**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

----

**FORM 10-Q**

 

 

 

**ý****QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thequarterly period ended September 30, 2001**

** **

** or**

** **

**o****TRANSITION REPORT TOSECTION 13 OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thetransition period from __________ to __________**

** **

**CommissionFile Number 000-31623**

 

**SIMPLETECH, INC.**

(Exact name of Registrantas 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 telephonenumber, 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

 

The number of shares outstanding of the Registrant’s common stock, parvalue $0.001, as of September 30, 2001 was 38,254,198.

 

 

# **SIMPLETECH, INC.**

**INDEX TO FORM 10-Q FOR THE**

**QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001**

 

 
|                                            |                                                                                                                            |   |   |
|-------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| PART I.  FINANCIAL INFORMATION             |                                                                                                                            |   |
|                                            |                                                                                                                            |   |   |
| Item 1.                                         | Financial Statements                                                                                                            |   |   |
|                                            |                                                                                                                            |   |   |
|                                            | Consolidated Balance Sheets  as of September 30, 2001 (unaudited) and December 31, 2000                                         |   |   |
|                                            |                                                                                                                            |   |   |
|                                            | Unaudited Consolidated  Statements of Operations for the Three and Nine Months Ended September 30,  2001 and September 30, 2000 |   |   |
|                                            |                                                                                                                            |   |   |
|                                            | Unaudited  Consolidated Statements of Cash Flows for the Nine Months Ended September 30,  2001 and September 30, 2000           |   |   |
|                                            |                                                                                                                            |   |   |
|                                            | 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 Disclosure about Market Risk                                                                      |   |   |
|                                            |                                                                                                                            |   |   |
| PART II.  OTHER INFORMATION AND SIGNATURES |                                                                                                                            |   |
|                                            |                                                                                                                            |   |   |  
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 noted in this report,“SimpleTech,” the “Company,” “we,” “us” and “our” collectively refer toSimpleTech, Inc.

 

 

 

 

 

 

**PARTI.  FINANCIAL INFORMATION**

 
**Item1.  Financial Statements**
 

SimpleTech, Inc.

Consolidated Balance Sheets

(in thousands, except share amounts)

(unaudited)

 

 

 

**September 30,**

 

**December 31,**

 

 

 

**2001**

 

**2000**

 

ASSETS:

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash  equivalents

 

$

45,786

 

$

33,747

 

Accounts  receivable, net of allowances of $1,040 at September 30, 2001 and $972 at  December 31, 2000

 

13,312

 

28,103

 

Inventory, net

 

8,595

 

31,052

 

Deferred income  taxes

 

2,060

 

2,060

 

Other current  assets

 

3,971

 

1,069

 

Total current  assets

 

73,724

 

96,031

 

Furniture,  fixtures and equipment, net

 

8,642

 

6,926

 

Deferred income  taxes

 

329

 

329

 

Total assets

 

$

82,695

 

$

103,286

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY:

 

 

 

 

 

Current  Liabilities:

 

 

 

 

 

Accounts  payable

 

$

5,871

 

$

25,950

 

Current  maturities of long-term debt

 

811

 

761

 

Current  maturities of capital lease obligations

 

487

 

801

 

Accrued and  other liabilities

 

2,755

 

4,219

 

Total current  liabilities

 

9,924

 

31,731

 

Long-term debt

 

468

 

1,083

 

Capital lease  obligations

 

227

 

560

 

Total  liabilities

 

10,619

 

33,374

 

 

 

 

 

 

 

Shareholders'  Equity:

 

 

 

 

 

Preferred  stock, $0.001 par value, 20,000,000 shares authorized, no shares issued and  outstanding

 

---

 

---

 

Common stock,  $0.001 par value, 100,000,000 shares authorized, 38,254,198 shares issued and  outstanding as of September 30, 2001; 37,572,667  shares issued and outstanding as of December 31, 2000

 

38

 

38

 

Additional  paid-in capital

 

64,857

 

63,911

 

Unearned  stock-based compensation

 

(26

)

(63

)

Retained  earnings

 

7,207

 

6,026

 

Total  shareholders' equity

 

72,076

 

69,912

 

Total  liabilities and shareholders' equity

 

$

82,695

 

$

103,286

 

 

See accompanyingnotes to unaudited consolidated financial statements.

 

 

 

 

SimpleTech, Inc.

Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

 

 

 

 

**Three Months**

 

**Nine Months**

 

 

 

**Ended September 30,**

 

**Ended September 30,**

 

 

 

**2001**

 

**2000**

 

**2001**

 

**2000**

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

33,177

 

$

84,709

 

$

128,660

 

$

217,356

 

Cost of  revenues

 

27,526

 

66,409

 

101,928

 

169,646

 

Gross profit

 

5,651

 

18,300

 

26,732

 

47,710

 

Sales and  marketing

 

4,057

 

5,312

 

13,962

 

14,773

 

General and  administrative

 

2,354

 

2,394

 

8,707

 

8,659

 

Research and  development

 

984

 

1,069

 

3,247

 

2,582

 

Non-recurring  expense

 

-

 

1,885

 

-

 

1,885

 

Total operating  expenses

 

7,395

 

10,660

 

25,916

 

27,899

 

Income (loss)  from operations

 

(1,744

)

7,640

 

816

 

19,811

 

Interest  expense

 

46

 

666

 

163

 

1,471

 

Interest income

 

(392

)

(1

)

(1,306

)

(1

)

Income (loss)  before provision (benefit) for income taxes

 

(1,398

)

6,975

   

1,959

   

18,341

   

Provision  (benefit) for income taxes

 

(555

)

(1,251

)

778

 

(1,076

)

Net income  (loss)

 

$

(843

)

$

8,226

 

$

1,181

 

$

19,417

 

 

 

 

 

 

 

 

 

 

 

Pro forma data:

 

 

 

 

 

 

 

 

 

Income before  provision for income taxes

 

 

 

$

6,975

 

 

 

$

18,341

 

Provision for  income taxes

 

 

 

2,651

 

 

 

6,970

 

Pro forma net  income

 

 

 

$

4,324

 

 

 

$

11,371

 

 

 

 

 

 

 

 

 

 

 

Net income  (loss) per share (pro forma in 2000):

 

 

   

 

   

 

   

 

   

Basic

 

$

(0.02

)

$

0.14

 

$

0.03

 

$

0.37

 

Diluted

 

$

(0.02

)

$

0.13

 

$

0.03

 

$

0.34

 

 

 

 

 

 

 

 

 

 

 

Weighted  average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

38,302

 

30,759

 

38,080

 

30,654

 

Diluted

 

38,302

 

33,768

 

39,462

 

33,531

 

 

See accompanyingnotes to unaudited consolidated financial statements.

 

 

 

 

 

SimpleTech, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

 

 

**Nine Months**

 

 

 

**Ended September 30,**

 

 

 

**2001**

 

**2000**

 

 

 

 

 

 

 

Cash flow from  operating activities:

 

 

 

 

 

Net income

 

$

1,181

 

$

19,417

 

Adjustments to  reconcile net income to net cash  provided by operating activities:

 

 

   

 

   

Depreciation  and amortization

 

2,614

 

2,106

 

Loss on sale of  furniture, fixtures and equipment

 

11

 

1

 

Accounts  receivable provision

 

1,945

 

675

 

Inventory  excess and obsolescence expense

 

1,898

 

715

 

Deferred income  taxes

 

-

 

(1,354

)

Compensation  related to stock options vesting

 

37

 

67

 

Foreign  currency translation adjustment

 

-

 

97

 

Change in  operating assets and liabilities:

 

 

 

 

 

Accounts  receivable

 

12,846

 

(6,295

)

Inventory

 

20,559

 

(23,953

)

Other assets

 

(2,902

)

(383

)

Accounts  payable

 

(20,079

)

8,009

 

Accrued and  other liabilities

 

(1,464

)

3,071

 

Net cash  provided by operating activities

 

16,646

 

2,173

 

 

 

 

 

 

 

Cash flows from  investing activities:

 

 

 

 

 

Purchase of  furniture, fixtures and equipment

 

(4,589

)

(1,725

)

Proceeds from  sale of furniture, fixtures and equipment

 

248

   

228

   

Net cash used  in investing activities

 

(4,341

)

(1,497

)

 

 

 

 

 

 

Cash flows from  financing activities:

 

 

 

 

 

Deferred  offering costs

 

-

 

(1,615

)

Borrowings  under line of credit, net

 

-

 

7,605

 

Repayment of  borrowings from banks

 

(565

)

(517

)

Payment on  capital lease obligations

 

(647

)

(693

)

Repayment of  loans to related parties, net

 

-

 

40

 

Distributions  to shareholders

 

-

 

(9,891

)

Stock repurchase

 

(94

)

-

 

Proceeds from  exercise of stock options

 

1,040

 

672

 

Net cash used  in financing activities

 

(266

)

(4,399

)

 

 

 

 

 

 

Net increase  (decrease) in cash

 

12,039

 

(3,723

)

Cash and cash  equivalents at beginning of period

 

33,747

 

3,779

 

Cash and cash  equivalents at end of period

 

$

45,786

 

$

56

 

 

 

 

 

 

 

Supplemental  Schedule of noncash activities:

 

 

 

 

 

Issuance of  common stock for IPO proceeds receivable

 

$

-

 

$

65,104

 

Declaration of  dividend payable

 

$

-

 

$

 25,148

 

 

See accompanyingnotes to unaudited consolidated financial statements.

 

**SIMPLETECH, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note1 - Basis of Presentation**

 

                Theaccompanying interim consolidated financial statements of SimpleTech, Inc., aCalifornia corporation (the “Company”), are unaudited and have been prepared inaccordance with the instructions to Form 10-Q and Article 10 of RegulationS-X.  In the opinion of management, alladjustments (consisting of normal and recurring accruals) considered necessaryfor a fair presentation of the consolidated financial position of the Companyat September 30, 2001, the consolidated results of operations for the three andnine months ended September 30, 2001 and 2000, and the consolidated statementsof cash flows for the nine months ended September 30, 2001 and 2000, have beenincluded.  These interim consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and related notes contained in the Annual Report on Form10-K filed with the SEC.  The December31, 2000 balances reported herein are derived from the audited consolidatedfinancial statements included in the Annual Report on Form 10-K for the yearended December 31, 2000.  The resultsfor the interim periods are not necessarily indicative of results to beexpected for the full fiscal year.

 

                Theconsolidated financial statements of the Company include the accounts of theCompany’s subsidiaries.  All significantintercompany accounts and transactions have been eliminated in consolidation.

 

**Note2 - Use of Estimates**

 

                Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makecertain estimates and assumptions that affect the reported amounts of assetsand liabilities (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 thoseestimates.

 

**Note3 - Net Income Per Share**

 

Basic earnings per share iscomputed 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 additionally reflect the effect ofpotentially dilutive securities. For the quarter ended September 30, 2000, andthe nine months ended September 30, 2001 and 2000, potentially dilutivesecurities consisted solely of options and resulted in potential common sharesof 3,009,091, 1,382,077 and 2,876,496, respectively.  No potential common shares were included in the diluted per shareamount for the three months ended September 30, 2001, as the effect would havebeen anti-dilutive due to the net loss.

 

For the three and nine monthsended September 30, 2000, pro forma net income was computed using an effectivetax rate of 38% to reflect the estimated income tax expense of the Company asif it had been subject to C corporation federal and state income taxes for theperiod, instead of S corporation income taxes.

 
**Note4 - Supplemental Balance Sheet Information**
 

                Inventoryconsists of the following:

 

(In thousands)

 

**September 30, 2001**

 

**December 31, 2000**

 

 

 

 

 

 

 

Raw materials

 

$

6,101

 

$

24,768

 

Work-in-progress

 

407

 

759

 

Finished goods

 

5,249

 

9,652

 

 

 

11,757

 

35,179

 

Reserve for  excess and obsolescence

 

(3,162

)

(4,127

)

 

 

 

 

 

 

Inventory, net

 

$

8,595

 

$

31,052

 

 

 

                Furniture,fixtures and equipment consist of the following:

 

(In thousands)

 

**September 30, 2001**

 

**December 31, 2000**

 

 

 

 

 

 

 

Furniture and  fixtures

 

$

299

 

$

294

 

Equipment

 

20,883

 

16,769

 

 

 

21,182

 

17,063

 

Accumulated  depreciation

 

(12,540

)

(10,137

)

 

 

 

 

 

 

Furniture,  fixtures and equipment, net

 

$

8,642

 

$

6,926

 

 

 
**Note 5 – DPACTechnologies, Inc. Litigation**
 

On February 7, 2001, the Court ruled on pendingsummary judgment motions in the lawsuit the Company filed in September 1998against DPAC Technologies, Inc, formerly Dense-Pac Microsystems, Inc.  In this lawsuit filed in Federal Court inSanta Ana, the Company alleged that DPAC Technologies infringed the Company’sIC Tower stacking patent, U.S. Patent No. 5,514,907. DPAC Technologies counterclaimedfor infringement of its stacking patent, U.S. Patent No. 4,956,694. The Companysought damages and an injunction against infringement of its patent by DPACTechnologies. DPAC Technologies denied the infringement and asserted a defenseof patent invalidity and a counterclaim against the Company alleginginfringement of its stacking patent.

 

In the Court's summary judgment rulings, the Courtfound non-infringement by DPAC Technologies as to the Company’s patent andnon-infringement by the Company as to DPAC Technologies’ patent.  The Company has appealed the adverse summaryjudgment ruling to U.S. Court of Appeals for the Federal Circuit in Washington,D.C. DPAC Technologies has not appealed the Court’s ruling that the Company didnot infringe the DPAC Technologies patent, and that ruling is now final.

 

On February 21, 2001, the Company filed a new lawsuitagainst DPAC Technologies in Federal Court in Santa Ana for infringement of itsIC Tower stacking patent, U.S. Patent No. Re. 36,916 (a reissue of U.S. PatentNo. 5,514,907 referenced above).  TheCompany is seeking damages, an injunction against further infringement, andrelated costs. DPAC Technologies filed its answer on March 13, 2001, denyinginfringement, asserting a defense of patent invalidity, and alleging technologymisappropriation by the Company.  Trialhas been set for October 22, 2002.

 

**Note6 – Segment Information:**

 

                TheCompany designs, manufactures and markets a comprehensive line of memory,storage and connectivity products used in high performance computing,networking and communications, consumer electronics and industrialapplications.  The Company providestechnology solutions for two reportable operating segments, Industrial(formerly termed Original Equipment Manufacturer or OEM) and Commercial(formerly termed Aftermarket), based on DRAM, SRAM and Flash memorytechnologies.

 

                Beginningin 1999, after completion of management information system enhancements, theCompany used net sales and gross profit as the basis for evaluating theperformance of its operating segments. The Company does not allocate operating expenses, interest or incometaxes to operating segments.  Due to thesimilarity of products manufactured for customers within each operatingsegment, the Company does not maintain separate records to identify assets byoperating segment.

 

                Summarizedfinancial information regarding the Company’s reportable segments is shown inthe following table:

 

(in thousands)

 

**Three Months Ended**

 

**Three Months Ended**

 

 

 

**September 30, 2001**

 

**September 30, 2000**

 

 

 

**Industrial**

 

**Commercial**

 

**Consolidated**

 

**Industrial**

 

**Commercial**

 

**Consolidated**

 

Net revenues

 

$

9,561

 

$

23,616

 

$

33,177

 

$

41,817

 

$

42,892

 

$

84,709

 

Cost of revenues

 

8,559

 

18,967

 

27,526

 

31,492

 

34,917

 

66,409

 

Gross profit

 

$

1,002

 

$

4,649

 

$

5,651

 

$

10,325

 

$

7,975

 

$

18,300

 

 

 

 

**Nine Months Ended**

 

**Nine Months Ended**

 

 

 
**September  30, 2001**
 

**September 30, 2000**

 

 

 

**Industrial**

 

**Commercial**

 

**Consolidated**

 

**Industrial**

 

**Commercial**

 

**Consolidated**

 

Net revenues

 

$

42,186

 

$

86,474

 

$

128,660

 

$

89,507

 

$

127,849

 

$

217,356

 

Cost of revenues

 

30,245

 

71,683

 

101,928

 

65,646

 

104,000

 

169,646

 

Gross profit

 

$

11,941

 

$

14,791

 

$

26,732

 

$

23,861

 

$

23,849

 

$

47,710

 

 

                Forthe three months ended September 30, 2001 and 2000, and the nine months endedSeptember 30, 2001 and 2000, international sales comprised 15.5%, 11.7%, 16.0%and 14.3% of the Company’s revenues, respectively.  During these periods, no single foreign country accounted formore than 10.0% of total revenues.  All internationalsales during these periods were shipped domestically to the Company’s foreigncustomers.

 

 

**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**CautionaryStatement**

 

Certain statements in thisreport, including statements regarding the Company's strategy, financialperformance and revenue sources, are forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995, Section 21E ofthe Securities Exchange Act of 1934, as amended, and Section 27A of theSecurities Act of 1933, as amended, and are subject to the safe harbors createdby those sections.  Theseforward-looking statements are based on our current expectations, estimates andprojections about our industry, management's beliefs, and certain assumptionsmade by us. Such statements are not guarantees of future performance and aresubject to certain risks, uncertainties and assumptions that are difficult topredict. Therefore, our actual results could differ materially and adverselyfrom those expressed in any forward-looking statements as a result of variousfactors. The section entitled "Risk Factors" set forth in this Form10-Q and similar information in filings with the Securities and Exchange Commissionmade from time to time, including, but not limited to, other quarterly reportson Form 10-Q and our Annual Report on Form 10-K, discuss some of the importantrisk factors that may affect our business, results of operations and financialcondition.

 

The following discussion shouldbe read in conjunction with the Company's consolidated financial statements andnotes thereto.

 
**Overview**
 

Incorporated in 1990, SimpleTech designs, manufacturesand markets a comprehensive line of memory, storage and connectivity productsused in high performance computing, networking and communications, consumerelectronics and industrial applications. Our memory and storage products are based on dynamic random accessmemory, or DRAM, static random access memory, or SRAM, and Flash memorytechnologies. In addition, we offer a line of high-density memory productsusing our three-dimensional IC Tower stacking technology that allows multiplememory chips to be stacked together to increase the capabilities of memorymodules without increasing the product footprint.

 

We provide technology solutions for two operatingsegments, Industrial (formerly termed Original Equipment Manufacturer or OEM)and Commercial (formerly termed Aftermarket). We sell our products to Commercial customers through our value addedreseller (VAR), mail order and retail channels. We do not allocate operatingexpenses, interest or income taxes to operating segments.  Due to the similarity of productsmanufactured for our customers within each operating segment, we do notmaintain separate records to identify assets by operating segment.

 

                From 1999 to 2000, combined Industrial and Commercialoperating segment revenues grew 60.1% due primarily to increased Flash memoryand IC Tower stacking product sales. Industrial customer revenues grew 190.7%from 1999 to 2000 due to strong growth in sales of Flash drives and IC Towerstacking products to Industrial customers in the networking and communicationindustries. Retail channel revenues increased 70.5% due to increased focus onthis sales channel and an increase in demand for Flash cards used in consumerapplications. During 1999, we aggressively expanded our presence in the VARchannel, experienced rapid growth in sales through the mail order channel andpenetrated the retail channel with customers such as Best Buy and CostcoWholesale.

 

                Historically, a relatively small number of customershave accounted for a significant percentage of our revenues. Our ten largestcustomers accounted for an aggregate of 57.2% of our total revenues in thefirst nine months of 2001 and 53.9% of our total revenues in the first ninemonths of 2000. Our ten largest Industrial customers accounted for an aggregateof 73.8% of our Industrial revenues or 24.2% of our total revenues in the firstnine months of 2001 and 79.7% of our Industrial revenues or 32.8% of our totalrevenues in the first nine months of 2000. Our largest Industrial customer inthe first nine months of 2001, Unisys, accounted for 40.5% of our Industrialrevenues or 13.3% of our total revenues. Our largest Industrial customer in the first nine months of 2000, CiscoSystems, accounted for 24.3% of our Industrial revenues or 10.0% of our totalrevenues.  Our ten largest Commercialcustomers accounted for an aggregate of 61.3% of our Commercial revenues or41.2% of our total revenues in the first nine months of 2001 and 51.4% of ourCommercial revenues or 30.2% of our total revenues in the first nine months of2000.  Our largest Commercial customer,CDW Computer Centers, accounted for 29.2% of our Commercial revenues or 19.6%of our total revenues in the first nine months of 2001 and 31.4% of ourCommercial revenues or 18.5% of our total revenues in the first nine months of2000. Other than Unisys, Cisco Systems and CDW Computer Centers, no customeraccounted for more than 10.0% of our total revenues in the first nine months of2001 or 2000. The composition of our major customer base changes from quarterto quarter as market conditions fluctuate and we expect this variability willcontinue in the future. We expect that sales of our products to a small numberof customers will continue to contribute materially to our revenues in theforeseeable future and believe that our financial results will depend insignificant part upon the success of our customers' business.

 

                International sales of our products constituted 16.0%of our revenues for first nine months of 2001 and 14.3% of our revenues in thefirst nine months of 2000. No single foreign country accounted for more than10.0% of our revenues in the first nine months of 2001 or 2000. During thefirst nine months of 2001 and 2000, over 95.0% of our international sales weredenominated in U.S. dollars. Consequently, if the value of the U.S. dollarincreases relative to a particular foreign currency, our products could becomerelatively more expensive, which could result in a reduction of sales in aparticular country. In addition, we purchase substantially all of theintegrated circuit (IC) components used in our products from local distributorsof Japanese, Korean and Taiwanese suppliers. Although our purchases of ICcomponents are currently denominated in U.S. dollars, devaluation of the U.S.dollar relative to the currency of a foreign supplier would likely result in anincrease in our cost of IC components. Our international sales also could beadversely affected by risks including regulatory risks, tariffs and other tradebarriers.

 

                In the past we have been impacted by seasonalpurchasing patterns resulting in higher sales in the third and fourth quartersof each calendar year. Our ability to adjust our short-term operating expensesin response to fluctuations in revenues is limited. As a result, if revenuesare lower than expected in any given period, our results of operations could beharmed.

 

                Substantially all of our revenues are recognized atthe time of shipment. A majority of our sales through Commercial channelsinclude limited rights to return unsold inventory. In addition, while we maynot be contractually obligated to accept returned products, we may determinethat it is in our best interest to accept returns in order to maintain goodrelations with our customers. Product returns would increase our inventory andreduce our revenues. We have had to write down inventory in the past forreasons such as obsolescence, excess quantities and declines in market valuebelow our costs. These inventory write-downs were approximately $1.9 millionfor the first nine months of 2001 and $715,000 in the first nine months of2000.  The increase in inventorywrite-downs resulted from significant declines in the price of DRAM and Flashcomponents from the fourth quarter of 2000 through the third quarter of2001.  In addition, we offer some of ourCommercial customers limited price protection rights for inventories of ourproducts held by them. If we reduce the list price of our products, thesecustomers may receive credits from us. We incurred price protection charges ofapproximately $1.3 million in the first nine months of 2001 and $413,000 in thefirst nine months of 2000. Price protection charges increased in the first ninemonths of 2001 due primarily to increased component price volatility and anexpansion of retail sales, which are subject to price protection charges.

 

                From formation in March 1990 to September 26, 2000,we elected for federal and state income tax purposes to be treated as an Scorporation under Subchapter S of the Internal Revenue Code. Under thiselection, our shareholders, rather than SimpleTech, were subject to federalincome taxes on their respective share of our taxable income. We also hadelected similar treatment for California franchise tax purposes which, inaddition, requires a state income tax at our level of 1.5%. On September 26,2000, we terminated our Subchapter S election. Subsequent to thetermination, we are required to pay federal and state corporate-level incometaxes.

 

**Results ofOperations - Comparison of the third quarter of 2001 to the third quarter of2000**

 

                *Net Revenues.*  Our revenues were $33.2 million in the thirdquarter of 2001 compared to $84.7 million in the same period in 2000.  Sales of Flash and IC Tower stackingproducts accounted for 29.0% of total revenues in the third quarter of 2001,compared to 43.7% in the same period in 2000. This decline resulted from a decreased concentration of Industrialsegment revenues, which are typically comprised of a significantly higher mixof Flash and IC Tower stacking products. Industrial segment revenues declined from 49.4% of total revenues in thethird quarter of 2000 to 28.8% of total revenue in the third quarter of2001.  Total revenues declined dueprimarily to a decrease in average sales price from $146 in the third quarterof 2000 to $50 in the third quarter of 2001, partially offset by an increase inunit volume of 15.1%.  The decrease inour average sales price resulted from significant declines in DRAM and Flashcomponent prices from late 2000 through the third quarter of 2001. Weexperienced unit volume increases of 71.1% for standard memory products and7.7% for Flash products, offset partially by unit volume decreases of 89.4% forIC Tower stacking products and 77.3% for non-DRAM, non-Flash products such asSRAM, hard drive upgrade kits and connectivity products. The increase in unitshipments resulted primarily from the expansion of our retail channel marketshare.  We have approximately doubledour retail store presence in the past year. The mix of products sold and sales channels varies from quarter toquarter and may vary in the future, affecting our overall average sales pricesand gross margins.

 

                Our Industrial segment revenuesdeclined 77.0% from $41.8 million in the third quarter of 2000 to $9.6 millionin the third quarter of 2001. The decrease in revenues resulted primarily froma 76.9% reduction in unit volume.  OurCommercial segment revenues declined 45.0% from $42.9 million in the thirdquarter of 2000 to $23.6 million in the third quarter of 2001. Commercialrevenues declined primarily due to a decrease in average sales price from $107in the third quarter of 2000 to $38 in the third quarter of 2001, partiallyoffset by an increase in unit volume of 56.7%. The decrease in average sales price for both our Industrial andCommercial segments resulted from significant declines in DRAM and Flashcomponent prices from late 2000 through the third quarter of 2001.  In the third quarter of 2001, Commercialsegment revenues were also negatively impacted by the September 11, 2001terrorist attacks on the United States. The attacks resulted in significantly lower demand for our consumerproducts in the two weeks following September 11th, which causedreduced revenues and earnings in the quarter.

 

                Our combined backlog was $5.1million as of September 30, 2001, consisting of $4.0 million for the Industrialsegment and $1.1 million for the Commercial segment.  Our combined backlog was $48.8 million as of September 30, 2000,consisting of $46.7 million for the Industrial segment and $2.1 million for theCommercial segment.  The decrease inIndustrial segment backlog between these periods was due primarily to the pushout and cancellation of orders by our Industrial customers in the networkingand communication industries as a result of a global economic slowdown and abuild-up of their inventory levels. Commercial segment backlog is typically nominal since substantially allCommercial customer orders are filled on a same–day or next–daybasis. We include in our backlog only those customer orders for which we haveaccepted purchase orders and to which we have assigned shipment dates withinthe upcoming nine months. Since orders constituting our backlog are subject tochange due to, among other things, customer cancellations and reschedulings,and our ability to procure necessary components, backlog is not necessarily anindication of future revenues.

 

*                Gross Profit.*  Our grossprofit was $5.7 million in the third quarter of 2001, compared to $18.3 millionin the same period in 2000.  Grossprofit declined due primarily to the overall decrease in revenues, an inventorywrite-down of approximately $980,000 during the quarter and the impact of theSeptember 11, 2001 terrorist attacks on the United States.  Gross profit as a percentage of revenues was17.2% in the third quarter of 2001, compared to 21.6% in the same period in2000. Gross profit as a percentage of revenues for our Industrial segment was10.5% in the third quarter of 2001, compared to 24.7% in the third quarter of2000. The decline in gross profit as a percentage of revenues for ourIndustrial segment in the third quarter of 2001 resulted from pricingconcessions made in order to sell through stale Industrial inventory.  We expect gross profit as a percentage ofrevenues for our Industrial segment to return to normalcy in futurequarters.  Gross profit as a percentageof revenues for our Commercial segment increased from 18.6% in the thirdquarter of 2000 to 19.7% in the third quarter of 2001.

 

                *Sales and Marketing.*  Sales and marketing expenses are comprisedprimarily of personnel costs and travel expenses for our domestic andinternational sales and marketing employees, commissions paid to internalsalespersons and independent manufacturers' representatives, shipping costs andmarketing programs. Sales and marketing expenses were $4.1 million in the thirdquarter of 2001, compared to $5.3 million in the same period in 2000. Sales andmarketing expenses decreased during this period due primarily to a decrease incommission expense.  Sales and marketingexpenses as a percentage of revenues were 12.3% in the third quarter of 2001,compared to 6.3% in the same period in 2000. The increase in sales andmarketing expenses as a percentage of revenues resulted primarily from reducedrevenues.

 

                *General and Administrative.*  General and administrative expenses arecomprised primarily of personnel costs for our executive and administrativeemployees, professional fees and facilities overhead. General andadministrative expenses were flat at $2.4 million in both the third quarters of2001 and 2000. General and administrative expenses as a percentage of revenueswere 7.2% in the third quarter of 2001, compared to 2.8% in the same period in2000. The increase in general and administrative expenses as a percentage ofrevenues resulted primarily from reduced revenues.

 

*                Research and Development.*  Researchand development expenses are comprised primarily of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses were $1.0 million in the third quarter of 2001, comparedto $1.1 million in the same period in 2000. Research and development expensesas a percentage of revenues were 3.0% in the third quarter of 2001, compared to1.3% in the same period in 2000. The increase in research and development expensesas a percentage of revenues resulted primarily from reduced revenues.

 

                *Non-Recurring Expenses.*  Non-recurring expenses were comprised of a$1.9 million litigation settlement reached in the third quarter of 2000 withInteractive Flight Technologies, Inc. There were no litigation settlement charges in the third quarter of2001.

 

                *Interest Expense and Income.*Interest expense is comprised of interest related to our line of credit andequipment financing. Interest expense was $46,000 in the third quarter of 2001,compared to $666,000 in the same period in 2000. The decrease in interestexpense in the third quarter of 2001 resulted from the pay down of our line ofcredit to zero in October 2000. Interest income was $392,000 in the third quarter of 2001, compared to$1,000 in the same period in 2000.  Thisincrease in interest income in the third quarter of 2001 resulted from theinvestment of cash received in October 2000 from our initial public offering.

 

                *Pro Forma Provision for Income Taxes.*From our formation in March 1990 to September 26, 2000, we elected for federaland state income tax purposes to be treated as an S corporation underSubchapter S of the Internal Revenue Code. Under this election, ourshareholders, rather than SimpleTech, were subject to federal income taxes ontheir respective share of our taxable income. We also had elected similartreatment for California franchise tax purposes which, in addition, requires astate income tax at our level of 1.5%. On September 26, 2000, we terminated ourSubchapter S election. Subsequent to the termination, we are required to payfederal and state corporate-level income taxes.

 

                *Netloss.*Net loss was $843,000 in the third quarter of2001.  The September 11, 2001 terroristattacks on the United States had a negative impact on our earnings in the thirdquarter of 2001, causing significantly reduced consumer demand for out productsin the two weeks following the attacks. Assuming the termination of our S corporation status, pro forma netincome would have been $4.3 million in the third quarter of 2000.

 

**Results ofOperations - Comparison of the first nine months of 2001 to the first ninemonths of 2000**

 

                *Net Revenues.*  Our revenues were $128.7 million in thefirst nine months of 2001, compared to $217.4 million in the same period in2000.  Sales of Flash and IC Towerstacking products accounted for 33.2% of our revenues in the first nine monthsof 2001, compared to 37.2% in the same period in 2000.  Revenues decreased due to a decline inaverage sales price from $120 in the first nine months of 2000 to $66 in thefirst nine months of 2001, which was partially offset by a 7.8% unit volumeincrease.  The decrease in our averagesales price resulted from significant declines in DRAM and Flash componentprices from late 2000 through the third quarter of 2001.  We experienced unit volume increases of28.8% for standard memory products and 8.9% for Flash products, partiallyoffset by decreases of 69.4% for IC Tower stacking products and 43.0% fornon-DRAM, non-Flash products such as SRAM, hard drive upgrade kits andconnectivity products. The mix of products sold varies from period to periodand may vary in the future, affecting our overall average sales prices andgross margins.

 

                Our Industrial segment revenuesdecreased 52.8% from $89.5 million in the first nine months of 2000 to $42.2million in the first nine months of 2001. The decrease in revenues resulted primarily from a 51.1% reduction inunit volume. The decline in product shipments resulted primarily from abuild-up of excess inventory by our Industrial customers in the second half of2000. Our Commercial segment revenues declined 32.3% from $127.8 million in thefirst nine months of 2000 to $86.5 million in the first nine months of 2001.Commercial revenues declined due to a reduction in average sales price from $95in the first nine months of 2000 to $50 in the first nine months of 2001,offset by an increase in unit volume of 28.1%. The decrease in average salesprice for our Commercial segment revenues resulted from significant declines inDRAM and Flash component prices from late 2000 through the third quarter of2001.

 

                *Gross Profit.*  Our gross profit was $26.7 million in thefirst nine months of 2001, compared to $47.7 million in the same period in 2000.  Gross profit as a percentage of revenuesdecreased from 21.9% in the first nine months of 2000 to 20.7% in the firstnine months of 2001.  Gross profit as apercentage of revenues for our Industrial segment was 28.3% in the first ninemonths of 2001, compared to 26.7% in the same period in 2000.  This increase in gross profit as apercentage of revenues for our Industrial segment resulted from shift in mixtoward higher margin product lines. Gross profit as a percentage of revenues for our Commercial segmentdecreased from 18.7% in the first nine months of 2000 to 17.1% in the firstnine months of 2001.  The decrease ingross profit as a percentage of revenues for our Commercial segment resultedprimarily from relatively flat fixed production expenses versus reducedrevenues and inventory write-downs recorded during the period.

 

                *Sales and Marketing.*  Sales and marketing expenses are comprisedprimarily of personnel costs and travel expenses for our domestic andinternational sales and marketing employees, commissions paid to internalsalespersons and independent manufacturers' representatives, shipping costs andmarketing programs. Sales and marketing expenses were $14.0 million in thefirst nine months of 2001, compared to $14.8 million in the same period in2000. The decrease in sales and marketing expenses resulted from reducedcommissions related to lower revenues. Sales and marketing expenses as a percentage of revenues were 10.9% inthe first nine months of 2001, compared to 6.8% in the same period in 2000. Theincrease in sales and marketing expenses as a percentage of revenues resultedprimarily from reduced revenues.

 

                *General and Administrative.*  General and administrative expenses arecomprised primarily of personnel costs for our executive and administrativeemployees, professional fees and facilities overhead. General andadministrative expenses were flat at $8.7 million in both the first nine monthsof 2001 and 2000.  General andadministrative expenses as a percentage of revenues were 6.8% in the first ninemonths of 2001, compared to 4.0% in the same period in 2000. The increase ingeneral and administrative expenses as a percentage of revenues resultedprimarily from reduced revenues.

 

*                Research and Development.*  Researchand development expenses are comprised primarily of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses were $3.2 million in the first nine months of 2001,compared to $2.6 million in the same period in 2000. The increase in researchand development expenses resulted from increased personnel costs related to theexpansion of our engineering staff. Research and development expenses as a percentage of revenues were 2.5%in the first nine months of 2001, compared to 1.2% in the same period in 2000.The increase in research and development expenses as a percentage of revenuesresulted from the expansion of our engineering staff and reduced revenues.

 

                *Non-Recurring Expenses.*  Non-recurring expenses were comprised of a$1.9 million litigation settlement reached with Interactive FlightTechnologies, Inc. in the first nine months of 2000.  There were no litigation settlement charges in the first ninemonths of 2001.

 

                *Interest Expense and Income.*  Interest expense is comprised of interestrelated to our line of credit and equipment financing. Interest expense was$163,000 in the first nine months of 2001, compared to $1.5 million in the sameperiod in 2000. The decrease in interest expense in the first nine months of2001 resulted from the pay down of our line of credit to zero in October2000.  Interest income was $1.3 millionin the first nine months of 2001, compared to $1,000 in the same period in2000. This increase in interest income in 2001 resulted from the investment ofcash received in October 2000 from our initial public offering.

 

                *Pro Forma Provision for Income Taxes.*From our formation in March 1990 to September 26, 2000, we elected for federaland state income tax purposes to be treated as an S corporation underSubchapter S of the Internal Revenue Code. Under this election, ourshareholders, rather than SimpleTech, were subject to federal income taxes ontheir respective share of our taxable income. We also had elected similartreatment for California franchise tax purposes which, in addition, requires astate income tax at our level of 1.5%. On September 26, 2000, we terminated ourSubchapter S election. Subsequent to the termination, we are required to payfederal and state corporate-level income taxes.

 

                *Netincome.*Net income was $1.2 million in the first nine months of2001.  Assuming the termination of our Scorporation status, pro forma net income would have been $11.4 million in thefirst nine months of 2000.

 

                **Liquidity and Capital Resources**

 

                As of September 30, 2001, we hadworking capital of $63.8 million including $45.8 million of cash and cashequivalents.  As of December 31, 2000,we had working capital of $64.3 million including $33.7 million of cash andcash equivalents.  In addition, we hadunused availability of $27.5 million at September 30, 2001 and December 31,2000 under our line of credit with Comerica Bank.  We had no outstanding principal balance under our line of creditat September 30, 2001 and December 31, 2000. There is no unused line fee under our line of credit agreement withComerica Bank.  As a result of ourinitial public offering on September 29, 2000, Comerica Bank has the option toreduce our available line of credit to a range between $15.0 million to $20.0million as determined in their sole and absolute discretion.

 

                Net cash provided by operatingactivities was $16.6 million in the first nine months of 2001. Net cashprovided by operating activities in the first nine months of 2001 resultedprimarily from net income of $1.2 million, a decrease in accounts receivable of$12.8 million and a decrease in inventory of $20.6 million, offset partially bya decrease in accounts payable of $20.1 million.  Accounts receivable, inventory of and accounts payable levelsdecreased due to declining sequential revenues.

 

                Net cash used in investingactivities was $4.3 million in the first nine months of 2001, attributableprimarily to purchases of furniture, fixtures and equipment.  We expect to spend approximately $3.0-5.0million during the next 12 months, primarily for the purchase of manufacturing,testing and engineering equipment.

 

                Net cash used in financingactivities totaled $266,000 in the first nine months of 2001.  Net cash used in financing activities in thefirst nine months of 2001 resulted primarily from $1.2 million in paymentsrelated to equipment loans and capital lease obligations, offset partially by$1.0 million in proceeds from the exercise of stock options.

 

Wehave several capital leases and loans to finance manufacturing and testingequipment, including leases and loans with companies affiliated with ourexecutive officers and directors as described under "Certain Relationshipsand Related Transactions-MDC Land Corporation and MDC Land LLC" in ourAnnual Report on Form 10-K filed with the SEC on April 2, 2001. Our obligationsunder capital leases were $714,000 on September 30, 2001 and $1.4 million onDecember 31, 2000, with interest rates ranging from 8.1% to 9.6% per annum. Ourequipment financing loan balances were $1.3 million on September 30, 2001 and$1.8 million on December 31, 2000, with interest rates ranging from 8.4% to9.1% per annum.  One of the equipmentnote payable agreements contains various nonfinancial covenants that, amongother things, limit distributions and dividends to our shareholders without theprior written consent of the lender, and requires the equipment to remainunencumbered by other liens. As of September 30, 2001, we were in compliancewith all covenants under the equipment note payable agreements.

 

Webelieve that our existing cash, cash equivalents, investments on hand, existingassets, anticipated debt and expected cash flow from operations will besufficient to fund our operations for the next 12 months. Thereafter, we mayrequire additional sources of funds to continue to support our business. Suchfunds, if needed, may not be available or may not be available on termsacceptable to us.

 

 

**Risk Factors**

 

***You should carefully consider thefollowing risks before you decide to buy shares of our common stock.  The risks and uncertainties described beloware not the only ones facing us. Additional risks and uncertainties, including those risks set forth in“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” above, may also adversely impact and impair our business.  If any of the following risks actuallyoccur, our business, results of operations or financial condition would likelysuffer.  In such case, the trading priceof our common stock could decline, and you may lose all or part of the moneyyou paid to buy our stock.***

** **

***This Report contains forward-looking statements based on thecurrent expectations, assumptions, estimates and projections about us and ourindustry.  These forward-looking statementsinvolve risks and uncertainties.  Ouractual results could differ materially from those discussed in theseforward-looking statements as a result of certain factors, as more fullydescribed in this section and elsewhere in this Report.  We do not undertake to update publicly anyforward-looking statements for any reason, even if new information becomesavailable or other events occur in the future.***

 

**Declinesin our average sales prices may result in declines in our revenues and grossmargins.**

 

In the past nine months, overcapacity in the memoryproduct market has negatively impacted our average selling prices.  We expect this overcapacity to continue tohave a negative impact our revenues and profitability until at least the end of2001 if not longer.  Declines insemiconductor prices could affect the valuation of our inventory, which couldharm our business. Our ability to maintain or increase revenues will dependupon our ability to increase unit sales volumes of existing products and tointroduce and sell new products in quantities sufficient to offset declines insales prices. Our efforts to reduce costs and develop new products to offsetthe impact of further declines in average sales prices may not be successful.Declines in average sales prices also would result in more memory being builtinto products by Industrial customers, which would favor our largestcompetitors and reduce the demand for our Commercial memory products.

 

**We aresubject to the cyclical nature of the semiconductor industry and changes fromthe current point in the cycle could adversely affect our business.**

 

The semiconductor industry, including the memorymarkets in which we compete, is highly cyclical and is characterized byconstant and rapid technological change, rapid product obsolescence and priceerosion, evolving standards, short product life cycles and wide fluctuations inproduct supply and demand. The industry has experienced significant downturns,often connected 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. Since the end of 2000, the semiconductor industry has suffered a severedownturn.  Industrial and Commercialcustomers have scaled back their purchases of memory products and have reliedon their excess memory inventory to meet their needs and have moved to reducetheir overall inventory levels. Consequently, the slowdown continues to have a negative impact on ourbusiness.  The continued downturn in ourindustry could have a material adverse effect on our business and operatingresults. Furthermore, any upturn in the semiconductor industry could result inincreased demand for, and possible shortages of, components we use tomanufacture and assemble our ICs. Such shortages could have a material adverseeffect on our business and operating results.

 

**Becausewe depend on a small number of suppliers for IC components, any disruption inour supply relationships could harm our ability to fulfill orders.**

 

We have no long-term supply contracts and aredependent on a small number of suppliers to supply DRAM components, whichrepresent approximately 95% of the component costs of our DRAM memory products.Our dependence on a small number of suppliers and our lack of long-term supplycontracts expose us to several risks, including the inability to obtain anadequate supply of components, price increases, late deliveries and poorcomponent quality. Elpida, Hyundai Electronics, Micron and SamsungSemiconductor currently supply a majority of the DRAM components used in ourDRAM-based memory products.  A disruptionin or termination of our supply relationship with any of these significantsuppliers by natural disaster or otherwise, or our inability to developrelationships with new suppliers, if required, would cause delays, disruptionsor reductions in product shipments or require product redesigns which coulddamage relationships with our customers, and would increase our costs and/orprices.

 

**Sales toa small number of customers represent a significant portion of our revenues andthe loss of any key customer would materially reduce our sales.**

 

Our dependence on a small number of customers meansthat the loss of a major customer or any reduction in orders by a majorcustomer would materially reduce our sales. Historically, a relatively smallnumber of customers have accounted for a significant percentage of ourrevenues. Our ten largest Industrial segment customers accounted for anaggregate of 85.5% of our Industrial revenues or 24.6% of our total revenues inthe third quarter of 2001 and an aggregate of 73.8% of our Industrial revenuesor 24.2% of our total revenues in the first nine months of 2001.  Our largest Industrial customer, Unisys,accounted for 60.8% of our Industrial revenues or 17.5% of our total revenuesin the third quarter of 2001 and 40.5% of our Industrial revenues or 13.3% ofour total revenues in the first nine months of 2001. No other Industrialsegment customer accounted for more than 10.0% of our total revenues in thethird quarter or first nine months of 2001. Our ten largest Commercial segmentcustomers accounted for an aggregate of 66.1% of our Commercial revenues or47.0% of our total revenues in the third quarter of 2001 and an aggregate of61.3% of our Commercial revenues or 41.2% of our total revenues in the firstnine months of 2001.  Our largestCommercial customer, CDW Computer Centers, accounted for 29.2% of ourCommercial revenues or 20.8% of our total revenues in the third quarter of 2001and 29.2% of our Commercial revenues or 19.6% of our total revenues in thefirst nine months of 2001. No other Commercial segment customer accounted formore than 10.0% of our total revenues in the third quarter or first nine monthsof 2001. Consolidation in some of our customers' industries may result inincreased customer concentration and the potential loss of customers as aresult of acquisitions. In addition, the composition of our major customer basechanges from quarter to quarter as the market demand for our customers'products changes and we expect this variability will continue in the future. Weexpect that sales of our products to a small number of customers will continueto contribute materially to our revenues in the foreseeable future and believethat our financial results will depend in significant part upon the success ofour customers' products.

 

**Three ofour beneficial shareholders have substantial influence over our operations andcan significantly influence matters requiring shareholder approval.**

 

Manouch Moshayedi, Mike Moshayedi and Mark Moshayedi,each of whom is an executive officer and director of SimpleTech, are brothersand beneficially own approximately 80.0% of our common stock. As a result, theyhave the ability to control all matters requiring approval by our shareholders,including the election and removal of directors, approval of significantcorporate transactions and the ability to control the decision of whether achange in control will occur.

 

**We areinvolved from time to time in claims and litigation over intellectual propertyrights, which may adversely affect our ability to manufacture and sell ourproducts.**

 

The semiconductor industry is characterized byvigorous protection and pursuit of intellectual property rights. We believethat it may be necessary, from time to time, to initiate litigation against oneor more parties to preserve our intellectual property rights. In addition, fromtime to time, we have received, and may continue to receive in the future,notices that claim we have infringed upon, misappropriated or misused otherparties' proprietary rights, which claims could result in litigation. Suchlitigation would likely result in significant expense to us and divert theefforts of our technical and management personnel. In the event of an adverseresult in such litigation, we could be required to pay substantial damages,cease the manufacture, use and sale of certain products, expend significantresources to develop non-infringing technology, discontinue the use of certainprocesses or obtain licenses to use the infringed technology. Such a licensemay not be available on commercially reasonable terms, if at all. Our failureto obtain a license or our failure to obtain a license on commerciallyreasonable terms could cause us to incur substantial costs and suspendmanufacturing products using the infringed technology. If we obtain a license,we would likely be required to make royalty payments for sales under thelicense. Such payments would increase our costs of revenues and reduce ourgross profit.

 

We are currently a party to two lawsuits regardingintellectual property as further described below under “Part II – OtherInformation – Item I - Legal Proceedings.” The outcome of litigation isinherently uncertain and we cannot predict the outcome of these lawsuits withcertainty. These lawsuits have diverted, and are expected to continue todivert, the efforts and attention of our key management and technicalpersonnel. In addition, we have incurred, and expect to continue to incur,substantial legal fees and expenses in connection with these lawsuits. As aresult, our defense of these lawsuits, regardless of their eventual outcomes,has been, and will continue to be, costly and time consuming. In addition, ifour IC Tower stacking patent is found to be invalid, our ability to excludecompetitors from making, using or selling the same or similar products to ourIC Tower stacking products would cease. In addition, if we are found toinfringe valid patents of others, we may be excluded from using the infringedtechnology without a license, which may not be available on commerciallyreasonable terms, if at all.

 

**We maybe unable to maintain a steady supply of components.**

 

The electronics industry has experienced in the past,and may experience in the future, shortages in IC components, including DRAM,static random access memory, or SRAM, and Flash memory. We have experienced andmay continue to experience delays in component deliveries and quality problemswhich have caused and could in the future cause delays in product shipments andhave required and could in the future require the redesign of some of ourproducts. In addition, industry capacity has, from time to time, becomeconstrained such that some vendors which supply components for our productshave placed their customers, ourselves included, on allocation. This means thatwhile we may have customer orders, we may not be able to obtain the materialsthat we need to fill those orders in a timely manner.

 

**Ifindustry sales of products using Flash memory do not grow, our revenues, grossmargins and profitability would be harmed.**

 

The market for consumer electronics incorporatingFlash memory is relatively new and emerging. The success of our Flash businesswill depend largely on the level of consumer interest in consumer electronicsutilizing Flash memory, such as digital cameras, MP3 digital audio players andpersonal digital assistants, or PDAs, many of which have only recently beenintroduced to the market. If sales of products using Flash memory do notincrease, we will be unable to grow our Flash business. In addition, if we areunable to anticipate and fulfill customer demand for our products, we may losesales to our competitors.

 

**Demandfor our products would decline if the market for Flash memory does not develop,or if a competing technology displaces Flash memory.**

 

There is currently an absence of a single Flash memorystandard. It is possible that Flash memory standards other than those to whichour products conform will emerge as the industry standard. If we are unable toanticipate and adequately allocate our resources in a timely and efficientmanner toward the production and development of industry-standard Flash memoryproducts, we may experience significant delays in releasing new andcommercially viable products. These delays would provide a competitor afirst-to-market opportunity and allow a competitor to achieve greater marketshare. Some of our competitors are in a better financial and marketing positionfrom which to influence industry acceptance of a particular Flash memorystandard or competing technology than we are. In particular, a primary sourceof competition may come from companies that offer alternative technologies suchas ferroelectric random access memory products. If a competing technologyreplaces or takes significant market share from the Flash memory market, wewould not be able to sell our Flash products.

 

**Theexecution of our growth strategy depends on our ability to retain keypersonnel, including our executive officers, and to attract qualifiedpersonnel.**

 

Competition for employees in our industry is intense.We have had and may continue to have difficulty hiring the necessaryengineering, sales and marketing and management personnel to support ourgrowth. The successful implementation of our business model and growth strategydepends on the continued contributions of our senior management and other keyresearch and development, sales and marketing and operations personnel,including Manouch Moshayedi, our Chief Executive Officer, Mike Moshayedi, ourPresident, and Mark Moshayedi, our Chief Operating Officer, Chief TechnicalOfficer and Secretary. The loss of any key employee, the failure of any keyemployee to perform in his or her current position, or the inability of ourofficers and key employees to expand, train and manage our employee base wouldprevent us from executing our growth strategy.

 

**Ourproprietary technology and intellectual property may not be adequatelyprotected, which could harm our competitive position.**

 

Our proprietary technology and other intellectualproperty are critical to our success. We protect our intellectual propertyrights 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 thechallenge, invalidation or circumvention of our existing patents;

•      result inpatents that lead to commercially viable products or provide competitiveadvantages for our products;

•      prevent ourcompetitors from independently developing similar products, duplicating ourproducts or designing around the patents owned by us;

•      preventthird-party patents from having an adverse effect on our ability to dobusiness;

•      result inpatents with claims that are sufficiently broad to preclude competition;

•      provideadequate protection for our intellectual property rights;

•      preventdisputes with third parties regarding ownership of our intellectual propertyrights;

•      preventdisclosure of our trade secrets and know-how to third parties or into thepublic domain; and

•      result inpatents from any of our pending applications.

 

As part of our confidentiality procedures, we enterinto non-disclosure and invention assignment agreements with all of ouremployees and attempt to control access to and distribution of our technology,documentation and other proprietary information. However, if such agreementsare found to be unenforceable, we may be unable to adequately protect ourintellectual property rights. In addition, despite these procedures, thirdparties could copy or otherwise obtain and make unauthorized use of ourtechnologies or independently develop similar technologies.

 

We have not applied and do not expect to apply forpatent protection in foreign countries. In addition, the laws of foreigncountries may not adequately protect our intellectual property rights. ManyU.S. companies have encountered substantial infringement problems in someforeign countries. Because we sell some of our products overseas, we haveexposure 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 effect a number of agreements inwhich we have agreed to defend, indemnify and hold harmless certain of ourcustomers and suppliers from damages and costs which may arise from theinfringement by our products of third-party patents, trademarks or other proprietaryrights. We may periodically have to respond to claims and litigate these typesof indemnification obligations. Any such indemnification claims could requireus to pay substantial damages. Our insurance does not cover intellectualproperty infringement.

 

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

 

A number of our product sales and product purchaseagreements provide that we will defend, indemnify and hold harmless ourcustomers and suppliers from damages and costs which may arise from productwarranty claims or claims for injury or damage resulting from defects in ourproducts. We maintain insurance to protect against certain claims associatedwith the use of our products, but our insurance coverage may not be adequate tocover all or any part of the claims asserted against us. A successful claimbrought against us that is in excess of, or excluded from, our insurancecoverage could substantially harm our business, financial condition and resultsof operations.

 

**Our limited experience inacquiring other businesses, product lines and technologies may make itdifficult for us to overcome problems encountered in connection with anyacquisitions we may undertake.**

 

We intend to pursue selective acquisitions tocomplement our internal growth. If we make any future acquisitions, we couldissue stock that would dilute our shareholders' percentage ownership, incursubstantial debt or assume contingent liabilities. We have limited experiencein acquiring other businesses, product lines and technologies. In addition, theattention of our small management team may be diverted from our core businessif we undertake an acquisition. Potential acquisitions also involve numerousrisks, including, among others:

 

•              Problemsassimilating the purchased operations, technologies or products;

•              Costsassociated with the acquisition;

•              Adverseeffects on existing business relationships with suppliers and customers;

•              Risksassociated with entering markets in which we have no or limited priorexperience;

•              Potentialloss of key employees of purchased organizations; and

•              Potentiallitigation arising from the acquired company's operations before theacquisition.

 

Our inability to overcome problems encountered inconnection with such acquisitions could divert the attention of management,utilize scarce corporate resources and harm our business. In addition, we areunable to predict whether or when any prospective acquisition candidate willbecome available or the likelihood that any acquisition will be completed.

 

**Productreturns, price protection and order cancellations could reduce our revenues.**

 

To the extent we manufacture products in anticipationof future demand that does not materialize, or in the event a customer cancelsoutstanding orders, we could experience an unanticipated increase in ourinventory. A lack of consumer demand for our products may also cause increasedproduct returns. A majority of our sales through Commercial segment channelsinclude limited rights to return unsold inventory. In addition, while we maynot be contractually obligated to accept returned products, we may determinethat it is in our best interest to accept returns in order to maintain goodrelations with our customers. Product returns would increase our inventory andreduce our revenues.  We have had towrite-down inventory in the past for reasons such as obsolescence, excessquantities and declines in market value below our costs. The inventorywrite-down for the first nine months of 2001 was $1.9 million.  In addition, we offer some of our Commercialcustomers 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$1.3 million in the first nine months of 2001.

 

We are also subject to repurchase agreements withvarious financial institutions in connection with wholesale inventoryfinancing. Under these agreements, we may be required to repurchase inventoryupon customer default with a financing institution and then resell theinventory through normal distribution channels. As of September 30, 2001, wehave not been required to repurchase inventory in connection with the customerdefault agreements noted above. However, it may be possible that we will berequired to repurchase inventory, upon customer default, in the future.  Sales under such agreements were approximately$1.0 million in the first nine months of 2001.

 

We have no long-term volume commitments from ourcustomers. Sales of our products are made through individual purchase ordersand, in certain cases, are made under master agreements governing the terms andconditions of the relationships. Customers may change, cancel or delay orderswith limited or no penalties. We have experienced cancellations of orders andfluctuations in order levels from period-to-period and we expect to continue toexperience similar cancellations and fluctuations in the future which couldresult in fluctuations in our revenues.

 

**We maynot be able to maintain or improve our competitive position because of theintense competition in the memory industry.**

 

We conduct business in an industry characterized byintense competition, rapid technological change, evolving industry standards,declining average sales prices and rapid product obsolescence. Our competitorsinclude many large domestic and international companies that have substantiallygreater financial, technical, marketing, distribution and other resources,broader product lines, lower cost structures, greater brand recognition andlonger-standing relationships with customers and suppliers. As a result, ourcompetitors may be able to respond better to new or emerging technologies orstandards and to changes in customer requirements. Our competitors may also beable to devote greater resources to the development, promotion and sale ofproducts, and may be able to deliver competitive products at a lower price.

 

We expect to face competition from existingcompetitors and new and emerging companies that may enter our existing orfuture markets that have similar or alternative products which may be lesscostly or provide additional features. In addition, some of our significantsuppliers are also our competitors, many of whom have the ability tomanufacture competitive products at lower costs as a result of their higherlevels of integration. We also face competition from current and prospectivecustomers that evaluate our capabilities against the merits of manufacturingproducts internally. Competition may arise due to the development ofcooperative relationships among our current and potential competitors or thirdparties to increase the ability of their products to address the needs of ourprospective customers. Accordingly, it is possible that new competitors oralliances among competitors may emerge and rapidly acquire significant marketshare.

 

We expect our competitors will continue to improve theperformance of their current products, reduce their prices and introduce newproducts that may offer greater performance and improved pricing, any of whichcould cause a decline in sales or loss of market acceptance of our products. Inaddition, our competitors may develop enhancements to or future generations ofcompetitive products that may render our technology or products obsolete oruncompetitive.

 

**Recentterrorist activities and the continued threat of terrorism could adverselyaffect our business.**

 

                Recentterrorist attacks in the United States, as well as continued threats ofterrorism within the United States and abroad and current and future militaryresponses to them, 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 reduced predictability challenges ourability to grow our business.  Inparticular, it is difficult to develop and implement strategies, efficientoperations, and effectively manage capacity and supply-chainrelationships.  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 to these threats or futureattacks may result in transportation and supply-chain disruptions, increase ourcosts for both receipt of inventory and shipment of products to our customers,and cause customers to defer their purchasing decisions.  Disruptions in commerce could also causeconsumer confidence and spending to decrease or result in increased volatilityin the United States and worldwide financial markets and economy.  They could also result in economic recessionin the United States or abroad.  Any ofthese occurrences could have a significant impact on our operating results,revenues and costs and may result in the volatility of the market price of ourcommon stock and on the future price of our common stock.

 

**We maylose our competitive position if we fail to develop new and enhanced productsand introduce them in a timely manner.**

 

The high performance computing, networking andcommunications, consumer electronics and industrial markets are subject torapid technological change, product obsolescence, frequent new productintroductions and enhancements, changes in end-user requirements and evolvingindustry standards. Our ability to compete in these markets will depend insignificant part upon our ability to successfully develop, introduce and sellnew and enhanced products on a timely and cost-effective basis, and to respondto changing customer requirements.

 

We have experienced, and may in the future experience,delays in the development and introduction of new products. Our productdevelopment is inherently risky because it is difficult to foresee developmentsin technology, coordinate our technical personnel, and identify and eliminatedesign flaws. Defects or errors found in our products after commencement ofcommercial shipments, could result in delays in market acceptance of theseproducts. Delays in developing, manufacturing or marketing new or enhancedproducts could give our competitors an advantage, hurt our reputation and harmour business, financial condition and results of operations. Such products,even if introduced, may not gain market acceptance. In addition, we may not beable to respond effectively to new technological changes or new productannouncements by others.

 

**We rely on a continuous power supply to conduct ouroperations, and California’s current energy crisis could disrupt our operationsand increase our expenses.**

 

All of our manufacturing operations are located in ourfacility in Santa Ana, California.  California is in the midst of an energy crisisthat could disrupt our operations and increase our expenses.  In the event power reserves for the State ofCalifornia fall to a critically low level, California has on some occasionsimplemented, and may in the future continue to implement, rolling powerblackouts throughout the state of California.  We currently do not have backup generators or alternate sources of powerin the event of a blackout, and our current insurance does not provide coveragefor any damages we may suffer as a result of any interruption in our powersupply.  If blackouts interrupt ourpower supply, we would be temporarily unable to continue operations.  Any such interruption in our ability tocontinue operations would delay the manufacture and development of ourproducts, disrupt communications with our customers and suppliers and delayproduct shipment.  Power interruptionscould also damage our reputation and could result in lost revenue.  Any loss of power could have a materialadverse effect on our business, operating results and financial condition.  Furthermore, shortages in wholesaleelectricity supplies have caused power prices to increase.  If electricity prices continue to increase,our operating expenses will likely increase which will have a negative effecton our operating results.

 

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

 

If we expand more rapidly than currently anticipatedor if our working capital needs exceed our current expectations, we may need toraise additional capital through public or private equity offerings or debtfinancings. Our future capital requirements depend on many factors includingour research, development, sales and marketing activities. We do not knowwhether additional financing will be available when needed, or will beavailable on terms favorable to us. If we cannot raise needed funds onacceptable terms, we may not be able to develop or enhance our products, takeadvantage of future opportunities or respond to competitive pressures orunanticipated requirements. To the extent we raise additional capital byissuing equity securities, our shareholders may experience substantial dilutionand the new equity securities may have greater rights, preferences orprivileges than our existing common stock.

 

**We facerisks associated with doing business in foreign countries, including foreigncurrency fluctuations and trade barriers, that could lead to a decrease indemand for our products or an increase in the cost of the components used inour products.**

 

The volatility of general economic conditions andfluctuations in currency exchange rates affect the prices of our products andthe prices of the components used in our products. International sales of ourproducts accounted for 15.5% in the third quarter of 2001 and 16.0% in thefirst nine months of 2001. No single foreign country accounted for more than10.0% of our revenues in the third quarter or first nine months of 2001. In thethird quarter and first nine months of 2001, over 95.0% of our internationalsales were denominated in U.S. dollars. However, if there is a significantdevaluation of the currency in a specific country, the prices of our productswill increase relative to that country's currency and our products maybe lesscompetitive in that country. In addition, we cannot be sure that ourinternational customers will continue to be willing to place orders denominatedin U.S. dollars. If they do not, our revenues and results of operations will besubject to foreign exchange fluctuations which could harm our business. We donot hedge against foreign currency exchange rate risks.

 

In addition, we purchase substantially all of the ICcomponents used in our products from local distributors of foreign suppliers.Although our purchases of IC components are currently denominated in U.S.dollars, devaluation of the U.S. dollar relative to the currency of a foreignsupplier would likely result in an increase in our cost of IC components.

 

Our international sales also are subject to certainother risks, including regulatory risks, tariffs and other trade barriers,timing and availability of export licenses, political and economic instability,difficulties in accounts receivable collections, difficulties in managingdistributors, lack of a local sales presence, difficulties in obtaininggovernmental approvals, compliance with a wide variety of complex foreign lawsand treaties and potentially adverse tax consequences. In addition, the UnitedStates or foreign countries may implement quotas, duties, taxes or othercharges or restrictions upon the importation or exportation of our products,leading to a reduction in sales and profitability in that country.

 

**Disruptionof our operations in our Santa Ana, California manufacturing facility wouldsubstantially harm our business.**

 

All of our manufacturing operations are located in ourfacility in Santa Ana, California. Due to this geographic concentration, adisruption of our manufacturing operations, resulting from sustained processabnormalities, human error, government intervention or natural disasters suchas earthquakes, fires or floods could cause us to cease or limit ourmanufacturing operations and consequently harm our business, financialcondition and results of operations.

 

**Compliancewith environmental laws and regulations could harm operating results.**

 

Weare subject to a variety of environmental laws and regulations governing, amongother things, air emissions, waste water discharge, waste storage, treatment anddisposal, and remediation of releases of hazardous materials. Our failure tocomply with present 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**

 

Atany time, fluctuations in interest rates could effect interest earnings on ourcash and cash equivalents and interest expense on our existing variable ratedebt.  We believe that the effect, ifany, of reasonably possible near term changes in interest rates on ourfinancial position, results of operations, and cash flows would not bematerial. Currently, we do not hedge these interest rate exposures.  At September 30, 2001, our cash and cashequivalents were $45.8 million and our variable rate debt, consisting of termloans for equipment, was $1.3 million. In 2001, we have not utilized our floating rate debt under our revolvingcredit facility.

 

                If interest rates were to decrease 1%, the resultwould be an annual decrease in our interest income related to our cash and cashequivalents of approximately $458,000. Conversely, if interest rates were to increase 1%, the result would bean annual increase in our interest expense related to our variable rate debt ofapproximately $13,000.  However, due tothe uncertainty of the actions that would be taken and their possible effects,this analysis assumes no such action. Further, this analysis does not consider the effect of the change in thelevel of overall economic activity that could exist in such an environment.

 

Over95% of our sales to foreign customers are denominated in U.S. dollars and assuch we have no material foreign currency fluctuation risk.

**PART II**

**OTHER INFORMATION**

 
**Item 1.  LegalProceedings**
 

Reference is made to our Annual Report on Form 10-Kfiled with the SEC on April 2, 2001underthe heading "Legal Proceedings" for a discussion of litigationinvolving the Company relating to patent litigation with DPAC Technologies,Inc.

 

**DPACTechnologies, Inc. -- Patent Litigation**

 

                There has been nomaterial change regarding the Company’s patent litigation with DPACTechnologies, Inc., formerly Dense-Pac Microsystems, Inc., since theinformation set forth in our Quarterly Report on Form 10-Q filed with the SECon August 14, 2001.

 
**Item 2. Changes in Securities and Use of Proceeds**
 

None.

 
**Item 3.  Defaults Upon Senior Securities**
 

        None.

 

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

 

None.

 

**Item5.  Other Information**

 

        None.

 

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

 

                (a)           None.

 

        (b)           A CurrentReport on Form 8-K was filed by SimpleTech with the Securities and ExchangeCommission on October 3, 2001 to report under Item 5 the press release issuedto the public on September 27, 2001 announcing a stock repurchase program.

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 

                                                                                                            SIMPLETECH,INC.,

                                                                                                            aCalifornia corporation

 

 

 

Date:

November 9, 2001

 

/s/ MANOUCH MOSHAYEDI

 

 

 

Manouch Moshayedi

 

 

 

Chief Executive Officer and Chairman of the Board of  Directors

 

 

Date:

November 9, 2001

 

/s/ DAN MOSES

 

 

 

Dan Moses

 

 

 

Chief Financial Officer (Principal Financial and  Accounting Officer) and Director

**EXHIBIT INDEX**

 

None.

  |