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 September 30, 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  ̈





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  ̈ No x





As of
November 9, 2009 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





PagePART
      I. FINANCIAL INFORMATIONItem
      1. Financial Statements (unaudited):Condensed
      Consolidated Balance Sheets as of September 30, 2009 and March 31,
      2009
                                                3Condensed
      Consolidated Statements of Operations for the three and six months ended
      September 30, 2009 and 2008
                                                4Condensed
      Consolidated Statements of Cash Flows for the six months ended September
      30, 2009 and 2008
                                                5Notes
      to Interim Consolidated Financial Statements
                                                6Item
      2. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                                                17Item
      4. Controls and Procedures
                                                23PART
      II. OTHER INFORMATIONItem
      1.
                                                Legal
      Proceedings
                                                24Item
      2.
                                                Unregistered
      Sales of Equity Securities and Use of Proceeds
                                                24Item
      3.
                                                Defaults
      Upon Senior Securities
                                                25Item
      4.
                                                Submission
      of Matters to a Vote of Security Holders
                                                25Item
      5.
                                                Other
      Information
                                                25Item
      6.
                                                Exhibits
                                                25SIGNATURES
                                                26


2


Part
I. Financial Information


Item
1. Financial Statements:


e.Digital
Corporation and subsidiary


CONSOLIDATED
BALANCE SHEETS





September 30,2009
                                  
                                  
                                  March 31,(Unaudited)
                                  
                                  
                                  2009$
                                  
                                  
                                  $ASSETSCurrentCash
      and cash equivalents
                                  
                                  
                                  2,616,717
                                  
                                  
                                  
                                  3,813,990Accounts
      receivable
                                  
                                  
                                  1,436,713
                                  
                                  
                                  
                                  93,771Inventory
                                  
                                  
                                  507,994
                                  
                                  
                                  
                                  517,163Deposits
      and prepaid expenses
                                  
                                  
                                  24,755
                                  
                                  
                                  
                                  26,108Total
      current assets
                                  
                                  
                                  4,586,179
                                  
                                  
                                  
                                  4,451,032Property,
      equipment and intangibles, net of accumulated depreciationand
      amortization of $174,851 and $165,449, respectively
                                  
                                  
                                  17,236
                                  
                                  
                                  
                                  26,638Total
      assets
                                  
                                  
                                  4,603,415
                                  
                                  
                                  
                                  4,477,670LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrentAccounts
      payable, trade
                                  
                                  
                                  187,693
                                  
                                  
                                  
                                  202,900Accrued
      and other liabilities
                                  
                                  
                                  941,324
                                  
                                  
                                  
                                  589,814Current
      maturity of convertible term note, net of $358 and $6,141 of debt
      discount
                                  
                                  
                                  96,899
                                  
                                  
                                  
                                  381,093Total
      current liabilities
                                  
                                  
                                  1,225,916
                                  
                                  
                                  
                                  1,173,807Deferred
      revenue - long term
                                  
                                  
                                  -
                                  
                                  
                                  
                                  24,000Total
      long-term liabilities
                                  
                                  
                                  -
                                  
                                  
                                  
                                  24,000Total
      liabilities
                                  
                                  
                                  1,225,916
                                  
                                  
                                  
                                  1,197,807Commitments
      and ContingenciesStockholders'
      equityPreferred
      stock, $0.001 par value; 5,000,000 shares authorizedSeries
      AA Convertible Preferred stock, $0.001 par value, 100,000shares
      designated: 65,000 and 75,000 issued and outstanding,
      respectivelyLiquidation
      preference of $690,959 and $778,459, respectively
                                  
                                  
                                  603,954
                                  
                                  
                                  
                                  610,774Common
      stock, $0.001 par value, authorized 350,000,000,285,588,372
      and 282,124,564 shares issued and outstanding,
respectively
                                  
                                  
                                  285,588
                                  
                                  
                                  
                                  282,125Additional
      paid-in capital
                                  
                                  
                                  81,856,249
                                  
                                  
                                  
                                  81,534,566Accumulated
      deficit
                                  
                                  
                                  (79,368,292
                                  )
                                  
                                  
                                  (79,147,602
                                  )Total
      stockholders' equity
                                  
                                  
                                  3,377,499
                                  
                                  
                                  
                                  3,279,863Total
      liabilities and stockholders' equity
                                  
                                  
                                  4,603,415
                                  
                                  
                                  
                                  4,477,670





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 six months endedSeptember 30,
                                
                                
                                September 30,2009
                                
                                
                                2008
                                
                                
                                2009
                                
                                
                                2008$
                                
                                
                                $
                                
                                
                                $
                                
                                
                                $Revenues:Products
                                
                                
                                43,440
                                
                                
                                
                                1,683
                                
                                
                                
                                57,515
                                
                                
                                
                                235,981Services
                                
                                
                                218,827
                                
                                
                                
                                172,747
                                
                                
                                
                                427,782
                                
                                
                                
                                316,176Patent
      license
                                
                                
                                1,250,000
                                
                                
                                
                                1,600,000
                                
                                
                                
                                1,250,000
                                
                                
                                
                                1,600,000Total
      revenues
                                
                                
                                1,512,267
                                
                                
                                
                                1,774,430
                                
                                
                                
                                1,735,297
                                
                                
                                
                                2,152,157Cost
      of revenues:Products
                                
                                
                                27,789
                                
                                
                                
                                13,975
                                
                                
                                
                                76,793
                                
                                
                                
                                207,459Services
                                
                                
                                104,834
                                
                                
                                
                                42,022
                                
                                
                                
                                176,808
                                
                                
                                
                                112,208Patent
      license
                                
                                
                                443,000
                                
                                
                                
                                561,326
                                
                                
                                
                                443,000
                                
                                
                                
                                561,326Total
      cost of revenues
                                
                                
                                575,623
                                
                                
                                
                                617,323
                                
                                
                                
                                696,601
                                
                                
                                
                                880,993Gross
      profit
                                
                                
                                936,644
                                
                                
                                
                                1,157,107
                                
                                
                                
                                1,038,696
                                
                                
                                
                                1,271,164Operating
      expenses:Selling
      and administrative
                                
                                
                                250,741
                                
                                
                                
                                627,497
                                
                                
                                
                                827,413
                                
                                
                                
                                1,166,392Research
      and related expenditures
                                
                                
                                126,749
                                
                                
                                
                                129,099
                                
                                
                                
                                206,330
                                
                                
                                
                                275,750Total
      operating expenses
                                
                                
                                377,490
                                
                                
                                
                                756,596
                                
                                
                                
                                1,033,743
                                
                                
                                
                                1,442,142Operating
      income (loss)
                                
                                
                                559,154
                                
                                
                                
                                400,511
                                
                                
                                
                                4,953
                                
                                
                                
                                (170,978
                                )Other
      income (expense):Interest
      and other income
                                
                                
                                -
                                
                                
                                
                                678
                                
                                
                                
                                -
                                
                                
                                
                                5,733Interest
      expense
                                
                                
                                (5,787
                                )
                                
                                
                                (42,114
                                )
                                
                                
                                (15,834
                                )
                                
                                
                                (90,708
                                )Warrant
      and finance (expense) income
                                
                                
                                1,269
                                
                                
                                
                                (123,908
                                )
                                
                                
                                (3,559
                                )
                                
                                
                                (178,087
                                )Other
      expense
                                
                                
                                (4,518
                                )
                                
                                
                                (165,344
                                )
                                
                                
                                (19,393
                                )
                                
                                
                                (263,062
                                )Income
      (loss) before provision for income taxes
                                
                                
                                554,636
                                
                                
                                
                                235,167
                                
                                
                                
                                (14,440
                                )
                                
                                
                                (434,040
                                )Provision
      for income taxes
                                
                                
                                (206,250
                                )
                                
                                
                                (264,000
                                )
                                
                                
                                (206,250
                                )
                                
                                
                                (264,000
                                )Income
      (loss) for the period
                                
                                
                                348,386
                                
                                
                                
                                (28,833
                                )
                                
                                
                                (220,690
                                )
                                
                                
                                (698,040
                                )Accrued
      and deemed dividends on preferred stock
                                
                                
                                (55,888
                                )
                                
                                
                                (43,283
                                )
                                
                                
                                (98,701
                                )
                                
                                
                                (44,694
                                )Income
      (loss) attributable to common stockholders
                                
                                
                                292,498
                                
                                
                                
                                (72,116
                                )
                                
                                
                                (319,391
                                )
                                
                                
                                (742,734
                                )Income
      (loss) per common share - basic and diluted
                                
                                
                                0.00
                                
                                
                                
                                (0.00
                                )
                                
                                
                                (0.00
                                )
                                
                                
                                (0.00
                                )Weighted
      average common shares outstandingBasic
                                
                                
                                284,407,839
                                
                                
                                
                                277,082,261
                                
                                
                                
                                283,462,799
                                
                                
                                
                                275,797,016Diluted
                                
                                
                                286,048,464
                                
                                
                                
                                277,082,261
                                
                                
                                
                                283,462,799
                                
                                
                                
                                275,797,016





See notes
to interim consolidated financial statements


4




e.Digital
Corporation and subsidiary





CONSOLIDATED
STATEMENTS OF CASH FLOWS


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





For the six months endedSeptember 302009
                        
                        
                        2008$
                        
                        
                        $OPERATING
      ACTIVITIESLoss
      for the period
                        
                        
                        (220,690
                        )
                        
                        
                        (698,040
                        )Adjustments
      to reconcile loss to net cash used in operating
activities:Depreciation
      and amortization
                        
                        
                        9,402
                        
                        
                        
                        8,228Accretion
      related to promissory notes
                        
                        
                        5,783
                        
                        
                        
                        23,180Warrant
      modification and warrant derivative revaluation
                        
                        
                        -
                        
                        
                        
                        174,667Interest
      paid with common stock
                        
                        
                        10,023
                        
                        
                        
                        22,477Warranty
      provision
                        
                        
                        8,466
                        
                        
                        
                        (35,600
                        )Stock-based
      compensation
                        
                        
                        18,326
                        
                        
                        
                        32,257Changes
      in assets and liabilities:Accounts
      receivable, trade
                        
                        
                        (1,342,942
                        )
                        
                        
                        (1,584,784
                        )Inventories
                        
                        
                        9,169
                        
                        
                        
                        (62,324
                        )Prepaid
      expenses and other
                        
                        
                        1,353
                        
                        
                        
                        (3,935
                        )Accounts
      payable, trade
                        
                        
                        (15,207
                        )
                        
                        
                        794,356Accrued
      and other liabilities
                        
                        
                        306,470
                        
                        
                        
                        (53,353
                        )Accrued
      employee benefits
                        
                        
                        (5,934
                        )
                        
                        
                        (18,543
                        )Customer
      deposits
                        
                        
                        -
                        
                        
                        
                        54,900Accrued
      income taxes
                        
                        
                        48,750
                        
                        
                        
                        264,000Warranty
      reserve
                        
                        
                        (17,262
                        )
                        
                        
                        (39,663
                        )Deferred
      revenue
                        
                        
                        (12,980
                        )
                        
                        
                        (27,000
                        )Cash
      used in operating activities
                        
                        
                        (1,197,273
                        )
                        
                        
                        (1,149,177
                        )FINANCING
      ACTIVITIESProceeds
      from sale of common stock
                        
                        
                        -
                        
                        
                        
                        500,000Proceeds
      from sale of preferred stock
                        
                        
                        -
                        
                        
                        
                        700,000Payment
      on convertible term note
                        
                        
                        -
                        
                        
                        
                        (25,599
                        )Payments
      on secured promissory note
                        
                        
                        -
                        
                        
                        
                        (50,000
                        )Proceeds
      from unsecured promissory note
                        
                        
                        -
                        
                        
                        
                        40,000Cash
      provided by financing activities
                        
                        
                        -
                        
                        
                        
                        1,164,401Net
      increase (decrease) in cash and cash equivalents
                        
                        
                        (1,197,273
                        )
                        
                        
                        15,224Cash
      and cash equivalents, beginning of period
                        
                        
                        3,813,990
                        
                        
                        
                        122,116Cash
      and cash equivalents, end of period
                        
                        
                        2,616,717
                        
                        
                        
                        137,340Supplemental
      disclosures of cash flow information:Cash
      paid for interest
                        
                        
                        28
                        
                        
                        
                        45,051Cash
      paid for taxes
                        
                        
                        160,000
                        
                        
                        
                        -Supplemental
      schedule of noncash investing and financing activities:Common
      stock issued on conversion of preferred stock
                        
                        
                        105,521
                        
                        
                        
                        -Accounts
      payable exchanged for preferred stock
                        
                        
                        -
                        
                        
                        
                        50,000Accrued
      and deemed dividends on preferred stock
                        
                        
                        98,701
                        
                        
                        
                        44,694Term
      note payments paid in common stock
                        
                        
                        300,000
                        
                        
                        
                        120,000Financing
      fees paid in common stock
                        
                        
                        -
                        
                        
                        
                        9,800Warrant
      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 eVUTM mobile entertainment device for the
travel and recreational industries. The Company also obtains revenue from
licensing its Flash-RTM 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 September 30, 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 six months ended September 30, 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
$79,368,292 at September 30, 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 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 six
months ended September 30, 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. The adoption of
this update to non-financial assets and liabilities, as codified in ASC 820-10,
did not have any impact on the Company’s consolidated financial
statements.





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 theadoptionon April 1, 2009did not have
a material impact on the Company’s consolidated financial
statements.





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.


7




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
September 30, 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 six months
ended September 30, 2009 of $55,888 and $98,701, respectively (three and six
months ended September 30, 2008 by $43,283 and $44,694, 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:


8





Three Months Ended
                  
                  
                  Six Months EndedSeptember 30,
                  
                  
                  September 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008BasicIncome
      (loss) attributable to common stockholders
                  
                  $
                  292,498
                  
                  
                  $
                  (72,116
                  )
                  
                  $
                  (319,391
                  )
                  
                  $
                  (742,734
                  )Weighted
      average common shares outstanding (basic)
                  
                  
                  284,407,839
                  
                  
                  
                  277,082,261
                  
                  
                  
                  283,462,799
                  
                  
                  
                  275,797,016Basic
      income (loss) per common share
                  
                  $
                  0.00
                  
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.00
                  )DilutedIncome
      (loss) attributable to common stockholders
                  
                  $
                  292,498
                  
                  
                  $
                  (72,116
                  )
                  
                  $
                  (319,391
                  )
                  
                  $
                  (742,734
                  )Plus:Accrued
      and deemed dividends on preferred stock (1)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Income
      (loss) for diluted
                  
                  $
                  292,498
                  
                  
                  $
                  (72,116
                  )
                  
                  $
                  (319,391
                  )
                  
                  $
                  (742,734
                  )Common
      and potential common shares:Weighted
      average common shares outstanding
                  
                  
                  284,407,839
                  
                  
                  
                  277,082,261
                  
                  
                  
                  283,462,799
                  
                  
                  
                  275,797,016Assumed
      exercise of options and warrants
                  
                  
                  1,640,625
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Common
      and potential common shares (1)
                  
                  
                  286,048,464
                  
                  
                  
                  277,082,261
                  
                  
                  
                  283,462,799
                  
                  
                  
                  275,797,016Diluted
      income (loss) per common share
                  
                  $
                  0.00
                  
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.00
                  )Potentially
      dilutive securities outstanding at period end excluded from diluted
      computation as they were antidilutive
                  
                  
                  14,269,281
                  
                  
                  
                  29,911,984
                  
                  
                  
                  21,769,281
                  
                  
                  
                  29,911,984





(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:


September 30,
                    
                    
                    March 31,2009
                    
                    
                    2009$
                    
                    
                    $Raw
      materials
                    
                    
                    133,591
                    
                    
                    
                    140,544Work
      in process
                    
                    
                    27,514
                    
                    
                    
                    28,335Finished
      goods
                    
                    
                    346,889
                    
                    
                    
                    348,284507,994
                    
                    
                    
                    517,163




5.
STOCK-BASED COMPENSATION COSTS




The
Company accounts for stock-based compensation under the provisions of ASC
718, Share-Based Paymentand 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:


9





Three Months Ended
                    
                    
                    Six Months EndedSeptember 30,
                    
                    
                    September 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008$
                    
                    
                    $
                    
                    
                    $
                    
                    
                    $Research
      and development
                    
                    
                    1,037
                    
                    
                    
                    -
                    
                    
                    
                    1,037
                    
                    
                    
                    -Selling
      and administrative
                    
                    
                    5,544
                    
                    
                    
                    17,536
                    
                    
                    
                    17,289
                    
                    
                    
                    32,257Total
      stock-based compensation expense
                    
                    
                    6,581
                    
                    
                    
                    17,536
                    
                    
                    
                    18,326
                    
                    
                    
                    32,257





As of
September 30, 2009 total estimated compensation cost of stock options granted
but not yet vested was $45,802 and is expected to be recognized over the
weighted average period of 1.5 years.





The
following table sets forth the weighted-average key assumptions and fair value
results for stock options granted during the six-month periods ended September
30, 2009 and 2008 (annualized percentages).





Six Months EndedSeptember 30,2009
                    
                    
                    2008Volatility
                    
                    
                    71
                    %
                    
                    
                    71
                    %Risk-free
      interest rate
                    
                    
                    1.45
                    %
                    
                    
                    2.5
                    %Forfeiture
      rate
                    
                    
                    0.0
                    %
                    
                    
                    0.0
                    %Dividend
      yield
                    
                    
                    0.0
                    %
                    
                    
                    0.0
                    %Expected
      life in years
                    
                    
                    2.5
                    
                    
                    
                    3.5Weighted-average
      fair value of options granted
                    
                    $
                    0.05
                    
                    
                    $
                    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 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.





6.
WARRANTY RESERVE





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





Three Months Ended
                    
                    
                    Six Months EndedSeptember 30,
                    
                    
                    September 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008$
                    
                    
                    $
                    
                    
                    $
                    
                    
                    $Beginning
      balance
                    
                    
                    16,138
                    
                    
                    
                    103,222
                    
                    
                    
                    14,155
                    
                    
                    
                    109,138Warranty
      provision
                    
                    
                    (3,406
                    )
                    
                    
                    (45,680
                    )
                    
                    
                    8,466
                    
                    
                    
                    (35,600
                    )Warranty
      deductions
                    
                    
                    (7,373
                    )
                    
                    
                    (23,667
                    )
                    
                    
                    (17,262
                    )
                    
                    
                    (39,663
                    )Ending
      balance
                    
                    
                    5,359
                    
                    
                    
                    33,875
                    
                    
                    
                    5,359
                    
                    
                    
                    33,875


10





7.
PROMISSORY NOTE


The
Company has the option, subject to certain limitations, to elect to make monthly
$50,000 installment payments on the 7.5% Convertible Subordinated 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 six months ended September 30, 2009 the Company
made the six monthly installment payments aggregating $300,000 through the
issuance of 2,408,603 shares of common stock. Subsequent to September 30, 2009
the Company made the October 2009 note payment through the issuance of 296,912
shares of common stock.





8.
STOCKHOLDERS’ EQUITY


The
following table summarizes stockholders’ equity transactions during the
six-month period ended September 30, 2009:





Preferred stock
                            
                            
                            Common stock
                            
                            
                            Additional
                            
                            
                            AccumulatedAmount
                            
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            paid-in capital
                            
                            
                            deficit
                            
                            
                            TotalBalance,
      March 31, 2009
                            
                            
                            610,774
                            
                            
                            
                            282,124,564
                            
                            
                            
                            282,125
                            
                            
                            
                            81,534,566
                            
                            
                            
                            (79,147,602
                            )
                            
                            
                            3,279,863Dividends
      on Series AA preferred stock
                            
                            
                            18,020
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (18,020
                            )
                            
                            
                            -
                            
                            
                            
                            -Accretion
      of discount on Series AA preferredstock
                            
                            
                            80,681
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (80,681
                            )
                            
                            
                            -
                            
                            
                            
                            -Conversion
      of Series AA preferred stock
                            
                            
                            (105,521
                            )
                            
                            
                            1,055,205
                            
                            
                            
                            1,055
                            
                            
                            
                            104,466
                            
                            
                            
                            -
                            
                            
                            
                            -Shares
      issued for term debt payments
                            
                            
                            -
                            
                            
                            
                            2,408,603
                            
                            
                            
                            2,408
                            
                            
                            
                            297,592
                            
                            
                            
                            -
                            
                            
                            
                            300,000Stock-based
      compensation
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            18,326
                            
                            
                            
                            -
                            
                            
                            
                            18,326Loss
      and comprehensive loss
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (220,690
                            )
                            
                            
                            (220,690
                            )Balance,
      September 30, 2009
                            
                            
                            603,954
                            
                            
                            
                            285,588,372
                            
                            
                            
                            285,588
                            
                            
                            
                            81,856,249
                            
                            
                            
                            (79,368,292
                            )
                            
                            
                            3,377,499





Options


The
following table summarizes stock option activity for the period:





Weighted average
                                          
                                          
                                          AggregateShares
                                          
                                          
                                          exercise price
                                          
                                          
                                          Intrinsic Value#
                                          
                                          
                                          $
                                          
                                          
                                          $Outstanding
      March 31, 2009
                                          
                                          
                                          8,050,500
                                          
                                          
                                          
                                          0.16Granted
                                          
                                          
                                          500,000
                                          
                                          
                                          
                                          0.11Exercised
                                          
                                          
                                          -Canceled/expired
                                          
                                          
                                          (1,515,000
                                          )
                                          
                                          
                                          0.22Outstanding
      September 30, 2009
                                          
                                          
                                          7,035,500
                                          
                                          
                                          
                                          0.14
                                          
                                          
                                          
                                          82,750Exercisable
      at September 30, 2009
                                          
                                          
                                          5,352,165
                                          
                                          
                                          
                                          0.15
                                          
                                          
                                          
                                          36,167





(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
      September 30, 2009 of $0.15 and excludes the impact of options that were
      not in-the-money.





Share
warrants


The
following table summarizes information on warrant activity during the six months
ended September 30, 2009:


11





Number
                  
                  
                  Average Purchase
                    Price Per Share $Shares
      purchasable under outstanding warrants at March 31, 2009
                  
                  
                  9,831,572
                  
                  
                  
                  0.11Stock
      purchase warrants exercised
                  
                  
                  -Stock
      purchase warrants expired
                  
                  
                  (2,331,572
                  )
                  
                  
                  0.15Shares
      purchasable under outstanding warrants at September 30,
    2009
                  
                  
                  7,500,000
                  
                  
                  
                  0.10





The
Company has outstanding share warrants as of September 30, 2009, as
follows:




Number of
                    
                    
                    Exercise PriceDescription
                    
                    Common Shares
                    
                    
                    Per Share $
                    
                    
                    Expiration DateWarrants
                    
                    
                    7,500,000
                    
                    
                    
                    0.10
                    
                    
                    June 30, 2011





9.
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.





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 six months ended September 30, 2009 of $55,888 and $98,701,
respectively (three and six months ended September 30, 2008 by $43,283 and
$44,694, respectively).





During
the six months ended September 30, 2009 the Company issued 1,055,205 shares of
common stock upon the conversion of 10,000 shares of Series AA Stock and
accordingly 65,000 shares of Series AA Stock were outstanding at September 30,
2009. Subsequent to September 30, 2009 the Company issued 1,065,616 shares of
common stock upon the conversion of 10,000 shares of Series AA
Stock.





10.
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.


12





As of
September 30, 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 September
30, 2009:





Fair Value Measurement as of September 30, 2009Total
                      
                      
                      Level 1
                      
                      
                      Level 2
                      
                      
                      Level 3Description
                      
                      $
                      
                      
                      $
                      
                      
                      $
                      
                      
                      $Cash
      and cash equivalents (1)
                      
                      
                      2,616,717
                      
                      
                      
                      2,616,717
                      
                      
                      
                      -
                      
                      
                      
                      -





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





11.
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.




Our
reportable segment information for the three and six months ended September 30,
2009 and 2008 is as follows:





For the three months ended
                  
                  
                  For the six months endedSeptember 30,
                  
                  
                  September 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008$
                  
                  
                  $
                  
                  
                  $
                  
                  
                  $REVENUES:Products
      and services
                  
                  
                  262,267
                  
                  
                  
                  174,430
                  
                  
                  
                  485,297
                  
                  
                  
                  552,157Patent
      licensing
                  
                  
                  1,250,000
                  
                  
                  
                  1,600,000
                  
                  
                  
                  1,250,000
                  
                  
                  
                  1,600,000Total
      revenue
                  
                  
                  1,512,267
                  
                  
                  
                  1,774,430
                  
                  
                  
                  1,735,297
                  
                  
                  
                  2,152,157GROSS
      PROFIT:Products
      and services
                  
                  
                  129,644
                  
                  
                  
                  118,433
                  
                  
                  
                  231,696
                  
                  
                  
                  232,490Patent
      licensing
                  
                  
                  807,000
                  
                  
                  
                  1,038,674
                  
                  
                  
                  807,000
                  
                  
                  
                  1,038,674Total
      gross profit
                  
                  
                  936,644
                  
                  
                  
                  1,157,107
                  
                  
                  
                  1,038,696
                  
                  
                  
                  1,271,164RECONCILIATION:Total
      segment gross profit
                  
                  
                  936,644
                  
                  
                  
                  1,157,107
                  
                  
                  
                  1,038,696
                  
                  
                  
                  1,271,164Operating
      expenses
                  
                  
                  (377,490
                  )
                  
                  
                  (756,596
                  )
                  
                  
                  (1,033,743
                  )
                  
                  
                  (1,442,142
                  )Other
      expense
                  
                  
                  (4,518
                  )
                  
                  
                  (165,344
                  )
                  
                  
                  (19,393
                  )
                  
                  
                  (263,062
                  )Income
      (loss) before income taxes
                  
                  
                  554,636
                  
                  
                  
                  235,167
                  
                  
                  
                  (14,440
                  )
                  
                  
                  (434,040
                  )  13




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 six months endedSeptember 30,
                              
                              September 30,2009
                              
                              2008
                              
                              2009
                              
                              2008$
                              
                              $
                              
                              $
                              
                              $United
      States
                              
                              
                              1,250,000
                              
                              
                              
                              1,600,000
                              
                              
                              
                              1,250,000
                              
                              
                              
                              1,600,000International
                              
                              
                              262,267
                              
                              
                              
                              174,430
                              
                              
                              
                              485,297
                              
                              
                              
                              552,157Total
      revenue
                              
                              
                              1,512,267
                              
                              
                              
                              1,774,430
                              
                              
                              
                              1,735,297
                              
                              
                              
                              2,152,157





Sales to
two customers comprised 72% and 12% of revenue for the six months ended
September 30, 2009. Sales to two customers comprised 74% and 10% of revenue for
the six months ended September 30, 2008. Accounts receivable from one customer
comprised 87% of net accounts receivable at September 30, 2009 and one customer
accounted for 91% of net accounts receivable at September 30, 2008.





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. (“digEcor”) in the Third
Judicial District Court of Utah, County of Salt Lake (the “Court”). In January
2007, March 2009 and April 2009 the Court ruled on certain motions of the
parties substantially limiting the issues for trial and each party voluntarily
dismissed additional claims and specific defendants.  In its rulings, the
Court dismissed digEcor's unjust enrichment, fraud, negligent misrepresentation,
tortious interference, non-competition, punitive damage and certain unfair
competition claims. The bulk of the bench trial related to digEcor’s claims for
breaches of three contracts and associated damages, and one claim for injunctive
relief was completed in May 2009 followed by the parties filing Proposed
Findings of Fact and Conclusions of Law and final arguments in July
2009.




On
September 14, 2009, the Company announced thatthe Court ruled in favor
of the Company by dismissing all remaining claims with prejudice and ordering
that digEcor recover no damages or injunctive relief. Specifically, the Court
dismissed digEcor's claims for breach of a November 2005 Purchase Order between
the parties, breach of a digital rights management (“DRM”) Agreement, and breach
of an October 22, 2002 Product Agreement. All claims were dismissed "with
prejudice and on the merits." The Court also declined to grant digEcor any
injunctive relief in connection with the DRM-related claim.  The Court’s
ruling and prior rulings may be subject to future appeal by either
party.




At
September 30, 2009 the Company had an accrual of $80,000 related to a deposit
for batteries made by digEcor.




On
November 13, 2009 the Company entered into a settlement agreement ending the
digEcor litigation with digEcor agreeing to waive any right to appeal the
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. The agreement included standard
mutual release of claims and covenants not to sue.


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 currently in
bankruptcy.





Subsequent
to September 30, 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.


14





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
corporateevents 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
September 30, 2009 the Company had outstanding unfilled purchase orders and was
committed to a contract manufacturer and component suppliers for approximately
$106,000 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 $6,159 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 $141,850 at September
30, 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 September 30, 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.





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.





13.
INCOME TAXES


During the quarter ended
September 30, 2009 the Company provided a tax provision of $206,250 representing
foreign taxes for which a credit (a deferred tax asset) may be allowable against
future United States taxes subject to certain limitations.At September
30, 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.


15





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.





14.
SUBSEQUENT EVENTS




The
subsequent events have been evaluated through November 16, 2009, which was the
date the Financial Statements were issued (see notes 7, 9 and
12).


16





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 eVUTM mobile entertainment device for the travel and
recreational industries. We also own and are licensing our Flash-RTM 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. Subsequent to September 30, 2009 we filed a
new patent infringement complaint against nineteen additional companies
that manufacture devices using flash memory.





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. And 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.


17





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
six months ended September 30, 2009 we recognized a net loss before income taxes
of $14,440 compared to a net loss before income taxes of $434,040 for the
comparable period of the prior fiscal year. Our revenues were $1.74 million for
the first six months of fiscal 2010 compared to $2.15 million for the prior
year’s first six months. In the prior year’s second quarter we recognized our
first patent license revenue of $1.6 million and in our most recent second
quarter we recognized $1.25 million of patent license revenue. We are in the
early stages of licensing our patents and while we expect additional patent
licenses in future periods there can be no assurance of the timing or amounts of
any such license revenue. We reported reduced operating expenses of $1,033,743
in the six months ended September 30, 2009 compared to $1,442,142 in the
comparable period prior primarily due to reduced staffing and reduced legal
fees.





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, excluding litigation costs that should now decline substantially due to
the favorable conclusion of business litigation (see Part II – Item 1 – Legal
Proceedings below). 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.


18





Results
of Operations





Three months ended September
30, 2009 compared to the three months ended September 30,
2008


Three Months Ended September 30,2009
                          
                          
                          
                          
                          
                          2008% of
                          
                          
                          
                          
                          
                          % of
                          
                          
                          ChangeDollars
                          
                          
                          Revenue
                          
                          
                          Dollars
                          
                          
                          Revenue
                          
                          
                          Dollars
                          
                          
                          %Revenues:Products
                          
                          
                          43,440
                          
                          
                          
                          3
                          %
                          
                          
                          1,683
                          
                          
                          
                          0
                          %
                          
                          
                          41,757
                          
                          
                          
                          2481
                          %Services
                          
                          
                          218,827
                          
                          
                          
                          14
                          %
                          
                          
                          172,747
                          
                          
                          
                          10
                          %
                          
                          
                          46,080
                          
                          
                          
                          27
                          %Patent
      license
                          
                          
                          1,250,000
                          
                          
                          
                          83
                          %
                          
                          
                          1,600,000
                          
                          
                          
                          90
                          %
                          
                          
                          (350,000
                          )
                          
                          
                          (22
                          )%1,512,267
                          
                          
                          
                          100
                          %
                          
                          
                          1,774,430
                          
                          
                          
                          100
                          %
                          
                          
                          (262,163
                          )
                          
                          
                          (15
                          )%Gross
      Profit:Product
      gross profit
                          
                          
                          15,651
                          
                          
                          
                          1
                          %
                          
                          
                          (12,292
                          )
                          
                          
                          (1
                          )%
                          
                          
                          27,943
                          
                          
                          
                          (227
                          )%Service
      gross profit
                          
                          
                          113,993
                          
                          
                          
                          8
                          %
                          
                          
                          130,725
                          
                          
                          
                          7
                          %
                          
                          
                          (16,732
                          )
                          
                          
                          (13
                          )%Patent
      license
                          
                          
                          807,000
                          
                          
                          
                          53
                          %
                          
                          
                          1,038,674
                          
                          
                          
                          59
                          %
                          
                          
                          (231,674
                          )
                          
                          
                          (22
                          )%936,644
                          
                          
                          
                          62
                          %
                          
                          
                          1,157,107
                          
                          
                          
                          65
                          %
                          
                          
                          (220,463
                          )
                          
                          
                          (19
                          )%Operating
      Expenses:Selling
      and administrative
                          
                          
                          250,741
                          
                          
                          
                          17
                          %
                          
                          
                          627,497
                          
                          
                          
                          35
                          %
                          
                          
                          (376,756
                          )
                          
                          
                          (60
                          )%Research
      and related
                          
                          
                          126,749
                          
                          
                          
                          8
                          %
                          
                          
                          129,099
                          
                          
                          
                          8
                          %
                          
                          
                          (2,350
                          )
                          
                          
                          (2
                          )%377,490
                          
                          
                          
                          25
                          %
                          
                          
                          756,596
                          
                          
                          
                          43
                          %
                          
                          
                          (379,106
                          )
                          
                          
                          (50
                          )%Other
      expenses
                          
                          
                          (4,518
                          )
                          
                          
                          (0
                          )%
                          
                          
                          (165,344
                          )
                          
                          
                          (9
                          )%
                          
                          
                          160,826
                          
                          
                          
                          (97
                          )%Income
      before provision for income taxes
                          
                          
                          554,636
                          
                          
                          
                          37
                          %
                          
                          
                          235,167
                          
                          
                          
                          13
                          %
                          
                          
                          319,469
                          
                          
                          
                          136
                          %





Income
before provision for income taxes


We
reported income before income taxes of $554,636 for the three months ended
September 30, 2009 compared to net income before income taxes of $235,167 for
the comparable period of the prior year. The $319,469 improvement was the result
of reduced operating and other expenses that more than offset a slight decline
in revenues and related gross profit.





Revenues


Revenues
of $1,512,267 in the second quarter of fiscal 2010 compared to $1,774,430 for
the comparable prior period. Our most recent quarter’s
revenues included $1,250,000 of one-time non-recurring patent license revenue
compared to $1,600,000 in the prior comparable quarter.Our most recent
quarter’s revenues also included $43,440 of eVU product and $218,827 of service
revenues. We recently filed a complaint against nineteen additional electronic
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.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 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. 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 second quarter of fiscal 2010 was $936,644 or 62% of
revenues.  The gross profit for the prior year’s second quarter was
$1,157,107 or 65% of revenues. 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.


19


Operating
Expenses


Selling
and administrative costs for the three months ended September 30, 2009, were
$250,741 compared to $627,497 for the second quarter of the prior year. The
significant $376,756 decrease included $42,700 of reduced staffing costs due to
fewer personnel, a $72,000 reduction in shareholder related costs due do the
timing of this year's annual meeting scheduled in the third quarter of the
current year rather than the second quarter and $265,500 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. While we expect to incur costs related to our
annual shareholder meeting in the third quarter of this fiscal year, we do not
expect them to be as high as the prior year’s second quarter costs primarily due
to reduced mailing costs. We expect professional fees in the third and fourth
quarter to be less than the prior year due to the conclusion of the business
litigation.





Research
and related expenditures for the three months ended September 30, 2009 were
comparable to the prior year’s second quarter.





Other
Income (Expenses)


Net other
expenses of $4,518 for the second quarter of fiscal 2010 included $5,787 of
noncash interest expense offset by a foreign exchange gain of $1,269. Net other
expenses for the second quarter of the prior year of $165,344 included a
non-cash financing expense of $177,125 related to a charge for warrant
modification, a non-cash $53,217 gain from warrant derivative revaluation
reduced by $42,114 of interest expense including $15,471 of non-cash
interest.





Provision
for Income Taxes


Income
tax expense of $206,250 consists of foreign taxes payable on patent license
revenue.





Income
Attributable to Common Stockholders


The
income attributable to common stockholders for the most recent second quarter
included the net income after taxes of $348,386 reduced by accrued and deemed
dividends on Series AA Stock
of $55,888 for a net income attributable to common stockholders of $292,498. The
net loss after tax for the prior comparable second quarter was $28,833 increased
by accrued and deemed dividends of $43,283 for a net loss attributable to common
stockholders of $72,116.





Six months ended September
30, 2009 compared to the six months ended September 30, 2008





Six Months Ended September 30,2009
                        
                        
                        
                        
                        
                        2008% of
                        
                        
                        
                        
                        
                        % of
                        
                        
                        ChangeDollars
                        
                        
                        Revenue
                        
                        
                        Dollars
                        
                        
                        Revenue
                        
                        
                        Dollars
                        
                        
                        %Revenues:Product
      revenues
                        
                        
                        57,515
                        
                        
                        
                        3
                        %
                        
                        
                        235,981
                        
                        
                        
                        11
                        %
                        
                        
                        (178,466
                        )
                        
                        
                        (76
                        )%Service
      revenues
                        
                        
                        427,782
                        
                        
                        
                        25
                        %
                        
                        
                        316,176
                        
                        
                        
                        15
                        %
                        
                        
                        111,606
                        
                        
                        
                        35
                        %Patent
      license
                        
                        
                        1,250,000
                        
                        
                        
                        72
                        %
                        
                        
                        1,600,000
                        
                        
                        
                        74
                        %
                        
                        
                        (350,000
                        )
                        
                        
                        (22
                        )%1,735,297
                        
                        
                        
                        100
                        %
                        
                        
                        2,152,157
                        
                        
                        
                        100
                        %
                        
                        
                        (416,860
                        )
                        
                        
                        (19
                        )%Gross
      Profit:Product
      gross profit
                        
                        
                        (19,278
                        )
                        
                        
                        (1
                        )%
                        
                        
                        28,522
                        
                        
                        
                        1
                        %
                        
                        
                        (47,800
                        )
                        
                        
                        (168
                        )%Service
      gross profit
                        
                        
                        250,974
                        
                        
                        
                        14
                        %
                        
                        
                        203,968
                        
                        
                        
                        10
                        %
                        
                        
                        47,006
                        
                        
                        
                        23
                        %Patent
      license gross profit
                        
                        
                        807,000
                        
                        
                        
                        47
                        %
                        
                        
                        1,038,674
                        
                        
                        
                        48
                        %
                        
                        
                        (231,674
                        )
                        
                        
                        (22
                        )%1,038,696
                        
                        
                        
                        60
                        %
                        
                        
                        1,271,164
                        
                        
                        
                        59
                        %
                        
                        
                        (232,468
                        )
                        
                        
                        (18
                        )%Operating
      Expenses:Selling
      and administrative
                        
                        
                        827,413
                        
                        
                        
                        48
                        %
                        
                        
                        1,166,392
                        
                        
                        
                        54
                        %
                        
                        
                        (338,979
                        )
                        
                        
                        (29
                        )%Research
      and related
                        
                        
                        206,330
                        
                        
                        
                        12
                        %
                        
                        
                        275,750
                        
                        
                        
                        13
                        %
                        
                        
                        (69,420
                        )
                        
                        
                        (25
                        )%1,033,743
                        
                        
                        
                        60
                        %
                        
                        
                        1,442,142
                        
                        
                        
                        67
                        %
                        
                        
                        (408,399
                        )
                        
                        
                        (28
                        )%Other
      income (expenses)
                        
                        
                        (19,393
                        )
                        
                        
                        (1
                        )%
                        
                        
                        (263,062
                        )
                        
                        
                        (12
                        )%
                        
                        
                        243,669
                        
                        
                        
                        (93
                        )%Loss
      before income taxes
                        
                        
                        (14,440
                        )
                        
                        
                        (1
                        )%
                        
                        
                        (434,040
                        )
                        
                        
                        (20
                        )%
                        
                        
                        419,600
                        
                        
                        
                        (97
                        )%


20





Loss
before income taxes


We showed
a loss before income taxes of $14,440 for the six months ended September 30,
2009 compared to a loss before income taxes of $434,040 for the comparable
period of the prior year. The $419,600 improvement was primarily attributable to
reduced operating and other expenses.




Revenues


Revenues of $1,735,297 for
the first six months of fiscal 2009 compared to $2,152,157 for the same period
of the prior year. The 19% reduction in revenues included reduced product
revenues and patent license revenues and increased service revenues. Fiscal 2010
six-month revenues included eVU products and service revenue of $485,297 and
patent license revenue of $1,250,000.We recently filed a complaint
against nineteen additional electronic 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.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 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. 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 first six months of fiscal 2010 was $1,038,696 or 60% of
revenues. The gross profit for the prior year’s
first six months was $1,271,164 or 59% of revenues. 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 six months ended September 30, 2009, were
$827,413 compared to $1,166,392 for the first six months of fiscal 2008. The
$338,979 decrease included $119,000 of reduced staffing costs due to fewer
personnel, a $72,000 reduction in shareholder related costs due do the timing of
this year's annual meeting scheduled for the third quarter rather than the
second quarter and $105,000 of reduced professional fees primarily due to
reduced business litigation costs and a $100,000 reversal of a legal accrual
related to such litigation as a result of the favorable litigation outcome.
While we expect to incur costs related to our annual shareholder meeting in the
third quarter of this fiscal year, we do not expect them to be as high as the
prior year’s second quarter costs primarily due to reduced mailing
costs.





Research
and related expenditures for the six months ended September 30, 2009 were
$206,330, compared to $275,750 for the
six months ended September 30, 2008. The decrease included $31,000 primarily
from reduced staffing and $38,000 from reduced outside engineering services due
to reduced internally funded research projects.





Other
Income (Expenses)


Net other expenses of
$19,393for thesix months ended September
30, 2009includedinterest expense of$15,834 (including $15,806
of noncash interest expense) and foreign exchange loss of $1,059.Net other expense
was $263,062 for the six months ended September 30, 2008 included a non-cash
financing expense of $177,125 related to a charge for warrant modification and
$90,708 of interest expense including $43,815 of non-cash interest.





Provision
for Income Taxes


Income
tax expense of $206,250 consists of foreign taxes payable on patent license
revenue.





Loss
Attributable to Common Stockholders


The loss
attributable to common stockholders for the six months ended September 30, 2009
included the loss after taxes of
$220,690 reduced by accrued and deemed dividends on Series AA Stock of $98,701
or a net loss of $319,391.  The
loss attributable to common stockholders for the prior comparable six months
included the loss after taxes of
$698,040 reduced by accrued and deemed dividends on convertible preferred stock
of $44,694 or a net loss of $742,734.





Liquidity
and Capital Resources


At
September 30, 2009, we had working capital of $3,360,263 compared to a working
capital of $3,277,225 at March 31, 2009. At September 30, 2009 we had cash on
hand of $2,616,717.


21





Operating
Activities


Cash used
in operating activities was $1,197,273 for the six months ended September 30,
2009. Cash used in operating activities included the net loss of $220,690
reduced by net non-cash expenses of $52,000. Major components also providing
operating cash was an increase of $48,750 in accrued foreign income taxes and
$306,470 in accrued and other liabilities that included a $408,000 increase in
accrued legal and professional fees offset by a $100,000 reduction in an accrual
for litigation. Major components using operating cash included an increase of
$1,342,942 in accounts receivable.





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 six months ended September 30, 2008 was
$1,149,177 resulting from the $698,040 net loss reduced by net non-cash expenses
of $225,209. Major components providing operating cash was an increase of
$794,356 in accounts payable and $264,000 in accrued income taxes payable. Major
components using operating cash included an increase of $1,584,784 in accounts
receivable.





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
six months ended September 30, 2009 we had no financing activities. For the six
months ended September 30, 2008, cash provided by financing activities was
$1,164,401. This included $500,000 from the sale of common stock and $700,000
cash from the sale of Series AA Stock. We reduced our secured note balance by
$50,000, reduced our term note balance by $25,599 and obtained $40,000 in July
2008 from a new one-year note.





Debt
and Other Commitments


We
currently have unsecured convertible term debt with a principal amount of
$97,258. 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. Aggregate principal and interest payments due
to mature in November 2009 are $98,165 with the October payment of $50,000 paid
in shares of common stock rather than cash.





At
September 30, 2009 we were committed to approximately $106,000 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.


22





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 September 30,
2009 and (a) current planned expenditures and level of operation, and (b) no
cash debt service (assuming convertible term debt payments are made in shares of
common stock) 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.





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 September 30,
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 September 30, 2009.


23





PART
II.     OTHER INFORMATION





Item
1. Legal Proceedings





Business
Litigation


In May
2006, we announced that a complaint had been filed against us and certain of our
officers and employees by digEcor, Inc. (“digEcor”) in the Third Judicial
District Court of Utah, County of Salt Lake (the “Court”). In January 2007,
March 2009 and April 2009 the Court ruled on certain motions of the parties
substantially limiting the issues for trial and each party voluntarily dismissed
additional claims and specific defendants.  In its rulings, the Court
dismissed digEcor's unjust enrichment, fraud, negligent misrepresentation,
tortious interference, non-competition, punitive damage and certain unfair
competition claims. The bulk of the bench trial related to digEcor’s claims for
breaches of three contracts and associated damages, and one claim for injunctive
relief was completed in May 2009 followed by the parties filing Proposed
Findings of Fact and Conclusions of Law and final arguments in July
2009.




On
September 14, 2009, we announced thatthe Court ruled in our
favor by dismissing all remaining claims with prejudice and ordering that
digEcor recover no damages or injunctive relief. Specifically, the Court
dismissed digEcor's claims for breach of a November 2005 Purchase Order between
the parties, breach of a DRM Agreement, and breach of an October 22, 2002
Product Agreement. All claims were dismissed "with prejudice and on the merits."
The Court also declined to grant digEcor any injunctive relief in connection
with the DRM-related claim.  The Court’s ruling and prior rulings may be
subject to future appeal by either party.




At
September 30, 2009 we had an accrual of $80,000 related to a deposit for
batteries made by digEcor.




On
November 13, 2009 we entered into a settlement agreement ending the digEcor
litigation with digEcor agreeing to waive any right to appeal the Court’s
rulings and orders in our favor and our withdrawing applications for costs of
suit. The agreement also reduced and settled the judgment (related to batteries)
to $60,000. The agreement included standard mutual release of claims and
covenants not to sue.


Intellectual Property
Litigation


In
September 2007 and 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.





Subsequent
to September 30, 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.





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)
            Thefollowing
      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:





·
            On
      July 31, 2009 the Company issued 458,715 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.





·
            On
      August 5, 2009 the Company issued 1,055,205 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
      August 31, 2009 the Company issued 431,034 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.


24





·
            On
      September 30, 2009 the Company issued 322,580 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


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).





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).


25





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
      CORPORATIONDate: November
      16, 2009
              By:
              /s/ROBERTPUTNAMRobert Putnam, Interim Chief Accounting Officer(Principal Accounting and Financial Officerand duly authorized to sign on behalf of the Registrant)




26