|UNITED
STATES
SECURITIES AND EXCHANGE COMMISSIONWashington,
D.C. 20549



FORM 10-Q



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


For the
quarterly period ended September 30, 2001


Commission File Number
0-20734


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

|                                                                              | 
|----------------------------------------------------------------------------- | 
|Delaware                                                                      | 
|(State or other jurisdiction of                                               | 
|incorporation or organization)                                                | 
|                                                                             
|13114 Evening Creek Drive South, San Diego, California                        | 
|(Address of principal executive offices)                                      | 
|                                                                             
|(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     NO



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)                        | 

|
|

|e.DIGITAL
CORPORATION


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

|                              |    |         | 
|----------------------------- | -- | ------- | 
|                              |    |         | 
|PART I. FINANCIAL INFORMATION
|                             
|                              |    | Item 1. | 
|                             
|                              |    |         | 
|                              |    |         | 
|                             
|                              |    |         | 
|                              |    |         | 
|                             
|                              |    |         | 
|                              |    |         | 
|                             
|                              |    |         | 
|                             
|                              |    | Item 2. | 
|                              |    |         | 
|                             
|                              |    | Item 3. | 
|                             
|PART II. OTHER INFORMATION   
|                             
|                              |    | Item 1. | 
|                              |    | Item 2. | 
|                              |    | Item 3. | 
|                              |    | Item 4. | 
|                              |    | Item 5. | 
|                              |    | Item 6. | 
|                             
|SIGNATURES                    | 15 |        

|2
|-

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


CONSOLIDATED BALANCE
SHEETS (UNAUDITED) [Expressed in US dollars]
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                | September 30, 2001$ | March 31, 2001$
|--------------------------------------------------------------- | ------------------- | ---------------
|ASSETS                                                          |                     |                
|Current                                                         |                    
|Cash and cash equivalents                                       |                     | 2,348,706      
|Certificate of deposit                                          |                     | 56,721         
|Accounts receivable, trade, less allowance of $61,121 and $nil  |                    
|for doubtful accounts, respectively [note 4 and 9]              |                     | 985,428        
|Inventory [notes 4 and 7]                                       |                     | 52,634         
|Prepaid expenses and other                                      |                     | 17,358         
|Deferred charges                                                |                     | 91,034         
|                                                                |                    
|Total current assets                                            |                     | 3,551,881      
|                                                                |                    
|Property and equipment, net of accumulated depreciation of      |                    
|$275,262 and $213,757, respectively                             |                     | 305,712        
|Intangible assets, net of accumulated amortization of           |                    
|$46,729 and $27,220, respectively                               |                     | 35,830         
|                                                                |                    
|Total assets                                                    |                     | 3,893,423      
|                                                                |                    
|                                                                |                    
|LIABILITIES, REDEEMABLE PREFERRED STOCK                         |                    
|AND COMMON STOCKHOLDERS EQUITY                                 |                    
|Current                                                         |                    
|Accounts payable, trade [note 8]                                |                     | 1,117,753      
|Other accounts payable and accrued liabilities                  |                     | 88,913         
|Accrued lease liability [note 8]                                |                     | 515,000        
|Accrued employee benefits                                       |                     | 232,998        
|Deferred revenue                                                |                     | 76,945         
|                                                                |                    
|Total current liabilities                                       |                     | 2,031,608      
|                                                                |                    
|Secured promissory notes [note 4]                               |                     | 594,264        
|                                                                |                    
|Total liabilities                                               |                     | 2,625,872      
|                                                                |                    
|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, 400 shares authorized, 74 and 74 shares              |                    
|outstanding, respectively at 7% cumulative                      |                     | 822,227        
|                                                                |                    
|Total redeemable preferred stock                                |                     | 822,227        
|                                                                |                    
|Commitments and contingencies [notes 1, 8 and 10]               |                    
|                                                                |                    
|Common stockholders equity [note 5]                            |                    
|Common stock, $0.001 par value, authorized 200,000,000,         |                    
|130,175,406 and 130,175,406 shares outstanding, respectively    |                     | 130,175        
|Additional paid-in capital                                      |                     | 53,331,740     
|Contributed surplus                                             |                     | 1,592,316      
|Accumulated deficit                                             |                     | (54,608,907    
|                                                                |                    
|Total common stockholders equity                               |                     | 445,324        
|                                                                |                    
|Total liabilities, redeemable preferred stock and common        |                    
|stockholders equity                                            |                     | 3,893,423      
|                                                                |                    

|See notes to interim consolidated
financial statements



3
|-----------------------------------------------------------

|e.Digital
Corporation and subsidiary

CONSOLIDATED STATEMENTS
OF OPERATIONS (UNAUDITED)[Expressed in US dollars]
|----------------------------------------------------------------------------------------------------------------

|                                                        | For the three months endedSeptember 30, | For the six months endedSeptember 30,
|------------------------------------------------------- | --------------------------------------- | -------------------------------------
|
|Revenues:                                               |                                         |                                      
|Products                                                |                                         | 200,648                              
|Services                                                |                                         | 306,349                              
|                                                        |                                        
|                                                        |                                         | 506,996                              
|                                                        |                                        
|                                                        |                                        
|Cost of revenues:                                       |                                        
|Products                                                |                                         | 165,432                              
|Services                                                |                                         | 71,784                               
|                                                        |                                        
|                                                        |                                         | 237,216                              
|                                                        |                                        
|Gross profit                                            |                                         | 269,780                              
|                                                        |                                        
|                                                        |                                        
|Operating expenses:                                     |                                        
|                                                        |                                        
|Selling and administrative                              |                                         | 548,390                              
|Research and related expenditures                       |                                         | 801,517                              
|                                                        |                                        
|Total operating expenses                                |                                         | 1,349,907                            
|                                                        |                                        
|Operating loss                                          |                                         | (1,080,127                           
|                                                        |                                        
|                                                        |                                        
|Other income (expense):                                 |                                        
|Interest income                                         |                                         | 17,774                               
|Loss on disposal of property and equipment              |                                         |                                     
|Gain on sale of investment                              |                                         |                                     
|Other                                                   |                                         |                                     
|                                                        |                                        
|Other income (expense)                                  |                                         | 17,774                               
|                                                        |                                        
|                                                        |                                        
|Loss and comprehensive loss for the period              |                                         | (1,062,354                           
|Accrued dividends on the Series A and C Preferred stock |                                         | (13,238                              
|                                                        |                                        
|Loss available to common stockholders [note 2]          |                                         | (1,075,592                           
|                                                        |                                        
|Loss per common share - basic and diluted [note 2]      |                                         | (0.01                                
|                                                        |                                        
|                                                        |                                        
|Weighted average common shares outstanding              |                                         | 130,175,406                          
|                                                        |                                        

|See notes to interim consolidated
financial statements



4
|-----------------------------------------------------------

|e.Digital Corporation
and subsidiary



CONSOLIDATED STATEMENTS
OF CASH FLOWS(UNAUDITED)[Expressed in US dollars]
|-----------------------------------------------------------------------------------------------------------------

|                                                                        | For the six months endedSeptember 30,
|----------------------------------------------------------------------- | -------------------------------------
|
|OPERATING ACTIVITIES                                                    |                                      
|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                              |                                      
|Gain on sale of investment                                              |                                      
|Changes in assets and liabilities:                                      |                                      
|Accounts receivable, trade                                              |                                      
|Certificate of deposit                                                  |                                      
|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                                        |                                      
|                                                                        |                                      
|Cash (used in) investing activities                                     |                                      
|                                                                        |                                      
|FINANCING ACTIVITIES                                                    |                                      
|Proceeds from issuance of secured promissory notes                      |                                      
|Proceeds from exercise of stock options                                 |                                      
|Proceeds from exercise of warrants                                      |                                      
|                                                                        |                                      
|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           |                                      
|Deemed dividends on Series C preferred stock                            |                                      
|Deemed dividends on Series A preferred stock                            |                                      

|See notes to interim consolidated
financial statements



5
|-----------------------------------------------------------

|E.DIGITAL
CORPORATION AND SUBSIDIARYNOTES TO
INTERIM CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)September
30, 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 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
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.


Management of the Company
has undertaken steps as part of a plan to increase revenues and improve
operations with the goal of sustaining Company operations for the next twelve
months and beyond. These steps include (a) focusing on the supply of product
under an existing OEM contract; (b) expanding sales and marketing to additional
OEM customers and markets; (c) controlling overhead and expenses; and (d)
raising, if necessary, 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 consolidated
unaudited interim financial statements should be read in conjunction with the
audited financial statements and notes thereto for the year ended March 31,
2001.


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, warrants, and redeemable preferred stock exercisable into
7,173,438 shares of Common Stock were outstanding as at September 30, 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 six months ended September 30, 2001 and
2000 by accrued dividends of $26,332 and $529, respectively. The loss available
to common stockholders is computed as follows:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                            | For the three months endedSeptember 30, | For the six months endedSeptember 30, |     
|------------------------------------------- | --------------------------------------- | ------------------------------------- | ----
|                                            | 2001                                    | 2000                                  | 2001
|Loss and comprehensive loss                 |                                         | $(1,062,354                           | )   
|Dividends on Series A and C preferred stock |                                         | (13,238                               | )   
|                                            |                                         |                                       |     
|Loss available to common stockholders       |                                         | $(1,075,592                           | )   
|                                            |                                         |                                       |     

|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). As of September 30, 2001, the adjusted
conversion price was $0.819.


The issuable maximum
initially was set at 2,666,666 shares and is to be adjusted each time the
conversion price is adjusted to equal the sum of (i) the issuable maximum in
effect on the trading day immediately preceding the date the adjustment of
the conversion price is required to
be made plus (ii) the difference between (A) the quotient obtained by dividing
(I) $4,000,000 by (II) 75% of the Adjusted Conversion Price and (B) 2,666,666.
The Series C stock is redeemable for cash in certain instances at the
Companys option (and at the holders election) upon the occurrence of
certain triggering events including, without limitation, a lapse of a
registration statement for ten non-consecutive trading days and certain other
events.


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

|The redemption price upon
such election following a triggering event is the greater of (a) 110% of the
stated value or (b) the product of the number of preferred shares multiplied by
the closing market price multiplied by the stated value per share divided by the
then conversion price per share. Because the redemption provisions are not
entirely within the Companys control, the Series C stock is presented as
redeemable preferred stock on the consolidated balance sheet.


At September 30, 2001, the
issuable maximum relating to the remaining 74 shares of Series C stock was
966,789 shares of Common Stock, except as may be subsequently modified as a
consequence of certain possible adjustments. Subsequent to September 30, 2001,
50 shares of the Series C stock were converted into 625,080 shares of Common
Stock.


4. 12%
PROMISSORY SECURED 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.


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 estimated fair market value of the warrants at issuance was
$405,736 and is being amortized as interest expense over the term of the SP
Notes. 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 is being amortized as a financing expense 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.


5. COMMON
STOCKHOLDERS EQUITY


The following table
summarizes common stockholders equity transactions during the six month
period ended September 30, 2001:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                        |  | Shares      |  | Amount   |  | Additionalpaid-in capital |  | Contributedsurplus |  | Accumulateddeficit |  
|--------------------------------------- |  | ----------- |  | -------- |  | ------------------------- |  | ------------------ |  | ------------------ | -
|Balance, March 31, 2001                 |  | 130,175,406 |  | $130,175 |  | $52,834,970               |  | $1,592,316         |  | $(52,547,592       | )
|Accrued dividends on the Series         | 
|C stock                                 |  |            |  |         |  |                          |  |                   |  | (26,332            | )
|Value assigned to 750,000 warrants      | 
|granted in connection with the issuance | 
|of the 12% Secured Promissory Notes     |  |            |  |         |  | 405,736                   |  |                   | 
|Value assigned to 100,000 warrants      | 
|granted in connection with the issuance | 
|of the 12% Secured Promissory Notes     |  |            |  |         |  | 91,034                    |  |                   |  |                   |  
|Loss for the period                     |  |            |  |         |  |                          |  |                   |  | (2,034,983         | )
|                                       
|Balance, September 30, 2001             |  | 130,175,406 |  | $130,175 |  | $53,331,740               |  | $1,592,316         |  | $(54,608,907       | )
|                                       

|7
|-

|6. WARRANTS
AND OPTIONS


At September 30, 2001
warrants were outstanding and exercisable into the following shares of Common
Stock.
|------------------------------------------------------------------------------------------------------------------------------------

| | Description | Number ofCommon Shares | Exercise Price$ | Expiration Date | 
| | ----------- | ---------------------- | --------------- | --------------- | 
| |            
| |             | Warrants               |                 | 571,429         | 
| |             | Warrants               |                 | 500,000         | 
| |             | Warrants               |                 | 369,514         | 
| |             | Warrants               |                 | 850,000         | 
| |            
| |             | Total                  |                 | 2,290,943       | 
| |            

|During the quarter ended
September 30, 2001, 369,514 warrants which had an original exercise price of
$5.20 were repriced to $0.75. The warrants were issued in conjunction with the
Series C stock and accordingly, the repricing does not impact the statement of
operations.


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

| |  | Number ofOptions                  | Weighted AverageExercise Price
| |  | --------------------------------- | ------------------------------
| | 
| |  | Outstanding at March 31, 2001     |                               
| |  | Granted                           |                               
| |  | Forfeited                         |                               
| |  |                                   |                               
| |  | Outstanding at September 30, 2001 |                               
| |  |                                   |                               
| |  | Exercisable at September 30, 2001 |                               
| |  |                                   |                               

|Options outstanding are
exercisable at prices ranging from $0.0875 to $5.46 and expire over the period
from 2001 to 2006 with an average life of 2.6 years. Subsequent to September 30,
2001, 170,000 stock options were exercised and 150,000 options were forfeited.


7. INVENTORY


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


8.
CONTINGENCIES


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 consolidated financial
statements and accordingly may be subject to measurement uncertainty in the near
term.


9. CREDIT RISK


Amounts owing from one
major customer comprise 80% of accounts receivable at September 30, 2001. [March
31, 2001  98%].


10. MAJOR
CUSTOMERS AND SUPPLIERS


The Company operates in one
major line of business, the development, manufacture and marketing of electronic
products. Sales to two major customers comprise of 88% of revenue for the second
quarter ended September 30, 2001 [second quarter of 2000  83%]. Details of
one customers plan of operations going forward are not known at this time.
The Company does not know the impact, if any, that their plans will have on
future orders under their agreement. Revenues from this customer for the six
month ended September 30, 2001 accounted 67% of total revenues for the Company.


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


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

|The Company has an
agreement with one supplier for the production of products of its major
customer. In the event that the major customer cancels or reduces its orders,
the Company 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 September 30, 2001 the remaining balance on open
purchase orders for product was shipped to the customer.


11.
COMPARATIVE FIGURES


Certain of the comparative
figures have been restated to conform with the current periods
presentation.



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

|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 electronics 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
(OEM) 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.


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 offer technology transfer, 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 result from the
sale of products and fees from engineering services, industrial order
fulfillment, technical support services, warranty services and 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
code-named MXP100 which incorporates our MicroOS 2.0 and
VoiceNav technologies into a handheld digital music and voice
recorder/player. This product 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 MXP100 player uses
either Microdrive storage media from IBM or CompactFlash storage
media from SanDisk. As of September 30, 2001 we had not received any revenue
from this product, which was launched on our website store on November 2, 2001
and although we have begun generating revenue from this product, such revenue
has not yet, to date, been material.


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, 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 or other
online sales sites. 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. As of September 30, 2001 we had not received any revenue from
this product, which was launched on our website store on November 2, 2001 and
although we have begun generating revenue from this product, such revenue has
not yet, to date, been material.


In August 2001, we signed a
draft 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 $200,788 in payments under this agreement with respect to
NRE fees only.


In September 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. To date we have not
received any licensing or royalty payments from Musical under this agreement.


10
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|In July 2001, we signed a
royalty-bearing licensing agreement with Bang & Olufsen, a premier European
electronics, telephony and audio/video manufacturer. Under this licensing
agreement, we will customize and provide Bang & Olufsen a MicroOS based
custom product platform for use in their branded music product line. To date we
have received $50,000 in payments for engineering design services from Bang
& Olufsen under this agreement, which has been deferred in the interim
consolidated financial statements.


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). These products represent the Cquence
Mobile portion of Laniers Cquence line of products for the medical
industry. The Cquence line is an integrated medical document management solution
that manages medical documents from creation, completion, distribution and
retention. Cquence Mobile offers healthcare providers a mobile digital dictation
unit and computer interface with a number of new advanced features.


The Lanier Agreement
provides that we will supply product to them through December 2001. In May 1999,
we commenced production, through a subcontract manufacturer, and in June 1999
commenced initial limited customer shipments pursuant to purchase orders. The
supply agreement provides 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 results in an
entity named Lanier Healthcare, which Platinum operates as a stand-alone entity.
Details of Platinums plan of operations going forward are not known at
this time. We do not know the impact, if any that their plans will have on
future orders under the Lanier Agreement.


During the six months ended
September 30, 2001, we shipped $791,320 of products to Lanier, compared to
$1,100,165 for the six months ended September 30, 2000. Subsequent to September
30, 2001, we satisfied our contractual commitment for delivering of product to
Lanier and, to date, have received no additional purchase orders.


We incurred operating
losses in each of the last two 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 $400,000 per month. However, we may increase expenditure levels
in future periods to support the launch of e.Digital branded
products and 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.


Results of
Operations


For the first six months of
fiscal 2002, we reported total revenues of $1,176,275, a 4% decrease from total
revenues of $1,221,357 for the first six months of fiscal 2001. Revenue for the
second quarter ending September 30, 2001 and 2000 were $506,996 and $1,096,286,
respectively. For the second quarter of fiscal 2002 and 2001 there were six and
three customers who accounted for total revenue, respectively.  The loss of a
customer could have a material adverse impact on the results of operations.


Revenue for the first six
months of fiscal 2002 included product revenue of $827,175 compared to
$1,100,165 for the prior years first six months. The decrease is due to
the decrease in OEM product shipments to Lanier. Product revenue generated a
gross profit for the six months ended September 30, 2001 of $164,992 compared to
a gross profit of $157,729 for the first six months of fiscal 2001. Product
sales for the three month period ending September 30, 2001 decreased to $200,648
as compared to $996,123 for the comparable period of the prior year.


Service revenues for the
first six months of fiscal 2002 were $349,099, a 188% increase from the
comparable period of the prior year of $121,192. Service revenues for the three
month periods ending September 30, 2001 and 2000 were $306,349 and $100,163,
respectively. The timing and amount of service revenues is dependent upon a
limited number of projects. At September 30, 2001 we had $76,945 of deferred
revenue from NRE contracts, which will be recognized based on the terms and
conditions of each agreement.


For the six months ended
September 30, 2001, we reported a gross profit of $421,776 compared to a gross
profit of $240,099 for the first six months of fiscal 2000. Gross profit as a
percentage of revenue increased from 20% to 36% for the second quarter ended
September 30, 2001. Cost of sales for the six months ended September 30, 2001
consisted of $662,183 of product costs and $92,316 of contract services
consisting mostly of research and development labor being funded in part by OEM
NRE agreements. 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
material. Our contract supply agreement on Lanier products provides a
twelve-month manufacturing warranty.



11
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|Total operating expenses
(consisting of research and related expenditures and selling and administrative
expenses) for the six months ended September 30, 2001, were $2,532,271, as
compared to $1,572,864 for the six months ended September 30, 2000. Selling and
administrative costs aggregated $1,038,819 for the first six months of fiscal
2001 compared to $755,002 in the prior period. The $283,817 increase in selling
and administrative costs resulted primarily from the following: increase in
personnel and benefit costs of $187,993, an increase of $20,295 in facilities
costs and an increase in professional fees expense of $49,541. We anticipate
selling and administrative expenses to continue at higher levels than prior
periods due to increased number of personnel compared to the prior year.


Research and related
expenditures for the six months ended September 30, 2001 were $1,493,452, as
compared to $817,862, for the six months ended September 30, 2000. The $675,590
increase in research and development costs resulted primarily from the increase
of $427,431 in personnel and benefit costs, a $9,920 increase in travel and
related costs and an increase of $188,053 for artwork, consulting and other
material 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 $2,110,495 for the six months ended September 30, 2001, as compared to
an operating loss of $1,332,765 for the six months ended September 30, 2000. The
increase 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 are not necessarily
indicative of operating results for future periods or the fiscal year.


We reported a loss for the
first six months of the current fiscal year of $2,034,983 as compared to a loss
of $1,265,812 for the prior years first six months.


The loss available to
common stockholders for the six months ended September 30, 2001 and 2000 is
$2,061,315 and $1,266,341, respectively. Included in the loss available to
common stockholders for the period ending September 30, 2001 and 2000 is accrued
dividends of $26,332 and $529, respectively, on the Series C and Series A stock.


Liquidity and
Capital Resources


At September 30, 2001, we
had working capital of $1,520,273 compared to a working capital of $2,445,655 at
March 31, 2001. We had $52,634 of working capital invested in inventory at
September 30, 2001. Cash used in operating activities for the six month period
ended September 30, 2001 was $2,127,560 resulting primarily from the loss for
the period. During the six months ended September 30, 2001, the Company
purchased $65,364 in property and equipment. For the six months ended September
30, 2001, net cash and cash equivalents decreased by $1,162,800.


At September 30, 2001, we
had net accounts receivable of $985,428 as compared to $530,014 at March 31,
2001. This represented approximately 235 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.


At September 30, 2001, we
had cash and cash equivalents of $ 2,348,706. 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 twelve 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.


Should additional funds be
required and not be available, we may be required to curtail or scale back
staffing or operations. We cannot guarantee that additional funding in the
future will be available or on what terms. 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.



12
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|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.


Future
Commitments and Financial Resources


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 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 September 30,
2001, we satisfied our contractual commitment for delivery of all products and
have not received any additional purchases orders.


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 September 30,
2001, the total operating lease obligation under the lease for office space is
$358,931.


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 $2,348,706. 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.


On September 28, 2001 the
Company sold for cash in a private offering an aggregate of $1,000,000 of 12%
Secured Promissory Notes due December 31, 2002 (SP Notes) to
accredited investors.



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.



13
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|Item 2.
Changes in Securities
|-----------------------------

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

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

|(c) |  | On September 28, 2001 the Company sold for cash in a private offering an
aggregate of $1,000,000 of 12% Secured Promissory Notes due December 31, 2002
(SP Notes) to accredited investors.  In addition,
the purchasers were granted warrants to purchase 750,000 common shares of the
Company at $0.75 per share until September 30, 2006 (Warrant). The
SP Notes are secured by the Companys accounts receivable and inventory.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Any shares
received on the exercise of the Warrants will be restricted securities unless the Company
elects to register such shares. The Company has no requirement to register the stock
underlying the Warrants but the holders have certain piggyback registration rights. The
securities have antidilution rights reducing the conversion and exercise price for
certain issuances of equity securities by the Company at an effective price below the
applicable exercise price of the Warrants.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The securities
were offered and sold without registration under the Securities Act of 1933, as amended
(the Act), in reliance upon the exemption provided by Section 4(2) hereunder and/or
Regulation D and an appropriate legend was placed on the SP Notes and Warrants and will
be placed on the shares issuable upon exercise of the Warrants unless an effective
registration statement is submitted to the transfer agent for the Company at the time of
exercise or conversion. The Company issued warrants to acquire 100,000 common shares (at
the same terms as the Warrants) as a findersfee in connection with identifying
investors for the SP Notes.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The proceeds
from the sale of the SP Notes are being applied to working capital primarily related to
the MXP100 digital audio player.
| |  | -------------------------------------------------------------------------------------------------------------------------------------

| |  | The description
of this transaction is qualified in its entirety by the full text of the agreements
attached as exhibits hereto.
| |  | --------------------------------------------------------------------------------------------------------------------------------

| |  | In the
event that 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.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

## Item 3.
Defaults Upon Senior Securities

NONE

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

NONE

## Item 5. Other
Information

NONE

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

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

|4.32 |  | Form
of 12% Secured Promissory Note due December 31, 2002 aggregating $1,000,000 entered into
with seven accredited investors (individual notes differ only as to holder and amount).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.33 |  | Form
of Stock Purchase Warrant exercisable until September 30, 2006 issued to seven accredited
investors for an aggregate of 750,000 common shares (individual warrants differ only as
to holder and number of shares).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|14
|--

|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.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date:      November 14, 2001 |  | e.DIGITAL CORPORATIONBy: /s/ RAN FURMAN 
RAN FURMAN 
Ran Furman, Chief Financial Officer
    (Principal Financial and Accounting Officer
    and duly authorized to sign on behalf of the Registrant)
|---------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------