** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

** **

**FORM 10-Q**

 

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

 

**Forthe quarterly period ended September 30, 2002**

 

**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 of  Registrant 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

 

The number of sharesoutstanding of the Registrant’s common stock, par value $0.001, as of September30, 2002 was 38,568,766.

 

 

----

 

# **SIMPLETECH,INC.**

**INDEXTO FORM 10-Q FOR THE**

**QUARTERLYPERIOD ENDED SEPTEMBER 30, 2002**

 
| PART I.   FINANCIAL INFORMATION    |
|-----------------------------------------|
|                                    |   |
| Item 1.                                 | Financial Statements |
|                                    |   |
|                                    | Consolidated Balance Sheets as of  September 30, 2002 and December 31, 2001 (unaudited) |
|                                    |   |
|                                    | Consolidated  Statements of Operations for the Three and Nine Months Ended September 30,  2002 and September 30, 2001 (unaudited) |
|                                    |   |
|                                    | Consolidated Statements of Cash Flows for  the Nine Months Ended September 30, 2002 and September 30, 2001 (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 Disclosure 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 noted in this report,“SimpleTech,” the “Company,” “we,” “us” and “our” collectively refer toSimpleTech, Inc.

 

2

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**PART I.****  FINANCIAL INFORMATION**

 

## **Item 1****.  Financial Statements**

 

**SimpleTech, Inc.**

**ConsolidatedBalance Sheets**

**(in thousands, except share and per share amounts)**

**(unaudited)**

 
|                                                                                                                                                                                                    |   | **September 30,  2002** |   | **December 31,  2001** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
| ASSETS:                                                                                                                                                                                                 |   |                    |   |                   |   |
| Current Assets:                                                                                                                                                                                         |   |                    |   |                   |   |
| Cash and cash equivalents                                                                                                                                                                               |   | $                       | 45,316 |                   | $      | 51,831 |   |
| Accounts receivable, net of allowances of $973 at  September 30, 2002 and $1,080 at December 31, 2001                                                                                                   |   | 13,347                  |   | 12,062                 |   |
| Inventory, net                                                                                                                                                                                          |   | 12,129                  |   | 9,843                  |   |
| Deferred income taxes                                                                                                                                                                                   |   | 786                     |   | 786                    |   |
| Other current assets                                                                                                                                                                                    |   | 4,828                   |   | 4,474                  |   |
| Total current assets                                                                                                                                                                                    |   | 76,406                  |   | 78,996                 |   |
| Furniture, fixtures and equipment, net                                                                                                                                                                  |   | 10,732                  |   | 9,127                  |   |
| Goodwill                                                                                                                                                                                                |   | 835                     |   | —                 |   |
| Deferred income taxes                                                                                                                                                                                   |   | 587                     |   | 587                    |   |
| Total assets                                                                                                                                                                                            |   | $                       | 88,560 |                   | $      | 88,710 |   |
|                                                                                                                                                                                                    |   |                    |   |                   |   |
| LIABILITIES AND SHAREHOLDERS’  EQUITY:                                                                                                                                                             |   |                    |   |                   |   |
| Current Liabilities:                                                                                                                                                                                    |   |                    |   |                   |   |
| Accounts payable                                                                                                                                                                                        |   | $                       | 11,653 |                   | $      | 10,320 |   |
| Current maturities of long-term debt                                                                                                                                                                    |   | 53                      |   | 741                    |   |
| Current maturities of capital lease obligations                                                                                                                                                         |   | 226                     |   | 441                    |   |
| Accrued and other liabilities                                                                                                                                                                           |   | 3,578                   |   | 2,951                  |   |
| Total current liabilities                                                                                                                                                                               |   | 15,510                  |   | 14,453                 |   |
| Long-term debt                                                                                                                                                                                          |   | —                  |   | 271                    |   |
| Capital lease obligations                                                                                                                                                                               |   | —                  |   | 113                    |   |
| Total liabilities                                                                                                                                                                                       |   | 15,510                  |   | 14,837                 |   |
|                                                                                                                                                                                                    |   |                    |   |                   |   |
| Commitments and contingencies                                                                                                                                                                           |   |                    |   |                   |   |
|                                                                                                                                                                                                    |   |                    |   |                   |   |
| 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, 38,568,766 shares issued and outstanding as of September 30, 2002  and 38,272,050 shares issued and outstanding as of December 31, 2001 |   | 39                      |   | 38                     |   |
| Additional paid-in capital                                                                                                                                                                              |   | 66,106                  |   | 65,484                 |   |
| Unearned stock based compensation                                                                                                                                                                       |   | (2                      | )      | (15                    | )      |
| Retained earnings                                                                                                                                                                                       |   | 6,907                   |   | 8,366                  |   |
| Total shareholders’ equity                                                                                                                                                                         |   | 73,050                  |   | 73,873                 |   |
| Total liabilities and shareholders’ equity                                                                                                                                                         |   | $                       | 88,560 |                   | $      | 88,710 |   |

 

See accompanying notes to unauditedconsolidated financial statements.

 

3

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**SimpleTech, Inc.**

**ConsolidatedStatements of Operations**

**(in thousands, except per share amounts)**

**(unaudited)**

 
|                                                       |   | **Three Months  Ended September 30,** |   | **Nine Months  Ended September 30,** |   |
|------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                       |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
|                                                       |   |                                  |   |                                 |   |   |   |   |   |
| Net revenues                                               |   | $                                     | 36,501 |                                 | $      | 33,177 |   | $ | 130,754 |   | $ | 128,660 |   |
| Cost of revenues                                           |   | 29,911                                |   | 27,526                               |   | 106,554 |   | 101,928 |   |
| Gross profit                                               |   | 6,590                                 |   | 5,651                                |   | 24,200 |   | 26,732 |   |
| Sales and marketing                                        |   | 4,065                                 |   | 4,057                                |   | 13,132 |   | 13,962 |   |
| General and administrative                                 |   | 2,316                                 |   | 2,354                                |   | 8,020 |   | 8,707 |   |
| Research and development                                   |   | 2,503                                 |   | 984                                  |   | 6,448 |   | 3,247 |   |
| In-process research and development                        |   | —                                |   | —                               |   | 1,360 |   | — |   |
| Total operating expenses                                   |   | 8,884                                 |   | 7,395                                |   | 28,960 |   | 25,916 |   |
| (Loss) income from operations                              |   | (2,294                                | )      | (1,744                               | )      | (4,760 | ) | 816 |   |
| Interest and other, net                                    |   | (198                                  | )      | (346                                 | )      | (594 | ) | (1,143 | ) |
| (Loss) income before (benefit) provision for income  taxes |   | (2,096                                | )      | (1,398                               | )      | (4,166 | ) | 1,959 |   |
| (Benefit) provision for income taxes                       |   | (1,040                                | )      | (555                                 | )      | (2,707 | ) | 778 |   |
| Net (loss) income                                          |   | $                                     | (1,056 | )                                    | $      | (843 | ) | $ | (1,459 | ) | $ | 1,181 |   |
|                                                       |   |                                  |   |                                 |   |   |   |   |   |
| Net (loss) income per share:                               |   |                                  |   |                                 |   |   |   |   |   |
| Basic                                                      |   | $                                     | (0.03  | )                                    | $      | (0.02 | ) | $ | (0.04 | ) | $ | 0.03 |   |
| Diluted                                                    |   | $                                     | (0.03  | )                                    | $      | (0.02 | ) | $ | (0.04 | ) | $ | 0.03 |   |
|                                                       |   |                                  |   |                                 |   |   |   |   |   |
| Weighted average shares outstanding:                       |   |                                  |   |                                 |   |   |   |   |   |
| Basic                                                      |   | 38,551                                |   | 38,302                               |   | 38,461 |   | 38,080 |   |
| Diluted                                                    |   | 38,551                                |   | 38,302                               |   | 38,461 |   | 39,462 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

4

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**SimpleTech, Inc.**

**ConsolidatedStatements of Cash Flows**

**(in thousands)**

**(unaudited)**

 
|                                                                                      |   | **Nine  Months  Ended September 30,** |   |
|-------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                      |   | **2002**                              |   | **2001** |   |
|                                                                                      |   |                                  |   |   |   |
| Cash flow from operating activities:                                                      |   |                                  |   |   |   |
| Net (loss) income                                                                         |   | $                                     | (1,459 | ) | $ | 1,181 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by operating activities: |   |                                  |   |   |   |
| Depreciation                                                                              |   | 2,627                                 |   | 2,614 |   |
| Loss on sale of furniture, fixtures and equipment                                         |   | 121                                   |   | 11 |   |
| Accounts receivable provisions                                                            |   | 869                                   |   | 1,945 |   |
| Inventory excess and obsolescence expense                                                 |   | 240                                   |   | 1,898 |   |
| In-process research and development                                                       |   | 1,360                                 |   | — |   |
| Compensation related to stock options vesting                                             |   | 13                                    |   | 37 |   |
| Change in operating assets and liabilities:                                               |   |                                  |   |   |   |
| Accounts receivable                                                                       |   | (2,154                                | )      | 12,846 |   |
| Inventory                                                                                 |   | (2,526                                | )      | 20,559 |   |
| Other current assets                                                                      |   | (354                                  | )      | (2,902 | ) |
| Accounts payable                                                                          |   | 1,333                                 |   | (20,079 | ) |
| Accrued and other liabilities                                                             |   | 627                                   |   | (1,464 | ) |
| Net cash provided by operating activities                                                 |   | 697                                   |   | 16,646 |   |
|                                                                                      |   |                                  |   |   |   |
| Cash flows from investing activities:                                                     |   |                                  |   |   |   |
| Purchase of furniture, fixtures and equipment                                             |   | (4,962                                | )      | (4,589 | ) |
| Proceeds from sale of furniture, fixtures and  equipment                                  |   | 709                                   |   | 248 |   |
| Acquisition of business                                                                   |   | (2,295                                | )      | — |   |
| Net cash used in investing activities                                                     |   | (6,548                                | )      | (4,341 | ) |
|                                                                                      |   |                                  |   |   |   |
| Cash flows from financing activities:                                                     |   |                                  |   |   |   |
| Repayment of borrowings from banks                                                        |   | (959                                  | )      | (565 | ) |
| Payment on capital lease obligations                                                      |   | (328                                  | )      | (647 | ) |
| Stock repurchase                                                                          |   | —                                |   | (94 | ) |
| Proceeds from issuance of common stock                                                    |   | 623                                   |   | 1,040 |   |
| Net cash used in financing activities                                                     |   | (664                                  | )      | (266 | ) |
|                                                                                      |   |                                  |   |   |   |
| Net (decrease) increase in cash                                                           |   | (6,515                                | )      | 12,039 |   |
| Cash and cash equivalents at beginning of period                                          |   | 51,831                                |   | 33,747 |   |
| Cash and cash equivalents at end of period                                                |   | $                                     | 45,316 |   | $ | 45,786 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

5

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**SIMPLETECH,INC**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**Note 1 -Basis of Presentation**

 

The accompanying interim consolidated financialstatements of SimpleTech, Inc., a California corporation (the “Company”), areunaudited and have been prepared in accordance with the instructions to Form10-Q and Article 10 of Regulation S-X. In the opinion of management, all normal and recurring adjustmentsconsidered necessary for a fair presentation of the consolidated financialposition of the Company at September 30, 2002 and the consolidated results ofoperations and cash flows for the three and nine months ended September 30,2002 and 2001 have been included.  Theseinterim consolidated financial statements should be read in conjunction withthe consolidated financial statements and related notes contained in the mostrecent Annual Report on Form 10-K filed with the SEC.  The December 31, 2001 balances reported herein are derived fromthe audited consolidated financial statements included in the Annual Report onForm 10-K for the year ended December 31, 2001.  The results for the interim periods are not necessarilyindicative of results to be expected for the full year.

 

The consolidated financial statements of the Companyinclude the accounts of the Company’s subsidiaries.  All significant intercompany accounts and transactions have beeneliminated in consolidation.

 

**Note 2 -Use of Estimates**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make certain estimates and assumptions that affect thereported amounts of assets and liabilities (e.g., bad debt reserves andinventory reserves), disclosure of contingent assets and liabilities at thedate of the financial statements, and the reported amounts of revenues andexpenses 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 nine months ended September 30, 2001, potentially dilutivesecurities consisted solely of options and resulted in potential common sharesof 1,382,077.  For the threemonths ended September 30, 2002 and 2001, and the nine months ended September30, 2002, no potential common shares were included in the diluted per shareamount as the effect would have been anti-dilutive.

 

###### **Note 4 - SupplementalBalance Sheet Information**

 

Inventory consists of the following:

 
| **(in  thousands)**  |   | **September 30, 2002** |   | **December 31, 2001** |   |
|----------------------|--------|------------------------|--------|-----------------------|--------|
|                 |   |                   |   |                  |   |
| Raw materials        |   | $                      | 7,362  |                  | $      | 5,421 |   |
| Work-in-progress     |   | 286                    |   | 927                   |   |
| Finished goods       |   | 5,426                  |   | 4,785                 |   |
|                 |   | 13,074                 |   | 11,133                |   |
| Valuation allowances |   | (945                   | )      | (1,290                | )      |
|                 |   |                   |   |                  |   |
| Inventory, net       |   | $                      | 12,129 |                  | $      | 9,843 |   |

 

6

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Furniture, fixtures and equipment consist of thefollowing:

 
| **(in  thousands)**                    |   | **September 30, 2002** |   | **December 31, 2001** |   |
|----------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                   |   |                   |   |                  |   |
| Furniture and fixtures                 |   | $                      | 324    |                  | $      | 299 |   |
| Equipment                              |   | 24,226                 |   | 21,557                |   |
|                                   |   | 24,550                 |   | 21,856                |   |
| Accumulated depreciation               |   | (13,818                | )      | (12,729               | )      |
|                                   |   |                   |   |                  |   |
| Furniture, fixtures and equipment, net |   | $                      | 10,732 |                  | $      | 9,127 |   |

 

### **Note 5 - Legal Proceedings**

 

Reference is made to the Company’s Annual Report onForm 10-K filed with the SEC in March 2002 and its Quarterly Reports on Form10-Q filed with the SEC on May 3, 2002 and August 13, 2002  under the heading “LegalProceedings”  for a discussion oflitigation involving the Company relating to (i) patent litigation with DPACTechnologies, Inc. and (ii) patent litigation with Lemelson Medical, Education& Research Foundation, LLP.

 

#### **DPAC Technologies, Inc. –Patent Litigation**

 

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. On March 29, 2001, the courtentered final judgement finding DPAC did not infringe the Company’s patent. Theappeals court affirmed the final judgement on March 7, 2002.  On September3, 2002, the Company filed a petition for certiori with the U.S. SupremeCourt.  On October 7, 2002, the petition to the Supreme Court was grantedand the matter has been remanded to the Circuit Court of Appeals.

 

On October 17, 2000, the U.S. Patent and TrademarkOffice granted the Company a reissue patent on the Company’s ICTower stacking patent.  The reissue patent is U.S. Patent No. Re. 36,916.

 

On February 21, 2001, theCompany filed a new lawsuit against DPAC in the United States District Courtfor the Central District of California for infringement of the reissuepatent.  The Company is seeking damages and an injunction against furtherinfringement.  On March 13, 2001, DPAC filed an answer to the Company’scomplaint denying infringement and asserting a defense of patentinvalidity.  In addition, DPAC counterclaimed alleging the Companymisappropriated unspecified DPAC technology and allegedly used thatunspecified technology in the Company’s IC Tower products.  On September 9, 2002, the Company and DPACagreed to dismiss this lawsuit without prejudice.    Although a dismissal without prejudice allows for the potentialrefiling of the lawsuit in the future, the Company has not pursued a refiling.

 

**LemelsonMedical, Education & Research Foundation, LLP - Patent Infringement**

 

The Company receivednotice on November 26, 2001, that the Lemelson Medical, Education &Research Foundation, LLP (“Lemelson Foundation”) filed a complaint on November13, 2001, against the Company and other defendants. The complaint was filed inthe District 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 and bar coding technology. On March 7, 2002, theCompany was served with the Lemelson Foundation complaint. Thereafter, the casewas stayed pending the outcome of related cases against other parties involvingthe same patents. Because of the preliminary stage of this case, an estimate ofpotential damages, if any, would be premature and speculative, and the Companyhas not made any such estimate at this time.

 

7

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**Lexar Media, Inc. – Unfair Trade Practice**

 

On October 1, 2002, the Company filed a lawsuitagainst Lexar Media, Inc. in the Superior Court of Orange County, Californiafor unfair trade practices and is seeking unspecified damages, includingpunitive and trebled damages.  TheCompany’s complaint sets forth various causes of actions against Lexar Media,including trade libel, libel per se, interference with business opportunities,violation of the California Unfair Competition Act, and violation of theCalifornia Unfair Trade Practices Act. The lawsuit was filed in response to letters that Lexar Media sent toone of the Company's customers that allege certain of the Company's productsinfringe upon one or more of Lexar Media's patents.  On October 30, 2002, Lexar Media filed a notice of removal, whichremoved the matter from the Orange County Superior Court to the United StatesDistrict Court for the Central District of California. This lawsuit is in theearly stages. No formal discovery has been conducted and no trial date has beenset.  The Company believes that thepatent infringement allegations made by Lexar Media in its letters to one ofthe Company's customers are without merit and intends to defend itselfvigorously if patent infringement claims are brought by Lexar Media against it.

 

On October 1, 2002, theCompany lodged a formal complaint against Lexar Media with the Federal TradeCommission’s Bureau of Competition for unfair trade practices.

 

**Note 6 –Segment Information:**

 

The Company designs, manufactures and markets acomprehensive line of memory, storage and connectivity products used in highperformance computing, networking and communications, consumer electronics andindustrial applications.  The Companyprovides both technology solutions for two reportable operating segments,Industrial and Commercial, based on dynamic random access memory (DRAM), staticrandom access memory (SRAM) and Flash memory technologies.

 

The Company uses net sales and gross profit as thebasis for evaluating the performance of its operating segments.  The Company does not allocate operatingexpenses, interest or income taxes to operating segments.  Due to the similarity of products manufacturedfor customers within each operating segment, the Company does not maintainseparate records to identify assets by operating segment.

 

Summarized financial information regarding theCompany’s reportable segments is shown in the following table:

 
|               |   | **Three Months Ended  September 30, 2002** |   | **Three Months Ended  September 30, 2001** |   |
|--------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
| **(in thousands)** |   | **Industrial**                             |   | **Commercial**                             |   | **Consolidated** |   | **Industrial** |   | **Commercial** |   | **Consolidated** |   |
| Net revenues       |   | $                                          | 9,126  |                                       | $      | 27,375 |   | $ | 36,501 |   | $ | 9,561 |   | $ | 23,616 |   | $ | 33,177 |   |
| Cost of revenues   |   | 6,573                                      |   | 23,338                                     |   | 29,911 |   | 8,559 |   | 18,967 |   | 27,526 |   |
| Gross profit       |   | $                                          | 2,553  |                                       | $      | 4,037 |   | $ | 6,590 |   | $ | 1,002 |   | $ | 4,649 |   | $ | 5,651 |   |

 
|             |   | **Nine Months Ended  September 30, 2002** |   | **Nine Months Ended  September 30, 2001** |   |
|------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|
|             |   | **Industrial**                            |   | **Commercial**                            |   | **Consolidated** |   | **Industrial** |   | **Commercial** |   | **Consolidated** |   |
| Net revenues     |   | $                                         | 29,963 |                                      | $      | 100,791 |   | $ | 130,754 |   | $ | 42,186 |   | $ | 86,474 |   | $ | 128,660 |   |
| Cost of revenues |   | 21,263                                    |   | 85,291                                    |   | 106,554 |   | 30,245 |   | 71,683 |   | 101,928 |   |
| Gross profit     |   | $                                         | 8,700  |                                      | $      | 15,500 |   | $ | 24,200 |   | $ | 11,941 |   | $ | 14,791 |   | $ | 26,732 |   |

 

For the three months ended September 30, 2002 and2001, international sales comprised 17.9% and 15.5%, of the Company’srevenues.  For the nine months endedSeptember 30, 2002 and 2001, international sales comprised 14.2% and 16.0%, ofthe Company’s revenues.   During theseperiods, no single foreign country accounted for more than 10.0% of totalrevenues.  All international salesduring these periods were shipped from the Company’s domestic warehouse toforeign customers.

 

8

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**ITEM2.****  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Cautionary Statement**

 

Certainstatements in this report, including statements regarding the Company’s strategy,financial performance and revenue sources, are forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995,Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27Aof the Securities Act of 1933, as amended, and are subject to the safe harborscreated by 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 Form 10-Q andsimilar discussions in filings with the Securities and Exchange Commission madefrom time to time, including other quarterly reports on Form 10-Q, ourAnnual Reports on Form 10-K, and in our other SEC filings, discuss some ofthe important risk factors that may affect our business, results of operationsand financial condition.

 

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

 

#### **Overview**

 

SimpleTech, Inc.,originally incorporated in 1990 as Simple Technology, Inc., is a technologysolutions provider offering products based on DRAM, SRAM and Flash memorytechnologies. Headquartered in Santa Ana, California, the company is a leaderin the design, development, manufacturing and marketing of memory solutions. Inaddition, we offer a line of high-density memory products using ourthree-dimensional IC Tower stacking technology that allows multiple memorychips to be stacked together to increase the capabilities of memory moduleswithout increasing the product footprint. Our products are used in high-performance computing, networking andcommunications, consumer electronics and industrial applications.

** **

As a result of increased demand for consumer electronics andhigh-density memory products used in Internet infrastructure and embeddedapplications, the percentage of our revenues derived from the sales of Flashmemory and IC Tower stacking products increased from 13.0% in 1998 to 20.8% in1999 and 40.2% in 2000.  However, due tothe softening macro-economic conditions and excess inventory levels at ourIndustrial Division customers in 2001 and the first nine months of 2002, thepercentage of our revenue derived from the sale of Flash memory and IC Towerstacking products decreased from 40.2% in 2000 to 34.1% in2001 and 33.5% in the first nine months of 2002. In the first nine months of2002, our highest profit margin product line was our IC Tower stacking productline.

** **

We sell our productsthrough our Industrial and Commercial Divisions.  Our Industrial Division was created in late 1998 to enhance themarketing of our products to original equipment manufacturers, or OEMs.  Our Commercial Division sells our productsthrough the following five channels: value added reseller, or VAR, mail order, commercial and industrialdistribution, and retail. After experiencing year-over-year total revenuegrowth of 57.5% from 1998 to 1999 and 60.1% from 1999 to 2000, our IndustrialDivision revenues declined 66.7% and our Commercial Division revenues declined29.2% in 2001.  Both our Industrial andCommercial Division revenues were negatively impacted in 2001 due to softeningmacro-economic conditions and severe declines in the price of DRAM and Flashcomponents, which resulted in significantly lower average selling prices.  In addition, our Industrial Divisionrevenues in 2001 were further impacted by a build-up of inventory by our communicationsand networking customers during 2000. Although the inventory levels of our communications and networkingcustomers appear to have returned to normal levels, we do not expect revenuesfrom customers in these industries to return to fiscal year 2000 levels forseveral years.

** **

In 2001, our CommercialDivision significantly expanded our retail presence through the addition of newcustomers, such as Sam’s Club. Commercial Division units shipped increased 42.7% from 2000 to 2001 and14.7% from the first nine months of 2001 to the first nine months of 2002.

** **

**9**

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Industrial Division unitsshipped decreased 47.6% from 2000 to 2001 due primarily to a build-up ofinventory by our communications and networking customers.  Industrial Division units shipped increased158.3% from the first nine months of 2001 to the first nine months of2002.  This increase resulted primarilyfrom several Industrial Division customers in the networking and telecomindustries placing orders after several quarters of inactivity and the shipmentof inaugural orders to new Industrial Division customers in the casino gaming,in-flight information and entertainment, and defense industries.  Typically, our highest profit margindivision is our Industrial Division.  Wehave not tracked and do not intend to track operating expenses on a divisionalbasis.

** **

DRAM prices have beenvolatile during the past two years. DRAM prices declined sharply from September 2000 through October 2001followed by a brief period of price increases through April 2002.  DRAM prices declined rapidly in early May2002 to prices below DRAM manufacturers’ production costs.  We believe that in the next nine to twelvemonths increased demand for memory products and further DRAM manufacturerconsolidation will lead to firmer DRAM component prices, which would result inincreased average selling prices, gross profit and earnings for us.

** **

Historically, arelatively small number of customers have accounted for a significant percentageof our revenues. Our ten largest customers accounted for an aggregate of 54.1%of our total revenues for the first nine months of 2002 and 56.3% of our totalrevenues for 2001.  Our ten largestIndustrial Division customers accounted for an aggregate of 54.3% of ourIndustrial Division revenues or 17.5% of our total revenues for the first ninemonths of 2002 and 71.0% of our Industrial Division revenues or 20.8% of ourtotal revenues for 2001.  No IndustrialDivision customer accounted for more than 10% of our total revenues for thefirst nine months of 2002.  Unisysaccounted for 37.6% of our Industrial Division revenues or 11.0% of our totalrevenues for 2001.  No other IndustrialDivision customer accounted for more than 10.0% of our total revenues for 2001.

** **

Our ten largestCommercial Division customers accounted for an aggregate of 68.7% of ourCommercial Division revenues or 45.4% of our total revenues for the first ninemonths of 2002 and 61.6% of our Commercial Division revenues or 43.6% of ourtotal revenues for 2001. Our largest Commercial Division customer for the firstnine months of 2002 and for 2001, CDW Computer Centers, accounted for 32.6% ofour Commercial Division revenues or 21.5% of our total revenues for the firstnine months of 2002 and 27.9% of our Commercial Division revenues or 19.7% ofour total revenues for 2001. No other Commercial Division customer accountedfor more than 10.0% of our total revenues for the first nine months of 2002 orfor 2001. The composition of our major customer base changes from quarter toquarter as the market demand for our customers’ products changes and we expectthis variability will continue in the future. We expect that sales of ourproducts to a small number of customers will continue to contribute materiallyto our revenues in the foreseeable future and believe that our financialresults will depend in significant part upon the success of our customers’products.

** **

International sales ofour products constituted 14.2% of our revenues for the first nine months of2002 and 16.0% of our revenues for 2001. No single foreign country accounted for more than 10.0% of our revenuesin the first nine months of 2002 or for 2001. During the first nine months of2002 and for 2001, over 95.0% of our international sales were denominated inU.S. dollars. Consequently, if the value of the U.S. dollar increases relativeto a particular foreign currency, our products could become more expensive,which could result in a reduction of sales in a particular country. In addition,we purchase substantially all of the integrated circuit (“IC”) components usedin our products from local distributors of Japanese, Korean and Taiwanesesuppliers. Although our purchases of IC components are currently denominated inU.S. dollars, devaluation of the U.S. dollar relative to the currency of aforeign supplier would likely result in an increase in our cost of ICcomponents. Our international sales could also be adversely affected by risksincluding regulatory risks, tariffs and other trade barriers.

** **

In the past we have beenimpacted by seasonal purchasing patterns resulting in higher sales in the thirdand fourth quarters of each year. Our ability to adjust our short-termoperating expenses in response to fluctuations in revenues is limited. As aresult, if revenues are lower than expected in any given period, our results ofoperations could be harmed.

** **

Revenues are recognizedat the time of shipment. A majority of our sales through commercial channelsinclude limited rights to return unsold inventory.  Such returns are estimated and recorded as a reduction of netrevenues at the time of sale.  Inaddition, 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

 

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maintain good relationswith our customers. Product returns would increase our inventory and reduce ourrevenues. We have had to write-down inventory in the past for reasons such asobsolescence, excess quantities and declines in market value below our costs.We had inventory write-downs of approximately $240,000 for the first ninemonths of 2002 and $1.9 million for the first nine months of 2001.  We also have price protection agreementswith a number of our Commercial Division customers in which we retain limitedliability for price declines related to unsold inventory. If we reduce the listprice of our products, these customers may receive credits from us.  Such credits are estimated and recorded as areduction of net revenues at the time we reduce the list price of ourproducts.  We incurred price protectioncharges of approximately $985,000 for the first nine months of 2002 and $1.3million for the first nine months of 2001. In addition, we have rebate agreements with a number of our CommercialDivision customers in which we make payments to our customers’ end-users for aportion of their purchase price.  Suchrebate payments are estimated and recorded as a reduction of net revenues atthe time of sale.   We incurred rebateexpenses of approximately $722,000 for the first nine months of 2002 and$170,000 for the first nine months of 2001.

 

**Recent Developments**

 

                On November 11, 2002, Thomas A.Beaver, one of our three independent directors, resigned from our board ofdirectors, including his positions on the audit and compensation committees, toassume the position of Senior Vice President and General Manager of our XiranDivision.  Mr. Beaver had been a memberof our board of directors since October 2000. As of November 11, 2002, our board of directors consisted of a total ofsix members, including two independent directors.  We have requested from Nasdaq a temporary exception to theindependent director rules to permit us to find a suitable replacement for Mr.Beaver on our board of directors, including our audit and compensationcommittees.  Mr. Beaver's resignationwas not the result of any disagreement on matters relating to our operations,policies or practices, including the policies and practices of our auditcommittee.

 

**Results of Operations - Comparison ofthe Third Quarter of 2002 to the Third Quarter of 2001**

 

*Net Revenues.*  Our revenues were $36.5 millionfor the third quarter of 2002, compared to $33.2 million for the same period in2001.  Revenues increased 9.9% due to aunit volume increase of 16% from 669,000 units for the third quarter of 2001 to776,000 for the third quarter of 2002, partially offset by a 6% decline inaverage sales price from $50 for the third quarter of 2001 to $47 for the thirdquarter of 2002.  The decrease in ouraverage sales price resulted from lower DRAM and Flash component prices for thethird quarter of 2002 compared to the third quarter of 2001.  Stronger demand for our products by both ourIndustrial and Commercial Division customers led to the overall unit volumeincrease, comprised of unit volume increases of 93% for Flash products, 215%for IC Tower stacking products, and 235% for non-DRAM, non-Flash products suchas SRAM, hard drive upgrade kits and connectivity products, partially offset bya decrease of 21% for non-stacked DRAM memory products. The mix of productssold varies from quarter to quarter and may vary in the future, affecting ouroverall average sales prices and gross margins.

 

OurIndustrial Division revenues decreased 5.2% from $9.6 million for the thirdquarter of 2001 to $9.1 million for the third quarter of 2002.  Industrial Division unit volume increased278% during this period and Industrial Division average sales price decreasedfrom $229 for the third quarter of 2001 to $58 for the third quarter of2002.  This decrease in average salesprice resulted primarily from lower DRAM and Flash component prices for thethird quarter of 2002 compared to the third quarter of 2001 and a shift inproduct mix toward lower capacity products. Our Commercial Division revenues increased 16.1% from $23.6 million forthe third quarter of 2001 to $27.4 million for the third quarter of 2002.Commercial Division revenues increased due to an increase in average salesprice from $38 for the third quarter of 2001 to $44 for the third quarter of2002, partially offset by a decrease in unit volume of 1%.  The increase in average selling priceresulted from a shift in product mix.

 

Ourcombined backlog was $5.5 million as of September 30, 2002, consisting of $4.9million for the Industrial Division and $624,000 for the CommercialDivision.  Our combined backlog was $5.1million as of September 30, 2001, consisting of $4.0 million for the IndustrialDivision and $1.1 million for the Commercial Division.  Commercial Division backlog is typicallynominal since substantially all Commercial Division customer orders are filledon a same-day or next-day basis. We include in our backlog only those customerorders for which we have accepted purchase orders and to which we have assignedshipment dates within the upcoming nine months. Since orders constituting ourbacklog are subject to change due to, among other things, customercancellations and reschedulings, and our ability to procure necessarycomponents, backlog is not necessarily an indication of future revenues.

 

*Gross Profit.*  Our gross profit was $6.6million for the third quarter of 2002, compared to $5.7 million for the sameperiod in 2001. Gross profit as a percentage of revenues was 18.1% for thethird quarter of 2002, compared to 17.2% for the same period in 2001. Grossprofit for our Industrial Division as a percentage of revenues was 28.0% forthe third quarter of 2002, compared to 10.5% for the third quarter of2001.  This increase in gross profit asa percentage of revenues for our Industrial Division resulted primarily frompricing concessions made in the third quarter of 2001 in order to sell throughstale Industrial inventory.  Gross profit as a percentage of revenues forour Commercial Division was 14.7% for the third quarter of 2002, compared to19.7% for the third quarter of 2001. This decrease in gross profit as a percentage of revenues for our CommercialDivision was due to the impact of DRAM price declines for the third quarter of2002 on DRAM inventory held in stock.

 

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*Sales and Marketing.*  Sales andmarketing expenses are comprised primarily of personnel costs and travelexpenses for our domestic and international sales and marketing employees,commissions paid to internal salespersons and independent manufacturers’representatives, shipping costs and marketing programs. Sales and marketingexpenses were $4.1 million for the third quarter of 2002 and the third quarterof 2001. Sales and marketing expenses as a percentage of revenues were 11.2%for the third quarter of 2002, compared to 12.3% for the same period in2001.  Sales and marketing expenses as apercentage of revenues decreased due to increased revenue in the third quarterof 2002.

 

*General and Administrative.*  Generaland administrative expenses are primarily comprised of personnel costs for ourexecutive and administrative employees, professional fees and facilitiesoverhead. General and administrative expenses were $2.3 million for the thirdquarter of 2002 and $2.4 million for the third quarter of 2001. General andadministrative expenses as a percentage of revenues were 6.3% for the thirdquarter of 2002 and 7.2% for the third quarter of 2001.  General and administrative expenses as apercentage of revenues decreased due to increased revenue in the third quarterof 2002.

 

*Research and Development.*  Researchand development expenses are primarily comprised of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses were $2.5 million for the third quarter of 2002, comparedto $1.0 million for the same period in 2001. Research and development expensesas a percentage of revenues were 6.8% for the third quarter of 2002, comparedto 3.0% for the same period in 2001. The increase in research and developmentexpenses resulted from expenditures related to our Xiran Division, establishedas a result of our acquisition of the assets of Irvine Networks in January2002.  The Xiran Division is developinginnovative content processing technology for Web-based server platforms. As aresult of increased research and development expenses for the Xiran Division,total research and development expenses are expected to increase significantlyin 2002 to approximately $9 million.

 

*Interest and Other, Net.*  Interestand other income, net was $198,000 for the third quarter of 2002 and $346,000for the third quarter of 2001.  Interestexpense is comprised of interest related to equipment financing. Interestexpense was $19,000 for the third quarter of 2002, compared to $46,000 for thesame period in 2001.  Interest income iscomprised of interest earned on our cash and cash equivalents.  Interest income was $217,000 for the thirdquarter of 2002 and $392,000 for the third quarter of 2001.  This decrease in interest income resultedprimarily from lower interest rates for the third quarter of 2002 compared tothe third quarter of 2001.

 

*Benefit for Income Taxes.* Benefit for income taxes was $1.0 million for thethird quarter of 2002 and $555,000 for the third quarter of 2001.  As a percentage of income before benefit forincome taxes, benefit for income taxes was 47.6% for the third quarter of 2002and 42.9% for the third quarter of 2001. The increase in  the benefit as a percentage of loss beforethe benefit for income taxes resulted primarily from a non-recurring enterprisezone hiring credit of approximately $190,000 in the third quarter of 2002.

 

*Net Loss. *Net loss was $1.1 million for the third quarter of2002 and $843,000 for the third quarter of 2001.

 

**Results of Operations - Comparison ofthe First Nine Months of 2002 to the First Nine Months of 2001**

 

*Net Revenues.*  Our revenues were $130.8million for the first nine months of 2002, compared to $128.7 million for thesame period in 2001.  Revenues increased1.6% due to a unit volume increase of 30% from 2.0 million units for the firstnine months of 2001 to 2.6 million for the first nine months of 2002, partiallyoffset by a 23% decline in average sales price from $66 for the first ninemonths of 2001 to $51 for the first nine months of 2002.  The decrease in our average sales priceresulted from lower DRAM and Flash component prices for the first nine monthsof 2002 compared to the first nine months of 2001.  Stronger demand for our products by both our Industrial andCommercial Division customers led to the overall unit volume increase,comprising of unit volume increases of 113% for Flash products, 101% for ICTower stacking products and 106% for non-DRAM, non-Flash products such as SRAM,hard drive upgrade kits and connectivity products, partially offset by a unitvolume decrease of 6% for standard memory products. The mix of products soldvaries from period to period and may vary in the future, affecting our overallaverage sales prices and gross margins.

 

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OurIndustrial Division revenues declined 28.9% from $42.2 million for the first ninemonths of 2001 to $30.0 million for the first nine months of 2002. IndustrialDivision unit volume increased 158% during this period and Industrial Divisionaverage sales price decreased from $186 for the first nine months of 2001 to$51 for the first nine months of 2002. This decrease in average sales price resulted primarily from lower DRAMand Flash component prices for the first nine months of 2002 compared to thefirst nine months of 2001 and a shift in product mix toward lower capacityproducts.  Our Commercial Divisionrevenues increased 16.5% from $86.5 million for the first nine months of 2001to $100.8 million for the first nine months of 2002. Commercial Divisionrevenues increased due to an increase in unit volume of 15% and an increase in averagesales price from $50 for the first nine months of 2001 to $51 for the firstnine months of 2002.  The increase inunit volume for our Commercial Division resulted from an increase in unitsshipped to the retail channel.

 

*Gross Profit.*  Our gross profit was $24.2million for the first nine months of 2002, compared to $26.7 million for thesame period in 2001. Gross profit as a percentage of revenues was 18.5% for thefirst nine months of 2002, compared to 20.8% for the same period in 2001. Grossprofit for our Industrial Division as a percentage of revenues was 29.0% forthe first nine months of 2002, compared to 28.3% for the first nine months of2001.  Gross profit as a percentage ofrevenues was relatively flat for our Industrial Division during the first ninemonths of 2002 and the first nine months of 2001.  Gross profit as a percentage of revenues for our CommercialDivision was 15.4% for the first nine months of 2002, compared to 17.1% for thefirst nine months of 2001.  Thisdecrease in gross profit as a percentage of revenues for our CommercialDivision was due to the impact of DRAM price declines during the second andthird quarters of 2002 on DRAM inventory held in stock.

 

*Sales and Marketing.*  Sales andmarketing expenses are primarily comprised of personnel costs and travelexpenses for our domestic and international sales and marketing employees,commissions paid to internal salespersons and independent manufacturers’representatives, shipping costs and marketing programs. Sales and marketingexpenses were $13.1 million for the first nine months of 2002, compared to$14.0 million for the same period in 2001. Sales and marketing expenses as apercentage of revenues were 10.0% for the first nine months of 2002, comparedto 10.9% for the same period in 2001. Sales and marketing expenses as apercentage of revenues decreased due to cost-cutting programs that commenced inthe second half of 2001.

 

*General and Administrative.*  Generaland administrative expenses are primarily comprised of personnel costs for ourexecutive and administrative employees, professional fees and facilitiesoverhead. General and administrative expenses were $8.0 million for the firstnine months of 2002 and $8.7 million for the first nine months of 2001. Generaland administrative expenses as a percentage of revenues were 6.1% for the firstnine months of 2002 and 6.8% for the first nine months of 2001.  General and administrative expenses as apercentage of revenues decreased due to cost-cutting programs that commenced inthe second half of 2001.

 

*Research and Development.*  Researchand development expenses are primarily comprised of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses were $6.4 million for the first nine months of 2002,compared to $3.2 million for the same period in 2001. Research and developmentexpenses as a percentage of revenues were 4.9% for the first nine months of2002, compared to 2.5% for the same period in 2001. The increase in researchand development expenses resulted from expenditures related to our XiranDivision, established as a result of our acquisition of the assets of IrvineNetworks in January 2002.

 

*Non-recurring In-process Research and Development.*  Wedid not have non-recurring in-process research and development expenses for thefirst nine months of 2001.  Non-recurring in-process research and developmentexpenses related to our acquisition of Irvine Networks in January 2002 were$1.4 million for the first nine months of 2002.

 

*Interest and Other, Net.*  Interestand other income, net was $594,000 for the first nine months of 2002 and $1.1million for the first nine months of 2001. Interest expense is comprised of interest related to equipmentfinancing. Interest expense was $72,000 for the first nine months of 2002,compared to $163,000 for the same period in 2001.  Interest income is comprised of interest earned on our cash andcash equivalents.  Interest income was$666,000 for the first nine months of 2002 and $1.3 million for the first ninemonths of 2001.  This decrease ininterest income resulted primarily from lower interest rates for the first ninemonths of 2002 compared to the first nine months of 2001.

 

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*(Benefit) Provision for Income Taxes.*(Benefit) provision for income taxes was ($2.7) million for the first ninemonths of 2002 and $778,000 for the first nine months of 2001.  As a percentage of the (loss) income before(benefit) provision for income taxes, (benefit) provision for income taxes was64.3% for the first nine months of 2002 and 39.7% for the first nine months of2001.  The increase in the (benefit)provision as a percentage of income before (benefit) provision for income taxesresulted primarily from a non-recurring research and development income taxbenefit in the second quarter of 2002 of approximately $800,000 and anon-recurring enterprise zone hiring credit of approximately $190,000 in thethird quarter of 2002.

 

*Net (Loss) Income. *Net (loss) incomewas ($1.5) million for the first nine months of 2002 and $1.2 million for thefirst nine months of 2001.

 

**Liquidity and Capital Resources**

 

Asof September 30, 2002, we had working capital of $60.9 million including $45.3million of cash and cash equivalents. As of December 31, 2001, we hadworking capital of $64.5 million including $51.8 million of cash and cashequivalents.  Current assets were 4.9times current liabilities at September 30, 2002, compared to 5.5 times currentliabilities at December 31, 2001.

 

Netcash provided by operating activities was $697,000 for the first nine months of2002 and resulted primarily from $3.7 million in non-cash expenses, $1.4million in non-cash in-process research and development expenses and a $2.0million increase in accounts payable and accrued and other liabilities,partially offset by a $2.5 million increase in inventory, a $2.2 millionincrease in net accounts receivable and a net loss of $1.5 million.

 

Netcash used in investing activities was $6.5 million for the first nine months of2002, attributable primarily to $5.0 million in purchases of furniture,fixtures and equipment and $2.3 million related to the acquisition of IrvineNetworks in January 2002, partially offset by $709,000 in proceeds from thesale of furniture, fixtures and equipment. We expect to spend approximately $6.0 to $8.0 million on capitalexpenditures during the next 24 months, primarily for the purchase ofmanufacturing, testing and engineering equipment.

 

Netcash used in financing activities was $664,000 for the first nine months of2002 and resulted from payments of $1.3 million related to equipment loans andcapital lease obligations, partially offset by the receipt of $623,000 inproceeds from the issuance of common stock primarily related to the exercise ofemployee stock options.

 

We believe that ourcurrent assets, including cash and cash equivalents, and expected cash flowfrom operations will be sufficient to fund our operations for at least the nexttwelve months.  However, it is possiblethat we may need or elect to raise additional funds to fund our activitiesbeyond the next year or to consummate acquisitions of other businesses,products or technologies.  We couldraise such funds by selling more stock to the public or to selected investors,or by borrowing money.  In addition,even though we may not need additional funds, we may still elect to selladditional equity securities or obtain credit facilities for other reasons.  We cannot assure you that we will be able toobtain additional funds on commercially favorable terms, or at all.  If we raise additional funds by issuingadditional equity or convertible debt securities, the ownership percentages ofexisting shareholders would be reduced. In addition, the equity or debt securities that we issue may haverights, preferences or privileges senior to those of the holders of our commonstock.

 

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

•                  the levels of promotion andadvertising that will be required to launch our new products and achieve andmaintain a competitive position in the marketplace

•                  price discounts on our products toour customers

•                  our business, product, capitalexpenditure and research and development plans and product and technology roadmaps

•                  the levels of inventory and accountsreceivable that we maintain

 

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•                  capital improvements to new andexisting facilities

•                  technological advances

•                  our competitors’ response to ourproducts

•                  our pursuit of strategic transactionsand

•                  our relationships with suppliers andcustomers

 

**Inflation**

** **

**Inflationwas not a material factor in either revenue or operating expenses during thefirst nine months of 2002 or the first nine months of 2001.**

** **

**IrvineNetworks, LLC**

** **

In January 2002, wecompleted a $2.3 million acquisition of the assets, including intellectualproperty, of Irvine Networks, LLC, and hired their engineering staff. Theon-going operation has become our Xiran Division. For the past three years, thegroup has been developing innovative content processing technology forWeb-based server platforms. The effort is in the final stages of developing aworking prototype. The completed products, incorporating our patented memorystacking technology, will be inserted into Web-based servers to enable thefaster transmission of files.

 

**CriticalAccounting Policies and Estimates**

 

Our discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States of America.The preparation 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 each period.The following represents a summary of our critical accounting policies, definedas those policies that we believe are: (a) the most important to the portrayalof our financial condition and results of operations, and (b) that requiremanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about the effects of matters that are inherentlyuncertain.

 

•                  *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 and customer demand, andthe somewhat unpredictable fluctuations in market values for such materials,however, can limit our ability to effectively utilize all of the raw materialspurchased and sold through resulting finished goods to customers for a profit.We regularly monitor potential inventory excess, obsolescence and lower marketvalues compared to costs and, when necessary, reduce the carrying amount of ourinventory to its market value.

 

•                  *Allowancesfor doubtful accounts, price protection and rebates*—We maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments. Additionally, we maintainallowances for limited price protection rights for inventories of our productsheld by our customers as a result of recent sales transactions to them. If wereduce the list price of our products, these customers may receive a creditfrom us. We also maintain allowances for rebates related to payments we make tocertain of our customers’ end-users for a portion of their purchase price.  We estimate the impact of such pricingchanges and rebates on a regular basis and adjust our allowances accordingly.

 

•                  *Productreturns*—We offer a majority of our customers that purchase productsthrough our commercial channels limited rights to return unsold inventory. Inaddition, 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 relationships with our customers. We provide forestimated future returns of inventory at the time of sale based on historicalexperience and actual results have been within our expectations.

 

•                  *Incometaxes*—As part of the process of preparing our consolidated financialstatements, we are required to estimate our income taxes in each of thejurisdictions in which we operate. The process

 

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incorporates anassessment of the current tax exposure together with temporary differencesresulting from different treatment of transactions for tax and financialstatement purposes. Such differences result in deferred tax assets andliabilities, which are included within the consolidated balance sheet. The recoveryof deferred tax assets from future taxable income must be assessed and, to theextent that recovery is not likely, we establish a valuation allowance.Increases in valuation allowances result in the recording of additional taxexpense. Further, if our ultimate tax liability differs from the periodic taxprovision reflected in the consolidated statements of operations, additionaltax expense may be recorded.

 

•                  *Litigationand other contingencies*—Management regularly evaluates our exposureto threatened or pending litigation and other business contingencies. Becauseof the uncertainties related to the amount of loss from litigation and otherbusiness contingencies, the recording of losses relating to such exposuresrequires significant judgment about the potential range of outcomes. Asadditional information about current or future litigation or othercontingencies becomes available, our management will assess whether suchinformation warrants the recording of additional expense relating to our contingencies.We base our estimates on historical experience and on various other assumptionsthat are believed to be reasonable. The results of these estimates form thebasis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources. Actual results may differfrom these estimates under different assumptions or conditions.

 

•                  *Valuationof long-lived assets*—We assess the potential impairment oflong-lived tangible and intangible assets whenever events or changes incircumstances indicate that the carrying value may not be recoverable. Changesin our operating strategy can significantly reduce the estimated useful life ofsuch assets.

 

**Risk Factors**

 

***This Report contains forward-looking statements based on thecurrent expectations, assumptions, estimates and projections about our industryand us. These forward-looking statements involve 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. You should carefullyconsider the following risks before you decide to buy shares of our commonstock. The risks and uncertainties described below are not the only ones facingus. 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 ofthe following risks actually occur, our business, results of operations orfinancial condition would likely suffer. In such case, the trading price of ourcommon stock could decline, and you may lose all or part of the money you paidto buy our stock.  We do not undertaketo update publicly any forward-looking statements for any reason, even if newinformation becomes available or other events occur in the future.***

 

**Declines in our average sales pricesmay result in declines in our revenues and gross margins.**

 

During the fourth quarterof 2000, fiscal year 2001 and the second and third quarters of 2002,overcapacity in the memory product market resulted in significant declines incomponent prices, which negatively impacted our average selling prices, gross marginsand earnings.  Declines in semiconductorprices could also affect the valuation of our inventory, which could harm ourbusiness. During periods of overcapacity, our ability to maintain or increaserevenues will depend upon our ability to increase unit sales volumes ofexisting products and to introduce and sell new products in quantitiessufficient to offset declines in sales prices. Our efforts to reduce costs anddevelop new products to offset the impact of further declines in average salesprices may not be successful. Declines in average sales prices also wouldresult in more memory being built into products by original equipmentmanufacturers, which would favor our largest competitors and reduce the demandfor our commercial memory products.

 

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**Becausewe depend on a small number of suppliers for IC devices, any disruption in oursupply relationships could harm our ability to fulfill orders.**

 

We have no long-term ICdevice supply contracts and are dependent on a small number of suppliers tosupply IC devices, which represent approximately 95% of our component costs.Our dependence on a small number of suppliers and our limited number oflong-term supply contracts expose us to several risks, including the inabilityto obtain an adequate supply of components, price increases, late deliveriesand poor component quality. Hitachi Semiconductor and Samsung Semiconductorsupply substantially all of the IC devices used in our Flash memory products.In addition, Elpida Memory, Micron Semiconductor Electronics and SamsungSemiconductor currently supply a majority of the DRAM IC devices used in ourDRAM memory products. A disruption in or termination of our supply relationshipwith any of these significant suppliers by natural disaster or otherwise, orour inability to develop relationships with new suppliers, if required, wouldcause delays, disruptions or reductions in product shipments or require productredesigns which could damage relationships with our customers, and wouldincrease our costs and/or prices. In particular, if our flash supplyrelationship with Hitachi Semiconductor or Samsung Semiconductor is disruptedor terminated, our ability to manufacture and sell our Flash products would belimited and our Flash business would be adversely affected.

** **

**Weare subject to the cyclical nature of the semiconductor industry and changesfrom the current point in the cycle could adversely affect our business.**

** **

The semiconductorindustry, including the memory markets in which we compete, is highly cyclicaland is 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, often connected with, or in anticipation of,maturing product cycles of both semiconductor companies’ and their customers’products and declines in general economic conditions. These downturns have beencharacterized by diminished product demand, production overcapacity, highinventory levels and accelerated erosion of average selling prices. Any futuredownturns could have a material adverse effect on our business and operatingresults. During the fourth quarter of 2000, fiscal year 2001 and the second andthird quarters of 2002, a semiconductor downturn negatively impacted ouraverage selling prices, gross margins and earnings.  Furthermore, any upturn in the semiconductor industry couldresult in increased demand for, and possible shortages of, components we use tomanufacture and assemble our ICs.  Suchshortages could have a material adverse effect on our business and operatingresults.

** **

**Wemay be unable to maintain 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 redesign of someof our products. 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.

** **

**Salesto a small number of customers represent a significant portion of our revenuesand the loss of any key customer would materially 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 ofcustomers have accounted for a significant percentage of our revenues.  Our ten largest Industrial Divisioncustomers accounted for an aggregate of 69.4% of our Industrial Divisionrevenues or 17.4% of our total revenues for the third quarter of 2002 and anaggregate of 54.3% of our Industrial Division revenues or 17.5% of our totalrevenues for the first nine months of 2002. No Industrial Division customer accounted for more than 10.0% of ourtotal revenues for the third quarter of 2002 or the first nine months of 2002.

** **

Our ten largest Commercial Division customers accounted for anaggregate of 58.9% of our Commercial Division revenues or 44.2% of our totalrevenues for the third quarter of 2002 and an aggregate of 68.7% of ourCommercial Division revenues or45.4% of our total revenues for the first nine months of 2002.  CDW Computer Centers was our largestCommercial Division customer for the third quarter of 2002 and the first ninemonths of 2002.  CDW ComputerCenters accounted for 29.8% of our

 

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Commercial Divisionrevenues or 22.4% of our total revenues for the third quarter of 2002 and 32.6%of our Commercial Division revenuesor 21.5% of our total revenues for the first nine months of 2002.  No otherCommercial Division customer accounted for more than 10.0% of our totalrevenues for the third quarter of 2002 or the first nine months of 2002.

** **

Consolidation in some ofour customers’ industries may result in increased customer concentration andthe potential 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 and believe that our financial results willdepend in significant part upon the success of our customers’ business.

** **

**Threeof our beneficial shareholders have substantial influence over our operationsand can significantly 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 79.5% of ourcommon stock. As a result, they have the ability to control all mattersrequiring approval by our shareholders, including the election and removal ofdirectors, approval of significant corporate transactions and the ability tocontrol the decision of whether a change in control will occur.

** **

**Weare involved from time to time in claims and litigation over intellectualproperty rights, which may adversely affect our ability to manufacture and sellour products.**

** **

The semiconductorindustry is characterized by vigorous protection and pursuit of intellectualproperty rights. We believe that it may be necessary, from time to time, toinitiate litigation against one or more third parties to preserve ourintellectual property rights. In addition, from time to time, we have received,and may continue to receive in the future, notices that claim we have infringedupon, misappropriated or misused other parties’ proprietary rights, whichclaims could result in litigation. Such litigation would likely result insignificant expense to us and divert the efforts of our technical andmanagement personnel. In the event of an adverse result in such litigation, wecould be required to pay substantial damages, cease the manufacture, use andsale of certain products, expend significant resources to develop non-infringingtechnology, discontinue the use of certain processes or obtain licenses to usethe infringed 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.

** **

We are currently a partyto two 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 ability to exclude competitors from making, using orselling the same or similar products to our IC Tower stacking products wouldcease. In addition, if we are found to infringe valid patents of others, we maybe excluded from using the infringed technology without a license, which maynot be available on commercially reasonable terms, if at all.

** **

**If industry sales of products usingFlash memory do not grow, our revenues and profitability would be harmed.**

** **

The market for consumerelectronics incorporating Flash memory is relatively new and emerging. Thesuccess of our Flash business will depend largely on the level of consumerinterest in consumer electronics utilizing Flash memory, such as digitalcameras, MP3 digital audio players and personal digital assistants, or PDAs,many of which have only recently been introduced to the market. If sales ofproducts

 

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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 mayexperience reduced revenues and earnings.

** **

**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 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 acompetitor to achieve greater market share. Some of our competitors are in abetter financial and marketing position from which to influence industryacceptance of a particular Flash memory standard or competing technology thanwe are. In particular, a primary source of competition may come from companiesthat offer alternative technologies such as ferroelectric random access memoryproducts. If a competing technology replaces or takes significant market sharefrom the Flash memory market, we would 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 employeesin our industry is intense. We have had and may continue to have difficultyhiring the necessary engineering, sales and marketing and management personnelto support 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 proprietary technology and intellectualproperty may not be adequately protected, which could harm our competitiveposition.**

 

Our proprietary technologyand other intellectual property are critical to our success. We protect ourintellectual property rights through patents, trademarks, copyrights and tradesecret laws, confidentiality procedures and employee disclosure and inventionassignment agreements. It is possible that our efforts to protect ourintellectual property rights may not:

 

• preventthe challenge, invalidation or circumvention of our existing patents

 

• resultin patents that lead to commercially viable products or provide competitiveadvantages for our products

 

• preventour competitors 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 do business

 

• 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

 

• resultin patents from 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

 

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unenforceable, we may beunable 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 anddo not 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 products overseas,we have exposure to foreign intellectual property risks.

 

**Our indemnification obligations for theinfringement by our products on the intellectual property rights of otherscould require us to pay substantial damages.**

 

We currently have ineffect a number of agreements in which we have agreed to defend, indemnify andhold harmless certain of our customers and suppliers from damages and costswhich may 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.

 

**Our indemnification obligations to ourcustomers and suppliers for product defects could require us to pay substantialdamages.**

 

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.

 

**Our limited experience in acquiring otherbusinesses, product lines and technologies may make it difficult for us toovercome problems encountered in connection with any acquisitions we mayundertake.**

 

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 theacquisition of assets of Irvine Networks, LLC, a leading-edge engineeringcompany, in January 2002, our experience inacquiring other businesses, product lines and technologies is limited. Inaddition, the attention of our small management team may be diverted from ourcore business if we undertake an acquisition. Potential acquisitions alsoinvolve numerous risks, 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 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.

 

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

** **

To the extent wemanufacture products in anticipation of future demand that does notmaterialize, or in the event a customer cancels outstanding orders, we could experiencean unanticipated 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-down inventory in the past for reasons suchas obsolescence, excess quantities and declines in market value below ourcosts. These inventory write-downs were approximately $240,000 for the firstnine months of 2002. In addition, we offer some of our Commercial Division customerslimited price protection rights for inventories of our products held by them.If we reduce the list price of our products, these customers may receivecredits from us. We incurred price protection charges of approximately $985,000for the first nine months of 2002.  Inaddition, we have rebate agreements with a number of our Commercial Divisioncustomers in which we make payments to our customers’ end-users for a portionof their purchase price.  We incurredrebate expenses of approximately $722,000 for the first nine months of 2002.

** **

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 September30, 2002, we have not been required to repurchase inventory in connection withthe customer default agreements noted above. However, it may be possible thatwe will be required to repurchase inventory, upon customer default, in thefuture. Sales under such agreements were approximately $582,000 for the firstnine months of 2002.

** **

We have no long-termvolume commitments 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.

** **

**Wemay not be able to maintain or improve our competitive position because of theintense competition in the memory industry.**

** **

We conduct business in anindustry characterized by intense competition, rapid technological change, evolvingindustry 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 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 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.

** **

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

** **

Recent terrorist attacksin the United States, as well as continued threats of terrorism within theUnited States and abroad and current and future military responses to them,have resulted in delayed and canceled orders and created many economic andpolitical uncertainties that make it extremely difficult for us, our customersand our suppliers to accurately forecast and plan future businessactivities.  This reduced predictability challenges our ability to growour business.  In particular, it is difficult to develop and implementstrategies, efficient operations, and effectively manage capacity andsupply-chain relationships.  In addition, the continued threats ofterrorism and the heightened security measures in response to such threats haveand may continue to cause significant disruption to commerce throughout theworld.  Disruption in air transportation in response to these threats orfuture attacks may result in transportation and supply-chain disruptions,increase our costs for both receipt of inventory and shipment of products toour customers, and cause customers to defer their purchasing decisions. Disruptions in commerce could also cause consumer confidence and spending todecrease or result in increased volatility in the United States and worldwidefinancial markets and economy.  They could also result in economicrecession in the United States or abroad.  Any of these occurrences couldhave a significant impact on our operating results, revenues and costs and mayresult in the volatility of the market price of our common stock and on thefuture price of our common stock.

** **

**Wemay lose our competitive position if we fail to develop new and enhancedproducts and introduce 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, andmay in 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 technologicalchanges or 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.

** **

**Weface risks associated with doing business in foreign countries, includingforeign currency fluctuations and trade barriers, that could lead to a decreasein demand for our products or an increase in the cost of the components used inour 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 17.9% of our revenues for thethird quarter of 2002 and 14.2% of our revenues for

 

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the first nine months of2002.  No single foreign countryaccounted for more than 10.0% of our revenues for the third quarter of 2002 orthe first nine months of 2002.  For thethird quarter of 2002 and the first nine months of 2002, more than 95.0% of ourinternational sales were denominated in U.S. dollars. However, if there is asignificant devaluation of the currency in a specific country, the prices ofour products will increase relative to that country’s currency and our productsmaybe less competitive 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 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.

** **

Our international salesalso are subject to certain other risks, including regulatory risks, tariffsand other trade barriers, timing and availability of export licenses, politicaland economic 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.

** **

**Disruptionof our operations 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 such as earthquakes, fires or floods couldcause us to cease or limit our manufacturing operations and consequently harmour business, financial condition and results of operations.

** **

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

** **

We are subject to avariety of environmental laws and regulations governing, among other things,air emissions, waste water discharge, waste storage, treatment and disposal,and remediation 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.

** **

**Ourstock price is likely to be volatile and could drop unexpectedly.**

** **

Our common stock has beenpublicly traded only since September 29, 2000. The market price of our commonstock has been subject to significant fluctuations since the date of ourinitial public offering.  The stockmarket has from time to time experienced significant price and volumefluctuations that have affected the market prices of securities, particularlysecurities of technology companies. As a result, the market price of our commonstock may materially decline, regardless of our operating performance. In thepast, following periods of volatility in the market price of a particularcompany’s securities, securities class action litigation has often been broughtagainst that company. We may become involved in this type of litigation in thefuture. Litigation of this type is often expensive and diverts management’sattention and resources.

 

**Our revenues may fluctuate and ourresults of operations could be harmed due to the seasonality of our business**

 

Sales of our products inthe consumer electronics market are subject to seasonality. As a result, salesof these products are impacted by seasonal purchasing patterns with highersales generally occurring

 

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in the first, third andfourth quarters of each year and lower sales occurring in the second quarter ofeach year.   Sales of our products aretypically positively impacted by increased purchasing of memory upgradesrelated to computing and consumer electronic products purchased during theChristmas season in the first quarter, back-to-school season computing andconsumer electronics purchases during the third quarter and Christmas seasoncomputing and consumer electronics purchases during the fourth quarter.  Our ability to adjust our short-termoperating expenses in response to fluctuations in seasonal revenues is limited.As a result, if seasonal revenues are lower than expected in any given period,our results of operations could be harmed.

 

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

 

**InterestRate Risk**

** **

At any time, fluctuationsin interest rates could affect interest earnings on our cash and cashequivalents and interest expense on our existing variable rate debt.  Webelieve 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 donot hedge these interest rate exposures.  The primary objective of ourinvestment activities is to preserve capital. We have not used derivativefinancial instruments in our investment portfolio.

** **

At September 30, 2002, ourcash and cash equivalents were $45.3 million and our variable rate debt,consisting of term loan borrowing, was $53,000.  At September 30, 2002,our cash and cash equivalents included $36.9 million invested in money marketand other interest bearing accounts and $8.4 million invested in marketablesecurities, which represents investments in United States treasury notes andtreasury bonds.

** **

At September 30, 2002,our investment in marketable securities had a weighted-average time to maturityof approximately 17.3 days. Marketable securities represent United Statestreasury notes and treasury bonds with a maturity of greater than three months.These securities are classified as held to maturity because we have theintention and ability to hold the securities to maturity. Gross unrealizedgains and losses on held-to-maturity marketable securities have historicallynot been material. As of September 30, 2002, unrealized gains in ourinvestments in marketable securities was $5,000.  Maturities on held-to-maturity marketable debt securities rangefrom three months to two years.

** **

During the third quarterof 2002, our investments in marketable securities yielded an effective interestrate of 1.97%.  If interest rates wereto decrease 1%, the result would be an annual decrease in our interest incomerelated to our cash and cash equivalents of approximately $453,000. Conversely, if interest rates were to increase 1%, the result would be anannual increase in our interest expense related to our variable rate debt of approximately$530.  However, due to the uncertainty of the actions that would be takenand their possible effects, this analysis assumes no such action. Further, this analysis does not consider the effect of the change in the levelof overall economic activity that could exist in such an environment.

** **

**ForeignCurrency Risk**

** **

More than 95.0% of ourinternational sales are denominated in U.S. dollars.  Consequently, if the value of the U.S. dollar increases relativeto a particular foreign currency, our products could become relatively moreexpensive.  In addition, we purchasesubstantially all of our IC devices from local distributors of Japanese, Koreanand Taiwanese suppliers.  Fluctuationsin the currencies of Japan, Korea or Taiwan could have an adverse impact on thecost of our raw materials.  The effectof foreign exchange rate fluctuations on our operating results in the thirdquarter of 2002 were not material. To date, we have not entered any derivativeinstruments to manage risks related to interest rate or foreign currencyexchange rates.  We assess the need toutilize financial instruments to hedge currency exposures on an ongoingbasis.  As of September 30, 2002, we had$97,000 in cash and cash equivalents denominated in foreign currencies.

** **

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**ITEM 4.**  CONTROLSAND PROCEDURES

 

**(a) Evaluation of Disclosure Controlsand Procedures.** Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of our disclosure controls and procedures, as such term is definedunder Rule 13a-14(c) and Rule 15d promulgated under the Securities Exchange Actof 1934, as amended (the “Exchange Act”), within 90 days of the filing date ofthis report. Based on their evaluation, our principal executive officer andprincipal accounting officer concluded that our disclosure controls andprocedures are effective.

** **

**(b) Changes in InternalControls. **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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**PARTII**

**OTHER INFORMATION**

 

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

 

Reference is made to ourAnnual Report on Form 10-K filed with the SEC on March 20, 2002 and ourQuarterly Reports on Form 10-Q filed with the SEC on May3, 2002 and August 13,2002  under the heading “LegalProceedings” for a discussion of litigation involving us relating to (i) patentlitigation with DPAC Technologies, Inc. and (ii) patent litigation withLemelson Medical, Education & Research Foundation, LLP.

 

#### **DPAC Technologies, Inc. –Patent Litigation**

 

On September 23, 1998, wefiled 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 stackingpatent, U.S. Patent No. 5,514,907. On March 29, 2001, the court entered finaljudgement finding DPAC did not infringe our patent and that we did not infringeDPAC’s patent. The appeals court affirmed the final judgement on March 7, 2002.On September 3, 2002, we filed a petition for certiori with the U.S. SupremeCourt.  On October 7, 2002, the petitionto the Supreme Court was granted and the matter has been remanded to theCircuit Court of Appeals.

 

On October 17, 2000, theU.S. Patent and Trademark Office granted us a reissue patent on our IC Towerstacking patent. The reissue patent is U.S. Patent No. Re. 36,916.

 

On February 21, 2001, wefiled a new lawsuit against DPAC in the United States District Court for theCentral District of California for infringement of the reissue patent. We areseeking damages and an injunction against further infringement. On March 13,2001, DPAC filed an answer to our complaint denying infringement, and asserteda defense of patent invalidity. In addition, DPAC counterclaimed alleging wemisappropriated unspecified DPAC technology and allegedly used that unspecifiedtechnology in our IC Tower products.  OnSeptember 9, 2002, DPAC and us agreed to dismiss this lawsuit withoutprejudice.    Although a dismissalwithout prejudice allows for the potential refiling of the lawsuit in thefuture, we have not pursued a refiling.

 

**LemelsonMedical, 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 District Courtof Arizona and alleges that our manufacturing processes infringe severalpatents that the Lemelson Foundation allegedly owns. The complaint also statesthat these allegedly infringed patents relate to machine vision technology andbar coding technology. On March 7, 2002, we were served with the LemelsonFoundation complaint. Thereafter, the case was stayed pending the outcome ofrelated cases against other parties involving the same patents. Because of thepreliminary stage of this case, an estimate of potential damages, if any, wouldbe premature and speculative, and we have not made any such estimate at thistime.

 

**Lexar Media, Inc. – Unfair Trade Practice**

 

On October 1, 2002, wefiled a lawsuit against Lexar Media, Inc. in the Superior Court of OrangeCounty, California for unfair trade practices and are seeking unspecifieddamages, including punitive and trebled damages.  Our complaint sets forth various causes of actions against LexarMedia, including trade libel, libel per se, interference with businessopportunities, violation of the California Unfair Competition Act, andviolation of the California Unfair Trade Practices Act.  The lawsuit was filed in response to lettersthat Lexar Media sent to one of our customers that allege certain of ourproducts infringe upon one or more of Lexar Media's patents.  On October 30, 2002, Lexar Media filed anotice of removal, which removed the matter from the Orange County SuperiorCourt to the United States District Court for the Central District of California.  This lawsuit is in the early stages. Noformal discovery has been conducted and no trial date has been set.  We believe that the patent infringementallegations made by Lexar Media in its letters to one of our customers arewithout merit and intend to defend ourselves vigorously if patent infringementclaims are brought by Lexar Media against us.

 

On October 1, 2002, welodged a formal complaint against Lexar Media with the Federal TradeCommission’s Bureau of Competition for unfair trade practices.

 

27

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Other than the mattersdiscussed above, we are not a party to any other material legal proceedings,nor are we aware of any pending or threatened litigation that would have amaterial adverse effect on our business, operating results, cash flows orfinancial condition. From time to time, we may become subject to additionallegal proceedings, claims, and litigation arising in the ordinary course ofbusiness. In addition, we may receive letters alleging infringement of patentor other intellectual property rights. Our management believes that theseletters generally are without merit and intends to contest them vigorously.

 

 

**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 ofSecurity Holders**

 

None.

 

**Item 5****.  OtherInformation**

 

None.

 

**Item 6.****  Exhibits andReports 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 therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                                      | SIMPLETECH, INC.,                                                                  |
|-------------------------------------------|------------------------------------------------------------------------------------|
|                                      | a California  corporation                                                          |
|                                      |                                                                               |
|                                      |                                                                               |
| Date:    November 13, 2002 | /s/ MANOUCH MOSHAYEDI                                                              |   |
|                                      | Manouch Moshayedi                                                                  |
|                                      | Chief Executive Officer  and Chairman of the Board of Directors                    |
|                                      |                                                                               |
|                                      |                                                                               |
| Date:    November 13, 2002 | /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, pursuant to §302 of theSarbanes-Oxley Act of 2002, that:

 

1.  I have reviewed thisquarterly report on Form 10-Q of SimpleTech, Inc.;

 

2.  Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.  The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14 for theregistrant and we have:

 

(i)  designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

(ii)  evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (“Evaluation Date”); and

 

(iii)  presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of the registrant’s board of directors (orpersons performing the equivalent function):

 

(i) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors any materialweaknesses in internal controls; and

 

(ii) any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
|   | /s/ MANOUCH MOSHAYEDI          |   |
|--------|--------------------------------|--------|
|   | Manouch Moshayedi              |
|   | Chief Executive Officer        |
|   | (Principal Executive  Officer) |
|   | November 13, 2002              |

 

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**PERIODIC REPORT CERTIFICATION**

**of the Chief Financial Officer**

 

I, Dan Moses, ChiefFinancial Officer of SimpleTech , Inc., certify, pursuant to §302 of theSarbanes-Oxley Act of 2002, that:

 

1.  I have reviewed this quarterly report onForm 10-Q of SimpleTech, Inc.;

 

2.  Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.  The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14 for theregistrant and we have:

 

(i)  designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

(ii)  evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (“Evaluation Date”); and

 

(iii)  presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of the registrant’s board of directors (orpersons performing the equivalent function):

 

(i) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(ii) any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
|   | /s/ DAN MOSES                  |   |
|--------|--------------------------------|--------|
|   | Dan Moses                      |
|   | Chief Financial Officer        |
|   | (Principal Financial  Officer) |
|   | November 13, 2002              |

 

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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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