E Digital (EDIG) 10-Q 2010 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, 2009

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

Indicate by check mark 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 ¨	Accelerated filer ¨
Non-accelerated filer ¨  (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 10, 2010 a total of 286,950,900 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):	3
	Condensed Consolidated Balance Sheets as of December 31, 2009
	and March 31, 2009	3
	Condensed Consolidated Statements of Operations for the three
	and nine months ended December 31, 2009 and 2008	4
	Condensed Consolidated Statements of Cash Flows for the nine
	months ended December 31, 2009 and 2008	5
	Notes to Interim Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial
	Condition and Results of Operations	16
Item 4.	Controls and Procedures	22
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	23
Item 3.	Defaults Upon Senior Securities	23
Item 4.	Submission of Matters to a Vote of Security Holders	23
Item 5.	Other Information	24
Item 6.	Exhibits	24
SIGNATURES		24

2

Part I. Financial Information

Item 1. Financial Statements:

e.Digital Corporation and subsidiary

CONDENSED CONSOLIDATED BALANCE SHEETS

	December 31,
	2009			March 31,
	(Unaudited)			2009
	$			$
ASSETS
Current
Cash and cash equivalents		2,838,967			3,813,990
Accounts receivable		212,656			93,771
Inventory		427,098			517,163
Deposits and prepaid expenses		19,452			26,108
Total current assets		3,498,173			4,451,032
Property, equipment and intangibles, net of accumulated depreciation and amortization of $179,230 and $165,449, respectively		14,068			26,638
Total assets		3,512,241			4,477,670
LIABILITIES AND STOCKHOLDERS' EQUITY
Current
Accounts payable, trade		100,957			202,900
Accrued and other liabilities		169,733			589,814
Current maturity of convertible term note, net of $-0- and $6,141 of debt discount		-			381,093
Total current liabilities		270,690			1,173,807
Deferred revenue - long term		-			24,000
Total long-term liabilities		-			24,000
Total liabilities		270,690			1,197,807
Commitments and Contingencies
Stockholders' equity
Preferred stock, $0.001 par value; 5,000,000 shares authorized
Series AA Convertible Preferred stock, $0.001 par value, 100,000 shares designated: 55,000 and 75,000 issued and outstanding, respectively Liquidation preference of $591,589 and $778,459, respectively		542,779			610,774
Common stock, $0.001 par value, authorized 350,000,000, 286,950,900 and 282,124,564 shares issued and outstanding, respectively		286,951			282,125
Additional paid-in capital		82,095,398			81,534,566
Accumulated deficit		(79,683,577	)		(79,147,602	)
Total stockholders' equity		3,241,551			3,279,863
Total liabilities and stockholders' equity		3,512,241			4,477,670

See notes to interim consolidated financial statements

3

e.Digital Corporation and subsidiary

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the three months ended						For the nine months ended
	December 31,						December 31,
	2009			2008			2009			2008
	$			$			$			$
Revenues:
Products		106,570			120,463			164,085			356,444
Services		177,600			135,570			605,382			451,746
Patent license		-			3,650,000			1,250,000			5,250,000
Total revenues		284,170			3,906,033			2,019,467			6,058,190
Cost of revenues:
Products		96,630			96,334			173,423			303,793
Services		83,188			57,230			259,996			169,438
Patent license		-			1,465,919			443,000			2,027,245
Total cost of revenues		179,818			1,619,483			876,419			2,500,476
Gross profit		104,352			2,286,550			1,143,048			3,557,714
Operating expenses:
Selling and administrative		558,600			576,997			1,386,013			1,743,389
Research and related expenditures		130,163			111,922			336,493			387,672
Total operating expenses		688,763			688,919			1,722,506			2,131,061
Operating income (loss)		(584,411	)		1,597,631			(579,458	)		1,426,653
Other income (expense):
Interest expense		(1,265	)		(38,717	)		(17,099	)		(129,425	)
Other income (expense) - net		32,891			(11,119	)		29,332			(183,473	)
Other income (expense)		31,626			(49,836	)		12,233			(312,898	)
Income (loss) before income taxes		(552,785	)		1,547,795			(567,225	)		1,113,755
Income tax benefit (provision)		237,500			-			31,250			(264,000	)
Income (loss) for the period		(315,285	)		1,547,795			(535,975	)		849,755
Accrued and deemed dividends on preferred stock		(45,387	)		(43,284	)		(144,088	)		(87,978	)
Income (loss) attributable to common stockholders		(360,672	)		1,504,511			(680,063	)		761,777
Income (loss) per common share - basic and diluted		(0.00	)		0.01			(0.00	)		0.00
Weighted average common shares outstanding
Basic		286,625,653			279,143,996			284,520,917			276,916,733
Diluted		286,625,653			281,454,506			284,520,917			277,912,376

See notes to interim consolidated financial statements

4

e.Digital Corporation and subsidiary

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

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

	For the nine months ended
	December 31,
	2009			2008
	$			$
OPERATING ACTIVITIES
Income (loss) for the period		(535,975	)		849,755
Adjustments to reconcile income (loss) to net cash used in operating activities:
Depreciation and amortization		13,781			12,175
Accretion related to promissory notes		6,141			32,632
Warrant modification and warrant derivative revaluation		-			174,667
Interest paid with common stock		10,631			29,500
Warranty provision		9,502			(41,615	)
Stock-based compensation		147,663			31,526
Changes in assets and liabilities:
Accounts receivable		(118,885	)		(1,963,060	)
Inventory		90,065			(26,796	)
Deposits and prepaid expenses		6,656			2,959
Accounts payable, trade		(101,943	)		(262,760	)
Accrued and other liabilities		(217,665	)		758,251
Accrued employee benefits		(22,105	)		(44,634	)
Accrued income taxes		(157,500	)		-
Warranty reserve		(18,298	)		(43,072	)
Deferred revenue		(38,015	)		(7,547	)
Cash used in operating activities		(925,947	)		(498,019	)
INVESTING ACTIVITIES
Purchase of equipment		(1,211	)		-
Cash used in investing activities		(1,211	)		-
FINANCING ACTIVITIES
Proceeds from sale of common stock		-			580,000
Proceeds from sale of preferred stock		-			700,000
Payment on convertible term note		(47,865	)		(51,357	)
Payments on secured promissory note		-			(150,000	)
Proceeds from unsecured promissory note		-			40,000
Cash (used in) provided by financing activities		(47,865	)		1,118,643
Net increase (decrease) in cash and cash equivalents		(975,023	)		620,624
Cash and cash equivalents, beginning of period		3,813,990			122,116
Cash and cash equivalents, end of period		2,838,967			742,740
Supplemental disclosures of cash flow information:
Cash paid for interest		327			64,893
Cash paid for taxes		368,750			264,000
Supplemental schedule of noncash investing and financing activities:
Common stock issued on conversion of preferred stock		212,083			-
Accounts payable exchanged for preferred stock		-			50,000
Accrued and deemed dividends on preferred stock		144,088			87,978
Term note payments paid in common stock		350,000			230,000
Financing fees paid in common stock		-			9,800
Warrant derivative liability reclassified to equity		-			132,315

See accompanying notes to 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 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, 2009, and the results of its 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, 2009 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2010. For further information, refer to the Company's consolidated financial statements and footnotes thereto for the year ended March 31, 2009 filed on Form 10-K.

Going Concern

Until the fiscal year ended March 31, 2009 (fiscal 2009), the Company incurred significant losses and negative cash flow from operations and has an accumulated deficit of $79,683,577 at December 31, 2009. The Company’s profitability for the prior year resulted from one-time patent licensing revenues and there is no assurance of future licensing revenues from new licensees. Accordingly, the Company has incurred losses in the current fiscal year to date and could continue to incur losses in the future until product, service and/or licensing revenues are sufficient to sustain continued profitability. Until the Company can demonstrate sustained profitability its ability to continue as a going concern is in doubt and may be dependent upon obtaining additional financing in the future. These consolidated financial statements do not give effect to any adjustments that would be necessary should the Company be unable to continue as a going concern and therefore be required to realize its assets and discharge its liabilities in other than the normal course of business and at amounts different from those reflected in the accompanying consolidated financial statements.

Estimates

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.

2. RECENT ACCOUNTING PRONOUNCEMENTS

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the three and nine months ended December 31, 2009, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2009, that are of significance, or potential significance to the Company.

Adopted Accounting Pronouncements

Effective July 1, 2009, the Company adopted The “FASB Accounting Standards Codification” and the Hierarchy of Generally Accepted Accounting Principles (ASC 105). This standard establishes only two levels of U.S. generally acceptedaccounting principles (“GAAP”), authoritative and nonauthoritative. The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification” or “ASC”) became the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of theSEC, which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literaturenot included in the Codification became nonauthoritative. The Company began using the new guidelines and numbering systemprescribed by the Codification when referring to GAAP in the second quarter of fiscal 2010. As the Codification was not intendedto change or alter existing GAAP, it did not have any impact on the Company’s consolidated financial statements.

6

Effective April 1, 2009, the Company adopted three accounting standard updates that were intended to provide additional application guidance and enhanced disclosures regarding fair value measurements and impairments of securities established in ASC 820, Fair Value Measurements and Disclosures. They also provide additional guidelines for estimating fair value in accordance with fair value accounting. The first update, as codified in ASC 820-10-65, provides additional guidelines for estimating fair value in accordance with fair value accounting. The second accounting update, as codified in ASC 320-10-65, changes accounting requirements for other-than-temporary-impairment for debt securities by replacing the current requirement that a holder have the positive intent and ability to hold an impaired security to recovery in order to conclude an impairment was temporary with a requirement that an entity conclude it does not intend to sell an impaired security and it will not be required to sell the security before the recovery of its amortized cost basis. The third accounting update, as codified in ASC 825-10-65, increases the frequency of fair value disclosures. These updates were effective for fiscal years and interim periods ended after June 15, 2009. The adoption of these accounting updates did not have any impact on the Company’s consolidated financial statements.

In February 2008, the FASB issued an accounting standard update that delayed the effective date of fair value measurements accounting for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2010. These include goodwill and other non-amortizable intangible assets. The Company adopted this accounting standard update effective April 1, 2009 and elected not to adopt the option available under ASC 825-10-10 to measure any of its other eligible financial instruments or other items at fair value. Accordingly, the Company continues to measure all of its assets and liabilities on the historical cost basis of accounting except as required under generally accepted accounting principles.

Effective April 1, 2009, the Company adopted a new accounting standard for subsequent events, as codified in ASC 855-10. The update modifies the names of the two types of subsequent events either as recognized subsequent events (previously referred to in practice as Type I subsequent events) or non-recognized subsequent events (previously referred to in practice as Type II subsequent events). In addition, the standard modifies the definition of subsequent events to refer to events or transactions that occur after the balance sheet date, but before the financial statements are issued (for public entities) or available to be issued (for nonpublic entities). It also requires the disclosure of the date through which subsequent events have been evaluated. The update did not result in significant changes in the practice of subsequent event disclosures, and therefore the adoption did not have any impact on the Company’s consolidated financial statements.

Effective April 1, 2009, the Company adopted a new accounting standard update regarding business combinations. As codified under ASC 805 the update requires the acquisition method to be applied to all transactions and other events in which an entity obtains control over one or more other businesses, requires the acquirer to recognize the fair value of all assets and liabilities acquired, even if less than one hundred percent ownership is acquired, and establishes the acquisition date fair value as measurement date for all assets and liabilities assumed. For the Company, this accounting update was effective on a prospective basis for all business combinations for which the acquisition date is on or after April 1, 2009. Since the Company is not contemplating any business combinations it does not presently expect any impact of adoption on its consolidated financial statements.

ASC 810, Consolidation (“ASC 810”), ASC 810-10-65, Transition and Open Effective Date Information (“ASC 810-10-65”) establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated financial statements. ASC 810-10-65 is effective for our fiscal years beginning after December 15, 2008.

The provisions of are applied prospectively upon adoption except for the presentation and disclosure requirements that are applied retrospectively. The Company has no non-controlling interests and accordingly the adoption on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

ASC 815, Derivatives and Hedging (“ASC 815”) and ASC 815-10-65, Transition and Open Effective Date Information (“ASC 815-10-65”) includes a requirement for enhanced disclosures about an entity’s derivative and hedging activities. ASC 815 is effective prospectively for fiscal years beginning after November 15, 2008. The Company currently has no derivatives or hedging activities and the adoption on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

7

ASC 808, Collaborative Arrangements provides guidance for income statement presentation, classification, and disclosures related to collaborative arrangements. The arrangements generally provide that the collaborators will share, based on contractually defined calculations, the profits or losses from the associated activities. Periodically, the collaborators share financial information related to product revenues generated (if any) and costs incurred that may trigger a sharing payment for the combined profits or losses. The guidance requires collaborators in such an arrangement to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable GAAP or, in the absence of other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. ASC 808 is effective for collaborative arrangements in place at the beginning of the annual period beginning after December 15, 2008. The Company does not have any such collaborative arrangements and the adoption of ASC 808 on April 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

In June 2008, the FASB issued ASC 850-15-5, Evaluating Whether an Instrument Involving a Contingency Is Considered Indexed to an Entity's Own Stock.  ASC 850-15-5 requires entities to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock by assessing the instrument’s contingent exercise provisions and settlement provisions.  Instruments not indexed to their own stock fail to meet the first part of the scope exception in ASC 815-10-15-74(a), and should be classified as a liability and marked-to-market.  The statement is effective for fiscal years beginning after December 15, 2008 and is to be applied to outstanding instruments upon adoption with the cumulative effect of the change in accounting principle recognized as an adjustment to the opening balance of retained earnings.  The Company evaluated its various convertible securities and determined that no change in accounting was required related to this pronouncement at April 1, 2009 or for the period ended December 31, 2009.

New Accounting Pronouncements

In September 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (ASU 2009-13). It updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21). The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The Company is currently assessing the future impact of this new accounting update to its consolidated financial statements.

3. INCOME (LOSS) PER SHARE

Basic earnings (loss) 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 was reduced by and the loss to common stockholders increased by accrued and deemed dividends on preferred stock during the three and nine months ended December 31, 2009 of $45,387 and $144,088, respectively (three and nine months ended December 31, 2008 by $43,283 and $87,978, 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 included 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:

8

	Three Months Ended					Nine Months Ended
	December 31,					December 31,
	2009			2008		2009			2008
Basic
Income (loss) attributable to common stockholders	$	(360,672	)	$	1,504,511	$	(680,063	)	$	761,777
Weighted average common shares outstanding (basic)		286,625,653			279,143,996		284,520,917			276,916,733
Basic income (loss) per common share	$	(0.00	)	$	0.01	$	(0.00	)	$	0.00
Diluted
Income (loss) attributable to common stockholders	$	(360,672	)	$	1,504,511	$	(680,063	)	$	761,777
Plus:
Accrued and deemed dividends on preferred stock (1)		-			-		-			-
Income (loss) for diluted	$	(360,672	)	$	1,504,511	$	(680,063	)	$	761,777
Common and potential common shares:
Weighted average common shares outstanding		286,625,653			279,143,996		284,520,917			276,916,733
Assumed exercise of options and warrants		-			2,310,510		-			995,643
Common and potential common shares (1)		286,625,653			281,454,506		284,520,917			277,912,376
Diluted income (loss) per common share	$	(0.00	)	$	0.01	$	(0.00	)	$	0.00
Potentially dilutive securities outstanding at period end excluded from diluted computation as they were antidilutive		22,281,390			18,597,387		22,281,390			18,897,387

 (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,
	2009		2009
	$		$
Raw materials		129,225		140,544
Work in process		25,636		28,335
Finished goods		272,237		348,284
		427,098		517,163

5. STOCK-BASED COMPENSATION COSTS

The Company accounts for stock-based compensation under the provisions of ASC 718, Share-Based Payment and ASC 505-50, Equity-Based Payments to Non-Employees. ASC 718requires 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 ASC 718, the Company estimates forfeitures for stock-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,
	2009		2008			2009		2008
	$		$			$		$
Research and development		19,446		8,918			20,483		8,918
Selling and administrative		109,891		(731	)		127,180		31,526
Total stock-based compensation expense		129,337		8,187			147,663		40,444

As of December 31, 2009 total estimated compensation cost of stock options granted but not yet vested was $37,147 and is expected to be recognized over the weighted average period of 1.3 years.

9

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, 2009 and 2008 (annualized percentages).

	Nine Months Ended
	December 31,
	2009			2008
Volatility		77	%		71	%
Risk-free interest rate		0.95	%		2.3	%
Forfeiture rate		0.0%-0.5	%		0.0	%
Dividend yield		0.0	%		0.0	%
Expected life in years		2.2			3.5
Weighted-average fair value of options granted	$	0.06		$	0.05

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 and expected 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 7 for further information on outstanding stock options.

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,
	2009			2008			2009			2008
	$			$			$			$
Beginning balance		5,359			33,875			14,155			109,138
Warranty provision		1,036			(7,472	)		9,502			(43,072	)
Warranty deductions		(1,036	)		(1,952	)		(18,298	)		(41,615	)
Ending balance		5,359			24,451			5,359			24,451

7. STOCKHOLDERS’ EQUITY

The following table summarizes stockholders’ equity transactions during the nine-month period ended December 31, 2009:

	Preferred stock			Common stock				Additional			Accumulated
	Amount			Shares		Amount		paid-in capital			deficit			Total
Balance, April 1, 2009		610,774			282,124,564		282,125		81,534,566			(79,147,602	)		3,279,863
Dividends on Series AA preferred stock		25,212			-		-		(25,212	)		-			-
Accretion of discount on Series AA preferred stock		118,876			-		-		(118,876	)		-			-
Conversion of Series AA preferred stock		(212,083	)		2,120,821		2,121		209,962			-			-
Shares issued for term debt payments		-			2,705,515		2,705		347,295			-			350,000
Stock-based compensation		-			-		-		147,663			-			147,663
Loss and comprehensive loss		-			-		-		-			(535,975	)		(535,975	)
Balance, December 31, 2009		542,779			286,950,900		286,951		82,095,398			(79,683,577	)		3,241,551

10

Options

The following table summarizes stock option activity for the period:

				Weighted average		Aggregate
	Shares			exercise price		Intrinsic Value
	#			$		$
Outstanding April 1, 2009		8,050,500			0.16
Granted		2,330,000			0.15
Exercised		-
Canceled/expired		(1,515,000	)		0.22
Outstanding December 31, 2009		8,865,500			0.15		111,000
Exercisable at December 31, 2009		7,369,665			0.15		60,000

(1) Options outstanding are exercisable at prices ranging from $0.11 to $0.23 and expire over the period from 2010 to 2013.

(2) Aggregate intrinsic value is based on the closing price of our common stock on December 31, 2009 of $0.155 and excludes the impact of options that were not in-the-money.

Share warrants

The following table summarizes information on warrant activity during the nine months ended December 31, 2009:

	Number			Average Purchase Price Per Share $
Shares purchasable under outstanding warrants at April 1, 2009		9,831,572			0.11
Stock purchase warrants exercised		-
Stock purchase warrants expired		(2,331,572	)		0.15
Shares purchasable under outstanding warrants at December 31, 2009		7,500,000			0.10

The Company has outstanding share warrants as of December 31, 2009, as follows:

	Number of		Exercise Price
Description	Common Shares		Per Share $		Expiration Date
Warrants		7,500,000		0.10	June 30, 2011

8. PREFERRED STOCK

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.

During the nine months ended December 31, 2009 the Company issued 2,120,821 shares of common stock upon the conversion of 20,000 shares of Series AA Stock and accordingly 55,000 shares of Series AA Stock were outstanding at December 31, 2009.

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9. FAIR VALUE MEASUREMENTS

The carrying amounts of cash and cash equivalents, accounts receivables, accounts payable, accrued liabilities and convertible term debt approximate their fair values due to the short-term maturities of these instruments.

On April 1, 2008, the Company adopted ASC 820, Fair Value Measurements and Disclosures that defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 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.

ASC 820 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, 2009, 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 ASC 820 at December 31, 2009:

	Fair Value Measurement as of December 31, 2009
	Total		Level 1		Level 2		Level 3
Description	$		$		$		$
Cash and cash equivalents (1)		2,838,967		2,838,967		-		-

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

10. SEGMENT INFORMATION

ASC 280 Segment Reporting provides annual and interim reporting standards for an enterprise’s business segments and related disclosures about its products, services, geographical areas and major customers. The Company 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.

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Our reportable segment information for the three and nine months ended December 31, 2009 and 2008 is as follows:

	For the three months ended						For the nine months ended
	December 31,						December 31,
	2009			2008			2009			2008
	$			$			$			$
REVENUES:
Products and services		284,170			256,033			769,467			808,190
Patent licensing		-			3,650,000			1,250,000			5,250,000
Total revenue		284,170			3,906,033			2,019,467			6,058,190
GROSS PROFIT:
Products and services		104,352			102,469			336,048			334,959
Patent licensing		-			2,184,081			807,000			3,222,755
Total gross profit		104,352			2,286,550			1,143,048			3,557,714
RECONCILIATION:
Total segment gross profit		104,352			2,286,550			1,143,048			3,557,714
Operating expenses		(688,763	)		(688,919	)		(1,722,506	)		(2,131,061	)
Other income (expense)		31,626			(49,836	)		12,233			(312,898	)
Income (loss) before income taxes		(552,785	)		1,547,795			(567,225	)		1,113,755

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,
	2009		2008		2009		2008
	$		$		$		$
United States		77,600		3,650,000		1,327,600		5,250,000
International		206,570		256,033		691,867		808,190
Total revenue		284,170		3,906,033		2,019,467		6,058,190

Revenues from two customers comprised 61% and 13% of revenue for the nine months ended December 31, 2009. Revenues from three customers comprised 33%, 27% and 26% of revenue for the nine months ended December 31, 2008. Accounts receivable from four customers comprised 23%, 20%, 20% and 11% of net accounts receivable at December 31, 2009 and one customer accounted for 95% of net accounts receivable at December 31, 2008.

11. COMMITMENTS AND CONTINGENCIES

Legal Matters

Business Litigation

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

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Intellectual Property Litigation

In September 2007 and March 2008, the Company filed complaints against eight electronic product manufacturers in the U.S. District Court for the Eastern District of Texas asserting that products made by the companies infringe four of the Company's U.S. patents covering the use of flash memory technology. These patents are part of the Company’s Flash-R patent portfolio. By September 30, 2009 the Company had licensed and settled the litigation with seven of the manufacturers and suspended the complaint against one defendant in bankruptcy.

In November 2009 the Company filed an additional patent infringement complaint in the United States District Court for the District of Colorado against nineteen companies that manufacture devices using flash memory.

Although most fees, costs and expenses of intellectual property litigation are covered under the Company’s arrangement with Duane Morris LLP as described below, the Company may incur support and related expenses for this litigation that may become material.

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

At December 31, 2009 the Company had outstanding unfilled purchase orders and was committed to a contract manufacturer and component suppliers for approximately $108,000 of future deliveries.

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 $6,344 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 $122,819 at December 31, 2009.

Concentration of Credit Risk and Sources of Supply

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents and trade receivables. The Company at December 31, 2009 had substantially all of its cash and cash equivalents at one financial institution in a non-interest bearing account. Effective October 14, 2008, Federal Deposit Insurance Corporation deposit insurance was changed to provide full deposit insurance coverage for non-interest bearing deposit transaction accounts through December 31, 2009.

Concentrations of credit risk with respect to trade accounts receivable are limited due to the number and nature of customers comprising the Company’s customer base and their geographic dispersion. The Company has not incurred any significant credit related losses.

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The Company relies on one third-party contract manufacturer to produce its eVU mobile entertainment product and generally relies on single suppliers for batteries, charging stations and other components. The Company also currently relies on one legal firm to represent it in patent licensing matters.

12. INCOME TAXES

During the nine months ended December 31, 2009 the Company recorded a tax benefit of $31,250 which included a refund of prior taxes paid offset by foreign taxes paid during the period for which a credit (a deferred tax asset) may be allowable against future United States taxes subject to certain limitations. At December 31, 2009, the Company had deferred tax assets associated with federal net operating losses (“NOLs”), related state NOLs, foreign tax credits and certain Federal and California research and development tax credits but recorded a corresponding full valuation allowance as it is more likely than not that some portion or all of the deferred tax assets will not be realized. In spite of state NOLs the Company may be subject to California state taxes during fiscal 2010 if it generates sufficient taxable income due to the California suspension of the net operating loss (“NOL”) carryforwards for the 2008 and 2009 tax years.

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 and/or tax credits prior to their expiration, then the valuation allowance can be reduced or eliminated.

13. SUBSEQUENT EVENTS

The subsequent events have been evaluated through February 11, 2010, which was the date the Financial Statements were issued.

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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, 2009.

Cautionary Note on Forward Looking Statements

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

General

We are a holding company incorporated under the laws of Delaware that operates through a wholly-owned California subsidiary of the same name.  We 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 strategy is to market our eVU products and services to a growing base of U.S. and international companies for use in the airline, healthcare, and other travel and leisure industries. We employ direct sales and sales through value added resellers (“VARs”) that provide marketing, logistic and/or content services to corporate customers.

We are commercializing our Flash-R patent portfolio through licensing and we are aggressively pursuing enforcement by litigating against targeted parties who we believe may be infringing our patents. The international law firm of Duane Morris LLP is handling our patent enforcement matters on a contingent fee basis. In September 2007 and March 2008 we filed a first tranche of patent infringement litigation against eight defendants. In September 2008 we recorded our first patent license revenue and by September 30, 2009 we had licensed and settled the litigation with seven of the defendants and suspended the complaint against one defendant currently in bankruptcy. In November 2009 we filed a new patent infringement complaint against nineteen additional companies that manufacture devices using flash memory. In December 2009 we licensed and settled with one defendant that agreed to make a lump sum payment in November 2010 for past infringing sales through December 31, 2009 and to pay an annual royalty for any on-going sales that practice our U.S. Patent 5,491,774, until its expiration.  

We believe the successful licensing of all seven active manufacturers from our first round of patent enforcement actions evidences strength of our fundamental intellectual property. While we expect additional patent license revenues from the manufacturers in the new complaint and from others in future periods, there can be no assurance of the timing or amounts of any related license revenue. A number of factors, many outside our control, affect the amount of each licensing arrangement and the timing of when parties elect to license our intellectual property. These factors include the number and nature of infringing products, estimates of past and future infringement, importance of the infringing technology to the total product, the legal environment surrounding a particular case, estimates of the cost, time and complexity of litigation through trial and possible appeals as well as other factors.

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.

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Overall Performance and Trends

Until the fiscal year ended March 31, 2009 (fiscal 2009), we incurred significant losses and negative cash flow from operations. Our fiscal 2009 profitability 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.

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 eVU orders and any future patent licenses. We seek to expand and diversify our customer base both in the in-flight entertainment (“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.

For the nine months ended December 31, 2009 we recognized a net loss before income taxes of $567,225 compared to a net income before income taxes of $1,113,755 for the comparable period of the prior fiscal year. Our revenues were $2.0 million for the first nine months of fiscal 2010 including $1.25 million of patent license revenue. This compares to $6.1 million for the prior year’s first nine months including $5.25 million of patent license revenue. We reported reduced operating expenses of $1.7 million in the nine months ended December 31, 2009 compared to $2.1 million in the comparable period prior primarily due to reduced staffing and reduced legal fees.

We are in the early stages of licensing our patents and only recently filed additional infringement claims as described above and in Part II, Item 1 “Legal Proceedings” below.  While we expect additional patent licenses in future periods there can be no assurance of the timing or amounts of any such license revenue. Our quarterly results are highly dependent on the timing and amount of licensing fees and accordingly quarterly results can vary dramatically from period to period. As a result of this and other factors, past results and expenditure levels may not be indicative of future quarters.

We expect our operating costs to be lower for the balance of fiscal 2010 compared to the prior year. Our monthly cash operating costs average approximately $150,000 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.

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, 2009. 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.

Our previous patent licenses have been one time fully paid up license agreements and the accounting policy for such agreements is detailed in the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended March 31, 2009. In December 2009 we entered into our first on-going royalty bearing license agreement. We recognize revenue from on-going royalty patent license agreements when all revenue recognition criteria have been met: (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. We generally recognize on-going royalties as amounts are reported, verified and collection is probable. We recorded no revenue from this first license as no amounts have yet been reported pursuant to the terms of the license agreement.

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Results of Operations

Three months ended December 31, 2009 compared to the three months ended December 31, 2008

	Three Months Ended December 31,
	2009						2008
				% of						% of			Change
	Dollars			Revenue			Dollars			Revenue			Dollars			%
Revenues:
Products		106,570			38	%		120,463			3	%		(13,893	)		(12	)%
Services		177,600			62	%		135,570			3	%		42,030			31	%
Patent license		-			0	%		3,650,000			93	%		(3,650,000	)		(100	)%
		284,170			100	%		3,906,033			100	%		(3,621,863	)		(93	)%
Gross Profit:
Product gross profit		9,940			3	%		24,129			1	%		(14,189	)		(59	)%
Service gross profit		94,412			33	%		78,340			2	%		16,072			21	%
Patent license		-			0	%		2,184,081			56	%		(2,184,081	)		(100	)%
		104,352			37	%		2,286,550			59	%		(2,182,198	)		(95	)%
Operating Expenses:
Selling and administrative		558,600			197	%		576,997			15	%		(18,397	)		(3	)%
Research and related		130,163			46	%		111,922			3	%		18,241			16	%
		688,763			242	%		688,919			18	%		(156	)		(0	)%
Other income (expense)		31,626			11	%		(49,836	)		(1	)%		81,462			(163	)%
Income (loss) before income taxes		(552,785	)		(195	)%		1,547,795			40	%		(2,100,580	)		(136	)%

Income (Loss) Before Income Taxes

We reported loss before income taxes of $552,785 for the three months ended December 31, 2009 compared to net income before income taxes of $1,547,795 for the comparable period of the prior year. The prior year’s third quarter included $3,650,000 of patent license revenue and related margin while no comparable revenue was recognized in the most recent quarter.

Revenues

Revenues of $284,170 in the third quarter of fiscal 2010 compared to $3,906,033 for the comparable prior period. Our most recent quarter’s revenues included $106,570 of eVU product and $177,600 of service revenues. While the prior year’s third quarter eVU product and service revenues were comparable, the prior year included $3,650,000 of patent license revenue. We recently filed a complaint against nineteen additional electronics manufacturers, and while we expect additional patent licenses from these and other companies in future periods, there can be no assurance of the timing or amounts of any future license revenue.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 service revenues have grown as result of prior year customer additions but as service arrangements and terms vary with each customer there is no assurance in the current airline environment that our service revenues will continue at comparable levels for the balance of the fiscal year or in future periods. We are pursuing new business but our results will continue to be dependent on the timing and quantity of eVU orders and the timing and amount of any patent licensing arrangements.

Gross Profit

Gross profit for the third quarter of fiscal 2010 was $104,352 or 37% of revenues.  The gross profit for the prior year’s third quarter was $2,286,550 or 59% of revenues including $2,184,081 of patent licensing margin. Gross profit margins are highly dependent on revenue mix, prices charged, volume of orders, and for patent licensing the amounts of contingency legal fees and costs.

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Operating Expenses

While selling and administrative costs for the three months ended December 31, 2009, were comparable to the same period in the year prior there were changes in the components. The current period included a $57,500 expense for shareholder related costs due to the annual meeting held in the third quarter of the current year and $109,891 of noncash stock-based compensation expense. Reduced current period expenses included $28,000 of reduced staffing costs due to fewer personnel and $163,000 of reduced professional fees primarily due to reduced business litigation costs as a result of the favorable outcome of the digEcor litigation. We expect professional fees in the fourth quarter to be less than the prior year due to the conclusion of the digEcor business litigation.

Research and related expenditures for the three months ended December 31, 2009 were comparable to the prior year’s third quarter but included $19,446 of noncash stock-based compensation expense compared to $8,918 for the prior year’s third quarter.

Other Income (Expense)

Net other income of $31,626 for the third quarter of fiscal 2010 included a foreign exchange gain of $10,391 and $20,000 of other income from a favorable litigation settlement. Net other expenses for the third quarter of the prior year of $49,836 included $38,717 of interest expense including $20,717 of non-cash interest.

Income Taxes

Income tax benefit of $237,500 resulted primarily from foreign taxes refunded.

Income (Loss) Attributable to Common Stockholders

The loss attributable to common stockholders for the most recent third quarter included the net loss after taxes of $315,285 reduced by accrued and deemed dividends on the Series AA Stock of $45,387 for a net loss attributable to common stockholders of $360,672. The net income after tax for the prior comparable third quarter was $1,547,795 decreased by accrued and deemed dividends of $43,284 for net income attributable to common stockholders of $1,504,511.

Nine months ended December 31, 2009 compared to the nine months ended December 31, 2008

	Nine Months Ended December 31,
	2009						2008
				% of						% of			Change
	Dollars			Revenue			Dollars			Revenue			Dollars			%
Revenues:
Product revenues		164,085			8	%		356,444			6	%		(192,359	)		(54	)%
Service revenues		605,382			30	%		451,746			7	%		153,636			34	%
Patent license		1,250,000			62	%		5,250,000			87	%		(4,000,000	)		(76	)%
		2,019,467			100	%		6,058,190			100	%		(4,038,723	)		(67	)%
Gross Profit:
Product gross profit		(9,338	)		(0	)%		52,651			1	%		(61,989	)		(118	)%
Service gross profit		345,386			17	%		282,308			5	%		63,078			22	%
Patent license gross profit		807,000			40	%		3,222,755			53	%		(2,415,755	)		(75	)%
		1,143,048			57	%		3,557,714			59	%		(2,414,666	)		(68	)%
Operating Expenses:
Selling and administrative		1,386,013			69	%		1,743,389			29	%		(357,376	)		(20	)%
Research and related		336,493			17	%		387,672			6	%		(51,179	)		(13	)%
		1,722,506			85	%		2,131,061			35	%		(408,555	)		(19	)%
Other income (expense)		12,233			1	%		(312,898	)		(5	)%		325,131			(104	)%
Income (loss) before income taxes		(567,225	)		(28	)%		1,113,755			18	%		(1,680,980	)		(151	)%

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Income (loss) Before Income Taxes

We showed a loss before income taxes of $567,225 for the nine months ended December 31, 2009 compared to net income before income taxes of $1,113,755 for the comparable period of the prior year. The income from the prior period resulted primarily from the higher patent licensing gross margin in such period.

Revenues

Revenues of $2,019,467 for the first nine months of fiscal 2010 compared to $6,058,190 for the same period of the prior year. The reduction in revenues reflected reduced patent license revenues. Fiscal 2010 nine-month revenues included eVU products and service revenue of $769,467 and patent license revenue of $1,250,000.

Gross Profit

Gross profit for the first nine months of fiscal 2010 was $1,143,048 or 57% of revenues. The gross profit for the prior year’s first nine months was $3,557,714 or 59% of revenues as a result of higher patent license revenue. The amount and percentage of gross profit margins are highly dependent on revenue mix, prices charged, volume of orders and costs.

Operating Expenses

Selling and administrative costs for the nine months ended December 31, 2009, were $1,386,013 compared to $1,743,389 for the first nine months of fiscal 2009. The $357,376 decrease included $147,000 of reduced staffing costs due to fewer personnel, a $18,000 reduction in shareholder related costs primarily from reduced annual meeting mailing costs and $273,000 of reduced professional fees primarily due to reduced business litigation costs and the effect of a $100,000 reversal of a legal accrual related to such litigation as a result of the favorable litigation outcome. The decreases were offset by a $95,456 increase in noncash stock-based compensation expenses resulting from granting options in December 2009 that vested on grant.

Research and related expenditures for the nine months ended December 31, 2009 were $336,493, compared to $387,672 for the nine months ended December 31, 2008. The decrease resulted primarily from reduced outside engineering services of $55,000 due to reduced internally funded research projects.

Other Income (Expense)

Net other income of $12,233 for the nine months ended December 31, 2009 included a foreign exchange gain of $9,332 and $20,000 of other income from a favorable litigation settlement reduced by interest expense of $17,099 (including $16,772 of noncash interest expense). Net other expense of $312,898 for the nine months ended December 31, 2008 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.

Income Taxes

Income tax benefit of $31,250 included a refund of foreign taxes paid in the prior year offset by foreign taxes paid on current year patent license revenue.

Income (Loss) Attributable to Common Stockholders

The loss attributable to common stockholders for the nine months ended December 31, 2009 included the loss after taxes of $535,975 reduced by accrued and deemed dividends on Series AA Stock of $144,088 or a net loss of $680,063.  The income attributable to common stockholders for the prior comparable nine months included the income after taxes of $849,755 reduced by accrued and deemed dividends on Series AA Stock of $87,978 or a net income of $761,777.

Liquidity and Capital Resources

At December 31, 2009, we had working capital of $3,227,483 compared to a working capital of $3,277,225 at March 31, 2009. At December 31, 2009 we had cash on hand of $2,838,967.

Operating Activities

Cash used in operating activities was $925,947 for the nine months ended December 31, 2009. Cash used in operating activities included the net loss of $535,975 reduced by net non-cash expenses of $187,718. Major components also providing operating cash was a decrease of $90,065 in inventories. Major components using operating cash included an increase of $118,885 in accounts receivable, a $101,943 reduction in accounts payable, a $217,665 reduction in accruals and customer deposits and a $157,500 reduction in accrued income taxes.

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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, 2008 was $498,019 resulting from the $849,755 net income reduced by net non-cash expenses of $238,885. Major components providing operating cash was an increase of $713,617 in accrued liabilities. Major components using operating cash included an increase of $1,963,060 in accounts receivable and a $262,760 reduction in accounts payable.

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, 2009 we paid $47,865 as the final payment on our term debt. At December 31, 2009 we had no debt outstanding. 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 and $700,000 cash from the sale of Series AA Stock. We reduced our secured note balance by $150,000, reduced our term note balance by $51,357 and obtained $40,000 in July 2008 from a new one-year note.

Debt and Other Commitments

We currently have no debt outstanding.At December 31, 2009 we were committed to approximately $108,000 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 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.

Cash Requirements

Other than cash on hand and accounts receivable, we have no material unused sources of liquidity at this time.  Based on our cash position at December 31, 2009 and current planned expenditures and level of operation, we believe we have sufficient capital resources for the next twelve months. Actual results could differ significantly from management plans. We believe we may be able to obtain additional funds from future patent licensing and eVU product sales and services but the timing of licenses and shipments and the amount and quantities of shipments, orders and reorders are subject to many factors and risks, many outside our control.

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

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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, 2009, 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, 2009. 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, 2009, there was a material weakness in our internal control over financial reporting: the lack of independent oversight by an audit committee of independent members of the Board of Directors. In light of this material weakness, management concluded that, as of March 31, 2009, 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. Management has concluded that with certain management oversight controls that are in place, the risks associated with the lack of independent audit committee oversight is not sufficient to justify the costs of adding additional directors and independent audit committee members at this time. Management will periodically reevaluate this situation. If we secure sufficient capital or sustain our improved operating results it is our intention to change the composition and/or size of the Board of Directors with emphasis on recruiting qualified independent audit committee members.

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.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

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, 2009.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Intellectual Property Litigation

During the period commencing September 2007 through and including March 2008, we filed complaints against eight electronic product manufacturers in the U.S. District Court for the Eastern District of Texas asserting that products made by the companies infringe four of our U.S. patents covering the use of flash memory technology. These patents are part of our Flash-R patent portfolio. By September 30, 2009 we had licensed and settled the litigation with seven of the manufacturers and suspended the complaint against one defendant currently in bankruptcy.

In November 2009 we filed an additional patent infringement complaint in the United States District Court for the District of Colorado against nineteen companies that manufacture devices using flash memory. In December 2009 we licensed and settled with one defendant that agreed to make a future lump sum payment for past infringing sales and to pay a royalty for any on-going sales that practice our U.S. Patent 5,491,774.  

Although most fees, costs and expenses of the litigation are covered under our 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) The following shares of common stock 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:

· On October 20, 2009 we issued 1,065,616 shares of common stock upon the conversion of 10,000 shares of Series AA Stock sold for $100,000 cash on June 27, 2008. The shares issued on exchange were issued without restrictive legend in reliance on Rule 144(d).

· On October 29, 2009 we issued 296,912 shares of common stock to Davric Corporation in consideration of a $50,000 monthly payment on its 7.5% term note. The shares were sold upon the exemption provided by Section 4(2) under the Securities Act of 1933, no commissions were paid and a restrictive legend was placed on the shares issued.

(b) NONE

(c) NONE

Item 3. Defaults Upon Senior Securities

NONE

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

At our Annual Meeting of Stockholders held on November 19, 2009, the following individuals, all of the members of the Board of Directors were elected: Alfred H. Falk, Allen Cocumelli, Robert Putnam, Renee Warden and Eric M. Polis. For each elected director, the results of the voting were:

	Affirmative		Against		Abstain/Withheld
Alfred H. Falk		243,805,181		3,268,956		1,491,398
Allen Cocumelli		246,993,528		79,609		1,492,398
Robert Putnam		246,443,848		630,289		1,491,398
Renee Warden		241,274,309		5,798,828		1,492,398
Eric M. Polis		244,838,051		2,236,086		1,491,398

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Our stockholders also voted to ratify SingerLewak LLP as the Company’s independent auditors for the fiscal year ending March 31, 2010. The results of the voting on this proposal were:

Affirmative	Against		Abstain
247,167,932		1,098,141		299,462

The foregoing proposal was approved and accordingly ratified.

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).

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 11, 2010	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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