E Digital (EDIG) 10-Q 2009 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2008

Commission File Number 0-20734

e.Digital Corporation

(Exact name of registrant as specified in its charter)

Delaware	33-0591385
(State or other jurisdiction of	(I.R.S. Empl. Ident. No.)
incorporation or organization)
16770 West Bernardo Drive, San Diego, California	92127
(Address of principal executive offices)	(Zip Code)

(858) 304-3016

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o	Accelerated filer o
Non-accelerated filer o  (Do not check if a smaller reporting company)	Smaller reporting company x

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

As of February 6, 2009 a total of 281,376,657 shares of the Registrant’s Common Stock, par value $0.001, were issued and outstanding.

e.DIGITAL CORPORATION

INDEX

			Page
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements (unaudited):
		Consolidated Balance Sheets as of December 31, 2008 and
		and March 31, 2008	3
		Consolidated Statements of Operations for the three and nine
		months ended December 31, 2008 and 2007	4
		Consolidated Statements of Cash Flows for the nine
		months ended December 31, 2008 and 2007	5
		Notes to Interim Consolidated Financial Statements	6
	Item 2.	Management's Discussion and Analysis of Financial
		Condition and Results of Operations	19
	Item 4.	Controls and Procedures	26
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	27
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
	Item 3.	Defaults Upon Senior Securities	28
	Item 4.	Submission of Matters to a Vote of Security Holders	28
	Item 5.	Other Information	28
	Item 6.	Exhibits	28
SIGNATURES			29

2

Part I. Financial Information

Item 1. Financial Statements:

e.Digital Corporation and subsidiary

CONSOLIDATED BALANCE SHEETS

	December 31,			March 31,
	2008			2008
	(Unaudited) $				$
ASSETS
Current
Cash and cash equivalents		742,740			122,116
Accounts receivable, trade		2,137,965			174,905
Inventories		516,034			489,238
Deposits and prepaid expenses		31,758			34,717
Total current assets		3,428,497			820,976
Property and equipment, net of accumulated depreciation of
$497,212 and $485,037, respectively		27,886			40,061
Total assets		3,456,383			861,037
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current
Accounts payable, trade		523,457			836,217
Other accounts payable and accrued liabilities		874,774			198,210
Accrued employee benefits		104,849			149,483
Customer deposits		80,000			80,000
Deferred revenue		68,953			36,500
Current maturity of convertible term note, less $11,241 and $25,842 of debt discount		516,967			366,989
Secured promissory note, less $2,868 and $4,131 of note discount		297,132			445,869
Promissory note, less $1,173 and $-0- of note discount		38,827			-
Total current liabilities		2,504,959			2,113,268
Long-term convertible term note, less $-0- and $6,141 of debt discount		-			381,093
Deferred revenue-long term		32,000			72,000
Total long-term liabilities		32,000			453,093
Total liabilities		2,536,959			2,566,361
Commitments and Contingencies
Stockholders' equity (deficit)
Series AA Convertible Preferred stock, $0.001 par value, 100,000
shares designated: 75,000 and -0- issued and outstanding, respectively
Liquidation preference of $769,212 and $-0-, respectively		568,432			-
Common stock, $0.001 par value, authorized 350,000,000,
280,062,704 and 272,494,867 shares outstanding, respectively		280,063			272,495
Additional paid-in capital		81,302,762			80,103,769
Accumulated deficit		(81,231,833	)		(82,081,588	)
Total stockholders' equity (deficit)		919,424			(1,705,324	)
Total liabilities and stockholders' equity (deficit)		3,456,383			861,037

See notes to interim consolidated financial statements

3

e.Digital Corporation and subsidiary

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	For the three months ended						For the nine months ended
	December 31,						December 31,
		2008		2007				2008		2007
		$		(as restated) $				$		(as restated) $
Revenues:
Products		120,463			1,006,485			356,444			4,304,197
Services		135,570			184,362			451,746			507,065
Patent license		3,650,000			-			5,250,000			-
		3,906,033			1,190,847			6,058,190			4,811,262
Cost of revenues:
Products		96,334			748,529			303,793			3,455,058
Services		57,230			45,967			169,438			116,340
Patent license		1,465,919			-			2,027,245			-
		1,619,483			794,496			2,500,476			3,571,398
Gross profit		2,286,550			396,351			3,557,714			1,239,864
Operating expenses:
Selling and administrative		576,997			484,252			1,743,389			1,427,344
Research and related expenditures		111,922			243,345			387,672			739,592
Total operating expenses		688,919			727,597			2,131,061			2,166,936
Operating income (loss)		1,597,631			(331,246	)		1,426,653			(927,072	)
Other income (expense):
Interest expense		(38,717	)		(56,115	)		(129,425	)		(187,783	)
Other income and expense		(11,119	)		(10,010	)		(183,473	)		(33,662	)
Other income (expense)		(49,836	)		(66,125	)		(312,898	)		(221,445	)
Income (loss) before provision for income taxes		1,547,795			(397,371	)		1,113,755			(1,148,517	)
Provision for income taxes		-			-			(264,000	)		-
Income (loss) for the period		1,547,795			(397,371	)		849,755			(1,148,517	)
Accrued and deemed dividends on preferred stock		(43,284	)		(27,225	)		(87,978	)		(81,975	)
Income (loss) attributable to common stockholders		1,504,511			(424,596	)		761,777			(1,230,492	)
Income (loss) per common share - basic and diluted		0.01			(0.00	)		0.00			(0.00	)
Weighted average common shares outstanding
Basic		279,143,996			249,097,860			276,916,733			246,631,374
Diluted		281,454,506			249,097,860			277,912,376			246,631,374

See notes to interim consolidated financial statements

4

e.Digital Corporation and subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	For the nine months ended
	December 31,
		2008		2007
		$		$
OPERATING ACTIVITIES
Income (loss) for the period		849,755		(1,148,517	)
Adjustments to reconcile income (loss) to net cash used in operating activities:
Depreciation and amortization		12,175		12,616
Accrued interest and accretion of discount relating to promissory notes		32,632		21,893
Interest paid with common stock		29,500		77,381
Warranty provision		(41,615	)	185,602
Stock-based compensation		31,526		129,209
Warrant modification and warrant derivative revaluation		174,667		-
Changes in assets and liabilities:
Accounts receivable, trade		(1,963,060	)	(131,800	)
Inventories		(26,796	)	51,723
Deposits and prepaid expenses		2,959		9,756
Accounts payable		(262,760	)	(165,837	)
Other accounts payable and accrued liabilities		758,251		(57,246	)
Customer deposits		-		(38,850	)
Accrued employee benefits		(44,634	)	49,562
Deferred revenue		(7,547	)	112,000
Warranty reserve		(43,072	)	(81,904	)
Cash used in operating activities		(498,019	)	(974,412	)
INVESTING ACTIVITIES
Purchase of property and equipment		-		(7,167	)
Cash used in investing activities		-		(7,167	)
FINANCING ACTIVITIES
Sale of common stock		580,000		640,000
Proceeds from sale of preferred stock		700,000		-
Proceeds from exercise of warrants		-		214,480
Proceeds from exercise of stock options		-		11,310
Payment on convertible term note		(51,357	)	-
Payment on secured promissory note		(150,000	)	(300,000	)
Proceeds from unsecured promissory note		40,000		-
Cash provided by financing activities		1,118,643		565,790
Net increase (decrease) in cash and cash equivalents		620,624		(415,789	)
Cash and cash equivalents, beginning of period		122,116		694,757
Cash and cash equivalents, end of period		742,740		278,968
Supplemental disclosures of cash flow information:
Cash paid for interest		64,893		88,509
Supplemental schedule of noncash investing and financing activities:
Accounts payable exchanged for preferred stock		50,000		-
Common stock issued on conversion of preferred stock		-		1,456,000
Accrued and deemed dividends on preferred stock		87,978		81,975
Term note payments paid in common stock		230,000		120,000
Financing fees paid in common stock		8,800		21,500
Warrant derivative liability reclassified to equity		132,315		-

See notes to interim consolidated financial statements

5

1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION

e.Digital Corporation is a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name. The Company has innovated a proprietary secure digital video/audio technology platform ("DVAP") and markets the eVU™ mobile entertainment device for the travel and recreational industries. The Company also obtains revenue from licensing and enforcing its Flash-R™ portfolio of patents related to the use of flash memory in portable devices.

Unaudited Interim Financial Statements

These unaudited consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X 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. These interim consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments considered necessary for a fair statement of the Company's financial position at December 31, 2008, and the results of operations and cash flows for the periods presented, consisting only of normal and recurring adjustments. All significant intercompany transactions have been eliminated in consolidation. Operating results for the three and nine months ended December 31, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2009. For further information, refer to the Company's consolidated financial statements and footnotes thereto for the year ended March 31, 2008 filed on Form 10-K.

Prior Period Presentation

As more fully described in Note 15 to the Company’s consolidated financial statements and footnotes thereto for the year ended March 31, 2008 filed on Form 10-K, the Company restated the two quarters ended September 30, 2007 and December 31, 2007 due to an overstatement of both revenues and cost of revenues of $104,000 and $62,400 for the quarters, respectively, due to a misclassification of supplier material transfers with no effect on gross profit, operating loss or net loss in either quarter or for the fiscal year ended March 31, 2008. The results for December 31, 2007 included herein reflect such restatement. Certain other amounts reported in prior periods have been reclassified to be consistent with the current period presentation.

Going Concern

These consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has experienced significant operating losses and negative cash flow from operations in each of the last three years and has an accumulated deficit of $81.2 million at December 31, 2008. The Company’s recent profitability has resulted from one-time patent licensing revenues and there is no assurance of future licensing revenues from new licensees. Accordingly, the Company could incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability. The Company's ability to continue as a going concern is in doubt and is dependent upon achieving a profitable level of operations and if necessary obtaining additional financing. In the event the Company is unable to continue as a going concern, it may elect or be required to seek protection from creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. To date, management has not considered this alternative, nor does management view it as a likely occurrence.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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 interim financial statements.

2. RECENT ACCOUNTING PRONOUNCEMENTS

On April 1, 2008, the Company adopted certain provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”), which establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and expands on required disclosures about fair value measurement. The provisions of SFAS 157 adopted on April 1, 2008 relate to financial assets and liabilities as well as other assets and liabilities carried at fair value on a recurring basis and did not have a material impact on the Company’s consolidated financial statements. The provisions of SFAS 157 related to other nonfinancial assets and liabilities will be effective for the Company on April 1, 2009, and will be applied prospectively. The Company is currently evaluating the impact that these additional SFAS 157 provisions will have on the Company’s consolidated financial statements. See Note 10 - Fair Value Measurements.

6

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” Under SFAS No. 159, companies may elect to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 for fiscal 2009. However the Company did not elect to apply the fair value option to any financial instruments or other items upon adoption of SFAS No. 159 or during the nine months ended December 31, 2008. Therefore, the adoption of SFAS No. 159 did not impact the Company’s consolidated financial position, results of operations or cash flows.

In December 2007, the Financial Accounting Standards Board (“ FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R retains the fundamental requirements in SFAS No. 141 that the acquisition method of accounting (which SFAS No. 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. SFAS No. 141R also establishes principles and requirements for how the acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (b) improves the completeness of the information reported about a business combination by changing the requirements for recognizing assets acquired and liabilities assumed arising from contingencies; (c) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (d) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 (for acquisitions closed on or after April 1, 2009 for the Company). Early application is not permitted. Since the Company is not contemplating any business combinations after its effective date it does not presently expect any impact of SFAS No. 141R on its consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, “Non-Controlling Interests in Consolidated Financial Statements an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new standards for the accounting for and reporting of non-controlling interests (formerly minority interests) and for the loss of control of partially owned and consolidated subsidiaries. SFAS 160 does not change the criteria for consolidating a partially owned entity. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The provisions of SFAS 160 will be applied prospectively upon adoption except for the presentation and disclosure requirements which will be applied retrospectively. The Company does not expect the adoption of SFAS 160 will have a material impact on its consolidated financial statements.

On March 19, 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities. These enhanced disclosures will discuss (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company has not determined the impact, if any SFAS No. 161 will have on its consolidated financial statements.

 

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the GAAP hierarchy). SFAS 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company does not currently expect the adoption of SFAS 162 to have a material effect on its consolidated results of operations and financial condition.

7

3. INCOME (LOSS) PER SHARE

Basic earnings per common share is computed by dividing income (loss) attributable to common shareholders by the weighted-average number of shares of common stock outstanding during the period. The income attributable to common stockholders is reduced by accrued and deemed dividends on preferred stock during the three and nine months ended December 31, 2008 of $43,284 and $87,978, respectively. The loss attributable to common stockholders is increased by accrued and deemed dividends on preferred stock during the three and nine months ended December 31, 2007 of $27,225 and $81,975, respectively. Diluted earnings per common share is computed by dividing income (loss) attributable to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding convertible preferred stock, stock options, warrants, and convertible debt. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.

 The following table sets forth the computation of basic and diluted earnings per share:

	Three Months Ended					Nine Months Ended
	December 31,					December 31,
	2008		2007			2008		2007
			(as restated)					(as restated)
Basic
Income (loss) attributable to common stockholders	$	1,504,511	$	(424,596	)	$	761,777	$	(1,230,492	)
Weighted average common shares outstanding (basic)		279,143,996		249,097,860			276,916,733		246,631,374
Basic income (loss) per common share	$	0.01	$	(0.00	)	$	0.00	$	(0.00	)
Diluted
Income (loss) attributable to common stockholders	$	1,504,511	$	(424,596	)	$	761,777	$	(1,230,492	)
Plus:
Accrued and deemed dividends on preferred stock (1)		-		-			-		-
Income (loss) for diluted	$	1,504,511	$	(424,596	)	$	761,777	$	(1,230,492	)
Common and potential common shares:
Weighted average common shares outstanding		279,143,996		249,097,860			276,916,733		246,631,374
Assumed conversion of  preferred stock (1)		-		-			-		-
Assumed exercise of options and warrants		2,310,510		-			995,643		-
Common and potential common shares		281,454,506		249,097,860			277,912,376		246,631,374
Diluted income (loss) per common share	$	0.01	$	(0.00	)	$	0.00	$	(0.00	)
Potentially dilutive securities outstanding at period end excluded from diluted computation as they were antidilutive		18,597,387		16,440,925			18,897,387		16,440,925

(1) The convertible preferred stock and convertible term note were antidilutive for the respective periods.

4. INVENTORIES

Inventories are stated at the lower of cost, which approximates actual costs on a first in, first out cost basis, or market.

Inventories consisted of the following:

	December 31,		March 31,
		2008		2008
		$		$
Raw materials		32,957		41,354
Work in process		321,673		217,820
Finished goods		161,404		230,064
		516,034		489,238

8

5. STOCK-BASED COMPENSATION COSTS

The Company accounts for stock-based compensation under the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123R). SFAS 123R requires measurement of all employee stock-based awards using a fair-value method and recording of related compensation expense in the consolidated financial statements over the requisite service period. Further, as required under SFAS 123R, the Company estimates forfeitures for share based awards that are not expected to vest. The Company recorded stock-based compensation in its consolidated statements of operations for the relevant periods as follows:

	Three Months Ended					Nine Months Ended
	December 31,					December 31,
	2008			2007		2008		2007
				(as restated)				(as restated)
	$			$		$		$
Cost of revenues		-			4,310		-		13,442
Research and development		8,918			15,282		8,918		30,349
Selling and administrative		(731	)		37,445		31,526		85,418
Total stock-based compensation expense		8,187			57,037		40,444		129,209

Stock-based compensation expense for the three and nine months ended December 31, 2008 includes $8,918 for stock appreciation rights of three former employees in lieu of cash severance.  The value of such rights is recognized at fair value, remeasured at each reporting date and recorded as an accrued liability. Outstanding rights covered an aggregate of 437,500 shares with exercise prices ranging from $0.145 to $0.22 and a term ranging from 0.7 to 1.25 years. The rights were valued using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free rate of 0.56%; volatility of 63% to 78% and a term equal to the term of the rights.

As of December 31, 2008 total estimated compensation cost of stock options granted but not yet vested was approximately $60,404 and is expected to be recognized over the weighted average period of 1.3 years.

The following table sets forth the weighted-average key assumptions and fair value results for stock options granted during the nine-month periods ended December 31, 2008 and 2007 (annualized percentages):

	Nine Months Ended
	December 31,
	2008			2007
Volatility		71	%		78	%
Risk-free interest rate		2.3	%		4.1%-5.0	%
Forfeiture rate		0.0	%		5.0	%
Dividend yield		0.0	%		0.0	%
Expected life in years		3.5			3
Weighted-average fair value of options granted	$	0.05		$	0.10

The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the common stock over the period commensurate with the expected life of the options. The Company has a small number or option grants and limited exercise history and accordingly has for all new option grants applied the simplified method prescribed by SEC Staff Accounting Bulletin 110 to estimate expected life (computed as vesting term plus contractual term divided by two). The expected forfeiture rate is estimated based on historical experience for each option group. Additional expense is recorded when the actual forfeiture rates are lower than estimated and a recovery of prior expense will be recorded if the actual forfeitures are higher than estimated.

See Note 8 for further information on outstanding stock options.

9

6. WARRANTY RESERVE

Details of the estimated warranty liability included in other accounts payable and accrued liabilities are as follows:

	Three Months Ended						Nine Months Ended
	December 31,						December 31,
	2008			2007			2008			2007
	$			$			$			$
Beginning balance		33,875			137,900			109,138			40,072
Warranty provision		(7,472	)		52,638			(43,072	)		185,602
Warranty deductions		(1,952	)		(46,768	)		(41,615	)		(81,904	)
Ending balance		24,451			143,770			24,451			143,770

7. PROMISSORY NOTES

The following table summarizes outstanding promissory notes at December 31, 2008:

		Principal Due at December 31,		Less Unamortized			Net at December 31,		Long-Term
		2008		Discount			2008		Portion
Description and Rate	Maturity	$		$			$		$		Collateral	Conversion
18% Secured Promissory Note	Interest monthly, principal at June 23, 2009		300,000		(2,868	)		297,132		-	Security interest in substantially all assets	Not applicable
12% Promissory Note	Principal and interest due April 3, 2009		40,000		(1,173	)		38,827		-	None	Not applicable
7.5% Convertible Term Note	Principal and interest in monthly installments $50,000 per month through maturity in November 2009		528,208		(11,241	)		516,967		-	None	At $.30 per share at holder option and callable for conversion at market of $0.40 per common share
			868,208		(15,282	)		852,926		-

In April 2008 the Company issued 40,000 shares of common stock as payment of a $4,800 finance fee on the $40,000 12% promissory note.

On October 8, 2008 Eric M. Polis was appointed as a director of the Company. Mr. Polis is Secretary, Treasurer and a director of ASI Technology Corporation the holder of the 18% Secured Promissory Note. In June 2008 the Company made a $50,000 principal reduction and incurred a $4,000 finance fee upon a six month renewal and in December 2008 made a $100,000 principal reduction and incurred a $3,000 finance fee for a six-month renewal of the note. The $4,000 finance fee was paid by issuing 40,404 shares of common stock and the Company issued 28,517 shares in payment of the $3,000 fee in February 2009. Note financing fees paid to creditors are recorded as a debt discount and amortized over the term of each note using the interest method. Interest expense incurred during the nine months ended December 31, 2008 on this note was $30,750.

The Company has the option, subject to certain limitations, to elect to make installment payments on the 7.5% Convertible Term Note either in cash or in shares of common stock (“Monthly Installment Shares”). Monthly Installment Shares are valued at the arithmetic average of the closing prices for the last five trading days of the applicable month without discount. Payments must be paid in cash if the computed average price is less than $0.10 per share. During the nine months ended December 31, 2008 the Company made seven monthly installment payments aggregating $230,000 through the issuance of 1,941,884 shares of common stock and made two installment payments in cash of $60,000.

8. STOCKHOLDERS’ EQUITY

The following table summarizes stockholders’ equity transactions during the nine-month period ended December 31, 2008:

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	Preferred stock					Common stock				Additional paid-in			Accumulated
	Shares		Amount			Shares		Amount		capital			deficit
Balance, March 31, 2008		-		-			272,494,867		272,495		80,103,769			(82,081,588	)
Sale of Series AA preferred stock and warrants
net of $134,773 recorded as warrant liability (1)		75,000		615,227			-		-		-			-
Record $134,773  beneficial conversion
related to Series AA preferred stock (1)		-		(134,773	)		-		-		134,773			-
Reclassification of warrant liability to equity (2)		-		-			-		-		132,315			-
Value assigned to modification of Seriess AA
warrants (2)		-		-			-		-		177,125			-
Dividends on Series AA preferred stock		-		19,212			-		-		(19,212	)		-
Accretion of discount on Series AA preferred
stock (1)		-		68,766			-		-		(68,766	)		-
Shares issued for term debt payments		-		-			1,941,884		1,942		228,058			-
Shares issued for debt financing fees		-		-			80,404		80		8,720			-
Proceeds from sale of common stock at an average price of $0.101 per share		-		-			5,545,549		5,546		574,454			-
Stock-based compensation		-		-			-		-		31,526			-
Income for the period		-		-			-		-		-			849,755
Balance, December 31, 2008		75,000		568,432			280,062,704		280,063		81,302,762			(81,231,833	)

(1) The $134,773 allocated as the value of detachable warrants and the beneficial conversion feature of $134,773 are treated as a discount to the value of the Series AA Stock (see Note 9) and are being accreted  as a deemed dividend over the term of the preferred stock. Due to the accumulated deficit these charges are recorded  to paid-in capital.

(2) See Note 9.

Fusion Capital Equity Purchase Agreement

On January 2, 2007, the Company entered into an agreement with Fusion Capital Fund II, LLC (“Fusion”) pursuant to which the Company had the right, subject to certain conditions and limitations, to sell to Fusion up to $8.0 million worth of common stock, at the Company’s election, over a period that ended February 4, 2009 at prices determined based upon the market price of the Company’s common stock at the time of each sale. During the nine months ended December 31, 2008, the Company sold 5,545,549 common shares to Fusion under the agreement for cash of $580,000.

Subsequent to December 31, 2008 the Company sold 800,000 common shares to Fusion under the agreement for cash of $80,000.

Options

The following table summarizes stock option activity for the period:

	Shares			Weighted average exercise price		Weighted average life		Aggregate intrinsic value (2)
		#		$		(years)		$
Outstanding March 31, 2008		10,897,167			0.16
Granted		1,100,000			0.11
Canceled/expired		(2,584,167	)		0.16
Exercised		-			-
Outstanding December 31, 2008 (1)		9,413,000			0.15		1.8		30,000
Exercisable at December 31, 2008		7,655,332			0.15		1.6		30,000

(1) Options outstanding are exercisable at prices ranging from $0.09 to $0.44 and expire over the period from 2009 to 2013.

(2) Aggregate intrinsic value is based on the closing price of our common stock on December 31, 2008 of $0.11 and excludes the impact of options that were not in-the-money.

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Share warrants

The following table summarizes information on warrant activity during the nine months ended December 31, 2008:

			Weighted average
	Shares		exercise price
		#	$
Outstanding March 31, 2008		2,331,572		0.15
Granted		7,500,000		0.10
Canceled/expired		-		-
Exercised		-		-
Outstanding December 31, 2008		9,831,572		0.11

The Company has outstanding share warrants as of December 31, 2008, as follows:

Description	Number of Common Shares		Exercise Price Per Share $		Expiration Date
Warrants (1)		2,331,572		0.15	August 31, 2009
Warrants		7,500,000		0.10	June 30, 2011

(1) exercise price subject to certain antidilution price protection.

9. PREFERRED STOCK

On December 30, 2002, the Company issued 205,000 shares of 12% Series D non-redeemable convertible preferred stock (the "Series D Stock") with a stated value of $10 per share. Dividends of 12% per annum were payable, with certain exceptions, either in cash or in shares of common stock at the Company's election. The remaining 91,000 shares of Series D Stock and accumulated dividends automatically converted to 18,200,000 shares of common stock at $0.08 per share on December 31, 2007. Dividends accrued during the nine months ended December 31, 2007 totaled $81,975 and increased the loss attributable to common stockholders.

On June 27, 2008 the Company issued 75,000 shares of 5% Series AA Convertible Preferred Stock (the “Series AA Stock”) with a stated value of $10 per share. Dividends of 5% per annum are payable in shares of common stock or at the Company’s election additional shares of Series AA Stock or under certain circumstances in cash. The Series AA Stock has voting rights of ten votes per share and a liquidation preference equal to $10.00 per share plus accrued and unpaid dividends. The stated value plus accrued dividends on Series AA Stock is convertible into common stock at $0.10 per common share with automatic conversion on June 30, 2010 subject to certain limitations. The Company may call the Series AA Stock for conversion if the common stock market price is at least $0.25 per share for ten consecutive trading days.

The Series AA Stock was issued for aggregate proceeds of $750,000 including $700,000 of cash and conversion of $50,000 of vendor debt. Purchasers were also issued warrants to purchase an aggregate of 7,500,000 shares of common stock exercisable at $0.10 per common share until June 30, 2011 (“Series AA Warrants”). One officer/director purchased for $100,000 cash 10,000 shares of Series AA Stock and was issued warrants to purchase 1,000,000 shares of common stock on the same terms as unaffiliated investors.

At the holder’s option the Series AA Stock and the Series AA Warrants were redeemable for cash at June 30, 2009 should sufficient shares of common stock not be authorized and reserved for conversion of all underlying shares by such date. This redemption right was terminated effective September 17, 2008 with the shareholders authorizing additional shares of common stock and the Board of Directors reserving sufficient shares for future conversions of the Series AA Stock and exercise of the Series AA Warrants.

The proceeds of $750,000 were allocated between the fair value of the Series AA Stock ($615,227) with the value of the Series AA Warrants ($134,773) treated as a discount to the Series AA Stock. The Company determined the fair value of the Series AA Warrants using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free rate of 2.93%; volatility of 60.6% and a term of one year. Because  the redemption event was not certain to occur but was outside the Company’s control, the Company originally recorded the portion of the proceeds attributable to the stock as mezzanine equity pursuant to EITF Topic D-98, Classification and Measurement of Redeemable Securities after determining the guidance in FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity did not apply. Upon termination of the redemption right on September 17, 2008 the value of the stock was reclassified as permanent equity.

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Additionally, the Company evaluated whether the embedded conversion feature in the preferred stock required bifurcation and determined that the economic characteristics and risks of the embedded conversion feature in the stock were clearly and closely related to the stock and concluded that bifurcation was not required under SFAS 133. The Company calculated the intrinsic value of the beneficial conversion feature as $134,773 pursuant to the guidance in EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments. The total discount to the Series AA Stock of $269,546, consisting of the value of the Series AA Warrants and the amount of the beneficial conversion feature, is being accreted  as a deemed dividend over the term of the Series AA Stock. A total of $68,766 of the discount was accreted  as a deemed dividend for the nine month period ended December 31, 2008 by a charge to paid-in capital. The stated 5% dividend also accrues to the carrying value of the Series AA Stock. The deemed and stated dividends are also used in determining the net income (loss) attributable to common stockholders for the respective periods.

The Company determined that the warrants met the definition of a derivative instrument at issuance as defined in SFAS 133, Accounting for Derivative Instruments and Hedging Activities, and was treated as a liability due to the lack of sufficient authorized shares of common stock. The Company recorded a liability of $134,773 for the value of the warrants. As a derivative liability this amount was evaluated for reclassification and if a derivative liability adjusted at each reporting period based on the current market price. Upon the authorization and reservation of shares of common stock for exercise of the warrants on September 17, 2008, the Company determined the warrants were no longer a derivative liability. The value at that date of $132,315 was reclassified to paid-in capital and a net non-cash gain of $2,458 was recorded in other income (expense).  The Company also determined that the termination of the warrant redemption rights was an effective modification of the warrant term and calculated the fair value of the warrants immediately prior to the modification compared to the value immediately after the modification and recorded the difference in warrant value of $177,125 as a financing expense in other expenses.

10. FAIR VALUE MEASUREMENTS

On April 1, 2008, the Company adopted SFAS No. 157 which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. In February 2008, the FASB deferred the effective date of SFAS 157 by one year for certain non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company adopted the provisions of SFAS 157, except as it applies to those nonfinancial assets and nonfinancial liabilities for which the effective date has been delayed by one year.

SFAS No. 157 establishes a three-level valuation hierarchy of valuation techniques that is based on observable and unobservable inputs. Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The first two inputs are considered observable and the last unobservable, that may be used to measure fair value and include the following:

Level 1 - - Quoted prices in active markets for identical assets or liabilities.

Level 2 - - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

As of December 31, 2008, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis, including its cash and cash equivalents. The fair value of these assets and liabilities was determined using the following inputs in accordance with SFAS 157 at December 31, 2008:

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	Fair Value Measurement as of December 31, 2008
	Total		Level 1		Level 2		Level 3
Description	$		$		$		$
Cash and cash equivalents (1)		742,740		742,740		-		-
Warrant derivative liability (2)		-		-		-		-

(1) Included in cash and cash equivalents on the accompanying consolidated balance sheet.

(2) Represents Series AA Warrants issued in June 2008 and valued using the income approach using the Black-Scholes option pricing model (see Note 9). An initial liability of $134,773 was revalued to $132,315 at September 17, 2008 and reclassified as equity (see Note 9).

The following table reconciles the warrant derivative liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended December 31, 2008:

	Warrant
	Derivative
	Liability
	$
Balance at April 1, 2008		-
Issuance of warrant derivative (1)		134,773
Adjustment to fair value included in net loss (2)		(2,458	)
Reclassification to equity (2)		(132,315	)
Balance at December 31, 2008		-

(1) Represents Series AA Warrants issued in June 2008 (see Note 9).

(2) The warrant derivative liability was revalued at the end of each reporting period until reclassification as equity and the resulting difference was included in the results of operations in “Other income and expense”.

11. SEGMENT INFORMATION

SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” (“SFAS No. 131”) provides annual and interim reporting standards for an enterprise’s business segments and related disclosures about its products, services, geographical areas and major customers. With the inception of patent license revenue in the current year, the Company determined that it has two operating segments: (1) products and services and (2) patent licensing. Products and services consist of sales of the Company’s electronic eVU mobile entertainment device and related content services and patent licensing consists of intellectual property revenues from the Flash-R patent portfolio.

Accounting policies for each of the operating segments are the same as on a consolidated basis however the Company has only recently commenced receiving patent license revenue. The Company recognizes revenue from patent license agreements when (i) the patent license agreement is executed, (ii) the amounts due are fixed, determinable, and billable, (iii) the customer has been provided rights to the licensed technology and (iv) collection of the resulting receivable, if any, is probable. At the time the Company enters into a contract and provides the customer with the licensed technology the Company has performed all of its obligations under contract, the rights to the Company’s technology have been transferred and no significant performance obligations remain. License revenue to date consists of one-time licenses requiring no future performance. The Company values nonexclusive cross licenses received only if directly used in operations. Patent license costs of revenues include contingency legal and other direct costs associated with patent licensing.

Our reportable segment information for the three and nine months ended December 31, 2008 is as follows:

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	For the three months ended						For the nine months ended
	December 31,						December 31,
	2008			2007			2008			2007
				(as restated)						(as restated)
	$			$			$			$
REVENUES:
Products and services		256,033			1,190,847			808,190			4,811,262
Patent licensing		3,650,000			-			5,250,000			-
Total revenue		3,906,033			1,190,847			6,058,190			4,811,262
GROSS PROFIT:
Products and services		102,469			396,351			334,959			1,239,864
Patent licensing		2,184,081			-			3,222,755			-
Total gross profit		2,286,550			396,351			3,557,714			1,239,864
RECONCILIATION:
Total segment gross profit		2,286,550			396,351			3,557,714			1,239,864
Operating expenses		(688,919	)		(727,597	)		(2,131,061	)		(2,166,936	)
Other income (expense)		(49,836	)		(66,125	)		(312,898	)		(221,445	)
Income (loss) before provision for income taxes		1,547,795			(397,371	)		1,113,755			(1,148,517	)

The Company does not have significant assets employed in the patent license segment and does not track capital expenditures or assets by reportable segment. Consequently it is not practical to show this information.

Revenue by geographic region is determined based on the location of the Company’s direct customers or distributors for product sales and services. Patent license revenue is considered United States revenue as payments are for licenses for United States operations irrespective of the location of the licensee’s home domicile.

	For the three months ended				For the nine months ended
	December 31,				December 31,
	2008		2007		2008		2007
			(as restated)				(as restated)
	$		$		$		$
United States		3,650,000		-		5,250,000		-
International		256,033		1,190,847		808,190		4,811,262
Total revenue		3,906,033		1,190,847		6,058,190		4,811,262

Revenues from three customers comprised 33%, 27% and 26% of revenue for the nine months ended December 31, 2008. Sales to three customer comprised 37%, 26% and 20% of revenue for the nine months ended December 31, 2007. Accounts receivable from one customer comprised 95% of net accounts receivable at December 31, 2008 and three customers accounted for 61%, 14% and 12% of net accounts receivable at December 31, 2007.

12. COMMITMENTS AND CONTINGENCIES

Legal Matters

Business Litigation

In May 2006, the Company announced that a complaint had been filed against it and certain of its officers and employees by digEcor, Inc. in the Third Judicial District Court of Utah, County of Salt Lake. The complaint alleged breaches of contract, unjust enrichment, breaches of good faith and fair dealing, fraud, negligent misrepresentation, and interference with prospective economic relations. digEcor sought, among other things, an injunction to prevent our Company from selling or licensing certain digital rights management technology and "from engaging in any competition with digEcor until after 2009." digEcor also sought "actual damages" of $793,750 and "consequential damages...not less than an additional $1,000,000." This action was related to a purchase order the Company placed for this customer in the normal course of business on November 11, 2005 for 1,250 digEplayers with its contract manufacturer, Maycom Co., Ltd.. Maycom was paid in full for the order by both e.Digital and digEcor by March 2006, but Maycom failed to timely deliver the order. The Company recorded an impairment charge of $603,750 in March 2006 for deposits paid to Maycom due to the uncertainty of obtaining future delivery. In October 2006 the Company received delivery from Maycom of the delayed 1,250-unit digEplayer order and delivered the order to digEcor. The Company recognized $713,750 of revenue from this order and reversed an impairment charge of $603,750 in its third fiscal 2007 quarter.  The Company answered digEcor's complaint and is pursuing certain counterclaims.

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In January 2007, the Court ruled on certain motions of the parties. In its ruling, the Court dismissed digEcor's unjust enrichment, fraud, negligent misrepresentation, tortious interference and punitive damage claims. The Court further acknowledged the delivery of the 1,250-unit order and a partial settlement between the parties reducing digEcor's claim for purchase-price or actual damages from $793,750 to $94,846 with such amount still being disputed by e.Digital. digEcor's contract and damages claims remain in dispute. digEcor has subsequently amended its Complaint to assert an alternative breach of contract claim, and claims for federal, state and common law unfair competition, and sought an injunction prohibiting us "from engaging in any competition with digEcor until after 2013."

In April 2007 the Company filed a second amended counterclaim in the United States District Court of Utah seeking a declaratory judgment confirming the status of prior agreements between the parties, alleging breach of the Company’s confidential information and trade secrets by digEcor, seeking an injunction against digEcor's manufacture and sale of a portable product based on the Company’s technology, alleging breach of duty to negotiate regarding revenue sharing dollars the Company believes it has the right to receive and tortious interference by digEcor in the Company’s contracts with third parties. The Company intends to vigorously prosecute these counterclaims.

In April 2007 digEcor filed a motion for summary judgment seeking enforcement of an alleged non-compete provision and an injunction prohibiting the Company from competing with digEcor. In October 2007 the Court denied, without prejudice, digEcor's motion for partial summary judgment and request for injunction. The foregoing and other findings of the Court may be subject to appeal by either party.

In September 2008 digEcor filed their third request for a partial summary judgment again seeking enforcement of the alleged non-compete provision.  digEcor also asked the Court to rule on issues surrounding the delayed 1250-unit order and e.Digital's alleged breach of  a 2002 contract between the parties.  

In September 2008 the Company filed a summary judgment motion seeking a ruling (i) that the alleged non-compete provision is unenforceable and /or superseded by the 2002 agreement between the parties, and (ii) that the Company has not breached any alleged non-compete provisions or the 2002 agreement.  The Company also asked the Court to dismiss digEcor's unfair competition claims and limit digEcor's damages claim.

The case has now completed the discovery phase. The Company has voluntarily dismissed some of its counterclaims, alleging misappropriation of its confidential information and trade secrets.  The Company believes that it has substantive and multiple defenses and intends to vigorously challenge the remaining matters and pursue all remaining counterclaims. However, there can be no assurance the Company will prevail in its counterclaims or in its defense of digEcor's remaining claims.

The Company is also unable to determine at this time the impact this complaint and matter may have on its financial position or results of operations. The Company has an accrual of $80,000 as an estimate of its obligation related to the remaining general damage claim and the Company intends to seek restitution from Maycom for any damages it may incur. Recovery from Maycom is not assured. Maycom is not involved in the design, tooling or production of the Company’s proprietary eVU mobile product. Moreover, the Company does not presently plan or expect to produce or sell digEplayer models to digEcor or other customers in the future.

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Commitment Related to Intellectual Property Legal Services

On March 23, 2007 the Company entered into an agreement for legal services and a contingent fee arrangement with Duane Morris LLP. The agreement provides that Duane Morris is the Company’s legal counsel in connection with the assertion of the Company’s flash memory related patents against infringers (“Patent Enforcement Matters’).

Duane Morris has agreed to handle the Company’s Patent Enforcement Matters and certain related appeals on a contingent fee basis. Duane Morris also has agreed to advance certain costs and expenses including travel expenses, court costs and expert fees. The Company has agreed to pay Duane Morris a fee equal to 40% of any license or litigation recovery related to Patent Enforcement Matters, after recovery of expenses, and 50% of recovery if appeal is necessary.

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

Contract Manufacturers and Suppliers

The Company depends on contract manufacturers and suppliers to (i) allocate sufficient capacity to its manufacturing needs, (ii) produce acceptable quality products at agreed pricing and (iii) deliver on a timely basis. If a manufacturer is unable to satisfy these requirements, the Company's business, financial condition and operating results may be materially and adversely affected. Any failure in performance by either of these manufacturers for any reason could have a material adverse affect on the Company's business. Production and pricing by such manufacturers is subject to the risk of price fluctuations and periodic shortages of components. The Company does not have supply agreements with component suppliers and, accordingly, it is dependent on the future ability of its manufacturers to purchase components. Failure or delay by suppliers in supplying necessary components could adversely affect the Company's ability to deliver products on a timely and competitive basis in the future.

At December 31, 2008 the Company had outstanding unfilled purchase orders and was committed to a contract manufacturers and component suppliers for approximately $127,000 of future deliveries. Purchase commitments for product and components are generally subject to modifications as to timing, quantities and scheduling and in certain instances may be cancelable without penalty.

Facility Lease

In March 2006 the Company entered into a sixty-two month lease, commencing June 1, 2006, for approximately 4,800 square feet with an aggregate payment of $5,805 per month excluding utilities and costs. The aggregate payments adjust annually with maximum aggregate payments totaling $6,535 in the fifty-first through the sixty-second month. Future lease commitments aggregated $197,652 at December 31, 2008.

Royalties

In connection with a prior note financing, the Company is obligated to pay a royalty of $20.00 for each entertainment device sold through December 31, 2008. During the nine months ended December 31, 2008 and 2007 the Company incurred royalties of $4,640 and $69,620, respectively.

Other Concentrations and Financial Instruments

The global economy, including the electronics industry, is experiencing a widespread decline in business activity, together with a reduction in general credit availability and instability in the commercial and investment banking systems, all of which are likely to have far-reaching effects on economic activity for an indeterminate period. The near- and long-term impact of these factors on the Company's operations cannot be predicted at this time but may be substantial.

From time-to-time, the Company carries cash and securities balances on deposit with financial institutions that are in excess of federally insured limits, and the risk of losses related to such concentrations may be increasing as a result of recent economic developments discussed in the foregoing paragraph. The extent of a future loss to be sustained as a result of uninsured deposits in the event of a future failure of a bank or other financial institution, if any, however, is not subject to estimation at this time.

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13. INCOME TAX

The Company adopted the provisions of FIN 48 on April 1, 2007 and commenced analyzing filing positions in the Jurisdictions where we are required to file income tax returns. As a result of the implementation of FIN 48, the Company recognized no adjustment for uncertain tax provisions and the total amount of unrecognized tax benefits as of April 1, 2007 was $-0-. The Tax Reform Act of 1986 (the Act) provides pursuant to Internal Revenue Code Sections 382 and 383 for a limitation of the annual use of NOL and research and development tax credit carryforwards (following certain ownership changes, as defined by the Act) that could significantly limit the Company's ability to utilize these carryforwards. The Company has experienced various ownership changes as a result of past financings and could experience future ownership changes. The Company's ability to utilize the aforementioned carryforwards may therefore be significantly limited. Additionally, because U.S. tax laws limit the time during which these carryforwards may be applied against future taxes, the Company may not be able to take full advantage of these reduced attributes for federal income tax purposes. The Company has not performed an analysis of its deferred tax assets for net operating losses or any possible research and development credits sufficient to meet the more likely than not threshold required by FIN 48. Accordingly, the deferred tax assets related to net operating losses and the offsetting valuation allowance were removed from deferred tax assets at April 1, 2007 until such an analysis is documented.

As discussed above, as of April 1, 2007, the Company removed its net operating losses from deferred tax assets and the offsetting valuation allowance until documented by a Section 382 analysis. During the quarter ended September 30, 2008 the Company provided a tax provision of $264,000 representing foreign taxes for which a credit (a deferred tax asset) may be allowable against future United States taxes subject to certain limitations. A full valuation allowance has been established to offset the remaining net deferred tax assets (after applying sufficient net operating losses to offset current income) and to the new foreign tax credit at December 31, 2008 as realization of these assets is uncertain. For the three and nine months ended December 31, 2008, the deferred tax expense of $755,000 and $543,000 respectively, was offset by a corresponding decrease of the deferred tax asset valuation allowance.  When, and if, the Company can sustain consistent profitability, and management determines that it is likely it will be able to utilize the net operating losses prior to their expiration and the amounts are adequately documented, then any additional valuation allowance can be reduced or eliminated.

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

THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW AND UNDER THE SUB-HEADING, "BUSINESS RISKS." SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2008.

Cautionary Note on Forward Looking Statements

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

General

We are a holding company incorporated under the laws of Delaware  that operates through our wholly-owned California subsidiary of the same name. We have innovated a proprietary secure digital video/audio technology platform ("DVAP") and market our eVU™ mobile entertainment device for the travel and recreational industries. We also own and are licensing our Flash-R™ portfolio of patents related to the use of flash memory in portable devices. Our revenue is derived from the sale of DVAP products and accessories to customers, warranty and technical support services and content fees and related services. We also obtain patent license revenue from our Flash-R patent portfolio.

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

We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against those who may be infringing our patents. Our international legal firm Duane Morris LLP is handling our patent enforcement matters on a contingent fee basis. In September 2007 and March 2008 we filed our first tranche of patent infringement litigation against eight defendants. In September 2008 we recorded our first patent license revenue and recognized additional license revenue during the quarter ended December 31, 2008. While we expect additional patent licenses in future periods there can be no assurance of the timing or amounts of any related license revenue.

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

Overall Performance and Trends

We have experienced significant operating losses and negative cash flow from operations in each of the last three years. Our recent profitability has resulted from one-time patent licensing revenues and there is no assurance of future licensing revenues from new licensees. Accordingly, we could incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability. Our ability to continue as a going concern is in doubt and is dependent upon achieving a profitable level of operations and if necessary obtaining additional financing.

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For the nine months ended December 31, 2008:

· We recognized net income before income taxes of $1,113,755 for the nine months ended December 31, 2008. This was before income tax expense of $264,000 for foreign taxes. The resulting net income of $849,755 was an improvement from the net loss of $1,148,517 for the first nine months of the prior year.  The improvement resulted primarily from new higher margin patent licensing revenue that offset a decline in eVU product and service revenues.

· Our revenues were $6.1 million for the first nine months compared to $4.8 million for the prior year’s nine months. Revenues in the first nine months included $5.25 million of patent license revenue. Last year’s first nine months revenues included product sales to new European in flight entertainment (“IFE”) customers. Recent eVU sales activity has been slow due to airline industry economics and industry credit concerns resulting in airlines curtailing expansion and new projects. We are aggressively pursuing new business but our results will be dependent on the timing and quantity of additional patent licenses and eVU orders. We seek to expand and diversify our customer base both in the IFE space and other markets. The failure to obtain additional patent license revenues or eVU orders or delays of orders or production delays could have a material adverse impact on our operations.

· Our gross profit for the first nine months was $3.6 million or 59% of revenues compared to $1.2 million or 26% of revenues for the prior year’s first nine months. Results benefited from higher patent licensing gross profit percentages as compared to product sales. Gross profit margins are highly dependent on revenue and product mix, prices charged, volume of orders and costs.

· Operating expenses were $2.1 million for the first nine months of fiscal 2009 (year ending March 31, 2009) compared to $2.2 million for the first nine months of fiscal 2008.

We have recently reduced our monthly cash operating costs to an average of approximately $200,000 per month. However, we may increase expenditure levels in future periods to support and expand our revenue opportunities and continue advanced product and technology research and development. Accordingly, we may incur future losses until such time as we are able to realize recurring revenues and margins sufficient to cover our costs of operations.  We may also face unanticipated technical or manufacturing obstacles and face warranty and other risks in our business.

Critical Accounting Policies

We have identified a number of accounting policies as critical to our business operations and the understanding of our results of operations. These are described in our consolidated financial statements located in Item 1 of Part I, “Financial Statements,” and in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report of Form 10-K for the year ended March 31, 2008. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations when such policies affect our reported and expected financial results.

The methods, estimates and judgments we use in applying our accounting policies, in conformity with generally accepted accounting principles in the United States, have a significant impact on the results we report in our financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The estimates affect the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

The following critical accounting policies guided our judgment and estimates used in accounting for the new issuance of convertible preferred stock in June 2008, fair value measurements and new patent license revenues:

Accounting for Convertible Preferred Stock

The Company accounts for preferred stock subject to provisions for redemption that are outside of its control as mezzanine equity in accordance with FAS 150 "Accounting for Certain Financial Instruments with Characteristics of Both Debt and Equity," EITF Topic D-98 “Classification and Measurement of Redeemable Securities” and  SEC Accounting Series Release (ASR) No. 268 “Redeemable Preferred Stocks,” and is shown net of discounts for warrant values and beneficial conversion features. These securities are recorded at fair value at the date of issue and related discounts are accreted over the term of the securities. The securities are reclassified to permanent equity when the provisions for redemption are terminated.

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The Company accounts for redeemable convertible preferred stock and the related common stock warrants in accordance with the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock,” EITF Issue No. 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,” EITF Issue No. 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments” and other related accounting guidance.  Pursuant to this guidance, the Company has concluded that the conversion and redemption features of the redeemable convertible preferred stock are not embedded derivatives that need to be bifurcated from the host instrument and separately valued. In addition, the Company has accounted for its detachable common stock warrants as a derivative liability in accordance with the guidance of EITF 00-19 and reevaluates the status of such instruments at each reporting period.

Fair Value Measurements

The Company follows the provisions of SFAS No. 157, “Fair Value Measurements,” or SFAS 157, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., the exit price) in an orderly transaction between market participants at the measurement date. In measuring fair value, the Company considers the hierarchy for inputs provided in SFAS 157 to determine appropriate valuation approaches. Generally, valuations are based on quoted market prices for identical assets or liabilities which the Company has the ability to access, or for which significant inputs are observable either directly or indirectly. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires judgment. The Company’s assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date; however, different judgments could yield different results. The Company’s valuation pricing models consider time value, volatility factors, current market and contractual prices for the underlying financial instruments as well as other measurements. Changes in these factors can have a significant impact on carrying values and results of operations.

Patent License Revenue Recognition

The Company has only recently commenced receiving patent license revenue. The Company recognizes revenue from patent license agreements when (i) the patent license agreement is executed, (ii) the amounts due are fixed, determinable, and billable, (iii) the customer has been provided rights to the licensed technology and (iv) collection of the resulting receivable, if any, is probable. At the time the Company enters into a contract and provides the customer with the licensed technology the Company has performed all of its obligations under contract, the rights to the Company’s technology have been transferred and no significant performance obligations remain. License revenue to date consists of one-time licenses requiring no future performance. The Company values nonexclusive cross licenses received only if directly used in operations.

Patent license costs of revenues include contingency legal and other direct costs associated with patent licensing.

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Results of Operations

Three months ended December 31, 2008 compared to the three months ended December 31, 2007

	Three Months Ended December 31,
	2008						2007
				% of			(as restated)			% of			Change
	Dollars			Revenue			Dollars			Revenue			Dollars			%
Revenues:
Product revenues		120,463			3.1	%		1,006,485			84.5	%		(886,022	)
Service revenues		135,570			3.5	%		184,362			15.5	%		(48,792	)
Patent license		3,650,000			93.4	%		-			0.0	%		3,650,000
		3,906,033			100.0	%		1,190,847			100.0	%		2,715,186			228.0	%
Gross Profit:
Product gross profit		24,129						257,956						(233,827	)
Service gross profit		78,340						138,395						(60,055	)
Patent license gross profit		2,184,081						-						2,184,081
		2,286,550			58.5	%		396,351			33.3	%		1,890,199			476.9	%
Operating Expenses:
Selling and administrative		576,997			14.8	%		484,252			40.7	%		92,745			19.2	%
Research and related		111,922			2.9	%		243,345			20.4	%		(131,423	)		(54.0	%)
		688,919			17.6	%		727,597			61.1	%		(38,678	)		(5.3	%)
Other income (expenses)		(49,836	)		(1.3	%)		(66,125	)		(5.6	%)		16,289			(24.6	%)
Income (loss) before provision for income taxes		1,547,795			39.6	%		(397,371	)		(33.4	%)		1,945,166			(489.5	%)

Income (loss) before provision for income taxes

We reported income before income taxes of $1,547,795 for the three months ended December 31, 2008 compared to a loss of $397,371 for the comparable period of the prior year. The $1,945,166 improvement was the result of higher margin patent license revenues that offset a decline in eVU product and service revenues.

Revenues

Revenues of $3,906,033 in the third quarter of fiscal 2009 compared to $1,190,847 for the comparable prior period. The revenue mix was significantly different each period. During the prior year’s third quarter revenues consisted of $1,006,485 from selling eVU players and related equipment for use by airline customers and $184,362 from service revenues for content and support services. Recent eVU product sales activity has been slow due to airline industry economics and industry credit concerns resulting in airlines curtailing expansion and new projects. Our most recent quarter’s revenues consisted primarily of $3,650,000 of one-time non-recurring patent license revenue and $256,033 of eVU product and service revenues. We are pursuing new business but our results will continue to be dependent on the timing and quantity of eVU orders or the timing of patent licensing arrangements.

Gross Profit

Gross profit for the third quarter of fiscal 2009 was $2,286,550 or 58.5% of revenues.  The gross profit for the prior year’s third quarter was $396,351 or 33.3% of revenues. The improved gross profit percentage resulted from higher margin patent license revenue. Gross profit margins are highly dependent on revenue mix, prices charged, volume of orders, contingency patent legal fees and costs.

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Operating Expenses

Selling and administrative costs for the three months ended December 31, 2008, were $576,997 compared to $484,252 for the third quarter of fiscal 2008. While most cost categories were comparable we have experienced an increase in litigation related legal expenses of $202,000, offset by a $87,000 reduction in staffing costs due to reduced personnel.

Research and related expenditures for the three months ended December 31, 2008 were $111,922, compared to $243,345 for the three months ended December 31, 2007. The decrease resulted from reduced personnel and from reassigning other engineers and technicians to customer support and service roles in the current year.

Other Income (Expenses)

Net other expenses were $49,836 for the third quarter of fiscal 2009 compared to net expenses of $66,125 for the third quarter of the prior year. The most recent quarter included $38,717 of interest expense including $20,717 of non-cash interest. The third quarter of fiscal 2008 included interest of $56,115, of which $32,112 was non-cash interest from the amortization of debt discount, and $21,640 of financing royalties.

Provision for Income Taxes

There was no income tax provision or benefit for the third quarter of fiscal 2009 or 2008. The deferred tax expense of $755,000 for the most recent third quarter was offset by a benefit related to the decrease  of the deferred tax asset valuation allowance.

Income (Loss) Attributable to Common Stockholders

The income (loss) attributable to common stockholders for the most recent third quarter included the net income after taxes of $1,547,795 reduced by accrued  and deemed dividends on convertible preferred stock of $43,284 or a net income attributable to common stockholders of $1,504,511. The net loss after tax for the prior comparable third quarter was $397,371 reduced by accrued and deemed dividends of $27,225 for a net loss attributable to common stockholders of $424,596.

Nine months ended December 31, 2008 compared to the nine months ended December 31, 2007

	Nine Months Ended December 31,
	2008						2007
				% of			(as restated)			% of			Change
	Dollars			Revenue			Dollars			Revenue			Dollars			%
Revenues:
Product revenues		356,444			5.9	%		4,304,197			89.5	%		(3,947,753	)
Service revenues		451,746			7.5	%		507,065			10.5	%		(55,319	)
Patent license		5,250,000			86.7	%		-			0.0	%		5,250,000
		6,058,190			100.0	%		4,811,262			100.0	%		1,246,928			25.9	%
Gross Profit:
Product gross profit		52,651						849,139						(796,488	)
Service gross profit		282,308						390,725						(108,417	)
Patent license gross profit		3,222,755						-						3,222,755
		3,557,714			58.7	%		1,239,864			25.8	%		2,317,850			186.9	%
Operating Expenses:
Selling and administrative		1,743,389			28.8	%		1,427,344			29.7	%		316,045			22.1	%
Research and related		387,672			6.4	%		739,592			15.4	%		(351,920	)		(47.6	%)
		2,131,061			35.2	%		2,166,936			45.0	%		(35,875	)		(1.7	%)
Other income (expenses)		(312,898	)		(5.2	%)		(221,445	)		(4.6	%)		(91,453	)		41.3	%
Income (loss) before provision for income taxes		1,113,755			18.4	%		(1,148,517	)		(23.9	%)		2,262,272			(197.0	%)

Income (Loss) before provision for income taxes

We showed income before income taxes of $1,113,755 for the nine months ended December 31, 2008 compared to a loss of $1,148,517 for the comparable period of the prior year. The $2,262,272 improvement was the result of higher margin patent license revenues.

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Revenues

Revenues of $6,058,190 for the first nine months of fiscal 2009 compared to $4,811,262 for the same period of the prior year. The revenue mix was different in the most recent nine month period due to initial patent license revenues. Fiscal 2009 nine-month revenues included eVU products and service revenue of $808,190 and patent license revenue of $5,250,000. We are reliant on a limited number of customers with three customers accounting for 33%, 27% and 26% of our first nine-month revenues. During the prior year’s first nine months revenues consisted of $4,811,262 from selling eVU players and related service revenues for content and support services. Recent eVU product sales activity has been slow due to airline industry economics and industry credit concerns resulting in airlines curtailing expansion and new projects. We are pursuing new business but our results will continue to be dependent on the timing and quantity of eVU orders or the timing of patent licensing arrangements.

Gross Profit

Gross profit for the first nine months of fiscal 2009 was $3,557,714 or 58.7% of revenues.  The gross profit for the prior year’s first nine months was $1,239,864 or 25.8% of revenues. The improved gross profit percentage resulted from higher margin patent license revenue. Gross profit margins are highly dependent on revenue mix, prices charged, volume of orders, contingency patent legal fees and costs.

Operating Expenses

Selling and administrative costs for the nine months ended December 31, 2008, were $1,743,389 compared to $1,427,344 for the first nine months of fiscal 2008. The $316,045 increase included an increase in litigation related legal expenses of $410,000 and an increase of $73,000 of shareholder costs primarily related to holding the September shareholders meeting offset by a $103,000 reduction in sales commissions from reduced product sales and a $70,000 reduction in personnel costs due primarily to reduced stock-based compensation costs.

Research and related expenditures for the nine months ended December 31, 2008 were $387,672, compared to $739,592 for the nine months ended December 31, 2007. The decrease resulted primarily from a reduction in personnel and reassigning other engineers and technicians to customer support and service roles in the current year.

Other Income (Expenses)

Net other expense was $312,898 for the nine months ended December 31, 2008 compared to net expenses of $221,445 for the nine months ended December 31, 2007. The most recent period included a non-cash financing expense of $177,125 related to a charge for warrant modification and $129,425 of interest expense including $62,132 of non-cash interest.

For the first nine months of fiscal 2008 other expenses of $221,445 included interest expense of $187,783, of which $99,274 was non-cash interest from the amortization of debt discount, and $69,620 of financing royalties.

Provision for Income Taxes

Income tax expense of $264,000 consists of foreign taxes paid on patent license revenue. There was no domestic income tax provision or benefit for the first three quarters of fiscal 2009 or 2008. The deferred tax expense of $543,000 for the most recent nine months was offset by a benefit related to the decrease of the deferred tax asset valuation allowance.

Income (Loss) Attributable to Common Stockholders

The income attributable to common stockholders for the nine months ended December 31, 2008 included the income after taxes of $849,755 reduced by accrued and deemed dividends on convertible preferred stock of $87,978 or a net income attributable to common stockholders of $761,777. The net loss after tax for the prior comparable nine months was $1,148,517 reduced by accrued and deemed dividends of $81,975 for a net loss attributable to common stockholders of $1,230,492.

Liquidity and Capital Resources

At December 31, 2008, we had working capital of $923,538 compared to a working capital deficit of $1.3 million at March 31, 2008. At December 31, 2008 we had cash on hand of $742,740.

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Operating Activities

Cash used in operating activities was $498,019 for the nine months ended December 31, 2008. Cash provided by operating activities included income of $849,755 increased by net non-cash expenses of $238,885. Major components also providing operating cash was an increase of $758,251 in other accounts payable and accrued liabilities. Major components using operating cash included an increase of $1,963,060 in accounts receivable, a $26,796 increase in inventory and a $262,760 decrease in accounts payable. Our terms to customers vary but we often require payment prior to shipment of product and any such payments are recorded as deposits. Patent license payments are normally due at signing of the license or within 30-45 days.

Cash used in operating activities during the nine months ended December 31, 2007 was $974,412. Individual working capital components can change dramatically from period to period due to timing of sales and shipments and corresponding receivable, inventory and payable balances. Accordingly operating cash requirements vary significantly from period to period.

Investing Activities

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

Financing Activities

For the nine months ended December 31, 2008, cash provided by financing activities was $1,118,643. This included $580,000 from the sale of common stock to Fusion Capital Fund II, LLC (“Fusion”) pursuant to a purchase agreement and $700,000 cash from the sale of preferred stock. We reduced our secured note balance by $150,000, made term principal payments of $51,357 and obtained $40,000 in July 2008 from a new one year note. During the first nine months of the prior year we obtained $640,000 from the sale of common stock to Fusion and made a secured note payment of $300,000.

Subsequent to December 31, 2008 we obtained $80,000 from the sale of common stock pursuant to the Fusion agreement that terminated in accordance with its terms on February 4, 2009.

Related Party Debt and Other Commitments

We currently have a secured note for $300,000 due on June 23, 2009, an unsecured note for $40,000 due in July 2009 and an unsecured convertible term debt with a principal amount of $528,208. We made $230,000 of term note principal and interest payments through the issuance of common shares during the first nine months. Our plans are to make future principal and interest payments with shares of common stock, subject to maintaining the $0.10 minimum share price and other covenants of the term loan.

At December 31, 2008 we were committed to approximately $127,000 as purchase commitments for product and components. These orders are generally subject to modification as to timing, quantities and scheduling and in certain instances may be cancelable without penalty.

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

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

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

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Cash Requirements

Other than cash on hand, accounts receivable and the proceeds from the subsequent Fusion stock sale, we have no material unused sources of liquidity at this time.  Based on our cash position at December 31, 2008 and (a) assuming expected receivable collections (b) current planned expenditures and level of operation, and (c) expected cash debt service of $370,000 (assuming convertible term debt payments are made in shares of common stock) we believe we will require approximately $0.7 million of additional capital resources for the next twelve months. Actual results could differ significantly from management plans. We believe we may be able to obtain such additional funds from future patent licensing and eVU product sales and services but the timing of licenses and shipments and the amount and quantities of shipments, orders and reorders are subject to many factors and risks, many outside our control. Accordingly we may need equity or debt financing in the next twelve months for working capital and we may need equity or debt financing for payment of existing debt obligations and other obligations.

Our operating plans require additional funds and should additional funds not be available, we may be required to curtail or scale back staffing or operations.  Failure to obtain additional financings could have a material adverse effect on our Company. Our company’s ability to continue as a going concern is in doubt and is dependent upon achieving sustained profitability and until then obtaining additional financing. Potential sources of such funds include exercise of outstanding warrants and options, or debt financing or additional equity offerings.  However, there is no guarantee that warrants and options will be exercised or that debt or equity financing will be available when needed.  Any future financing may be dilutive to existing stockholders.

In the future, if our operations increase significantly, we may require additional funds.  We also may require additional capital to meet our debt and other commitments, finance future developments, acquisitions or expansion of facilities.  We currently have no plans, arrangements or understandings regarding any acquisitions.

Item 4. Controls and Procedures

Based on an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of December 31, 2008, our President and CEO (“Principal Executive Officer” or “PEO”) and Interim Chief Accounting Officer (“Principal Financial Officer” or “PFO”) have concluded that our disclosure controls and procedures were not effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms.

In connection with the preparation of our annual financial statements, our management performed an assessment of the effectiveness of internal control over financial reporting as of March 31, 2008. Management's assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls. Based on this evaluation, management determined that, as of March 31, 2008, there were material weaknesses in our internal control over financial reporting. The material weaknesses identified during management's assessment were (i) the lack of independent oversight by an audit committee of independent members of the Board of Directors, and (ii) ineffective controls over the period ending closing process that failed to identify a misclassification of supplier material transfers during the second and third quarter of fiscal 2008. In light of these material weaknesses, management concluded that, as of March 31, 2008, we did not maintain effective internal control over financial reporting. As defined by the Public Company Accounting Oversight Board Auditing Standard No. 5, a material weakness is a deficiency or a combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected. While management has taken remediation steps to improve its closing process including additional management reviews at December 31, 2008 there had been no change in the audit committee.

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the relationship between the benefit of desired controls and procedures and the cost of implementing new controls and procedures.

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The interim consolidated financial statements as of and for the period ended December 31, 2008 include all adjustments identified as a result of the evaluation performed.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

As of December 31, 2008 we are in the process of remediating the second material weakness identified above which existed at March 31, 2008 by improving our period ending closing process each quarter. Due to our small size and limited financial resources we rely on part-time personnel to assist in the closing process with limited but period to period growing knowledge of daily operations. Also due to our size and limited resources it is difficult to attract qualified independent directors and qualified audit committee members. Management has concluded that with certain management oversight controls that are in place, the risks associated with the use of part-time personnel in the closing process and the lack of independent audit committee oversight are not sufficient to justify the costs of adding personnel, additional directors and independent audit committee members at this time. Management will periodically reevaluate this situation. If we secure sufficient capital or improve our operating results it is our intention to hire additional full-time accounting and reporting personnel and change the composition and/or size of the Board of Directors with emphasis on recruiting qualified independent audit committee members. We plan to be testing and re-evaluating our controls periodically during fiscal 2009.

Other than described above there were no changes in our internal controls over financial reporting that could significantly affect internal controls over financial reporting during the quarter ended December 31, 2008.

PART II.       OTHER INFORMATION

Item 1. Legal Proceedings

Business Litigation

In May 2006, we announced that a complaint had been filed against our Company and certain of our officers and employees by digEcor, Inc. in the Third Judicial District Court of Utah, County of Salt Lake. The complaint alleged breaches of contract, unjust enrichment, breaches of good faith and fair dealing, fraud, negligent misrepresentation, and interference with prospective economic relations. digEcor sought, among other things, an injunction to prevent our Company from selling or licensing certain digital rights management technology and "from engaging in any competition with digEcor until after 2009." digEcor also sought "actual damages" of $793,750 and "consequential damages...not less than an additional $1,000,000." This action was related to a purchase order we placed for this customer in the normal course of business on November 11, 2005 for 1,250 digEplayers(tm) with our contract manufacturer, Maycom Co., Ltd.. Maycom was paid in full for the order by both e.Digital and digEcor by March 2006, but Maycom failed to timely deliver the order. We recorded an impairment charge of $603,750 in March 2006 for deposits paid to Maycom due to the uncertainty of obtaining future delivery. In October 2006 we received delivery from Maycom of the delayed 1,250-unit digEplayer order and delivered the order to digEcor. We recognized $713,750 of revenue from this order and reversed an impairment charge of $603,750 in our third fiscal 2007 quarter.  We have answered digEcor's complaint and are pursuing certain counterclaims.

In January 2007, the Court ruled on certain motions of the parties. In its ruling, the Court dismissed digEcor's unjust enrichment, fraud, negligent misrepresentation, tortious interference and punitive damage claims. The Court further acknowledged the delivery of the 1,250-unit order and a partial settlement between the parties reducing digEcor's claim for purchase-price or actual damages from $793,750 to $94,846 with such amount still being disputed by e.Digital. digEcor's contract and damages claims remain in dispute. digEcor has subsequently amended its Complaint to assert an alternative breach of contract claim, and claims for federal, state and common law unfair competition, and sought an injunction prohibiting us "from engaging in any competition with digEcor until after 2013."

In April 2007 we filed a second amended counterclaim in the United States District Court of Utah seeking a declaratory judgment confirming the status of prior agreements between the parties, alleging breach of our confidential information and trade secrets by digEcor, seeking an injunction against digEcor's manufacture and sale of a portable product based on our technology, alleging breach of duty to negotiate regarding revenue sharing dollars we believe we have the right to receive and tortious interference by digEcor in our contracts with third parties. We intend to vigorously prosecute these counterclaims.

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In April 2007 digEcor filed a motion for summary judgment seeking enforcement of an alleged non-compete provision and an injunction prohibiting us from competing with digEcor. In October 2007 the Court denied, without prejudice, digEcor's motion for partial summary judgment and request for injunction. The foregoing and other findings of the Court may be subject to appeal by either party.

In September 2008 digEcor filed their third request for a partial summary judgment again seeking enforcement of the alleged non-compete provision.  digEcor also asked the Court to rule on issues surrounding the delayed 1250-unit order and e.Digital's alleged breach of  a 2002 contract between the parties.  

In September 2008 we filed a summary judgment motion seeking a ruling (i) that the alleged non-compete provision is unenforceable and /or superseded by the 2002 agreement between the parties, and (ii) that the we have not breached any alleged non-compete provisions or the 2002 agreement.  We also asked the Court to dismiss digEcor's unfair competition claims and limit digEcor's damages claim.

The case has now completed the discovery phase. We voluntarily dismissed some of our counterclaims, alleging misappropriation of its confidential information and trade secrets.  We believe we have substantive and multiple defenses and intend to vigorously challenge the remaining matters and pursue all remaining counterclaims. However, there can be no assurance we will prevail in our counterclaims or in our defense of digEcor's remaining claims.

We are also unable to determine at this time the impact this complaint and matter may have on our financial position or results of operations. We have an accrual of $80,000 as an estimate of our obligation related to the remaining general damage claim and we intend to seek restitution from Maycom for any damages we may incur. Recovery from Maycom is not assured. Maycom is not involved in the design, tooling or production of our proprietary eVU mobile product. Moreover, we do not presently plan or expect to produce or sell digEplayer models to digEcor or other customers in the future.

Intellectual Property Litigation

In September 2007 and March 2008, we filed a complaint against eight companies in the U.S. District Court for the Eastern District of Texas asserting that products made by the listed companies infringe four of our U.S. patents covering the use of flash memory technology. These patents are part of our Flash-R patent portfolio. As we license and settle with individual defendants they are dropped from the complaint. We intend to pursue our claims vigorously against remaining defendants but the litigation is in the early stage and there is no assurance of further settlements or recovery. Although most fees, costs and expenses of the litigation are covered under our contingent fee arrangement with Duane Morris LLP, we may incur support and related expenses for this litigation that may become material.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) No common shares were issued during the fiscal quarter and not previously reported in a Quarterly Report on Form 10-Q or Current Report on Form 8-K.

(b) NONE

(c) NONE

Item 3. Defaults Upon Senior Securities

NONE

Item 4. Submission of Matters to a Vote of Security Holders

NONE

Item 5. Other Information

(a) NONE

(b) NONE

Item 6. Exhibits

Exhibit 31.1 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk, President and CEO (Principal Executive Officer).

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Exhibit 31.2 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, signed by Robert Putnam, Interim Accounting Officer (Principal Accounting Officer).

Exhibit 32.1 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk, President and CEO (Principal Executive Officer) and Robert Putnam, Interim Accounting Officer (Principal Accounting Officer).

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

			e.DIGITAL CORPORATION
Date:	February 10, 2009	By:	/s/ ROBERT PUTNAM
			Robert Putnam, Interim Chief Accounting Officer
			(Principal Accounting and Financial Officer
			and duly authorized to sign on behalf of the Registrant)

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