|UNITED
STATESSECURITIES
AND EXCHANGE COMMISSIONWashington,
D.C. 20549


FORM 10-Q/A
|-----------------------------------------------------------------------------------

|X | QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934 | 
|- | -------------------------------------------------------------------------------------- | 

|For the
quarterly period ended December 31, 2001


Commission File Number
0-20734


e.Digital Corporation(Exact name of registrant as
specified in its charter)
|---------------------------------------------------------------------------------------------------------------------------------------------------------------

|Delaware(State or other jurisdiction ofincorporation or organization) |  | 33-0865123(I.R.S. Empl. Ident. No.)
|--------------------------------------------------------------------- |  | -----------------------------------

|13114 Evening
Creek Drive South, San Diego, California(Address of principal
executive offices) |  | 92128(Zip Code)
|---------------------------------------------------------------------------------------------- |  | ---------------

|(858) 679-1504(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
|    |  

|Indicate the number of
shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date:
|-----------------------------------------------------------------------------------------------------------------------------

|Common Stock,
par value $0.001(Class) |  | 131,865,870(Outstanding at February 8, 2002)
|------------------------------------- |  | --------------------------------------------

|
|

|e.DIGITAL
CORPORATION


INDEX
|-----------------------------

| |  | Page
| |  | ----

|PART I.
FINANCIAL INFORMATION |  | 
|----------------------------- |  | 

| | Item 1. | Financial Statements (unaudited):
| | ------- | ---------------------------------

| |  | Consolidated Balance
Sheets as of December 31, 2001 andand March 31, 2001 | 3
| |  | ------------------------------------------------------------------------- | -

| |  | Consolidated Statements
of Operations for the three and ninemonths ended December 31, 2001 and 2000 | 4
| |  | --------------------------------------------------------------------------------------------------- | -

| |  | Consolidated Statements
of Cash Flows for the ninemonths ended December 31, 2001 and 2000 | 5
| |  | ----------------------------------------------------------------------------------------- | -

| |  | Notes to
Interim Consolidated Financial Statements | 6
| |  | -------------------------------------------------- | -

| | Item 2. | Managements Discussion and Analysis of FinancialCondition and
Results of Operations | 11
| | ------- | ------------------------------------------------------------------------------------ | --

| | Item 3. | Quantitative and Qualitative Disclosure about Market Risk | 16
| | ------- | --------------------------------------------------------- | --

|PART II. OTHER INFORMATION |  | 
|-------------------------- |  | 

| | Item 1. | Legal Proceedings | 17
| | ------- | ----------------- | --

| | Item 2. | Changes in Securities | 17
| | ------- | --------------------- | --

| | Item 3. | Defaults Upon Senior Securities | 17
| | ------- | ------------------------------- | --

| | Item 4. | Submission of Matters to a Vote of Security Holders | 17
| | ------- | --------------------------------------------------- | --

| | Item 5. | Other Information | 17
| | ------- | ----------------- | --

| | Item 6. | Exhibits and Reports on Form 8-K | 17
| | ------- | -------------------------------- | --

|SIGNATURES |  |  | 18
|---------- |  |  | --

|2
|-

|Part I. Financial Information Item
1. Financial Statements: e.Digital Corporation and subsidiary


CONSOLIDATED BALANCE
SHEETS(UNAUDITED)[Note 1 - Basis of presentation][Expressed in US dollars]
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                     | December 31, 2001$ | March 31, 2001$
|-------------------------------------------------------------------- | ------------------ | ---------------
|ASSETS [note 4]                                                      |                    |                
|Current                                                              |                   
|Cash and cash equivalents                                            |                    | 520,132        
|Certificate of deposit                                               |                    | 58,176         
|Accounts receivable, trade, less allowance of $73,899 and $nil       |                   
|for doubtful accounts, respectively [note 10]                        |                    | 818,796        
|Inventory [note 7]                                                   |                    | 1,173,606      
|Prepaid expenses and other                                           |                    | 101,449        
|                                                                     |                    |                
|Total current assets                                                 |                    | 2,672,158      
|                                                                     |                    |                
|Deferred financing charges                                           |                    | 35,527         
|Property and equipment, net of accumulated depreciation of           |                   
|$328,820 and $213,757, respectively                                  |                    | 295,566        
|Intangible assets, net of accumulated amortization of                |                   
|$34,121 and $27,220, respectively                                    |                    | 26,076         
|Restricted cash [note 9]                                             |                    | 144,724        
|                                                                     |                    |                
|Total assets                                                         |                    | 3,174,052      
|                                                                     |                    |                
|LIABILITIES, REDEEMABLE PREFERRED STOCK                              |                   
|AND COMMON STOCKHOLDERS EQUITY (DEFICIT)                            |                   
|Current                                                              |                   
|Accounts payable, trade [note 8]                                     |                    | 1,824,444      
|Other accounts payable and accrued liabilities                       |                    | 200,807        
|Accrued lease liability [note 8]                                     |                    | 515,000        
|Accrued employee benefits                                            |                    | 188,785        
|Deferred revenue                                                     |                    | 180,703        
|                                                                     |                    |                
|Total current liabilities                                            |                    | 2,909,739      
|                                                                     |                    |                
|Secured promissory notes [note 4]                                    |                    | 705,411        
|                                                                     |                    |                
|Total liabilities                                                    |                    | 3,615,150      
|                                                                     |                    |                
|                                                                     |                    |                
|Redeemable preferred stock [note 3]                                  |                   
|Series C, convertible voting preferred stock, $0.001 par value,      |                   
|redeemable at $10,000 per share plus accrued and unpaid              |                   
|dividends at 7% cumulative, 400 shares authorized, nil and 74 shares |                   
|outstanding, respectively                                            |                    |               
|                                                                     |                    |                
|Total redeemable preferred stock                                     |                    |               
|                                                                     |                    |                
|Commitments and contingencies [notes 1 and 8]                        |                   
|                                                                     |                   
|Common stockholders equity (deficit) [note 5]                       |                   
|Common stock, $0.001 par value, authorized 200,000,000,              |                   
|131,443,491 and 130,175,406 shares outstanding, respectively         |                    | 131,443        
|Additional paid-in capital                                           |                    | 54,308,604     
|Contributed surplus                                                  |                    | 1,592,316      
|Accumulated deficit                                                  |                    | (56,473,461    
|                                                                     |                    |                
|Total common stockholders equity (deficit)                          |                    | (441,098       
|                                                                     |                    |                
|Total liabilities, redeemable preferred stock and common             |                   
|stockholders equity (deficit)                                       |                    | 3,174,052      
|                                                                     |                    |                

|3
|-

|e.Digital
Corporation and subsidiary


CONSOLIDATED STATEMENTS
OF OPERATIONS(UNAUDITED)[Note 1  Basis of presentation][Expressed in US dollars]
|------------------------------------------------------------------------------------------------------------------------------------------------

|                                                        | For the three months endedDecember 31 | For the nine months endedDecember 31
|------------------------------------------------------- | ------------------------------------- | ------------------------------------
|
|Revenues:                                               |                                       |                                     
|Products                                                |                                       | 455,379                             
|Services                                                |                                       | 136,776                             
|                                                        |                                       |                                     
|                                                        |                                       | 592,155                             
|                                                        |                                       |                                     
|Cost of revenues:                                       |                                      
|Products                                                |                                       | 810,739                             
|Services                                                |                                       | 86,506                              
|                                                        |                                       |                                     
|                                                        |                                       | 897,245                             
|                                                        |                                       |                                     
|Gross profit (loss)                                     |                                       | (305,090                            
|                                                        |                                       |                                     
|Operating expenses:                                     |                                      
|Selling and administrative                              |                                       | 868,433                             
|Research and related expenditures                       |                                       | 586,543                             
|                                                        |                                       |                                     
|Total operating expenses                                |                                       | 1,454,976                           
|                                                        |                                       |                                     
|Operating loss                                          |                                       | (1,760,066                          
|                                                        |                                       |                                     
|Other income (expense):                                 |                                      
|Interest income                                         |                                       | 6,660                               
|Loss on disposal of property and equipment              |                                       |                                    
|Gain on sale of investment                              |                                       |                                    
|Interest expense                                        |                                       | (111,147                            
|Other                                                   |                                       |                                    
|                                                        |                                       |                                     
|Other income (expense)                                  |                                       | (104,487                            
|                                                        |                                       |                                     
|Loss and comprehensive loss for the period              |                                       | (1,864,553                          
|Accrued dividends on the Series A and C Preferred stock |                                       |                                    
|                                                        |                                       |                                     
|Loss available to common stockholders [note 2]          |                                       | (1,864,553                          
|                                                        |                                       |                                     
|Loss per common share - basic and diluted[note 2]       |                                       | (0.01                               
|                                                        |                                       |                                     
|Weighted average common shares outstanding              |                                       | 130,862,557                         
|                                                        |                                       |                                     

|4
|-

|e.Digital
Corporation and subsidiary


CONSOLIDATED STATEMENTS
OF CASH FLOWS(UNAUDITED)[Note 1  Basis of presentation][Expressed in US dollars]
|------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                        | For the nine months endedDecember 31,
|----------------------------------------------------------------------- | -------------------------------------
|
|Loss for the period                                                     |                                      
|Adjustments to reconcile loss to net cash used by operating activities: |                                      
|Depreciation and amortization                                           |                                      
|Loss on disposal of property and equipment                              |                                      
|Stock issued as payment to supplier                                     |                                      
|Gain on sale of investment                                              |                                      
|Accrued interest and accretion relating to secured promissory notes     |                                      
|Changes in assets and liabilities:                                      |                                      
|Accounts receivable, trade                                              |                                      
|Inventory                                                               |                                      
|Prepaid expenses and other                                              |                                      
|Accounts payable, trade                                                 |                                      
|Other accounts payable and accrued liabilities                          |                                      
|Accrued employee benefits                                               |                                      
|Deferred revenue                                                        |                                      
|                                                                        |                                      
|Cash (used in) operating activities                                     |                                      
|                                                                        |                                      
|INVESTING ACTIVITIES                                                    |                                      
|Purchase of property and equipment                                      |                                      
|Proceeds from sale of investment                                        |                                      
|Purchase of intangibles                                                 |                                      
|Increase in restricted cash                                             |                                      
|Increase in certificate of deposit                                      |                                      
|                                                                        |                                      
|Cash (used in) investing activities                                     |                                      
|                                                                        |                                      
|FINANCING ACTIVITIES                                                    |                                      
|Proceeds from issuance of secured promissory notes                      |                                      
|Proceeds from sale of Series C preferred stock                          |                                      
|Proceeds from exercise of stock options                                 |                                      
|Proceeds from exercise of warrants                                      |                                      
|Deferred financing charges                                              |                                      
|                                                                        |                                      
|Cash provided by financing activities                                   |                                      
|                                                                        |                                      
|Net (decrease) in cash and cash equivalents                             |                                      
|Cash and cash equivalents, beginning of period                          |                                      
|                                                                        |                                      
|Cash and cash equivalents, end of period                                |                                      
|                                                                        |                                      
|Supplemental schedule of noncash investing and financing activities:    |                                      
|Common stock issued on conversion of Series A preferred stock           |                                      
|Common stock issued on conversion of Series C preferred stock           |                                      
|Deemed dividends on Series A and C preferred stock                      |                                      
|Deemed dividends on warrants                                            |                                      
|Value assigned to warrants issued as private placement fee              |                                      

|5
|-

|E.DIGITAL CORPORATION
AND SUBSIDIARY NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) December
31, 2001



1. NATURE OF OPERATIONS
AND BASIS OF PRESENTATION


E.Digital Corporation (the Company)
is incorporated under the laws of Delaware. The Company offers engineering partnerships
to electronics companies to create portable digital devices that can link to personal
computers (PCs) and the Internet. The Company markets to Original Equipment
Manufacturers (OEMs) complete reference designs and technology platforms with
a focus on digital music and voice player/recorders using the latest in digital storage
media and technology. In September 2001, the Company announced plans to brand and sell
its own line of digital audio products for consumers.


The accompanying unaudited interim
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiary of the same name, based in San Diego, California. The unaudited
interim consolidated financial statements have been prepared, by management, in
accordance with accounting principles generally accepted in the United States for interim
financial information and in the opinion of management reflect all adjustments, which
consist of normal and recurring adjustments, necessary to present fairly the financial
position and results of operations and cash flows of the Company.


The financial statements have been
prepared on the going concern basis, which presumes that the Company will be able to
realize its assets and discharge its liabilities in the normal course of business for the
foreseeable future.


The Company has incurred significant
losses and negative cash flow from operations in each of the last three years and for the
nine month period ended December 31, 2001 and has an accumulated deficit of $56,473,461
at December 31, 2001. As at December 31, 2001 the Company has a working capital
deficiency of $237,580. A substantial portion of the losses is attributable to marketing
costs of the Companys new technology and substantial investments in research and
development of technologies. The Companys operating plans, including its plans to
brand and sell its own line of digital audio products require additional funds which may
take the form of debt or equity financings. There can be no assurance that any additional
funds will be available. The Companys ability to continue as a going concern is in
substantial doubt and is dependent upon achieving a profitable level of operations and,
if necessary, obtaining additional financing.


Management of the Company has
undertaken steps as part of a plan to improve operations with the goal of sustaining
Company operations for the next twelve months and beyond. These steps include (a)
branding and selling its own line of digital audio products; (b) expanding sales and
marketing to OEM customers and markets; (c) controlling overhead and expenses and (d)
raising additional capital and/or financing. There can be no assurance the Company can
successfully accomplish these steps and it is uncertain the Company will achieve a
profitable level of operations and, if necessary, obtain additional financing.


These unaudited interim 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.


These consolidated unaudited interim
financial statements should be read in conjunction with the audited consolidated financial statements
and notes thereto for the year ended March 31, 2001 included in the Companys
Amended Registration Statement on Form S-3 of March 2002.


2. LOSS PER SHARE


The Companys losses for the
periods presented cause the inclusion of potential common stock (Common Stock)
instruments outstanding to be antidilutive and, therefore, the Company is not required to
present a diluted loss per common share. Stock options and warrants exercisable into
8,093,220 shares of Common Stock were outstanding as of December 31, 2001. These
securities were not included in the computation of diluted loss per share because they
are antidilutive, but they could potentially dilute earnings per share in future periods.


The loss available to common
stockholders increased during the nine months ended December 31, 2001and 2000 by accrued
dividends of $26,332 and $68,196, respectively. The loss available to common stockholders
is computed as follows:


6
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|E.DIGITAL CORPORATION
AND SUBSIDIARY NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) December
31, 2001
|---------------------------------------------------------------------------------------------------------------------

|                                                      | For the three months endedDecember 31, | For the nine months endedDecember 31,
|----------------------------------------------------- | -------------------------------------- | -------------------------------------
|
|Loss for the period                                   |                                        | $(1,864,553                          
|Accretion of discount on redeemable                   |                                       
|Series C preferred stock                              |                                        |                                     
|Series B and C preferred stock beneficial conversion  |                                       
|feature                                               |                                        |                                     
|Cumulative catch up adjustment relating to EITF 00-27 |                                        |                                     
|Redemption premium on Series C preferred stock        |                                        |                                     
|Dividends on Series A and C preferred stock           |                                        |                                     
|                                                      |                                        |                                      
|Loss available to common stockholders                 |                                        | $(1,864,553                          
|                                                      |                                        |                                      

|3. REDEEMABLE
PREFERRED STOCK


Series C


On October 5, 2000, the
Company issued 400 shares of 7% Series C convertible preferred stock (the
Series C stock) with a stated value of $10,000 per share and
warrants to purchase 230,946 shares of Common Stock, at $5.20 per share until
October 5, 2005, for gross proceeds of $4,000,000. Dividends of 7% per annum are
payable, with certain exceptions, either in cash or in shares of Common Stock at
the Companys election. The conversion price for each share of Series C
stock is subject to adjustment on the 90th day following the original
issue date from a fixed conversion price of $4.33 to the lower of (i) $4.33 or
(ii) 90% of the average of the five lowest per share market values during the 20
consecutive trading days immediately preceding the conversion date
(Adjusted Conversion Price). The Company also recorded a $400,000
redemption premium on the Series C stock during the quarter ended December 31,
2000. At December 31, 2001, all remaining 74 shares Series C stock were
converted into 912,612 shares of Common Stock.


4. SECURED
PROMISSORY NOTES


12% Promissory Notes


On September 28, 2001, the
Company issued 12% Secured Promissory Notes (SP Notes) for gross
cash proceeds of $1,000,000 to certain accredited investors. The SP Notes mature
December 31, 2002 and are secured by the Companys accounts receivable and
inventory. The interest under the SP Notes accrues at a rate of 12% per annum
simple interest and is payable in one installment on the maturity date. All of
the holders of the SP Notes subsequently have agreed to subordinate their rights
in favor of the rights granted of the holder of the 5% Secured Promissory Note
(5% SP Note) so long as the 5% SP Note is outstanding.


In connection with the sale
of the SP Notes, the Company issued warrants to purchase 750,000 shares of
Common Stock at a purchase price of $0.75 per common share expiring September
20, 2006. The Company has allocated $405,736 of the proceeds raised to the
warrants and $594,264 to the SP Notes based on the relative fair value the
instruments. The discount on the SP Notes will be subject to accretion over
their term to maturity. The Company also issued warrants to purchase 100,000
shares of Common Stock at a purchase price of $0.75 per common share expiring
September 30, 2006, as a finders fee. The estimated fair market value of
these warrants at issuance was $91,034 and has been recorded as a deferred
financing charge related to the SP Notes of $53,734 and $37,300 as a cost of
issuing the warrants charged to Additional Paid in Capital. The deferred
financing charge is being amortized over the term of the SP Notes.


In the event the Company
offers shares of its common stock or securities convertible into shares of
Common Stock in connection with an equity financing, each noteholder shall have
the right and option, at any time prior to the maturity date, subject to and
upon compliance with the provisions and the terms of the equity offering
document, to convert the unpaid principal amount of each SP Notes and accrued
unpaid interest into shares of the Common Stock being offered at a conversion
price equal to the offering price of the Common Stock in effect at the time of
conversion. The Company may recognize a contingent beneficial conversion feature
of $405,736 in the event that it offers its common shares or securities
convertible into common shares in connection with an equity financing, assuming
an effective conversion price of $1.065.


7
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|E.DIGITAL CORPORATION
AND SUBSIDIARY NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) December
31, 2001



4. SECURED PROMISSORY
NOTES (contd)



5% Secured Promissory Note


On January 18, 2002, the
Company issued a 5% SP Note for gross cash proceeds of $1,200,000 to a single
institutional investor. The note matures April 18, 2002 and is secured by all of
the tangible and intangible assets of Company and its wholly owned subsidiary.
The interest under the note accrues at a rate of 5% per annum simple interest
and is payable in one installment on the maturity date. The note ranks senior to
the SP Notes.


5. COMMON STOCKHOLDERSEQUITY
(DEFICIT)


The following table
summarizes common stockholders equity transactions during the nine month
period ended December 31, 2001:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                        | Shares |             | Amount |          | Additionalpaid-in capital |             | Contributedsurplus |            | Accumulateddeficit
|--------------------------------------- | ------ | ----------- | ------ | -------- | ------------------------- | ----------- | ------------------ | ---------- | ------------------
|Balance, March 31, 2001                 |        | 130,175,406 |        | $130,175 |                           | $52,834,970 |                    | $1,592,316 |                   
|Accrued dividends on the Series         |       
|C stock                                 |        |            |        |         |                           |            |                    |           |                   
|Exercise of stock options               |        | 170,000     |        | 170      |                           | 16,830      |                    |           |                   
|Exercise of warrants                    |        | 115,473     |        | 116      |                           | 86,489      |                    |           |                   
|Conversion of the Series C Stock        |        | 912,612     |        | 912      |                           | 821,315     |                    |           |                   
|Value assigned to 70,000 shares         |       
|of common stock issued as               |       
|payment to supplier                     |        | 70,000      |        | 70       |                           | 89,530      |                    |           |                   
|Value assigned to 750,000 warrants      |       
|granted in connection with the issuance |       
|of the 12% SP Notes                     |        |            |        |         |                           | 405,736     |                    |           |                   
|Value assigned to 100,000 warrants      |       
|granted in connection with the issuance |       
|of the 12% SP Notes                     |        |            |        |         |                           | 53,734      |                    |           |                   
|Loss for the period                     |        |            |        |         |                           |            |                    |           |                   
|                                       
|Balance, December 31, 2001              |        | 131,443,491 |        | $131,443 |                           | $54,308,604 |                    | $1,592,316 |                   
|                                       

|6. WARRANTS
AND OPTIONS


At December 31, 2001,
warrants were outstanding and exercisable into the following shares of Common
Stock.
|------------------------------------------------------------------------------------------------------------------------------------

| | Description | Number ofCommon Shares | Exercise Price$ | Expiration Date |      
| | ----------- | ---------------------- | --------------- | --------------- | -----
| | Warrants    |                        | 571,429         |                 | $0.15
| | Warrants    |                        | 500,000         |                 | $0.10
| | Warrants    |                        | 254,041         |                 | $0.75
| | Warrants    |                        | 850,000         |                 | $0.75
| |            
| | Total       |                        | 2,175,470       |                
| |            

|Subsequent to December 31,
2001, 92,379 warrants were exercised for cash proceeds of $62,284.


In connection with the
issuance Preferred Class C shares in October 2000, the company had issued
warrants with an exercise price $5.20. During the quarter ended September 30,
2001, 369,514 warrants which were issued to the investors and a placement agent
in connection with the Series C Stock with an original exercise price of $5.20
were repriced to $0.75. The warrants were repriced pursuant to anti-dilution
protection given to the warrant holders triggered by the exercise price of the
warrants issued in conjunction with sale of the SP Notes. No other terms of the
warrants were effected.


8
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|E.DIGITAL CORPORATION
AND SUBSIDIARY NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) December
31, 2001


6. WARRANTS AND OPTIONS
(contd)



The following table
summarizes stock option activity for the period:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                  | Number ofOptions | Weighted AverageExercise Price |  
| | -------------------------------- | ---------------- | ------------------------------ | -
| | Outstanding at March 31, 2001    |                  | 5,729,000                      |  
| | Granted                          |                  | 685,000                        |  
| | Cancelled                        |                  | (150,000                       | )
| | Exercised                        |                  | (170,000                       | )
| | Forfeited                        |                  | (176,250                       | )
| |                                  |                  |                                |  
| | Outstanding at December 31, 2001 |                  | 5,917,750                      |  
| |                                  |                  |                                |  
| | Exercisable at December 31, 2001 |                  | 3,895,287                      |  
| |                                  |                  |                                |  

|Options outstanding are
exercisable at prices ranging from $0.0875 to $5.46 and expire over the period
from 2002 to 2006 with an average life of 2.4 years. Subsequent to December 31,
2001, 330,000 stock options were exercised for cash proceeds of $29,250.


7. INVENTORY


Inventory is recorded at
the lower of cost and net realizable value. Cost is determined on a first-in,
first-out basis.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | December 31, 2001 | March 31, 2000
| | ----------------- | --------------
| | Finished goods    |               
| | Raw materials     |               
| |                   |               
| |                   |               
| |                   |               

|8. COMMITMENTS
AND CONTINGENCIES


The Company has entered into
a three year fulfillment, storage and freight management agreement with APL
Direct Logistics ending on September 30, 2004. As part of this agreement, the
Company provided APL Direct Logistics with a letter of credit amounting to
$144,724 and prepaid $90,000 to APL Direct Logistics for inbound and outbound
freight management services which will be drawn down upon submission of invoices
from APL. As of December 31, 2001 the Company had a balance in prepaid freight
of $56,903.The Company also paid APL Direct Logistics $14,000 for initial
integration and implementation expenses. The Companys minimum monthly
commitment, which includes call center support, is approximately $46,000.
Depending on the volume of units shipped, this amount may increase. The Company
relies on APL Direct Logistics to provide product fulfillment and customer
support services for e.Digital and its OEM customers and licensees. Failure or
delay by APL Direct Logistics to provide multi-channel sales, fulfillment, and
after-sale support services for the Companys products and those of its
OEMs could adversely affect the Companys ability to deliver products and
provide customer and product support services on a timely and competitive basis.


The Company relies on
Maycom Co., Ltd. and Amistar Corporation for the manufacture and assembly of its
MXP 100 and TREO 10 products, respectively. The Company depends on its contract
manufacturers 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 either 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 each such manufacturer is
subject to the risk of price fluctuations and periodic shortages of components.
The Company has no supply agreements with component suppliers and, accordingly,
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.


Approximately $213,000 of
accounts payable and $515,000 of the accrued lease liability arose in the normal
course of business for services rendered to the Company or for goods delivered
to the Company and were recorded at amounts reflected on the invoices and other
documentation received from third party vendors. These amounts are approximately
five to seven years old. The amounts owing to the vendors are still due but as
the Company has had no contact with them, the amounts may not require
payments. Accordingly, certain of the accounts payable and the accrued lease
liability reflect managements best estimate of the amounts that may be
due. Settlement of these liabilities may be either more or less than the amounts
recorded in the consolidated financial statements and accordingly may be subject
to measurement uncertainty in the near term.



9
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|E.DIGITAL CORPORATION
AND SUBSIDIARY NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) December
31, 2001



In September 2000, the
Company entered into a three-year sublease agreement expiring on July 31, 2003.
The Company is occupying approximately 13,000 square feet with aggregate monthly
lease payments of $15,967 inclusive of utilities and costs. As of December 31,
2001, the total operating lease obligation under the lease for office space is
$311,031.


9. RESTRICTED
CASH


Restricted cash represents
the stand-by letter of credit issued to APL Direct Logistics in the amount of
$144,724 expiring in October 2004.


10. CREDIT RISK


Amounts owing from one
major customer comprise 73% of accounts receivable at December 31, 2001. [March
31, 2001  98%]. Revenue from one customer for the three and the nine
months ended December 31, 2001 amounted to 13% and 54% respectively of total
revenues for the Company. As at December 31, 2001, The Company satisfied its
contractual agreement to this customer and as at December 31, 2001 it had
received no additional purchase orders. The Companys agreement with this
customer has not been renewed and it expects no additional sales.


11. MAJOR
CUSTOMERS AND SUPPLIERS


The Company operates in one
major line of business, the development, manufacture and marketing of electronic
products. Sales to three major customers comprise 81% of revenue for the quarter
ended December 31, 2001 [2000  90%].


The Company has entered
into a supply agreement with two suppliers for the production of products. The
Company has no other significant suppliers.


12.
COMPARATIVE FIGURES


Certain of the comparative
figures have been restated to conform with the current periods presentation.


13. ACCOUNTING
PRONOUCEMENTS


In June 2001, the Financial
Accounting Standards Board issued Statements of Financial Accounting Standards
No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible
Assets. Statement 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. Statement 141 also
includes guidance on the initial recognition and measurement of goodwill and
other intangible assets. Statement 142 prohibits the amortization of goodwill
and intangible assets with indefinite useful lives. Statement 142 requires that
these assets be reviewed for impairment at least annually. Intangible assets
with finite lives will continue to be amortized over their estimated useful
lives. The Company does not expect that the adoption of the Statements to have a
significant impact on the Companys financial position and results of
operations


In August 2001, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets (FAS 144), which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, and the accounting and reporting provisions of APB Opinion No.
30, Reporting the Results of Operations for a disposal of a segment of a
business. FAS 144 is effective for fiscal years beginning after December 15,
2001, with earlier application encouraged. The Company expects to adopt FAS 144
as of April 1, 2002 and does not believe it will have a material impact on the
Companys financial position and results of operations.



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


THE FOLLOWING DISCUSSION
INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE COMPANYS FUTURE
FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY
ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS,
INCLUDING THOSE DESCRIBED BELOW AND UNDER THE SUB-HEADING, BUSINESS
RISKS. SEE ALSO THE COMPANYS ANNUAL REPORT ON FORM 10-KSB FOR THE
YEAR ENDED MARCH 31, 2001.


General


We offer engineering
partnerships with leading companies to create portable digital devices that can
link to PCs, the Internet and other electronic devices. We market our services
and technologies to Original Equipment Manufacturers (OEMs) with a
focus on developing digital music and voice players/recorders using the latest
in digital storage media and technology. We offer complete reference designs and
technology platforms for private labeling by OEMs. We may sometimes integrate
our OEMs unique or proprietary features and/or technology into new
products for their product lines. We focus our marketing efforts on OEMs in
various digital processing markets including digital music, dictation equipment,
consumer electronics, digital image and video and other electronic product
markets. In addition, we recently commenced selling our own branded products on
the Internet.


We have relationships with
ISO certified manufacturing facilities in the United States, Malaysia, Taiwan,
China, Singapore, and Korea. We have expertise in developing, performing and
overseeing manufacturing processes. We license technology and offer
manufacturing supervision, documentation and quality control services to our OEM
customers.


Services offered include
custom hardware, firmware, and software development, technology platform
development, product design, manufacturing services, warranty services, and
licensing of our patented file management systems. Our revenues may result from
the sale of products and fees from engineering services, industrial order
fulfillment, technical support services, warranty services and/or design
services. In some cases, we rely on outside subcontractors to perform services
including manufacturing, testing and certification, industrial design, and
assembly.


In September 2001, we
announced plans to brand and sell our own line of digital audio products for
consumers. The first product in this program is a digital audio player named
MXP100, which incorporates our MicroOS 2.0 and VoiceNav
technologies into a handheld digital music and voice recorder/player. This
product which was launched on our website store on November 2, 2001 incorporates
a proprietary PC software interface program designed and developed by us, called
MXP Music Explorer, that allows users to download MP3 and Windows
Media files from their PCs hard drive to the portable player. The
MXP-100 player uses either Microdrive storage media from IBM or
CompactFlash storage media from SanDisk.


The second product in our
e.Digital branding program is the TREÓ 10 portable large-capacity digital
jukebox. This product incorporates a 10 gigabyte (GB) capacity embedded 2.5-inch
hard disk drive and, using our proprietary MXP Music Explorer PC software
interface, allows users to download MP3 and Windows Media files from their
PCs hard drive to the portable player. This product was launched on our
website store on December 4, 2001. In December, 2001 we also introduced and
began selling through our website store the MXP 100 Sport model, a
version of the MXP-100 featuring a yellow, rubberized finish. This product has
the same features as the first MXP-100 model.


Directly related to our
consumer product sales plans, in September 2001, we signed an agreement with APL
Direct Logistics, a custom fulfillment partner, for product distribution,
fulfillment, and support services. Under the multi-year agreement, which expires
September 30, 2004, APL Direct Logistics will receive our product inventory in
their distribution center in Hebron, Kentucky, and will fulfill orders directly
to consumers. These orders will come from our secure online store, which has
been established at http://www.edigital-store.com. Orders also may come from our
partners, from other online sales sites, from other distributors, from
resellers, or from retail stores. This agreement includes provisions for APL
Direct Logistics or a subcontractor to provide call center support to answer
consumer questions about our e.Digital branded products and to take
orders by phone when necessary. This agreement requires certain minimum payments
to APL Direct Logistics and is for a term of three years (terminating September
30, 2004).


In July 2001, we signed a
royalty-bearing licensing agreement, which expires in October 2004, with Bang
& Olufsen, a premier European electronics, telephony and audio/video
manufacturer. Under this licensing agreement, we customized and provided Bang
& Olufsen a MicroOS based custom product platform for use in their
branded music product line. To date under this agreement we have received
$75,000 in payments for engineering design services from Bang & Olufsen, of
which $72,580 has been deferred in the unaudited interim consolidated financial
statements.


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|In September 2001, we
signed a strategic alliance agreement with DataPlay, Inc. of Boulder, Colorado.
The agreement specifies that we will provide engineering and technology
development to DataPlay, specifically to incorporate DataPlays removable
digital media and micro-optical engine into a variety of portable products. The
agreement also states that DataPlay will refer OEM customers to our Company for
product design, technology integration, and application development around
DataPlays technology. This agreement includes provisions for non-recurring
engineering (NRE) fees to be paid by DataPlay to us and specifies
that we will collect royalties from OEM customers on certain DataPlay-enabled
products. To date we have received $300,788 in payments under this agreement
with respect to NRE fees only, which has been recognized as revenue.


In June 2001, we signed a
royalty-bearing licensing agreement with Hong Kong manufacturer Musical
Electronics, Ltd. Under the agreement, Musical licensed technology from our
Company for use in Musicals OEM products. The agreement calls for Musical
to pay us licensing fees as well as per-unit royalties. On December 3, 2001,
Musical announced that its first product, the Classic XP3, created under their
licensing agreement with e.Digital, will be sold through Circuit City. To date
we have received $50,000 in payments for NRE fees, of which $48,333 has been
deferred in the unaudited interim consolidated financial statements. We have not
received any licensing or royalty payments from Musical under this agreement,
although such royalties are due to commence in or about April 2002 for product
sales occurring during the preceding quarter.


Subsequent to the end of
the quarter, in January 2002, we announced that we collaborated with Evolution
Technologies and DataPlay, Inc. on the development and design of the MTV
DataPlay-enabled music player, which was introduced at the 2002 International
Consumer Electronics Show in Las Vegas. The next-generation portable device,
with DataPlay removable storage media, functions as a music player, a recorder,
an external storage drive, and an optical media burner. Consumers can encode
compressed music files, download content, store and transport files, and
playback user-recorded files and/or pre-recorded content. Under our agreements
with DataPlay and Musical, we will collect royalties on this product.


Also in January 2002, we
announced collaboration with Eclipse by Fujitsu Ten, a car stereo company. Under
our agreement, we are providing advanced integration of digital data management
technology for Eclipse by Fujitsu Tens advanced automotive infotainment
platforms. We have collaborated with Eclipse by Fujitsu Ten for several months
to develop and deliver state-of-the-art automotive OEM and aftermarket
infotainment systems integrating the latest digital audio, voice recognition,
data storage, video, and wireless Internet technologies for sale under the
Eclipse brand name. The first system was unveiled at the 2002 International
Consumer Electronics Show in Las Vegas January 8  11.


We designed, developed and
produced a digital voice recorder and computer docking station for the medical
industry pursuant to a January 1997 development and supply agreement with Lanier
Healthcare, LLC (Lanier). The Lanier Agreement provided that we
would supply product to them through December 2001. The supply agreement
provided for rolling six month requirement forecasts and three month advance
orders.


On December 22, 2000,
Lanier announced that it had completed the sale of its voice processing
(dictation) business (including the Cquence Mobile line) to Platinum Equity, LLC
(Platinum). Platinum announced that this acquisition resulted in an
entity named Lanier Healthcare, which Platinum operates as a stand-alone entity.


During the nine months
ended December 31, 2001, we shipped $856,000 of products to Lanier, compared to
$1,143,865 for the nine months ended December 31, 2000. During the third quarter
ended December 31, 2001, we satisfied our contractual commitment to deliver of
product to Lanier and, to date, have received no additional purchase orders. Our
agreement with Lanier has not been renewed and we expect no additional sales.


We incurred operating
losses in each of the last three fiscal years and these losses have been
material. We incurred an operating loss of $3.9 million in fiscal year 2001 and
$2.6 million in fiscal year 2000. Our current level of monthly cash operating
costs is approximately $425,000 per month. However, we may increase expenditure
levels in future periods to support the launch, marketing, and distribution of
e.Digital branded products, expand our OEM revenue opportunities,
and continue advanced product and technology research and development.
Accordingly, our losses are expected to continue until such time as we are able
to realize supply, licensing, royalty, sales, and development revenues
sufficient to cover the fixed costs of operations. 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 the future.


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|Results of
Operations


Nine months ended
December 31, 2001 compared to nine months ended December 31, 2000


For the nine months ended
December 31, 2001, we reported total revenues of $1,768,429, a 37% increase from
total revenues of $1,304,200 for the nine months ended December 31, 2000.
Revenue for the first nine months ended December 31, 2001 included product
revenue of $1,282,554 compared to $1,144,548 for the nine months ended December
31, 2000. The 12% increase in product
revenues was due to the launch in the quarter ended December 31, 2001 of our
branded portable digital audio products, offset by lower sales of product to
Lanier.


Service revenues for the
nine months ended December 31, 2001 were $485,875, a 204% increase from service
revenues of $159,652 for the nine months ended December 31, 2000. The increase
in service revenue is primarily attributable to the fulfillment of our Dataplay
agreement. The timing and amount of service revenues is dependent upon a limited
number of projects. At December 31, 2001 we had $180,703 of deferred revenue
from NRE contracts, which will be recognized based on the terms and conditions
of each agreement.


For the nine months ended
December 31, 2001, we reported a gross profit of $116,685 compared to a gross
profit of $230,613 for the nine months ended December 31, 2000. Cost of sales
for the nine months ended December 31, 2001 consisted of $1,472,922 of product
costs and $178,822 of contract services consisting mostly of research and
development labor. Gross profit as a percentage of revenue decreased from 17.7%
to 6.6%, due primarily to increased start-up costs relating to the launch of our
branded products. Although we do not anticipate any significant future contract
losses, we cannot guarantee that we can maintain positive gross margins in the
future or with future customers. At the present time warranty costs are not
significant. Our contract supply agreement on Lanier products provides a
twelve-month manufacturing warranty.


Total operating expenses
(consisting of research and related expenditures and selling and administrative
expenses) for the nine months ended December 31, 2001, were $3,987,248, as
compared to $2,824,807 for the nine months ended December 31, 2000. Selling and
administrative costs aggregated $1,907,253 for the nine months ended December
31, 2001 compared to $1,460,290 for the nine months ended December 31, 2001. The
$446,963 increase in selling and administrative costs resulted primarily from an
increase in personnel and benefit costs of $279,991 and an increase of $136,980
in marketing and advertising costs. We anticipate selling and administrative
expenses to continue at higher levels than prior periods due to additional costs
involved in branding and selling our own line of digital audio products and
increased number of personnel compared to the prior year.


Research and related
expenditures for the nine months ended December 31, 2001 were $2,079,995, as
compared to $1,364,517, for the nine months ended December 31, 2000. The
$715,478 increase in research and development costs resulted primarily from the
increase of $609,281 in personnel and benefit costs, a $29,032 increase in
travel and related costs and an increase of $34,581 for artwork, consulting and
other material costs, offset by a decrease of $86,952 in other engineering
costs. Research and development costs are subject to significant quarterly
variations depending on the use of outside services, the assignment of engineers
to development projects and the availability of financial resources.


We reported an operating
loss of $3,870,562 for the nine months ended December 31, 2001, as compared to
an operating loss of $2,594,194 for the nine months ended December 31, 2000. The
increase loss resulted primarily from increased operating expenses. We believe,
but we cannot guarantee, that our strategy of investing in OEM developments with
supply or royalty provisions, when combined with our own e.Digital
branded products, will provide positive margins in future periods. The timing
and amount of product sales and the recognition of contract service revenues
impact our operating losses. Accordingly, there is uncertainty about future
operating results and the results for the nine months ended December 31, 2001
are not necessarily indicative of operating results for future periods or the
fiscal year.


We reported a loss for the
nine months ended December 31, 2001 of $3,899,537 as compared to a loss of
$2,459,086 for the nine months ended December 31, 2000.


The loss available to
common stockholders for the nine months ended December 31, 2001 is $7,007,172.
Included in the loss available to common stockholders for the nine months ended
December 31, 2001 is an accrued dividend of $26,332 on the Series C stock and a
beneficial conversion feature of $3,081,303 computed from the discount provision
included in the Series C stock. As at December 31, 2001 all 400 shares had been
converted into common stock. The loss available to common stockholders for the
nine months ended December 31, 2000 is $4,145,979. Included in the loss
available to common stockholders for the nine months ended December 31, 2000 are
accrued dividends on the Series A and C stock of $529 and $67,667, respectively,
$582,905 which represents accretion on the discount on the Series C stock and
$335,792 relating to the Series C stock beneficial conversion feature. In
connection with the issuance of EITF 00-27, the Company recorded as a cumulative
catch up adjusted to retained earnings of $300,000 which increased additional
paid in capital and accumulated deficit and increased the loss per share for the
quarter ended December 31, 2000. The Company also recorded a $400,000 redemption
premium on the Series C stock.


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|Three months ended
December 31, 2001 compared to three months ended December 31, 2000


For the three months ended
December 31, 2001, we reported total revenues of $592,155, a 615% increase from
the $82,843 total revenues for the three months ended December 31, 2000. Revenue
for the three months ended December 31, 2001 included product revenue of
$455,379 compared to $44,383 for the three months ended December 31, 2000. The
increase in product revenues was due to the launch in the quarter ended December
31, 2001 of our branded portable digital audio products. Service revenues for
the three months ended December 31, 2001 were $136,776, a 256% increase from
service revenues of $38,460 for the three months ended December 31, 2000. The
increase in service revenue is primarily attributable to the recognition of NRE
fees associated with the fulfillment of the Dataplay agreement. The timing and
amount of service revenues is dependent upon a limited number of projects.


For the three months ended
December 31, 2001, we reported a gross loss of $305,090 compared to a gross loss
of $9,486 for the three months ended December 31, 2000. Cost of sales for the
three months ended December 31, 2001 consisted of $810,739 of product costs and
$86,506 of contract services consisting mostly of research and development
labor. The increased gross loss for the quarter ended December 31, 2001 is due
primarily to increased start-up costs relating to the launch of our branded
products and fulfillment of the Lanier contract.


Total operating expenses
(consisting of research and related expenditures and selling and administrative
expenses) for the three months ended December 31, 2001, were $1,454,977, as
compared to $1,251,943 for the three months ended December 31, 2000. Selling and
administrative costs aggregated $868,434 for the three months ended December 31,
2001 compared to $705,288 for the three months ended December 31, 2001. The
$163,146 increase in selling and administrative costs resulted primarily from an
increase in personnel and benefit costs of $51,074 an increase of $62,413 in
marketing and advertising costs and an increase of $15,879 in trade shows and
related costs. We anticipate selling and administrative expenses to continue at
higher levels than prior periods due to additional costs involved in branding
and selling our own line of digital audio products and increased number of
personnel compared to the prior year.


Research and related
expenditures for the three months ended December 31, 2001 were $586,543, as
compared to $546,655, for the nine months ended December 31, 2000. The $39,888
increase in research and development costs resulted primarily from personnel and
related costs. Research and development costs are subject to significant
quarterly variations depending on the use of outside services, the assignment of
engineers to development projects and the availability of financial resources.


We reported an operating
loss of $1,760,066 for the three months ended December 31, 2001, as compared to
an operating loss of $1,261,429 for the three months ended December 31, 2000.
The increase loss resulted primarily from increased operating expenses. We
believe, but we cannot guarantee, that our strategy of investing in OEM
developments with supply or royalty provisions, when combined with our own
e.Digital branded products, will provide positive margins in future
periods. The timing and amount of product sales and the recognition of contract
service revenues impact our operating losses. Accordingly, there is uncertainty
about future operating results and the results for the three months ended
December 31, 2001 are not necessarily indicative of operating results for future
periods or the fiscal year.


We reported a loss for the
three months ended December 31, 2001 of $1,864,553 as compared to a loss of
$1,193,274 for the three months ended December 31, 2000.


The loss available to
common stockholders for the three months ended December 31, 2001 and 2000 is
$1,864,553 and $2,880,167, respectively. Included in the loss available to
common stockholders for the three months ended December 31, 2000 are accrued
dividends on the Series A and C stock of $68,196, $582,905 which represents
accretion of the discount on the Series C stock and $335,792 relating to the
Series C stock beneficial conversion feature. In connection with the issuance of
EITF 00-27, the Company recorded as a cumulative catch up adjusted to retained
earnings of $300,000 which increased additional paid in capital and accumulated
deficit and increased the loss per share for the three months ended December 31,
2000. The Company also recorded a $400,000 redemption premium on the Series C
stock.



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|Liquidity and
Capital Resources


At December 31, 2001, we
had working capital deficit of $237,580 compared to a working capital of
$2,445,655 at March 31, 2001. We had $1,173,606 of working capital invested in
inventory at December 31, 2001. Cash used in operating activities for the nine
months ended December 31, 2001 was $3,909,221 resulting primarily from the loss
for the period and the increased investment in inventory, offset by an increase
in accounts payable. During the nine months ended December 31, 2001, the Company
purchased $86,413 in property and equipment. For the nine months ended December
31, 2001, net cash and cash equivalents decreased by $2,991,373.


At December 31, 2001, we
had net accounts receivable of $818,796 as compared to $530,014 at March 31,
2001. This represented approximately 159 days of revenues. The increase in
receivables resulted from increased product sales and a delayed collection of
the amount in the current period. Receivables can vary dramatically due to the
timing of product shipments and contract arrangements on development agreements.
As at December 31, 2001, $600,000 was due from one customer and we have
negotiated with this customer that the amount outstanding will be repaid before
March 31, 2002 in equal monthly installments.


At December 31, 2001, we
had cash and cash equivalents of $520,132. Other than cash and cash equivalents
and accounts receivable, we have no material unused sources of liquidity at this
time. We have no material commitments for capital expenditures or resources.
Based on our cash position assuming (a) introduction of the
e.Digital branded products (b) expansion of existing OEM
arrangements, and (c) currently planned expenditures and level of operation, we
believe we have sufficient capital resources for the next 6-9 months. However
actual results could differ significantly from management plans. The actual
future margins to be realized, if any, and the timing of shipments and the
amount and quantities, orders and reorders are subject to many factors and
risks, many outside our control.


Since March 31, 2001, we
have experienced substantial reduction in cash, projected revenues and increased
costs that adversely affect our current result of operations and liquidity. Our
operating plans, including our plans to brand and sell our own line of digital
audio products, require additional funds which may take the form of debt or
equity financings. There can be no assurance that any additional funds will be
available. Our Companys ability to continue as a going concern is in
substantial doubt and is dependent upon achieving a profitable level of
operations and, if necessary, obtaining additional financing.


Management of our Company
has undertaken steps as part of a plan to improve options with the goal of
sustaining our operations for the next twelve months and beyond. These steps
include (a) branding and selling our own line of digital products; (b) expanding
sales and marketing to OEM customers and markets; (c) controlling overhead and
expenses; and (d) raising, if necessary additional capital and/or financing.


On September 28, 2001, the
Company issued 12% Promissory notes (SP Notes) for gross cash
proceeds of $1,000,000 to certain accredited investors. The SP Notes mature
December 31, 2002 and are secured by our accounts receivable and inventory. The
interest under the SP Notes accrues at a rate of 12% per annum simple interest
and is payable in one installment on the maturity date. In connection with the
sale of the SP Notes, the Company issued warrants to purchase 750,000 shares of
common stock at a purchase price of $0.75 per common share expiring September
30, 2006. The proceeds raised have been allocated to the SP Notes and warrants
based on their relative fair value.


On January 18, 2002, we
issued a 5% Secured Promissory Notes (5% SP Note) for gross cash
proceeds of $1,200,000. The 5% SP notes matures April 18, 2002 and is secured by
all assets of our Company including, without limitation, our intellectual
property. The interest under the 5% SP Notes accrues at a rate of 5% per annum
simple interest and is payable in one installment on the maturity date.


We are actively seeking
additional equity financing. There can be no assurance that any additional
financings will be available to our Company on satisfactory terms and
conditions, if at all. Failure to obtain additional financings will have a
material adverse affect on our Company. Should additional funds be required and
not be available, we may be required to curtail or scale back staffing or
operations. Potential sources of such funds include exercise of outstanding
warrants and options, loans from stockholders or other debt financing or equity
offerings. However, there is no guarantee that warrants and options will be
exercised or that loans, debt or equity financing will be available. We may,
from time to time, seek additional funds through lines of credit, public or
private debt or equity financing. We estimate that we will require additional
capital to finance future developments and improvements to our technology. We
can not guarantee that additional capital will be available when needed. Any
future financing may be dilutive to existing stockholders.


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|There can be assurance that
we can successfully accomplish these steps and it is uncertain whether our
Company will achieve a profitable level of operations and, if necessary, obtain
additional financing.


Future
Commitments and Financial Resources


We have entered into a
three year fulfillment, storage and freight management agreement with APL Direct
Logistics ending on September 30, 2004. As part of this agreement, we provided
APL Direct Logistics with a letter of credit amounting to $144,724, we paid
$90,000 to APL Direct Logistics as escrow deposit for inbound and outbound
freight management services and we paid APL Direct Logistics $14,000 for initial
integration and implementation expenses. Our minimum monthly commitment amount,
which includes call center support, is approximately $46,000. Depending on the
volume of units shipped, this amount may increase.


Certain accounts payable
and the accrued lease liability reflect managements best estimate of
amounts due for matters in dispute. Settlement of these liabilities may either
be more or less than the amounts recorded in the unaudited interim consolidated
financial statements and accordingly may be subject to measurement uncertainty
in the near term. In the future, if our operations increase significantly, we
may require additional funds. We also may require additional capital to finance
future developments, acquisitions or expansion of facilities. We currently have
no plans, arrangements or understandings regarding any acquisitions.


We have an agreement with
the supplier of products for our major product customer (Lanier). In the event
that this customer cancels or reduces its orders, we may be required to purchase
from the supplier up to one months finished goods orders and all work in
progress, raw materials and any excess materials. Subsequent to December 31,
2001, we satisfied our contractual commitment for delivery of all products and
have not received any additional purchases orders.


In September 2000, we
entered into a three-year sublease agreement expiring on July 31, 2003. We are
occupying approximately 13,000 square feet with aggregate monthly lease payments
of $15,967 inclusive of utilities and costs. As of December 31, 2001, the total
operating lease obligation under the lease for office space is $311,031.


Business Risks


This report contains a
number of forward-looking statements that reflect our current views with respect
to future events and financial performance. These forward-looking statements are
subject to certain risks and uncertainties 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 and
substantial business risk factors described above and in the Companys
Annual Report on Form 10-KSB for the year ended March 31, 2001 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.


Item 3.
Quantitative and Qualitative Disclosure about Market Risk


Market risk represents the
risk of loss that may impact our financial position, results of operations or
cash flows due to adverse changes in market prices, including interest rate risk
and other relevant market rate or price risks.


We are exposed to some
market risk through interest rates, related to our investment of our current
cash and cash equivalents of $520,132. A 10% change in market interest rates
would not have a material affect on earnings or cash flows. We do not consider
this risk to be material, and we manage the risk by continuing to evaluate the
best investment rates available for short-term high quality investments.


The Companys
operating plans, including its plans to brand and sell its own line of digital
audio products require additional funds which may take the form of debt or
equity financings. There can be no assurance that any additional funds will be
available.



16
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|PART II. OTHER
INFORMATION


Item 1. Legal
Proceedings


We are involved in routine
litigation incidental to the conduct of our business. There are currently no
material pending legal proceedings to which we are a party or to which any of
our property is subject.


Item 2.
Changes in Securities
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(a) |  | NONE
|--- |  | ----

|(b) |  | NONE
|--- |  | ----

|(c) |  | Subsequent to December 31, 2001, the Company issued the 5% SP Note for gross
cash proceeds of $1,200,000 to an institutional investor. The note matures April
18, 2002 and is secured by all of the tangible and intangible assets of Company
and its wholly owned subsidiary. The interest under the note accrues at a rate
of 5% per annum simple interest and is payable in one installment on the
maturity date. The 5% SP Note ranks senior to the 12% SP Notes.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The description of this
transaction is qualified in its entirety by the full text of the 5% SP Note
filed as Exhibit 4.9 to Registration Statement No. 333-82272.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(d) |  | NONE
|--- |  | ----

|Item 3.
Defaults Upon Senior Securities


NONE


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


At the Companys
fiscal 2001 Annual Meeting of Stockholders held on November 6, 2001 the
following individuals, constituting all of the members of the Board of Directors
were elected: Allen Cocumelli, Alfred H. Falk, Robert Putnam, Walter
Skip Matthews, Victor Ramsauer and Robert Jecmen.


The following proposals
were approved at the Companys Annual Meeting of Stockholders:


1. ELECTION OF DIRECTORS:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                        | Affirmative Votes | Negative Votes | Votes Withheld
| | ---------------------- | ----------------- | -------------- | --------------
| | Allen Cocumelli        |                   | 123,500,220    |               
| | Alfred H. Falk         |                   | 124,523,602    |               
| | Robert Putnam          |                   | 123,168,435    |               
| | Walter Skip Matthews |                   | 123,515,640    |               
| | Victor G Ramsauer      |                   | 123,512,727    |               
| | Robert Jecmen          |                   | 123,470,880    |               

|2. PROPOSAL TO RATIFY THE
APPOINTMENT OF ERNST & YOUNG LLP, AS THE INDEPENDENT AUDITORS OF THE COMPANY
FOR THE FISCAL YEAR ENDING MARCH 31, 2002.
|-------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Affirmative Votes | Negative Votes | Votes Withheld
| |  | ----------------- | -------------- | --------------
| |  |                   | 124,860,632    |               

|Item 5. Other
Information


NONE


Item 6.
Exhibits and Reports on Form 8-K
|---------------------------------------------------------------------------

|(a) |  | Exhibits
|--- |  | --------

| |  | NONE
| |  | ----

|(b) |  | Reports
on Form 8-K
|--- |  | -------------------

| |  | NONE
| |  | ----

|17
|--

|SIGNATURES


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

| | e.DIGITAL
CORPORATION
| | ---------------------

|Date:
March 22, 2002 | By: | /s/ RAN FURMANRan Furman, Chief
Financial Officer (Principal Financial and Accounting Officer and duly authorized to sign
on behalf of the Registrant)
|-------------------- | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|18
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