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|UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q


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


For the quarterly period ended June 30, 2002


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) | 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|   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) | 138,065,251(Outstanding at August 6, 2002)
|------------------------------------- | ------------------------------------------

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|e.DIGITAL CORPORATION


INDEX


Page


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

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

| |  |  | Consolidated Balance Sheets as of June 30, 2002 andand March 31, 2002 |  | 3
| |  |  | --------------------------------------------------------------------- |  | -

| |  |  | Consolidated Statements of Operations for the threemonths ended June 30, 2002 and 2001 |  | 4
| |  |  | -------------------------------------------------------------------------------------- |  | -

| |  |  | Consolidated Statements of Cash Flows for the threemonths ended June 30, 2002 and 2001 |  | 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 |  | 17
| | ------- |  | --------------------------------------------------------- |  | --

|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 - Nature of Operations and Basis of Presentation]
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                  | June 30, 2002$ |  | March 31, 2002$ |            
|----------------------------------------------------------------- | -------------- |  | --------------- | -----------
|ASSETS                                                            |                |  |                 |            
|Current                                                           |                | 
|Cash and cash equivalents                                         |                |  |                 | 223,108    
|Certificate of deposit                                            |                |  |                 | 59,073     
|Accounts receivable, trade, less allowance of $73,899 and $73,899 |                | 
|for doubtful accounts, respectively [note 9]                      |                |  |                 | 473,061    
|Inventory net of allowance for obsolete inventory of $218,237 and |                | 
|$55,965 respectively [note 6]                                     |                |  |                 | 990,978    
|Prepaid expenses and other                                        |                |  |                 | 118,754    
|Deferred financing charges                                        |                |  |                 | 139,303    
|Deferred contract charges                                         |                |  |                 | 63,092     
|                                                                  |                | 
|Total current assets                                              |                |  |                 | 2,067,369  
|                                                                  |                | 
|Property and equipment, net of accumulated depreciation of        |                | 
|$389,891 and $352,510, respectively                               |                |  |                 | 349,853    
|Intangible assets, net of accumulated amortization of             |                | 
|$53,491 and $47,468, respectively                                 |                |  |                 | 14,608     
|Restricted Cash [note 8]                                          |                |  |                 | 145,435    
|                                                                  |                | 
|Total assets                                                      |                |  |                 | 2,577,265  
|                                                                  |                | 
|LIABILITIES AND STOCKHOLDERS DEFICIT                             |                | 
|Current                                                           |                | 
|Accounts payable, trade                                           |                |  |                 | 1,421,583  
|Other accounts payable and accrued liabilities                    |                |  |                 | 243,165    
|Accrued lease liability [note 7]                                  |                |  |                 | 515,000    
|Accrued employee benefits                                         |                |  |                 | 132,932    
|Deferred revenue                                                  |                |  |                 | 134,222    
|Secured promissory notes [note 3]                                 |                |  |                 | 1,786,174  
|                                                                  |                | 
|Total liabilities                                                 |                |  |                 | 4,233,076  
|                                                                  |                | 
|Commitments and Contingencies [note 1, 7 and 10]                  |                | 
|                                                                 
|Stockholders deficit [note 4]                                    |                | 
|Common stock, $0.001 par value, authorized 200,000,000,           |                | 
|137,472,751 and 132,537,298 shares outstanding, respectively      |                |  |                 | 137,472    
|Additional paid-in capital                                        |                |  |                 | 56,923,673 
|Contributed surplus                                               |                |  |                 | 1,592,316  
|Accumulated deficit                                               |                |  |                 | (60,309,272
|                                                                  |                | 
|Total stockholders deficit                                       |                |  |                 | (1,655,811 
|                                                                  |                | 
|                                                                 
|Total liabilities and stockholders deficit                       |                |  |                 | 2,577,265  
|                                                                  |                | 

|See notes to interim consolidated financial statements
|------------------------------------------------------

|3
|-

|e.Digital Corporation and subsidiary


CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
[Note 1 - Nature of Operations and Basis of Presentation]
|--------------------------------------------------------------------------------------------------------------------------------------------------

|                                                   | For the three months endedJune 30, | 
|-------------------------------------------------- | ---------------------------------- | 
|
|Revenues:                                          |                                    | 
|Products [note 11]                                 |                                    | 
|Services [note 11]                                 |                                    | 
|                                                   |                                    | 
|                                                   |                                    | 
|                                                   |                                    | 
|Cost of revenues:                                  |                                    | 
|Products                                           |                                    | 
|Services                                           |                                    | 
|                                                   |                                    | 
|                                                   |                                    | 
|                                                   |                                    | 
|Gross profit  (loss)                               |                                    | 
|                                                   |                                    | 
|Operating expenses:                                |                                    | 
|Selling and administrative                         |                                    | 
|Research and related expenditures                  |                                    | 
|                                                   |                                    | 
|Total operating expenses                           |                                    | 
|                                                   |                                    | 
|Operating loss                                     |                                    | 
|                                                   |                                    | 
|Other income (expense):                            |                                    | 
|Interest income                                    |                                    | 
|Interest expense                                   |                                    | 
|Loss on disposal of asset                          |                                    | 
|Other income                                       |                                    | 
|                                                   |                                    | 
|Other income (expense)                             |                                    | 
|                                                   |                                    | 
|Loss and comprehensive loss for the period         |                                    | 
|                                                  
|Accrued dividends on the Series C Preferred stock  |                                    | 
|                                                   |                                    | 
|Loss attributable to common stockholders [note 2]  |                                    | 
|                                                   |                                    | 
|Loss per common share - basic and diluted [note 2] |                                    | 
|                                                   |                                    | 
|Weighted average common shares outstanding         |                                    | 
|                                                   |                                    | 

|See notes to interim consolidated financial statements
|------------------------------------------------------

|4
|-

|e.Digital Corporation and subsidiary


CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
[Note 1 - Nature of Operations and Basis of Presentation]
|--------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                        | For the three months endedJune 30, | 
|----------------------------------------------------------------------- | ---------------------------------- | 
|
|OPERATING ACTIVITIES                                                    |                                    | 
|Loss for the period                                                     |                                    | 
|Adjustments to reconcile loss to net cash used in operating activities: |                                    | 
|Depreciation and amortization                                           |                                    | 
|Loss on disposal of asset                                               |                                    | 
|Gain on sale of investment                                              |                                    | 
|Accrued interest and accretion relating to secured promissory notes     |                                    | 
|Changes in assets and liabilities:                                      |                                    | 
|Accounts receivable, trade                                              |                                    | 
|Certificate of deposit                                                  |                                    | 
|Inventory                                                               |                                    | 
|Prepaid expenses and other                                              |                                    | 
|Deferred contract charges                                               |                                    | 
|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                                        |                                    | 
|Increase in restricted cash                                             |                                    | 
|Interest earned on certificate of deposit                               |                                    | 
|                                                                        |                                    | 
|Cash (used in) investing activities                                     |                                    | 
|                                                                        |                                    | 
|FINANCING ACTIVITIES                                                    |                                    | 
|Proceeds from issuance of Shares                                        |                                    | 
|Payment on 5% SP Notes                                                  |                                    | 
|Deferred financing charge                                               |                                    | 
|                                                                        |                                    | 
|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:    |                                    | 
|Deemed dividends on Series C preferred stock                            |                                    | 

|See notes to interim consolidated financial statements
|------------------------------------------------------

|5
|-

|E.DIGITAL CORPORATION AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
June 30, 2002


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 (working, full-featured
designs sometimes implemented as prototypes that can be customized to a
customers preferred look and feel or branded and sold as they are,
according to the customers wishes) and technology platforms (basic working
technology that can be developed into a finished consumer product, or
incorporated into an existing consumer product design) with a focus on digital
music and voice player/recorders using the latest in digital storage media (a
device used to store data) 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 unaudited interim
consolidated financial statements have been prepared on the going concern basis,
which contemplates the realization of assets and the discharge of 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 three month period ended June 30, 2002 and has an
accumulated deficit of $60,309,272 at June 30, 2002. At June 30, 2002, the
Company has a working capital deficiency of $2,165,706. A substantial portion of
the losses is attributable to marketing costs of the Companys new
technology and substantial expenditures on 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 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) expanding sales and marketing to OEM customers and markets; (b)
controlling overhead and expenses and (c) 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 obtain additional financing.


The Company is actively
seeking additional equity financing. There can be no assurance that any
additional financings will be available to the Company on satisfactory terms and
conditions, if at all. In the event the Company is unable to continue as a going
concern, it may elect or be required to seek protection from its creditors by
filing a voluntary petition in bankruptcy or may be subject to an involuntary
petition in bankruptcy. To date, management has not considered this alternative,
nor does management view it as a likely occurrence.


These consolidated
financial statements do not give effect to any adjustments which would be
necessary should the Company be unable to continue as a going concern and
therefore be required to realize its assets and discharge its liabilities in
other than the normal course of business and at amounts different from those
reflected in the accompanying consolidated financial statements.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6
|-

|E.DIGITAL CORPORATION AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
June 30, 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 9,673,662 shares of Common
Stock were outstanding as at June 30, 2002. 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 was increased during the three months ended June 30, 2002
and 2001 by accrued dividends of $nil and $13,094, respectively. The loss
available to common stockholders is computed as follows
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                      | Three months ended June 30, | 
|------------------------------------- | --------------------------- | 
|
|Loss and comprehensive loss           |                             | 
|Dividends on Series C preferred stock |                             | 
|                                      |                             | 
|Loss available to common stockholders |                             | 
|                                      |                             | 

|3. 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 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 note holder 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 Note 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. As at June 30, 2002, accrued interest totaled $90,667 [March 31,
2002  $60,491].


5% Secured Promissory
Note


On January 18, 2002, the
Company issued a 5% Secured Promissory Note (5% SP Note) for gross
cash proceeds of $1,200,000. The 5% SP Note, originally matured on April 18,
2002 and is secured by all assets of the Company including, without limitation,
the Companys intellectual property. The interest under the 5% SP Note
accrued at a rate of 5% per annum simple interest and was payable in one
installment on maturity date. On April 17, 2002, the 5% SP Note holder agreed to
extend the maturity date of the 5% SP Note from April 18, 2002 to May 2, 2002
for no consideration. On April 29, 2002, the 5% SP Note holder agreed to extend
the maturity date of the 5% SP Note from May 2, 2002 to October 29, 2002 and to
reduce the interest rate from 5% to 4% in exchange for (i) a $200,000 finance
fee that increased the principal amount from $1,200,000 to $1,400,000, (ii) a
minimum monthly principal reduction of $100,000; (iii) an immediate principal
repayment of $300,000 and (iv) repayment of accrued interest to April 18, 2002
of $15,000. As at June 30, 2002, accrued interest totaled $8,469 [March 31, 2002
 $11,343].  The $200,000 financing fee has been recorded as a deferred
financing charge and will be recorded as an interest expense over the period from
April 29, 2002 to October 29, 2002.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|7
|-

|E.DIGITAL CORPORATION AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
June 30, 2002


4. STOCKHOLDERS EQUITY


The following table
summarizes stockholders equity transactions during the three month period
ended June 30, 2002:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                        | Shares# |  | Amount$ |             | Additionalpaid-in capital$ |   | Contributedsurplus$ |  | Accumulateddeficit$ |           
|----------------------- | ------- |  | ------- | ----------- | -------------------------- | - | ------------------- |  | ------------------- | ----------
|                       
|Balance, March 31, 2002 |         |  |         | 132,537,298 |                            | $ | 132,537             |  | $                   | 54,628,608
|Shares issued           |         |  |         | 4,935,453   |                            |   | 4,935               |  |                     | 2,295,065 
|Loss for the period     |         |  |         |            |                            |   |                    |  |                     |          
|                       
|Balance, June 30, 2002  |         |  |         | 137,472,751 |                            | $ | 137,472             |  | $                   | 56,923,673
|                       

|On August 2, 2002, the
Company issued 360,000 restricted shares of Common Stock to a director for gross
proceeds of $120,000. The restricted shares of Common Stock may only be disposed of pursuant to
an affective registration statement.


5. WARRANTS AND OPTIONS


At June 30, 2002 warrants
were outstanding and exercisable into the following shares of Common Stock:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Description | Number ofCommon Shares | Exercise Price$ | Expiration Date | 
| | ----------- | ---------------------- | --------------- | --------------- | 
| |             |                       
| |             |                        | Warrants        |                 | 
| |             |                        | Warrants        |                 | 
| |             |                        | Warrants        |                 | 
| |             |                       
| |             |                        | Total           |                 | 
| |             |                       

|In connection with the
issuance of the Series C stock in October 2000, the Company issued warrants with
an exercise price $5.20. In May 2002, 161,662 warrants, which were issued to the
investors and a placement agent in connection with the Series C stock were
repriced from $0.75 to $0.53. The warrants were repriced pursuant to
anti-dilution protection given to the warrant holders triggered by the sale of
$1,500,000 of common shares in May 2002. On June 7, 2002, the 161,662 warrants
were repriced again from $0.53 to $0.38 triggered by the sale of $800,000 of
common shares in June 2002.


In connection with the
issuance of the SP Notes, the Company issued warrants with an exercise price of
$0.75. On June 7, 2002, 850,000 warrants, which were issued to the investors and
placement agent in connection with the SP Notes were repriced to $0.38. The
warrants were repriced pursuant to anti-dilution protection given to the warrant
holders triggered by the sale of $800,000 of common shares in June 2002.


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

| | Number ofOptions |  | Weighted AverageExercise Price | 
| | ---------------- |  | ------------------------------ | 
| |                 
| |                  |  | Outstanding at March 31, 2002  | 
| |                  |  | Granted                        | 
| |                  |  | Forfeited                      | 
| |                  |  | Outstanding at June 30, 2002   | 
| |                  |  |                                | 
| |                  |  | Exercisable at June 30, 2002   | 
| |                  |  |                                | 

|
|

|8
|-

|E.DIGITAL CORPORATION AND SUBSIDIARY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
June 30, 2002


Options outstanding are
exercisable at prices ranging from $0.0875 to $5.46 and expire over the period
from 2002 to 2007 with an average life of 3.01 years. Subsequent to June 30,
2002, two officers of the Company voluntarily cancelled a total of 2,115,000
vested options exercisable at $5.46 and a total of 107,500 options were
exercised for gross proceeds of $46,225.


6. INVENTORY


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

|               | June 30, 2002$ | March 31, 2002$ | 
|-------------- | -------------- | --------------- | 
|               |               
|Finished goods |                |                 | 
|Raw materials  |                |                 | 
|               |               
|               |                |                 | 
|               |               

|At March 31, 2002, the provision
for inventory obsolescence was $59,965. During the quarter ended June 30, 2002,
the provision was increased by $158,272 without a reduction in the opening
provision, and accordingly the provision for inventory obsolescence at June 30,
2002 amounted to $218,237.


7. 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 ($145,435 at June 30, 2002) 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. The Company also paid APL Direct Logistics
$14,000 for initial integration and implementation expenses. In June, the
Company made a payment of $35,000 to APL Direct Logistics as an additional
prepayment for freight management. As of June 30, 2002, the Company had a
balance in prepaid freight of $37,700. 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 branded products. Failure or delay by APL Direct
Logistics to provide multi-channel sales, fulfillment, and after-sale support
services for the Companys products 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, Musical Electronics, Ltd, and Digitalway Co., Ltd. for the
manufacture and assembly of its MXP 100, TREO 15 and Odyssey 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 a
manufacturer is unable to satisfy these requirements, the Companys
business, financial condition and operating results may be materially and
adversely affected. Any failure in performance by 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.


On March 25, 2002, the
Company entered into a supply agreement with Digitalway Co., Ltd., one of its
contract manufacturers, and has agreed in good faith to purchase a minimum of
approximately $5.96 million of product in the twelve-month period from initial
order date. As of June 30, 2002, the Company has not taken delivery of any
products under this agreement.


Approximately $515,000 of
the accrued lease liability arose in the normal course of business for goods and
services delivered to the Company and were recorded at amounts reflected on the
invoices and other documentation received from the third party vendor. This
amount is approximately five years old. The amount owing to the vendor is still
due but as the Company has had no contact with the vendor, the amount may not
require payment. Accordingly, the accrued lease liability reflects
managements best estimate of the amount that may be due. Settlement of
this liability may be either more or less than the amount 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)
June 30, 2002


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. The aggregate
monthly lease payments will increase to $16,606 beginning August 1, 2002. As of
June 30, 2002, the total operating lease obligation under the lease for office
space is $215,239.


The Company maintains a
credit card facility of up to $50,000 for corporate credit cards and a $129,000
facility for a standby letter of credit.


8. RESTRICTED CASH


Restricted cash represents
the stand-by letter of credit issued to APL Direct Logistics in the amount of
$145,435 expiring in October 2004.


9. CREDIT RISK


Amounts owing from two
major customers comprise 79% of accounts receivable at June 30, 2002. Amounts
owing from three major customer comprised 85% of accounts receivable at March
31, 2002.


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 63% of revenue for the first
quarter ended June 30, 2002. Sales to one major customer (Lanier) comprised 94%
of revenue for the quarter ended June 30, 2001. In October 2001, the Company
satisfied its contractual commitment to deliver of product to Lanier and, to
date, have received no additional purchase orders. The Companys agreement
with Lanier has not been renewed and the Company expects no additional sales.
The loss of this customer could have a material adverse impact on the Company
and its results of operations.


11. COMPARATIVE FIGURES


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


12. SUBSEQUENT EVENTS


In July 2002, the Company
issued Unsecured Promissory Notes (Unsecured Notes) for gross cash
proceeds of $1,050,000 to certain investors to finance various purchase orders
and accounts payable. The Unsecured Notes mature sixty days from issuance,
commencing September 1, 2002. The interest under the Unsecured Notes accrues at
a rate of 24% per annum simple interest and is payable in one installment on the
maturity date. The Company is currently in negotiations with the holders of the
Unsecured Notes about restructuring the balance of the Unsecured Notes into a
financing agreement with a maturity date of December 31, 2002. The noteholders
may, at their sole discretion, elect to convert at any time prior to maturity the
Unsecured Notes into another financing currently being contemplated by the Company.
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|10
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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-K FOR THE YEAR
ENDED MARCH 31, 2002.


General


We offer engineering
services to 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 (OEMs)
with a focus on developing digital music, voice, and video players/recorders
using the latest in digital storage media (a device used to store data) and
technology. OEMs are business customers that license or purchase our products or
our technology to embed in their own products. We offer complete reference
designs (working, full-featured designs sometimes implemented as prototypes that
can be customized to a customers preferred look and feel or branded and
sold as they are, according to the customers wishes) and technology
platforms (basic working technology that can be developed into a finished
consumer product, or incorporated into an existing consumer product design) 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. The ISO, or International Standards Organization,
creates uniform, measurable quality standards used around the world. They
measure, judge, and certify companies based upon compliance with stringent
standards applicable to their industry. 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 (an instruction set programmed into a chip which
determines the products functionality and user interface), and software
development, technology platform development, product design, manufacturing
services, fulfillment 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.


Directly related to our
consumer product sales plans, in September 2001, we signed a three-year
agreement with APL Direct Logistics, a custom fulfillment partner, for product
distribution, fulfillment, and support services. Under the multi-year agreement,
APL Direct Logistics receives our product inventory in their distribution center
in Hebron, Kentucky, and fulfills orders directly to consumers. These orders
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 non-branded products marketed by
us and to take orders by phone when necessary. The agreement requires certain
minimum payments to APL Direct Logistics and is for a term of three years,
terminating September 30, 2004.


In January 2002, we
announced the formation of our Consumer Electronics Group, to develop retail
markets, retail and e-tail distribution, and product bundling opportunities with
various partners for our e.Digital branded consumer electronics products. This
strategy has been instrumental in having e.Digital branded products placed in
CompUSA, a national computer and consumer electronics retailer and e-tailer with
over 220 stores, and in The Good Guys, Inc. (Good Guys), a regional
consumer electronics retailer and e-tailer with approximately 72 stores on the
West Coast. In May 2002, we began using a network of independent sales
representatives to market e.Digital consumer electronics products. Per
agreements with the representatives, they will be paid exclusively through
commissions as a percentage of their sales of our products.
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|11
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|In May 2002, we signed a
strategic development agreement with Digitalway Co., Ltd.,
(Digitalway) of Korea. Under the agreement, we will co-develop and
market advanced digital audio players for the consumer market. The products will
be branded by e.Digital and marketed in the United States and Canada. The
products will be branded by Digitalway and marketed in Asia and other
territories. The new products developed under the agreement will be also branded
by e.Digital and marketed in Europe. On May 30, 2002, we announced the first
products resulting from this agreement, the Odyssey 100, Odyssey 200, and
Odyssey 300. In July 2002, the products became available for sale. All of these
portable MP3 player products use embedded Flash-memory technology with a
SmartMedia card expansion slot for optional storage media upgrades. The Odyssey
100 is an extremely compact MP3 player with very efficient power management,
providing up to 30 hours of playback time on a single AA Alkaline battery. The
Odyssey 200 incorporates an FM tuner and a digital voice recorder. The Odyssey
300 features direct MP3 encoding, allowing users to plug in their personal CD
player and encode MP3 files directly to the Odyssey 300 without the use of a
computer. It also incorporates a digital voice recorder, FM tuner, and FM
recorder. The Odyssey products include software to interface with PC and Mac
platforms to organize and upload/download files.


In September 2001, we
signed a strategic alliance agreement with DataPlay, Inc. (DataPlay)
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 us 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 for design services and specifies that we will collect royalties
from OEM customers on certain DataPlay-enabled products. To date we have
received $335,000 in payments under this agreement with respect to NRE fees
only, which have all been recorded as revenue.


In September 2001, we
signed a royalty-bearing licensing agreement with Hong Kong manufacturer Musical
Electronics, Ltd. (Musical). Under the agreement, Musical licensed
technology from us 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, a national consumer electronics retailer. To date, we have received $6,560
of licensing revenues and anticipate receiving an additional $11,176 in the
quarter ending September 30, 2002. We have, to date, recognized a total of
$6,560 as revenue under this agreement. In addition, we have received $50,000
with respect to NRE fees, of which $38,333 has been deferred at June 30,
2002.


In January 2002, we
announced that we collaborated with Evolution Technologies and DataPlay 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 expect
to collect royalties on the MTV DataPlay-enabled music player when production
units begin shipping. To date, shipments of the MTV device have not begun and we
have not received any royalties from this collaboration.


In March 2002, we announced
that we had entered into a Development and Manufacturing Agreement with Eclipse
by Fujitsu Ten (Eclipse), a car stereo company. Under the agreement,
e.Digital will receive NRE fees for design and development services, as well as
revenues for the manufacture and delivery of Eclipse-branded audio products.
Specifically, the agreement states that e.Digital will provide Eclipse with
engineering services to integrate file management and compressed audio
management technology designed by e.Digital into an advanced automotive audio
system. Eclipse refers to their automotive audio system as an
infotainment platform because it includes not only a radio and CD
Player, but also may (i) connect wirelessly to the Internet to download music or
other data, (ii) store, organize, retrieve, and play back data, including
digital audio files, from a hard disk drive, (iii) connect wirelessly to a
users home personal computer while parked in the driveway for purposes of
downloading and/or uploading music or other information, (iv) record radio
signals to a built-in hard disk drive as they are received and (v) recognize the
drivers voice commands to perform a variety of operations. Prior to
entering into the Development and Manufacturing Agreement, we had collaborated
with Eclipse 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. To date, we have received $15,000 under this agreement with
respect to NRE fees only, of which $15,000 has been deferred as of June 30,
2002.
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|12
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|In April 2002, we announced
a strategic collaboration with DivXNetwork, Inc. (DivX Networks) of
San Diego, California. DivX Networks created and markets a motion picture
compression format (the DivX codec, a leading standard for
MPEG-4 video distribution) that is used for storing, playing back, and streaming
motion pictures over the Internet. Over 50 million users worldwide have
downloaded the DivX codec and the format is frequently used for distribution of
news, information, and entertainment by corporations and video producers
including major motion picture companies. Under the agreement we are working
with DivX to jointly develop and market a range of consumer electronics devices
that play back DivX video. To date, we have received no revenues from this
collaboration.


In July 2001, we signed a
royalty-bearing licensing agreement with Bang & Olufsen Multimedia A/S
(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, we have received $75,000 under
this agreement with respect to NRE fees only, of which $58,064 has been deferred
as of June 30, 2002. The first product developed under our licensing agreement
(the BeoSound 2 digital audio player) became available to consumers in the
United States and Canada in late June 2002, and in European markets in the
following weeks. Bang & Olufsen sells their branded products through
exclusive retail stores worldwide. We expect to receive royalty payments on Bang
& Olufsen products incorporating our technology, but have received no
royalties to date.


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 provided that we would supply and deliver product to them through
December 2001. In May 1999, we commenced production, through a subcontract
manufacturer, and in June 1999 commenced initial limited customer deliveries
pursuant to purchase orders. The supply agreement provided for rolling six-month
requirement forecasts and three-month advance orders. During the quarter ended
June 30, 2002, we delivered no product to Lanier, compared to $626,528 for
the quarter ended June 30, 2001. In October 2001, we satisfied our contractual
commitment to deliver 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 for the quarter ended June 30,
2002 and these losses have been material. We incurred operating losses of $1.8
million, $5.9 million, $3.9 million and $2.6 million in the quarter ended June
30, 2002 and fiscal years ended March 31, 2002, 2001 and 2000, respectively. At
June 30, 2002, we had a working capital deficit of $2.2 million. Our current
level of monthly cash operating costs is approximately $500,000. 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.


Since March 31, 2002, we
have experienced increased costs that adversely affect our current results 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 to our company on satisfactory terms and
conditions, if at all. 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 obtaining additional financing.


Management of our company
has undertaken steps as part of a plan to improve operations with the goal of
sustaining our operations for the next twelve months and beyond. These steps
include (a) expanding sales and marketing to OEM customers and markets; (b)
controlling overhead and expenses; and (c) raising additional
capital and/or obtaining third party financing.
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|On February 6, 2002, we
filed a shelf registration statement on Form S-3, No. 333-82272 (the
Registration Statement) to sell up to 20,000,000 shares of common
stock. The Registration Statement was declared effective by the Securities and
Exchange Commission on April 29, 2002. On April 30, 2002, we sold 2,830,189
shares of common stock for gross proceeds of $1,500,000, and utilized $300,000
to reduce the principal amount due under the 5% SP Note, $15,000 to reduce
accrued interest due under the 5% SP Note, and $5,105 for offering expenses. On
June 7, 2002, we sold 2,105,264 shares of common stock for gross proceeds of
$800,000, and utilized $250,000 to reduce the principal amount due under the 5%
SP Note and $1,000 for offering expenses.


In July 2002, we issued
Unsecured Promissory Notes (Unsecured Notes) for gross cash proceeds
of $1,050,000 to certain investors to finance various purchase orders and
accounts payable. The Unsecured Notes mature sixty days from issuance,
commencing September 1, 2002. The interest under the Unsecured Notes accrues at
a rate of 24% per annum simple interest and is payable in one installment on the
maturity date. We are currently in negotiations with the holders of the
Unsecured Notes about rolling the balance of the Unsecured Notes into a
financing agreement with a maturity date of December 31, 2002. The noteholders may, at their sole descretion,
elect to convert at any time prior to maturity the Unsecured Notes into another financing currently being
contemplated by the Company.


On August 2, 2002, we
issued 360,000 restricted shares of Common Stock to a director for gross
proceeds of $120,000. The restricted shares of Common Stock may only be disposed of pursuant to an effective registration statement.


Results of Operations


For the first three months
of fiscal 2003, we reported total revenues of $551,507, a 17.6% decrease from
total revenues of $669,279 for the first three months of fiscal 2002. Product
revenues for the quarter ending June 30, 2002 were $484,502, a 22.7% decrease
from product revenues of $626,528 for the quarter ending June 30, 2001. Product
revenues in the quarter ending June 30, 2002 consisted almost entirely of sale
of our branded portable digital audio players, which we launched during the
3rd and 4th fiscal quarter of 2002, while product revenues
for the quarter ending June 30, 2001 consisted almost entirely of product
shipment to Lanier. The loss of Lanier as a customer could have a material
adverse impact on our results of operations. We shipped approximately $220,000
of products to CompUSA during the last days of our first fiscal quarter that is
not included in product revenues for the quarter ended June 30, 2002 as CompUSA
didnt take possession of the shipments until July 2002. Beginning in the
quarter ending September 30, 2002, we will begin recognizing revenue from
products sold to CompUSA based on CompUSAs shipments to its customers and
not when we ship products to CompUSA. We anticipate that as we gain more
experience with the purchasing and payment history of our customers, we will
recognize revenue for many of these customers as they ship product to their
customers rather than when we ship products to them.


Service revenues for the
first three months of fiscal 2003 were $67,005 compared to $42,751 for the
comparable period of the prior year. The timing and amount of service revenues
is dependent upon a limited number of projects. At June 30, 2002 we had $134,222
of deferred revenue from development contracts which will be recognized based on
the terms and conditions of each agreement. We are increasing our focus on
internally developed technology to be offered to OEM customers in order to speed
adoption of our technology and enhance our future revenues.


For the three months ended
June 30, 2002, we reported a gross loss of $434,435 compared to a gross profit
of $151,996 for the first three months of fiscal 2002. Cost of sales for the
three months ended June 30, 2002 consisted of $920,526 of product costs and
$65,416 of service costs, consisting mostly of research and development labor
being funded in part by OEM development 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.
Gross profit as a percentage of revenue decreased from 22.7% to gross loss of 78.7%, due
primarily to start-up costs relating to the launch of our branded products, the
write-down of inventory by $158,272 related to slow moving and obsolete products
and the APL Direct Logistics costs. At the present time, warranty costs
are not significant. We generally sell our branded products with a six-month
manufacturing warranty, while the contract supply agreement on Lanier products
provided a twelve-month manufacturing warranty.


Total operating expenses
(consisting of research and related expenditures and selling and administrative
expenses) for the three months ended June 30, 2002, were $1,371,418, as compared
to $1,182,363 for the three months ended June 30, 2001. Selling and
administrative costs aggregated $987,263 for the first three months of fiscal
2002 compared to $490,264 in the prior period. The $496,835 increase in selling
and administrative costs resulted primarily from the following: increase in
personnel and benefit costs of $261,881, an increase of $116,866 in professional
fees, an increase in advertising and promotional items of $47,430, offset by a
decrease in outside public relations expense of $29,561.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.
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|14
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|Research and related
expenditures for the three months ended June 30, 2002 were $384,155, as compared
to $691,935, for the three months ended June 30, 2001. The $307,780 decrease in
research and development costs resulted primarily from a decrease in the use of
outside consultants and temporary labor of approximately $138,897, and a
decrease of approximately $113,565 in personnel and benefit costs for personnel
who have moved from the research and development department into the sales and
marketing departments. 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 $1,805,583 for the three months ended June 30, 2002, as compared to an
operating loss of $1,030,367 for the three months ended June 30, 2001. The
increase in operating loss resulted primarily from the gross loss for the three
months ended June 30, 2002 as compared to a gross profit for the three months
ended June 30, 2001, as well as increased selling and administrative costs. We
believe, but we can not guarantee, that our strategy of branding and marketing
our own branded e.Digital portable audio players and investing in OEM
developments with supply or royalty provisions 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 three months of the current fiscal year of $1,942,282 as compared to a
loss of $972,628 for the prior years three months. For the three months
ended June 30, 2002, we incurred interest expense of $204,479 as compared to
$nil for the comparable period in the prior year.


The loss available to
common stockholders for the three months ended June 30, 2002 and 2001 is
$1,942,282 and $985,722, respectively. Included in the loss available to common
stockholders for the period ending June 30, 2002 and 2001 is accrued dividends
of $nil and $13,094, respectively on the Series C stock.


Liquidity and Capital Resources


At June 30, 2002, we had
working capital deficit of $2,165,706 compared to a working capital deficit of
$2,543,657 at March 31, 2002. We had $990,978 of working capital invested in
inventory at June 30, 2002. Cash used in operating activities for the three
month period ended June 30, 2002 was $1,840,760 resulting primarily from the
loss for the period. During the three months ended June 30, 2002 the Company
purchased $22,809 in property and equipment. For the three months ended June 30,
2002, cash provided by financing activities was $1,642,198 resulting primarily
from the $2,300,000 proceeds from issuance of shares, offset by a payment of
$550,000 on the 5% SP Notes. For the three months ended June 30, 2002, net cash
and cash equivalents decreased by $222,111.


At June 30, 2002, we had
net accounts receivable of $473,061 as compared to $618,509 at March 31, 2002.
This represented approximately 313 days of revenues. The decrease in receivables
resulted from collections during the quarter ending June 30, 2002. Receivables
can vary dramatically due to the timing of product shipments and contract
arrangements on development agreements.


At June 30, 2002, we had
cash and cash equivalents of $223,108. 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) continuation of existing OEM
arrangements, and (b) currently planned expenditures and level of operation, we
believe we have sufficient capital resources for the next two 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 of OEM shipments, orders and reorders are subject to many
factors and risks, many outside our control.


On February 6, 2002, we
filed a shelf registration statement on Form S-3, No. 333-82272 (the
Registration Statement) to sell up to 20,000,000 shares of common
stock. The Registration Statement was declared effective by the Securities and
Exchange Commission on April 29, 2002. On April 30, 2002, we sold 2,830,189
shares of common stock for gross proceeds of $1,500,000, and utilized $300,000
to reduce the principal amount due under the 5% SP Note, $15,000 to reduce
accrued interest due under the 5% SP Note, and $5,105 for offering expenses. On
June 7, 2002, we sold 2,105,264 shares of common stock for gross proceeds of
$800,000, and utilized $250,000 to reduce the principal amount due under the 5%
SP Note and $1,000 for offering expenses.
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|In July 2002, we issued
Unsecured Promissory Notes (Unsecured Notes) for gross cash proceeds
of $1,050,000 to certain investors to finance various purchase orders and
accounts payable. The Unsecured Notes mature sixty days from issuance,
commencing September 1, 2002. The interest under the Unsecured Notes accrues at
a rate of 24% per annum simple interest and is payable in one installment on the
maturity date. We are currently in negotiations with the holders of the
Unsecured Notes about restructuring the balance of the Unsecured Notes into a
financing agreement with a maturity date of December 31, 2002.  The noteholders may, at their sole descretion,
elect to convert at any time prior to maturity the Unsecured Notes into another financing currently being
contemplated by the Company.


On August 2, 2002, the
Company issued 360,000 restricted shares of Common Stock to a director for gross
proceeds of $120,000. The restricted shares of Common Stock may only be disposed pursuant
to an effective registration statement.


We are actively seeking
equity financing and intend to use proceeds from equity sales for working
capital and to repay the SP Notes, the 5% SP Notes and the Unsecured Notes. If
we are unable to secure equity financing, we will attempt to renegotiate the
terms of all of the notes with the lenders. There can be no guarantee that we
will be able to raise additional equity and/or renegotiate the terms of the
notes with the lenders. If we are able to renegotiate the terms of the notes we
are unable to determine what terms the lenders may demand. If we fail to raise
additional equity and/or refinance or renegotiate the terms of the notes the
holders of the notes may have the right to take possession of our intellectual
property and all of our assets or may have the right to operate our business and
have the right to assign, sell, lease or otherwise dispose of our intellectual
property and all of our assets.  In the event we are unable to continue as a going concern,
we may elect or be required to seek protection from our creditors by filing a voluntary petition in bankruptcy
or may be subject to an involuntary petition in bankruptcy.


We require additional
capital to finance future developments and improvements to our technology.
Should additional funds not be available, we may be required to curtail or scale
back staffing or operations. Failure to obtain additional financings will have a
material adverse affect on our company. Potential sources of such funds include
exercise of outstanding warrants and options, or debt financing or additional
equity offerings. However, there is no guarantee that warrants and options will
be exercised or that debt or equity financing will be available when needed. Any
future financing may be dilutive to existing stockholders.


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 a 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. As of June 30, 2002, the
total minimum commitment to APL is $1,242,000 through the end of the contract in
2004.


The accrued lease liability
reflects managements best estimate of amounts due for matters in dispute.
Settlement of this liability may either be more or less than the amount recorded
in the unaudited items 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.


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. The aggregate monthly lease
payments will increase to $16,606 beginning in August 1, 2002. As of June 30,
2002, the total operating lease obligation under the lease for office space is
$215,239 through the end of the lease in 2003.


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-K for the year ended March 31, 2002 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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|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 $223,108 as of June 30, 2002. 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.


We have no activities in
long-term indebtedness and our other investments are insignificant as of the
date of this report.


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) |  | In
July 2002, we issued Unsecured Promissory Notes (Unsecured Notes) for gross
cash proceeds of $1,050,000 to certain investors to finance various purchase orders and
accounts payable. The Unsecured Notes mature sixty days from issuance, commencing
September 1, 2002. The interest under the Unsecured Notes accrues at a rate of 24% per
annum simple interest and is payable in one installment on the maturity date. The Company
is currently in negotiations with the holders of the Unsecured Notes about restructuring
the balance of the Unsecured Notes into a financing agreement with a maturity date of
December 31, 2002. The noteholders may, at their sole descretion, elect to convert at any
time prior to maturity the Unsecured Notes into another financing currently being
contemplated by the Company.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
August 2, 2002, we issued 360,000 restricted shares of Common Stock to a director for
gross proceeds of $120,000. The restricted shares of Common Stock may only be disposed pursuant to an effective registration statement.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
August 6, 2002, we issued 125,000 shares of Common Stock, valued at $50,000, to two
individuals in connection with the purchase of certain tangible and intangible assets
with respect to our digital multimedia website.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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


NONE


(b) Reports on Form 8-K


NONE
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|17
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|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: August 14, 2002 |  | e.DIGITAL CORPORATION
By: /s/ RAN FURMAN
      
      Ran Furman, Chief Financial Officer
      (Principal Financial and Accounting Officer and
      duly authorized to sign on behalf of the Registrant)
|--------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

|18
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