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[ISSUER
LETTERHEAD]
February
28, 2008
Securities
and Exchange Commission
Division
of Corporation Finance
Mail
Stop
6010
Washington,
D.C. 20549
Attn:
Mr.
Brian
Cascio, Accounting Branch Chief
Gary
Todd
RE:
e.Digital
Corporation
Form
10-K
for the fiscal year ended March 31, 2007
File
No.
000-20734
Dear
Mr.
Cascio:
This
letter is in response to staff comments dated February 13, 2008.
We
acknowledge on behalf of the company that:
| · |
the
company is responsible for the adequacy and accuracy of the disclosure
in
the filing;
|
| · |
staff
comments or changes to disclosure in response to staff comments do
not
foreclose the Commission from taking any action with respect to the
filing; and
|
| · |
the
company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
laws of the United States.
|
The
itemized responses below are keyed to and respond to the same comment number
enumerated in your letter dated February 13, 2008.
Comment
1.
Please tell us and more specifically disclose how and when you recognize revenue
for content and related services, including how you recognize revenue when
you
have been engaged to provide both hardware and content. The written response
should also address the basis in GAAP for your underlying
policies.
Response
1.
In
late calendar 2006 we commenced selling hardware (eVU video hard-drive playback
units) and offering services to periodically encode and update content (movies,
music, games etc.) for players to customers. Prior to that time our video
hardware product revenues were from sales to customers that provided their
own
content services. Our prior service revenue (FY 2005 and 2006) was primarily
from research and development contracts for customers.
As
disclosed in the body of our 10-K content services include coding
content (purchased by us or provided by the customer), integrating the content
with our proprietary GUI (graphical user interface) software to produce a master
content file (containing content and the customized GUI interface) for rapid
uploading to multiple players. Our GUI allows ease of use and can accommodate
multiple languages. Our tested and Hollywood studio approved encryption methods
protect content from being pirated. These services allow protected content
on
eVU players to be periodically updated through e.Digital Content Loading
Stations by our customers or VARs or others on their behalf.
For
the period ended March 31, 2007 we had no content service revenue as we had
yet
to provide a customer with such a periodic content load (See response 2 below
for current policy). We concluded after an analysis including Statement
of Financial Accounting Concepts No. 5, Staff Accounting Bulletin No. 104 and
EITF Issue No. 00-21
that hardware sales and the provision of periodic content services were separate
accounting elements. We used the application guidance contained in Issue #1
of
EITF 00-21 which lists three criteria that a deliverable must meet, within
a
multiple element arrangement, in order to qualify as a separate unit of
accounting:
| (a) |
The
delivered item(s) has value to the customer on a standalone
basis,
|
| (b) |
There
is objective and reliable evidence of the fair value of the undelivered
item(s), and
|
| (c) |
If
the arrangement includes a general right of return relative to the
delivered item, delivery or performance of the undelivered item(s)
is
considered probable and substantially in control of the
vendor.
|
Each
element (hardware and content services) has standalone value to the customer
and
there is objective and reliable evidence of the fair value of each element
and
no general right of return exists. We separately price each element for certain
customers. We have sold players separately in the past without providing content
services. And other vendors provide competing hardware and other vendors and
customers provide competing content services.
Our
initial customer relationships separately priced and provided separate contract
arrangements for the hardware sales versus content services but we determined
that if future arrangements do not separately price hardware sales and a series
of content services that the values would be allocated based on the best
evidence available. In our current fiscal year we entered into one such
arrangement where the pricing included hardware and a series of future content
services.
Comment
2.
Please revise future filings to specifically identify when you apply multiple
element accounting. In that regard, please identify the multiple elements
involved, state how you determine fair value of the individual elements and
describe the revenue policy for each element. Overall, your disclosure should
clarify why you believe the transactions are appropriately accounted for as
multiple element arrangements as described in EITF 00-21.
Response
2.
Our
first transaction with multiple elements that was not separately contracted
and
priced occurred in Q2 of FY 2008. We point staff to our disclosure starting
in
our second quarterly report on Form 10-Q for the current year in a subsection
entitled “Critical Accounting Policies” of Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
This
expanded revenue recognition policy disclosure reflects the fact that content
services became a larger element of accounting and our Company had its first
arrangement that combined multiple elements in one contract. This expanded
and
revised policy from our Form 10-Q for the second quarter ended September 30,
2007 and filed on November 9, 2007 from page 15 states:
.
. .
As
our revenues from both products and services related to our eVU product line
have increased we have refined and expanded our critical accounting policy
titled “Revenue Recognition” as follows:
Revenue
recognition
The
Company recognizes product revenue upon shipment of a product to the customer,
FOB shipping point, or upon acceptance by the customer depending on the specific
contract terms, if a signed contract exists, the fee is fixed and determinable,
collection of resulting receivables is probable and there are no resulting
obligations. Research and development contract revenues on short-term projects
or service revenue is recognized once the services or product has been
delivered, the fee is fixed and determinable, collection of the resulting
receivable is probable and there are no resulting obligations. If all of the
service or product has been delivered and there is one element that is more
than
perfunctory to the services or product that has not been delivered, revenue
will
be recognized evenly over the remaining term of the undelivered
element.
The
Company enters into arrangements that include multiple elements such as hardware
and content and other services. Revenue from these arrangements is allocated
based on the fair value of each element. The Company defers revenue for any
undelivered elements, and recognizes revenue when the product is delivered
or
over the period in which the service is performed, in accordance with the
Company’s revenue recognition policy for such element. If the Company cannot
objectively determine the fair value of any undelivered element included in
a
multiple-element arrangement, revenue is deferred until all elements are
delivered and/or services have been performed, or until the Company can
objectively determine the fair value of all remaining undelivered
elements.
Revenue
from separately priced extended warranty or product replacement arrangements
is
deferred and recognized to income on a straight-line basis over the contract
period. The Company evaluates these arrangements to determine if there are
excess costs greater than future revenues to be recorded as a loss.
Funds
received in advance of meeting the criteria for revenue recognition are deferred
and are recorded as revenue as they are earned.
We
will
revise future filings to specifically identify when we apply multiple element
accounting and identify the multiple elements involved, the determination of
the
fair value of individual elements and our revenue policy for each element.
We
understand it is our responsibility to account for such multiple element
transactions as described in EITF 00-21. We
will expand our 10-Q policy description above and disclosure in future filings
additional information on how we determine fair value (prices regularly used
with other customers) and disclosing that content revenue is recognized when
the
content services are delivered to the customer and other revenue elements are
met.
Comment
3.
In
future filings, please also describe the circumstances that result in long-term
deferred revenue.
Response
3.
In future filings we will describe the circumstances that result in long-term
deferred revenue which to date have principally been provision of content
services and separately priced extended warranties.
Comment
4.
We
see from page 23 that you reduced accrued liabilities by $515,000 for a disputed
lease liability. Please tell us about the background and nature of the dispute
related to the lease liability. Please also clarify why you believe that the
expiration of the statute of limitations negates the legal liability that should
be recorded under U.S. GAAP. Please specifically address the requirements of
paragraph 16 to SFAS 140.
Response
4.
In our FY2007 Q4 we reduced accrued liabilities by $515,000. This liability
was
described in prior filings as:
We
have an accrued lease liability of $515,000 that arose in the normal course
of
business for equipment delivered to the company. This amount is approximately
nine years old. The accrued lease liability reflects management's best estimate
of amounts due for matters in dispute. Settlement of this liability may either
be more or less than the amount recorded in the audited consolidated financial
statements and accordingly may be subject to measurement uncertainty in the
near
term.
This
line item was also discussed in prior fair value policy notes in our financial
statements.
The
$515,000 reduction in accrued liabilities was described and quantified in the
overall performance and the results of operations sections of our
MD&A.
Background
and Nature of Accrual
This
liability arose in 1997 when we discontinued certain contract manufacturing
services and returned a chip on board machine under lease from Comdisco and
had
been carried on the balance sheet since that time period.
Although
we concluded at that time that some amount may be owed we were unable to
validate the claim by the lessor or obtain documentation regarding their
computation of the claimed amount. This was apparently due to multiple sales
of
the subject leasing legal entity to a series of companies and the financial
failure of same. So while we had an invoiced amount we were not convinced that
the lessor had actually incurred such a loss on the early takeback of the leased
equipment. Since no attempt was made to collect by any entity during the ensuing
years we disclosed the nature of the item in the future commitments section
of
our 10-Ks identifying it as both being in dispute and subject to measurement
uncertainty.
Negation
of Legal Liability and GAAP
Based
on discussions with counsel we have been advised that after ten years in the
state of Illinois it is improbable that this liability could be enforced.
Since
no
further action is contemplated related to this item, the tolling of the statute
of limitations could be considered an effective judicial release under Paragraph
16(b) of SFAS 140. International Accounting Standards IAS
39.AG 57(b) uses the term “process of law” rather than judicial release and we
believe the statute of limitations tolling qualifies for debt
derecognition. However,
we
note that Paragraph 4 of SFAS 140 states: “This Statement does not address
subsequent measurement of assets and liabilities, except for (a) servicing
assets and servicing liabilities.” We do not believe the accrued lease liability
is a servicing liability (Glossary of SFAS 140). The liability does not related
to servicing a financial asset. The extinguishment of liabilities discussion
at
Paragraph 309 et.al. refers to this scope limitation and Paragraph 315
specifically refers to liabilities within the scope of Paragraph 4. We do not
believe the referenced debt is within the scope of Paragraph 4 and that
accounting is more appropriate under APB 26, as amended and SFAS 5. APB 26
paragraph 3(a) refers to those instances where SFAS 140 is applicable. A
distinction exists between the extinguishment of liability (SFAS 140) versus
extinguishment of debt (APB 26). APB 26 applies to “all extinguishments of debt,
whether early or not,” (Paragraph 2) and accordingly we do not believe it
requires a payment to settle (the process of law could suffice). Paragraph
19
and 20 provide that regardless of the means to achieve extinguishment that
the
gain should be in current income.
Also
we view the original accrual made ten years ago as an estimate of what was
possibly due on settling a claim on the equipment lease takeback, effectively
a
loss contingency for an actual or possible claim under SFAS 5. Factors to be
considered under Paragraph 33 include the period in which an actual or possible
claim occurred and the probability of unfavorable outcome. We believe the
tolling of the statute of limitations made the probability of unfavorable
outcome to now be remote. Although nonauthoritative, AICPA Technical Practice
Aids Section 3400.01 discusses a contested liability that is extinguished upon
the statute of limitations effectively baring filing suit (in our case the
statute of limitations effectively bars collection of the contested debt).
Comment
5.
As
a related matter the notes to future financial statements should include a
description of this transaction and the basis in GAAP for the accounting
applied. In addition, please note that the impact of any unusual material items
included in operating results should be described and quantified in
MD&A.
Response
5.
In future financial statements we will provide a description of this transaction
and the GAAP basis for recording the gain in fiscal 2007. The impact of unusual
material items that are included in operating results will be described and
quantified in MD&A.
We
hope that the foregoing responses satisfactorily address the Staff’s comments.
Please do not hesitate to call the undersigned at 858-304-3016, Ext 205 if
we
can address any follow-up questions or if the staff has any further
comments.
Sincerely,
/s/
Robert Putnam
Robert
Putnam
Interim
Chief Accounting Officer