**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended March 31, 2003**

 

**or**

 

**o****  TRANSITION REPORT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe transition period from             to             **

 

**CommissionFile Number 000-31623**

 

**SIMPLETECH, INC.**

(Exact name ofRegistrant as specified in its charter)

 

| **CALIFORNIA**                                                   |   | **33-0399154**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or  organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **3001  Daimler Street  Santa Ana, CA**                          |   | **92705-5812**                        |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |
|                                                             |   |                                  |
| **(949)  476-1180**                                              |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes     ý     No     o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).  Yes     o     No     ý

 

The number of sharesoutstanding of the Registrant’s common stock, par value $0.001, as of March 31,2003 was 38,900,883.

 

 

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**SIMPLETECH,INC.**

**INDEXTO FORM 10-Q FOR THEQUARTERLY PERIOD ENDED MARCH 31, 2003**

 
| PART I.    | FINANCIAL INFORMATION                                                                                            |
|------------|------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                             |   |
| Item 1.    | Financial Statements                                                                                             |
|       |                                                                                                             |   |
|       | Consolidated Balance  Sheets as of December 31, 2002 and March 31, 2003 (unaudited)                              |
|       |                                                                                                             |   |
|       | Consolidated  Statements of Operations for the Three Months Ended March 31, 2003 and March  31, 2002 (unaudited) |
|       |                                                                                                             |   |
|       | Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2003 and March  31, 2002 (unaudited) |
|       |                                                                                                             |   |
|       | Notes to  Consolidated Financial Statements (unaudited)                                                          |
|       |                                                                                                             |   |
| Item 2.    | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                      |
|       |                                                                                                             |   |
| Item 3.    | Quantitative and Qualitative Disclosures about  Market Risk                                                      |
|       |                                                                                                             |
| Item 4     | Controls  and Procedures                                                                                         |
|       |
| PART II.   | OTHER INFORMATION                                                                                                |
|       |                                                                                                             |
| Item 1.    | Legal Proceedings                                                                                                |
|       |                                                                                                             |   |
| Item 2.    | Changes  in Securities and Use of Proceeds                                                                       |
|       |                                                                                                             |   |
| Item 3.    | Defaults Upon  Senior Securities                                                                                 |
|       |                                                                                                             |   |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                                             |
|       |                                                                                                             |   |
| Item 5.    | Other Information                                                                                                |
|       |                                                                                                             |   |
| Item 6.    | Exhibits and  Reports on Form 8-K                                                                                |
|       |                                                                                                             |   |
| Signatures |                                                                                                             |
|            |                                                                                                                  |  |  |  |

 

Except as otherwise notedin this report, “SimpleTech,” the “Company,” “we,” “us” and “our” collectivelyrefer to SimpleTech, Inc.

 

2

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**PARTI.  FINANCIAL INFORMATION**

 

## **ITEM 1.****  FINANCIAL STATEMENTS**

 

**SimpleTech, Inc.**

**Consolidated Balance Sheets**

**(inthousands, except share and per share amounts)**

**(unaudited)**

 
|                                                                                                                                                                                                 |   | **March 31,  2003** |   | **December  31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
|                                                                                                                                                                                                 |   |                |   |                    |   |
| ASSETS:                                                                                                                                                                                              |   |                |   |                    |   |
| Current Assets:                                                                                                                                                                                      |   |                |   |                    |   |
| Cash and cash equivalents                                                                                                                                                                            |   | $                   | 31,857 |                    | $      | 33,992 |   |
| Marketable securities                                                                                                                                                                                |   | 9,980               |   | 9,980                   |   |
| Accounts  receivable, net of allowances of $764 at March 31, 2003 and $782 at December  31, 2002                                                                                                     |   | 14,701              |   | 19,019                  |   |
| Inventory, net                                                                                                                                                                                       |   | 10,776              |   | 14,141                  |   |
| Income taxes receivable                                                                                                                                                                              |   | 4,250               |   | 3,860                   |   |
| Deferred income taxes                                                                                                                                                                                |   | 28                  |   | 28                      |   |
| Other current assets                                                                                                                                                                                 |   | 998                 |   | 59                      |   |
| Total current assets                                                                                                                                                                                 |   | 72,590              |   | 81,079                  |   |
| Furniture, fixtures and equipment, net                                                                                                                                                               |   | 9,710               |   | 10,169                  |   |
| Intangible assets                                                                                                                                                                                    |   | 835                 |   | 835                     |   |
| Deferred income taxes                                                                                                                                                                                |   | 2,378               |   | 2,378                   |   |
| Total assets                                                                                                                                                                                         |   | $                   | 85,513 |                    | $      | 94,461 |   |
|                                                                                                                                                                                                 |   |                |   |                    |   |
| LIABILITIES AND  SHAREHOLDERS' EQUITY:                                                                                                                                                               |   |                |   |                    |   |
| Current Liabilities:                                                                                                                                                                                 |   |                |   |                    |   |
| Accounts payable                                                                                                                                                                                     |   | $                   | 9,131  |                    | $      | 16,381 |   |
| Current maturities of capital lease obligations                                                                                                                                                      |   | —              |   | 113                     |   |
| Accrued and other liabilities                                                                                                                                                                        |   | 3,992               |   | 4,152                   |   |
| Total current liabilities                                                                                                                                                                            |   | 13,123              |   | 20,646                  |   |
|                                                                                                                                                                                                 |   |                |   |                    |   |
| Total liabilities                                                                                                                                                                                    |   | 13,123              |   | 20,646                  |   |
|                                                                                                                                                                                                 |   |                |   |                    |   |
| Commitments and contingencies (Note 5)                                                                                                                                                               |   |                |   |                    |   |
|                                                                                                                                                                                                 |   |                |   |                    |   |
| Shareholders' Equity:                                                                                                                                                                                |   |                |   |                    |   |
| Preferred stock, $0.001 par value, 20,000,000  shares authorized, no shares outstanding                                                                                                              |   | —              |   | —                  |   |
| Common stock, $0.001 par value, 100,000,000 shares  authorized,  38,900,883 shares issued and outstanding as of March 31, 2003 and  38,725,800 shares issued and outstanding as of December 31, 2002 |   | 39                  |   | 39                      |   |
| Additional paid-in capital                                                                                                                                                                           |   | 66,952              |   | 66,716                  |   |
| Retained earnings                                                                                                                                                                                    |   | 5,399               |   | 7,060                   |   |
| Total shareholders' equity                                                                                                                                                                           |   | 72,390              |   | 73,815                  |   |
| Total liabilities and shareholders' equity                                                                                                                                                           |   | $                   | 85,513 |                    | $      | 94,461 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

3

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**SimpleTech, Inc.**

**Consolidated Statements of Operations**

**(inthousands, except share and per share amounts)**

**(unaudited)**

 
|                                                        |   | **Three  Months  Ended March 31,** |   |
|-------------------------------------------------------------|--------|------------------------------------|--------|
|                                                        |   | **2003**                           |   | **2002** | ** ** |
|                                                        |   |                               |   |   |   |
| Net revenues                                                |   | $                                  | 40,918 |   | $ | 50,952 |   |
| Cost of revenues                                            |   | 33,987                             |   | 39,476 |   |
| Gross profit                                                |   | 6,931                              |   | 11,476 |   |
| Sales and marketing                                         |   | 5,372                              |   | 4,837 |   |
| General and administrative                                  |   | 2,514                              |   | 3,031 |   |
| Research and development                                    |   | 2,117                              |   | 1,938 |   |
| In-process research and development                         |   | —                             |   | 1,360 |   |
| Total operating expenses                                    |   | 10,003                             |   | 11,166 |   |
| (Loss) income from operations                               |   | (3,072                             | )      | 310 |   |
| Interest and other, net                                     |   | 151                                |   | 209 |   |
| (Loss) income before (benefit) provision for income  taxes  |   | (2,921                             | )      | 519 |   |
| (Benefit) provision for income taxes                        |   | (1,260                             | )      | 206 |   |
| Net (loss) income                                           |   | $                                  | (1,661 | ) | $ | 313 |   |
|                                                        |   |                               |   |   |   |
| Net (loss) income per share:                                |   |                               |   |   |   |
| Basic                                                       |   | $                                  | (0.04  | ) | $ | 0.01 |   |
| Diluted                                                     |   | $                                  | (0.04  | ) | $ | 0.01 |   |
|                                                        |   |                               |   |   |   |
| Shares used in computation of net (loss) income per  share: |   |                               |   |   |   |
| Basic                                                       |   | 38,843                             |   | 38,329 |   |
| Diluted                                                     |   | 38,843                             |   | 40,575 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

4

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**SimpleTech, Inc.**

**Consolidated Statements of Cash Flows**

**(in thousands)**

**(unaudited)**

 
|                                                                                  |   | **Three  Months  Ended March 31,** |   |
|---------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                  |   | **2003**                           |   | **2002** | ** ** |
|                                                                                  |   |                               |   |   |   |
| Cash flow from operating activities:                                                  |   |                               |   |   |   |
| Net (loss) income                                                                     |   | $                                  | (1,661 | ) | $ | 313 |   |
| Adjustments to reconcile net (loss) income to net  cash used in operating activities: |   |                               |   |   |   |
| Depreciation and amortization                                                         |   | 974                                |   | 836 |   |
| Loss (gain) on sale of furniture, fixtures and  equipment                             |   | (24                                | )      | 59 |   |
| Accounts receivable provisions                                                        |   | 583                                |   | 331 |   |
| Inventory excess and obsolescence expense                                             |   | 25                                 |   | 355 |   |
| In-process research and development                                                   |   | —                             |   | 1,360 |   |
| Compensation related to stock options vesting                                         |   | —                             |   | 9 |   |
| Change in operating assets and liabilities:                                           |   |                               |   |   |   |
| Accounts receivable                                                                   |   | 3,735                              |   | (4,973 | ) |
| Inventory                                                                             |   | 3,340                              |   | (9,789 | ) |
| Other current assets                                                                  |   | (1,329                             | )      | 2,431 |   |
| Accounts payable                                                                      |   | (7,250                             | )      | 5,725 |   |
| Accrued and other liabilities                                                         |   | (160                               | )      | 739 |   |
| Net cash used in operating activities                                                 |   | (1,767                             | )      | (2,604 | ) |
|                                                                                  |   |                               |   |   |   |
| Cash flows from investing activities:                                                 |   |                               |   |   |   |
| Purchase of furniture, fixtures and equipment                                         |   | (555                               | )      | (2,206 | ) |
| Proceeds from sale of furniture, fixtures and  equipment                              |   | 64                                 |   | 191 |   |
| Acquisition of assets                                                                 |   | —                             |   | (2,295 | ) |
| Net cash used in investing activities                                                 |   | (491                               | )      | (4,310 | ) |
|                                                                                  |   |                               |   |   |   |
| Cash flows from financing activities:                                                 |   |                               |   |   |   |
| Repayment of borrowings from banks                                                    |   | —                             |   | (192 | ) |
| Payment on capital lease obligations                                                  |   | (113                               | )      | (107 | ) |
| Proceeds from issuance of common stock                                                |   | 236                                |   | 239 |   |
| Net cash provided by (used in) financing activities                                   |   | 123                                |   | (60 | ) |
|                                                                                  |   |                               |   |   |   |
| Net decrease in cash                                                                  |   | (2,135                             | )      | (6,974 | ) |
| Cash and cash equivalents at beginning of period                                      |   | 33,992                             |   | 51,831 |   |
| Cash and cash equivalents at end of period                                            |   | $                                  | 31,857 |   | $ | 44,857 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

5

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**SIMPLETECH,INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1 –Basis of Presentation**

 

The accompanyinginterim consolidated financial statements of SimpleTech, Inc., a Californiacorporation (the “Company”), are unaudited and have been prepared in accordancewith the instructions to Form 10-Q and Article 10 of Regulation S-X.  In the opinion of management, all normal andrecurring adjustments considered necessary for a fair presentation of theconsolidated financial position of the Company at March 31, 2003 and theconsolidated results of operations and cash flows for the three-month periodsended March 31, 2003 and 2002 have been included.  These interim consolidated financial statements should be read inconjunction with the consolidated financial statements and related notescontained in the most recent Annual Report on Form 10-K filed with theSEC.  The December 31, 2002 balancesreported herein are derived from the audited consolidated financial statementsincluded in the Annual Report on Form 10-K for the year ended December 31, 2002.  The results for the interim periods are notnecessarily indicative of results to be expected for the full year.

 

The consolidatedfinancial statements of the Company include the accounts of the Company’ssubsidiaries.  All significantintercompany accounts and transactions have been eliminated in consolidation.

 

**Note 2 - Summary of SignificantAccounting Policies**

* *

*Risks and Uncertainties:*

 

Financialinstruments, which potentially subject the Company to a concentration of creditrisk, principally consist of cash and cash equivalents and accounts receivable.As of March 31, 2003 and December 31, 2002, approximately 12% and 15%,respectively, of accounts receivable were concentrated with one customer. Forthe three-month periods ended March 31, 2003 and 2002, sales to CDWComputer Centers comprised 22% and 21%, respectively, of the Company’srevenues.  No other single customeraccounted for more than 10% of accounts receivable at March 31, 2003 andDecember 31, 2002, or revenues for the three-month periods ended March 31,2003 and 2002.

 

*Management Estimates:*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make certainestimates and assumptions that affect the reported amounts of assets andliabilities (e.g., bad debt reserves and inventory reserves), disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

**Note 3 –Net Income Per Share**

 

Basic earnings per shareis computed by dividing net income by the weighted average number of sharesoutstanding. In computing diluted earnings per share, the weighted averagenumber of shares outstanding is adjusted to reflect the potentially dilutivesecurities. For the three months ended March 31, 2002, potentially dilutivesecurities consisted solely of options and resulted in potential common sharesof 2,246,000.  Further, options topurchase approximately 428,000 shares of common stock at prices ranging from$6.10 to $11.00 which were outstanding at March 31, 2002, would not have beenincluded in the computation of diluted earnings per share for the three monthsended March 31, 2002, because the exercise prices of these options were greaterthan the average market price of the Company's common stock.  For the threemonths ended March 31, 2003, nopotential common shares were included in the diluted per share amount as theeffect would have been anti-dilutive.

 

Pursuant to SFASNo. 123, “Accounting for Stock-Based Compensation,” the Company haselected to continue the intrinsic value method of accounting for stock optionsgranted to employees and directors in accordance with APB Opinion No. 25and related interpretations in accounting for stock option plans.  Had compensation cost been determined basedon the fair value at the grant dates for stock options under the Planconsistent with the method promulgated by SFAS No. 123, the Company’s net(loss) income for the three-month periods ended March 31, 2003 and 2002,would have resulted in the pro forma amounts below:

 
| **Three-Month  Period Ended March 31,**                                                                                                             |   | **2003** |   | **2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                                                                                                                |   |     |   |     |   |
| Net (loss)  income, as reported                                                                                                                     |   | $        | (1,661 | )        | $      | 313 |   |
| Add:  Stock-based employee compensation expense included  in reported net (loss) income, net of related tax effects                            |   | —   |   | 6        |   |
| Deduct:  Total stock-based employee compensation  expense determined under  fair value based method for all awards, net of related tax effects |   | (767     | )      | (566     | )      |
| Pro forma net  loss                                                                                                                                 |   | $        | (2,428 | )        | $      | (247 | ) |
|                                                                                                                                                |   |     |   |     |   |
| Earnings per  share:                                                                                                                                |   |     |   |     |   |
| Basic — as  reported                                                                                                                           |   | $        | (0.04  | )        | $      | 0.01 |   |
| Basic — pro  forma                                                                                                                             |   | $        | (0.06  | )        | $      | (0.01 | ) |
|                                                                                                                                                |   |     |   |     |   |
| Diluted — as  reported                                                                                                                         |   | $        | (0.04  | )        | $      | 0.01 |   |
| Diluted — pro  forma                                                                                                                           |   | $        | (0.06  | )        | $      | (0.01 | ) |

 

 

6

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###### **Note 4 –**Supplemental Balance Sheet Information

 

Inventory consistsof the following:

 
| **(in thousands)**   |   | **March 31, 2003** |   | **December 31, 2002** |   |
|----------------------|--------|--------------------|--------|-----------------------|--------|
|                 |   |               |   |                  |   |
| Raw materials        |   | $                  | 5,523  |                  | $      | 6,325 |   |
| Work-in-progress     |   | 220                |   | 364                   |   |
| Finished goods       |   | 5,837              |   | 8,256                 |   |
|                 |   | 11,580             |   | 14,945                |   |
| Valuation allowances |   | (804               | )      | (804                  | )      |
|                 |   |               |   |                  |   |
| Inventory, net       |   | $                  | 10,776 |                  | $      | 14,141 |   |

 

### **Note 5 – Legal Proceedings**

 

Reference is made to theCompany’s Annual Report on Form 10-K filed with the SEC on March 25, 2003 underthe heading “Legal Proceedings” for a discussion of litigation involving theCompany relating to (i) patent litigation with DPAC Technologies, Inc.,  (ii) patent litigation with LemelsonMedical, Education & Research Foundation, LLP and (iii) unfair tradepractice with Lexar Media, Inc.

 

**DPACTechnologies, Inc.—Patent Infringement**

 

On September 23, 1998,the Company filed a lawsuit against DPAC Technologies, Inc., formerly Dense-PacMicrosystems, Inc. (“DPAC”), in the United States District Court for theCentral District of California for infringement of the Company’s IC Towerstacking patent, U.S. Patent No. 5,514,907. DPAC filed an answer to the Company’s complaint denying the Company’sclaim of infringement, asserted a defense of patent invalidity against theCompany’s IC Tower stacking patent and asserted a counterclaim against theCompany alleging infringement of its stacking patent, U.S. Patent No.4,956,694.  On March 29, 2001, the courtentered final judgment finding DPAC did not infringe the Company’s patent andthat the Company did not infringe DPAC’s patent. The appeals court affirmed thefinal judgment on March 7, 2002.  DPACdid not appeal the ruling in the Company’s favor, and that ruling is nowfinal.  On September 3, 2002, theCompany filed a petition for certiori with the U.S. Supreme Court.  OnOctober 7, 2002, the petition to the Supreme Court was granted and the matterwas remanded to the Circuit Court of Appeals.  DPAC filed a motion forsummary affirmance with the Court of Appeals.  On February 26, 2003, theCourt of Appeals denied DPAC’s motion and remanded the matter for trial to theUnited States District Court for the Central District of California.  No trialdate has been set by the District Court.

 

**Lemelson Medical,Education & Research Foundation, LLP – Patent Infringement**

 

The Company received noticeon November 26, 2001 that the Lemelson Medical, Education & ResearchFoundation, LLP (“Lemelson Foundation”) filed a complaint on November 13, 2001against the Company and other defendants.  The complaint was filed in theDistrict Court of Arizona and alleges that the Company’s manufacturingprocesses infringe several patents that the Lemelson Foundation allegedly owns. The complaint also states that these allegedly infringed patents relate tomachine vision technology

 

7

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and bar codingtechnology.  On March 7, 2002, the Company was served with the LemelsonFoundation complaint.  Thereafter, the case was stayed pending the outcomeof related cases against other parties involving the same patents. Because of the preliminary stage of this case, an estimate of potentialdamages, if any, would be premature and speculative, and the Company has notmade any such estimate at this time.

 

**Lexar Media, Inc. — Unfair TradePractice and Patent Infringement**

 

On October 1, 2002, the Companyfiled a lawsuit against Lexar Media, Inc. in the Superior Court of OrangeCounty, California for trade libel, libel per se, intentional interference withprospective economic advantage and California unfair competition, seekingunspecified damages, including punitive and trebled damages.   Thelawsuit arose from correspondence sent by Lexar Media to one of the Company’scustomers that alleged that certain of the Company’s products infringe LexarMedia’s patents.  On October 30, 2002,Lexar Media removed the matter from the Orange County Superior Court to the UnitedStates District Court for the Central District of California.  On November14, 2002, the Company amended its complaint to add violation of the ShermanAntitrust Act, violation of the California Unfair Trade Practices Act andcommon law unfair competition as causes of action.

 

On November 6, 2002, LexarMedia filed a motion to dismiss the Company’s complaint.  On January 8, 2003, the Court denied Lexar’smotion as to the initial four causes of actions and dismissed the violation ofthe Sherman Antitrust Act, violation of the California Unfair Trade PracticesAct and common law unfair competition causes of actions against Lexar Media.

 

On March 20, 2003, Lexar Mediafiled a counter claim against the Company alleging that the Memory Stickproducts sold by the Company violate Lexar Media’s U.S. patent No.5,479,638.  Lexar Media is seekingmonetary damages in an amount to be stated later, an injunction against furtherinfringement of its patent, attorneys’ fees and trebled damages.  The Company purchases its Memory Stickproducts from I-O Data.  Under the termsof the distribution agreement with I-O Data, I-O Data has agreed to indemnify,defend and hold the Company harmless from claims, damages, losses and costswhich may arise from the alleged infringement by its products of third-partypatents, trademarks or other proprietary rights.  The Company has submitted this claim to I-O Data and I-O Data hasassumed the Company’s defense of, and agreed to indemnify the Company forliabilities related to, this lawsuit pursuant to the terms of the distributionagreement.  Accordingly, the Companywill remain the named party in this lawsuit, but I-O Data will manage thelitigation including indemnifying the Company for costs, expenses and anyjudgments or settlements.  This lawsuitis in the early stage of discovery and the court has set a trial date in April2004.

 

**Other Legal Proceedings**

 

The Company is currently not aparty to any other material legal proceedings. However, the Company is involvedin other suits and claims in the ordinary course of business, and the Companymay from time to time become a party to other legal proceedings arising in theordinary course of business.

 

As is common in the industry,the Company currently has in effect a number of agreements in which the Companyhas agreed to defend, indemnify and hold harmless certain of its suppliers andcustomers from damages and costs which may arise from the infringement by theCompany’s products of third-party patents, trademarks or other proprietaryrights. The scope of such indemnity varies, but may, in some instances, includeindemnification for damages and expenses, including attorneys’ fees. TheCompany’s insurance does not cover intellectual property infringement.

 

**Note 6 –Segment Information:**

 

Historically, the Companyhas reported financial results for two reportable operating segments,Industrial and Commercial.  In January 2002, the Company acquired theassets of Irvine Networks, which was subsequently renamed the Xiran Division,and reports the Division’s operating results as a third operating segment.

 

The accounting policies foreach of the reportable operating segments are the same as those described inNote 2 from the Company's Annual Report on Form 10-K and reflect theinformation used by the Company’s management to evaluatethe performance of its segments. For the Industrial and Commercial segments,the Company tracks separately net sales and gross profit, but does not trackseparately operating expenses, interest or income taxes.  For the Xiransegment, which is not expected to produce revenues until 2004, the Companycurrently tracks operating expenses only.  The Company does not maintainseparate records to identify assets by operating segment.

 

Summarized financialinformation regarding the Company’s three reportable segments is shown in thefollowing table:

** **
|                 |   | **Three  Months Ended March 31, 2003** |   |
|----------------------|--------|----------------------------------------|--------|
| **(in thousands)**   |   | **Industrial**                         |   | **Commercial** |   | **Subtotal** |   | **Xiran** |   | **Consolidated** |   |
| Net revenues         |   | $                                      | 9,147  |   | $ | 31,771 |   | $ | 40,918 |   | $ | 0 |   | $ | 40,918 |   |
| Cost of revenues     |   | 6,562                                  |   | 27,425 |   | 33,987 |   | 0 |   | 33,987 |   |
| Gross profit         |   | $                                      | 2,585  |   | $ | 4,346 |   | 6,931 |   | 0 |   | $ | 6,931 |   |
| Operating expenses   |   |                                   |   |   |   | 8,129 |   | 1,874 |   | 10,003 |   |
| Loss from operations |   |                                   |   |   |   | $ | (1,198 | ) | $ | (1,874 | ) | $ | (3,072 | ) |
|                      |        |                                        |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                          |   | **Three  Months Ended March 31, 2002** | ** ** |
|-------------------------------|--------|----------------------------------------|------------|
|                          |   | **Industrial**                         |       | **Commercial** | ** ** | **Subtotal** | ** ** | **Xiran** | ** ** | **Consolidated** | ** ** |
| Net revenues                  |   | $                                      | 7,327      |   | $ | 43,625 |   | $ | 50,952 |   | $ | 0 |   | $ | 50,952 |   |
| Cost of revenues              |   | 5,078                                  |       | 34,398 |   | 39,476 |   | 0 |   | 39,476 |   |
| Gross profit                  |   | $                                      | 2,249      |   | $ | 9,227 |   | 11,476 |   | 0 |   | 11,476 |   |
| Operating expenses            |   |                                   |       |   |   | 8,654 |   | 2,512 |   | 11,166 |   |
| Income (loss) from operations |   |                                   |       |   |   | $ | 2,822 |   | $ | (2,512 | ) | $ | 310 |   |
|                               |        |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

8

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For the threemonths ended March 31, 2003 and 2002, international sales comprised 21.7% and12.0%, of the Company’s revenues. During these periods, no single foreign country accounted for more than10.0% of total revenues.  Allinternational sales during these periods were shipped from the Company’sdomestic warehouse to foreign customers.

 

**ITEM 2.****  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Cautionary Statement**

 

Certainstatements in this report, including statements regarding the Company’sstrategy, financial performance and revenue sources, are forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995, Section 21E of the Securities Exchange Act of 1934, as amended, andSection 27A of the Securities Act of 1933, as amended, and are subject to thesafe harbors created by those sections. These forward-looking statements are based on our current expectations,estimates and projections about our industry, management’s beliefs, and certainassumptions made by us. Such statements are not guarantees of futureperformance and are subject to certain risks, uncertainties and assumptionsthat are difficult to predict. Therefore, our actual results could differmaterially and adversely from those expressed in any forward-looking statementsas a result of various factors. The section entitled “Risk Factors” set forthin this Form 10-Q and similar discussions in filings with the Securities andExchange Commission made from time to time, including other quarterly reportson Form 10-Q, our Annual Reports on Form 10-K, and in our other SEC filings,discuss some of the important risk factors that may affect our business,results of operations and financial condition.

 

Thefollowing discussion should be read in conjunction with the Company’sconsolidated financial statements and notes thereto.

 

#### **Overview**

 

**SimpleTechnology, Inc., incorporated in March 1990 and renamed SimpleTech, Inc. inMay 2001, is a technology solutions provider offering products based on DRAM,SRAM and Flash memory technologies. Headquartered in Santa Ana, California, thecompany is a leader in the design, development, manufacturing and marketing ofmemory solutions.**

** **

**Afterexperiencing year-over-year revenue growth of 57.5% from 1998 to 1999 and 60.1%from 1999 to 2000, revenues declined 46.7% in 2001 and increased 7.5% in2002.  Revenues in 2001 and 2002 were negativelyimpacted due to softening macro-economic conditions, severe declines in theprice of DRAM and Flash components and significantly reduced sales to customersin the communications and networking markets.**

** **

**As aresult of increased demand for Flash-based consumer electronics and industrialapplications in which solid-state Flash-based storage displaces traditionalstorage, our Flash memory products as a percentage of our revenues increasedsteadily from 12.9% for 1999 to 31.0% in 2002. Flash memory product comprised 38.0% of our revenues in the firstquarter of 2003 compared to 26.4% of our revenues in the first quarter of2002.  In November 2002, Semico ResearchCorporation projected data storage Flash industry revenues to grow at acompounded annual growth rate of 41% from 2001 to 2004.**

** **

**In thefirst three months of 2003 and 2002, our highest margin division was ourIndustrial Division.  In the first threemonths of 2003 and 2002, our highest profit margin product line was our ICTower stacking product line.  We trackrevenues and gross margins for our Industrial and Commercial Divisions.  We do not track separately, and do notintend to track separately, operating expenses for our Industrial andCommercial Divisions.  Conversely, we dotrack operating expenses for our Xiran Division.  Although our Xiran Division is expected to ship beta-levelprototype units to potential customers in the third quarter of 2003, it is notexpected to generate revenues until 2004.**

** **

**Historically,a small number of customers have accounted for a significant percentage of ourrevenues.   Our ten largest customersaccounted for an aggregate of 58.9% of our total revenues in the first quarterof 2003 compared to 58.1% of our total revenues in the first quarter of2002.  CDW Computer Centers accounted for 22.1% of our total revenues inthe first quarter of 2003 compared to 21.2% of our total revenues in the firstquarter of 2002. Other than CDW Computer Centers, no customer accounted for**

 

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more than 10.0% of ourtotal revenues in each of the first quarters of 2003 or 2002.  The composition of our major customer basechanges from quarter to quarter as the market demand for our products changesand we expect this variability will continue in the future. We expect thatsales of our products to a small number of customers will continue tocontribute materially to our revenues in the foreseeable future.  The loss of, or a significant reduction inpurchases by any of our major customers, could harm our business, financialcondition and results of operations. See Risk Factors - “Sales to a smallnumber of customers represent a significant portion of our revenues and theloss of any key customer would materially reduce our sales.”

 

**Internationalsales of our products constituted 21.7% of our total revenues for the firstquarter of 2003 compared to 12.0% of our total revenues for the first quarterof 2002.  No single foreign countryaccounted for more than 10.0% of our revenues in the first quarter of 2003 or2002. During the first quarters of 2003 and 2002, over 95.0% of ourinternational sales were denominated in U.S. dollars.  In addition, our purchases of IC components are currentlydenominated in U.S. dollars.  However,we do face risks associated with doing business in foreign countries.  See Risk Factors - “We face risks associatedwith doing business in foreign countries, including foreign currencyfluctuations and trade barriers, that could lead to a decrease in demand forour products or an increase in the cost of the components used in our products.”**

 

**In thepast, we have been impacted by seasonal purchasing patterns resulting in lowersales in the first and second quarters of each year. Other factors, includingcomponent price fluctuations, may distort the effect of seasonality.  Our ability to adjust our short-termoperating expenses in response to fluctuations in revenues is limited. As aresult, should revenues decrease to a level lower than expected in any givenperiod, our results of operations could be harmed.**

 

**Revenuesare recognized at the time of shipment. We face risks associated with declines in the market value of ourproducts, product returns, inventory obsolescence, price protection andrebates.   See Risk Factors “Productreturns, order cancellations, inventory write-downs, price protection andrebates could adversely effect our results of operations.”**

 

**Results of Operations – Comparison of the first quarter of 2003 to thefirst quarter of 2002**

 

*Net Revenues.* Our revenues were $40.9 million in the first quarter of 2003, compared to $51.0million in the same period in 2002.  Revenues declined 19.8% due primarilyto a 19.3% decline in average sales price in the first quarter of 2003.  The decrease in our average sales priceresulted from lower DRAM and Flash component prices in the first quarter of2003 compared to the first quarter of 2002.  Unit shipments in the firstquarter of 2003 were relatively flat compared to the first quarter of2002.  The mix of products sold variesfrom quarter to quarter and may vary in the future, affecting our overallaverage sales prices and gross margins.

 

OurIndustrial Division revenues increased 24.7% from $7.3 million in the firstquarter of 2002 to $9.1 million in the first quarter of 2003. IndustrialDivision unit volume increased 31.6% during this period and Industrial Divisionaverage sales price decreased 6.4% in the first quarter of 2003.  Thisincrease in unit volume resulted primarily from increased shipments of DRAM andFlash memory products into new Industrial markets such as defense, casino gamingand in-flight entertainment.  OurCommercial Division revenues decreased 27.1% from $43.6 million in the firstquarter of 2002 to $31.8 million in the first quarter of 2003. CommercialDivision revenues decreased due to a 22.0% decrease in average sales price inthe first quarter of 2003 and a decrease in unit volume of 6.9%.  Thedecrease in average sales price resulted primarily from lower DRAM and Flashcomponent prices in the first quarter of 2003 compared to the first quarter of2002.

 

Sales of our memory productsare made under short-term cancelable purchase orders. We include in our backlogonly those customer orders for which we have accepted purchase orders and towhich we have assigned shipment dates within the upcoming six months. Sinceorders constituting our backlog are subject to change due to, among otherthings, customer cancellations and reschedulings, and our ability to procurenecessary components, backlog is not necessarily an indication of futurerevenues. In addition, there can be no assurance that current backlog willnecessarily lead to revenues in any future period.   Our combined backlog was $4.4million as of March 31, 2003, compared to $8.2 million as of March 31,2002.  Our Industrial Division backlogwas $2.9 million as of March 31, 2003, compared to $7.5 million as of

 

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March31, 2002.   Our CommercialDivision backlog was $1.5 million as of March 31, 2003, compared to $729,000 asof March 31, 2002.   Commercial Divisionbacklog is typically nominal since substantially all commercial orders arefilled on a same-day or next-day basis. Our ability to predict future sales islimited because a majority of our quarterly product revenues come from ordersthat are received and fulfilled in the same quarter

 

*Gross Profit.* Our gross profit was $6.9 million in the first quarter of 2003, compared to$11.5 million in the same period in 2002.  Gross profit as a percentage of revenues was 16.9% inthe first quarter of 2003, compared to 22.5% in the same period in 2002.  The decrease in our gross profit as apercentage of revenues resulted from a more than 40% decline in DRAM and Flashcomponent prices during the first quarter of 2003.  Gross profit for ourIndustrial Division as a percentage of revenues was 28.3% in the first quarterof 2003, compared to 30.7% in the first quarter of 2002.  This decrease ingross profit as a percentage of revenues for our Industrial Division resultedprimarily from a negative shift in product mix.  Gross profit as apercentage of revenues for our Commercial Division was 13.7% in the firstquarter of 2003, compared to 21.2% in the first quarter of 2002.  Thisdecrease in gross profit as a percentage of revenues for our CommercialDivision resulted from significant price declines in DRAM and Flash componentsduring the first quarter of 2003.

 

*Sales and Marketing.*  Sales and marketing expenses were primarily comprised ofpersonnel costs and travel expenses for our domestic and international salesand marketing employees, commissions paid to internal salespersons andindependent manufacturers’ representatives, shipping costs and marketingprograms. Sales and marketing expenses were $5.4 million in the first quarterof 2003, compared to $4.8 million in the same period in 2002. Sales andmarketing expenses as a percentage of revenues were 13.2% in the first quarterof 2003, compared to 9.4% in the same period in 2002.  Sales and marketing expenses increased due primarily to increasedsales and marketing efforts for the Xiran Division and expanded CommercialDivision channel marketing programs in the first quarter of 2003.

 

*General and Administrative.*  General and administrative expenses were primarily comprised ofpersonnel costs for our executive and administrative employees, professionalfees and facilities overhead. General and administrative expenses were $2.5million in the first quarter of 2003, compared to $3.0 million in the sameperiod in 2002. General and administrative expenses as a percentage of revenueswere 6.1% in the first quarter of 2003 and 5.9% in the first quarter of2002.  General and administrativeexpenses decreased due primarily to reduced legal costs and reduced executivesalaries in the first quarter of 2003.

 

*Research and Development.*  Research and development expenses were primarily comprised ofpersonnel costs for our engineering anddesign staff and the cost of new product development and prototype supplies.Research and development expenses were $2.1 million in the first quarter of2003, compared to $1.9 million in the same period in 2002. Research anddevelopment expenses as a percentage of revenues were 5.1% in the first quarterof 2003, compared to 3.7% in the same period in 2002. The increase in researchand development expenses resulted from a $388,000 increase in expendituresrelated to our Xiran Division, partially offset by a $209,000 decrease inexpenditures related to our Industrial and Commercial Divisions.

 

*Non-recurring In-process Research and Development.*  We did not have non-recurring in-process research anddevelopment expenses in the first quarter of 2003.  Non-recurring in-process research and developmentexpenses were $1.4 million in the first quarter of 2002 and related to ouracquisition of the assets of Irvine Networks (Xiran Division) in January 2002.

 

*Interest Income, Net.*  Interest income, net was $151,000 in the first quarter of 2003and $209,000 in the first quarter of 2002. Interest income is comprised of interest earned on our cash, cashequivalents and marketable securities. Interest income was $151,000 in the first quarter of 2003 and $239,000in the first quarter of 2002.  This decrease in interest income resultedfrom lower interest rates and a reduced average cash balance in the firstquarter of 2003 compared to the first quarter of 2002.  Interest expenseis comprised of interest related to equipment financing. Interest expense was$0 in the first quarter of 2003 and $30,000 in the first quarter of 2002.

 

*(Benefit) Provision for Income Taxes.*Benefit for income taxes was $1.3 million in the first quarter of 2003including approximately $127,000 in research and development income taxcredits.  Provision for income taxes was$206,000 in the first quarter of 2002.  We did not claim any research anddevelopment income tax credits in the first quarter of 2002.  As a percentage of income before benefit forincome taxes, benefit for income taxes was 43.1% in the first quarter of2003.  As a percentage of income beforeprovision for income taxes, provision for income taxes was 39.7% in the firstquarter of 2002.

 

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*Net (Loss) Income. *Net loss was $1.7 million in the first quarter of 2003. * *Netincome was $313,000 in the first quarter of 2002.

 

**Liquidity and Capital Resources**

 

As of March 31, 2003, we had working capital of $59.5 million, including$31.9 million of cash and cash equivalents and $10.0 million in marketablesecurities, compared to working capital of $60.4 million, including $34.0million of cash and cash equivalents and $10.0 million in marketable securitiesas of December 31, 2002.  Our cash andcash equivalents balance decreased over the first quarter of 2003 due primarilyto a net loss of $1.7 million and purchases of furniture, fixtures andequipment of $555,000.  Current assetswere 5.5 times current liabilities at March 31, 2003, compared to 3.9 timescurrent liabilities at December 31, 2002.

 

Net cash used in operating activities was $1.8 million for the firstquarter of 2003 and resulted primarily from a net loss of $1.7 million and a$7.3 million decrease in accounts payable, partially offset by a  $3.7 million decrease in account receivableand a $3.3 million decrease in inventory.

 

Net cash used in investing activities was $491,000 for the first quarterof 2003, attributable primarily to $555,000 in purchases of furniture, fixturesand equipment, partially offset by $64,000 in proceeds from the sale offurniture, fixtures and equipment.  Weexpect to spend approximately $3.0 to $5.0 million on capital expendituresduring the next 24 months, primarily for the purchase of manufacturing,testing and engineering equipment.

 

Net cash provided by financing activities was $123,000 for the firstquarter of 2003 and resulted from the receipt of $236,000 in proceeds from theissuance of common stock, partially offset by payments of $113,000 related toequipment capital lease obligations.

 

In prior years, we enteredinto several capital leases to finance manufacturing and testing equipment. Ourobligations under capital leases were paid down to zero at March 31, 2003 andhad a balance of $113,000 at December 31, 2002, with interest rates rangingfrom 8.1% to 9.6% per annum.

 

We believe that our current assets,including cash and cash equivalents, and expected cash flow from operationswill be sufficient to fund our operations for at least the next twelvemonths.  However, it is possible that wemay need or elect to raise additional funds to fund our activities beyond thenext year or to consummate acquisitions of other businesses, products ortechnologies.  We could raise such fundsby selling more stock to the public or to selected investors, or by borrowingmoney.  In addition, even though we maynot need additional funds, we may still elect to sell additional equity securitiesor obtain credit facilities for other reasons. We cannot assure you that we will be able to obtain additional funds oncommercially favorable terms, or at all. If we raise additional funds by issuing additional equity or convertibledebt securities, the ownership percentages of existing shareholders would bereduced.  In addition, the equity ordebt securities that we issue may have rights, preferences or privileges seniorto those of the holders of our common stock.

 

Although we believe wehave sufficient capital to fund our activities for at least the next twelvemonths, our future capital requirements may vary materially from those nowplanned.  The amount of capital that wewill need in the future will depend on many factors, including:

 

•      the market acceptance of our products;

•                  thelevels of promotion and advertising that will be required to launch our newproducts and achieve and maintain a competitive position in the marketplace;

•                  pricediscounts on our products to our customers;

•      our business, product, capital expenditureand research and development plans and product and technology roadmaps;

•      the levels of inventory and accountsreceivable that we maintain;

•      capital improvements to new and existingfacilities;

•      technological advances;

•      our competitors’ response to our products;

•      our pursuit of strategic transactions; and

 

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•      our relationships with suppliers andcustomers.

 

**Inflation**

** **

**Inflationwas not a material factor in either revenue or operating expenses during thefirst quarters of 2003 or 2002.**

** **

**CriticalAccounting Policies and Estimates**

 

Our discussion and analysisof our financial condition and results of operations are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amount of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amount of revenues and expenses for eachperiod.  The following represents a summary of our critical accountingpolicies, defined as those policies that we believe are: (a) the most importantto the portrayal of our financial condition and results of operations, and (b)that require management’s most difficult, subjective or complex judgments,often as a result of the need to make estimates about the effects of mattersthat are inherently uncertain.

 

•  *Reservesfor inventory excess, obsolescence and lower of market values over costs*—Wegenerally purchase raw materials in quantities that we anticipate will be fullyused in the near term. Changes in operating strategy, customer demand andunpredictable fluctuations in market values of raw materials can limit ourability to effectively utilize all of the raw materials purchased and soldthrough resulting finished goods to customers for a profit.  We regularlymonitor potential inventory excess, obsolescence and lower market valuescompared to costs and, when necessary, reduce the carrying amount of ourinventory to its market value.

 

•  *Allowancesfor doubtful accounts and price protection*—We maintain allowancesfor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments.  Additionally, we maintain allowancesfor limited price protection rights for inventories of our products held by ourcustomers as a result of recent sales transactions to them.

 

If we reduce the list price of our products, these customersmay receive a credit from us.  We estimate the impact of such pricingchanges on a regular basis and adjust our allowances accordingly.

 

• *Product returns*—Weoffer a majority of our customers that purchase products through our commercialchannels limited rights to return unsold inventory.  In addition, while wemay not be contractually obligated to accept returned products, we maydetermine that it is in our best interest to accept returns in order tomaintain good relationships with our customers. We provide for estimated futurereturns of inventory at the time of sale based on historical experience, andactual results have been within our expectations.

 

• *Income taxes*—Aspart of the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. The process incorporates an assessment of the current tax exposuretogether with temporary differences resulting from different treatment oftransactions for tax and financial statement purposes. Such differences resultin deferred tax assets and liabilities, which are included within theconsolidated balance sheet.  The recovery of deferred tax assets fromfuture taxable income must be assessed and, to the extent that recovery is notlikely, we establish a valuation allowance. Increases in valuation allowancesresult in the recording of additional tax expense. Further, if our ultimate taxliability differs from the periodic tax provision reflected in the consolidatedstatements of operations, additional tax expense may be recorded.

 

• *Litigation and othercontingencies*—Management regularly evaluates our exposure to threatenedor pending litigation and other business contingencies. Because of theuncertainties related to the amount of loss from litigation and other businesscontingencies, the recording of losses relating to such exposures requiressignificant judgment about the potential range of outcomes.  As additional

 

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information about current or future litigation or othercontingencies becomes available, our management will assess whether suchinformation warrants the recording of additional expense relating to ourcontingencies. We base our estimates on historical experience and on variousother assumptions that are believed to be reasonable. The results of theseestimates form the basis for making judgments about the carrying values ofassets and liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

 

• *Valuation of long-livedassets*—We assess the potential impairment of long-lived tangible andintangible assets whenever events or changes in circumstances indicate that thecarrying value may not be recoverable. Changes in our operating strategy cansignificantly reduce the estimated useful life of such assets.

 

**Risk Factors**

 

***This Report contains forward-lookingstatements based on the current expectations, assumptions, estimates andprojections about our industry and us. These forward-looking statements involverisks and uncertainties. Our actual results could differ materially from thosediscussed in these forward-looking statements as a result of certain factors,as more fully described in this section and elsewhere in this Report. Youshould carefully consider the following risks before you decide to buy sharesof our common stock. The risks and uncertainties described below are not theonly ones facing us. Additional risks and uncertainties, including those risksset forth in “Management’s Discussion and Analysis of Financial Condition andResults of Operations” above, may also adversely impact and impair ourbusiness. If any of the following risks actually occur, our business, resultsof operations or financial condition would likely suffer. In such case, thetrading price of our common stock could decline, and you may lose all or partof the money you paid to buy our stock. We do not undertake to update publicly any forward-looking statementsfor any reason, even if new information becomes available or other events occurin the future.***

 

**Our quarterlyoperating results may fluctuate in future periods and, as a result, we may failto meet expectations of investors and analysts, causing our stock price tofluctuate or decline.**

 

Our quarterly operatingresults have fluctuated in the past and we believe they will continue to do soin the future. Our future results of operations will depend on many factorsincluding:

 

•                    Fluctuating market demand forand declines in the average sales prices of our products;

•                    Overproductionby suppliers of the components used in our products;

•                    Ourability to procure required components or fluctuations in the cost of suchcomponents;

•                    Theeffects of litigation;

•                    Changes inour product and sales mix as well as seasonal demand for our products;

•                    Marketacceptance of new and enhanced versions of our products;

•                    The timingof the introduction of new products or components and enhancements to existingproducts or components by us, our competitors or our suppliers;

•                    Inventoryobsolescence, product returns and price protections;

•                    Manufacturinginefficiencies associated with the start-up of new products and volumeproduction; and

•                    Expensesassociated with acquisitions.

 

Due to the above factors,quarterly revenues and results of operations are difficult to forecast, and webelieve that period-to-period comparisons of our operating results are neithermeaningful nor predictive of future performance.  In one or more futurequarters our results of operations may fall below the expectations ofsecurities analysts and investors. In that event, the trading price of ourcommon stock would likely decline.

 

In addition, the tradingprice of our common stock may materially decline regardless of our operatingperformance.  The market price of our common stock has been subject tosignificant fluctuations since our

 

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initial public offeringin September 2000.  The stock market has experienced significant price andvolume fluctuations that have affected the market prices of securities,particularly securities of technology companies. In the past, following periodsof volatility in the market price of a particular company’s securities,securities class action litigation has often been brought against that company.We may become involved in this type of litigation in the future. Litigation ofthis type is often expensive and can divert management’s attention andresources.

 

**Declines in ouraverage sales prices may result in declines in our revenues and gross profit.**

 

During the substantialmajority of 2001, 2002 and the first quarter of 2003, overcapacity in thememory component market resulted in significant declines in component prices,which negatively impacted our average selling prices, revenues and grossprofit.  Declines in semiconductor prices could also affect the valuationof our inventory, which could harm our business. During periods ofovercapacity, our ability to maintain or increase revenues will depend upon ourability to increase unit sales volumes of existing products and to introduceand sell new products in quantities sufficient to offset declines in salesprices. Our efforts to reduce costs and develop new products to offset theimpact of further declines in average sales prices may not be successful.Declines in average sales prices would also result in more memory being builtinto products by OEMs, which would favor our largest competitors and reduce thedemand for our Commercial Division memory products.

 

**Because we dependon a small number of suppliers for IC devices, any disruption in our supply relationshipscould harm our ability to fulfill orders.**

 

We are dependent on asmall number of suppliers to supply Flash IC and DRAM IC devices. We have nolong-term DRAM IC device supply contract and only have a limited supplycontract with Hitachi for Flash IC devices.  Although we have a limitedcontract with Hitachi, there can be no assurance that Hitachi can or will agreeto supply the quantities of Flash IC devices we may need to meet our productiongoals.  IC devices represent approximately 95% of our component costs. Ourdependence on a small number of suppliers and our limited number of long-termsupply contracts expose us to several risks, including the inability to obtainan adequate supply of components, price increases, late deliveries and poor componentquality. Hitachi and Samsung supply substantially all of the IC devices used inour Flash memory products. In addition, Elpida, Micron and Samsung currentlysupply a majority of the DRAM IC devices used in our DRAM memory products. Adisruption in or termination of our supply relationship with any of thesesignificant suppliers by natural disaster or otherwise, or our inability todevelop relationships with new suppliers, if required, would cause delays,disruptions or reductions in product shipments or require product redesignswhich could damage relationships with our customers, and would increase ourcosts and/or prices. In particular, if our supply relationships with Hitachi orSamsung are disrupted or terminated, our ability to manufacture and sell ourFlash products would be harmed and our Flash business would be adverselyaffected.

 

**We are subject tothe cyclical nature of the semiconductor industry and a significant orprolonged downturn could continue to adversely affect our business.**

 

The semiconductorindustry, including the memory markets in which we compete, is highly cyclicaland characterized by constant and rapid technological change, rapid productobsolescence and price erosion, evolving standards, short product life cyclesand wide fluctuations in product supply and demand. The industry hasexperienced significant downturns, such as the one we are currently in, oftenconnected with, or in anticipation of, maturing product cycles of bothsemiconductor companies’ and their customers’ products and declines in generaleconomic conditions. These downturns have been characterized by diminishedproduct demand, production overcapacity, high inventory levels and acceleratederosion of average selling prices. In the past two and a half years, asemiconductor downturn has negatively impacted our average selling prices,revenues and earnings. Any future downturns, or a worsening of the currentdownturn, could have a material adverse effect on our business and operatingresults.

 

**We may be unable tomaintain a steady supply of components.**

 

The electronics industryhas experienced in the past, and may experience in the future, shortages in ICdevices, including DRAM, SRAM and Flash memory. We have experienced and maycontinue to experience delays in component deliveries and quality problems,which have caused and could in the future cause delays in product shipments. Inaddition, we have required and could in the future require the

 

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redesign of some of ourproducts. From time to time, industry capacity has become constrained such thatsome vendors have placed their customers, ourselves included, on componentallocation. This means that while we may have customer orders, we may not beable to obtain the materials that we need to fill those orders in a timelymanner which could have a material adverse effect on our business and operatingresults.

 

**Increasedworldwide production of DRAM or Flash components could lead to further declinesin average selling prices.**

 

The transition to smallergeometries and the use of 300 millimeter wafers by semiconductor manufacturers,which is expected to accelerate over the next five years, could lead to asignificant increase in the worldwide supply of DRAM and Flash components. Increases in the worldwide supply of DRAM and Flash components could alsoresult from fab capacity expansions.  Increases in worldwide supply ofDRAM and Flash components, if not offset by increases in demand, could lead tofurther declines in the average selling prices of our products and have amaterial adverse effect on our business and operating results.

 

**Our limitedexperience in acquiring other businesses, product lines and technologies maymake it difficult for us to overcome problems encountered in connection withany acquisitions we may undertake.**

 

We intend to pursueselective acquisitions to complement our internal growth. If we make any futureacquisitions, we could issue stock that would dilute our shareholders’percentage ownership, incur substantial debt, reduce our cash reserves orassume contingent liabilities. Although we completed the acquisition of assetsof Irvine Networks, LLC, renamed our Xiran Division, in January 2002, ourexperience in acquiring other businesses, product lines and technologies islimited. In addition, the attention of our small management team may bediverted from our core business by our Irvine Networks acquisition or if weundertake a future acquisition. Our recent acquisition and potentialacquisitions also involve numerous risks, including, among others:

 

•   Problemsassimilating the purchased operations, technologies or products;

 

•   Costs associatedwith the acquisition;

 

•   Adverse effects onexisting business relationships with suppliers and customers;

 

•   Risks associatedwith entering markets in which we have no or limited prior experience;

 

•   Potential loss ofkey employees of purchased organizations; and

 

•   Potential litigation arisingfrom the acquired company’s operations before the acquisition.

 

Our inability to overcomeproblems encountered in connection with such acquisitions could divert theattention of management, utilize scarce corporate resources and harm ourbusiness. In addition, we are unable to predict whether or when any prospectiveacquisition candidate will become available or the likelihood that anyacquisition will be completed.

 

**Sales to a smallnumber of customers represent a significant portion of our revenues and theloss of any key****customer wouldmaterially reduce our sales.**

 

Our dependence on a smallnumber of customers means that the loss of a major customer or any reduction inorders by a major customer would materially reduce our revenues. Historically,a relatively small number of customers have accounted for a significantpercentage of our revenues. Our ten largest customers accounted for anaggregate of 58.9% of our total revenues in the first quarter of 2003 comparedto 58.1% of our total revenues in the first quarter of 2002.

 

**Ourten largest Industrial Division customers accounted for an aggregate of 72.5%of our Industrial Division revenues, or 16.2% of our total revenues, in thefirst quarter of 2003 and 90.3% of our Industrial Division revenues, or 12.7%of our total revenues, in the first quarter of 2002.  Our ten largestCommercial**

 

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Division customersaccounted for an aggregate of 65.2% of our Commercial Division revenues, or50.6% of our total revenues, in the first quarter of 2003 and 60.1% of ourCommercial Division revenues, or 51.6% of our total revenues, in the firstquarter of 2002. Our largest Commercial Division customer in each of the firstquarters of 2003 and 2002, CDW Computer Centers, accounted for 28.5% of ourCommercial Division revenues, or 22.1% of our total revenues, in the firstquarter of 2003 and 24.8% of our Commercial Division revenues, or 21.2% of ourtotal revenues, in the first quarter of 2002. Other than CDW Computer Centers,no customer accounted for more than 10.0% of our total revenues in each of thefirst quarters of 2003 or 2002.

 

Consolidation in some of ourcustomers’ industries may result in increased customer concentration and thepotential loss of customers as a result of acquisitions. In addition, thecomposition of our major customer base changes from quarter to quarter as themarket demand for our customers’ products changes, and we expect thisvariability will continue in the future. We expect that sales of our productsto a small number of customers will continue to contribute materially to ourrevenues in the foreseeable future.  The loss of, or a significantreduction in purchases by any of our major customers, could harm our business,financial condition and results of operations.

 

**Three of ourbeneficial shareholders have substantial influence over our operations and cansignificantly influence matters requiring shareholder approval.**

 

Manouch Moshayedi, MikeMoshayedi and Mark Moshayedi, each of whom is an executive officer and directorof SimpleTech, are brothers and beneficially own approximately 78.8% of ourcommon stock at March 31, 2003. As a result, they have the ability to controlall matters requiring approval by our shareholders, including the election andremoval of directors, approval of significant corporate transactions and theability to control the decision of whether a change in control will occur.

 

**We are involvedfrom time to time in claims and litigation over intellectual property rights,which may adversely affect our ability to manufacture and sell our products.**

 

The semiconductor industryis characterized by vigorous protection and pursuit of intellectual propertyrights. We believe that it may be necessary, from time to time, to initiatelitigation against one or more third parties to preserve our intellectualproperty rights. In addition, from time to time, we have received, and maycontinue to receive in the future, notices that claim we have infringed upon,misappropriated or misused other parties’ proprietary rights, which claimscould result in litigation. Such litigation would likely result in significantexpense to us and divert the efforts of our technical and management personnel.In the event of an adverse result in such litigation, we could be required topay substantial damages, cease the manufacture, use and sale of certainproducts, expend significant resources to develop non-infringing technology,discontinue the use of certain processes or obtain licenses to use theinfringed technology. Such a license may not be available on commerciallyreasonable terms, if at all. Our failure to obtain a license or our failure toobtain a license on commercially reasonable terms could cause us to incursubstantial costs and suspend manufacturing products using the infringedtechnology. If we obtain a license, we would likely be required to make royaltypayments for sales under the license. Such payments would increase our costs ofrevenues and reduce our gross profit.  In addition, any litigation,whether as plaintiff or as defendant, would likely result in significantexpense to us and divert the efforts of our technical and management personnel,whether or not such litigation is ultimately determined in our favor. Inaddition, the results of any litigation are inherently uncertain.

 

In the event we desire toincorporate third-party technology into our products or our products are foundto infringe on others’ patents or intellectual property rights, we may berequired to license such patents or intellectual property rights. If we obtainlicenses from third parties, we may be required to pay license fees or makeroyalty payments, which could reduce our gross margins. If we are unable toobtain a license from a third party for technology, we could incur substantialliabilities or be required to expend substantial resources redesigning ourproducts to eliminate the infringement. There can be no assurance that we wouldbe successful in redesigning our products or that we could obtain licenses oncommercially reasonable terms, if at all. In addition, any development orlicense negotiations could require substantial expenditures of time and otherresources by us.

 

We are currently a party tothree lawsuits regarding intellectual property as further described under“Legal Proceedings.” The outcome of litigation is inherently uncertain and wecannot predict the outcome of these lawsuits with certainty. These lawsuitshave diverted, and are expected to continue to divert, the efforts andattention of our key management and technical personnel. In addition, we haveincurred, and expect to continue to incur, substantial legal fees and expensesin connection with these lawsuits. As a result, our defense of these lawsuits,regardless of their eventual outcomes, has been, and will continue to be,costly and time consuming. In addition, if our IC Tower stacking patent isfound to be invalid, our 

 

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ability to exclude competitors from making, using or selling the sameor similar products to our IC Tower stacking products would cease. In addition,if we are found to infringe valid patents of others, we may be excluded fromusing the infringed technology without a license, which may not be available oncommercially reasonable terms, if at all.

 

**If industry salesof products using Flash memory do not grow, our revenues, gross margins andprofitability would be harmed.**

 

The market for consumerelectronics incorporating data storage Flash memory is relatively new andemerging. The success of our Flash business will depend largely on the level ofconsumer interest in new and emerging consumer electronics utilizing Flashmemory. If sales of products using Flash memory do not increase, we will beunable to grow our Flash business. In addition, if we are unable to anticipateand fulfill customer demand for our products, we may lose sales to ourcompetitors.

** **

**Demand for ourproducts would decline if the market for Flash memory does not develop, or if acompeting technology displaces Flash memory.**

 

There is currently anabsence of a single Flash memory standard. It is possible that Flash memorystandards other than those to which our products conform will emerge as theindustry standard. If we are unable to anticipate and adequately allocate ourresources in a timely and efficient manner toward the production anddevelopment of industry-standard Flash memory products, we may experiencesignificant delays in releasing new and commercially viable products. Thesedelays would provide a competitor a first-to-market opportunity and allow a competitorto achieve greater market share. Some of our competitors are in a betterfinancial and marketing position from which to influence industry acceptance ofa particular Flash memory standard or competing technology than we are. Inparticular, a primary source of competition may come from companies that offeralternative technologies such as ferroelectric random access memory products.If a competing technology replaces or takes significant market share from theFlash memory market, we would not be able to sell our Flash products.

** **

**The execution ofour growth strategy depends on our ability to retain key personnel, includingour executive officers, and to attract qualified personnel.**

 

Competition for employees inour industry is intense. We have had and may continue to have difficulty hiringthe necessary engineering, sales and marketing and management personnel tosupport our growth. The successful implementation of our business model andgrowth strategy depends on the continued contributions of our senior managementand other key research and development, sales and marketing and operationspersonnel, including Manouch Moshayedi, our Chief Executive Officer, MikeMoshayedi, our President, and Mark Moshayedi, our Chief Operating Officer,Chief Technical Officer and Secretary. The loss of any key employee, thefailure of any key employee to perform in his or her current position, or theinability of our officers and key employees to expand, train and manage ouremployee base would prevent us from executing our growth strategy.

** **

**Our proprietarytechnology and intellectual property may not be adequately protected, whichcould harm our competitive position.**

 

Our proprietary technologyand other intellectual property are critical to our success. We protect our intellectualproperty rights through patents, trademarks, copyrights and trade secret laws,confidentiality procedures and employee disclosure and invention assignmentagreements. It is possible that our efforts to protect our intellectualproperty rights may not:

 

•   prevent the challenge,invalidation or circumvention of our existing patents;

 

•   result in patents that leadto commercially viable products or provide competitive advantages for ourproducts;

 

•   prevent our competitors fromindependently developing similar products, duplicating our products ordesigning around the patents owned by us;

 

•   third-party patents fromhaving an adverse effect on our ability to do business;

 

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•   provide adequate protectionfor our intellectual property rights;

 

•   prevent disputes with thirdparties regarding ownership of our intellectual property rights;

 

•   prevent disclosureof our trade secrets and know-how to third parties or into the public domain;and

 

•   result in patentsfrom any of our pending applications.

 

As part of ourconfidentiality procedures, we enter into non-disclosure and inventionassignment agreements with all of our employees and attempt to control accessto and distribution of our technology, documentation and other proprietaryinformation. However, if such agreements are found to be unenforceable, we maybe unable to adequately protect our intellectual property rights. In addition,despite these procedures, third parties could copy or otherwise obtain and makeunauthorized use of our technologies or independently develop similartechnologies.

 

We have not applied and donot expect to apply for patent protection in foreign countries. In addition,the laws of foreign countries may not adequately protect our intellectualproperty rights. Many U.S. companies have encountered substantial infringementproblems in some foreign countries. Because we sell some of our productsoverseas, we have exposure to foreign intellectual property risks.

 

**Ourindemnification obligations for the infringement by our products of theintellectual property rights of others could require us to pay substantialdamages.**

 

We currently have in effecta number of agreements in which we have agreed to defend, indemnify and holdharmless certain of our customers and suppliers from damages and costs whichmay arise from the infringement by our products of third-party patents,trademarks or other proprietary rights. We may periodically have to respond toclaims and litigate these types of indemnification obligations. Any suchindemnification claims could require us to pay substantial damages. Ourinsurance does not cover intellectual property infringement.

** **

**Ourindemnification obligations to our customers and suppliers for product defectscould require us to pay substantial damages.**

 

A number of our productsales and product purchase agreements provide that we will defend, indemnifyand hold harmless our customers and suppliers from damages and costs which mayarise from product warranty claims or claims for injury or damage resultingfrom defects in our products. We maintain insurance to protect against certainclaims associated with the use of our products, but our insurance coverage maynot be adequate to cover all or any part of the claims asserted against us. Asuccessful claim brought against us that is in excess of, or excluded from, ourinsurance coverage could substantially harm our business, financial conditionand results of operations.

** **

**Product returns,order cancellations, inventory write-downs, price protection and rebates couldadversely affect our results of operations.**

 

To the extent we manufactureproducts in anticipation of future demand that does not materialize, or in theevent a customer cancels outstanding orders, we could experience anunanticipated increase in our inventory. A lack of consumer demand for ourproducts may also cause increased product returns. A majority of our salesthrough commercial channels include limited rights to return unsold inventory.In addition, while we may not be contractually obligated to accept returnedproducts, we may determine that it is in our best interest to accept returns inorder to maintain good relations with our customers. Product returns wouldincrease our inventory and reduce our revenues.  We have had to write-downinventory in the past for reasons such as obsolescence, excess quantities anddeclines in market value below our costs. These inventory write-downs wereapproximately $25,000 in the first quarter of 2003 compared to $355,000 in thefirst quarter of 2002. In addition, we offer some of our Commercial Divisioncustomers limited price protection rights for inventories of our products heldby them. If we reduce the list price of our products, these customers mayreceive credits from us. We incurred price protection charges of approximately$515,000 in the first quarter of 2003 compared to $297,000 in the first quarterof 2002.  We also offer rebate programs through some of our CommercialDivision customers to end-users.  We incurred rebate charges of $353,000in the first quarter of 2003 compared to $351,000 in the first quarter of 2002.

 

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We are also subject torepurchase agreements with various financial institutions in connection withwholesale inventory financing. Under these agreements, we may be required torepurchase inventory upon customer default with a financing institution andthen resell the inventory through normal distribution channels. As of March 31,2003, we have not been required to repurchase inventory in connection with thecustomer default agreements noted above. However, it may be possible that wewill be required to repurchase inventory, upon customer default, in the future.Sales under such agreements were approximately $234,000 in the first quarter of2003 compared to $189,000 in the first quarter of 2002.

 

We have no long-term volumecommitments from our customers. Sales of our products are made throughindividual purchase orders and, in certain cases, are made under masteragreements governing the terms and conditions of the relationships. Customersmay change, cancel or delay orders with limited or no penalties. We haveexperienced cancellations of orders and fluctuations in order levels fromperiod-to-period and we expect to continue to experience similar cancellationsand fluctuations in the future, which could result in fluctuations in ourrevenues.

** **

**We may not be ableto maintain or improve our competitive position because of the intensecompetition in the memory industry.**

 

We conduct business in anindustry characterized by intense competition, rapid technological change,evolving industry standards, declining average sales prices and rapid productobsolescence. Our competitors include many large domestic and internationalcompanies that have substantially greater financial, technical, marketing,distribution and other resources, broader product lines, lower cost structures,greater brand recognition and longer-standing relationships with customers andsuppliers. As a result, our competitors may be able to respond better to new oremerging technologies or standards and to changes in customer requirements. Ourcompetitors may also be able to devote greater resources to the development,promotion and sale of products, and may be able to deliver competitive productsat a lower price.

 

We expect to facecompetition from existing competitors and new and emerging companies that mayenter our existing or future markets with similar or alternative products,which may be less costly or provide additional features. In addition, some ofour significant suppliers are also our competitors, many of whom have theability to manufacture competitive products at lower costs as a result of theirhigher levels of integration. We also face competition from current andprospective customers that evaluate our capabilities against the merits ofmanufacturing products internally. Competition may arise due to the developmentof cooperative relationships among our current and potential competitors orthird parties to increase the ability of their products to address the needs ofour prospective customers. Accordingly, it is possible that new competitors oralliances among competitors may emerge and rapidly acquire significant marketshare.

 

We expect our competitorswill continue to improve the performance of their current products, reducetheir prices and introduce new products that may offer greater performance andimproved pricing, any of which could cause a decline in sales or loss of marketacceptance of our products. In addition, our competitors may developenhancements to or future generations of competitive products that may renderour technology or products obsolete or uncompetitive.

** **

**Terrorist activitiesand resulting military and other actions could adversely affect our business.**

 

The September 11, 2001terrorist attacks in the United States and recent terrorist attacks in otherparts of the world, as well as continued threats of global terrorism, currentand future military response to them and the current United States militaryaction against Iraq have created many economic and political uncertainties thatmake it extremely difficult for us, our customers and our suppliers toaccurately forecast and plan future business activities. This reducedpredictability challenges our ability to operate profitably or to grow ourbusiness. In particular, it is difficult to develop and implement strategies,sustainable business models and efficient operations, and effectively managecontract manufacturing and supply chain relationships. In addition, thecontinued threats of terrorism and the heightened security measures in responseto such threats have and may continue to cause significant disruption tocommerce throughout the world. Disruption in air transportation in response tothese threats or future attacks may result in transportation and supply-chaindisruptions, increase our costs for both receipt of inventory and shipment ofproducts to our customers, and cause customers to defer their purchasingdecisions. Disruptions in commerce could also cause consumer confidence andspending to decrease or result in increased volatility

 

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in the United States and worldwide financial marketsand economy. They also could result in economic recession in the United Statesor abroad. Any of these occurrences could have a significant impact on ouroperating results, revenue and costs and may result in the volatility of the marketprice for our common stock and on the future price of our common stock.

 

**We may lose ourcompetitive position if we fail to develop new and enhanced products andintroduce them in a timely manner.**

 

The high-performancecomputing, networking and communications, consumer electronics and industrialmarkets are subject to rapid technological change, product obsolescence,frequent new product introductions and enhancements, changes in end-userrequirements and evolving industry standards. Our ability to compete in thesemarkets will depend in significant part upon our ability to successfullydevelop, introduce and sell new and enhanced products on a timely andcost-effective basis, and to respond to changing customer requirements.

 

We have experienced, and mayin the future experience, delays in the development and introduction of newproducts. Our product development is inherently risky because it is difficultto foresee developments in technology, coordinate our technical personnel, andidentify and eliminate design flaws. Defects or errors found in our productsafter commencement of commercial shipments could result in delays in marketacceptance of these products. Delays in developing, manufacturing or marketingnew or enhanced products could give our competitors an advantage, hurt ourreputation and harm our business, financial condition and results ofoperations. Such products, even if introduced, may not gain market acceptance.In addition, we may not be able to respond effectively to new technological changesor new product announcements by others.

** **

**Obtainingadditional capital to fund our operations and finance our growth could impairthe value of your investment.**

 

If we expand more rapidlythan currently anticipated or if our working capital needs exceed our currentexpectations, we may need to raise additional capital through public or privateequity offerings or debt financings. Our future capital requirements depend onmany factors including our research, development, sales and marketingactivities. We do not know whether additional financing will be available ifneeded, or will be available on terms favorable to us. If we cannot raiseneeded funds on acceptable terms, we may not be able to develop or enhance ourproducts, take advantage of future opportunities or respond to competitivepressures or unanticipated requirements. To the extent we raise additionalcapital by issuing equity securities, our shareholders may experiencesubstantial dilution and the new equity securities may have greater rights,preferences or privileges than our existing common stock.

** **

**We face risksassociated with doing business in foreign countries, including foreign currencyfluctuations and trade barriers, that could lead to a decrease in demand forour products or an increase in the cost of the components used in our products.**

 

The volatility of generaleconomic conditions and fluctuations in currency exchange rates affect theprices of our products and the prices of the components used in our products.International sales of our products accounted for 21.7% and 12.0% of ourrevenues in the first quarters of 2003 and 2002, respectively.  No singleforeign country accounted for more than 10.0% of our revenues in the firstquarters of 2003 or 2002.  For the first quarters of 2003 and 2002, morethan 95.0% of our international sales were denominated in U.S. dollars.However, if there is a significant devaluation of the currency in a specificcountry, the prices of our products will increase relative to that country’scurrency and our products may be less competitive in that country. In addition,we cannot be sure that our international customers will continue to be willingto place orders denominated in U.S. dollars. If they do not, our revenues andresults of operations will be subject to foreign exchange fluctuations, whichcould harm our business. We do not hedge against foreign currency exchange raterisks.

 

In addition, we purchasesubstantially all of the IC devices used in our products from localdistributors of foreign suppliers. Although our purchases of IC devices arecurrently denominated in U.S. dollars, devaluation of the U.S. dollar relativeto the currency of a foreign supplier would likely result in an increase in ourcost of IC devices.

 

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Our international sales alsoare subject to certain other risks, including regulatory risks, tariffs andother trade barriers, timing and availability of export licenses, political andeconomic instability, difficulties in accounts receivable collections,difficulties in managing distributors, lack of a local sales presence,difficulties in obtaining governmental approvals, compliance with a widevariety of complex foreign laws and treaties and potentially adverse taxconsequences. In addition, the United States or foreign countries may implementquotas, duties, taxes or other charges or restrictions upon the importation orexportation of our products, leading to a reduction in sales and profitabilityin that country.

 

**Disruption of ouroperations in our Santa Ana, California, manufacturing facility wouldsubstantially harm our business.**

 

All of our manufacturingoperations are located in our facility in Santa Ana, California. Due to thisgeographic concentration, a disruption of our manufacturing operations,resulting from sustained process abnormalities, human error, governmentintervention or natural disasters, including earthquakes, fires or floods,could cause us to cease or limit our manufacturing operations and consequentlyharm our business, financial condition and results of operations.

 

**Compliance withenvironmental laws and regulations could harm operating results.**

 

We are subject to a varietyof environmental laws and regulations governing, among other things, airemissions, waste water discharge, waste storage, treatment and disposal, andremediation of releases of hazardous materials. Our failure to comply withpresent and future requirements could harm our ability to continuemanufacturing our products. Such requirements could require us to acquirecostly equipment or to incur other significant expenses to comply withenvironmental regulations. The imposition of additional or more stringentenvironmental requirements, the results of future testing at our facilities, ora determination that we are potentially responsible for remediation at othersites where problems are not presently known to us, could result in expenses inexcess of amounts currently estimated to be required for such matters.

 

**ITEM 3.**** QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**InterestRate Risk**

 

At any time, fluctuations ininterest rates could affect interest earnings on our cash and cash equivalents.We believe that the effect, if any, of reasonably possible near term changes ininterest rates on our financial position, results of operations and cash flowswould not be material.  Currently, we do not hedge these interest rateexposures.  The primary objective of our investment activities is topreserve capital. We have not used derivative financial instruments in ourinvestment portfolio.

 

At March 31, 2003, our cashand cash equivalents were $31.9 million. Our variable rate equipment debt waspaid down to zero at December 31, 2002, and our floating rate debt under therevolving credit facility expired in August 2002 and was not renewed.  AtMarch 31, 2003, our cash and cash equivalents included $23.2 million investedin money market and other interest bearing accounts and $8.7 million investedin securities, which represents investments in corporate bonds, auction ratesecurities and commercial paper with maturities of less than threemonths.  At March 31, 2003, our investments in securities with maturitiesof less than three months had a weighted-average time to maturity of 18.0 days.

 

At March 31, 2003, ourinvestment in marketable securities was $10.0 million.  The marketablesecurities consist primarily of $100,000 certificates of deposit with anoriginal maturity of one year at 100 different financial institutions.  AtMarch 31, 2003, these marketable securities had a weighted-average time tomaturity of approximately 288 days. Marketable securities represent investmentswith an original maturity of greater than three months. These securities areclassified as held to maturity because we have the intention and ability tohold the securities to maturity. Gross unrealized gains and losses onheld-to-maturity marketable securities have historically not been material.

 

If interest rates were todecrease 1%, the result would be an annual decrease in our interest incomerelated to our cash and cash equivalents of approximately $319,000. However, due to the uncertainty of the actions that would be taken and theirpossible effects, this analysis assumes no such action.  Further, this analysisdoes not consider the effect of the change in the level of overall economicactivity that could exist in such an environment.

 

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More than 95.0% of ourinternational sales are denominated in U.S. dollars.  Consequently, if thevalue of the U.S. dollar increases relative to a particular foreign currency,our products could become relatively more expensive.  In addition, wepurchase substantially all of our IC devices from local distributors ofJapanese, Korean and Taiwanese suppliers.  Fluctuations in the currenciesof Japan, Korea or Taiwan could have an adverse impact on the cost of our rawmaterials.  To date, we have not entered any derivative instruments tomanage risks related to interest rate or foreign currency exchange rates.

** **

**ITEM 4.**  CONTROLSAND PROCEDURES

 

**(a)**Evaluation of Disclosure Controls andProcedures.  Under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, weconducted an evaluation of our disclosure controls and procedures, as such termis defined under Rule 13a-14(c) and Rule 15d promulgated under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), within 90 days of thefiling date of this report. Based on their evaluation, our principal executiveofficer and principal accounting officer concluded that our disclosure controlsand procedures are effective.

** **

**(b)**Changes in Internal Controls.  There havebeen no significant changes (including corrective actions with regard tosignificant deficiencies or material weaknesses) in our internal controls or inother factors that could significantly affect these controls subsequent to thedate of the evaluation referenced in paragraph (a) above.

 

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**PART II**

**OTHER INFORMATION**

 

### **Item 1.**  Legal Proceedings

 

Reference is made to ourAnnual Report on Form 10-K filed with the SEC on March 25, 2003  under the heading “Legal Proceedings” fora discussion of litigation involving us relating to (i) patent litigation withDPAC Technologies, Inc. (ii) patent litigation with Lemelson Medical, Education& Research Foundation, LLP and (iii) unfair trade practice with LexarMedia, Inc.

 

**DPACTechnologies, Inc.—Patent Infringement**

 

On September 23, 1998,we filed a lawsuit against DPAC Technologies, Inc., formerly Dense-PacMicrosystems, Inc. (“DPAC”) in the United States District Court for theCentral District of California for infringement of our IC Tower stacking patent,U.S. Patent No. 5,514,907. On March 29, 2001, the court entered finaljudgment finding DPAC did not infringe our patent and that we did not infringeDPAC’s patent. The appeals court affirmed the final judgment on March 7,2002.  On September 3, 2002, we filed a petition for ceritiori with theU.S. Supreme Court.  On October 7, 2002, the petition to the Supreme Courtwas granted and the matter was remanded to the Circuit Court of Appeals. DPAC filed a motion for summary affirmance with the Circuit Court ofAppeals.  The Court of Appeals denied the motion and remanded the matterfor trial to the United States District Court for the Central District ofCalifornia.  No trial date has been set by the District Court.

** **

**Lemelson Medical,Education & Research Foundation, LLP — Patent Infringement**

 

We received notice onNovember 26, 2001, that the Lemelson Medical, Education & ResearchFoundation, LLP (“Lemelson Foundation”) filed a complaint on November 13, 2001,against us and other defendants.  The complaint was filed in the DistrictCourt of Arizona and alleges that our manufacturing processes infringe severalpatents that the Lemelson Foundation allegedly owns.  The complaint alsostates that these allegedly infringed patents relate to machine vision technologyand bar coding technology.  On March 7, 2002, we were served with theLemelson Foundation complaint.  Thereafter, the case was stayed pendingthe outcome of related cases against parties involving the same patents. Because of the preliminary stage of this case, an estimate of potentialdamages, if any, would be premature and speculative, and we have not made anysuch estimate at this time.

** **

**Lexar Media, Inc. — Unfair TradePractice and Patent Infringement**

 

On October 1, 2002, we filed alawsuit against Lexar Media, Inc. in the Superior Court of Orange County,California for trade libel, libel per se, intentional interference withprospective economic advantage and California unfair competition, seekingunspecified damages, including punitive and trebled damages.    The lawsuit arose from correspondence sentby Lexar Media to one of our customers that alleged that certain of ourproducts infringe Lexar Media’s patents. On October 30, 2002, Lexar Media removed the matter from the OrangeCounty Superior Court to the United States District Court for the CentralDistrict of California.  On November 14, 2002, we amended our complaint toadd violation of the Sherman Antitrust Act, violation of the California UnfairTrade Practices Act and common law unfair competition as causes of action.

 

On November 6, 2002, LexarMedia filed a motion to dismiss our complaint. On January 8, 2003, the Court denied Lexar’s motion as to the initialfour causes of actions and dismissed the violation of the Sherman AntitrustAct, violation of the California Unfair Trade Practices Act and common lawunfair competition causes of actions against Lexar Media.

 

On March 20, 2003, Lexar Mediafiled a counter claim against us alleging that the Memory Stick products soldby us violate Lexar Media’s U.S. patent No. 5,479,638.  Lexar Media is seeking monetary damages inan amount to be stated later, an injunction against further infringement of itspatent, attorneys’ fees and trebled damages. We purchase our Memory Stick products from I-O Data.  Under the terms of our distribution agreementwith I-O Data, I-O Data has agreed to indemnify, defend and hold us harmlessfrom claims, damages, losses and costs which may arise from the allegedinfringement by its products of third-party patents, trademarks or otherproprietary rights.  We have submittedthis claim to I-O Data and I-O Data has assumed our defense of, and agreed toindemnify us for liabilities related to, this lawsuit pursuant to the terms ofthe distribution agreement. Accordingly, we will remain the named party in this lawsuit, but I-OData will manage the litigation including indemnifying us for costs, expensesand any judgments or settlements.  Thislawsuit is in the early stage of discovery and the court has set a trial datein April 2004.

 

We are not currentlyinvolved in any other material legal proceedings. We are not aware of any othermaterial legal proceedings threatened or pending against us. From time to time,however, we may become subject to additional legal proceedings, claims, andlitigation arising in the ordinary course of business. In addition, in the pastwe have received, and we may continue to receive in the future, letters

 

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alleging infringement of patent or other intellectualproperty rights. Our management believes that these letters generally arewithout merit and intend to contest them vigorously.

 

**Item 2.  Changes in S****ecurities and Use of Proceeds**

 

None.

 

**Item3.  Defaults Upon Senior Securities**

 

None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

None.

 

**Item 5.  Other Information**

 

None.

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)  Exhibits.

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                  |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                             |
| 99.1                |   | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

(b)  Reports on Form 8-K.

 

None.

 

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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 theundersigned thereunto duly authorized.

 
|   | SIMPLETECH, INC.,                                                                  |
|--------|------------------------------------------------------------------------------------|
|   | a California  corporation                                                          |
|   |                                                                               |
|   |                                                                               |
| Date:  | May 12, 2003                                                                       |   | /s/ MANOUCH MOSHAYEDI |   |
|   |                                                                               |   | Manouch Moshayedi |
|   |                                                                               |   | Chief Executive Officer  and Chairman of the Board of Directors |
|   |                                                                               |   |   |
| Date:  | May 12, 2003                                                                       |   | /s/ DAN MOSES |   |
|   | Dan Moses                                                                          |
|   | Chief Financial Officer  (Principal Financial and Accounting Officer) and Director |

 

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**PERIODIC REPORT CERTIFICATION**

**of the Chief Executive Officer**

 

I, Manouch Moshayedi,Chief Executive Officer of SimpleTech, Inc., certify that:

 

1.   Ihave reviewed this quarterly report on Form 10-Q of SimpleTech, Inc.;

 

2.   Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.   Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.   Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(i)   designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

(ii)   evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(“Evaluation Date”); and

 

(iii)   presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.   Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

(i)   allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(ii)   anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.   Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
|   | /s/ MANOUCH MOSHAYEDI          |   |
|--------|--------------------------------|--------|
|   | Manouch Moshayedi              |
|   | Chief Executive Officer        |
|   | (Principal Executive  Officer) |
|   | May 12, 2003                   |

 

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**PERIODIC REPORT CERTIFICATIONof the Chief Financial Officer**

 

I, Dan Moses, ChiefFinancial Officer of SimpleTech , Inc., certify that:

 

1.   Ihave reviewed this quarterly report on Form 10-Q of SimpleTech, Inc.;

 

2.   Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.   Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.   Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(i)   designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

(ii)   evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(“Evaluation Date”); and

 

(iii)   presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.   Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

(i)   allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the Company’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(ii)   anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.   Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
|   | /s/ DAN MOSES                  |   |
|--------|--------------------------------|--------|
|   | Dan Moses                      |
|   | Chief Financial Officer        |
|   | (Principal Financial  Officer) |
|   | May 12, 2003                   |

 

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### **SIMPLETECH, INC.**

### **Index to Exhibits**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                   |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 99.1                |   | Certification of  Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |

 

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