** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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** **

**FORM 10-Q**

** **

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

** **

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

 

**or**

** **

**o****TRANSITION REPORT TO SECTION13 OR 15(d) OFTHE SECURITIES EXCHANGEACT 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 shares outstanding of the Registrant’s common stock, parvalue $0.001, as of June 30, 2002 was 38,516,680.

 

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**SIMPLETECH,INC.**

**INDEX TOFORM 10-Q FOR THE**

**QUARTERLYPERIOD ENDED JUNE 30, 2002**

 
| PART I. FINANCIAL  INFORMATION |
|--------------------------------|
|                           |   |
| Item 1.                        | Financial Statements |
|                           |   |
|                           | Consolidated Balance Sheets  as of June 30, 2002 and December 31, 2001(unaudited) |
|                           |   |
|                           | Consolidated Statements  of Operations for the Three and Six Months Ended June 30, 2002 and June 30,  2001(unaudited) |
|                           |   |
|                           | Consolidated  Statements of Cash Flows for the Six Months Ended June 30, 2002 and June 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 |
|                           |   |
| 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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**PARTI.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

** **

**SimpleTech, Inc.**

**ConsolidatedBalance Sheets**

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

**(unaudited)**
|                                                                                                                                                                                            |   | **June 30, 2002** |   | **December 31, 2001** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|-----------------------|------------|
|                                                                                                                                                                                            |   |              |   |                  | ** ** |
| ASSETS:                                                                                                                                                                                         |   |              |   |                  |       |
| Current Assets:                                                                                                                                                                                 |   |              |   |                  |       |
| Cash and cash equivalents                                                                                                                                                                       |   | $                 | 47,620 |                  | $          | 51,831 |   |
| Accounts receivable, net of allowances of $990 at June 30, 2002 and  $1,080 at December 31, 2001                                                                                                |   | 15,068            |   | 12,062                |       |
| Inventory, net                                                                                                                                                                                  |   | 9,464             |   | 9,843                 |       |
| Deferred income taxes                                                                                                                                                                           |   | 786               |   | 786                   |       |
| Other current assets                                                                                                                                                                            |   | 4,151             |   | 4,474                 |       |
| Total current assets                                                                                                                                                                            |   | 77,089            |   | 78,996                |       |
| Furniture, fixtures and equipment, net                                                                                                                                                          |   | 10,655            |   | 9,127                 |       |
| Goodwill                                                                                                                                                                                        |   | 835               |   | —                |       |
| Deferred income taxes                                                                                                                                                                           |   | 587               |   | 587                   |       |
| Total assets                                                                                                                                                                                    |   | $                 | 89,166 |                  | $          | 88,710 |   |
|                                                                                                                                                                                            |   |              |   |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY:                                                                                                                                                     |   |              |   |                  |       |
| Current Liabilities:                                                                                                                                                                            |   |              |   |                  |       |
| Accounts payable                                                                                                                                                                                |   | $                 | 10,629 |                  | $          | 10,320 |   |
| Current maturities of long-term debt                                                                                                                                                            |   | 417               |   | 741                   |       |
| Current maturities of capital lease obligations                                                                                                                                                 |   | 338               |   | 441                   |       |
| Accrued and other liabilities                                                                                                                                                                   |   | 3,621             |   | 2,951                 |       |
| Total current liabilities                                                                                                                                                                       |   | 15,005            |   | 14,453                |       |
| Long-term debt                                                                                                                                                                                  |   | 208               |   | 271                   |       |
| Capital lease obligations                                                                                                                                                                       |   | —            |   | 113                   |       |
| Total liabilities                                                                                                                                                                               |   | 15,213            |   | 14,837                |       |
|                                                                                                                                                                                            |   |              |   |                  |       |
| Commitments and contingencies                                                                                                                                                                   |   |              |   |                  |       |
|                                                                                                                                                                                            |   |              |   |                  |       |
| Shareholders’ Equity:                                                                                                                                                                      |   |              |   |                  |       |
| Preferred stock, par value $0.001, 20,000,000 shares authorized, no  shares outstanding                                                                                                         |   | —            |   | —                |       |
| Common stock, $0.001 par value, 100,000,000 shares authorized,  38,516,680 shares issued and outstanding as of June 30, 2002; 38,272,050  shares issued and outstanding as of December 31, 2001 |   | 38                |   | 38                    |       |
| Additional paid-in capital                                                                                                                                                                      |   | 65,956            |   | 65,484                |       |
| Unearned stock based compensation                                                                                                                                                               |   | (4                | )      | (15                   | )          |
| Retained earnings                                                                                                                                                                               |   | 7,963             |   | 8,366                 |       |
| Total shareholders’ equity                                                                                                                                                                 |   | 73,953            |   | 73,873                |       |
| Total liabilities and shareholders’ equity                                                                                                                                                 |   | $                 | 89,166 |                  | $          | 88,710 |   |

 

See accompanying notes to unauditedconsolidated financial statements.

 

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**SimpleTech, Inc.**

**Consolidated Statements of Operations**

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

**(unaudited)**

 
|                                                      |   | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------|--------|----------------------------------|------------|--------------------------------|------------|
|                                                      |   | **2002**                         |       | **2001**                       |       | **2002** |   | **2001** |   |
|                                                      |   |                             |       |                           |       |   |   |   |   |
| Net revenues                                              |   | $                                | 43,301     |                           | $          | 36,768 |   | $ | 94,253 |   | $ | 95,483 |   |
| Cost of revenues                                          |   | 37,167                           |       | 31,149                         |       | 76,643 |   | 74,402 |   |
| Gross profit                                              |   | 6,134                            |       | 5,619                          |       | 17,610 |   | 21,081 |   |
| Sales and marketing                                       |   | 4,230                            |       | 4,625                          |       | 9,067 |   | 9,905 |   |
| General and administrative                                |   | 2,673                            |       | 3,377                          |       | 5,704 |   | 6,353 |   |
| Research and development                                  |   | 2,007                            |       | 1,206                          |       | 3,945 |   | 2,263 |   |
| In-process research and development                       |   | —                           |       | —                         |       | 1,360 |   | — |   |
| Total operating expenses                                  |   | 8,910                            |       | 9,208                          |       | 20,076 |   | 18,521 |   |
| (Loss) income from operations                             |   | (2,776                           | )          | (3,589                         | )          | (2,466 | ) | 2,560 |   |
| Interest and other, net                                   |   | (187                             | )          | (381                           | )          | (396 | ) | (797 | ) |
| (Loss) income before (benefit) provision for income taxes |   | (2,589                           | )          | (3,208                         | )          | (2,070 | ) | 3,357 |   |
| (Benefit) provision for income taxes                      |   | (1,873                           | )          | (1,274                         | )          | (1,667 | ) | 1,333 |   |
| Net (loss) income                                         |   | $                                | (716       | )                              | $          | (1,934 | ) | $ | (403 | ) | $ | 2,024 |   |
|                                                      |   |                             |       |                           |       |   |   |   |   |
| Net (loss) income per share:                              |   |                             |       |                           |       |   |   |   |   |
| Basic                                                     |   | $                                | (0.02      | )                              | $          | (0.05 | ) | $ | (0.01 | ) | $ | 0.05 |   |
| Diluted                                                   |   | $                                | (0.02      | )                              | $          | (0.05 | ) | $ | (0.01 | ) | $ | 0.05 |   |
|                                                      |   |                             |       |                           |       |   |   |   |   |
| Weighted average shares outstanding:                      |   |                             |       |                           |       |   |   |   |   |
| Basic                                                     |   | 38,476                           |       | 38,241                         |       | 38,414 |   | 37,968 |   |
| Diluted                                                   |   | 38,476                           |       | 38,241                         |       | 38,414 |   | 39,377 |   |

 

See accompanying notes to unauditedconsolidated financial statements.

 

4

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**SimpleTech, Inc.**

**Consolidated Statements of Cash Flows**

**(in thousands)**

**(unaudited)**

 
|                                                                                      |   | **Six  Months  Ended June 30,** |   |
|-------------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                      |   | **2002**                        |   | **2001** | ** ** |
|                                                                                      |   |                            |   |   |   |
| Cash flow from operating activities:                                                      |   |                            |   |   |   |
| Net (loss) income                                                                         |   | $                               | (403   | ) | $ | 2,024 |   |
| Adjustments to reconcile net (loss) income to net cash provided by  operating activities: |   |                            |   |   |   |
| Depreciation                                                                              |   | 1,691                           |   | 1,684 |   |
| Loss on sale of furniture, fixtures and equipment                                         |   | 89                              |   | 4 |   |
| Accounts receivable provisions                                                            |   | 696                             |   | 1,518 |   |
| Inventory excess and obsolescence expense                                                 |   | 477                             |   | 918 |   |
| In-process research and development                                                       |   | 1,360                           |   | — |   |
| Compensation related to stock options vesting                                             |   | 11                              |   | 25 |   |
| Change in operating assets and liabilities:                                               |   |                            |   |   |   |
| Accounts receivable                                                                       |   | (3,702                          | )      | 15,464 |   |
| Inventory                                                                                 |   | (98                             | )      | 12,853 |   |
| Other current assets                                                                      |   | 323                             |   | (2,438 | ) |
| Accounts payable                                                                          |   | 309                             |   | (21,409 | ) |
| Accrued and other liabilities                                                             |   | 670                             |   | (1,104 | ) |
| Net cash provided by operating activities                                                 |   | 1,423                           |   | 9,539 |   |
|                                                                                      |   |                            |   |   |   |
| Cash flows from investing activities:                                                     |   |                            |   |   |   |
| Purchase of furniture, fixtures and equipment                                             |   | (3,859                          | )      | (2,437 | ) |
| Proceeds from sale of furniture, fixtures and equipment                                   |   | 651                             |   | 167 |   |
| Acquisition of business                                                                   |   | (2,295                          | )      | — |   |
| Net cash used in investing activities                                                     |   | (5,503                          | )      | (2,270 | ) |
|                                                                                      |   |                            |   |   |   |
| Cash flows from financing activities:                                                     |   |                            |   |   |   |
| Repayment of borrowings from banks                                                        |   | (387                            | )      | (373 | ) |
| Payment on capital lease obligations                                                      |   | (216                            | )      | (461 | ) |
| Proceeds from issuance of common stock                                                    |   | 472                             |   | 909 |   |
| Net cash provided by financing activities                                                 |   | (131                            | )      | 75 |   |
|                                                                                      |   |                            |   |   |   |
| Net increase (decrease) in cash                                                           |   | (4,211                          | )      | 7,344 |   |
| Cash and cash equivalents at beginning of period                                          |   | 51,831                          |   | 33,747 |   |
| Cash and cash equivalents at end of period                                                |   | $                               | 47,620 |   | $ | 41,091 |   |

 

See accompanying notes to unauditedconsolidated financial statements.

 

5

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**SIMPLETECH,INC**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1 -Basis of Presentation**

 

The accompanying interimconsolidated financial statements of SimpleTech, Inc., a California corporation(the “Company”), are unaudited and have been prepared in accordance with theinstructions to Form 10-Q and Article 10 of Regulation S-X.  In the opinion of management, alladjustments (consisting of normal and recurring accruals) considered necessaryfor a fair presentation of the consolidated financial position of the Companyat June 30, 2002 and the consolidated results of operations and cash flows forthe three and six months ended June 30, 2002 and 2001 have been included.  These interim consolidated financialstatements should be read in conjunction with the consolidated financialstatements and related notes contained in the most recent Annual Report on Form10-K filed with the SEC.  The December31, 2001 balances reported herein are derived from the audited consolidated financialstatements included in the Annual Report on Form 10-K for the year endedDecember 31, 2001.  The results for theinterim periods are not necessarily indicative of results to be expected forthe full year.

 

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

** **

**Note 2 -Use of Estimates**

 

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

** **

**Note 3 -Net Income Per Share**

 

Basic earnings per share is computed by dividing net income by theweighted average number of shares outstanding. In computing diluted earningsper share, the weighted average number of shares outstanding is adjusted toreflect the potentially dilutive securities. For the six months ended June 30,2001, potentially dilutive securities consisted solely of options and resultedin potential common shares of 1,409,006.  For the threemonths ended  June 30, 2002 and 2001,and the six months ended June 30, 2002, no potential common shares wereincluded in the diluted per share amount as the effect would have beenanti-dilutive.

** **

**Note 4 - Supplemental Balance SheetInformation**

 

Inventory consists of thefollowing:

 
| **(in thousands)**   |   | **June 30, 2002** |   | **December 31, 2001** |   |
|----------------------|--------|-------------------|--------|-----------------------|--------|
|                 |   |              |   |                  |   |
| Raw materials        |   | $                 | 5,483  |                  | $      | 5,421 |   |
| Work-in-progress     |   | 205               |   | 927                   |   |
| Finished goods       |   | 5,160             |   | 4,785                 |   |
|                 |   | 10,848            |   | 11,133                |   |
| Valuation allowances |   | (1,384            | )      | (1,290                | )      |
| Inventory, net       |   | $                 | 9,464  |                  | $      | 9,843 |   |

 

6

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**Note 4 - Supplemental Balance SheetInformation (continued)**

 

Furniture, fixtures andequipment consist of the following:

 
| **(in thousands)**                     |   | **June 30, 2002** |   | **December 31, 2001** |   |
|----------------------------------------|--------|-------------------|--------|-----------------------|--------|
|                                   |   |              |   |                  |   |
| Furniture and fixtures                 |   | $                 | 321    |                  | $      | 299 |   |
| Equipment                              |   | 23,592            |   | 21,557                |   |
|                                   |   | 23,913            |   | 21,856                |   |
| Accumulated depreciation               |   | (13,258           | )      | (12,729               | )      |
| Furniture, fixtures and equipment, net |   | $                 | 10,655 |                  | $      | 9,127 |   |

 

**Note 5 - Item 1.  Legal Proceedings**

 

Reference is made to the Company’s Annual Report onForm 10-K filed with the SEC in March 2002  underthe heading “Legal Proceedings”  for adiscussion of litigation involving the Company relating to (i) patentlitigation with DPAC Technologies, Inc. and (ii) patent litigation withLemelson Medical, Education & Research Foundation, LLP.

 

**DPAC Technologies, Inc. — PatentLitigation**

 

On September 23, 1998, the Company filed a lawsuitagainst DPAC Technologies, Inc., formerly Dense-Pac Microsystems, Inc.(“DPAC”), in the United States District Court for the Central District ofCalifornia for infringement of the Company’s IC Tower stacking patent, U.S.Patent No. 5,514,907. On March 29, 2001, the court entered final judgementfinding DPAC did not infringe the Company’s patent. The appeals court affirmedthe final judgement on March 7, 2002.  On June 3, 2002, the Company fileda petition for certiori with the U.S. Supreme Court.  The petition is nowpending before the Supreme Court.

 

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, the Company filed a new lawsuitagainst DPAC in the United States District Court for the Central District ofCalifornia for infringement of the reissue patent.  The Company is seekingdamages and an injunction against further infringement.  On March 13,2001, DPAC filed an answer to the Company’s complaintdenying 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.  Trial isscheduled for June 2003.

** **

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

 

The Company received notice on November 26, 2001, thatthe Lemelson Medical, Education & Research Foundation, LLP (“LemelsonFoundation”) filed a complaint on November 13, 2001, against the Company andother defendants. The complaint was filed in the District Court of Arizona andalleges that the Company’s manufacturing processes infringe several patentsthat the Lemelson Foundation allegedly owns. The complaint also states thatthese allegedly infringed patents relate to machine vision technology and barcoding technology. On March 7, 2002, the Company was 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 the Company has not made any such estimate atthis time.

** **

**Note 6 -Segment Information:**

 

The Company designs,manufactures and markets a comprehensive line of memory, storage andconnectivity products used in high performance computing, networking andcommunications, consumer electronics and industrial applications.  The Company provides both technologysolutions for two 

 

7

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reportable operating segments, Industrial andCommercial, based on dynamic random access memory (DRAM), static random accessmemory (SRAM) and Flash memory technologies.

 

The Company uses netsales and gross profit as the basis for evaluating the performance of itsoperating segments.  The Company doesnot allocate operating expenses, interest or income taxes to operatingsegments.  Due to the similarity ofproducts manufactured for customers within each operating segment, the Companydoes not maintain separate records to identify assets by operating segment.

 

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

 
| **(in  thousands)** |   | **Three  Months Ended  June 30, 2002** |   | **Three  Months Ended  June 30, 2001** |   |
|---------------------|--------|----------------------------------------|--------|----------------------------------------|--------|
|                |   | **Industrial**                         |   | **Commercial**                         |   | **Consolidated** |   | **Industrial** |   | **Commercial** |   | **Consolidated** |   |
| Net revenues        |   | $                                      | 13,510 |                                   | $      | 29,791 |   | $ | 43,301 |   | $ | 7,738 |   | $ | 29,030 |   | $ | 36,768 |   |
| Cost of revenues    |   | 9,611                                  |   | 27,556                                 |   | 37,167 |   | 5,938 |   | 25,211 |   | 31,149 |   |
| Gross profit        |   | $                                      | 3,899  |                                   | $      | 2,235 |   | $ | 6,134 |   | $ | 1,800 |   | $ | 3,819 |   | $ | 5,619 |   |

 
|             |   | **Six Months  Ended  June 30, 2002** |       | **Six Months  Ended  June 30, 2001** |       |
|------------------|--------|--------------------------------------|------------|--------------------------------------|------------|
|             |   | **Industrial**                       | ** ** | **Commercial**                       | ** ** | **Consolidated** | ** ** | **Industrial** | ** ** | **Commercial** | ** ** | **Consolidated** |   |
| Net revenues     |   | $                                    | 20,837     |                                 | $          | 73,416 |   | $ | 94,253 |   | $ | 32,625 |   | $ | 62,858 |   | $ | 95,483 |   |
| Cost of revenues |   | 14,690                               |       | 61,953                               |       | 76,643 |   | 21,686 |   | 52,716 |   | 74,402 |   |
| Gross profit     |   | $                                    | 6,147      |                                 | $          | 11,463 |   | $ | 17,610 |   | $ | 10,939 |   | $ | 10,142 |   | $ | 21,081 |   |

 

For the three monthsended June 30, 2002 and 2001, international sales comprised 13.3% and 17.2%, ofthe Company’s revenues.  For the sixmonths ended June 30, 2002 and 2001, international sales comprised 12.7% and16.2%, of the Company’s revenues.  During these periods, no single foreign country accounted for more than10.0% of total revenues.  Allinternational sales during these periods were shipped from the Company’sdomestic warehouse to foreign customers.

 

**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

** **

**Cautionary Statement**

 

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

 

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

#### ** **

#### **Overview**

 

SimpleTech, Inc., originally incorporated in 1990 asSimple Technology, Inc., is a technology solutions provider offering productsbased on DRAM, SRAM and Flash memory technologies. Headquartered in Santa Ana,California, the company is a leader in the design, development, manufacturingand marketing of memory solutions. In addition, we offer a line of high-densitymemory products using our three-dimensional IC Tower stacking technology thatallows multiple memory chips to be stacked together to increase thecapabilities of memory modules without increasing the product footprint.  Our products are

 

8

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used in high-performance computing, networking and communications,consumer electronics and industrial applications.

 

As a result ofincreased demand for consumer electronics and high-density memory products usedin Internet infrastructure and embedded applications, the percentage of ourrevenues derived from the sales of Flash memory and IC Tower stacking productsincreased from 13.0% in 1998 to 20.8% in 1999 and 40.2% in 2000.  However, due to the softening macro-economicconditions and excess inventory levels at our Industrial Division customers in2001 and the first half of 2002, the percentage of our revenue derived from thesale of Flash memory and IC tower stacking products decreased from 40.2% in2000 to 34.1% in 2001 and 30.4% in the first half of 2002.In the first half of 2002, our highest profit margin product line was our ICTower stacking product line.

 

We sell our products through our Industrial andCommercial Divisions.  Our IndustrialDivision was created in late 1998 to enhance the marketing of our products tooriginal equipment manufacturers, or OEMs. Our Commercial Division sells our products through the following fivechannels:  value added reseller, or VAR,mail order, commercial and industrial distribution, and retail. Afterexperiencing year-over-year total revenue growth of 57.5% from 1998 to 1999 and60.1% from 1999 to 2000, our Industrial Division revenues declined 66.7% andour Commercial Division revenues declined 29.2% in 2001.  Both our Industrial and Commercial Divisionrevenues were negatively impacted in 2001 due to softening macro-economicconditions and severe declines in the price of DRAM and Flash components, whichresulted in significantly lower average selling prices.  In addition, our Industrial Divisionrevenues in 2001 were further impacted by a build-up of inventory by ourcommunications and networking customers during 2000.  Although the inventory levels of our communications andnetworking customers appear to have returned to normal levels, and ourIndustrial Division revenue increased 84.4% from the first quarter of 2002 tothe second quarter of 2002, we do not expect revenues from customers in theseindustries to return to fiscal year 2000 levels for several years.

 

In 2001, our Commercial Division significantlyexpanded our retail presence through the addition of new customers, such asSam’s Club.  Commercial Division unitsshipped increased 42.7% from 2000 to 2001 and 23.9% from the first half of 2001to the first half of 2002.

 

Industrial Division units shipped decreased 47.6% from2000 to 2001 due primarily to a build-up of inventory by our communications andnetworking customers.  IndustrialDivision units shipped increased 131.3% from the first half of 2001 to thefirst half of 2002.  This increaseresulted primarily from several Industrial Division customers in the networkingand telecom industries placing orders after several quarters of inactivity andthe shipment of inaugural orders to new Industrial Division customers in thecasino gaming, in-flight information and entertainment, and defenseindustries.  Historically, our highestprofit margin division was our Industrial Division.  We have not tracked, and do not intend to track, operatingexpenses on a divisional basis.

 

DRAM prices have been volatile during the past twoyears.  DRAM prices declined sharplyfrom September 2000 through October 2001 followed by a brief period of priceincreases through April 2002.  DRAMprices declined rapidly in early May 2002 to prices below DRAM manufacturers’production costs.    We believe that inthe next six to twelve months increased demand for memory products and furtherDRAM manufacturer consolidation will lead to firmer DRAM component prices,which would result in increased average selling prices, gross profit andearnings for us.

 

Historically, a relatively small number of customershave accounted for a significant percentage of our revenues. Our ten largestcustomers accounted for an aggregate of 56.6% of our total revenues for thefirst half of 2002 and 56.3% of our total revenues for 2001.  Our ten largest Industrial Divisioncustomers accounted for an aggregate of 80.4% of our Industrial Divisionrevenues or 18.0% of our total revenues for the first half of 2002 and 71.0% ofour Industrial Division revenues or 20.8% of our total revenues for 2001.  No Industrial Division customer accountedfor more than 10% of our total revenues for the first half of 2002.  Unisys accounted for 37.6% of our IndustrialDivision revenues or 11.0% of our total revenues for 2001.  No other Industrial Division customeraccounted for more than 10.0% of our total revenues for 2001.

 

Our ten largest Commercial Division customersaccounted for an aggregate of 60.1% of our Commercial Division revenues or 46.6%of our total revenues for the first half of 2002 and 61.6% of our CommercialDivision revenues or 43.6% of our total revenues for 2001. Our largestCommercial Division

 

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customer for the first half of 2002 and for 2001, CDW Computer Centers,accounted for 27.3% of our Commercial Division revenues or 21.2% of our totalrevenues for the first half of 2002 and 27.9% of our Commercial Divisionrevenues or 19.7% of our total revenues for 2001. No other Commercial Divisioncustomer accounted for more than 10.0% of our total revenues for the first halfof 2002 or for 2001. The composition of our major customer base changes fromquarter to quarter as the market demand for our customers’ products changes andwe expect this variability will continue in the future. We expect that sales ofour products to a small number of customers will continue to contributematerially to our revenues in the foreseeable future and believe that ourfinancial results will depend in significant part upon the success of ourcustomers’ products.

 

International sales of our products constituted 12.7%of our revenues for the first half of 2002 and 16.0% of our revenues for2001.  No single foreign countryaccounted for more than 10.0% of our revenues in the first half of 2002 or for2001. During the first half of 2002 and 2001, over 95.0% of our internationalsales were denominated in U.S. dollars. Consequently, if the value of the U.S.dollar increases relative to a particular foreign currency, our products couldbecome more expensive, which could result in a reduction of sales in aparticular country. In addition, we purchase substantially all of theintegrated circuit (“IC”) components used in our products from localdistributors of Japanese, Korean and Taiwanese suppliers. Although ourpurchases of IC components are currently denominated in U.S. dollars,devaluation of the U.S. dollar relative to the currency of a foreign supplierwould likely result in an increase in our cost of IC components. Ourinternational sales could also be adversely affected by risks includingregulatory risks, tariffs and other trade barriers.

 

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

 

Revenues are recognized at the time of shipment. Amajority of our sales through commercial channels include limited rights toreturn unsold inventory.  Such returnsare estimated and recorded as a reduction of net revenues at the time ofsale.  In addition, while we may not becontractually obligated to accept returned products, we may determine that itis in our best interest to accept returns in order to 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 $477,000 for the first half of2002 and $759,000 for 2001.  We alsohave price protection agreements with a number of our Commercial Divisioncustomers in which we retain limited liability for price declines related tounsold inventory. If we reduce the list price of our products, these customersmay receive credits from us.  Suchcredits are estimated and recorded as a reduction of net revenues at the timeof issuance.  We incurred priceprotection charges of approximately $787,000 for the first half of 2002 and$1.8 million for 2001.  In addition, wehave rebate agreements with a number of our Commercial Division customers inwhich we make payments to our customers’ end-users for a portion of theirpurchase price.  Such rebate paymentsare estimated and recorded as a reduction of net revenues at the time ofsale.   We incurred rebate expenses ofapproximately $569,000 for the first half of 2002 and $­­­839,000 for 2001.

** **

**Results of Operations - Comparison of the Second Quarter of2002 to the Second Quarter of 2001**

* *

*Net Revenues.*  Our revenues were $43.3 millionfor the second quarter of 2002, compared to $36.8 million for the same periodin 2001.  Revenues increased 17.7% dueto a unit volume increase of 44% from 622,000 units for the second quarter of2001 to 896,000 for the second quarter of 2002, partially offset by a 19%decline in average sales price from $59 for the second quarter of 2001 to $48for the second quarter of 2002.  Thedecrease in our average sales price resulted from lower DRAM and Flashcomponent prices for the second quarter of 2002 compared to the second quarterof 2001.  Stronger demand for ourproducts by both our Industrial and Commercial Division customers led to theoverall unit volume increase, comprised of unit volume increases of 158% forFlash products, 293% for IC Tower stacking products, and 193% for non-DRAM,non-Flash products such as SRAM, hard drive upgrade kits and connectivityproducts, partially offset by a decrease of 13% for non-stacked DRAM memoryproducts. The mix of products sold varies from quarter to quarter and may varyin the future, affecting our overall average sales prices and gross margins.

 

OurIndustrial Division revenues increased 74.6% from $7.7 million for the secondquarter of 2001 to $13.5 million for the second quarter of 2002.  Industrial Division unit volume increased346% during this

 

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period and Industrial Divisionaverage sales price decreased from $128 for the second quarter of 2001 to $50for the second quarter of 2002.  Thisdecrease in average sales price resulted primarily from lower DRAM and Flashcomponent prices for the second quarter of 2002 compared to the second quarterof 2001.  Our Commercial Divisionrevenues increased 2.6% from $29.0 million for the second quarter of 2001 to$29.8 million for the second quarter of 2002. Commercial Division revenuesincreased due to an increase in unit volume of 12%, partially offset by adecrease in average sales price from $52 for the second quarter of 2001 to $48for the second quarter of 2002.  Theincrease in unit volume for our Commercial Division resulted from an increasein units shipped to the retail channel including shipments to new customerssuch as Sam’s Club.

 

Ourcombined backlog was $4.9 million as of June 30, 2002, consisting of $3.8million for the Industrial Division and $1.1 million for the CommercialDivision.  Our combined backlog was $7.8million as of June 30, 2001, consisting of $6.9 million for the IndustrialDivision and $900,000 for the Commercial Division.  Commercial Division backlog is typically nominal sincesubstantially all Commercial Division customer orders are filled on a same–dayor next–day basis. We include in our backlog only those customer ordersfor which we have accepted purchase orders and to which we have assignedshipment dates within the upcoming six 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 $6.1million for the second quarter of 2002, compared to $5.6 million for the sameperiod in 2001. Gross profit as a percentage of revenues was 14.2% for thesecond quarter of 2002, compared to 15.3% for the same period in 2001. Grossprofit for our Industrial Division as a percentage of revenues was 28.9% forthe second quarter of 2002, compared to 23.3% for the second quarter of2001.  This increase in gross profit asa percentage of revenues for our Industrial Division resulted primarily from apositive product mix shift.  Grossprofit as a percentage of revenues for our Commercial Division was 7.5% for thesecond quarter of 2002, compared to 13.2% for the second quarter of 2001.  This decrease in gross profit as apercentage of revenues for our Commercial Division was due to the impact ofDRAM price declines for the second quarter of 2002 on DRAM inventory held instock.

* *

*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 marketing expenseswere $4.2 million for the second quarter of 2002, compared to $4.6 million forthe same period in 2001. Sales and marketing expenses as a percentage ofrevenues were 9.8% for the second quarter of 2002, compared to 12.6% for thesame period in 2001.   Sales andmarketing expenses as a percentage of revenues decreased due to cost-cuttingprograms that commenced in the 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 $2.7 million for the secondquarter of 2002 and $3.4 million for the second quarter of 2001. General andadministrative expenses as a percentage of revenues were 6.2% for the secondquarter of 2002 and 9.2% for the second quarter 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 $2.0 million for the second quarter of 2002, comparedto $1.2 million for the same period in 2001. Research and development expensesas a percentage of revenues were 4.6% for the second quarter of 2002, comparedto 3.3% 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 $8 to $9 million.

* *

*Interest and Other Income, Net.*  Interestand other income, net was $187,000 for the second quarter of 2002 and $381,000for the second quarter of 2001. Interest expense is comprised of interest related to equipmentfinancing. Interest expense was $24,000 for the second quarter of 2002,compared to $54,000 for the same period in 2001.  Interest income is comprised of interest earned on our cash andcash equivalents.  Interest income was$211,000 for the second quarter of 2002 and $435,000 for the second quarter of2001.

 

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This decrease in interest income resultedprimarily from lower interest rates for the second quarter of 2002 compared tothe second quarter of 2001.

* *

*Benefit for Income Taxes.* Benefit for income taxes was $1.9 million for thesecond quarter of 2002 and $1.3 million for the second quarter of 2001.  As a percentage of income before benefit forincome taxes, benefit for income taxes was 72.3% for the second quarter of 2002and 39.7% for the second quarter of 2001. The increase in the benefit as apercentage of income before benefit for income taxes resulted primarily from anon-recurring research and development income tax benefit in the second quarterof 2002 of approximately $800,000.

* *

*Net Loss. *Net loss was $716,000 for the second quarter of2002 and $1.9 million for the second quarter of 2001.

** **

**Results of Operations - Comparison of the First Half of 2002to the First Half of 2001**

* *

*Net Revenues.*  Our revenues were $94.3 millionfor the first half of 2002, compared to $95.5 million for the same period in2001.  Revenues declined 1.3% due to a28% decline in average sales price from $74 for the first half of 2001 to $53for the first half of 2002, partially offset by a unit volume increase of 38%from 1.3 million units for the first half of 2001 to 1.8 million for the firsthalf of 2002.  The decrease in ouraverage sales price resulted from lower DRAM and Flash component prices for thefirst half of 2002 compared to the first half of 2001.  Stronger demand for our products by both ourIndustrial and Commercial Division customers led to the overall unit volumeincrease, comprising of unit volume increases of 2% for standard memoryproducts, 124% for Flash products, 73% for IC Tower stacking products and 86%for non-DRAM, non-Flash products such as SRAM, hard drive upgrade kits andconnectivity products. The mix of products sold varies from period to periodand may vary in the future, affecting our overall average sales prices andgross margins.

 

OurIndustrial Division revenues declined 36.1% from $32.6 million for the firsthalf of 2001 to $20.8 million for the first half of 2002. Industrial Divisionunit volume increased 131% during this period and Industrial Division averagesales price decreased from $177 for the first half of 2001 to $49 for the firsthalf of 2002.  This decrease in averagesales price resulted primarily from lower DRAM and Flash component prices forthe first half of 2002 compared to the first half of 2001.  Our Commercial Division revenues increased16.8% from $62.9 million for the first half of 2001 to $73.4 million for thefirst half of 2002. Commercial Division revenues increased due to an increasein unit volume of 24%, partially offset by a decrease in average sales pricefrom $57 for the first half of 2001 to $54 for the first half of 2002.  The increase in unit volume for ourCommercial Division resulted from an increase in units shipped to the retailchannel including shipments to new customers such as Sam’s Club.

* *

*Gross Profit.*  Our gross profit was $17.6 millionfor the first half of 2002, compared to $21.1 million for the same period in2001. Gross profit as a percentage of revenues was 18.7% for the first half of2002, compared to 22.1% for the same period in 2001. Gross profit for ourIndustrial Division as a percentage of revenues was 29.5% for the first half of2002, compared to 33.5% for the first half of 2001.  This decrease in gross profit as a percentage of revenues for ourIndustrial Division resulted primarily from a negative product mix shift.  Gross profit as a percentage of revenues forour Commercial Division was 15.6% for the first half of 2002, compared to 16.1%for the first half of 2001.  Grossprofit as a percentage of revenues was relatively flat for our CommercialDivision during the first half of 2002 and the first half of 2001.

* *

*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 $9.1 million for the first half of 2002, compared to $9.9 millionfor the same period in 2001. Sales and marketing expenses as a percentage ofrevenues were 9.6% for the first half of 2002, compared to 10.4% for the sameperiod in 2001. Sales and marketing expenses as a percentage of revenuesdecreased due to cost-cutting programs that commenced in the second half of2001.

* *

*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 $5.7 million for the firsthalf of 2002 and $6.4 million for the first half of 2001. General andadministrative expenses as a percentage of revenues were 6.0% for the firsthalf of

 

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2002 and 6.7% for the first halfof 2001.  General and administrativeexpenses as a percentage of revenues decreased due to cost-cutting programsthat commenced in the 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 $3.9 million for the first half of 2002, compared to$2.3 million for the same period in 2001. Research and development expenses asa percentage of revenues were 4.2% for the first half of 2002, compared to 2.4%for the same period in 2001. The increase in research and development expensesresulted from expenditures related to our Xiran Division, established as aresult of our acquisition of the assets of Irvine Networks in January 2002.

* *

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

* *

*Interest and Other Income, Net.*  Interestand other income, net was $396,000 for the first half of 2002 and $797,000 forthe first half of 2001.  Interestexpense is comprised of interest related to equipment financing. Interestexpense was $53,000 for the first half of 2002, compared to $117,000 for thesame period in 2001.  Interest income iscomprised of interest earned on our cash and cash equivalents.  Interest income was $449,000 for the firsthalf of 2002 and $914,000 for the first half of 2001.  This decrease in interest income resulted from lower interestrates for the first half of 2002 compared to the first half of 2001, partiallyoffset by a higher average cash balance for the first half of 2002 compared tothe first half of 2001.

* *

*(Benefit) Provision for Income Taxes.*(Benefit) provision for income taxes was ($1.7) million for the first half of2002 and $1.3 million for the first half of 2001.  As a percentage of income before (benefit) provision for incometaxes, (benefit) provision for income taxes was 80.5% for the first half of2002 and 39.7% for the first half of 2001. The increase in the percentage of (benefit) provision as a percentage ofincome before (benefit) provision for income taxes resulted primarily from anon-recurring research and development income tax benefit in the second quarterof 2002 of approximately $800,000.

* *

*Net (Loss) Income. *Net (loss) income was ($403,000) for the firsthalf of 2002 and $2.0 million for the first half of 2001.

** **

**Liquidity and Capital Resources**

 

Asof June 30, 2002, we had working capital of $62.1 million including $47.6million of cash and cash equivalents. As of December 31, 2001, we had workingcapital of $64.5 million including $51.8 million of cash and cashequivalents.  We had no outstandingprincipal balance under our $27.5 million line of credit with Comerica Bank atJune 30, 2002 and December 31, 2001.  InAugust 2002, our line of credit with Comerica Bank, which had no balance sinceOctober 2000, expired.  We do not planto pursue a new line of credit agreement. Current assets were 5.1 times current liabilities at June 30, 2002,compared to 5.5 times current liabilities at December 31, 2001.

 

Netcash provided by operating activities was $1.4 million for the first half of2002 and resulted primarily from $1.7 million in non-cash depreciationexpenses, $1.4 million in non-cash in-process research and developmentexpenses, and a decrease in accounts payable and accrued and other liabilitiesof $1.0 million, partially offset by a $3.0 million increase in net accountsreceivable.

 

Netcash used in investing activities was $5.5 million for the first half of 2002,attributable primarily to $3.9 million in purchases of furniture, fixtures andequipment and $2.3 million related to the acquisition of Irvine Networks inJanuary 2002, partially offset by $651,000 in proceeds from the sale offurniture, fixtures and equipment.  Weexpect to spend approximately $6.0 to $8.0 million on capital expendituresduring the next 24 months, primarily for the purchase of manufacturing,testing and engineering equipment.

 

Netcash used in financing activities was $131,000 for the first half of 2002 andresulted from payments of $603,000 related to equipment loans and capital leaseobligations, partially offset by the receipt of $472,000 in proceeds from theissuance of common stock primarily related to the exercise of employee stockoptions.

 

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

 

Although we believe we have sufficient capital to fundour activities for at least the next twelve months, our future capitalrequirements may vary materially from those now planned.  The amount of capital that we will need inthe future will depend on many factors, including:

 

•    the market acceptance of our products;

•             the levels ofpromotion and advertising that will be required to launch our new products andachieve and maintain a competitive position in the marketplace;

•    price discounts on our products to ourcustomers;

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

roadmaps;

•    the levels of inventory and accountsreceivable that we maintain;

•    capital improvements to new and existingfacilities;

•    technological advances;

•    our competitors’ response to our products;

•    our pursuant of strategic transactions; and

•    our relationships with suppliers andcustomers.

 

**Inflation**

 

Inflation was not a material factor in either revenueor operating expenses during the first half of 2002 or the first half of 2001.

** **

**Irvine Networks, LLC**

 

In January 2002, we completed a $2.3 millionacquisition of the assets, including intellectual property, of Irvine Networks,LLC, and hired their engineering staff. The on-going operation has become ourXiran Division. For the past two-and-a-half years, Irvine Networks has beendeveloping innovative content processing technology for Web-based serverplatforms. The effort is in the final stages of developing a working prototype.The completed products, incorporating our patented memory stacking technology,will be inserted into Web-based servers to enable the faster transmission offiles.

** **

**Critical Accounting Policies andEstimates**

 

Our discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamount of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amount ofrevenues and expenses for each period. The following represents a summary ofour critical accounting policies, defined as those policies that we believeare: (a) the most important to the portrayal of our financial condition andresults of operations, and (b) that require management’s most difficult,subjective or complex judgments, often as a result of the need to makeestimates about the effects of matters that are inherently uncertain.

* *

•                       *Reserves for inventory excess, obsolescence and lowerof market values over costs*—We generally purchase raw materials inquantities that we anticipate will be fully used in the near term. Changes inoperating strategy and customer demand, and the somewhat unpredictablefluctuations in market

 

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values for such materials, however, can limit ourability to effectively utilize all of the raw materials purchased and soldthrough resulting finished goods to customers for a profit. We regularlymonitor potential inventory excess, obsolescence and lower market valuescompared to costs and, when necessary, reduce the carrying amount of ourinventory to its market value.

* *

•                       *Allowances for doubtful accounts, price protectionand rebates*—We maintain allowances for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredpayments. Additionally, we maintain allowances for limited price protectionrights for inventories of our products held by our customers as a result ofrecent sales transactions to them. If we reduce the list price of our products,these customers may receive a credit from us. We also maintain allowances forrebates related to payments we make to certain of our customers’ end-users fora portion of their purchase price.  Weestimate the impact of such pricing changes and rebates on a regular basis andadjust our allowances accordingly.

 

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

* *

•                       *Income taxes*—As part of the process ofpreparing our consolidated financial statements, we are required to estimateour income taxes in each of the jurisdictions in which we operate. The processincorporates an assessment of the current tax exposure together with temporarydifferences resulting from different treatment of transactions for tax andfinancial statement purposes. Such differences result in deferred tax assetsand liabilities, which are included within the consolidated balance sheet. Therecovery of deferred tax assets from future taxable income must be assessedand, to the extent that recovery is not likely, we establish a valuationallowance. Increases in valuation allowances result in the recording ofadditional tax expense. Further, if our ultimate tax liability differs from theperiodic tax provision reflected in the consolidated statements of operations,additional tax expense may be recorded.

 

•*                       Litigationand other contingencies*—Management regularly evaluates our exposure tothreatened or pending litigation and other business contingencies. Because of theuncertainties related to the amount of loss from litigation and other businesscontingencies, the recording of losses relating to such exposures requiressignificant judgment about the potential range of outcomes. As additionalinformation about current or future litigation or other contingencies becomesavailable, our management will assess whether such information warrants therecording of additional expense relating to our contingencies. We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable. The results of these estimates form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

* *

•*                       Valuationof long-lived assets*—We assess the potential impairment of long-livedtangible and intangible assets whenever events or changes in circumstancesindicate that the carrying value may not be recoverable. Changes in ouroperating strategy can significantly reduce the estimated useful life of suchassets.

 

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**Risk Factors**

* *

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

** **

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

 

During the fourth quarter of 2000, fiscal year 2001and the second quarter of 2002, overcapacity in the memory product marketresulted in significant declines in component prices, which negatively impactedour average selling prices, gross margins and earnings.  Declines in semiconductor prices could alsoaffect the valuation of our inventory, which could harm our business. Duringperiods of overcapacity, our ability to maintain or increase revenues willdepend upon our ability to increase unit sales volumes of existing products andto introduce and sell new products in quantities sufficient to offset declinesin sales prices. Our efforts to reduce costs and develop new products to offsetthe impact of further declines in average sales prices may not be successful.Declines in average sales prices also would result in more memory being builtinto products by original equipment manufacturers, which would favor ourlargest competitors and reduce the demand for our commercial memory products.

** **

**Because we depend on a small numberof suppliers for IC devices, any disruption in our supply relationships couldharm our ability to fulfill orders.**

 

We have no long-term IC device supply contracts andare dependent on a small number of suppliers to supply IC devices, whichrepresent approximately 95% of our component costs. Our dependence on a smallnumber of suppliers and our limited number of long-term supply contracts exposeus to several risks, including the inability to obtain an adequate supply ofcomponents, price increases, late deliveries and poor component quality.Hitachi Semiconductor and Samsung Semiconductor supply substantially all of theIC devices used in our Flash memory products. In addition, Elpida Memory,Micron Semiconductor Electronics and Samsung Semiconductor currently supply amajority of the DRAM IC devices used in our DRAM memory products. A disruptionin or termination of our supply relationship with any of these significantsuppliers by natural disaster or otherwise, or our inability to developrelationships with new suppliers, if required, would cause delays, disruptionsor reductions in product shipments or require product redesigns which coulddamage relationships with our customers, and would increase our costs and/orprices. In particular, if our flash supply relationship with HitachiSemiconductor or Samsung Semiconductor is disrupted or terminated, our abilityto manufacture and sell our Flash products would be limited and our Flashbusiness would be adversely affected.

** **

**We are subject to the cyclical natureof the semiconductor industry and changes from the current point in the cyclecould adversely affect our business.**

 

The semiconductor industry, including the memorymarkets in which we compete, is highly cyclical and is characterized byconstant and rapid technological change, rapid product obsolescence and priceerosion, evolving standards, short product life cycles and wide fluctuations inproduct supply and demand. The industry has experienced significant downturns,often connected with, or in anticipation of, maturing product cycles of bothsemiconductor companies’ and their customers’ products and declines in generaleconomic conditions. These downturns have been characterized by diminishedproduct demand, production overcapacity, high inventory levels and acceleratederosion of average selling prices. Any future downturns could have a materialadverse effect on our business and operating results. During the fourth quarterof 2000, fiscal year 2001 and the second quarter of 2002, a semiconductor downturnnegatively

 

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impacted our average selling prices, gross margins and earnings.  Furthermore, any upturn in the semiconductorindustry could result in increased demand for, and possible shortages of,components we use to manufacture and assemble our ICs.  Such shortages could have a material adverseeffect on our business and operating results.

** **

**We may be unable to maintain a steadysupply of components.**

 

The electronics industry has experienced in the past,and may experience in the future, shortages in IC devices, including DRAM, SRAMand Flash memory. We have experienced and may continue to experience delays incomponent deliveries and quality problems, which have caused and could in thefuture cause delays in product shipments. In addition, we have required andcould in the future require the redesign of some of our products. In addition,industry capacity has, from time to time, become constrained such that somevendors, which supply components for our products have placed their customers,ourselves included, on allocation. This means that while we may have customerorders, we may not be able to obtain the materials that we need to fill thoseorders in a timely manner.

** **

**Sales to a small number of customersrepresent a significant portion of our revenues and the loss of any keycustomer would materially reduce our sales.**

 

Our dependence on a small number of customers meansthat the loss of a major customer or any reduction in orders by a major customerwould materially reduce our revenues. Historically, a relatively small number of customers have accounted fora significant percentage of our revenues. Our ten largest Industrial Division customers accounted for an aggregateof 81.6% of our Industrial Division revenues or 23.9% of our total revenues forthe second quarter of 2002 and an aggregate of 80.4% of our Industrial Divisionrevenues or 18.0% of our total revenues for the first half of 2002. For thesecond quarter of 2002,Unisys accounted for 47.0% of our Industrial Divisionrevenues or 13.8% of our total revenues. No other Industrial Division customer accounted for more than 10.0% ofour total revenues for the second quarter of 2002 or the first half of 2002.

 

Our ten largest Commercial Division customersaccounted for an aggregate of 60.7% of our Commercial Division revenues or42.9% of our total revenues for the second quarter of 2002 and an aggregate of60.1% of our Commercial Division revenuesor 46.6% of our total revenues for the first half of 2002.  CDW Computer Centers was our largestCommercial Division customer for the second quarter of 2002 and the first halfof 2002.  CDW Computer Centers accounted for 30.0% of our Commercial Division revenues or21.2% of our total revenues for the second quarter of 2002 and 27.3% of ourCommercial Division revenues or 21.2%of our total revenues for the first half of 2002.  No otherCommercial Division customer accounted for more than 10.0% of our totalrevenues for the second quarter of 2002 or the first half of 2002.

 

Consolidation in some of our customers’ industries mayresult in increased customer concentration and the potential loss of customersas a result of acquisitions. In addition, the composition of our major customerbase changes from quarter to quarter as the market demand for our customers’products changes and we expect this variability will continue in the future. Weexpect that sales of our products to a small number of customers will continueto contribute materially to our revenues in the foreseeable future and believethat our financial results will depend in significant part upon the success ofour customers’ business.

** **

**Three of our beneficial shareholdershave substantial influence over our operations and can significantly influencematters requiring shareholder approval.**

 

Manouch Moshayedi, Mike Moshayedi and Mark Moshayedi,each of whom is an executive officer and director of SimpleTech, are brothersand beneficially own approximately 79.6% of our common stock. As a result, theyhave the ability to control all matters requiring approval by our shareholders,including the election and removal of directors, approval of significantcorporate transactions and the ability to control the decision of whether achange in control will occur.

** **

**We are involved from time to time inclaims and litigation over intellectual property rights, which may adverselyaffect our ability to manufacture and sell our products.**

** **

17

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The semiconductor industry is characterized byvigorous protection and pursuit of intellectual property rights. We believethat it may be necessary, from time to time, to initiate litigation against oneor more third parties to preserve our intellectual property rights. Inaddition, from time to time, we have received, and may continue to receive inthe future, notices that claim we have infringed upon, misappropriated ormisused other parties’ proprietary rights, which claims could result inlitigation. Such litigation would likely result in significant expense to usand divert the efforts of our technical and management personnel. In the eventof an adverse result in such litigation, we could be required to paysubstantial damages, cease the manufacture, use and sale of certain products,expend significant resources to develop non-infringing technology, discontinuethe use of certain processes or obtain licenses to use the infringedtechnology. Such a license may not be available on commercially reasonableterms, if at all. Our failure to obtain a license or our failure to obtain alicense on commercially reasonable terms could cause us to incur substantialcosts and suspend manufacturing products using the infringed technology. If weobtain a license, we would likely be required to make royalty payments forsales under the license. Such payments would increase our costs of revenues andreduce our gross profit.

 

We are currently a party to two lawsuits regardingintellectual property as further described under “Legal Proceedings.” The outcomeof litigation is inherently uncertain and we cannot predict the outcome ofthese lawsuits with certainty. These lawsuits have diverted, and are expectedto continue to divert, the efforts and attention of our key management andtechnical personnel. In addition, we have incurred, and expect to continue toincur, substantial legal fees and expenses in connection with these lawsuits.As a result, our defense of these lawsuits, regardless of their eventualoutcomes, has been, and will continue to be, costly and time consuming. Inaddition, if our IC Tower stacking patent is found to be invalid, our abilityto exclude competitors from making, using or selling the same or similarproducts to our IC Tower stacking products would cease. In addition, if we are foundto infringe valid patents of others, we may be excluded from using theinfringed technology without a license, which may not be available oncommercially reasonable terms, if at all.

** **

**If industry sales of products usingFlash memory do not grow, our revenues, gross margins and profitability wouldbe harmed.**

 

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

** **

**Demand for our products would declineif the market for Flash memory does not develop, or if a competing technologydisplaces Flash memory.**

 

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

** **

**The execution of our growth strategydepends on our ability to retain key personnel, including our executiveofficers, and to attract qualified personnel.**

 

Competition for employees in our industry is intense.We have had and may continue to have difficulty hiring the necessaryengineering, sales and marketing and management personnel to support ourgrowth. The successful implementation of our business model and growth strategydepends on the continued contributions of our senior management and other keyresearch and development, sales and marketing and operations personnel,including Manouch Moshayedi, our Chief Executive Officer, Mike 

 

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Moshayedi, our President, and Mark Moshayedi, our Chief OperatingOfficer, Chief Technical Officer and Secretary. The loss of any key employee,the failure of any key employee to perform in his or her current position, orthe inability of our officers and key employees to expand, train and manage ouremployee base would prevent us from executing our growth strategy.

** **

**Our proprietary technology andintellectual property may not be adequately protected, which could harm ourcompetitive position.**

 

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

 

•  prevent the challenge, invalidation orcircumvention of our existing patents;

 

•  result in patents that lead to commerciallyviable products or provide competitive advantages for our products;

 

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

 

•  prevent third-party patents from having anadverse effect on our ability to do business;

 

•  provide adequate protection for ourintellectual property rights;

 

•  prevent disputes with third parties regardingownership of our intellectual property rights;

 

•  prevent disclosure of our trade secrets andknow-how to third parties or into the public domain; and

 

•  result in patents from any of our pendingapplications.

 

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

 

We have not applied and do not expect to apply forpatent protection in foreign countries. In addition, the laws of foreigncountries may not adequately protect our intellectual property rights. ManyU.S. companies have encountered substantial infringement problems in someforeign countries. Because we sell some of our products overseas, we haveexposure to foreign intellectual property risks.

** **

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

 

We currently have in effect a number of agreements inwhich we have agreed to defend, indemnify and hold harmless certain of ourcustomers and suppliers from damages and costs which may arise from theinfringement by our products of third-party patents, trademarks or other proprietaryrights. We may periodically have to respond to claims and litigate these typesof indemnification obligations. Any such indemnification claims could requireus to pay substantial damages. Our insurance does not cover intellectualproperty infringement.

** **

**Our indemnification obligations toour customers and suppliers for product defects could require us to paysubstantial damages.**

 

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

 

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brought against us that is in excess of, or excluded from, our insurancecoverage could substantially harm our business, financial condition and resultsof operations.

** **

**Our limited experience in acquiringother businesses, product lines and technologies may make it difficult for usto overcome problems encountered in connection with any acquisitions we mayundertake.**

 

We intend to pursue selective acquisitions tocomplement our internal growth. If we make any future acquisitions, we couldissue stock that would dilute our shareholders’ percentage ownership, incursubstantial debt, reduce our cash reserves or assume contingent liabilities. Although we completed the acquisition of assets of IrvineNetworks, LLC, a leading-edge engineering company, in January 2002, our experience in acquiring other businesses, product linesand technologies is limited. In addition, the attention of our small managementteam may be diverted from our core business if we undertake an acquisition.Potential acquisitions also involve numerous risks, including, among others:

 

•  Problems assimilating the purchasedoperations, technologies or products;

 

•  Costs associated with the acquisition;

 

•  Adverse effects on existing businessrelationships with suppliers and customers;

 

•  Risks associated with entering markets inwhich we have no or limited prior experience;

 

•  Potential loss of key employees of purchasedorganizations; and

 

•  Potential litigation arising from the acquiredcompany’s operations before the acquisition.

 

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

** **

**Product returns, price protection andorder cancellations could reduce our revenues.**

 

To the extent we manufacture products in anticipationof future demand that does not materialize, or in the event a customer cancelsoutstanding orders, we could experience an unanticipated increase in ourinventory. A lack of consumer demand for our products may also cause increasedproduct returns. A majority of our sales through commercial channels includelimited rights to return unsold inventory. In addition, while we may not becontractually obligated to accept returned products, we may determine that itis in our best interest to accept returns in order to maintain good relationswith our customers. Product returns would increase our inventory and reduce ourrevenues.  We have had to write-downinventory in the past for reasons such as obsolescence, excess quantities anddeclines in market value below our costs. These inventory write-downs wereapproximately $612,000 for the first half of 2002. In addition, we offer someof our Commercial Division customers limited price protection rights forinventories of our products held by them. If we reduce the list price of ourproducts, these customers may receive credits from us. We incurred priceprotection charges of approximately $787,000 for the first half of 2002.  In addition, we have rebate agreements witha number of our Commercial Division customers in which we make payments to ourcustomers’ end-users for a portion of their purchase price.  We incurred rebate expenses of approximately$569,000 for the first half of 2002.

 

We are also subject to repurchase agreements withvarious financial institutions in connection with wholesale inventoryfinancing. Under these agreements, we may be required to repurchase inventoryupon customer default with a financing institution and then resell theinventory through normal distribution channels. As of June 30, 2002, we havenot been required to repurchase inventory in connection with the customerdefault agreements noted above. However, it may be possible that we will berequired to repurchase inventory, upon customer default, in the future. Salesunder such agreements were approximately $366,000 for the first half of 2002.

 

We have no long-term volume commitments from ourcustomers. Sales of our products are made through individual purchase ordersand, in certain cases, are made under master agreements governing the terms andconditions of the relationships. Customers may change, cancel or delay orderswith limited or no

 

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penalties. We have experienced cancellations of orders and fluctuationsin order levels from period-to-period and we expect to continue to experiencesimilar cancellations and fluctuations in the future, which could result influctuations in our revenues.

** **

**We may not be able to maintain orimprove our competitive position because of the intense competition in thememory industry.**

 

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

 

We expect to face competition from existingcompetitors and new and emerging companies that may enter our existing orfuture markets with similar or alternative products, which may be less costlyor provide additional features. In addition, some of our significant suppliersare also our competitors, many of whom have the ability to manufacturecompetitive products at lower costs as a result of their higher levels ofintegration. We also face competition from current and prospective customersthat evaluate our capabilities against the merits of manufacturing productsinternally. Competition may arise due to the development of cooperativerelationships among our current and potential competitors or third parties toincrease the ability of their products to address the needs of our prospectivecustomers. Accordingly, it is possible that new competitors or alliances amongcompetitors may emerge and rapidly acquire significant market share.

 

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

** **

**Recent terrorist activities and thecontinued threat of terrorism could adversely affect our business.**

 

Recent terrorist attacks in the United States, as wellas continued threats of terrorism within the United States and abroad andcurrent and future military responses to them, have resulted in delayed andcanceled orders and created many economic and political uncertainties that makeit extremely difficult for us, our customers and our suppliers to accuratelyforecast and plan future business activities.  This reduced predictabilitychallenges our ability to grow our business.  In particular, it isdifficult to develop and implement strategies, efficient operations, andeffectively manage capacity and supply-chain relationships.  In addition,the continued threats of terrorism and the heightened security measures inresponse to such threats have and may continue to cause significant disruptionto commerce throughout the world.  Disruption in air transportation inresponse to these threats or future attacks may result in transportation andsupply-chain disruptions, increase our costs for both receipt of inventory andshipment of products to our customers, and cause customers to defer theirpurchasing decisions.  Disruptions in commerce could also cause consumerconfidence and spending to decrease or result in increased volatility in theUnited States and worldwide financial markets and economy.  They couldalso result in economic recession in the United States or abroad.  Any ofthese occurrences could have a significant impact on our operating results,revenues and costs and may result in the volatility of the market price of ourcommon stock and on the future price of our common stock.

** **

**We may lose our competitive positionif we fail to develop new and enhanced products and introduce them in a timelymanner.**

 

The high-performance computing, networking andcommunications, consumer electronics and industrial markets are subject torapid technological change, product obsolescence, frequent new productintroductions and enhancements, changes in end-user requirements and evolvingindustry standards. Our ability to compete in these markets will depend insignificant part upon our ability to successfully develop,

 

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introduce and sell new and enhanced products on a timely andcost-effective basis, and to respond to changing customer requirements.

 

We have experienced, and may in the future experience,delays in the development and introduction of new products. Our productdevelopment is inherently risky because it is difficult to foresee developmentsin technology, coordinate our technical personnel, and identify and eliminatedesign flaws. Defects or errors found in our products after commencement ofcommercial shipments could result in delays in market acceptance of theseproducts. Delays in developing, manufacturing or marketing new or enhanced productscould give our competitors an advantage, hurt our reputation and harm ourbusiness, financial condition and results of operations. Such products, even ifintroduced, may not gain market acceptance. In addition, we may not be able torespond effectively to new technological changes or new product announcementsby others.

** **

**Obtaining additional capital to fundour operations and finance our growth could impair the value of yourinvestment.**

 

If we expand more rapidly than currently anticipatedor if our working capital needs exceed our current expectations, we may need toraise additional capital through public or private equity offerings or debtfinancings. Our future capital requirements depend on many factors includingour research, development, sales and marketing activities. We do not knowwhether additional financing will be available if needed, or will be availableon terms favorable to us. If we cannot raise needed funds on acceptable terms,we may not be able to develop or enhance our products, take advantage of futureopportunities or respond to competitive pressures or unanticipatedrequirements. To the extent we raise additional capital by issuing equitysecurities, our shareholders may experience substantial dilution and the newequity securities may have greater rights, preferences or privileges than ourexisting common stock.

** **

**We face risks associated with doingbusiness in foreign countries, including foreign currency fluctuations andtrade barriers, that could lead to a decrease in demand for our products or anincrease in the cost of the components used in our products.**

 

The volatility of general economic conditions andfluctuations in currency exchange rates affect the prices of our products andthe prices of the components used in our products. International sales of ourproducts accounted for 13.3% of our revenues for the second quarter of 2002 and12.7% of our revenues for the first half of 2002.  No single foreign country accounted for more than 10.0% of ourrevenues for the second quarter of 2002 or the first half of 2002.  For the second quarter of 2002 and the firsthalf of 2002, more than 95.0% of our international sales were denominated inU.S. dollars. However, if there is a significant devaluation of the currency ina specific country, the prices of our products will increase relative to thatcountry’s currency and our products maybe less competitive in that country. Inaddition, we cannot be sure that our international customers will continue tobe willing to place orders denominated in U.S. dollars. If they do not, ourrevenues and results of operations will be subject to foreign exchangefluctuations, which could harm our business. We do not hedge against foreigncurrency exchange rate risks.

 

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

 

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

** **

**Disruption of our operations in ourSanta Ana, California, manufacturing facility would substantially harm ourbusiness.**

 

All of our manufacturing operations are located in ourfacility in Santa Ana, California. Due to this geographic concentration, adisruption of our manufacturing operations, resulting from sustained process

 

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abnormalities, human error, government intervention or naturaldisasters such as earthquakes, fires or floods could cause us to cease or limitour manufacturing operations and consequently harm our business, financialcondition and results of operations.

** **

**Compliance with environmental lawsand regulations could harm operating results.**

 

We are subject to a variety of environmental laws andregulations governing, among other things, air emissions, waste waterdischarge, waste storage, treatment and disposal, and remediation of releasesof hazardous materials. Our failure to comply with present and futurerequirements could harm our ability to continue manufacturing our products.Such requirements could require us to acquire costly equipment or to incurother significant expenses to comply with environmental regulations. Theimposition of additional or more stringent environmental requirements, theresults of future testing at our facilities, or a determination that we arepotentially responsible for remediation at other sites where problems are notpresently known to us, could result in expenses in excess of amounts currentlyestimated to be required for such matters.

** **

**Our stock price is likely to bevolatile and could drop unexpectedly.**

 

Our common stock has been publicly traded only sinceSeptember 29, 2000. The market price of our common stock has been subject tosignificant fluctuations since the date of our initial public offering.  The stock market has from time to timeexperienced significant price and volume fluctuations that have affected themarket prices of securities, particularly securities of technology companies.As a result, the market price of our common stock may materially decline,regardless of our operating performance. In the past, following periods ofvolatility in the market price of a particular company’s securities, securitiesclass action litigation has often been brought against that company. We maybecome involved in this type of litigation in the future. Litigation of thistype is often expensive and diverts management’s attention and resources.

** **

**Our revenues may fluctuate and our results of operationscould be harmed due to the seasonality of our business**

 

Sales of our products in the consumer electronicsmarket are subject to seasonality. As a result, sales of these products areimpacted by seasonal purchasing patterns with higher sales generally occurringin the first, third and fourth quarters of each year and lower sales occurringin the second quarter of each year.  Sales of our products are typically positively impacted by increasedpurchasing of memory upgrades related to computing and consumer electronicproducts purchased during the Christmas season in the first quarter,back-to-school season computing and consumer electronics purchases during thethird quarter and Christmas season computing and consumer electronics purchasesduring the fourth quarter.  Our abilityto adjust our short-term operating expenses in response to fluctuations inseasonal revenues is limited. As a result, if seasonal revenues are lower thanexpected in any given period, our results of operations could be harmed.

 

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**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

At any time, fluctuations in interest rates couldaffect interest earnings on our cash and cash equivalents and interest expenseon our existing variable rate debt.  We believe that the effect, if any,of reasonably possible near term changes in interest rates on our financialposition, results of operations, and cash flows would not be material.  Currently, we do not hedge these interestrate exposures.  The primary objective of our investment activities is topreserve capital. We have not used derivative financial instruments in ourinvestment portfolio.

 

At June 30, 2002, our cash and cash equivalents were$47.6 million and our variable rate debt, consisting of term loan borrowing,was $625,000.  At June 30, 2002, our cash and cash equivalents included$39.0 million invested in money market and other interest bearing accounts and$8.6 million invested in marketable securities, which represents investments inUnited States treasury notes and treasury bonds.

 

At June 30, 2002, our investment in marketablesecurities had a weighted-average time to maturity of approximately 17.7 days.Marketable securities represent United States treasury notes and treasury bondswith a maturity of greater than three months. These securities are classifiedas held to maturity because we have the intention and ability to hold thesecurities to maturity. Gross unrealized gains and losses on held-to-maturitymarketable securities have historically not been material. Maturities onheld-to-maturity marketable debt securities range from three months to twoyears.

 

If interest rates were to decrease 1%, the resultwould be an annual decrease in our interest income related to our cash and cashequivalents of approximately $476,000.  Conversely, if interest rates wereto increase 1%, the result would be an annual increase in our interest expenserelated to our variable rate debt of approximately $6,250.  However, dueto the uncertainty of the actions that would be taken and their possibleeffects, this analysis assumes no such action.  Further, this analysisdoes not consider the effect of the change in the level of overall economicactivity that could exist in such an environment.

 

More than 95.0% of our international sales aredenominated in U.S. dollars. Consequently, if the value of the U.S. dollar increases relative to aparticular 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.  To date, wehave not entered any derivative instruments to manage risks related to interestrate or foreign currency exchange rates.

 

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**PART II**

**OTHERINFORMATION**

 

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

 

Reference is made to our Annual Report on Form 10-Kfiled with the SEC on March 20, 2002  underthe heading “Legal Proceedings” for a discussion of litigation involving usrelating to (i) patent litigation with DPAC Technologies, Inc. and (ii) patentlitigation with Lemelson Medical, Education & Research Foundation, LLP.

 

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

 

On September 23, 1998, we filed a lawsuit against DPACTechnologies, Inc., formerly Dense-Pac Microsystems, Inc. (“DPAC”), in theUnited States District Court for the Central District of California forinfringement of our IC Tower stacking patent, U.S. Patent No. 5,514,907. OnMarch 29, 2001, the court entered final judgement finding DPAC did not infringeour patent and that we did not infringe DPAC’s patent. The appeals court affirmedthe final judgement on March 7, 2002. On June 3, 2002, we filed a petition forcertiori with the U.S. Supreme Court. The petition is now pending before the Supreme Court.

 

On October 17, 2000, the U.S. Patent and TrademarkOffice granted us a reissue patent on our IC Tower stacking patent. The reissuepatent is U.S. Patent No. Re. 36,916.

 

On February 21, 2001, we filed a new lawsuit againstDPAC in the United States District Court for the Central District of Californiafor infringement of the reissue patent. We are seeking damages and aninjunction against further infringement. On March 13, 2001, DPAC filed ananswer to our complaint denying infringement, and asserted a defense of patentinvalidity. In addition, DPAC counterclaimed alleging we misappropriatedunspecified DPAC technology and allegedly used that unspecified technology inour IC Tower products.  Trial isscheduled for June 2003.

** **

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

 

We received notice on November 26, 2001, that theLemelson Medical, Education & Research Foundation, LLP (“LemelsonFoundation”) filed a complaint on November 13, 2001, against us and otherdefendants. The complaint was filed in the District Court of Arizona andalleges that our manufacturing processes infringe several patents that theLemelson Foundation allegedly owns. The complaint also states that theseallegedly infringed patents relate to machine vision technology and bar codingtechnology. On March 7, 2002, we were served with the Lemelson Foundationcomplaint. Thereafter, the case was stayed pending the outcome of related casesagainst other parties involving the same patents. Because of the preliminarystage of this case, an estimate of potential damages, if any, would be prematureand speculative, and we have not made any such estimate at this time.

 

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

 

None.

 

**Item3.  Defaults Upon Senior Securities**

 

None.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

We held our 2002 AnnualMeeting of Shareholders as further discussed below:

 

(a)           Our2002 Annual Meeting of Shareholders was held on May 15, 2002 in Irvine,California.

 

(b)           Proxiesfor the Annual Meeting were solicited pursuant to Regulation 14 under theSecurities Exchange Act of 1934, as amended, there was no solicitation inopposition to the management’s nominees as listed in the proxy statement, andall of such nominees were elected.

 

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(c)           Atthe Annual Meeting, the following matters were considered and voted upon:

 

(i)  The election of seven directorsto our board of directors.  Our board ofdirectors currently consists of seven persons. All seven positions on our board of directors were to be elected at ourAnnual Meeting.  At the Annual Meeting,our shareholders elected each of the following director nominees as directors,to serve on our board of directors until the next Annual Meeting ofShareholders or until their successors are duly elected and qualified. The votefor each director was as follows: 

 
| **Name**           |   | **For**    |   | **Withheld** |   |
|--------------------|--------|------------|--------|--------------|--------|
| Manouch  Moshayedi |   | 37,218,449 |   | 510,705      |   |
| Mike Moshayedi     |   | 37,218,449 |   | 510,705      |   |
| Mark Moshayedi     |   | 37,218,449 |   | 510,705      |   |
| Dan Moses          |   | 37,593,849 |   | 135,305      |   |
| F. Michael Ball    |   | 37,719,858 |   | 9,296        |   |
| Thomas A. Beaver   |   | 37,719,858 |   | 9,296        |   |
| Mark R.  Hollinger |   | 37,719,858 |   | 9,296        |   |

 

(ii) To ratify theappointment of PricewaterhouseCoopers LLP as our independent auditors for thefiscal year ending December 31, 2002. At the Annual Meeting, our shareholders approved this proposal by thevotes indicated below:

 

|        |   | **Shares** |   |
|-------------|--------|------------|--------|
| **For**     |   | 37,638,042 |   |
| **Against** |   | 80,928     |   |
| **Abstain** |   | 10,184     |   |

 

(d)           Not applicable.

 

**Item 5.  Other Information**

 

None.

 

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

 

(a)  Exhibits.

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

 

(b)  Reports on Form 8-K.

 

None.

 

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**SIGNATURES**

 

Pursuant to 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:   August 13, 2002  | /s/ MANOUCH MOSHAYEDI                                                               |   |
|                                    | Manouch Moshayedi                                                                   |
|                                    | Chief Executive Officer and Chairman of  the Board of Directors                     |
|                                    |                                                                                |
|                                    |                                                                                |
| Date:   August  13, 2002 | /s/ DAN MOSES                                                                       |   |
|                                    | Dan Moses                                                                           |
|                                    | Chief Financial Officer (Principal  Financial and Accounting Officer) and  Director |
|                                         |                                                                                     |  |  |

 

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**Exhibit 99.1**

 

**PERIODIC REPORT CERTIFICATION**

**of the Chief Executive Officer and Chief Financial Officer**

I, Manouch Moshayedi, Chief Executive Officer ofSimpleTech, Inc. (the “Company”), certify, pursuant to 18 U.S.C. § 1350, asadopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to myknowledge:

(1) the Report of the Company on Form 10-Q for thequarterly period ending  June 30, 2002,as filed with the Securities and Exchange Commission (the “Report”) fullycomplies with the requirements of Section 13(a) or 15(d) of the SecuritiesExchange Act of 1934; and

(2) the information contained in the Report fairlypresents, in all material respects, the financial condition and result ofoperations of the Company.

 
| /s/ MANOUCH MOSHAYEDI   |
|-------------------------|
|                    |
| Manouch Moshayedi       |
| Chief Executive Officer |
| August 13, 2002         |

 

I, Dan Moses, Chief Financial Officer of SimpleTech,Inc. (the “Company”), certify, pursuant to 18 U.S.C. § 1350, as adoptedpursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

(1) the Report of the Company on Form 10-Q for thequarterly period ending June 30, 2002, as filed with the Securities andExchange Commission (the “Report”) fully complies with the requirements ofSection 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairlypresents, in all material respects, the financial condition and result ofoperations of the Company.

 
| /s/ DAN MOSES           |
|-------------------------|
|                    |
| Dan Moses               |
| Chief Financial Officer |
| August 13, 2002         |

 

 

 

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