product applications have focused on CompactFlash cards.
CompactFlash is available in capacities ranging from two megabytes to 192
megabytes in Type I format, and up to 1 Gigabyte in Type II format. Our
technology also supports SanDisk's multimedia card format and Secure Digital
memory card format (created by SanDisk, Toshiba, and Matsushita, best known by
its Panasonic brand name), the IBM Microdrive format, Intel Miniature Card
format and others, thereby offering customers design flexibility and choices
among portable storage memory. Intel, SanDisk and other large manufacturers are
aggressively promoting high volume use of portable storage media in a variety of
new product concepts.
As a developer of advanced electronic products and technologies employing
portable storage media, the Company's success is in part dependent upon the
continued growth and use of various forms of portable storage media. New product
applications are also premised, in part, on continued reductions in the per-
megabyte cost of such memory.
Digital Recording, Related Mobile Devices and Mobile Enterprise Markets
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The consumer electronics market is undergoing a major technology convergence in
ever smaller products which combine multiple functions. Palm-type computers are
tiny PCs that allow users to access their e-mail from remote locations. Cellular
phones are incorporating PC features and pagers are combining with cellular
phones and voice-mail systems. Consumer electronic manufacturers are integrating
functions and devices at an extremely fast pace, and technology consumers are
eager to take advantage of "convergence" products.
The older analog dictation products market is evolving to fully digital
dictation systems interfacing with computers and the text-to-voice and emerging
voice-to-text technology markets. The mobile enterprise industry is focused on
integrating voice and voice processing into mobile devices and corporate
enterprise solution software. We believe these movements will impact all types
of portable and mobile products and technologies.
The Internet is impacting business and technology in unparalleled ways. Voice
and text mail is burgeoning. Music, data and audio can be downloaded through the
Internet to the personal computer creating a market for portable devices that
can interface digitally. Portable storage media prices are dropping, improving
the outlook for portable devices that employ such memory. These moves, along
with lower voltage storage media and improved battery technology, are expected
to expand the market for portable and mobile devices.
The worldwide electronics industry is quickly evolving to provide more
electronic content to consumer items, including portable devices. The fast-paced
electronics industry presents challenges for developers of electronic products,
where time-to-market, cost, performance, quality, reliability, size and the need
for product diversity become the focus in a volatile industry.
The Voice Technology Initiative for Mobile Enterprise Solutions (VoiceTIMES)
initiative, formed in April 1999, plans to establish standards for mobile speech
technology incorporate environments. Its membership is engaged in targeted
research studies to identify enterprise solutions where mobile devices can
change the way companies do business by providing plug and play compatible
mobile devices. The initial areas of research include the medical industry, law
enforcement, insurance, services, field sales and ERP systems. We believe, as an
inaugural member of VoiceTIMES, that we will benefit from this
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research which will provide a range of marketing and sales opportunities. We are
focusing research and development activities towards these product markets.
Digital Music and the Internet
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Music is one of the most popular forms of entertainment in the world. According
to the Recording Industry Association of America, or RIAA, worldwide sales of
recorded music were nearly $40 billion in 1999, with the U.S. recording industry
accounting for one-third of that world market. Five major global record
companies--BMG Entertainment, EMI Music, Sony Corporation, Universal Music Group
and Warner Communications Inc.--and their numerous affiliated labels account for
more than 80% of all recorded music sales worldwide. The recorded music industry
has operated under the same basic business model for many years. Typically,
record companies sign artists to exclusive contracts under which the record
companies develop and promote their music. The companies then sell this recorded
music through wholesale and retail distribution channels to consumers. In
addition, there are millions of amateur musicians who do not have access to
distribution through traditional channels.
The Internet presents a significant opportunity for the rapid and cost-effective
distribution, promotion and sale of recorded music. Music is one of the most
popular topics on the Internet as reflected by the increasing number of music-
related web sites and the growth of online sales of compact discs. To date,
online recorded music sales have occurred primarily through the purchase of
compact discs through online retailers. The popularity of online buying is
forcing traditional music retailers to sell recorded music using the Internet,
either through their own web sites, Internet portals and other sites or in the
future through in-store kiosks.
In recent years, consumers have increasingly used their computers to play music.
Music consumers increasingly want to hear recorded music in real time on their
computers and/or store these recordings for later playback on portable devices
as well as computers. One drawback is that music files can be very large. For
example, a three minute song can occupy more than thirty megabytes of storage.
Storing and transferring audio files can be expensive and slow. To address this
problem a number of compression formats have been developed and consumers are
employing faster Internet connections. Many consumers have upgraded from a 28.8
Kbps or 56 Kbps modem to a cable, xDSL or ISDN modem. According to In-Stat,
there will be 12 million DSL subscribers in North America by 2003, and
ComputerWorld Magazine reported an expected AGR of 95.5% in the number of cable
modem users in North America through 2002.
Advances in digital compression technologies now allow the transmission of near-
compact disc quality audio over the Internet. Several compression formats are
currently used, including Lucent's EPAC (Enhanced Perceptual Audio Coder), Dolby
Laboratories AAC, Microsoft's Windows Media 4.0 (WMA) format, Sony's ATRAC3
format and MP3 (an open digitally encoded audio standard arising from the Motion
Picture Experts Group). To date, recorded music sales delivered through digital
transmission have been minimal, but by 2004, 25 per cent of all music sold
online will be downloaded, earning music companies $1 billion, according to
Forrester Research.
As downloading music from the Internet has become increasingly popular--more
than 13 million Americans have experimented with downloading music files,
according to estimates and polls by the Pew Internet Project, which conducts
research on the Internet's effect on society--music content copyright owners,
including the major record companies, have expressed concerns about unauthorized
copying or "pirating" of copyrighted sound recordings. For example, many
compression technologies, including the basic MP3 format, lack copyright
protection. This can result in the unauthorized downloading and replication of
digital music. The major recording industry association, RIAA, formed a
committee, the Secure Digital Music Initiative (SDMI), that has issued
specifications for the secure digital distribution and use of recorded music.
SDMI compliant devices are expected to be available on the consumer market in
the summer of 2000 and will limit the transmission and playback of "pirated"
music.
The e-commerce market for downloadable recorded music is just emerging and there
is limited availability of digital music by major artists on the Internet. The
major record companies to date have engaged in limited efforts to sell recorded
music through digital transmission, but all five have announced general plans to
make their music available for downloading in the summer of 2000. The explosive
growth of the Internet, emergence of compression technologies, copy protection
systems and the SDMI standard setting process is causing rapid changes in the
music industry. Recently there have been rapid developments in the digital music
field with a large number of announcements by artists, global record companies,
compression and security firms, consumer product companies and others announcing
various alliances and ventures to provide secure music content over the
Internet. We believe these industry forces will drive demand for portable
devices capable of playing music files encoded in varying compression and
security formats.
Our Strategy
We were an early developer of state-of-the-art, handheld products designed to
store audio, video, images, and/or text on removable Flash memory and link to
the PC and the Internet. We offer our OEM customers and licensees services
ranging
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from the licensing of our patented MicroOS(TM) file management system to custom
software and hardware development, Printed Circuit Board (PCB) layout,
industrial design and manufacturing. Our custom product development utilizing
MicroOS(TM) helps shorten time to market for a variety of portable, digital
products. We are currently focusing development, sales, marketing, and support
efforts chiefly on digital voice recorders for professional dictation use, and
portable Internet music players for the general consumer audience.
We believe we were selected by Lanier, Intel, Lucent and Maycom for state-of-
the-art projects due to the combination of our technology and our experience in
implementing solutions. For simple memory interfaces many OEMs may develop
simple file management code; however, for more complex memory management
requirements we believe we offer a superior solution. As portable devices become
more robust and provide multiple functions and as we add features such as
Digital Rights Management Systems (DRM's) and (R)MDM to our designs, we believe
there will be expanded market opportunities for our file management system and
custom product development services. Our objective is to have MicroOS(TM) become
a leading file management system in a growing market for portable digital
devices.
We have experience in adapting MicroOS(TM) to leverage the strengths of various
DSPs and ARM-based processors. DSP chips are a key electronic component employed
in portable digital devices to manipulate digitized signals. We are also
experienced in adapting compression algorithms to DSP's. This experience and our
abilities position us to provide hardware and software solutions to developers
of portable digital devices. Within the last twelve months, we have hired
experienced DSP engineers to support OEM customers and perform further research
and development in this area.
Our strategy in the Internet music field is to create, maintain, offer, and
integrate flexible, full-featured portable Internet music player designs for OEM
customers and other licensees. Our designs are capable of playing music files
encoded in a number of different music compression formats, and can support a
number of different DRM's. The exterior appearance, button layout, and feature
set in these designs are customizable according to OEM customers' needs. We
believe our flexibility is important as the Internet music industry faces
choices of competing music compression formats and DRM's.
We have entered into licensing or compatibility agreements with Lucent, RioPort,
Liquid Audio, IBM, InterTrust, Sony, Microsoft, and QDesign in our strategy to
offer OEM customers flexible solutions in the nascent Internet music player
market. We plan to further leverage opportunities in this market with technology
providers, OEM's and content providers in the music industry.
Our strategy is to build upon our proprietary technology to develop long-term
strategic relationships with key manufacturers in various industries. We believe
we have the expertise and experience to offer a turnkey solution to major OEMs
seeking to implement portable digital sound processing. We offer a total
solution from product design through development and manufacturing. We actively
seek licensing, private label, and OEM opportunities in the digital sound
processing market. Our efforts include:
1. Expanding our business by developing custom products for OEM customers -
We seek to expand our business through sales and marketing targeted at
obtaining additional product development opportunities with existing
customers and new OEM customers.
2. Developing brand name recognition with OEM customers - We have limited
brand name recognition but seek to position the e.Digital name in the
portable digital sound processing field. This strategy is being pursued
through participation in industry alliances, trade show participation,
professional articles and attaching our name along with OEM products to the
extent possible.
3. Expanding the technology base through continued enhancements of the
MicroOS(TM) technology and new inventions - We develop in-house
proprietary designs, products, features or technologies that may be private
labeled or licensed to one or more OEMs. Our engineering team continues to
enhance and update the MicroOS(TM) software and related technology. We also
devote resources to expanding the technology to new applications. In
addition to improved music and voice processing, we believe our technology
may have applications in a wide range of products including voice pagers,
answering machines, cellular phones, computers and for the storage of still
images and motion pictures.
4. Leverage strategic and industry relationships - We have established
important strategic or industry relationships with a number of industry
participants including Lucent, Intel, IBM, SanDisk, Texas Instruments,
Microsoft, Sony, Liquid Audio and other music oriented companies. We seek
to leverage these relationships to achieve the strategies outlined above by
expanding our business and solidifying our position as a technology leader
in the field of voice, music and data processing.
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Accomplishments to Date
We innovated the use of Flash memory in a handheld digital voice recording
device, using removable digital recording media in a handheld device,
interfacing a portable digital voice recorder with a personal computer and the
Internet and employing CompactFlash in the recording and playback of near-
compact disc (CD) quality music in a portable device. It is our opinion that
these innovations position us as a leader in providing digital recording and
digital music solutions to consumers. We also believe the following
accomplishments have aided our industry positioning:
. We began shipments of a highly advanced mobile digital recorder and
docking station to OEM customer Lanier.
. We have licensed a portable Internet music player design to Maycom Co.
Ltd., and they are progressing with plans to release the product to the
consumer market in summer 2000 under their "Merit" brand name.
. We have produced a secure digital music player in cooperation with
Maycom and both parties are now demonstrating the technology to
prospective name brand OEM customers who may put out product(s) under
their own brand names
. We have established strategic or industry relationships with major
companies in the digital music and portable device market.
. We were selected by IBM to be an inaugural member of the VoiceTIMES
alliance to develop standards for voice technologies and handheld mobile
devices.
. We developed one of the first portable product designs to incorporate
IBM's new Microdrive 340MB media cartridge.
. We became official members of SDMI after participating for many months
in their meetings as a technical partner to Lucent Technologies.
. We have been granted U.S. patents on our core technology, the
MicroOS(TM) file management system.
Strategic and Industry Relationships
We have established strategic and industry relationships primarily in the fields
of digital music and advanced digital recorders.
Digital Music Relationships - We plan to continue to develop and build strategic
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relationships with key third parties in the digital music field that are engaged
in the compression, component, copy protection and product development segments
of digital music distribution. We believe these relationships enhance our
ability to participate in this explosive new field of business.
Lucent Technologies Inc. - Lucent contracted us to serve as the DSP
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engineering specialist to port (configure software to operate on a new
processor) EPAC software to a new class of Texas Instruments DSPs. In
addition, we collaborated with Lucent to develop a music player prototype
that features Lucent's EPAC audio compression technology and our
MicroOS(TM) file management system.
Maycom - As one of our first customers for our portable Internet music
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player design featuring EPAC music compression format, along with available
support for other audio codecs Maycom will incorporate our reference design
into their third-generation music player. Maycom is a turnkey manufacturer
of digital audio and radio communication products.
Texas Instruments - Our current music player designs use a new class of
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Digital Signal Processor manufactured by Texas Instruments. We served as
the DSP engineering specialist to port (configure software to operate on a
new processor) Lucent's EPAC software to a new class of Texas Instruments
DSPs. Texas Instruments is a global semiconductor company and a leading
designer and supplier of DSP solutions. We are currently working together
on business opportunities where their DSP's and our technology can be
combined.
SanDisk Corporation - We worked with SanDisk to incorporate their
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CompactFlash into our voice recorder and music player designs. We have also
worked with them to incorporate their new Secure Digital Card, or SD Card,
into our product designs. SanDisk specializes in designing, manufacturing
and marketing Flash memory data storage products. SanDisk developed the SD
Card with Toshiba and Matsushita, best known by their Panasonic brand name
in America, and the three companies introduced the new media in January
2000.
Sony Corporation - We have licensed Sony's ATRAC3 proprietary audio
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compression format for inclusion in our portable Internet music player
designs.
RioPort - We are collaborating with RioPort to integrate their secure
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digital audio platform with our Internet music player design which will
provide portable hardware manufacturers with a secure, licensable solution
for seamless delivery of digital audio content to consumers. RioPort, Inc.
is redefining digital audio by delivering an integrated, secure platform
for acquiring, managing and experiencing music and spoken audio programming
from the Internet.
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Liquid Audio - We have licensed Liquid Audio's Secure Portable Player
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Platform (SP3) for inclusion in our portable Internet music player designs.
SP3 is a comprehensive software solution for building interoperable,
secure, portable music devices. Users of the design will also be able to
take advantage of Liquid Audio's Liquid Player software to manage their
downloaded music collections, prepare play lists and transfer music to CD-
ROM.
Lydstrom - Our portable Internet music player design will include
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compatibility with Lydstrom, Inc.'s SongBank MZ3-5000. The SongBank is a
5,000 song capacity, home entertainment system capable of connecting to the
Internet. Users will be able to exchange songs between the two devices with
no loss of sound quality.
IBM - We are working with IBM to incorporate their EMMS ("Electronic Music
---
Management System"), for use in our portable Internet music player design.
The EMMS solution provides for secure distribution and piracy protection
for downloadable music content. IBM is the world's largest information
technology company and is helping media and entertainment companies
worldwide take advantage of the business opportunities made possible by
digital technology. We have also incorporated compatibility in our
portable product designs with IBM's Microdrive 340MB removable media
cartridge.
InterTrust - We have licensed InterTrust's Rights/PD(TM) software, DRM
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platform for embedded systems. This technology protects and manages rights
and interests in digital information and provides for a common foundation
for distributed e-commerce digital information and event management.
InterTrust Technologies Corporation is the leading developer of distributed
digital rights management technology.
QDesign - We support QDesign Music playback in our portable Internet music
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player design. QDesign's Music technology is an audio compression solution
for QuickTime 4, Apple Computer's cross-platform architecture for digital
media creation and delivery, and allows for music playback on a Mac or
Windows machine.
Microsoft - We are incorporating in our multi-codec portable Internet
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music player design Microsoft's Windows Media Audio (WMA) format, which
combines exceptional audio quality with a DRM system for content
protection. This technology will enable our customers to Play Windows
Media-formatted files from their e.Digital portable music player, and
access their portable player via their PC using Windows Media Player 7.
Through SDMI members and others we are also developing relationships with
additional digital music industry participants including other compression and
protection technology providers.
Advanced Digital Dictation and Mobile Devices - We have experience and expertise
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in developing advanced digital recorders employing computer and Internet
interface features. The introduction of the Lanier Cquence Mobile recorder with
its highly advanced features further positions us as a technical leader in this
field. We believe our reputation was the reason we were selected as one of seven
inaugural members of the VoiceTIMES initiative targeted to provide standards for
the integration of mobile devices in corporate environments. We are working with
the following companies in these fields:
Intel Corporation - We are working with Intel to design and develop an
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advanced digital voice recorder prototype with text-to-speech and
speech-to-text technologies to interface with the computer and Internet. In
addition, we continue to pursue opportunities with various divisions of
Intel. Intel is an inaugural member of the VoiceTIMES initiative. Intel is
a world leader in designing, manufacturing and marketing microcomputer
components and related products.
IBM - IBM is leading the VoiceTIMES initiative and e.Digital is working to
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expand its relationship with IBM through this and other activities. IBM is
a worldwide provider of advanced information technology.
We believe our experience in producing the Lanier recorder, and our
participation in the VoiceTIMES initiative will expand our opportunities to
develop additional advanced digital recorders and related mobile devices.
Customers
We have revenue producing contracts or marketing arrangements with the
following customers:
Lanier
-------
We designed, developed and produced a new digital voice recorder and computer
docking station for the medical industry pursuant to a January 1997 development
and supply agreement with Lanier (the "Lanier Agreement"). The contract provides
that we will supply product under the agreement through December 2001. In May
1999 the Company commenced production, through a subcontract manufacturer, and
in June 1999 commenced initial limited customer shipments pursuant to purchase
orders. The supply agreement provides for rolling six month requirement
forecasts and three month advance orders.
8
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Lanier is one of the world's largest providers of document management solutions,
services and support with over $1.5 billion in annual revenues. Lanier markets,
sells and services a wide array of tailored solutions. Lanier was the first to
market centralized digital dictation systems and the new recorder and docking
station is Lanier's first portable digital dictation system with advanced
features to interface with computerized digital dictation systems.
We are shipping product to Lanier Healthcare, a Lanier business unit. These
products represent the Cquence Mobile portion of Lanier's Cquence line of
products for the medical industry. The Cquence line is an integrated medical
document management solution that manages medical documents from creation,
completion, distribution and retention. Cquence Mobile offers healthcare
providers a mobile digital dictation unit and computer interface with a number
of new advanced features.
During the fiscal year ended March 31, 2000 we shipped $385,223 of products to
Lanier. At March 31, 2000 we had purchase orders aggregating $1,739,875 for
future shipments.
On April 27, 2000, Lanier announced that it intends to sell its voice processing
(dictation) business. Details of the transaction, including the identity of the
potential buyer or buyers and the time frame for the transaction, are not known
at this time. We do not know the impact, if any, that any such transaction, if
consummated, would have on future deliveries under the Lanier agreement.
Maycom
------
We have licensed our portable Internet music player design to Maycom Co. Ltd.
for use in its products. Maycom will incorporate our reference design into their
third-generation music player which will support multiple music codecs including
EPAC, AAC, WMA, and MP3 and will also support various DRM schemes. Units are
expected to go into production in summer 2000 depending on SDMI specifications
and the availability of secure music on the Internet.
Lucent Projects
---------------
We have produced certain prototype equipment based on purchase orders from
Lucent. The use of our technology allowed Lucent to present its audio
compression technology and Cognicity's watermarking technologies at a
demonstration in Beverly Hills and Manhattan in late October 1998. Our
technology was used to playback digital audio via the Internet from Manhattan to
the Beverly Hills demonstration. In January 1999, Lucent demonstrated our first-
generation digital music player at the MIDEM International Music Market trade
show in Cannes, France. In May 1999 we completed a second-generation device
which was demonstrated at PC Magazine Editor's day. Our latest third-generation
EPAC Internet music player offers high security, copyright protection and CD-
transparent sound quality.
Both Lucent and our personnel are demonstrating and marketing digital music
solutions to participants in the digital music arena including (a) providers of
infrastructure technology, products and services, (b) providers of online music
services, (c) Internet retrieval and portal companies, and (d) online music
retailers.
We also ported Lucent's EPAC compression algorithm software to the new class of
Texas Instrument DSPs pursuant to a purchase order from Lucent. This project was
completed in October 1999.
Standards
We believe that a successful solution for mobile business commerce and digital
music commerce must incorporate technical and industry standards. We are
participating in the standard-setting initiatives.
Voice Technology Initiative for Mobile Enterprise Solutions (VoiceTIMES)
------------------------------------------------------------------------
IBM, along with Intel and four other leaders in speech recognition and mobile
technologies announced in April 1999, we would be a founding member of
VoiceTIMES. VoiceTIMES goal is to coordinate the technical requirements needed
for companies to build and deploy solutions using voice technologies and
handheld mobile devices. With the growth of mobile devices and increasing demand
for network access, the VoiceTIMES initiative was formed to define
specifications for how voice commands and information are transmitted and
received by existing and future mobile devices. The VoiceTIMES alliance aims to
eliminate the complexities for the consumer and solutions integrator and provide
future generations standard compliant speech-enabled mobile products.
As a charter member, we believe the VoiceTIMES alliance will expand
opportunities for us to develop speech-based mobile information gathering
devices and leverage existing product designs and technology into additional
industry solutions and products.
Secure Digital Music Initiative (SDMI)
--------------------------------------
The SDMI was officially announced in December 1998 and is sponsored by the RIAA
to develop an open standard for the secure digital delivery of recorded music.
Over 200 companies are participating in this effort. To date, this effort has
focused
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on requirements for consumer portable music devices, such as our hand-held music
player. We joined SDMI as an official member in early 2000 after months of
participation in the organization as a technical partner to Lucent.
The worldwide recording industry recognized that many companies are developing
approaches to provide security for music that is digitally distributed via CD,
high-density disc, the Internet and other means. The SDMI goal is to encourage a
marketplace of interoperable products that will benefit consumers and spur
innovation. SDMI-compliant devices expected to reach the market in summer 2000
are expected to accept any content in any format the manufacturer allows. Phase
2 SDMI compliant devices are expected to accept open formats and only reject
pirated copies of new content released after Phase 2 compliant music creation
and playback technology becomes available in the future.
We believe the industry's adoption of SDMI standards will allow the development
and growth of the digital distribution of music on the Internet and increase the
demand for portable players and related devices.
SD Association
--------------
The SD (Secure Digital card) Association was founded in January 2000 by SD card
developers SanDisk Corporation, Toshiba, and Matsushita. We are one of the
inaugural members of this organization and have worked with the founders to
incorporate compatibility with the SD Card in our portable product designs. The
SD Association founders are working to promote this new removable storage media
for use in a variety of portable products.
Technology and Services
Our technology and services are focused on providing digital solutions for the
portable device marketplace.
MicroOS(TM) Core Technology
---------------------------
Our MicroOS(TM) is a real time operating system designed to transparently manage
the difficulties of writing, reading, and editing data on Flash or related
memory. Taking less than 8K (8,000 bytes) of memory, it serves as system
software to manage all operations in handheld devices using either removable or
embedded Flash (or related media) for data storage. MicroOS(TM) is compatible
with virtually all types of removable Flash memory as well as other standard IDE
drives. MicroOS(TM) facilitates advanced functionality, ease of use,
flexibility, and reliable performance in products that use Flash memory to store
data. MicroOS(TM) supports any type of data files including voice, text,
images, video and/or music.
We believe our MicroOS(TM) technology is an efficient, portable storage memory
file management system. The patented software architecture takes a unique
approach to file management that is robust, high-speed and efficient. This
approach is suited for the high-speed portable product market because it
requires minimal micro-controller support while providing broad product
functionality. This architecture offers OEMs the ability to reduce new product
development time and time to market, as well as produce a product featuring a
reduced chip count and correspondingly lower cost and power requirements.
Our design caters to ultra-miniature applications by reducing the need for a
high power micro-controller by paring down code to fit and run efficiently on
low-cost micro-controllers while preserving memory for other functions. The
software stores and manipulates compressed voice, data, image or video files. It
supports various Flash memory formats including CompactFlash, Secure Digital
Card (SD Card), Intel Miniature Card and IDE hard disks as well as the new
DataPlay drive, Iomega's Clik! Disks, and IBM Microdrive. Unlike less robust
systems, MicroOS(TM) can support an unlimited number of files, directories, and
subdirectories and is fully MS-DOS compatible. It is also easily adaptable to
function with Microsoft Windows CE platforms. The system is written in the
programming language "C" to facilitate porting to other environments.
For developers of voice and data recording devices, digital cameras and other
multimedia products, the intricacies of incorporating full-featured Flash memory
can add costly obstacles to a successful product release. These products require
a software system that will deliver Flash-based features and functionality to
users managing digital data for reliability in operations such as play, record,
edit, delete, insert, and rewind.
MicroOS(TM) Audio Technology
We have employed MicroOS(TM) in portable digital recorders and extended the
technology for implementation into various product concepts. One extension is
the Company's MicroOS(TM) Audio technology, provides the means for CD-quality,
stereo music and high-bandwidth speech and music playback from a CompactFlash
cartridge, other removable or embedded Flash memory, or other ATA/IDE/ATAPI
embedded or removable rotating drives. Record, edit and playback functions are
encoded and a PC interface links the portable unit to the computer. The
MicroOS(TM) Audio supports a number of popular music compression technologies,
such as MP3, AAC, ATRAC3, WMA, ePAC, and others.
MicroOS(TM) Audio's features include instant access to recorded material,
computer/Internet compatible files, a computer standard interface and
adaptability to various industry standard removable Flash memory devices. The
advantages of the MicroOS(TM) Audio stereo technology over portable CD players
include its small size, low power consumption, use of re-recordable media,
inexpensive computer interface/compatibility and no moving parts. In addition to
being a stand-alone, ultra
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compact, portable stereo, the MicroOS(TM) Audio technology can be integrated
into a variety of products, such as laptop or hand-held PC's, pagers, cellular
phones, PDAs, and other portable devices, as well as home or auto-based stereos
incorporating storage drives.
Services
--------
We offer developers of electronic products a portfolio of services within the
broad categories of design services, development services and manufacturing
services. Our revenue will be derived from a combination of fees from licensing,
engineering services, manufacturing services, warranty services, industrial
design services, and unit royalty payments.
We offer services to perform design projects for electronic components and
portable digital products. When developers of electronic products lack the
experience or resources to work with portable storage media to do their own
design work, or they want to keep internal engineers and designers on other
work, our design services help perform component and product design. We offer
design services in areas such as integrated circuit design, the design and
incorporation of custom digital signal processing solutions, wireless
communication, computer and Internet connectivity and physical product design.
We have expertise in embedded systems, digital and analog integrated circuit
design, wireless, multimedia, Internet and computer connectivity, DSP
customization, Flash memory interface and related fields. Generally, we contract
actual physical product design to independent firms.
In addition to design, our engineers can perform development services aimed to
convert designs into functional reference designs, prototypes and/or end
products. We are also experienced in arranging for manufacturing services
including factory hand-off and development of test procedures.
Marketing and Sales
We use internal sales and marketing, primarily two of our executives and one
technical business development manager, to target electronic product developers
and manufacturers. Targeted OEM customers include dictation equipment
manufacturers, Internet music participants, digital camera developers and
developers of other portable products.
In December 1997, we established a business development agreement on a
commission basis with TEKSEL Co. Ltd. of Tokyo, Japan wherein TEKSEL represents
e. Digital's MicroOS(TM) to the Japanese market. TEKSEL is a distributor of
advanced U.S. technology products by major technology companies. To date, the
Company has not expended any significant effort to pursue the Japanese market
but intends to do so at a future date.
Maycom is a licensee and a marketing partner. As a turnkey manufacturing
service provider, Maycom has access to a number of name-brand consumer
electronics customers to whom they are marketing product designs which include
e.Digital's technology. Their areas of interest are in Internet music players
and digital voice recorders. With Maycom, we are marketing Internet music
player designs worldwide to OEM companies who license and/or brand the designs
for introduction to the retail market under their brand name(s).
We primarily market our services through our strategic and industry
relationships and technical articles in trade and business journals. We may in
the future employ limited and selected advertising in targeted publications.
Manufacturing and Distribution
We have established a strategic manufacturing relationship with Eltech
Electronics, Inc. and its Malaysian affiliate Eltech Electronics Technology
("Eltech") to provide our OEM customers with leading edge turnkey electronic
product tooling and manufacturing capacity. The first project with Eltech has
been the Lanier digital recorder and docking station on which initial production
commenced in late May 1999. In December 1998, the Company entered into a one
year manufacturing agreement with Eltech to produce the Lanier products. This
contract features an automatic annual renewal clause.
We believe these relationships may be used for future products under development
but neither party is so bound. Our strategy is to arrange for the production of
products for our OEM customers on a turn-key basis, wherein we limit our need
for working capital to finance inventory, production and receivable financing.
In other instances we may enter into licensing and royalty agreements with OEM
customers who have existing manufacturing abilities or arrangements.
We believe, but there is no assurance, that we will be able to continue to offer
manufacturing services for our customers for future developed products through
contract manufacturing relationships on terms that will not require substantial
financial risk or the provision of significant working capital.
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Intellectual Property
We have five issued U.S. patents covering our MicroOS(TM) file management
software and certain technology related to portable digital devices. Our
software is also subject to 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.
The patent position of any item for which we have filed a patent application is
uncertain and may involve complex legal and factual issues. Although we are
currently prosecuting trademark applications with the U.S. Patent and Trademark
Office and also have filed certain international patent applications
corresponding to our U.S. patents or applications, we do not know whether any of
these applications will result in the issuance of patents or trademarks, or, for
any patents already issued or issued in the future, whether they will provide
significant proprietary protection or will be circumvented or invalidated.
Additionally, since an issued patent does not guarantee the right to practice
the claimed invention, there can be no assurance others will not obtain patents
that we would need to license or design around in order to practice our patented
technologies, or that licenses that might be required would be available on
reasonable terms. Further there can be no assurance that any unpatented
manufacture, use, or sale of our technology or products will not infringe on
patents or proprietary rights of others. We have made reasonable efforts in the
design and development of our products not to infringe on other known patents.
We also rely on trade secret laws for protection of our intellectual property,
but there can be no assurance others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to our trade secrets or disclose such technology, or that we can
protect our rights to unpatented trade secrets.
We have also filed a number of trademark applications with the U.S. Patent and
Trademark Office including e.Digital. We have received notification of allowance
from the United States Patent Office for use of FlashBack(R), Hold That
Thought(R), Fumble Free(R) and SoundClip(R) as registered trade names. We intend
to make every reasonable effort to protect our proprietary rights to make it
difficult for competitors to market equivalent competing products without being
required to conduct the same lengthy testing and development conducted by us and
not to use any of our innovative and novel solutions to overcome the many
technical obstacles involved in portable recording using Flash and related
memory.
Research and Development Costs
For the years ended March 31, 2000 and 1999, we spent $1,346,927 and $508,237,
respectively, on research and development. We anticipate we will continue to
devote substantial resources to research and development activities. During
fiscal 2000 and 1999, $100,743 and $849,997, respectively, of research and
development were borne by Lanier, a contract development customer and such
related costs were included in cost of services. Also in fiscal 2000 and 1999,
approximately $82,579 and $39,096 of research and development revenue was
recognized from the Intel and other contracts and related costs were included in
cost of services.
Competition
We believe we have developed a leading comprehensive file management system
capable of customization for individual customer requirements. Other companies
offering file management systems include M-Systems Flash Disk Pioneers Ltd.,
Intel and Datalight Inc. In addition to licensing file management systems, some
companies develop their own file management systems for a particular product,
either in total or by adapting from one of the competitive vendors. While this
self-development is common in simple memory management devices, we offer a
system attractive for more complex applications. Although we were successful in
competing against other systems in our selection by Lanier, Intel, and Maycom,
and in working with Lucent, there is no assurance we can continue to compete
against other providers of digital recording solutions, many of which have
substantially greater resources.
Our technology focuses on digital applications. Accordingly, competition for our
technology includes other analog tape solutions and traditional dictation
equipment. We and our OEM customers, therefore, compete with a wide range of
consumer and business product suppliers producing a wide variety of products and
solutions. The electronics product market is highly competitive with many large
international companies competing for the consumer and business market.
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 digital sound processing for portable
storage media.
The competition is expected to be fierce in the field of portable digital music
players. Diamond Multimedia Systems, Inc. introduced the Rio, the first
commercially available MP3 portable player, in November 1998. Other
manufacturers, including Creative Labs, Thompson Multimedia's RCA division, LG
Electronics, Samsung, Sony, Sanyo, Toshiba, and others, have recently released
or announced plans to sell portable digital music players, most using the MP3
format. Other manufacturers are expected to announce products in the future and
companies not normally associated with consumer electronics may enter the market
to use portable music players to seed the market for digital music. Our
technology will compete with other solutions, however we will focus on markets
requiring advanced features and a robust file management system.
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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.
Employees
As of June 16, 2000, we employed approximately 23 employees of whom three were
production, twelve were research, development and engineering, five were sales,
general and administrative and three were executive officers. None of the
Company's employees are represented by a labor union, and the Company is not
aware of any current efforts to unionize the employees. Management of the
Company considers the relationship between the Company and its employees to be
good.
We also engage consultant or lease engineering personnel on a temporary basis
from time to time and use other outside consultants for various services.
Regulation
Our operations are subject to certain federal, state and local regulatory
requirements relating to environmental, waste management, health and safety
matters and there can be no assurance that material costs and liabilities will
not be incurred or that past or future operations will not result in exposure or
injury or claims of injury by employees or the public. Some risk of costs and
liabilities related to these matters are inherent in our business, as with many
similar businesses. Management believes its business is operated in substantial
compliance with applicable environmental, waste management, health and safety
regulations, the violation of which could have a material adverse effect on our
operations. In the event of violation, these requirements provide for civil and
criminal fines, injunctions and other sanctions and, in certain instances, allow
third parties to sue to enforce compliance. In addition, new, modified or more
stringent requirements or enforcement policies could be adopted which could
adversely affect our operations.
ITEM 2. DESCRIPTION OF PROPERTY
We jointly extended our current lease for an additional two years expiring on
July 31, 2002, with American Technology Corporation ("ATC"), an affiliated
company (see "Item 12 - Certain Relationships and Related Transactions"), for an
aggregate of 18,056 square feet of office and engineering office space at 13114
Evening Creek Drive South, San Diego, California with an unaffiliated landlord.
We occupy approximately 11,000 square feet of the jointly leased space at a cost
of $12,950 per month for our share. We could become obligated for the entire
lease should ATC default on its share of payments thereon.
We believe that the terms of the above arrangement are no less favorable than
could be obtained from an independent and unaffiliated party.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in routine litigation incidental to the
conduct of its business. There are currently no material pending legal
proceedings to which we are party or to which any of our property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Our Common Stock trades in the over-the-counter market on the OTC 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.
<TABLE>
<CAPTION>
High Low
<S> <C> <C>
Fiscal year ended March 31, 1999
First quarter $ 0.146 $0.0610
Second quarter $ 0.115 $0.0525
Third quarter $ 0.066 $0.0525
Fourth quarter $ 0.247 $0.0600
Fiscal year ended March 31, 2000
First quarter $ 3.7344 $0.1406
Second quarter $ 2.8438 $1.0938
Third quarter $ 2.9062 $1.2344
Fourth quarter $24.5000 $2.9062
</TABLE>
At June 16, 2000 there were 126,261,182 shares of Common Stock outstanding.
There were approximately 1,146 shareholders of record.
We have never paid any dividends to our Common Stock shareholders. 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 Company's business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR 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 BELOW AND UNDER
THE SUB-HEADING, "CERTAIN FACTORS THAT MAY AFFECT E.DIGITAL'S BUSINESS, FUTURE
RESULTS AND FINANCIAL CONDITION."
General
e.Digital Corporation provides 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.
In June 1999 we commenced shipments against to Lanier resulting from a January
1997 development and supply agreement. These products are intended to be sold
worldwide by Lanier's sales force. The contract provides for rolling six month
forecasts of requirements and three month rolling orders for future products.
There can be no assurance of the level or continuation of shipments to Lanier.
We are actively developing licensing, private label, and OEM opportunities
seeking to penetrate the digital recording and playback market. Under the Lanier
agreement, we incurred approximately $1.6 million of non-recurring engineering
fees and costs from inception through March 31, 2000.
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 $1.8 million
in fiscal 1999 and $2.6 million in fiscal 2000. Our current level of monthly
cash operating costs is approximately $225,000 per month. However, we may
increase expenditure levels in future periods to support our digital music
business and ongoing research and development activities. 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 fixed
costs of operations. We continue
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to be subject to the risks normally associated with any new business activity,
including unforeseeable expenses, delays and complications. Accordingly, there
is no assurance we can or will report operating profits in the future.
Management is focused on OEM licensing with respect to the MicroOS(TM) file
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 may be delayed
or terminated by customers and are subject to a number of factors beyond our
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 operations. The markets for consumer electronic
products are subject to rapidly changing customer tastes and a high level of
competition. Demand for the Company's products is expected to be influenced by
OEM market success, technological developments and general economic conditions.
Because these factors can change rapidly, customer demand 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 fiscal year 2000, we reported revenues of $489,962, a 15% increase over
revenues of $426,350 for fiscal 1999. One customer accounted for 90% and three
customers accounted for 85% of fiscal 2000's and 1999's revenues, respectively
and the loss of a customer could have a material adverse impact on our
operations.
Revenue for fiscal 2000 included $387,576 of product sales to OEMs versus
$154,428 for the prior comparable period. We have received purchase orders from
Lanier for product until the third fiscal quarter. There can be no assurance of
the level or continuation of shipments to Lanier.
Our development arrangements are designed to produce limited current revenues
while creating proprietary OEM products to be sold to OEM customers or to be
produced under long-term license or royalty arrangements. Development service
revenue of $102,386 for the fiscal year ended March 31, 2000 is less than the
$271,922 for the prior year as we where in the final stage of the Lanier
agreement which accounted for substantially all development revenues in the
prior period.
For the year ended March 31, 2000, we reported a gross profit of $28,482 as
compared to a gross loss of $561,963 for fiscal 1999. Costs of sales consisted
of $328,158 of product costs and $133,322 of contract services consisting mostly
of research and development labor being funded in part by the Lanier, Intel and
other development agreements. We have devoted additional resources over a longer
than originally estimated time period to complete the Lanier development without
corresponding increases in development revenues. This produced the current year
gross development loss. There can be assurance we can attain positive gross
margins in the future.
Total operating expenses (consisting of research and related expenditures,
selling and administrative expenses and non-cash compensation costs) for the
year ended March 31, 2000, were $2,643,490 as compared to $1,262,578 for the
year ended March 31, 1999. Selling and administrative costs aggregated
$1,296,563 in fiscal 2000 compared to $754,341 in the prior period. The $542,222
increase was comprised primarily of a $212,944 increase in personnel and related
expenses, a $223,825 increase in public relations and shareholder costs, a
$70,400 increase in accounting and legal expenses, and a $47,716 increase in
travel and related costs offset by a reduction of $55,000 in finders fee.
Research and related expenditures for the year ended March 31, 2000 were
$1,346,927, as compared to $508,237, for the prior year. An aggregate of
$133,322 of development costs were incurred for contract development work during
the year ended March 31, 2000 and are included in cost of revenues. 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.
During fiscal 2000, we incurred no non-cash compensation from the issuance of
options and warrants versus $50,900 for the prior comparable period. We may from
time to time use options, warrants and shares in lieu of cash to pay for
services.
We reported an operating loss of $2,615,008 for the year ended March 31, 2000,
as compared to an operating loss of $1,824,541 for the year ended March 31,
1999. The increase in operating losses in the current fiscal year is primarily
due to the increase in research and development services. Management believes,
but there can be no assurance, that investments 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.
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Our cash interest expense for the year ended March 31, 2000 was $49,714, a
decrease from the $81,086 for the prior period resulting from the repayment of
the interest bearing debt in fiscal 2000. We also incurred during the fiscal
years ended March 31, 2000 and 1999 a total of $82,499 and $673,197,
respectively as non-cash interest expense from the issuance of convertible
promissory notes convertible at a discount and warrants issued with debt and
amortization of note discounts.
We reported a loss for the current fiscal year of $2,608,854 comparable to the
loss of $2,595,476 for the prior year.
Liquidity and Capital Resources
At March 31, 2000, we had a working capital of $2,369,744 compared to a working
capital deficit of $1,378,155 at March 31, 1999. We had $79,599 of working
capital invested in inventories at March 31, 2000 and $46,907 at March 31, 1999.
For the year ended March 31, 2000, net cash increased by $3,127,400. Cash used
in operating activities was $2,548,262. Major components using cash were a loss
of $2,608,854 reduced by $58,242 of aggregate depreciation and amortization,
$94,829 for services paid by issuance of common stock and $82,499 of non-cash
interest, or a loss use of cash of $2,373,284. The major change in assets and
liabilities providing cash from operating activities was a reduction in accounts
receivable on research and development contract of $92,725, an increase in
accrued employee benefits of $43,116. The major changes in assets and
liabilities using operating cash was a reduction in accounts payable trade of
$26,852, an reduction in other accounts payable and accrued liabilities of
$16,904, a decrease of $22,934 in accrued lease liability, an increase of
$211,939 in accounts receivable and a $32,692 increase in inventory.
During the fiscal year ended March 31, 2000, we obtained $3,227,340 of cash from
the exercise of options and warrants significantly improving our financial
position. At May 31, 2000 we had cash on hand of $3,294,366. 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 funds include exercise of outstanding warrants and options, or
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 that we may require additional
capital to finance future developments and improvements to its 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 leasing institution providing for future
payments of approximately $515,000 from time to time based on agreed upon
percentages of future equity raised.
In June 1999 we commenced production on the Lanier products. Management believes
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 it would be required to supply substantial working capital for the
production of the Lanier orders. We rely on this 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 the MicroOS(TM) Audio technology is 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.
Inflation
Inflation has not had any significant impact on our business.
16
<PAGE>
New 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 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
133 is effective for fiscal years beginning after June 15, 2000. We do not
expect the adoption of SFAS 133 to have a material effect on our consolidated
financial statements.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101), which
provides guidance on the recognition, presentation and disclosure of revenue in
financial statements of all public registrants. The provisions of SAB 101 are
effective for transactions beginning in the Company's fiscal year 2001. The
Company has not completed its assessment of the impact of SAB 101 and has not
determined its effect, if any, on its future reported results of operations.
On March 31, 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, " Accounting for Certain Transactions Involving Stock
Compensation"("FIN 44"). This statement is effective for certain transactions
from December 15, 1998 and is to be applied commencing July 1, 2000. The Company
has not completed its assessment of the impact of FIN 44 and has not determined
its effect, if any, on its future reported results of operations.
Year 2000 Readiness Disclosure
The Year 2000 Issue arises because many computerized systems use two digits
rather than four to identify a year. Date-sensitive systems may recognize the
year 2000 as 1900 or some other date, resulting in errors when information using
year 2000 dates is processed. In addition, similar problems may arise in some
systems which use certain dates in 1999 to represent something other than a
date. Although the change in date has occurred, it is not possible to conclude
that all aspects of the Year 2000 Issue that may affect the entity, including
those related to customers, suppliers, or other third parties have been fully
resolved.
Certain Factors That May Affect Our Business, Future Results and Financial
Condition
In addition to the other information in this Annual Report on Form 10-KSB, the
factors listed below should be considered in evaluating our business and
prospects. This Annual Report contains a number of forward-looking statements
which reflect our current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those discussed below and elsewhere herein, that could
cause actual results to differ materially from historical results or those
anticipated. In this report, the words "anticipates," "believes," "expects,"
"intends," "future" and similar expressions identify forward-looking statements.
Readers are cautioned to consider the specific factors described below and not
to place undue reliance on the forward-looking statements contained herein,
which speak only as of the date hereof. We undertake no obligation to publicly
revise these forward-looking statements, to reflect events or circumstances that
may arise after the date hereof.
FINANCIAL RISKS
---------------
We Have a History of Losses and May Incur Future Losses - We have incurred
-------------------------------------------------------
significant operating losses in prior fiscal years and at March 31, 2000 had an
accumulated deficit of $44,113,547. We had a loss of approximately $2.6 million
in fiscal 2000. To date, we have not achieved profitability and given the level
of operating expenditures and the uncertainty of revenues and margins, we may
continue to incur losses and negative cash flows in future periods. The failure
to obtain sufficient revenues and margins to support operating expenses could
harm our business.
We Expect Our Operating Results May 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 pricing for our contract development services
. Market acceptance of OEM products by end users
. Uncertainties with respect to future OEM customer product orders,
their timing and the margins to be received, if any
. Fluctuations in operating costs
. Changes in research and development costs
. Changes in general economic conditions
17
<PAGE>
We May Experience Product Delays, Cost Overruns and Errors - We have experienced
----------------------------------------------------------
development delays and cost overruns associated with contract development
services in the past. We may experience additional delays and cost overruns on
current projects or future projects. We have experienced delays in bringing the
Lanier products to production through our outside manufacturing arrangement.
Future delays and cost overruns could adversely affect our financial results and
could affect our ability to respond to technological changes, evolving industry
standards, competitive developments or customer requirements. Our technology,
the results of our contract services and the products produced for OEM customers
could contain errors that could cause delays, order cancellations, contract
terminations, adverse publicity, reduced market acceptance of products, or
lawsuits by customers or their customers.
We May Need to Obtain Additional Financing - We believe that with cash on hand
------------------------------------------
and proceeds from existing development and production contracts that we have
sufficient proceeds to meet cash requirements for the next twelve months.
However, we may need to raise additional funds to:
. Finance unanticipated working capital requirements
. Pay for increased operating expenses or shortfalls in anticipated
revenues
. Fund increases in research and development costs
. Develop new technology, products or services
. Respond to competitive pressures
. Support strategic and industry relationships
In the event additional funds are required we cannot assure you that such
additional financing will be available on terms favorable to us, or at all. If
adequate funds are not available to us then we may not be able to continue
operations or take advantage of opportunities. If we raise additional equity
funds, the percentage ownership of our stockholders will be reduced.
RISKS RELATED TO SALES, MARKETING AND COMPETITION
-------------------------------------------------
The Electronic Products Market in Which We Compete is Highly Competitive - We
------------------------------------------------------------------------
compete in the market for electronics products which is intensely competitive
and subject to rapid technological change. The market is also impacted by
evolving industry standards, rapid price changes and rapid product obsolescence.
Our competitors include a number of large foreign companies with U.S. operations
and a number of domestic companies, many of which have substantially greater
financial, marketing, personnel and other resources. Our current competitors or
new market entrants could introduce new or enhanced technologies or products
with features which render the Company's technology or products obsolete or less
marketable, or could develop means of producing competitive products at a lower
cost. Our ability to compete successfully will depend in large measure on our
ability to maintain our capabilities in connection with upgrading products and
quality control procedures and to adapt to technological changes and advances in
the industry. Competition could result in price reductions, reduced margins, and
loss of contracts, any of which could harm our business. There can be no
assurance that we will be able to keep pace with the technological demands of
the marketplace or successfully enhance our products or develop new products
which are compatible with the products of the electronics industry.
We Rely on a Limited Number of Customers - A substantial portion of our revenues
----------------------------------------
have been derived primarily from a limited number of customers. For the year
ended March 31, 2000, the provision of contract development services and product
shipments to Lanier accounted for approximately 90% of our revenues. We expect
that the production of Lanier products will account for a significant portion of
fiscal 2001 revenues. Lanier has announced that it intends to sell its voice
processing (dictation) business which we are informed would include the Cquence
Mobile line. Details of the transaction, including the identity of the potential
buyer or buyers and the time frame for the transaction, are not known at this
time. We do not know the impact, if any, that any such transaction, if
consummated, would have on future orders under the Lanier agreement. The loss of
the Lanier relationship, failure to produce products under our contract or a
decline in the economic prospects of Lanier or the products we produce would
have a material adverse effect on our operations.
We Cannot Predict Product Acceptance in the Market - Sales and marketing
--------------------------------------------------
strategy contemplates sales of developed products to the electronics and
computer software market, by OEM customers. The failure of such OEM customers to
penetrate their projected markets would have a material adverse effect upon our
operations and prospects. Market acceptance of our customer's products will
depend in part upon our ability to demonstrate and maintain the advantages of
our technology over competing products.
We Have Limited Marketing Capability - We have limited marketing capabilities
------------------------------------
and resources and are primarily dependent upon in-house executives for the
marketing of our OEM and licensing business. Attracting new OEM 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.
18
<PAGE>
We Depend on the Development of the Digital Music Market to Create a Market for
-------------------------------------------------------------------------------
Consumer Devices - We believe the market for portable consumer devices to play
----------------
digital music will not develop significantly until consumers are able to
download popular digital recordings from the Internet. We believe the
availability of popular recordings will depend on the adoption of one or more
formats to limit the unauthorized reproduction and distribution of music, called
"pirated" copies. Piracy is a significant concern of record companies and
artists. The failure of the industry to adopt a standard format or formats for
protecting from piracy will delay or have an adverse impact on the growth of
this market. This failure could harm our business.
We have designed our digital music prototype to include piracy protection and to
be adaptable to different music industry and technology standards. Numerous
standards in the marketplace, however, could cause confusion as to whether our
designs and services are compatible. If a competitor were to establish products
for OEM customers with a dominant industry standard unavailable to us, our
business would be harmed.
Our Business Depends on Emerging Markets and New Products - In order for demand
---------------------------------------------------------
for our technology, services and products to grow, the markets for portable
digital devices, such as digital recorders and digital music players and other
portable consumer devices, must develop and grow. If sales for these products do
not grow, our revenues could decline. To remain competitive, we intend to
develop new applications for our technology and develop new technology and
products. If new applications or target markets fail to develop, or if our
technology, services and products are not accepted by the market, our business,
financial condition and results of operations could suffer.
Our Technology May Become Obsolete - 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 would render our technology and products obsolete.
RISKS RELATED TO OPERATIONS
---------------------------
We Depend On a Single Contract Manufacturer and a Limited Number of Suppliers -
-----------------------------------------------------------------------------
We rely on Eltech Electronics for the manufacture and assembly of products
pursuant to our contract with Lanier. We depend on Eltech to (1) allocate
sufficient capacity to our manufacturing needs, (2) produce acceptable quality
products at agreed pricing and (3) deliver on a timely basis. If Eltech is
unable to satisfy these requirements, our business, financial condition and
operating results could be materially and adversely affected.
Under our supply agreement with Eltech, we are obligated to provide six month
rolling forecasts for anticipated purchases and 90 days of purchase orders. The
requirements of the contract could result in shortages or excess product and
adversely harm our business. Any failure in performance by this manufacturer for
any reason could have a material adverse affect on our business.
Production and pricing by Eltech 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
Eltech 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.
Our Future Success Depends on Our Key Personnel - 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, could harm our business.
Our future success also depends on our ability to attract, retain and motivate
highly skilled employees. Competition for employees in our industry is intense.
We may be unable to retain our key employees or to attract, assimilate and
retain other highly qualified employees in the future. We have from time to time
in the past experienced, and we expect to continue to experience in the future,
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications.
Some of Our Management are Part-Time and Have Certain Conflicts of Interest -
---------------------------------------------------------------------------
Our Secretary, Robert Putnam, is also a Vice President, Investor Relations of
American Technology Corporation (ATC) and Secretary of Patriot Scientific
Corporation (Patriot). Renee Warden is also Chief Accounting Officer, Treasurer
and Secretary of ATC.
19
<PAGE>
As a result of their ownership and involvement with ATC and Patriot, Mr. Putnam
and Ms. Warden have in the past, and are expected in the future to devote a
substantial portion of their time to their other endeavors and only part-time
services to e.Digital. Certain conflicts of interest now exist and will continue
to exist between the Company and certain of 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. It is
conceivable that the respective areas of interest of the Company, Patriot and
ATC could overlap or conflict.
It is possible that these factors could harm the Company which does not have the
benefit of a full-time executive team devoted to executing the Company's
strategies.
We Continue to Face Year 2000 Risks - Many existing computer programs cannot
-----------------------------------
distinguish between a year beginning with "20" and a year beginning with "19"
because they use only the last two digits to refer to a year. For example, these
programs cannot tell the difference between the year 2000 and the year 1900. As
a result, these programs may malfunction or fail completely. If we or any third
parties with whom we have a material relationship experience year 2000 problems,
our business may be seriously harmed. In particular, year 2000 problems could
temporarily prevent us from offering our goods and services. See "Management's
Discussion and Analysis or Plan of Operations -- Year 2000 Readiness
Disclosure."
RISKS RELATED TO INTELLECTUAL PROPERTY AND GOVERNMENT REGULATION
----------------------------------------------------------------
We Depend on Proprietary Rights to Develop and Protect Our Technology - 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 the quality of our brand is
maintained by our business partners, they may take actions that could impair the
value of our proprietary rights or our reputation. In addition, these business
partners may not take the same steps we have taken to prevent misappropriation
of our solutions or technologies.
We May Face Intellectual Property Infringement Claims That May Be Costly To
---------------------------------------------------------------------------
Resolve - 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 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, 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.
20
<PAGE>
RISKS RELATED TO TRADING IN OUR COMMON STOCK
--------------------------------------------
Our Stock Price May Continue to be Volatile - 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 OEM design wins by e.Digital or its
competitors
. general conditions in the markets for the Company's 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
We do not endorse and accept no 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 the our Common Stock in
the future.
Stocks Traded on the OTC Bulletin Board are Subject to Special Regulations - Our
--------------------------------------------------------------------------
shares of Common Stock are traded on the OTC Bulletin Board, an electronic,
screen-based trading system operated by the National Association of Securities
Dealers, Inc. ("NASD"). Securities traded on the OTC 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 $0.1406 to a high of $24.50 in the last twelve months.
Our Number of Common Shares has Increased and May Affect Future Stock Prices -
----------------------------------------------------------------------------
Our outstanding shares of Common Stock have increased from 97,321,297 shares at
March 31, 1999 to 126,261,182 shares at March 31, 2000. This increase of shares
has resulted primarily from the conversion of preferred shares, warrants and
exercise of employee stock options at low prices in comparison to recent trading
prices. Accordingly, there may be significant shares in the public float
acquired by holders at significantly lower prices. Additional shares may also be
issued in the future from existing dilutive securities outstanding or from the
issuance of new equity securities in the future. These factors could increase
the volatility of our stock price in the future.
FORWARD LOOKING STATEMENTS
--------------------------
Important Factors Related to Forward-Looking Statements and Associated Risks -
----------------------------------------------------------------------------
This annual report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Securities
Exchange Act of 1934 (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.
21
<PAGE>
In addition, as disclosed above, our business and operations are subject to
substantial risks which increase the uncertainty inherent in such forward-
looking statements. Any of the other factors disclosed above could cause our net
sales or net income (or loss), or our growth in net sales or net income (or
loss), to differ materially from prior results. Growth in absolute amounts of
costs of sales and selling and administrative expenses or the occurrence of
extraordinary events could cause actual results to vary materially from the
results contemplated in the forward-looking statements. Budgeting and other
management decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause us to alter our marketing, capital
expenditure or other budgets, which may in turn affect our results of
operations. In light of the significant uncertainties inherent in the forward-
looking information included herein, the inclusion of such information should
not be regarded as a representation by us or any other person that our
objectives or plans will be achieved.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company required to be included in
this Item 7 are set forth in a separate section of this report and commence on
Page F-1 immediately following page 31.
ITEM 8. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS: COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
Identification of Directors and Executive Officers
The directors and executive officers of the Company, their ages and positions
held are as follows:
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Allan Cocumelli 49 Chairman of the Board and Director, Audit Committee
Alfred H. Falk 45 President, Chief Executive Officer and Director
Robert Putnam 41 Vice President, Secretary and Director
Renee Warden 36 Controller and Assistant Secretary
Walter "Skip" Matthews 54 Director, Audit Committee
Victor G. Ramsauer 45 Director, Audit Committee
</TABLE>
The terms of all directors will expire at the next annual meeting of the
Company's stockholders, or when their successors are elected and qualified.
Directors are elected each year, and all directors serve one-year terms.
Officers serve at the pleasure of the Board of Directors. There are no
arrangements or understandings between the Company and any other person pursuant
to which he was or is to be selected as a director, executive officer or nominee
therefor. There are no other persons whose activities are material or are
expected to be material to the Company's affairs.
Biographical Information
Allen Cocumelli - Mr. Cocumelli was appointed to the Board of Directors on
August 25, 1999 and was elected as the Chairman of the Board in April 2000. Mr.
Cocumelli has been General Counsel of Simple Network Communications Inc.
("Simplenet") since 1996 and Chief Operating Officer of Simplenet since November
1997. Prior to joining Simplenet, Mr. Cocumelli was in the private practice of
law. From 1978 to 1986 Mr. Cocumelli served as a manager in the Components
Manufacturing Group and as Director of Corporate Training and Development at
Intel. Mr. Cocumelli obtained a B.S. degree in Industrial Psychology from the
University of California, Los Angeles in 1972 and a J.D. from Thomas Jefferson
University in 1991. Mr. Cocumelli is a member of the California Bar
Association.
Alfred H. Falk - Mr. Falk was appointed President and a Director of the
Company in January 1997 and on July 1, 1998 he was also appointed as Chief
Executive Officer. From March, 1995, prior to his appointment as President, he
served as Vice President, Business Development and Vice President of OEM and
International Sales of the Company. Before joining the Company, Mr. Falk was
with Resources Internationale where he served as Director of U.S. Sales from
1993 to 1995. From 1988 to 1993, Mr. Falk was the Manager of OEM Sales and
Technology Licensing for Personal Computer Products, Inc. in San Diego. From
1978 to 1988 Mr. Falk held several management positions at DH Technology and was
instrumental in its successful start up. Mr. Falk attended Palomar College in
San Marcos and Foothill College in Los Altos, California.
22
<PAGE>
Robert Putnam - Mr. Putnam was appointed Secretary of the Company in March
1988, and Vice President in April 1993. He was appointed a Director of the
Company in 1995. He served as a Director of ATC from 1984 to September 1997 and
served as Secretary/Treasurer until February 1994, President and Chief Executive
Officer from February 1994 to September 1997 and currently serves as Vice
President, Investor Relations of ATC. He has also served as Secretary/Treasurer
of Patriot since 1989 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.
Renee Warden - Ms. Warden was appointed Controller of the Company in June
1997. From November 1991 to June 1997 she was Accounting Manager for the
Company. Ms. Warden obtained a B.S. degree in business accounting from the
University of Phoenix in 1999. In March 1999 she was also appointed Chief
Accounting Officer, Treasurer and Secretary of ATC. Ms. Warden devotes only
part-time service to the Company, approximately twenty-five hours per week.
Walter "Skip" Matthews - Dr. Matthews was appointed to the Board of Directors
on August 1, 1999. From July 1974 until August 1999, Dr. Matthews was employed
by Intel Corporation ("Intel") in various management capacities until his
retirement in August 1999. Initially in charge of development of equipment for
manufacturing at Intel, Dr. Matthews worked the last eight years marketing
Intel's Flash memory products. Dr. Matthews last position with Intel was senior
Project Development Manager. Dr. Matthews obtained his B.S. in Chemistry from
Duke University in 1966 and his Ph.D. in organic chemistry from Southern
Illinois University in 1972. Prior to joining Intel in 1974, Dr. Matthews also
completed a National Science Foundation Post-Doctoral Fellowship at Northwestern
University.
Victor G. Ramsauer, CPA - Mr. Ramsauer was appointed to the Board of Directors
on April 12, 2000. Mr. Ramsauer has been a shareholder at Levitz, Zacks and
Ciceric, CPA's since 1985. Prior to joining Levitz, Zacks and Ciceric, Mr.
Ramsauer held a manager level position with Price Waterhouse from 1977 to 1985.
Mr. Ramsauer received his B.S. degree in Business Administration from California
State Polytechnic University, Pomona in 1976. Mr. Ramsauer obtained his CPA
license in both California and Nevada in 1980 and 1999, respectively. Mr.
Ramsauer is a member of the American Institute of Certified Public Accountants,
the California Society of Certified Public Accountants and the Nevada Society of
Certified Public Accountants.
Compliance With Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 (the "Act") requires the
Company's officers, directors and persons who own more than 10% of a class of
the Company's securities registered under Section 12(g) of the Act to file
reports of ownership and changes in ownership with the Securities and Exchange
Commission ("SEC"). Officers, directors and greater than 10% shareholders are
required by SEC regulation to furnish the Company with copies of all Section
16(a) forms they file.
Based solely on a review of copies of such reports furnished to the Company and
written representations that no other reports were required during the fiscal
year ended March 31, 2000, the Company believes that all persons subject to the
reporting requirements pursuant to Section 16(a) filed the required reports on a
timely basis with the SEC.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth for the years ended March 31, 2000, 1999 and
1998, the cash compensation of Mr. Falk, who functioned as Chief Executive
Officer during the year ended March 31, 2000. No other person served as an
Executive Officer of the Company during the fiscal year ended March 31, 2000,
received total salary and bonus in excess of $100,000.
Summary Compensation Table
--------------------------
<TABLE>
<CAPTION>
Long Term
Compensation Options
Name and Fiscal Annual Compensation -------------------- All Other
Principal Position Year Salary Bonus Other (# of Shares) Compensation
------------------ ----- ------ ----- ----- ------------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Alfred H. Falk, President and 2000 $154,558 $54,250 -0- 2,000,000 -0-
Chief Executive Officer 1999 $101,885 -0- -0- 882,000 -0-
1998 $ 80,936 -0- -0- 648,316(1) -0-
</TABLE>
A total of 148,316 of these options were voluntarily canceled during fiscal 1998
to allow warrant exercise by prepaid warrant holders.
23
<PAGE>
Option Grants
-------------
Shown below is further information on grants of stock options to the Named
Executive Officers reflected in the Summary Compensation Table shown above.
Option Grants for Fiscal Year Ended March 31, 2000
<TABLE>
<CAPTION>
Percent of Total
Number of Options Granted Exercise Expiration
Name Options Granted to Employees in Fiscal Year Price Date
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Alfred H. Falk 2,000,000 (1) 57% $5.46 January 10, 2004
</TABLE>
(1) These options vested 25% at issue and 25% vest each year thereafter from
issue until fully vested.
Aggregated Option Exercises and Fiscal Year-End Values
------------------------------------------------------
The following table provides information on exercised and unexercised options of
the Named Executive Officer at March 31, 2000.
<TABLE>
<CAPTION>
Value of
Number of Securities Unexercised
Underlying Unexercised In-The-Money
Options at Options at
March 31, 2000 March 31, 2000
(#) ($)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise (#) Value Realized Unexercisable Unexercisable
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Alfred H. Falk 751,684 $6,962,470 1,148,316 1,500,000 $8,763,202 $6,903,750
</TABLE>
The Company has not awarded stock appreciation rights to any employee of the
Company and has no long-term incentive plans, as that term is defined in
Securities and Exchange Commission regulations. The Company has no defined
benefit or actuarial plans covering any person.
Employment Agreements
In May 1999, the Company entered into an employment agreement with Alfred H.
Falk, the Company's President and Chief Executive Officer. The employment
agreement provides for a base salary of $155,000 per year and certain bonuses as
approved by the Board of Directors. The agreement is for a two year term. In the
event of a non-voluntary termination other than for cause, the employee is
entitled to six months severance payment. In the event of a change of control (a
new owner controls more than 51% of the Company's Common Stock) and employee is
terminated within 12 months of the change, other than cause, then the employee
shall receive a termination payment equal to one year's then annual
compensation.
Compensation of Directors
No direct or indirect remuneration has been paid or is payable by the Company to
the directors in their capacity as directors. It is anticipated that during the
next twelve months that the Company will not pay any direct or indirect
remuneration to any directors of the Company in their capacity as directors
other than in the form of reimbursement of expenses of attending directors' or
committee meetings. However, directors have received in the past, and may
receive in the future, stock options.
24
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Common Stock
The following table sets forth, as of June 16, 2000, information regarding
ownership of the Common Stock, by each person known by the Company to be the
beneficial owner of more than 5% of the Company's outstanding Common Stock, by
each director and by all executive officers and directors of the Company as a
group. All persons named have sole voting and investment power over their shares
except as otherwise noted.
<TABLE>
<CAPTION>
Number of Percent
Name Shares Owned of Class
<S> <C> <C>
Alfred H. Falk 1,615,000 /(2)/ 1.3%
Robert Putnam 1,325,000/(1)/ 1.0%
Renee Warden 37,000/(3)/ .0%
Walter Matthews 52,129/(4)/ .0%
Allen Cocumelli 51,000/(4)/ .0%
Victor Ramsauer -0- .0%
All officers and directors
as a group (6 persons) 3,080,129/(5)/ 2.3%
</TABLE>
(1) Includes options exercisable within 60 days to purchase 200,000 shares and
warrants to purchase 500,000 shares. Excludes unvested options to purchase
600,000 shares.
(2) Includes options exercisable within 60 days to purchase 1,148,316 shares.
Excludes unvested options to purchase 1,500,000 shares.
(3) Includes options exercisable within 60 days to purchase 27,000 shares.
Excludes unvested options to purchase 25, 000 shares.
(4) Includes options exercisable within 60 days to purchase 50,000 shares.
Excludes unvested options to purchase 50,000 shares.
(5) Includes options exercisable within 60 days to purchase 1,475,316 shares
and warrants on 500,000 shares.
Preferred Stock
The following security ownership information is set forth as of June 16, 2000,
with respect to certain persons or groups known to the Company to be beneficial
owners of more than 5% of the Company's outstanding Series A Stock, the only
class of preferred stock outstanding. Other than as set forth below, the Company
is not aware of any other person who may be deemed to be a beneficial owner of
more than 5% of the Company's preferred stock.
<TABLE>
<CAPTION>
Amount and
Nature of
Beneficial Percent of
Name and address of Beneficial Owner Ownership (1)(3) Class
----------------------------------- ---------------- -----
<S> <C> <C>
Canusa Trading Ltd. 1,500 79%
W.A. Manuel, Director (2)
37 Reid Street, 2nd Flr., Armoury Bldg.
Hamilton, Bermuda
R. Kirk Avery 400 21%
6121 Vista de la Mesa
La Jolla, California 92037
</TABLE>
(1) Represents number of shares of Series A Stock, held as of June 16, 2000. At
such date an aggregate of 1,900 shares of preferred stock were issued and
outstanding convertible into an aggregate of 261,909 shares of Common Stock.
(2) The Company believes that the representative named has the authority to
vote the shares on behalf of the preferred stockholder.
(3) The Company has no additional information regarding beneficial ownership
of Common Stock by the holders of preferred stock.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We jointly lease with ATC an aggregate of 18,056 square feet of
engineering office space at 13114 Evening Creek Drive South, San Diego,
California of which we occupy approximately 11,000 square feet at a
cost of $12,950 per month. We believe that the terms of these
arrangements are no less favorable than could be obtained from an independent
and unaffiliated party.
Certain conflicts of interest now exist and will continue to exist between the
Company 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. The Company has not established policies or
procedures for the resolution of current or potential conflicts of interest
between the Company and its management or management-affiliated entities. There
can be no assurance that members of management will resolve all conflicts of
interest in the Company's favor. The officers and directors are accountable to
the Company as fiduciaries, which means that they are legally obligated to
exercise good faith and integrity in
25
<PAGE>
handling the Company's affairs. Failure by them to conduct the Company's
business in its best interests may result in liability to them.
Officer and Director Robert Putnam also acts as Treasurer and Secretary of
Patriot where he ultimately reports to the Board of Directors. Mr. Putnam is
also Vice President, Investor Relations of ATC. Ms. Warden is Chief Accounting
Officer, Treasurer and Secretary of ATC. The possibility exists that these other
relationships could affect Mr. Putnam's independence as an officer and director
of the Company and Ms. Warden as an officer. The Company has not provided a
method of resolving this conflict and probably will not do so, partly due to
inevitable extra expenses and delay any measures would occasion. Mr. Putnam and
Ms. Warden are obligated to perform their duties in good faith and to act in the
best interest of the Company and its stockholders, and any failure on their part
to do so may constitute a breach of their fiduciary duties and expose them 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 or Ms. Warden would be excluded from liability or indemnified if
they breached their loyalty to the Company.
On June 12, 1998, the Company granted to Mr. Putnam a stock purchase warrant to
purchase 500,000 shares at $0.10 per share until June 12, 2003 in consideration
of Mr. Putnam providing purchasers of the Notes an option to purchase up to
25,000 shares of ATC stock owned by him. The Company believes the Company would
have been unable to obtain the Note financing without the inducement provided by
Mr. Putnam.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Each exhibit marked with an asterisk is filed with this Annual Report on Form
10-KSB. Each exhibit not marked with an asterisk is incorporated by reference to
the exhibit of the same number (unless otherwise indicated) previously filed by
the Company as indicated below.
Exhibit
Number Description of Exhibit
------ ----------------------
2.6 Plan of Reorganization and Agreement of Merger, dated July 1996 and
filed as Exhibit A to the Company's July 3, 1996 Proxy Statement.
3.1 Certificate of Incorporation of Norris Communications, Inc. (as amended
through May 28, 1996) and filed as Exhibit B to the Company's July 3,
1996 Proxy Statement.
3.1.1 Certificate of Amendment of Certificate of Incorporation of Norris
Communications, Inc. filed with the State of Delaware on January 14,
1998 and filed as Exhibit 3.1.1 to the Company's Quarterly Report on
Form 10-QSB for the quarter ended December 31, 1997.
3.1.2 Certificate of Amendment of Certificate of Incorporation of Norris
Communications Inc. filed with the State of Delaware on January 13, 1999
and filed as Exhibit 3.1.2 to the Company's Quarterly Report on Form 10-
QSB for the quarter ended December 31, 1998.
3.2 Bylaws of Norris Communications, Inc., filed as Exhibit C to the
Company's July 3, 1996 Proxy Statement.
3.3 Certificate of Designation of Preferences, Rights and Limitations of
Series A Redeemable Convertible Preferred Stock filed with the State of
Delaware on September 19, 1997 and filed as Exhibit 3.3 to the Company's
Current Report on Form 8-K dated October 3, 1997.
3.4 Certificate of Designation of Preferences, Rights and Limitations of
Series B Redeemable Convertible Preferred Stock filed with the State of
Delaware on June 24, 1999.
4.3 Form of Warrant Agreement dated June 7, 1996 for an aggregate of
$3,805,900 issued to a total of twelve investors and filed as an Exhibit
to the Company's Current Report on Form 8-K dated April 5, 1996.
4.3.1 Form of Amendment No. 1 to Common Stock Warrant between the Company and
three Warrant Holders holding an aggregate of $1,154,409 face value of
warrants granted in July and August 1996 (Each Amendment is identical
except for the dates and the name of the Warrant Holder), filed as
Exhibit 4.11.1 to the Company's Form 8-K, dated September 10, 1997.
26
<PAGE>
4.4 Warrant Agreement for 401,924 shares of Common Stock between the Company
and Klein Investment Group, L.P. (formerly known as Iacocca Capital
Partners, L.P.) dated August 7, 1996 and filed previously as an Exhibit
to the Company's Current Report on Form 8-K dated August 29, 1996.
4.4.1 First Amendment to Common Stock Warrant (increasing warrants to
801,924), Termination of January 7, 1997 Letter Agreement and Amendment
to Consulting Agreement dated September 29, 1997 between the Company and
Klein Investment Group, L.P., filed as Exhibit 4.12.1 to the Company's
Form 10-QSB for the quarter ended September 30, 1997.
4.6 Form of Series 98A 12% Convertible Promissory Note with Limited Guaranty
("Notes") due May 15, 1999 between the Company and 6 investors for an
aggregate of $1,000,000 (individual notes vary as to date, amount and
payee) and filed previously as Exhibit 4.6 to the Company's Annual
Report on Form 10-KSB dated March 31, 1998.
4.7 Stock Purchase Warrant dated June 3, 1998 for 571,429 Common Shares
between the Company and Renwick Corporate Finance, Inc. and filed
previously as Exhibit 4.6 to the Company's Annual Report on Form 10-KSB
dated March 31, 1998.
4.8 Form of Stock Purchase Warrant dated June 12, 1998 entered into between
the Company and Elwood G. Norris and Robert Putnam for an aggregate of
2,000,000 shares (1,500,000 shares as to Mr. Norris and 500,000 shares
as to Mr. Putnam) and filed previously as Exhibit 4.6 to the Company's
Annual Report on Form 10-KSB dated March 31, 1998.
4.9 Form of 15% Promissory Note due December 31, 1999 for an aggregate of
$500,000 issued to three investors and filed previously as Exhibit 4.9
to the Company's Quarterly Report on Form 10-QSB for the quarter ended
December 31, 1998.
4.10 Form of Warrant Exercisable into an aggregate of 5,000,000 shares of
Common Stock at $0.10 per share until June 30, 2000 issued to three
investors and filed previously as Exhibit 4.10 to the Company's
Quarterly Report on Form 10-QSB for the quarter ended December 31, 1998.
4.11 Stock Purchase Warrant for 33,750 Common Shares between the Company and
Cruttenden & Co., Inc. dated July 15,1994 and filed as Exhibit 4.3 to
the Company's 1995 Form 10-KSB.
4.12 Stock Purchase Warrant for 300,000 Common Shares between the Company and
CVD Financial Corporation dated July 15, 1994 and filed as Exhibit 4.4
to the Company's 1995 Form 10-KSB.
4.12.1 First Amendment to Stock Purchase Warrant for 300,000 Common Shares
between the Company and CVD Financial Corporation dated November 14,
1994 and filed as Exhibit 4.4.1 to the Company's 1995 Form 10-KSB.
4.12.2 Second Amendment to Stock Purchase Warrant (for 300,000 shares) between
the Company and CVD Financial Corporation dated August 1, 1995 and filed
as Exhibit 10.5.5 to the Company's Form 8-K dated October 27, 1995.
4.13 Stock Purchase Warrant for 150,000 Common Shares between the Company and
CVD Financial Corporation dated July 15, 1994 and filed as Exhibit 4.5
to the Company's 1995 Form 10-KSB.
4.13.1 First Amendment to Stock Purchase Warrant for 150,000 Common Shares
between the Company and CVD Financial Corporation dated November 14,
1994 and filed as Exhibit 4.5.1 to the Company's 1995 Form 10-KSB.
4.13.2 Second Amendment to Stock Purchase Warrant (for 150,000 shares) between
the Company and CVD Financial Corporation dated August 1, 1995 and filed
as Exhibit 10.5.4 to the Company's Form 8-K dated October 27, 1995.
4.14 Warrant Agreement for 82,100 Common Shares between the Company and
Comdisco, Inc. dated as of August 15, 1994 and filed as Exhibit 4.6 to
the Company's 1995 Form 10-KSB.
4.15 Warrant Agreement No. 1 for 106,986 Common Shares between the Company
and Pennsylvania Merchant Group Ltd. dated March 1, 1995 and filed as
Exhibit 4.7 to the Company's 1995 Form 10-KSB.
4.15.1 Warrant Agreement No. 2 for 87,300 Common Shares between the Company and
Pennsylvania Merchant Group Ltd. dated March 17, 1995 and filed as
Exhibit 4.7.1 to the Company's 1995 Form 10-KSB.
27
<PAGE>
4.15.2 Warrant Agreement No. 3 for 714 Common Shares between the Company and
Pennsylvania Merchant Group Ltd. dated March 20, 1995 and filed as
Exhibit 4.7.2 to the Company's 1995 Form 10-KSB.
4.15.3 First Amendments to Warrant Agreements No. 1, 2 and 3 between the
Company and Pennsylvania Merchant Group Ltd. dated as of September 29,
1997 (amended to 45,570 shares), filed as Exhibit 4.7.3 to the Company's
Form 10-QSB for the quarter ended September 30, 1997.
4.16 First Amendment to Warrant Agreement between the Company and First
Bermuda Securities Ltd. dated as of September 30, 1997 (27,500 shares),
filed as Exhibit 4.10.1 to the Company's Form 10-QSB for the quarter
ended September 30, 1997.
4.17 Placement Agent's Warrant Agreement between Auerbach, Pollack &
Richardson, Inc. and the Company, filed as Exhibit 10.17 to the
Company's Form 8-K dated November 13, 1995.
4.17.1 Warrant Certificate Issued to Auerbach, Pollak & Richardson, Inc. and
filed as Exhibit 10.18 to the Company's Form 8-K dated November 13, 1995
and filed previously as an Exhibit to the Company's Current Report on
Form 8-K, dated November 13, 1995.
4.17.2 Release and Termination of Right of First Refusal and Amendment to
Warrant between the Company and Auerbach, Pollak & Richardson, Inc.
dated May 13, 1996 and filed previously as an Exhibit to the Company's
Annual Report on Form 10-KSB for the fiscal year ended March 31, 1996.
4.17.3 Form of Amendment to Warrant Certificate and Warrant Agreement between
the Company and Auerbach, Pollack & Richardson, Inc. and six individual
assignees (identical amendments except as to the number of shares (total
of 128,067 shares) and the name of holder) dated as of September 30,
1997, filed as Exhibit 10.18.2 to the Company's Form 10-QSB for the
quarter ended September 30, 1997.
4.18 Warrant Agreement for 150,000 Common Shares between the Company and
Higham, McConnell & Dunning dated October 10, 1996 and filed previously
as an Exhibit to Registration Statement No. 333-13779.
4.18.1 Amendment No. 1 to Stock Purchase Warrant Agreement between the Company
and Higham, McConnell & Dunning dated September 30, 1997, filed as
Exhibit 4.13.1 to the Company's Form 10-QSB for the quarter ended
September 30, 1997.
4.18.2 Amendment No. 2 to Stock Purchase Warrant Agreement between the
Company and Higham, McConnell & Dunning dated May 27, 1999.
4.19 Warrant Agreement for 500,000 shares dated January 15, 1999 between
the Company and Sunrise Capital, Inc.
4.20 Form of Warrant Agreement for an aggregate of 2,907,142 shares (as of
March 31, 1999) issued at various dates between the Company and six
investors.
4.21 Form of Warrant Agreement for an aggregate of 1,117,857 shares (as of
March 31, 1999) dated March 1999 between the Company and four investors.
4.22 Warrant Agreement for 125,000 shares dated October 15, 1998 between
the Company and Renwick Corporate Finance, Inc.
4.23 Warrant Agreement for 100,000 shares dated January 15, 1999 between
the Company and Pomerado Properties.
4.24 Warrant Agreement for 195,000 shares dated June 24, 1999 between the
Company and JNC Opportunity Fund Limited.
4.25 Warrant Agreement for 137,615 shares dated June 24, 1999 between the
Company and Jesup & Lamont Securities Corporation.
4.26 Convertible Preferred Stock Purchase Agreement between the Company and
JNC Opportunity Fund Limited dated June 24, 1999.
28
<PAGE>
4.27 Registration Rights Agreement between the Company and JNC Opportunity
Fund Limited dated June 24, 1999.
10.1 Stock Option Plan adopted by the Company on August 21, 1992 ("1992
Plan"), filed as Exhibit 10.10 to the Company's Registration Statement
on Form 10, as amended.
10.2 Stock Option Plan adopted by the Company on September 29, 1994 ("1994
Plan"), filed as Exhibit 10.10 to the Company's 1995 Form 10-KSB.
10.2.1 First Amendment to Stock Option Plan adopted by the Company on January
26, 1996 and filed previously as Exhibit 10.14.1 to the Company's Annual
Report on Form 10-KSB dated March 31, 1998.
10.2.2 Second Amendment to Stock Option Plan adopted by the Company on
September 3, 1997 and filed previously as Exhibit 10.14.2 to the
Company's Annual Report on Form 10-KSB dated March 31, 1998.
10.3 Employment Agreement dated September 12, 1995 between the Company and
Elwood G. Norris, filed as an Exhibit to the Company's Annual Report on
Form 10-KSB for the fiscal year ended March 31, 1996.
10.3.1 First Amendment to Employment Agreement between the Company and Elwood
G. Norris dated May 20, 1999.
10.4 Employment Agreement dated September 8, 1995 between the Company and
Robert Putnam, filed as Exhibit 10.21 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended March 31, 1996.
10.5 Employment Agreement dated October 3, 1997 between the Company and
Alfred H. Falk.
*10.5.1 First Amendment to Employment Agreement between the Company and Alfred
H. Falk dated May 19, 1999
10.6 Agreement dated January 6, 1997 between the Company and Lanier
Worldwide, Inc., filed as an Exhibit to Registration Statement No. 333-
7709 [Portions of this Exhibit have been omitted (based upon a request
for confidential treatment) and have been filed separately with the
Securities & Exchange Commission pursuant to Rule 406].
10.6.1 First Amendment to Lanier Agreement between the Company and Lanier
Worldwide, Inc. dated May 19, 1998.
10.7 Lease Settlement Agreement and Promissory Note dated as of September 30,
1997 between the Company and Pomerado Properties, filed as Exhibit
10.13.1 to the Company's Form 10-QSB for the quarter ended September 30,
1997.
10.8 Purchase Agreement - Services between Company and Intel Corporation,
dated August 4, 1998 [Portions of this Exhibit have been omitted (based
upon a request for confidential treatment) and have been filed
separately with the Securities and Exchange Commission pursuant to Rule
24b-2] and filed previously as Exhibit 10.28 to the Company's Form 10-
QSB/A dated October 21, 1998.
10.9 Sublease Agreement between Global Associates, Ltd. and American
Technology Corporation and the Company dated July 11, 1997 and filed as
Exhibit 10.34 to the Company's Form 10-QSB for the quarter ended June
30, 1997.
*10.9.1 First Amendment to Sublease Agreement between Global Associates Ltd. and
American Technology Corporation and the Company dated November 1, 1999.
10.10 Manufacturing Agreement between the Company and Eltech Electronics,
Inc. dated December 3, 1998.
*10.11 License Agreement between the Company and Maycom Co., Ltd., dated
January 4, 2000. [Portions of this Exhibit have been omitted (based upon
a request for confidential treatment) and have been filed separately
with the Securities & Exchange Commission pursuant to Rule 24b-2].
*21.1 List of subsidiaries.
*23.2 Consent of Ernst & Young LLP.
*27.1 Financial Data Schedule.
29
<PAGE>
----------------
* Filed concurrently herewith.
(b) Reports on Form 8-K.
The Company filed the following report on Form 8-K during the last fiscal
quarter ended March 31, 2000:
None
30
<PAGE>
* * * * * * * * * * * * * * * * * * * * * * *
E.DIGITAL CORPORATION AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000 and 1999
<TABLE>
<CAPTION>
Page
----
<S> <C>
Consolidated Financial Statements of the Company
Report of Independent Auditors F-1
Consolidated Balance Sheets as at March 31, 2000 F-2
and 1999
Consolidated Statements of Operations for the years F-3
ended March 31, 2000 and 1999
Consolidated Statements of Common Stockholders' Equity (Deficiency) for F-4
the years ended March 31, 2000 and 1999
Consolidated Statements of Cash Flows for the years F-5
ended March 31, 2000 and 1999
Notes to Consolidated Financial Statements F-6
</TABLE>
31
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS
e.Digital Corporation
and subsidiary
March 31, 2000 and 1999
32
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
e.Digital Corporation and subsidiary
We have audited the accompanying consolidated balance sheets of e.Digital
Corporation and subsidiary as of March 31, 2000 and 1999 and the related
consolidated statements of operations, stockholders' equity (deficiency) and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the 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 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 consolidated financial position of
e.Digital Corporation and subsidiary at March 31, 2000 and 1999 and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States.
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's recurring losses from
operations and its inability to generate sufficient cash flows from operations
to meet its obligations, raises substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
described in Note 1. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Vancouver, Canada, /s/ ERNST & YOUNG LLP
June 1 , 2000 Chartered Accountants
F-1
<PAGE>
e.Digital Corporation and subsidiary
CONSOLIDATED BALANCE SHEETS
(See Note 1 - Nature of Operations and Basis of Presentation)
<TABLE>
<CAPTION>
As at March 31,
2000 1999
$ $
-----------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current
Cash and cash equivalents 3,294,366 166,966
Accounts receivable, less allowance for doubtful
accounts of $nil and $953, respectively [note 3] 272,732 60,793
Amounts receivable on research and development contracts [note 10] -- 92,725
Inventory [note 6] 79,599 46,907
Prepaid expenses and other 8,459 8,961
-----------------------------------------------------------------------------------------------------
Total current assets 3,655,156 376,352
-----------------------------------------------------------------------------------------------------
Property and equipment [note 7] 142,371 72,675
Intangible assets, net of accumulated amortization
of $15,052 and $12,611, respectively 9,357 11,798
-----------------------------------------------------------------------------------------------------
Total assets 3,806,884 460,825
-----------------------------------------------------------------------------------------------------
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIENCY)
Current
Accounts payable, trade 571,101 597,953
Other accounts payable and accrued liabilities 45,000 61,904
Accrued lease liability 515,000 537,934
Accrued employee benefits 154,311 111,195
15% promissory notes payable, net of unamortized discount
of $nil and $82,499, respectively [note 9] -- 417,501
Current portion of term note payable [note 8] -- 28,020
-----------------------------------------------------------------------------------------------------
Total current liabilities 1,285,412 1,754,507
-----------------------------------------------------------------------------------------------------
Term note payable [note 8] -- 98,163
-----------------------------------------------------------------------------------------------------
Total liabilities 1,285,412 1,852,670
-----------------------------------------------------------------------------------------------------
Redeemable preferred stock
Series A, convertible voting preferred stock, $.001 par value,
redeemable at $10 plus accrued and unpaid dividends at
8% cumulative, 100,000 shares authorized, 1,900 and 32,500
outstanding, respectively [note 12] 22,840 364,205
-----------------------------------------------------------------------------------------------------
Total redeemable preferred stock 22,840 364,205
-----------------------------------------------------------------------------------------------------
Commitments and contingencies [notes 1 and 13]
Stockholders' equity (deficiency)
Common stock, $.001 par value, authorized 200,000,000,
126,261,182 and 97,321,297 shares outstanding,
respectively [note 12] 126,261 97,321
Additional paid-in capital [note 12] 44,893,602 35,229,282
Prepaid warrants [note 14] -- 261,047
Contributed surplus 1,592,316 1,592,316
Accumulated deficit (44,113,547) (38,936,016)
-----------------------------------------------------------------------------------------------------
Total stockholders' equity (deficiency) 2,498,632 (1,756,050)
-----------------------------------------------------------------------------------------------------
3,806,884 460,825
-----------------------------------------------------------------------------------------------------
See accompanying notes
</TABLE>
F-2
<PAGE>
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended March 31,
<TABLE>
<CAPTION>
2000 1999
$ $
<S> <C> <C>
-----------------------------------------------------------------------------------------------------------------------
Revenues - products [notes 4 & 10] 387,576 154,428
- services [notes 4 & 10] 102,386 271,922
-----------------------------------------------------------------------------------------------------------------------
489,962 426,350
-----------------------------------------------------------------------------------------------------------------------
Cost of revenues - products [note 10] 328,158 138,316
- services [note 10] 133,322 849,997
-----------------------------------------------------------------------------------------------------------------------
461,480 988,313
-----------------------------------------------------------------------------------------------------------------------
Gross profit (loss) 28,482 (561,963)
-----------------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative 1,296,563 754,341
Research and related expenditures 1,346,927 508,237
-----------------------------------------------------------------------------------------------------------------------
Total operating expenses 2,643,490 1,262,578
-----------------------------------------------------------------------------------------------------------------------
Operating loss (2,615,008) (1,824,541)
-----------------------------------------------------------------------------------------------------------------------
Other income (expense)
Interest expense [note 9] (49,714) (81,086)
Non-cash interest expense [note 9] (82,499) (673,197)
Interest income 101,167 6,026
Other 37,200 (22,678)
-----------------------------------------------------------------------------------------------------------------------
Total other income (expense) 6,154 (770,935)
-----------------------------------------------------------------------------------------------------------------------
Loss before provision for income taxes (2,608,854) (2,595,476)
-----------------------------------------------------------------------------------------------------------------------
Provision for income taxes [note 11] -- --
-----------------------------------------------------------------------------------------------------------------------
Loss and comprehensive loss for the year (2,608,854) (2,595,476)
Beneficial conversion feature on the Series B
preferred stock [note 12] (1,200,000) --
Inducement warrants [note 12] (1,281,805) --
Accrued dividends on the Series A and B preferred stock (86,872) (102,368)
-----------------------------------------------------------------------------------------------------------------------
Loss attributable to common stockholders for the year (5,177,531) (2,697,844)
-----------------------------------------------------------------------------------------------------------------------
Loss per share (.05) (.04)
-----------------------------------------------------------------------------------------------------------------------
Weighted average number of common shares 114,639,649 66,492,289
-----------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes
F-3
<PAGE>
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY (DEFICIENCY)
<TABLE>
<CAPTION>
Common stock Additional
---------------------- paid-in Prepaid Contributed Accumulated
Shares Amount capital warrants surplus deficit
# $ $ $ $ $
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, March 31, 1998 57,171,119 57,171 31,333,437 903,996 1,592,316 (36,238,172)
Stock issued on exercise of prepaid warrant 10,783,128 10,782 632,167 (642,949) -- --
Stock issued on conversion of secured notes
payable 5,714,284 5,715 494,285 -- -- --
Stock issued on conversion of Series A preferred
stock 8,466,565 8,467 732,357 -- -- --
Stock issued on conversion of 12% convertible
promissory notes payable 12,379,059 12,379 1,527,818 -- -- --
Stock issued on exercise of warrants 2,807,142 2,807 242,818 -- -- --
Value assigned to 2,000,000 warrants granted in
connection with
issuance of 12% convertible promissory notes
payable -- -- 100,000 -- -- --
Value assigned to 5,000,000 warrants granted in
connection with
issuance of 15% promissory notes payable -- -- 110,000 -- -- --
Value assigned to the 1,171,429 warrants issued
for services -- -- 46,500 -- -- --
Compensatory stock options [note 12] -- -- 9,900 -- -- --
Loss for the year -- -- -- -- -- (2,595,476)
Accrued dividends on the Series A preferred stock -- -- -- -- -- (102,368)
------------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 97,321,297 97,321 35,229,282 261,047 1,592,316 (38,936,016)
Stock issued on exercise of prepaid warrants 4,493,335 4,493 256,554 (261,047) -- --
Stock issued for services 98,867 99 94,730
Stock issued on exercise of stock options 3,801,184 3,801 639,349 -- -- --
Stock issued on conversion of Series A preferred
stock 4,006,995 4,007 342,968 -- -- --
Stock issued on conversion of Series B preferred
stock 2,053,049 2,053 2,554,211
Series B preferred stock beneficial conversion
feature -- -- 1,200,000 -- -- (1,200,000)
Value assigned to 137,615 warrants granted in
connection
with issuance of Series B preferred stock -- -- 275,000 -- -- --
Stock issued on exercise of warrants 9,113,684 9,114 2,575,076 -- -- --
Exercise of cashless warrants 872,771 873 (873) -- -- --
15% Promissory note principal applied to warrant
exercise 4,500,000 4,500 445,500 -- -- --
Inducement warrants issued -- -- 1,281,805 -- -- (1,281,805)
Loss for the year -- -- -- -- -- (2,608,854)
Accrued dividends on the Series A and B
preferred stock -- -- -- -- -- (86,872)
------------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2000 126,261,182 126,261 44,893,602 -- 1,592,316 (44,113,547)
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes
F-4
<PAGE>
e.Digital Corporation and subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended March 31,
<TABLE>
<CAPTION>
2000 1999
$ $
<S> <C> <C>
---------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Loss for the year (2,608,854) (2,595,476)
Adjustments to reconcile loss to net cash used by
operating activities:
Depreciation and amortization 58,242 48,600
Loss (gain) on disposal of property and equipment -- 11,233
Professional services paid by issuance of common stock 94,829 --
Non-cash compensation -- 50,900
Non-cash interest expense 82,499 673,197
Changes in assets and liabilities:
Accounts receivable (211,939) (6,134)
Amounts receivable on research and development contract 92,725 75,256
Inventory (32,692) 133,844
Prepaid expenses and other 502 1,279
Accounts payable, trade (26,852) (84,974)
Other accounts payable and accrued liabilities (16,904) (2,644)
Accrued lease liability (22,934) 793
Accrued employee benefits 43,116 57,103
---------------------------------------------------------------------------------------------------------
Cash (used in) operating activities (2,548,262) (1,637,023)
---------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment (125,497) (3,880)
Proceeds on disposal of property and equipment -- 12,109
---------------------------------------------------------------------------------------------------------
Cash provided by (used in) investing activities (125,497) 8,229
---------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Repayment of term note payable (126,181) (12,235)
Proceeds from 15% promissory notes payable -- 500,000
Repayment on 15% promissory notes payable (50,000) --
Proceeds from 12% convertible promissory notes payable -- 1,000,000
Proceeds from sale of Series B preferred stock, net of issuance costs 2,750,000 --
Proceeds from exercise of warrants 2,584,190 245,625
Proceeds from exercise of stock options 643,150 --
---------------------------------------------------------------------------------------------------------
Cash provided by financing activities 5,801,159 1,733,390
---------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents during the year 3,127,400 104,596
Cash and cash equivalents, beginning of year 166,966 62,370
---------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year 3,294,366 166,966
---------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes
F-5
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
e.Digital Corporation, (the "Company") is incorporated under the laws of
Delaware and is engaged, through its wholly owned subsidiary, in research and
development, manufacturing, and marketing advanced electronic products.
The consolidated financial statements have been prepared, by management, in
accordance with accounting principles generally accepted in the United States on
a going concern basis, which contemplates the realization of assets and the
discharge of liabilities in the normal course of business for the foreseeable
future.
The Company has incurred significant losses and negative cash flow from
operations in each of the last three years and has an accumulated deficit of
$44,113,547 at March 31, 2000 [1999 - $38,936,016]. A substantial portion of the
losses is attributable to marketing costs of the Company's new technology and
substantial investments in research and development of technologies. The
Company's ability to continue as a going concern is in substantial doubt and is
dependent upon achieving a profitable level of operations and, if necessary,
obtaining additional financing.
Management of the Company has undertaken steps as part of a plan to improve
operations with the goal of sustaining Company operations for the next twelve
months and beyond. These steps include (a) focusing on the supply of product
under an existing OEM contract; (b) expanding sales and marketing to additional
OEM markets; and (c) controlling overhead and expenses. There can be no
assurance the Company can attain profitable operations in the future.
These consolidated financial statements do not give effect to any adjustments
which would be necessary should the Company be unable to continue as a going
concern and therefore be required to realize its assets and discharge its
liabilities in other than the normal course of business and at amounts different
from those reflected in the accompanying consolidated financial statements.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies used in the
preparation of these consolidated financial statements:
Principles of consolidation
These consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, e.Digital Corporation (a company incorporated in
the State of California). All significant intercompany accounts and transactions
have been eliminated.
Comparative figures
Certain amounts in the 1999 consolidated financial statements have been
reclassified to conform to the 2000 presentation.
Use of estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the period. Actual results could differ from those estimates.
Fair value of financial instruments
The Company's financial instruments consist of cash and cash equivalents,
accounts receivable, amounts receivable on research and development contracts,
accounts payable trade, other accounts payable and accrued liabilities, accrued
lease liability accrued employees benefits, 15% promissory notes payable, term
notes payable and redeemable preferred
F-6
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
stock. Unless otherwise stated the recorded value of the financial instruments
approximates their fair values. The Company has not entered into foreign
exchange derivative contracts.
Translation of foreign currencies
Monetary assets and liabilities denominated in foreign currencies are translated
into U.S. dollars at the rate in effect at the balance sheet date. Other balance
sheet items and revenues and expenses are translated into U.S. dollars at the
rates prevailing on the respective transaction dates. Gains and losses on
foreign currency transactions, which have not been material, are reflected in
the consolidated statements of operations.
Loss per share
Basic earnings (loss) per share is computed by dividing income (loss) available
to common stockholders by the weighted average number of common shares
outstanding for the year. Diluted earnings (loss) per share reflect the
potential dilution of securities that could share in the earnings (loss) of an
entity. Stock options, warrants, and redeemable convertible preferred stock
exercisable into 7,355,251 shares of common stock were outstanding as at March
31, 2000 and stock options, warrants and prepaid warrants exercisable into
29,011,591 shares of common stock were outstanding as at March 31, 1999. These
securities were not included in the computation of diluted earnings (loss) per
share because they are antidilutive, but they could potentially dilute earnings
(loss) per share in future years.
Revenue recognition
The Company recognizes license revenue and product revenue upon shipment of a
product to the customer if a signed contract exists, the fee is fixed and
determinable and collection of resulting receivables is probable. Research and
development contract revenue is recognized in the period the related research
and development expenditures are incurred. Funds received in advance of meeting
the criteria for revenue recognition are deferred and are recorded as revenue as
they are earned.
Cash equivalents
Cash equivalents, consisting of commercial paper with maturities of less than 90
days, certificates of deposit and money market funds, are recorded at amortized
cost, which approximates market value.
Inventory
Inventory is recorded at the lower of cost and net realizable value. Cost is
determined on a first-in, first-out basis.
Property and equipment
Property and equipment are recorded at cost. Depreciation and amortization are
provided on the straight-line method over the estimated useful lives of the
related assets, ranging from 3 to 7 years or, in the case of leasehold
improvements, over the lesser of the useful life of the related asset or the
lease term. When assets are sold or retired, the cost and accumulated
depreciation are removed from the respective accounts and any gain or loss on
the disposition is credited or charged to income. Maintenance and repair costs
are charged to operations when incurred.
Intangible assets
Intangible assets include third party costs relating to obtaining patents, which
are deferred when management is reasonably certain the patent will be granted.
Such costs are be amortized to operations over the life of the patent. If
management determines that development of products to which patent costs relate
is not reasonably certain, or that deferred patent costs exceed net recoverable
value, such costs are charged to operations.
F-7
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
Advertising
Advertising costs are charged to expense as incurred.
Leases
Leases entered into are classified as either capital or operating leases.
Leases, which substantially transfer all benefits and risks of ownership of
property to the Company, are accounted for as capital leases. At the time a
capital lease is entered into, an asset is recorded together with its related
long-term obligation to reflect the purchase and financing.
Rental payments under operating leases are expensed as incurred.
Income taxes
The Company follows the liability method of accounting for income taxes. Under
this method, deferred tax assets and liabilities are determined based on the
difference between the financial reporting and tax bases of assets and
liabilities using enacted tax rates that will be in effect for the year in which
the differences are expected to reverse.
Stock based compensation
The Company accounts for stock-based employee compensation arrangements using
the intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25") and complies with the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Under APB No. 25, compensation expense is based
on the difference, if any, on the date of the grant, between the fair value of
the Company's stock and the exercise price.
Comprehensive income
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. For the years
ended March 31, 2000 and 1999, there were no material differences between
comprehensive income and net loss for the year.
Segment information
The Company identifies its operating segments based on how management internally
evaluates separate financial information (if available), business activities and
management responsibility. The Company believes it operates in a single business
segment.
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.
F-8
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
2. SIGNIFICANT ACCOUNTING POLICIES (cont'd.)
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101), which
provides guidance on the recognition, presentation and disclosure of revenue in
financial statements of all public registrants. The provisions of
SAB 101 are effective for transactions beginning in the Company's fiscal year
2001. The Company has not completed its assessment of the impact of SAB 101 and
has not determined its effect, if any, on its future reported results of
operations.
On March 31, 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, " Accounting for Certain Transactions Involving Stock
Compensation"("FIN 44"). This statement is effective for certain transactions
from December 15, 1998 and is to be applied commencing July 1, 2000. The Company
has not completed its assessment of the impact of FIN 44 and has not determined
its effect, if any, on its future reported results of operations.
3. CREDIT RISK
Financial instruments, which potentially subject the Company to concentrations
of credit risk, consist principally of cash and cash equivalents, trade
receivables and amounts receivable on research and development contracts. The
Company performs ongoing credit evaluations of its customers and maintains
allowances for potential credit losses which, when realized, have been within
the range of management's expectations.
Amounts owing from two major customers comprise 89% and 11%, respectively of the
accounts receivable at March 31, 2000. Amounts owing from three major customers
comprised, 46%, 28% and 15%, respectively of the accounts receivable at March
31, 1999.
4. MAJOR CUSTOMERS AND SUPPLIERS
The Company operates in one major line of business, the development, manufacture
and marketing of electronic products. Sales to one major customer comprise 90%
of revenue in 2000. Sales to three major customers comprised 57%, 20% and 11%,
respectively, of revenues in 1999. The Company has entered into a supply
agreement with one supplier for the production of products. The Company has no
other significant suppliers.
F-9
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
5. STATEMENT OF CASH FLOWS
The Company had non-cash operating and financing activities and made cash
payments as follows:
<TABLE>
<CAPTION>
2000 1999
$ $
-----------------------------------------------------------------------------------------------------
<S> <C> <C>
Non-cash financing activities:
Professional services paid through the reduction of a warrant
exercise price and the issuance of common stock 94,829 --
Compensatory stock options -- 9,900
Common stock issued on conversion of 12% convertible
promissory notes payable -- 1,000,000
Common stock issued on conversion of secured notes payable -- 500,000
Common stock issued on conversion of Series A preferred stock 346,975 740,824
Common stock issued on conversion of Series B preferred stock 3,079,572 --
Value assigned to 137,615 warrants granted in connection
with the issuance of the Series B preferred stock 275,000 46,500
Deemed dividend on 195,000 warrants granted in connection with
issuance of Series B preferred stock 390,000 --
Accrued dividends on Series A and B preferred stock 86,872 102,368
Unamortized non-cash financing charges included in 15%
promissory notes payable -- 82,499
Common stock issued on exercise of prepaid warrants 261,047 642,949
15% Promissory note principal applied to warrant exercise 450,000 --
Cash payments for interest and income taxes were as follows:
Interest 49,714 81,086
Taxes -- --
-----------------------------------------------------------------------------------------------------
</TABLE>
6. INVENTORY
Inventory balance at March 31, 2000 and March 31, 1999 is comprised solely of
raw materials. During 1999, the Company wrote-off all remaining finished goods,
consisting of electronic products which the Company no longer manufactured.
<TABLE>
<CAPTION>
7. PROPERTY AND EQUIPMENT
Accumulated
depreciation and Net book
Cost amortization value
$ $ $
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
2000
Computer hardware and software 230,467 171,295 59,172
Furniture and equipment 49,069 48,316 753
Machinery and equipment 66,092 39,017 27,075
Leasehold improvements 52,487 8,283 44,204
Testing equipment 13,400 2,233 11,167
-----------------------------------------------------------------------------------------------------
411,515 269,144 142,371
-----------------------------------------------------------------------------------------------------
1999
Computer hardware and software 195,988 135,055 60,933
Furniture and equipment 48,258 47,474 784
Machinery and equipment 37,108 29,221 7,887
Leasehold improvements 4,664 1,593 3,071
-----------------------------------------------------------------------------------------------------
286,018 213,343 72,675
-----------------------------------------------------------------------------------------------------
</TABLE>
F-10
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
8. TERM NOTE PAYABLE
<TABLE>
<CAPTION>
2000 1999
$ $
<S> <C> <C>
-------------------------------------------------------------------------------------------------------------------------
Term note payable, unsecured, interest at 10% per annum, with monthly payments of principal
and interest of $5,000, maturing February 2002. -- 126,183
Less: current portion -- 28,020
-------------------------------------------------------------------------------------------------------------------------
-- 98,163
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
In January 1999, the Company granted the term note payable holder, warrants to
purchase 100,000 shares of common stock at an exercise price of $0.10 per share
through January 2002 in consideration for amending certain terms on the above
term note. The estimated fair value of the warrants granted at the date of
issuance was $2,750 and has been recorded in the statements of operations. The
Black Scholes options pricing model was used to value the warrants with the
following assumptions: no dividend yield; risk free interest rate of 6%,
expected volatility of 1.16 and an expected life of 1.5 years. The term note
was retired during the year ended March 31, 2000.
9. NOTES PAYABLE
[a] Secured notes payable
In June 1997, the Company issued $500,000 of secured convertible 12% notes
payable ("Secured Notes") for cash. Interest is payable quarterly in cash and
the Secured Notes were due on September 30, 1999. The Secured Notes were
collateralized by the Company's issued and pending patents and Flashback
technology. The Secured Notes were convertible into common stock at the lowest
conversion price of the prepaid warrants [note 14], which was fixed at $0.0875
per share. Upon a distribution in shares, subdivision, split-up, combination,
reclassification or other change in the common stock, the conversion price of
the Secured Notes is the lesser of $0.0875 (or lower amount effective at the
time) or 70% of the average closing bid price of the common stock for the 20
trading days after each such event. Pursuant to the terms of the Secured Notes,
during 1999 the Company issued 5,714,284 shares of common stock upon the
conversion of the Secured Notes, and warrants to purchase an additional
5,714,284 shares of common stock exercisable for three years at $0.0875 per
share. During the year ended March 31, 1999, the Company issued warrants to
purchase 1,117,857 shares of common stock through March 2002 at $0.15 per share
as an inducement to exercise the existing warrants. Through March 31, 2000,
2,907,142 [1999 - 2,807,142] shares of common stock were issued upon exercise of
these warrants for cash of $254,375 [1999 - $245,625].
[b] 12% Convertible promissory notes payable
In June 1998, the Company completed the sale of $1,000,000 of 12% convertible
promissory notes payable with limited guaranty ("12% Convertible Notes") due May
15, 1999. Pursuant to a conversion feature exercised by the Company in February
1999, the 12% Convertible Notes were converted into 12,379,059 shares of common
stock. The 12% Convertible Notes were convertible at a discount at the time of
issuance and accordingly, the Company recorded $540,197 as non-cash interest
expense.
In connection with the sale of the 12% Convertible Notes, the Company issued
warrants to purchase 571,429 common shares at $0.0875 per share, which expire on
June 30, 2000 and granted warrants to two officers and shareholders of the
Company, to purchase an aggregate of 2,000,000 common shares at $0.10 per share,
which expire on June 12, 2003, for certain guarantees and inducements granted to
the purchasers of the 12% Convertible Notes. The estimated fair value of the
warrants at the date of issuance was $100,000 and was recorded as non-cash
interest expense during the year ended March 31, 1999.
The Black Scholes options pricing model was used to value the warrants with the
following assumptions: no dividend yield; risk free interest rate of 6%,
expected volatility of 1.40 and an expected life of five years.
F-11
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
9. NOTES PAYABLE (cont'd.)
[c] 15% Promissory notes payable
In December 1998 and January 1999, the Company issued $500,000 of 15% unsecured,
subordinated, promissory notes payable ("15% Promissory Notes") for cash to
assist in the completion of its research and development projects. Interest is
payable quarterly in cash and the notes are due December 31, 1999.
In connection with the sale of the 15% Promissory Notes, the Company issued
warrants to purchase 5,000,000 common shares at $0.10 per share, which expire
June 30, 2000. The estimated fair value of the warrants at issuance was
$110,000 and is being amortized as non-cash interest expense over the term of
the 15% Promissory Notes. The Black Scholes options pricing model was used to
value the warrants with the following assumptions: no dividend yield; risk free
interest rate of 6%, expected volatility of 1.10 and an expected life of 1.5
years.
The Company retired $450,000 of the 15% promissory notes during the year ended
March 31, 2000 by applying $450,000 receivable upon the exercise of 4,500,000
warrants by the noteholders. In December 1999, the balance of the note
principal of $50,000 was repaid in cash to the noteholders. Interest on the 15%
Promissory Notes, amounting to $49,714, was paid during the year ended March 31,
2000. The unamortized discount of $82,499 was charged to the statement of
operations during the year ended March 31, 2000.
10. RESEARCH AND DEVELOPMENT CONTRACTS
In January 1997, the Company entered into a long-term contract with an third
party company to provide research and development services with respect to a
digital recorder. To date the Company has received aggregate cash payments of
approximately $935,000 for engineering development services and has incurred
$1,563,000 in direct costs associated with the contract. Development services
were completed as of March 31, 2000. Pursuant to the contract the Company is
obligated to provide production and delivery of finished product to certain
specifications through December 26, 2001. The Company has entered into a
separate supply agreement for the production of these products.
In August 1998, the Company entered into a development contract with a third
party company to develop a reference design and initial prototypes of an
advanced digital recorder. Total payments received to date on the contract
aggregate $81,000 [1999 - $81,000].
The Company provides other contract development pursuant to purchase orders or
agreements with third parties from time to time in the normal course of its
business.
F-12
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
11. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. For financial statement
purposes, a change in valuation allowance of $1,059,000 [1999, $1,095,000] has
been recognized to offset certain deferred tax assets for which realization is
uncertain. Significant components of the Company's deferred tax liabilities and
assets as of March 31 are as follows:
<TABLE>
2000 1999
$ $
-------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities
Tax over book depreciation 341,000 339,000
-------------------------------------------------------------------------------
Total deferred tax liabilities 341,000 339,000
-------------------------------------------------------------------------------
Deferred tax assets
Net operating loss carryforwards 12,371,000 11,331,000
Other 328,000 307,000
-------------------------------------------------------------------------------
Total deferred tax assets 12,699,000 11,638,000
Valuation allowance for deferred tax assets (12,358,000) (11,299,000)
-------------------------------------------------------------------------------
Net deferred tax assets 341,000 339,000
-------------------------------------------------------------------------------
Net deferred tax balance -- --
-------------------------------------------------------------------------------
</TABLE>
The net provision for income taxes in 2000 and 1999 is $Nil as the Company
incurred losses in those years.
A reconciliation between federal statutory income tax rates and the effective
tax rate of the Company at March 31 is as follows:
<TABLE>
<CAPTION>
Liability method
----------------
2000 1999
% %
-----------------------------------------------------------
<S> <C> <C>
U.S. federal statutory rate 35.0 35.0
U.S. federal net operating loss rate (35.0) (35.0)
U.S. state tax rate -- --
-----------------------------------------------------------
Effective rate on operating loss -- --
-----------------------------------------------------------
</TABLE>
The Company has U.S. net operating loss carryforwards available at March 31,
2000 of approximately $32,504,000 [1999 - $29,945,000] and $17,293,000 [1999 -
$14,787,000] for federal and state tax purposes, respectively, to offset income
in future years. These carryforwards will begin to expire in the years 2006 and
2000, respectively, unless previously utilized. The tax losses of the Company
identified above may be subject to limitation arising from changes of ownership
over the three year statutory testing period.
12. CAPITAL STOCK
Authorized capital
The authorized capital of the Company consists of 200,000,000 common shares with
a par value of $.001 per share and 5,000,000 preferred shares with a par value
of $.001 per share.
Common stock
The issued common stock of the Company consisted of 126,261,182 and 97,321,297
common shares as of March 31, 2000 and 1999, respectively.
F-13
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
12. CAPITAL STOCK (cont'd.)
Redeemable preferred stock
Series A
The Company is authorized to issue 5,000,000 shares of $.001 par value preferred
stock in one or more series from time to time by action of the Board of
Directors. During September 1997, the first series, consisting of up to 100,000
shares, was designated by the Board of Directors as Series A (the "Series A
stock"). During September and October 1997, the Company sold 99,500 shares of
Series A stock at $10 per share for gross proceeds of $995,000 and net proceeds
of $962,500. The Series A stock has voting rights equal to the number of shares
of common stock into which the Series A stock is convertible. Dividends of 8%
per annum are cumulative and may be payable in cash or shares of common stock,
at the Company's election. The Series A stock has a liquidation preference of
$10 per share, plus accrued and unpaid dividends, with no participation after
the liquidation preference is paid.
During the year ended March 31, 2000, a total of $346,975 [1999- $740,824] of
Series A stock and dividends were converted into 4,006,995 [1999 - 8,466,565]
shares of common stock. The cumulative amount of unpaid dividends at March 31,
2000 is $3,838 [1999 - $39,205] which has been recorded as an increase in the
carrying value of the Series A stock.
Each share of Series A stock is currently convertible into 137.37 [1999 -
118.90] shares of common stock computed by dividing $10 plus accrued and unpaid
dividends by the lesser of (i) $0.0875 or (ii) 80% of the average closing bid
price for the common stock for the ten trading days immediately following any
and each distribution in shares, subdivision, split-up, combination,
reclassification or other change in common stock. At March 31, 2000, the 1,900
[1999 - 32,500] shares of Series A stock outstanding would have been convertible
into approximately 261,000 shares of common stock [1999 - 4.2 million]. The
Company is required to redeem the Series A stock on September 1, 2000 and upon
the occurrence of certain other events. The Company may redeem the Series A
stock earlier only if there are sufficient shares available for conversion of
the Series A stock. The redemption price is $10 per share plus accrued and
unpaid dividends if there are sufficient shares available for the conversion of
the Series A stock, otherwise the redemption price is equal to the greater of
(i) $10 per share plus accrued interest and unpaid dividends or (ii) an amount
equal to a five day market price multiplied by the number of common shares into
which the Series A stock would be convertible if shares were authorized, plus a
10% premium.
Series B
On June 25, 1999, the Company issued 300, 7% Series B convertible preferred
stock (the "Series B stock"), par value $.001, for cash of $10,000 per share and
gross proceeds of $3,000,000. Dividends of 7% per annum are cumulative and are
payable, with certain exceptions, either in cash or in shares of common stock at
the election of the Company. The 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. On September 8,
1999, the adjusted conversion price was determined to be $1.50 in accordance
with the terms of the agreement set out above. The adjusted conversion price
resulted in a beneficial conversion feature in the amount of $1,200,000 because
the adjusted conversion price was less then the fair market value of the common
stock when the preferred shares were issued. This has been recorded as a
beneficial conversion feature on the issuance of the Series B stock and
increases the loss attributable to common shareholders and the resulting loss
per share for the year ended March 31, 2000.
The Series B stock was redeemable in certain instances at the Company's option
and at the holder's election upon the occurrence of certain triggering events.
The Series B stock was subject to automatic conversion on June 24, 2002, subject
to certain conditions.
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
warrants to purchase 137,615 common shares of the Company with an exercise price
of $3.27 per share until June 24, 2004. The fair value of the warrants granted
was estimated at $275,000 on the date of the grant using the Black Scholes
options price model with the following assumptions: no dividend yield; risk free
interest rate of
F-14
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
12. CAPITAL STOCK (cont'd.)
6%, expected volatility of 1.844 and an expected life of 5 years. This amount
was been recorded as a cost of issuance by reducing Series B stock capital and
increasing common stock additional paid in capital.
In addition, in connection with the issuance of the Series B stock, the Company
issued to the Series B stock holders, warrants to purchase 195,000 shares of
Common Stock at $2.40 per share until June 24, 2004. The fair value of the
warrants granted was estimated at $390,000 on the date of the grant using the
Black Scholes options pricing model with the following assumptions: no dividend
yield; risk free interest rate of 6%, expected volatility of 1.844 and an
expected life of 5 years. A portion of the proceeds received, allocated to the
warrants, has been recorded as an increase in common stock additional paid in
capital. During the year ended March 31, 2000, all 300 shares of Series B stock
and accrued dividends of $79,572 were converted, in accordance with the terms of
the Series B stock agreement, into 2,053,049 shares of common stock.
Stock options
The Company maintains two stock option plans. The 1992 Stock Option Plan is a
non-qualified stock option plan, which entitles certain directors and key
employees to purchase common shares of the Company. A maximum of 10% of
outstanding common shares are authorized for grant under the Plan. Options are
granted at a price not less than fair market value at the date of grant, and are
subject to approval of the Board of Directors. The 1994 Stock Option Plan
entitles certain directors, key employees and consultants of the Company to
purchase common shares of the Company. The 1994 Plan covered a maximum aggregate
of 10,000,000 shares, as amended and approved by shareholders on July 25, 1996
and January 5, 1998. On April 29, 1999, the directors authorized the
registration of the 10,000,000 common shares under the Company's 1994 Stock
Option Plan. In addition, the directors authorized the issuance of 250,000
common shares to be issued to consultants in consideration of consulting
services rendered to the Company. The 1994 Plan provides for the granting of
options which either qualify for treatment as incentive stock options or non-
statutory stock options.
During 2000, 3,500,000 [1999 - 3,777,660] options were granted at exercise
prices ranging from $1.27 to $5.46 per share [1999 - $0.0875 to $0.10]. Options
granted during 2000 and 1999 were under the 1994 Stock Option Plan. The
following table summarizes stock option transactions:
<TABLE>
<CAPTION>
Weighted average
Shares exercise price
# $
---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, March 31, 1998 2,735,340 0.2220
Granted 3,777,660 0.0940
Expired (44,000) 2.8400
Forfeited (135,000) 0.0875
---------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 6,334,000 0.1362
Granted 3,500,000 4.7529
Exercised (3,801,184) 0.1765
Expired (60,000) 3.5125
---------------------------------------------------------------------------------------------------------
Balance, March 31, 2000 5,972,816 2.7867
---------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes the number of options exercisable at March 31,
2000 and the weighted average exercise prices and remaining contractual lives of
the options.
<TABLE>
<CAPTION>
Weighted average
Weighted exercise price
Range of Number Number Weighted average of options
exercise outstanding at exercisable at average remaining exercisable at
prices March 31, 2000 March 31, 2000 exercise price contractual March 31, 2000
$ # # $ life $
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
0.0875 to 0.10 2,623,316 2,623,316 0.0919 3.11 years 0.0925
1.27 to 2.03 475,000 130,000 1.5003 3.85 years 1.3562
3.375 to 5.46 2,874,500 737,000 5.4585 3.78 years 5.4500
----------------------------------------------------------------------------------------------------------------
5,972,816 3,490,316
----------------------------------------------------------------------------------------------------------------
</TABLE>
F-15
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
12. CAPITAL STOCK (cont'd.)
The non-exercisable options vest over a period of two to three years.
During the year ended March 31, 2000, the Company recorded no compensation
expense [1999 - $9,900] under its stock option plan with respect to options
granted to non employees.
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standard No. 123 "Accounting for Stock-Based Compensation" ("SFAS No.
123") for stock options granted to employees. Accordingly, no compensation cost
has been recognized for the granting of options to employees. Had compensation
cost for the stock option plans been determined based on the fair market value
at the grant date for awards in 2000 and 1999, consistent with the provisions of
SFAS No. 123, the Company's loss and loss per share for the years ended March
31, 2000 and 1999 would have been increased as follows:
<TABLE>
<CAPTION>
2000 1999
$ $
-----------------------------------------------------------------------
<S> <C> <C>
Loss attributable to common stockholders 5,177,531 2,697,844
Additional compensation expense 1,173,904 262,157
-----------------------------------------------------------------------
Pro forma loss 6,351,435 2,960,001
Pro forma loss per share 0.06 0.04
-----------------------------------------------------------------------
</TABLE>
The pro forma loss per share is not necessarily representative of the effects on
reported net income (loss) for future years due to such things as the potential
for issuance of additional stock options and warrants in future years.
The fair value of options, used as a basis for the above pro forma disclosures,
was estimated at the date of grant using the Black-Scholes option pricing model.
The option pricing assumptions include a dividend yield of 0% [1999 - 0%];
expected volatility ranges of 1.92 to 2.03 [1999 - 1.20]; a risk free interest
rate of 6% [1999 - 6.0%]; and an expected life of 1 month to 3 years. The
weighted average fair value of the options granted during the year for which the
exercise price equals fair market value on the date of grant was $16.6 million.
No options were granted during the year with exercise prices that were either
above or below the fair market price.
Share warrants
The Company has outstanding share warrants as of March 31, 2000, in connection
with private placements and convertible notes payable, entitling the holders to
purchase one common share for each warrant held as follows:
<TABLE>
<CAPTION>
Number of Exercise price
warrants $ Expiration date
---------------------------------------------------
<S> <C> <C>
571,429 0.15 March 31, 2002
500,000 0.10 June 12, 2003
50,000 0.10 January 15, 2004
---------------------------------------------------
1,121,429
---------------------------------------------------
</TABLE>
During the year, the Company issued 1,453,570 additional warrants to existing
warrantholders to induce them to exercise outstanding warrants. The fair value
of the additional warrants was determined using the Black Scholes Option pricing
model and amounted to $1,281,805 which has been recorded as a charge to retained
earnings. The option pricing assumptions include a dividend yield of 0%;
expected volatility of ranges of 1.60 to 1.80; a risk free interest rate of 6%;
and an expected life of 1.5 years.
Common stock issued for services
During the year ended March 31, 2000, the Company issued 98,867 shares of common
stock, based on quoted market prices, to third parties as consideration for the
fair value of services provided to the Company.
F-16
<PAGE>
e.Digital Corporation and subsidiary
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
March 31, 2000 and 1999
13. COMMITMENTS
The Company and American Technology Corporation ("ATC"), a company related
through common management and ownership, have a joint lease for office space in
San Diego, California. The lease expires on July 31, 2002. Office rent expense
recorded by the Company for the years ended March 31, 2000 and 1999 was $111,562
and $76,447, respectively.
The total commitments under the joint non-cancelable lease for office space is
$624,015 of which the Company's share of the minimum commitments under the
operating lease are as follows:
<TABLE>
<CAPTION>
$
-----------------------------------------------------------
<S> <C>
2001 159,044
2002 165,653
2003 55,952
-----------------------------------------------------------
380,649
-----------------------------------------------------------
</TABLE>
The Company could become obligated for the entire lease obligation should ATC
default on its share of payments thereon.
14. PREPAID WARRANTS
During 2000, the holders of prepaid warrants, issued in 1997 for cash, converted
the remaining balance of $261,047 [1999 - $642,949] of prepaid warrants into
4,493,335 common shares [1999 - 10,783,128] of the Company at a conversion price
of $0.0875 [1999 - $0.0875].
15. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) plan covering eligible employees. Matching
contributions are made on behalf of all participants at the discretion of the
Board of Directors. During the years ended March 31, 2000 and 1999, the Company
made no matching contributions.
F-17
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
e.Digital Corporation
By: /s/ ALFRED H. FALK
------------------------
Alfred H. Falk
Chief Executive Officer and President
Date: June 27, 2000
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
Name Position Date
---- -------- ----
<S> <C> <C>
/s/ Allen Cocumelli Chairman of the Board and Director June 27, 2000
-------------------------
Allen Cocumelli
/s/ Alfred H. Falk Chief Executive Officer, President June 27, 2000
------------------------- and Director
Alfred H. Falk (principal executive officer)
/s/ Renee Warden Controller and Assistant Secretary June 27, 2000
------------------------- (principal financial officer)
Renee Warden
/s/ Robert Putnam Vice President, Secretary and Director June 27, 2000
-------------------------
Robert Putnam
/s/ Walter Matthews Director June 27, 2000
-------------------------
Walter Matthews
/s/ Victor G. Ramsauer Director June 27, 2000
-------------------------
Victor G. Ramsauer
</TABLE>
