UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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


SECURITIES
EXCHANGE ACT OF 1934





For the
quarterly period ended December 31, 2008





Commission
File Number 0-20734





e.Digital
Corporation


(Exact
name of registrant as specified in its charter)








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





(858)
304-3016


(Registrant’s
telephone number, including area code)





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





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


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


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




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








e.DIGITAL
CORPORATION





INDEX


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





2






Part
      I. Financial InformationItem
      1. Financial Statements:e.Digital
      Corporation and subsidiaryCONSOLIDATED
      BALANCE SHEETS


December
      31,
                                      
                                      
                                      March
      31,2008
                                      
                                      
                                      2008(Unaudited)

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





See notes to
interim consolidated financial statements




3


e.Digital
      Corporation and subsidiary


CONSOLIDATED
      STATEMENTS OF OPERATIONS
                (UNAUDITED)
 
 For
      the three months ended
                                
                                
                                For
      the nine months endedDecember
      31,
                                
                                
                                December
      31,2008
                                
                                
                                2007
                                
                                
                                
                                2008
                                
                                
                                2007$
                                
                                
                                (as
      restated)

                                    $
                                
                                
                                
                                $
                                
                                
                                (as
      restated)

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





See notes to
interim consolidated financial statements


4


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


5


1. NATURE OF OPERATIONS AND BASIS OF
PRESENTATION


e.Digital Corporation is a holding
company incorporated under the laws of Delaware that operates through a
wholly-owned California subsidiary of the same name. The Company has innovated a
proprietary secure digital video/audio technology platform ("DVAP") and markets
the eVUTM mobile entertainment device for the travel and recreational industries.
The Company also obtains revenue from licensing and enforcing 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 December 31, 2008,
and the results of operations and cash flows for the periods presented,
consisting only of normal and recurring adjustments. All significant
intercompany transactions have been eliminated in consolidation. Operating
results for the three and nine months ended December 31, 2008 are not
necessarily indicative of the results that may be expected for the fiscal year
ending March 31, 2009. For further information, refer to the Company's
consolidated financial statements and footnotes thereto for the year ended March
31, 2008 filed on Form 10-K.





Prior Period
Presentation


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





Going
Concern


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





The preparation of financial statements
in conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, and disclosures of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. These consolidated financial statements do not give effect
to any adjustments which would be necessary should the Company be unable to
continue as a going concern and therefore be required to realize its assets and
discharge its liabilities in other than the normal course of business and at
amounts different from those reflected in the accompanying consolidated interim
financial statements.





2.
RECENT ACCOUNTING PRONOUNCEMENTS


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





6





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





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




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


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


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


7





3. INCOME (LOSS) PER
SHARE


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




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


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


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




4.
INVENTORIES




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


Inventories
consisted of the following:


December
31,
                                  
                                  
                                  March 31,2008
                                  
                                  
                                  
                                  2008$
                                  
                                  
                                  
                                  $Raw
    materials
                                  
                                  
                                  32,957
                                  
                                  
                                  
                                  41,354Work in
    process
                                  
                                  
                                  321,673
                                  
                                  
                                  
                                  217,820Finished
    goods
                                  
                                  
                                  161,404
                                  
                                  
                                  
                                  230,064516,034
                                  
                                  
                                  
                                  489,238





8





5.
STOCK-BASED COMPENSATION COSTS


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


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





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





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





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





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





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





See Note 8 for further information on
outstanding stock options.


9


6.
WARRANTY RESERVE


Details
of the estimated warranty liability included in other accounts payable and
accrued liabilities are as follows:
 
 Three
      Months Ended
                          
                          
                          Nine
      Months EndedDecember
      31,
                          
                          
                          December
      31,2008
                          
                          
                          2007
                          
                          
                          2008
                          
                          
                          2007$
                          
                          
                          $
                          
                          
                          $
                          
                          
                          $Beginning
      balance
                          
                          
                          33,875
                          
                          
                          
                          137,900
                          
                          
                          
                          109,138
                          
                          
                          
                          40,072Warranty
      provision
                          
                          
                          (7,472
                          )
                          
                          
                          52,638
                          
                          
                          
                          (43,072
                          )
                          
                          
                          185,602Warranty
      deductions
                          
                          
                          (1,952
                          )
                          
                          
                          (46,768
                          )
                          
                          
                          (41,615
                          )
                          
                          
                          (81,904
                          )Ending
      balance
                          
                          
                          24,451
                          
                          
                          
                          143,770
                          
                          
                          
                          24,451
                          
                          
                          
                          143,770
 
 7.
PROMISSORY NOTES


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


Principal
                                                          Due
      at
                                                          December
      31,
                                                        
                                                        
                                                        Less
      Unamortized
                                                        
                                                        
                                                        Net
      at December 31,
                                                        
                                                        
                                                        Long-Term2008
                                                        
                                                        
                                                        Discount
                                                        
                                                        
                                                        2008
                                                        
                                                        
                                                        PortionDescription
      and Rate
                                                        
                                                        Maturity
                                                        
                                                        $
                                                        
                                                        
                                                        $
                                                        
                                                        
                                                        $
                                                        
                                                        
                                                        $
                                                        
                                                        Collateral
                                                        
                                                        Conversion18%
      Secured Promissory Note
                                                        
                                                        Interest
      monthly, principal at June 23, 2009
                                                        
                                                        
                                                        300,000
                                                        
                                                        
                                                        
                                                        (2,868
                                                        )
                                                        
                                                        
                                                        297,132
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        Security
      interest in substantially
                                                          all
      assets
                                                        
                                                        Not
      applicable12%
      Promissory
                                                          Note
                                                        
                                                        Principal
      and interest due April 3, 2009
                                                        
                                                        
                                                        40,000
                                                        
                                                        
                                                        
                                                        (1,173
                                                        )
                                                        
                                                        
                                                        38,827
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        None
                                                        
                                                        Not
      applicable7.5%
      Convertible
                                                          Term
      Note
                                                        
                                                        Principal
      and interest in monthly installments $50,000 per month through maturity in
      November 2009
                                                        
                                                        
                                                        528,208
                                                        
                                                        
                                                        
                                                        (11,241
                                                        )
                                                        
                                                        
                                                        516,967
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        None
                                                        
                                                        At
      $.30 per share at holder option and callable for conversion at market of
      $0.40 per common share868,208
                                                        
                                                        
                                                        
                                                        (15,282
                                                        )
                                                        
                                                        
                                                        852,926
                                                        
                                                        
                                                        
                                                        -





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





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





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





8.
STOCKHOLDERS’ EQUITY


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





10








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




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


(2)
            See
      Note 9.





Fusion
Capital Equity Purchase Agreement


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





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


Options
 The
following table summarizes stock option activity for the period:
 
 Shares
                            
                            
                            Weighted
      average exercise price
                            
                            
                            Weighted
      average life
                            
                            
                            Aggregate
      intrinsic value (2)#
                            
                            
                            $
                            
                            
                            (years)
                            
                            
                            $Outstanding
      March 31, 2008
                            
                            
                            10,897,167
                            
                            
                            
                            0.16Granted
                            
                            
                            1,100,000
                            
                            
                            
                            0.11Canceled/expired
                            
                            
                            (2,584,167
                            )
                            
                            
                            0.16Exercised
                            
                            
                            -
                            
                            
                            
                            -Outstanding December 31, 2008
      (1)
                            
                            
                            9,413,000
                            
                            
                            
                            0.15
                            
                            
                            
                            1.8
                            
                            
                            
                            30,000Exercisable at December 31,
      2008
                            
                            
                            7,655,332
                            
                            
                            
                            0.15
                            
                            
                            
                            1.6
                            
                            
                            
                            30,000
 (1)
                Options
      outstanding are exercisable at prices ranging from $0.09 to $0.44 and
      expire over the period from 2009 to
2013.
 (2)
                Aggregate
      intrinsic value is based on the closing price of our common stock on
      December 31, 2008 of $0.11 and excludes the impact of options that were
      not in-the-money.
  11
  
 Share
warrants
 The
following table summarizes information on warrant activity during the nine
months ended December 31, 2008:
 
 Weighted
      averageShares
                          
                          
                          exercise
      price#
                          
                          
                          $Outstanding
      March 31, 2008
                          
                          
                          2,331,572
                          
                          
                          
                          0.15Granted
                          
                          
                          7,500,000
                          
                          
                          
                          0.10Canceled/expired
                          
                          
                          -
                          
                          
                          
                          -Exercised
                          
                          
                          -
                          
                          
                          
                          -Outstanding December 31,
    2008
                          
                          
                          9,831,572
                          
                          
                          
                          0.11
 
 The
Company has outstanding share warrants as of December 31, 2008, as
follows:
 
 Description
                                
                                Number of Common Shares
                                
                                
                                Exercise Price Per Share $
                                
                                Expiration
  DateWarrants
      (1)
                                
                                
                                2,331,572
                                
                                
                                
                                0.15
                                
                                August
      31, 2009Warrants
                                
                                
                                7,500,000
                                
                                
                                
                                0.10
                                
                                June
      30,
2011
  (1)
              exercise
      price subject to certain antidilution price
  protection.
 
 9.
PREFERRED STOCK
 On
December 30, 2002, the Company issued 205,000 shares of 12% Series D
non-redeemable convertible preferred stock (the "Series D Stock") with a stated
value of $10 per share. Dividends of 12% per annum were payable, with certain
exceptions, either in cash or in shares of common stock at the Company's
election. The remaining 91,000 shares of Series D Stock and accumulated
dividends automatically converted to 18,200,000 shares of common stock at $0.08
per share on December 31, 2007. Dividends accrued during the nine months ended
December 31, 2007 totaled $81,975 and increased the loss attributable to common
stockholders.
 
 On June
27, 2008 the Company issued 75,000 shares of 5% Series AA Convertible Preferred
Stock (the “Series AA Stock”) with a stated value of $10 per share. Dividends of
5% per annum are payable in shares of common stock or at the Company’s election
additional shares of Series AA Stock or under certain circumstances in cash. The
Series AA Stock has voting rights of ten votes per share and a liquidation
preference equal to $10.00 per share plus accrued and unpaid dividends. The
stated value plus accrued dividends on Series AA Stock is convertible into
common stock at $0.10 per common share with automatic conversion on June 30,
2010 subject to certain limitations. The Company may call the Series AA Stock
for conversion if the common stock market price is at least $0.25 per share for
ten consecutive trading days.
 
 The
Series AA Stock was issued for aggregate proceeds of $750,000 including $700,000
of cash and conversion of $50,000 of vendor debt. Purchasers were also issued
warrants to purchase an aggregate of 7,500,000 shares of common stock
exercisable at $0.10 per common share until June 30, 2011 (“Series AA
Warrants”). One officer/director purchased for $100,000 cash 10,000 shares of
Series AA Stock and was issued warrants to purchase 1,000,000 shares of common
stock on the same terms as unaffiliated investors.
 
 At the
holder’s option the Series AA Stock and the Series AA Warrants were redeemable
for cash at June 30, 2009 should sufficient shares of common stock not be
authorized and reserved for conversion of all underlying shares by such date.
This redemption right was terminated effective September 17, 2008 with the
shareholders authorizing additional shares of common stock and the Board of
Directors reserving sufficient shares for future conversions of the Series AA
Stock and exercise of the Series AA Warrants.
 
 The
proceeds of $750,000 were allocated between the fair value of the Series AA
Stock ($615,227) with the value of the Series AA Warrants ($134,773) treated as
a discount to the Series AA Stock. The Company determined the fair value of the
Series AA Warrants using the Black-Scholes option pricing model with the
following assumptions: no dividend yield; weighted average risk free rate of
2.93%; volatility of 60.6% and a term of one year. Because  the
redemption event was not certain to occur but was outside the Company’s control,
the Company originally recorded the portion of the proceeds attributable to the
stock as mezzanine equity pursuant to EITF Topic D-98, Classification and
Measurement of Redeemable Securities after determining the guidance in FAS 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity did not apply. Upon termination of the redemption right
on September 17, 2008 the value of the stock was reclassified as permanent
equity.
 
  12
  Additionally,
the Company evaluated whether the embedded conversion feature in the preferred
stock required bifurcation and determined that the economic characteristics and
risks of the embedded conversion feature in the stock were clearly and closely
related to the stock and concluded that bifurcation was not required under SFAS
133. The Company calculated the intrinsic value of the beneficial conversion
feature as $134,773 pursuant to the guidance in EITF 00-27, Application of Issue
No. 98-5 to Certain Convertible Instruments. The total discount to the Series AA
Stock of $269,546, consisting of the value of the Series AA Warrants and the
amount of the beneficial conversion feature, is being accreted  as a
deemed dividend over the term of the Series AA Stock. A total of $68,766 of the
discount was accreted  as a deemed dividend for the nine month period
ended December 31, 2008 by a charge to paid-in capital. The stated 5% dividend
also accrues to the carrying value of the Series AA Stock. The deemed and stated
dividends are also used in determining the net income (loss) attributable to
common stockholders for the respective periods.
 
 The
Company determined that the warrants met the definition of a derivative
instrument at issuance as defined in SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, and was treated as a liability due to the
lack of sufficient authorized shares of common stock. The Company recorded a
liability of $134,773 for the value of the warrants. As a derivative liability
this amount was evaluated for reclassification and if a derivative liability
adjusted at each reporting period based on the current market price. Upon the
authorization and reservation of shares of common stock for exercise of the
warrants on September 17, 2008, the Company determined the warrants were no
longer a derivative liability. The value at that date of $132,315 was
reclassified to paid-in capital and a net non-cash gain of $2,458 was recorded
in other income (expense).  The Company also determined that the
termination of the warrant redemption rights was an effective modification of
the warrant term and calculated the fair value of the warrants immediately prior
to the modification compared to the value immediately after the modification and
recorded the difference in warrant value of $177,125 as a financing expense in
other expenses.
 
 10.
FAIR VALUE MEASUREMENTS
 On April
1, 2008, the Company adopted SFAS No. 157 which defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements.
SFAS 157 does not require any new fair value measurements, but provides guidance
on how to measure fair value by providing a fair value hierarchy used to
classify the source of the information. In February 2008, the FASB deferred the
effective date of SFAS 157 by one year for certain non-financial assets and
non-financial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually). The
Company adopted the provisions of SFAS 157, except as it applies to those
nonfinancial assets and nonfinancial liabilities for which the effective date
has been delayed by one year.
 
 SFAS
No. 157 establishes a three-level valuation hierarchy of valuation
techniques that is based on observable and unobservable inputs. Classification
within the hierarchy is determined based on the lowest level of input that is
significant to the fair value measurement. The first two inputs are considered
observable and the last unobservable, that may be used to measure fair value and
include the following:
 Level 1
- Quoted prices in active markets for identical assets or
liabilities.
 Level 2
- Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of
the assets or liabilities.
 Level 3
- Unobservable inputs that are supported by little or no market activity and
that are significant to the fair value of the assets or
liabilities.
 
 As of
December 31, 2008, the Company held certain assets and liabilities that are
required to be measured at fair value on a recurring basis, including its cash
and cash equivalents. The fair value of these assets and liabilities was
determined using the following inputs in accordance with SFAS 157 at December
31, 2008:
  13
  
 Fair
      Value Measurement as of December 31, 2008Total
                            
                            
                            Level
      1
                            
                            
                            Level
      2
                            
                            
                            Level
      3Description
                            
                            $
                            
                            
                            $
                            
                            
                            $
                            
                            
                            $Cash
      and cash equivalents (1)
                            
                            
                            742,740
                            
                            
                            
                            742,740
                            
                            
                            
                            -
                            
                            
                            
                            -Warrant
      derivative liability (2)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
  (1)
              Included
      in cash and cash equivalents on the accompanying consolidated balance
      sheet.
 (2)
              Represents
      Series AA Warrants issued in June 2008 and valued using the income
      approach using the Black-Scholes option pricing model (see Note 9). An
      initial liability of $134,773 was revalued to $132,315 at September 17,
      2008 and reclassified as equity (see Note
9).
 
 The
following table reconciles the warrant derivative liability measured at fair
value on a recurring basis using significant unobservable inputs (Level 3) for
the nine months ended December 31, 2008:
 
 WarrantDerivativeLiability$Balance
      at April 1, 2008
                          
                          
                          -Issuance
      of warrant derivative (1)
                          
                          
                          134,773Adjustment
      to fair value included in net loss (2)
                          
                          
                          (2,458
                          )Reclassification
      to equity (2)
                          
                          
                          (132,315
                          )Balance
      at December 31, 2008
                          
                          
                          -
 (1)
              Represents
      Series AA Warrants issued in June 2008 (see Note
  9).
 (2)
              The
      warrant derivative liability was revalued at the end of each reporting
      period until reclassification as equity and the resulting difference was
      included in the results of operations in “Other income and
      expense”.
 
 11.
SEGMENT INFORMATION
 SFAS No.
131, “Disclosures About Segments of an Enterprise and Related Information,”
(“SFAS No. 131”) provides annual and interim reporting standards for an
enterprise’s business segments and related disclosures about its products,
services, geographical areas and major customers. With the inception of patent
license revenue in the current year, the Company determined that it has two
operating segments: (1) products and services and (2) patent licensing. Products
and services consist of sales of the Company’s electronic eVU mobile
entertainment device and related content services and patent licensing consists
of intellectual property revenues from the Flash-R patent
portfolio.
  Accounting
policies for each of the operating segments are the same as on a consolidated
basis however the Company has only recently commenced receiving patent license
revenue. The Company recognizes revenue from patent license agreements when (i)
the patent license agreement is executed, (ii) the amounts due are fixed,
determinable, and billable, (iii) the customer has been provided rights to the
licensed technology and (iv) collection of the resulting receivable, if any, is
probable. At the time the Company enters into a contract and provides the
customer with the licensed technology the Company has performed all of its
obligations under contract, the rights to the Company’s technology have been
transferred and no significant performance obligations remain. License revenue
to date consists of one-time licenses requiring no future performance. The
Company values nonexclusive cross licenses received only if directly used in
operations. Patent license costs of revenues include contingency legal and other
direct costs associated with patent licensing.
 
 Our
reportable segment information for the three and nine months ended December 31,
2008 is as follows:
  14
   
 For
      the three months ended
                  
                  
                  For
      the nine months endedDecember
      31,
                  
                  
                  December
      31,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007(as
      restated)
                  
                  
                  
                  
                  
                  (as
      restated)$
                  
                  
                  $
                  
                  
                  $
                  
                  
                  $REVENUES:Products
      and services
                  
                  
                  256,033
                  
                  
                  
                  1,190,847
                  
                  
                  
                  808,190
                  
                  
                  
                  4,811,262Patent
      licensing
                  
                  
                  3,650,000
                  
                  
                  
                  -
                  
                  
                  
                  5,250,000
                  
                  
                  
                  -Total
      revenue
                  
                  
                  3,906,033
                  
                  
                  
                  1,190,847
                  
                  
                  
                  6,058,190
                  
                  
                  
                  4,811,262GROSS
      PROFIT:Products
      and services
                  
                  
                  102,469
                  
                  
                  
                  396,351
                  
                  
                  
                  334,959
                  
                  
                  
                  1,239,864Patent
      licensing
                  
                  
                  2,184,081
                  
                  
                  
                  -
                  
                  
                  
                  3,222,755
                  
                  
                  
                  -Total
      gross profit
                  
                  
                  2,286,550
                  
                  
                  
                  396,351
                  
                  
                  
                  3,557,714
                  
                  
                  
                  1,239,864RECONCILIATION:Total
      segment gross profit
                  
                  
                  2,286,550
                  
                  
                  
                  396,351
                  
                  
                  
                  3,557,714
                  
                  
                  
                  1,239,864Operating
      expenses
                  
                  
                  (688,919
                  )
                  
                  
                  (727,597
                  )
                  
                  
                  (2,131,061
                  )
                  
                  
                  (2,166,936
                  )Other
      income (expense)
                  
                  
                  (49,836
                  )
                  
                  
                  (66,125
                  )
                  
                  
                  (312,898
                  )
                  
                  
                  (221,445
                  )Income
      (loss) before provision for income taxes
                  
                  
                  1,547,795
                  
                  
                  
                  (397,371
                  )
                  
                  
                  1,113,755
                  
                  
                  
                  (1,148,517
                  )
  The
Company does not have significant assets employed in the patent license segment
and does not track capital expenditures or assets by reportable segment.
Consequently it is not practical to show this information.
  Revenue
by geographic region is determined based on the location of the Company’s direct
customers or distributors for product sales and services. Patent license revenue
is considered United States revenue as payments are for licenses for United
States operations irrespective of the location of the licensee’s home
domicile.
 For
      the three months ended
                  
                  
                  For
      the nine months endedDecember
      31,
                  
                  
                  December
      31,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007(as
      restated)
                  
                  
                  
                  
                  
                  (as
      restated)$
                  
                  
                  $
                  
                  
                  $
                  
                  
                  $United
      States
                  
                  
                  3,650,000
                  
                  
                  
                  -
                  
                  
                  
                  5,250,000
                  
                  
                  
                  -International
                  
                  
                  256,033
                  
                  
                  
                  1,190,847
                  
                  
                  
                  808,190
                  
                  
                  
                  4,811,262Total
      revenue
                  
                  
                  3,906,033
                  
                  
                  
                  1,190,847
                  
                  
                  
                  6,058,190
                  
                  
                  
                  4,811,262
 Revenues
from three customers comprised 33%, 27% and 26% of revenue for the nine months
ended December 31, 2008. Sales to three customer comprised 37%, 26% and 20% of
revenue for the nine months ended December 31, 2007. Accounts receivable from
one customer comprised 95% of net accounts receivable at December 31, 2008 and
three customers accounted for 61%, 14% and 12% of net accounts receivable at
December 31, 2007.
 
 12.
COMMITMENTS AND CONTINGENCIES
 
 Legal
Matters
 
 Business
Litigation
 
 In May
2006, the Company announced that a complaint had been filed against it and
certain of its officers and employees by digEcor, Inc. in the Third Judicial
District Court of Utah, County of Salt Lake. The complaint alleged breaches of
contract, unjust enrichment, breaches of good faith and fair dealing, fraud,
negligent misrepresentation, and interference with prospective economic
relations. digEcor sought, among other things, an injunction to prevent our
Company from selling or licensing certain digital rights management technology
and "from engaging in any competition with digEcor until after 2009." digEcor
also sought "actual damages" of $793,750 and "consequential damages...not less
than an additional $1,000,000." This action was related to a purchase order the
Company placed for this customer in the normal course of business on November
11, 2005 for 1,250 digEplayers with its contract manufacturer, Maycom Co., Ltd..
Maycom was paid in full for the order by both e.Digital and digEcor by March
2006, but Maycom failed to timely deliver the order. The Company recorded an
impairment charge of $603,750 in March 2006 for deposits paid to Maycom due to
the uncertainty of obtaining future delivery. In October 2006 the Company
received delivery from Maycom of the delayed 1,250-unit digEplayer order and
delivered the order to digEcor. The Company recognized $713,750 of revenue from
this order and reversed an impairment charge of $603,750 in its third fiscal
2007 quarter.  The Company answered digEcor's complaint and is pursuing
certain counterclaims.
 
  15
  
 In
January 2007, the Court ruled on certain motions of the parties. In its ruling,
the Court dismissed digEcor's unjust enrichment, fraud, negligent
misrepresentation, tortious interference and punitive damage claims. The Court
further acknowledged the delivery of the 1,250-unit order and a partial
settlement between the parties reducing digEcor's claim for purchase-price or
actual damages from $793,750 to $94,846 with such amount still being disputed by
e.Digital. digEcor's contract and damages claims remain in dispute. digEcor has
subsequently amended its Complaint to assert an alternative breach of contract
claim, and claims for federal, state and common law unfair competition, and
sought an injunction prohibiting us "from engaging in any competition with
digEcor until after 2013."
 
 In April
2007 the Company filed a second amended counterclaim in the United States
District Court of Utah seeking a declaratory judgment confirming the status of
prior agreements between the parties, alleging breach of the Company’s
confidential information and trade secrets by digEcor, seeking an injunction
against digEcor's manufacture and sale of a portable product based on the
Company’s technology, alleging breach of duty to negotiate regarding revenue
sharing dollars the Company believes it has the right to receive and tortious
interference by digEcor in the Company’s contracts with third parties. The
Company intends to vigorously prosecute these counterclaims.
 
 In April
2007 digEcor filed a motion for summary judgment seeking enforcement of an
alleged non-compete provision and an injunction prohibiting the Company from
competing with digEcor. In October 2007 the Court denied, without prejudice,
digEcor's motion for partial summary judgment and request for injunction. The
foregoing and other findings of the Court may be subject to appeal by either
party.
 
 In
September 2008 digEcor filed their third request for a partial summary judgment
again seeking enforcement of the alleged non-compete provision.  digEcor
also asked the Court to rule on issues surrounding the delayed 1250-unit order
and e.Digital's alleged breach of  a 2002 contract between the parties.
 
 In
September 2008 the Company filed a summary judgment motion seeking a ruling (i)
that the alleged non-compete provision is unenforceable and /or superseded by
the 2002 agreement between the parties, and (ii) that the Company has not
breached any alleged non-compete provisions or the 2002 agreement.  The
Company also asked the Court to dismiss digEcor's unfair competition claims and
limit digEcor's damages claim.
 
 The case
has now completed the discovery phase. The Company has voluntarily dismissed
some of its counterclaims, alleging misappropriation of its confidential
information and trade secrets.  The Company believes that it has
substantive and multiple defenses and intends to vigorously challenge the
remaining matters and pursue all remaining counterclaims. However, there can be
no assurance the Company will prevail in its counterclaims or in its defense of
digEcor's remaining claims.
 
 The
Company is also unable to determine at this time the impact this complaint and
matter may have on its financial position or results of operations. The Company
has an accrual of $80,000 as an estimate of its obligation related to the
remaining general damage claim and the Company intends to seek restitution from
Maycom for any damages it may incur. Recovery from Maycom is not assured. Maycom
is not involved in the design, tooling or production of the Company’s
proprietary eVU mobile product. Moreover, the Company does not presently plan or
expect to produce or sell digEplayer models to digEcor or other customers in the
future.
 
  16
  Commitment Related to
Intellectual Property Legal Services
 On March
23, 2007 the Company entered into an agreement for legal services and a
contingent fee arrangement with Duane Morris LLP. The agreement provides that
Duane Morris is the Company’s legal counsel in connection with the assertion of
the Company’s flash memory related patents against infringers (“Patent
Enforcement Matters’).
 
 Duane
Morris has agreed to handle the Company’s Patent Enforcement Matters and certain
related appeals on a contingent fee basis. Duane Morris also has agreed to
advance certain costs and expenses including travel expenses, court costs and
expert fees. The Company has agreed to pay Duane Morris a fee equal to 40% of
any license or litigation recovery related to Patent Enforcement Matters, after
recovery of expenses, and 50% of recovery if appeal is necessary.
 
 In the
event the Company is acquired or sold or elects to sell the covered patents or
upon certain other corporate events or in the event the Company terminates the
agreement for any reason, then Duane Morris shall be entitled to collect accrued
costs and a fee equal to three times overall time and expenses accrued in
connection with the agreement and a fee of 15% of a good faith estimate of the
overall value of the covered patents. The Company has provided Duane Morris a
lien and a security interest in the covered patents to secure its obligations
under the agreement.
 Contract
Manufacturers and Suppliers
 The
Company depends on contract manufacturers and suppliers to (i) allocate
sufficient capacity to its manufacturing needs, (ii) produce acceptable quality
products at agreed pricing and (iii) deliver on a timely basis. If a
manufacturer is unable to satisfy these requirements, the Company's business,
financial condition and operating results may be materially and adversely
affected. Any failure in performance by either of these manufacturers for any
reason could have a material adverse affect on the Company's business.
Production and pricing by such manufacturers is subject to the risk of price
fluctuations and periodic shortages of components. The Company does not have
supply agreements with component suppliers and, accordingly, it is dependent on
the future ability of its manufacturers to purchase components. Failure or delay
by suppliers in supplying necessary components could adversely affect the
Company's ability to deliver products on a timely and competitive basis in the
future.
 
 At
December 31, 2008 the Company had outstanding unfilled purchase orders and was
committed to a contract manufacturers and component suppliers for approximately
$127,000 of future deliveries. Purchase commitments for product and components
are generally subject to modifications as to timing, quantities and scheduling
and in certain instances may be cancelable without penalty.
 
 Facility
Lease
 In March
2006 the Company entered into a sixty-two month lease, commencing June 1, 2006,
for approximately 4,800 square feet with an aggregate payment of $5,805 per
month excluding utilities and costs. The aggregate payments adjust annually with
maximum aggregate payments totaling $6,535 in the fifty-first through the
sixty-second month. Future lease commitments aggregated $197,652 at December 31,
2008.
 
 Royalties
 In
connection with a prior note financing, the Company is obligated to pay a
royalty of $20.00 for each entertainment device sold through December 31, 2008.
During the nine months ended December 31, 2008 and 2007 the Company incurred
royalties of $4,640 and $69,620, respectively.
  Other
Concentrations and Financial Instruments
 The
global economy, including the electronics industry, is experiencing a widespread
decline in business activity, together with a reduction in general credit
availability and instability in the commercial and investment banking systems,
all of which are likely to have far-reaching effects on economic activity for an
indeterminate period. The near- and long-term impact of these factors on the
Company's operations cannot be predicted at this time but may be
substantial.
 
 From
time-to-time, the Company carries cash and securities balances on deposit with
financial institutions that are in excess of federally insured limits, and the
risk of losses related to such concentrations may be increasing as a result of
recent economic developments discussed in the foregoing paragraph. The extent of
a future loss to be sustained as a result of uninsured deposits in the event of
a future failure of a bank or other financial institution, if any, however, is
not subject to estimation at this time.
 
  17
  13.
INCOME TAX
 The
Company adopted the provisions of FIN 48 on April 1, 2007 and commenced
analyzing filing positions in the Jurisdictions where we are required to file
income tax returns. As a result of the implementation of FIN 48, the Company
recognized no adjustment for uncertain tax provisions and the total amount of
unrecognized tax benefits as of April 1, 2007 was $-0-. The Tax Reform Act of
1986 (the Act) provides pursuant to Internal Revenue Code Sections 382 and 383
for a limitation of the annual use of NOL and research and development tax
credit carryforwards (following certain ownership changes, as defined by the
Act) that could significantly limit the Company's ability to utilize these
carryforwards. The Company has experienced various ownership changes as a result
of past financings and could experience future ownership changes. The Company's
ability to utilize the aforementioned carryforwards may therefore be
significantly limited. Additionally, because U.S. tax laws limit the time during
which these carryforwards may be applied against future taxes, the Company may
not be able to take full advantage of these reduced attributes for federal
income tax purposes. The Company has not performed an analysis of its deferred
tax assets for net operating losses or any possible research and development
credits sufficient to meet the more likely than not threshold required by FIN
48. Accordingly, the deferred tax assets related to net operating losses and the
offsetting valuation allowance were removed from deferred tax assets at April 1,
2007 until such an analysis is documented.
 
 As
discussed above, as of April 1, 2007, the Company removed its net operating
losses from deferred tax assets and the offsetting
valuation allowance until documented by a Section 382 analysis. During the
quarter ended September 30, 2008 the Company provided a tax provision of
$264,000 representing foreign taxes for which a credit (a deferred tax asset)
may be allowable against future United States taxes subject to certain
limitations. A full valuation allowance has been established to offset the
remaining net deferred tax assets (after applying sufficient net operating
losses to offset current income) and to the new foreign tax credit at December
31, 2008 as realization of these assets is uncertain. For the three and nine
months ended December 31, 2008, the deferred tax expense of $755,000 and
$543,000 respectively, was offset by a corresponding decrease of the deferred
tax asset valuation allowance.  When, and if, the Company can sustain
consistent profitability, and management determines that it is likely it will be
able to utilize the net operating losses prior to their expiration and the
amounts are adequately documented, then any additional valuation allowance can
be reduced or eliminated.
  18
  Item
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations
 
 THE
FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE
COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW AND UNDER THE SUB-HEADING,
"BUSINESS RISKS." SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED MARCH 31, 2008.
 
 Cautionary
Note on Forward Looking Statements
 
 In
addition to the other information in this report, the factors listed below
should be considered in evaluating our business and prospects.  This
prospectus contains a number of forward-looking statements that reflect our
current views with respect to future events and financial
performance.  These forward-looking statements are subject to certain
risks and uncertainties, including those discussed below and elsewhere herein,
that could cause actual results to differ materially from historical results or
those anticipated.  In this report, the words “anticipates,”
“believes,” “expects,” “intends,” “future” and similar expressions identify
forward-looking statements.  Readers are cautioned to consider the
specific factors described below and not to place undue reliance on the
forward-looking statements contained herein, which speak only as of the date
hereof.  We undertake no obligation to publicly revise these
forward-looking statements, to reflect events or circumstances that may arise
after the date hereof.
 
 General
 We are a
holding company incorporated under the laws of Delaware  that operates
through our wholly-owned California subsidiary of the same name. We have
innovated a proprietary secure digital video/audio technology platform ("DVAP")
and market our 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 revenue is derived
from the sale of DVAP products and accessories to customers, warranty and
technical support services and content fees and related services. We also obtain
patent license revenue from our Flash-R patent portfolio.
 
 Our
strategy is to market our eVU products and services to a growing base of U.S.
and international companies in the airline, healthcare, and other travel and
leisure industries. We employ both direct sales to customers and sales through
value added resellers (VARs) that provide marketing, logistic and/or content
services to customers.
 
 We are
commercializing our Flash-R patent portfolio through licensing and we are
aggressively pursuing enforcement by litigating against those who may be
infringing our patents. Our international legal firm Duane Morris LLP is
handling our patent enforcement matters on a contingent fee basis. In September
2007 and March 2008 we filed our first tranche of patent infringement litigation
against eight defendants. In September 2008 we recorded our first patent license
revenue and recognized additional license revenue during the quarter ended
December 31, 2008. While we expect additional patent licenses in future periods
there can be no assurance of the timing or amounts of any related license
revenue.
 
 Our
business is high risk in nature. There can be no assurance we can achieve
sufficient eVU or patent license revenues to sustain profitability. We continue
to be subject to the risks normally associated with any new business activity,
including unforeseeable expenses, delays and complications. Accordingly, there
is no guarantee that we can or will report operating profits in future
periods.
 
 Overall
Performance and Trends
 We have
experienced significant operating losses and negative cash flow from operations
in each of the last three years. Our recent profitability has resulted from
one-time patent licensing revenues and there is no assurance of future licensing
revenues from new licensees. Accordingly, we could incur losses in the future
until product, service and/or licensing revenues are sufficient to sustain
continued profitability. Our ability to continue as a going concern is in doubt
and is dependent upon achieving a profitable level of operations and if
necessary obtaining additional financing.
 
 
 
  19
  For the
nine months ended December 31, 2008:
 
 ·
              We
      recognized net income before income taxes of $1,113,755 for the nine
      months ended December 31, 2008. This was before income tax expense of
      $264,000 for foreign taxes. The resulting net income of $849,755 was an
      improvement from the net loss of $1,148,517 for the first nine months of
      the prior year.  The improvement resulted primarily from new
      higher margin patent licensing revenue that offset a decline in eVU
      product and service revenues.
 
 ·
              Our
      revenues were $6.1 million for the first nine months compared to $4.8
      million for the prior year’s nine months. Revenues in the first nine
      months included $5.25 million of patent license revenue. Last year’s first
      nine months revenues included product sales to new European in flight
      entertainment (“IFE”) customers. Recent eVU sales activity has been slow
      due to airline industry economics and industry credit concerns resulting
      in airlines curtailing expansion and new projects. We are aggressively
      pursuing new business but our results will be dependent on the timing and
      quantity of additional patent licenses and eVU orders. We seek to expand
      and diversify our customer base both in the IFE space and other markets.
      The failure to obtain additional patent license revenues or eVU orders or
      delays of orders or production delays could have a material adverse impact
      on our operations.
 
 ·
              Our
      gross profit for the first nine months was $3.6 million or 59% of revenues
      compared to $1.2 million or 26% of revenues for the prior year’s first
      nine months. Results benefited from higher patent licensing gross profit
      percentages as compared to product sales. Gross profit margins are highly
      dependent on revenue and product mix, prices charged, volume of orders and
      costs.
 
 ·
              Operating
      expenses were $2.1 million for the first nine months of fiscal 2009 (year
      ending March 31, 2009) compared to $2.2 million for the first nine months
      of fiscal 2008.
 
 We have
recently reduced our monthly cash operating costs to an average of approximately
$200,000 per month. However, we may increase expenditure levels in future
periods to support and expand our revenue opportunities and continue advanced
product and technology research and development. Accordingly, we may incur
future losses until such time as we are able to realize recurring revenues and
margins sufficient to cover our costs of operations.  We may also face
unanticipated technical or manufacturing obstacles and face warranty and other
risks in our business.
 
 Critical
Accounting Policies
 We have
identified a number of accounting policies as critical to our business
operations and the understanding of our results of operations. These are
described in our consolidated financial statements located in Item 1 of
Part I, “Financial Statements,” and in Management’s Discussion and Analysis of
Financial Condition and Results of Operations in our Annual Report of Form 10-K
for the year ended March 31, 2008. The impact and any associated risks related
to these policies on our business operations is discussed throughout
Management’s Discussion and Analysis of Financial Condition and Results of
Operations when such policies affect our reported and expected financial
results.
 
 The
methods, estimates and judgments we use in applying our accounting policies, in
conformity with generally accepted accounting principles in the United States,
have a significant impact on the results we report in our financial statements.
We base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. The estimates affect
the carrying values of assets and liabilities. Actual results may differ from
these estimates under different assumptions or conditions.
 
 The
following critical accounting policies guided our judgment and estimates used in
accounting for the new issuance of convertible preferred stock in June 2008,
fair value measurements and new patent license revenues:
 
 Accounting for Convertible
Preferred Stock
 The
Company accounts for preferred stock subject to provisions for redemption that
are outside of its control as mezzanine equity in accordance with FAS 150
"Accounting for Certain Financial Instruments with Characteristics of Both Debt
and Equity," EITF Topic D-98 “Classification and
Measurement of Redeemable Securities”and  SEC
Accounting Series Release (ASR) No. 268 “Redeemable Preferred Stocks,”
and is shown net of discounts for warrant values and beneficial conversion
features. These securities are recorded at fair value at the date of issue and
related discounts are accreted over the term of the securities. The securities
are reclassified to permanent equity when the provisions for redemption are
terminated.
 
  20
  The
Company accounts for redeemable convertible preferred stock and the related
common stock warrants in accordance with the provisions of SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities,” EITF 00-19,
“Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock,” EITF Issue No. 98-5 “Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios,” EITF Issue No. 00-27 “Application of Issue No.
98-5 to Certain Convertible Instruments” and other related accounting
guidance.  Pursuant to this guidance, the Company has concluded that
the conversion and redemption features of the redeemable convertible preferred
stock are not embedded derivatives that need to be bifurcated from the host
instrument and separately valued. In addition, the Company has accounted for its
detachable common stock warrants as a derivative liability in accordance with
the guidance of EITF 00-19 and reevaluates the status of such instruments at
each reporting period.
 
 Fair Value
Measurements
 The
Company follows the provisions of SFAS No. 157, “Fair Value Measurements,” or
SFAS 157, which defines fair value as the price that would be received to sell
an asset or paid to transfer a liability (i.e., the exit price) in an orderly
transaction between market participants at the measurement date. In measuring
fair value, the Company considers the hierarchy for inputs provided in SFAS 157
to determine appropriate valuation approaches. Generally, valuations are based
on quoted market prices for identical assets or liabilities which the Company
has the ability to access, or for which significant inputs are observable either
directly or indirectly. To the extent that valuation is based on models or
inputs that are less observable or unobservable in the market, the determination
of fair value requires judgment. The Company’s assumptions are set to reflect
those that market participants would use in pricing the asset or liability at
the measurement date; however, different judgments could yield different
results. The Company’s valuation pricing models consider time value, volatility
factors, current market and contractual prices for the underlying financial
instruments as well as other measurements. Changes in these factors can have a
significant impact on carrying values and results of operations.
 
 Patent License Revenue
Recognition
 The
Company has only recently commenced receiving patent license revenue. The
Company recognizes revenue from patent license agreements when (i) the patent
license agreement is executed, (ii) the amounts due are fixed, determinable, and
billable, (iii) the customer has been provided rights to the licensed technology
and (iv) collection of the resulting receivable, if any, is probable. At the
time the Company enters into a contract and provides the customer with the
licensed technology the Company has performed all of its obligations under
contract, the rights to the Company’s technology have been transferred and no
significant performance obligations remain. License revenue to date consists of
one-time licenses requiring no future performance. The Company values
nonexclusive cross licenses received only if directly used in
operations.
 
 Patent
license costs of revenues include contingency legal and other direct costs
associated with patent licensing.
  21
  
 Results
of Operations
 
 Three months ended December
31, 2008 compared to the three months ended December 31,
2007
 Three
      Months Ended December 31,2008
                        
                        
                        
                        
                        
                        2007%
      of
                        
                        
                        (as
      restated)
                        
                        
                        %
      of
                        
                        
                        ChangeDollars
                        
                        
                        Revenue
                        
                        
                        Dollars
                        
                        
                        Revenue
                        
                        
                        Dollars
                        
                        
                        %Revenues:Product
      revenues
                        
                        
                        120,463
                        
                        
                        
                        3.1
                        %
                        
                        
                        1,006,485
                        
                        
                        
                        84.5
                        %
                        
                        
                        (886,022
                        )Service
      revenues
                        
                        
                        135,570
                        
                        
                        
                        3.5
                        %
                        
                        
                        184,362
                        
                        
                        
                        15.5
                        %
                        
                        
                        (48,792
                        )Patent
      license
                        
                        
                        3,650,000
                        
                        
                        
                        93.4
                        %
                        
                        
                        -
                        
                        
                        
                        0.0
                        %
                        
                        
                        3,650,0003,906,033
                        
                        
                        
                        100.0
                        %
                        
                        
                        1,190,847
                        
                        
                        
                        100.0
                        %
                        
                        
                        2,715,186
                        
                        
                        
                        228.0
                        %Gross
      Profit:Product
      gross profit
                        
                        
                        24,129
                        
                        
                        
                        
                        
                        
                        
                        257,956
                        
                        
                        
                        
                        
                        
                        
                        (233,827
                        )Service
      gross profit
                        
                        
                        78,340
                        
                        
                        
                        
                        
                        
                        
                        138,395
                        
                        
                        
                        
                        
                        
                        
                        (60,055
                        )Patent
      license gross profit
                        
                        
                        2,184,081
                        
                        
                        
                        
                        
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        2,184,0812,286,550
                        
                        
                        
                        58.5
                        %
                        
                        
                        396,351
                        
                        
                        
                        33.3
                        %
                        
                        
                        1,890,199
                        
                        
                        
                        476.9
                        %Operating
      Expenses:Selling
      and administrative
                        
                        
                        576,997
                        
                        
                        
                        14.8
                        %
                        
                        
                        484,252
                        
                        
                        
                        40.7
                        %
                        
                        
                        92,745
                        
                        
                        
                        19.2
                        %Research
      and related
                        
                        
                        111,922
                        
                        
                        
                        2.9
                        %
                        
                        
                        243,345
                        
                        
                        
                        20.4
                        %
                        
                        
                        (131,423
                        )
                        
                        
                        (54.0
                        %)688,919
                        
                        
                        
                        17.6
                        %
                        
                        
                        727,597
                        
                        
                        
                        61.1
                        %
                        
                        
                        (38,678
                        )
                        
                        
                        (5.3
                        %)Other
      income (expenses)
                        
                        
                        (49,836
                        )
                        
                        
                        (1.3
                        %)
                        
                        
                        (66,125
                        )
                        
                        
                        (5.6
                        %)
                        
                        
                        16,289
                        
                        
                        
                        (24.6
                        %)Income
      (loss) before provision for income taxes
                        
                        
                        1,547,795
                        
                        
                        
                        39.6
                        %
                        
                        
                        (397,371
                        )
                        
                        
                        (33.4
                        %)
                        
                        
                        1,945,166
                        
                        
                        
                        (489.5
                        %)
 
 Income
(loss) before provision for income taxes
 We
reported income before income taxes of $1,547,795 for the three months ended
December 31, 2008 compared to a loss of $397,371 for the comparable period of
the prior year. The $1,945,166 improvement was the result of higher margin
patent license revenues that offset a decline in eVU product and service
revenues.
 
 Revenues
 Revenues
of $3,906,033 in the third quarter of fiscal 2009 compared to $1,190,847 for the
comparable prior period. The revenue mix was significantly different each
period. During the prior year’s third quarter revenues consisted of $1,006,485
from selling eVU players and related equipment for use by airline customers and
$184,362 from service revenues for content and support services. Recent eVU
product sales activity has been slow due to airline industry economics and
industry credit concerns resulting in airlines curtailing expansion and new
projects. Our most recent quarter’s revenues consisted primarily of $3,650,000
of one-time non-recurring patent license revenue and $256,033 of eVU product and
service revenues. We are pursuing new business but our results will continue to
be dependent on the timing and quantity of eVU orders or the timing of patent
licensing arrangements.
 
 Gross
Profit
 Gross
profit for the third quarter of fiscal 2009 was $2,286,550 or 58.5% of
revenues.  The gross profit for the prior year’s third quarter was
$396,351 or 33.3% of revenues. The improved gross profit percentage resulted
from higher margin patent license revenue. Gross profit margins are highly
dependent on revenue mix, prices charged, volume of orders, contingency patent
legal fees and costs.
  22
  Operating
Expenses
 Selling
and administrative costs for the three months ended December 31, 2008, were
$576,997 compared to $484,252 for the third quarter of fiscal 2008. While most
cost categories were comparable we have experienced an increase in litigation
related legal expenses of $202,000, offset by a $87,000 reduction in staffing
costs due to reduced personnel.
 
 Research
and related expenditures for the three months ended December 31, 2008 were
$111,922, compared to $243,345 for the three months ended December 31, 2007. The
decrease resulted from reduced personnel and from reassigning other engineers
and technicians to customer support and service roles in the current
year.
 
 Other
Income (Expenses)
 Net other
expenses were $49,836 for the third quarter of fiscal 2009 compared to net
expenses of $66,125 for the third quarter of the prior year. The most recent
quarter included $38,717 of interest expense including $20,717 of non-cash
interest. The third quarter of fiscal 2008 included interest of $56,115, of
which $32,112 was non-cash interest from the amortization of debt discount, and
$21,640 of financing royalties.
 
 Provision
for Income Taxes
 There was
no income tax provision or benefit for the third quarter of fiscal 2009 or 2008.
The deferred tax expense of $755,000 for the most recent third quarter was
offset by a benefit related to the decrease  of the deferred tax asset
valuation allowance.
 
 Income
(Loss) Attributable to Common Stockholders
 The
income (loss) attributable to common stockholders for the most recent third
quarter included the net income after taxes of $1,547,795 reduced by
accrued  and deemed dividends on convertible preferred stock of
$43,284 or a net income attributable to common stockholders of $1,504,511. The
net loss after tax for the prior comparable third quarter was $397,371 reduced
by accrued and deemed dividends of $27,225 for a net loss attributable to common
stockholders of $424,596.
 
 Nine months ended December
31, 2008 compared to the nine months ended December 31, 2007
 Nine
      Months Ended December 31,2008
                        
                        
                        
                        
                        
                        2007%
      of
                        
                        
                        (as
      restated)
                        
                        
                        %
      of
                        
                        
                        ChangeDollars
                        
                        
                        Revenue
                        
                        
                        Dollars
                        
                        
                        Revenue
                        
                        
                        Dollars
                        
                        
                        %Revenues:Product
      revenues
                        
                        
                        356,444
                        
                        
                        
                        5.9
                        %
                        
                        
                        4,304,197
                        
                        
                        
                        89.5
                        %
                        
                        
                        (3,947,753
                        )Service
      revenues
                        
                        
                        451,746
                        
                        
                        
                        7.5
                        %
                        
                        
                        507,065
                        
                        
                        
                        10.5
                        %
                        
                        
                        (55,319
                        )Patent
      license
                        
                        
                        5,250,000
                        
                        
                        
                        86.7
                        %
                        
                        
                        -
                        
                        
                        
                        0.0
                        %
                        
                        
                        5,250,0006,058,190
                        
                        
                        
                        100.0
                        %
                        
                        
                        4,811,262
                        
                        
                        
                        100.0
                        %
                        
                        
                        1,246,928
                        
                        
                        
                        25.9
                        %Gross
      Profit:Product
      gross profit
                        
                        
                        52,651
                        
                        
                        
                        
                        
                        
                        
                        849,139
                        
                        
                        
                        
                        
                        
                        
                        (796,488
                        )Service
      gross profit
                        
                        
                        282,308
                        
                        
                        
                        
                        
                        
                        
                        390,725
                        
                        
                        
                        
                        
                        
                        
                        (108,417
                        )Patent
      license gross profit
                        
                        
                        3,222,755
                        
                        
                        
                        
                        
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        3,222,7553,557,714
                        
                        
                        
                        58.7
                        %
                        
                        
                        1,239,864
                        
                        
                        
                        25.8
                        %
                        
                        
                        2,317,850
                        
                        
                        
                        186.9
                        %Operating
      Expenses:Selling
      and administrative
                        
                        
                        1,743,389
                        
                        
                        
                        28.8
                        %
                        
                        
                        1,427,344
                        
                        
                        
                        29.7
                        %
                        
                        
                        316,045
                        
                        
                        
                        22.1
                        %Research
      and related
                        
                        
                        387,672
                        
                        
                        
                        6.4
                        %
                        
                        
                        739,592
                        
                        
                        
                        15.4
                        %
                        
                        
                        (351,920
                        )
                        
                        
                        (47.6
                        %)2,131,061
                        
                        
                        
                        35.2
                        %
                        
                        
                        2,166,936
                        
                        
                        
                        45.0
                        %
                        
                        
                        (35,875
                        )
                        
                        
                        (1.7
                        %)Other
      income (expenses)
                        
                        
                        (312,898
                        )
                        
                        
                        (5.2
                        %)
                        
                        
                        (221,445
                        )
                        
                        
                        (4.6
                        %)
                        
                        
                        (91,453
                        )
                        
                        
                        41.3
                        %Income
      (loss) before provision for income taxes
                        
                        
                        1,113,755
                        
                        
                        
                        18.4
                        %
                        
                        
                        (1,148,517
                        )
                        
                        
                        (23.9
                        %)
                        
                        
                        2,262,272
                        
                        
                        
                        (197.0
                        %)
 Income
(Loss) before provision for income taxes
 We showed
income before income taxes of $1,113,755 for the nine months ended December 31,
2008 compared to a loss of $1,148,517 for the comparable period of the prior
year. The $2,262,272 improvement was the result of higher margin patent license
revenues.
  23
  
 Revenues
 Revenues
of $6,058,190 for the first nine months of fiscal 2009 compared to $4,811,262
for the same period of the prior year. The revenue mix was different in the most
recent nine month period due to initial patent license revenues. Fiscal 2009
nine-month revenues included eVU products and service revenue of $808,190 and
patent license revenue of $5,250,000. We are reliant on a limited number of
customers with three customers accounting for 33%, 27% and 26% of our first
nine-month revenues. During the prior year’s first nine months revenues
consisted of $4,811,262 from selling eVU players and related service revenues
for content and support services. Recent eVU product sales activity has been
slow due to airline industry economics and industry credit concerns resulting in
airlines curtailing expansion and new projects. We are pursuing new business but
our results will continue to be dependent on the timing and quantity of eVU
orders or the timing of patent licensing arrangements.
  Gross
Profit
 Gross
profit for the first nine months of fiscal 2009 was $3,557,714 or 58.7% of
revenues.  The gross profit for the prior year’s first nine months was
$1,239,864 or 25.8% of revenues. The improved gross profit percentage resulted
from higher margin patent license revenue. Gross profit margins are highly
dependent on revenue mix, prices charged, volume of orders, contingency patent
legal fees and costs.
 
 Operating
Expenses
 Selling
and administrative costs for the nine months ended December 31, 2008, were
$1,743,389 compared to $1,427,344 for the first nine months of fiscal 2008. The
$316,045 increase included an increase in litigation related legal expenses of
$410,000 and an increase of $73,000 of shareholder costs primarily related to
holding the September shareholders meeting offset by a $103,000 reduction in
sales commissions from reduced product sales and a $70,000 reduction in
personnel costs due primarily to reduced stock-based compensation
costs.
 
 Research
and related expenditures for the nine months ended December 31, 2008 were
$387,672, compared to $739,592 for the nine months ended December 31, 2007. The
decrease resulted primarily from a reduction in personnel and reassigning other
engineers and technicians to customer support and service roles in the current
year.
 
 Other
Income (Expenses)
 Net other
expense was $312,898 for the nine months ended December 31, 2008 compared to net
expenses of $221,445 for the nine months ended December 31, 2007. The most
recent period included a non-cash financing expense of $177,125 related to a
charge for warrant modification and $129,425 of interest expense including
$62,132 of non-cash interest.
 
 For the
first nine months of fiscal 2008 other expenses of $221,445 included interest
expense of $187,783, of which $99,274 was non-cash interest from the
amortization of debt discount, and $69,620 of financing royalties.
 
 Provision
for Income Taxes
 Income
tax expense of $264,000 consists of foreign taxes paid on patent license
revenue. There was no domestic income tax provision or benefit for the first
three quarters of fiscal 2009 or 2008. The deferred tax expense of $543,000 for
the most recent nine months was offset by a benefit related to the decrease of
the deferred tax asset valuation allowance.
 
 Income
(Loss) Attributable to Common Stockholders
 The
income attributable to common stockholders for the nine months ended December
31, 2008 included the income after taxes of $849,755 reduced by accrued and
deemed dividends on convertible preferred stock of $87,978 or a net income
attributable to common stockholders of $761,777. The net loss after tax for the
prior comparable nine months was $1,148,517 reduced by accrued and deemed
dividends of $81,975 for a net loss attributable to common stockholders of
$1,230,492.
 
 Liquidity
and Capital Resources
 At
December 31, 2008, we had working capital of $923,538 compared to a working
capital deficit of $1.3 million at March 31, 2008. At December 31, 2008 we had
cash on hand of $742,740.
 
 
 
  24
  Operating
Activities
 Cash used
in operating activities was $498,019 for the nine months ended December 31,
2008. Cash provided by operating activities included income of $849,755
increased by net non-cash expenses of $238,885. Major components also providing
operating cash was an increase of $758,251 in other accounts payable and accrued
liabilities. Major components using operating cash included an increase of
$1,963,060 in accounts receivable, a $26,796 increase in inventory and a
$262,760 decrease in accounts payable. Our terms to customers vary but we often
require payment prior to shipment of product and any such payments are recorded
as deposits. Patent license payments are normally due at signing of the license
or within 30-45 days.
 
 Cash used
in operating activities during the nine months ended December 31, 2007 was
$974,412. Individual working capital components can change dramatically from
period to period due to timing of sales and shipments and corresponding
receivable, inventory and payable balances. Accordingly operating cash
requirements vary significantly from period to period.
 
 Investing
Activities
 The
Company’s efforts are primarily on operations and currently we have no
significant investing capital needs. We have no commitments requiring investment
capital.
 
 Financing
Activities
 For the
nine months ended December 31, 2008, cash provided by financing activities was
$1,118,643. This included $580,000 from the sale of common stock to Fusion
Capital Fund II, LLC (“Fusion”) pursuant to a purchase agreement and $700,000
cash from the sale of preferred stock. We reduced our secured note balance by
$150,000, made term principal payments of $51,357 and obtained $40,000 in July
2008 from a new one year note. During the first nine months of the prior year we
obtained $640,000 from the sale of common stock to Fusion and made a secured
note payment of $300,000.
 
 Subsequent
to December 31, 2008 we obtained $80,000 from the sale of common stock pursuant
to the Fusion agreement that terminated in accordance with its terms on February
4, 2009.
 
 Related
Party Debt and Other Commitments
 We
currently have a secured note for $300,000 due on June 23, 2009, an unsecured
note for $40,000 due in July 2009 and an unsecured convertible term debt with a
principal amount of $528,208. We made $230,000 of term note principal and
interest payments through the issuance of common shares during the first nine
months. Our plans are to make future principal and interest payments with shares
of common stock, subject to maintaining the $0.10 minimum share price and other
covenants of the term loan.
 
 At
December 31, 2008 we were committed to approximately $127,000 as purchase
commitments for product and components. These orders are generally subject to
modification as to timing, quantities and scheduling and in certain instances
may be cancelable without penalty.
 
 We are
also committed for our office lease as more fully described in Note 12 to our
interim consolidated financial statements.
 
 Our legal
firm Duane Morris is handling Patent Enforcement Matters and certain related
appeals on our Flash-R patent portfolio on a contingent fee basis. Duane Morris
also has agreed to advance certain costs and expenses including travel expenses,
court costs and expert fees. We have agreed to pay Duane Morris a fee equal to
40% of any license or litigation recovery related to Patent Enforcement Matters,
after recovery of expenses, and 50% of recovery if appeal is
necessary.
 
 In the
event we are acquired or sold or elect to sell the covered patents or upon
certain other corporate events or in the event we terminate the agreement for
any reason, then Duane Morris shall be entitled to collect accrued costs and a
fee equal to three times overall time and expenses accrued in connection with
the agreement and a fee of 15% of a good faith estimate of the overall value of
the covered patents. Duane Morris has a lien and a security interest in the
covered patents to secure its obligations under the agreement.
 
 
  25
  Cash
Requirements
 Other
than cash on hand, accounts receivable and the proceeds from the subsequent
Fusion stock sale, we have no material unused sources of liquidity at this
time.  Based on our cash position at December 31, 2008 and (a)
assuming expected receivable collections (b) current planned expenditures and
level of operation, and (c) expected cash debt service of $370,000 (assuming
convertible term debt payments are made in shares of common stock) we believe we
will require approximately $0.7 million of additional capital resources for the
next twelve months. Actual results could differ significantly from management
plans. We believe we may be able to obtain such additional funds from future
patent licensing and eVU product sales and services but the timing of licenses
and shipments and the amount and quantities of shipments, orders and reorders
are subject to many factors and risks, many outside our control. Accordingly we
may need equity or debt financing in the next twelve months for working capital
and we may need equity or debt financing for payment of existing debt
obligations and other obligations.
 
 Our
operating plans require additional funds and should additional funds not be
available, we may be required to curtail or scale back staffing or
operations.  Failure to obtain additional financings could have a
material adverse effect on our Company. Our company’s ability to continue as a
going concern is in doubt and is dependent upon achieving sustained
profitability and until then obtaining additional financing. Potential sources
of such funds include exercise of outstanding warrants and options, or debt
financing or additional equity offerings.  However, there is no
guarantee that warrants and options will be exercised or that debt or equity
financing will be available when needed.  Any future financing may be
dilutive to existing stockholders.
 
 In the
future, if our operations increase significantly, we may require additional
funds.  We also may require additional capital to meet our debt and
other commitments, finance future developments, acquisitions or expansion of
facilities.  We currently have no plans, arrangements or
understandings regarding any acquisitions.
 
 Item
4. Controls and Procedures
 Based on
an evaluation of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended)
required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of December 31,
2008, our President and CEO (“Principal Executive Officer” or “PEO”) and Interim
Chief Accounting Officer (“Principal Financial Officer” or “PFO”) have concluded
that our disclosure controls and procedures were not effective in ensuring that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the Commission's rules and forms.
 
 In
connection with the preparation of our annual financial statements, our
management performed an assessment of the effectiveness of internal control over
financial reporting as of March 31, 2008. Management's assessment included an
evaluation of the design of our internal control over financial reporting and
testing of the operational effectiveness of those controls. Based on this
evaluation, management determined that, as of March 31, 2008, there were
material weaknesses in our internal control over financial reporting. The
material weaknesses identified during management's assessment were (i) the lack
of independent oversight by an audit committee of independent members of the
Board of Directors, and (ii) ineffective controls over the period ending closing
process that failed to identify a misclassification of supplier material
transfers during the second and third quarter of fiscal 2008. In light of these
material weaknesses, management concluded that, as of March 31, 2008, we did not
maintain effective internal control over financial reporting. As defined by the
Public Company Accounting Oversight Board Auditing Standard No. 5, a material
weakness is a deficiency or a combination of deficiencies, such that there is a
reasonable possibility that a material misstatement of the annual or interim
financial statements will not be prevented or detected. While management has
taken remediation steps to improve its closing process including additional
management reviews at December 31, 2008 there had been no change in the audit
committee.
 
 In
designing and evaluating our disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management necessarily is required to apply its judgment in
evaluating the relationship between the benefit of desired controls and
procedures and the cost of implementing new controls and
procedures.
 
  26
 
 The
interim consolidated financial statements as of and for the period ended
December 31, 2008 include all adjustments identified as a result of the
evaluation performed.
  CHANGES
IN INTERNAL CONTROL OVER FINANCIAL REPORTING
 As of
December 31, 2008 we are in the process of remediating the second material
weakness identified above which existed at March 31, 2008 by improving our
period ending closing process each quarter. Due to our small size and limited
financial resources we rely on part-time personnel to assist in the closing
process with limited but period to period growing knowledge of daily operations.
Also due to our size and limited resources it is difficult to attract qualified
independent directors and qualified audit committee members. Management has
concluded that with certain management oversight controls that are in place, the
risks associated with the use of part-time personnel in the closing process and
the lack of independent audit committee oversight are not sufficient to justify
the costs of adding personnel, additional directors and independent audit
committee members at this time. Management will periodically reevaluate this
situation. If we secure sufficient capital or improve our operating results it
is our intention to hire additional full-time accounting and reporting personnel
and change the composition and/or size of the Board of Directors with emphasis
on recruiting qualified independent audit committee members. We plan to be
testing and re-evaluating our controls periodically during fiscal
2009.
 
 Other
than described above there were no changes in our internal controls over
financial reporting that could significantly affect internal controls over
financial reporting during the quarter ended December 31, 2008.
 
 PART
II.       OTHER INFORMATION
 
 Item
1. Legal Proceedings
 
 Business
Litigation
 In May
2006, we announced that a complaint had been filed against our Company and
certain of our officers and employees by digEcor, Inc. in the Third Judicial
District Court of Utah, County of Salt Lake. The complaint alleged breaches of
contract, unjust enrichment, breaches of good faith and fair dealing, fraud,
negligent misrepresentation, and interference with prospective economic
relations. digEcor sought, among other things, an injunction to prevent our
Company from selling or licensing certain digital rights management technology
and "from engaging in any competition with digEcor until after 2009." digEcor
also sought "actual damages" of $793,750 and "consequential damages...not less
than an additional $1,000,000." This action was related to a purchase order we
placed for this customer in the normal course of business on November 11, 2005
for 1,250 digEplayers(tm) with our contract manufacturer, Maycom Co., Ltd..
Maycom was paid in full for the order by both e.Digital and digEcor by March
2006, but Maycom failed to timely deliver the order. We recorded an impairment
charge of $603,750 in March 2006 for deposits paid to Maycom due to the
uncertainty of obtaining future delivery. In October 2006 we received delivery
from Maycom of the delayed 1,250-unit digEplayer order and delivered the order
to digEcor. We recognized $713,750 of revenue from this order and reversed an
impairment charge of $603,750 in our third fiscal 2007 quarter.  We have
answered digEcor's complaint and are pursuing certain
counterclaims.
 
 In
January 2007, the Court ruled on certain motions of the parties. In its ruling,
the Court dismissed digEcor's unjust enrichment, fraud, negligent
misrepresentation, tortious interference and punitive damage claims. The Court
further acknowledged the delivery of the 1,250-unit order and a partial
settlement between the parties reducing digEcor's claim for purchase-price or
actual damages from $793,750 to $94,846 with such amount still being disputed by
e.Digital. digEcor's contract and damages claims remain in dispute. digEcor has
subsequently amended its Complaint to assert an alternative breach of contract
claim, and claims for federal, state and common law unfair competition, and
sought an injunction prohibiting us "from engaging in any competition with
digEcor until after 2013."
 
 In April
2007 we filed a second amended counterclaim in the United States District Court
of Utah seeking a declaratory judgment confirming the status of prior agreements
between the parties, alleging breach of our confidential information and trade
secrets by digEcor, seeking an injunction against digEcor's manufacture and sale
of a portable product based on our technology, alleging breach of duty to
negotiate regarding revenue sharing dollars we believe we have the right to
receive and tortious interference by digEcor in our contracts with third
parties. We intend to vigorously prosecute these counterclaims.
 
  27
  In April
2007 digEcor filed a motion for summary judgment seeking enforcement of an
alleged non-compete provision and an injunction prohibiting us from competing
with digEcor. In October 2007 the Court denied, without prejudice, digEcor's
motion for partial summary judgment and request for injunction. The foregoing
and other findings of the Court may be subject to appeal by either
party.
 
 In
September 2008 digEcor filed their third request for a partial summary judgment
again seeking enforcement of the alleged non-compete provision.  digEcor
also asked the Court to rule on issues surrounding the delayed 1250-unit order
and e.Digital's alleged breach of  a 2002 contract between the parties.
 
 In
September 2008 we filed a summary judgment motion seeking a ruling (i) that the
alleged non-compete provision is unenforceable and /or superseded by the 2002
agreement between the parties, and (ii) that the we have not breached any
alleged non-compete provisions or the 2002 agreement.  We also asked the
Court to dismiss digEcor's unfair competition claims and limit digEcor's damages
claim.
 
 The case
has now completed the discovery phase. We voluntarily dismissed some of our
counterclaims, alleging misappropriation of its confidential information and
trade secrets.  We believe we have substantive and multiple defenses
and intend to vigorously challenge the remaining matters and pursue all
remaining counterclaims. However, there can be no assurance we will prevail in
our counterclaims or in our defense of digEcor's remaining claims.
 
 We are
also unable to determine at this time the impact this complaint and matter may
have on our financial position or results of operations. We have an accrual of
$80,000 as an estimate of our obligation related to the remaining general damage
claim and we intend to seek restitution from Maycom for any damages we may
incur. Recovery from Maycom is not assured. Maycom is not involved in the
design, tooling or production of our proprietary eVU mobile product. Moreover,
we do not presently plan or expect to produce or sell digEplayer models to
digEcor or other customers in the future.
 
 Intellectual Property
Litigation
 In
September 2007 and March 2008, we filed a complaint against eight companies in
the U.S. District Court for the Eastern District of Texas asserting that
products made by the listed companies infringe four of our U.S. patents covering
the use of flash memory technology. These patents are part of our Flash-R patent
portfolio. As we license and settle with individual defendants they are dropped
from the complaint. We intend to pursue our claims vigorously against remaining
defendants but the litigation is in the early stage and there is no assurance of
further settlements or recovery. Although most fees, costs and expenses of the
litigation are covered under our contingent fee arrangement with Duane Morris
LLP, we may incur support and related expenses for this litigation that may
become material.
 
 Item 2.Unregistered Sales of Equity
Securities and Use of Proceeds
 (a)
                No
      common shares were issued during the fiscal quarter and not previously
      reported in a Quarterly Report on Form 10-Q or Current Report on Form
      8-K.
 (b)
                NONE
 (c)
                NONE
 
 Item
3. Defaults Upon Senior Securities
 NONE
 
 Item
4. Submission of Matters to a Vote of Security Holders
 NONE
 
 Item
5. Other Information
 (a)
NONE
 (b)
NONE
 
 Item
6. Exhibits
 Exhibit
31.1 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk,
President and CEO (Principal Executive Officer).
 
  28
  Exhibit
31.2 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, signed by Robert Putnam, Interim
Accounting Officer (Principal Accounting Officer).
 
 Exhibit
32.1 – Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, signed by Alfred H. Falk,
President and CEO (Principal Executive Officer) and Robert Putnam, Interim
Accounting Officer (Principal Accounting Officer).
 
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 e.DIGITAL
      CORPORATIONDate:
              February
      10, 2009
              
              By:
              /s/ ROBERT PUTNAMRobert
      Putnam, Interim Chief Accounting Officer(Principal
      Accounting and Financial Officerand
      duly authorized to sign on behalf of the Registrant)
 
  29