**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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

 

**For the quarterly period ended June 30,2003**

 

**or**

 

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

 

**For the transition period from                to                **

 

**Commission File Number 000-31623**

 

**SIMPLETECH, INC.**

(Exact name of Registrant as specified in itscharter)

 

| **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 check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.  Yes     ý     No     o

 

Indicate by check mark whether the registrant is an accelerated filer(as described in Exchange Act Rule 12b-2).  Yes     o     No     ý

 

The number of shares outstanding of the Registrant’s common stock, parvalue $0.001, as of June 30, 2003 was 38,914,423.

 

 

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# **SIMPLETECH,INC.**

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

**QUARTERLY PERIOD ENDED JUNE 30, 2003**

 
| PART I.    | FINANCIAL  INFORMATION                                                                                                           |
|------------|----------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                             |
| Item 1.    | Financial Statements                                                                                                             |
|       |                                                                                                                             |
|       | Consolidated Balance Sheets as of December 31, 2002 and  June 30, 2003 (unaudited)                                     |
|       |                                                                                                                             |
|       | Consolidated Statements of Operations for  the Three and Six Months Ended June 30, 2003 and June 30, 2002  (unaudited) |
|       |                                                                                                                             |
|       | Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2003 and June 30, 2002 (unaudited)            |
|       |                                                                                                                             |
|       | Notes to Consolidated Financial Statements  (unaudited)                                                                          |
|       |                                                                                                                             |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                      |
|       |                                                                                                                             |
| Item 3.    | Quantitative  and Qualitative Disclosures about Market Risk                                                                      |
|       |                                                                                                                             |
| Item 4.    | Controls  and Procedures                                                                                                         |
|       |                                                                                                                             |
| PART  II.  | OTHER  INFORMATION                                                                                                               |
|       |                                                                                                                             |
| Item 1.    | Legal Proceedings                                                                                                                |
|       |                                                                                                                             |
| Item 2.    | Changes in Securities and Use of Proceeds                                                                                        |
|       |                                                                                                                             |
| Item 3.    | Defaults Upon Senior Securities                                                                                                  |
|       |                                                                                                                             |
| Item 4.    | Submission of Matters to a Vote of Security  Holders                                                                             |
|       |                                                                                                                             |
| Item 5.    | Other Information                                                                                                                |
|       |                                                                                                                             |
| Item 6.    | Exhibits and Reports on Form 8-K                                                                                                 |
|       |                                                                                                                             |
| Signatures |
|            |                                                                                                                                  |  |

 

Except asotherwise noted in this report, “SimpleTech,” the “Company,” “we,” “us” and “our”collectively refer to SimpleTech, Inc.

 

2

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**PART I****.  FINANCIALINFORMATION**

 

## **ITEM1.  FINANCIAL STATEMENTS**

 

**SimpleTech,Inc.**

**ConsolidatedBalance Sheets**

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

**(unaudited)**

 
|                                                                                                                                                                                                         |   | **June 30,  2003** |   | **December 31,  2002** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|------------|
| ASSETS:                                                                                                                                                                                                      |   |                    |   |                        |       |
| Current Assets:                                                                                                                                                                                              |   |                    |   |                        |       |
| Cash and cash equivalents                                                                                                                                                                                    |   | $                       | 34,036 |                        | $          | 33,992 |   |
| Marketable securities                                                                                                                                                                                        |   | 9,980                   |   | 9,980                       |       |
| Accounts receivable, net of allowances of $763 at  June 30, 2003 and $782 at December 31, 2002                                                                                                     |   | 16,572                  |   | 19,019                      |       |
| Inventory, net                                                                                                                                                                                               |   | 15,462                  |   | 14,141                      |       |
| Income taxes receivable                                                                                                                                                                                      |   | 2,799                   |   | 3,860                       |       |
| Deferred income taxes                                                                                                                                                                                        |   | —                  |   | 28                          |       |
| Other current assets                                                                                                                                                                                         |   | 804                     |   | 59                          |       |
| Total current assets                                                                                                                                                                                         |   | 79,653                  |   | 81,079                      |       |
| Furniture, fixtures and equipment, net                                                                                                                                                                       |   | 9,003                   |   | 10,169                      |       |
| Intangible assets                                                                                                                                                                                            |   | 378                     |   | 835                         |       |
| Deferred income taxes                                                                                                                                                                                        |   | 4,327                   |   | 2,378                       |       |
| Total assets                                                                                                                                                                                                 |   | $                       | 93,361 |                        | $          | 94,461 |   |
|                                                                                                                                                                                                         |   |                    |   |                        |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY:                                                                                                                                                                   |   |                    |   |                        |       |
| Current Liabilities:                                                                                                                                                                                         |   |                    |   |                        |       |
| Accounts payable                                                                                                                                                                                             |   | $                       | 18,414 |                        | $          | 16,381 |   |
| Current maturities of capital lease obligations                                                                                                                                                              |   | —                  |   | 113                         |       |
| Accrued and other liabilities                                                                                                                                                                                |   | 3,091                   |   | 4,152                       |       |
| Deferred income taxes                                                                                                                                                                                        |   | 231                     |   | —                      |       |
| Total current liabilities                                                                                                                                                                                    |   | 21,736                  |   | 20,646                      |       |
|                                                                                                                                                                                                         |   |                    |   |                        |       |
| Total liabilities                                                                                                                                                                                            |   | 21,736                  |   | 20,646                      |       |
|                                                                                                                                                                                                         |   |                    |   |                        |       |
| Commitments and contingencies (Note 5)                                                                                                                                                                       |   |                    |   |                        |       |
|                                                                                                                                                                                                         |   |                    |   |                        |       |
| Shareholders’ Equity:                                                                                                                                                                                   |   |                    |   |                        |       |
| Preferred stock, $0.001 par value, 20,000,000  shares authorized, no shares outstanding                                                                                                                      |   | —                  |   | —                      |       |
| Common stock, $0.001 par value, 100,000,000 shares  authorized, 38,914,423 shares issued and outstanding as of June 30, 2003  and 38,725,800 shares issued and outstanding as of December 31, 2002 |   | 39                      |   | 39                          |       |
| Additional paid-in capital                                                                                                                                                                                   |   | 67,051                  |   | 66,716                      |       |
| Retained earnings                                                                                                                                                                                            |   | 4,535                   |   | 7,060                       |       |
| Total shareholders’ equity                                                                                                                                                                              |   | 71,625                  |   | 73,815                      |       |
| Total liabilities and shareholders’ equity                                                                                                                                                              |   | $                       | 93,361 |                        | $          | 94,461 |   |

 

See accompanying notes to unaudited consolidated financial statements.

 

3

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**SimpleTech, Inc.**

**ConsolidatedStatements of Operations**

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

**(unaudited)**

 
|                                               |   | **Three  Months  Ended June 30,** |       | **Six Months  Ended June 30,** | ** ** |
|----------------------------------------------------|--------|----------------------------------------|------------|-------------------------------------|------------|
|                                               |   | **2003**                               |       | **2002**                            | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                               |   |                                   | ** ** |                                | ** ** |   | ** ** |   | ** ** |
| Net  revenues                                      |   | $                                      | 44,745     |                                | $          | 43,301 |   | $ | 85,663 |   | $ | 94,253 |   |
| Cost  of revenues                                  |   | 37,021                                 |       | 37,167                              |       | 71,008 |   | 76,643 |   |
| Gross  profit                                      |   | 7,724                                  |       | 6,134                               |       | 14,655 |   | 17,610 |   |
| Sales  and marketing                               |   | 4,958                                  |       | 4,230                               |       | 10,330 |   | 9,067 |   |
| General  and administrative                        |   | 2,361                                  |       | 2,673                               |       | 4,875 |   | 5,704 |   |
| Research  and development                          |   | 2,055                                  |       | 2,007                               |       | 4,172 |   | 3,945 |   |
| In-process  research and development               |   | —                                 |       | —                              |       | — |   | 1,360 |   |
| Total  operating expenses                          |   | 9,374                                  |       | 8,910                               |       | 19,377 |   | 20,076 |   |
| Loss  from operations                              |   | (1,650                                 | )          | (2,776                              | )          | (4,722 | ) | (2,466 | ) |
| Interest  and other, net                           |   | 125                                    |       | 187                                 |       | 276 |   | 396 |   |
| Loss  before benefit for income taxes              |   | (1,525                                 | )          | (2,589                              | )          | (4,446 | ) | (2,070 | ) |
| Benefit  for income taxes                          |   | (661                                   | )          | (1,873                              | )          | (1,921 | ) | (1,667 | ) |
| Net  loss                                          |   | $                                      | (864       | )                                   | $          | (716 | ) | $ | (2,525 | ) | $ | (403 | ) |
|                                               |   |                                   |       |                                |       |   |   |   |   |
| Net  loss per share:                               |   |                                   |       |                                |       |   |   |   |   |
| Basic                                              |   | $                                      | (0.02      | )                                   | $          | (0.02 | ) | $ | (0.06 | ) | $ | (0.01 | ) |
| Diluted                                            |   | $                                      | (0.02      | )                                   | $          | (0.02 | ) | $ | (0.06 | ) | $ | (0.01 | ) |
|                                               |   |                                   |       |                                |       |   |   |   |   |
| Shares  used in computation of net loss per share: |   |                                   |       |                                |       |   |   |   |   |
| Basic                                              |   | 38,905                                 |       | 38,476                              |       | 38,874 |   | 38,414 |   |
| Diluted                                            |   | 38,905                                 |       | 38,476                              |       | 38,874 |   | 38,414 |   |

 

Seeaccompanying notes to unaudited consolidated financial statements.

 

4

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**SimpleTech,Inc.**

**ConsolidatedStatements of Cash Flows**

**(inthousands)**

**(unaudited)**

 
|                                                                             |   | **Six  Months  Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                                             |   | **2003**                             |       | **2002** | ** ** |
|                                                                             |   |                                 | ** ** |   | ** ** |
| Cash flow from operating activities:                                             |   |                                 |       |   |   |
| Net loss                                                                         |   | $                                    | (2,525     | ) | $ | (403 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |   |                                 |       |   |   |
| Depreciation and amortization                                                    |   | 2,069                                |       | 1,691 |   |
| Gain (loss) on sale of furniture, fixtures and  equipment                        |   | (22                                  | )          | 89 |   |
| Accounts receivable provisions                                                   |   | 747                                  |       | 696 |   |
| Inventory excess and obsolescence expense                                        |   | 195                                  |       | 477 |   |
| In-process research and development                                              |   | —                               |       | 1,360 |   |
| Deferred income taxes                                                            |   | (1,690                               | )          | — |   |
| Compensation related to stock options vesting                                    |   | —                               |       | 11 |   |
| Tax benefit from exercise of stock options                                       |   | 68                                   |       | — |   |
| Change in operating assets and liabilities:                                      |   |                                 |       |   |   |
| Accounts receivable                                                              |   | 1,700                                |       | (3,702 | ) |
| Inventory                                                                        |   | (1,516                               | )          | (98 | ) |
| Income taxes receivable                                                          |   | 1,061                                |       | 686 |   |
| Other assets                                                                     |   | (450                                 | )          | (363 | ) |
| Accounts payable                                                                 |   | 2,033                                |       | 309 |   |
| Accrued and other liabilities                                                    |   | (1,061                               | )          | 670 |   |
| Net cash provided by operating activities                                        |   | 609                                  |       | 1,423 |   |
|                                                                             |   |                                 |       |   |   |
| Cash flows from investing activities:                                            |   |                                 |       |   |   |
| Purchase of furniture, fixtures and equipment                                    |   | (823                                 | )          | (3,859 | ) |
| Proceeds from sale of furniture, fixtures and  equipment                         |   | 104                                  |       | 651 |   |
| Acquisition of assets                                                            |   | —                               |       | (2,295 | ) |
| Net cash used in investing activities                                            |   | (719                                 | )          | (5,503 | ) |
|                                                                             |   |                                 |       |   |   |
| Cash flows from financing activities:                                            |   |                                 |       |   |   |
| Repayment of borrowings from banks                                               |   | —                               |       | (387 | ) |
| Payment on capital lease obligations                                             |   | (113                                 | )          | (216 | ) |
| Proceeds from issuance of common stock                                           |   | 267                                  |       | 472 |   |
| Net cash provided by (used in) financing activities                              |   | 154                                  |       | (131 | ) |
|                                                                             |   |                                 |       |   |   |
| Net increase (decrease) in cash                                                  |   | 44                                   |       | (4,211 | ) |
| Cash and cash equivalents at beginning of period                                 |   | 33,992                               |       | 51,831 |   |
| Cash and cash equivalents at end of period                                       |   | $                                    | 34,036     |   | $ | 47,620 |   |

 

See accompanying notes to unaudited consolidated financial statements.

 

5

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**SIMPLETECH, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1 – Basis of Presentation**

 

The accompanying interim consolidated financial statements ofSimpleTech, Inc., a California corporation (the “Company”), are unaudited andhave been prepared in accordance with the instructions to Form 10-Q and Article10 of Regulation S-X.  In the opinion ofmanagement, all normal and recurring adjustments considered necessary for afair presentation of the consolidated financial position of the Company atJune 30, 2003 and the consolidated results of operations and cash flowsfor the three months and six months ended June 30, 2003 and 2002 have beenincluded.  These interim consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and related notes contained in the most recent AnnualReport on Form 10-K filed with the SEC. The December 31, 2002 balances reported herein are derived from theaudited consolidated financial statements included in the Annual Report on Form10-K for the year ended December 31, 2002.  The results for the interim periods are not necessarilyindicative of results to be expected for the full year.

 

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

 

**Note 2 – Summary of Significant AccountingPolicies**

 

*Risks and Uncertainties:*

 

Financial instruments, which potentially subject the Company to aconcentration of credit risk, principally consist of cash and cash equivalentsand accounts receivable. As of June 30, 2003 and December 31, 2002,approximately 14% and 15%, respectively, of accounts receivable wereconcentrated with one customer, Ingram Micro. For the three months ended June 30, 2003, CDW Computer Centers andSam’s Club comprised 19% and 12%, respectively, of the Company’s revenues.  For the three months ended June 30,2002, CDW Computer Centers and Unisys comprised 21% and 14%, respectively, ofthe Company’s revenues.  For the sixmonths ended June 30, 2003 and 2002, sales to CDW Computer Centerscomprised 21% and 21%, respectively, of the Company’s revenues.  No othersingle customer accounted for more than 10% of accounts receivable atJune 30, 2003 and December 31, 2002, or revenues for the three monthsand six months ended June 30, 2003 and 2002.

 

*Warranties:*

* *

The Company's memory products are generallysold under various limited warranty arrangements. The estimated future costs ofrepair or replacement are immaterial and have approximated management'sestimates.

 

*Management Estimates:*

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make certain estimates and assumptions that affect the reportedamounts of assets and liabilities (e.g., bad debt reserves and inventoryreserves), disclosure of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenues and expenses duringthe reporting period.  Actual resultscould differ from those estimates.

* *

*Recently Issued Accounting Standards:*

* *

In January 2003, the FASB issuedInterpretation No. 46, “Consolidation of Variable InterestEntities – an interpretation of ARB No. 51.”  The objective of FIN46 is to improve financial reporting by companies involved with variableinterest entities.  This new model forconsolidation applies to an entity in which either (1) the powers or rights ofthe equity holders do not give them sufficient decision making powers or (2)the equity investment at risk is insufficient to finance that entity'sactivities without receiving additional subordinated financial support fromother parties.  FIN 46 requires avariable interest entity to be consolidated into the company that is subject toa majority of the risk of loss from the variable interest entity's activitiesor that is entitled to receive a majority of the entity's residual returns orboth.  The consolidation requirements ofFIN 46 apply immediately to variable interest entities created after January31, 2003.  For entities created on orprior to January 31, 2003, the consolidation requirements apply in the firstfiscal year or interim period beginning after June 15, 2003.  For variable interest entities created priorto January 31, 2003, the Company is currently evaluating the impact of theadoption of FIN 46 for these entities, and thus is not able to disclose theimpact on the Company's results of operations, financial position or cashflows.

 

**Note 3 – Net Income (Loss) Per Share**

 

Basic earnings per share is computed by dividing net loss 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. Options to purchase 9.3 million and 7.2 million shares of common stockwere outstanding at June 30, 2003 and 2002, respectively.  For the threemonths and six months ended June 30, 2003 and 2002, no potential common shares were included in thediluted per share amount as the effect would have been anti-dilutive.

 

Pursuant to SFASNo. 123, “Accounting for Stock-Based Compensation,” the Company haselected to continue the intrinsic value method of accounting for stock optionsgranted to employees and directors in accordance with APB Opinion No. 25and related interpretations in accounting for stock option plans. Hadcompensation cost been determined based on the fair value at the grant datesfor stock options under the Plan consistent with the method promulgated by SFASNo. 123, the Company’s net loss for the three months and six months endedJune 30, 2003 and 2002, would have resulted in the pro forma amountsbelow:

 

6

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|                                                                                                                                          |   | **Three Months  Ended June 30,** |       | **Six Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|-------------------------------------|------------|
|                                                                                                                                          |   | **2003**                              |       | **2002**                            | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                                                          |   |                                  | ** ** |                                | ** ** |   | ** ** |   | ** ** |
| Net loss, as reported                                                                                                                         |   | $                                     | (864       | )                                   | $          | (716 | ) | $ | (2,525 | ) | $ | (403 | ) |
|                                                                                                                                          |   |                                  |       |                                |       |   |   |   |   |
| Add: Stock-based compensation expense  included in reported net loss, net of related tax effects                                              |   | —                                |       | 1                                   |       | — |   | 7 |   |
|                                                                                                                                          |   |                                  |       |                                |       |   |   |   |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (956                                  | )          | (561                                | )          | (1,723 | ) | (1,127 | ) |
|                                                                                                                                          |   |                                  |       |                                |       |   |   |   |   |
| Pro forma net loss                                                                                                                            |   | $                                     | (1,820     | )                                   | $          | (1,276 | ) | $ | (4,248 | ) | $ | (1,523 | ) |
|                                                                                                                                          |   |                                  |       |                                |       |   |   |   |   |
| Loss per share:                                                                                                                               |   |                                  |       |                                |       |   |   |   |   |
|                                                                                                                                          |   |                                  |       |                                |       |   |   |   |   |
| Basic - as reported                                                                                                                           |   | $                                     | (0.02      | )                              | $          | (0.02 | )  | $ | (0.06 | )  | $ | (0.01 | )  |
| Basic - pro forma                                                                                                                             |   | $                                     | (0.05      | )                              | $          | (0.03 | )  | $ | (0.11 | )  | $ | (0.04 | )  |
|                                                                                                                                          |   |                                  |       |                                |       |   |   |   |   |
| Diluted - as reported                                                                                                                         |   | $                                     | (0.02      | )                              | $          | (0.02 | )  | $ | (0.06 | )  | $ | (0.01 | )  |
| Diluted - pro forma                                                                                                                           |   | $                                     | (0.05      | )                              | $          | (0.03 | )  | $ | (0.11 | )  | $ | (0.04 | )  |

 

###### **Note 4**– SupplementalBalance Sheet Information

###### ** **

Inventory consists of the following:

 
| **(in  thousands)**  |   | **June 30, 2003** |       | **December 31, 2002** |       |
|----------------------|--------|------------------------|------------|----------------------------|------------|
|                 |   |                   | ** ** |                       | ** ** |
| Raw materials        |   | $                      | 6,663      |                       | $          | 6,325 |   |
| Work-in-progress     |   | 634                    |       | 364                        |       |
| Finished goods       |   | 9,073                  |       | 8,256                      |       |
|                 |   | 16,370                 |       | 14,945                     |       |
| Valuation allowances |   | (908                   | )          | (804                       | )          |
|                 |   |                   |       |                       |       |
| Inventory, net       |   | $                      | 15,462     |                       | $          | 14,141 |   |

 

7

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### **Note 5 – Commitments and Contingencies**

### ** **

**DPACTechnologies, Inc.—Patent Infringement**

 

On September 23, 1998,the Company filed a lawsuit against DPAC Technologies, Inc., formerly Dense-PacMicrosystems, Inc. (“DPAC”), in the United States District Court for theCentral District of California for infringement of the Company’s IC Towerstacking patent, U.S. Patent No. 5,514,907. On March 29, 2001, the courtentered final judgment finding DPAC did not infringe the Company’s patent andthat the Company did not infringe DPAC’s patent. The appeals court affirmed thefinal judgment on March 7, 2002.  DPAC did not appeal the ruling inthe Company’s favor, and that ruling is now final.  On September 3, 2002, the Company filed a petition forcertiorari with the U.S. Supreme Court.  On October 7, 2002, thepetition to the Supreme Court was granted and the matter was remanded to theCircuit Court of Appeals.  DPAC filed a motion for summary affirmance withthe Court of Appeals.  On February 26, 2003, the Court of Appealsdenied DPAC’s motion and remanded the matter for trial to the United StatesDistrict Court for the Central District of California.  No trial date hasbeen set by the District Court.

 

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

 

The Company received noticeon November 26, 2001 that the Lemelson Medical, Education & ResearchFoundation, LLP (“Lemelson Foundation”) filed a complaint on November 13,2001 against the Company and other defendants.  The complaint was filed inthe District Court of Arizona and alleges that the Company’s manufacturingprocesses infringe several patents that the Lemelson Foundation allegedlyowns.  The complaint also states that these allegedly infringed patentsrelate to machine vision technology and bar coding technology.  OnMarch 7, 2002, the Company was served with the Lemelson Foundationcomplaint.  Thereafter, the case was stayed pending the outcome of relatedcases 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.

 

**Lexar Media, Inc.– Unfair Trade Practice and Patent Infringement**

 

On October 1, 2002, theCompany filed a lawsuit against Lexar Media, Inc. in the Superior Court ofOrange County, California for trade libel, libel per se, intentionalinterference with prospective economic advantage and California unfaircompetition, seeking unspecified damages, including punitive and trebleddamages.  The lawsuit arose from correspondence sent by Lexar Mediato one of the Company’s customers that alleged that certain of the Company’sproducts infringe Lexar Media’s patents.  On October 30, 2002, LexarMedia filed a notice of removal, which removed the matter from the OrangeCounty Superior Court to the United States District Court for the CentralDistrict of California.  OnNovember 14, 2002, the Company amended its complaint to add violation ofthe Sherman Antitrust Act, violation of the California Unfair Trade PracticesAct and common law unfair competition as causes of action.  On November 6, 2002, Lexar Media fileda motion to dismiss the Company’s complaint.  On January 8, 2003, theCourt denied Lexar’s motion as to the initial four causes of actions anddismissed the violation of the Sherman Antitrust Act, violation of theCalifornia Unfair Trade Practices Act and common law unfair competition causesof actions against Lexar Media.

 

On July 21, 2003, Lexar fileda motion for summary judgment seeking dismissal of the Company's amendedcomplaint and a Rule 11 motion requesting sanctions against the Company forfiling the amended complaint. On August 11, 2003, the Court ruled on Lexar'smotion for summary judgment on SimpleTech's underlying causes of action.  According to the Court's ruling, there wasnot clear and convincing evidence that Lexar's actions were conducted in badfaith. As a result, the Court granted Lexar's motion for summary judgment, butdenied Lexar's Rule 11 motion.

 

On March 20, 2003,Lexar Media filed a counter claim against the Company alleging that the MemoryStick products sold by the Company violate Lexar Media’s U.S. patent No.5,479,638.  Lexar Media is seeking monetary damages in an amount to bestated later, an injunction against further infringement of its patent,attorneys’ fees and trebled damages.  The Company purchases its MemoryStick products from I-O Data.  Under theterms of the distribution agreement with I-O Data, I-O Data has agreed toindemnify, defend and hold harmless the Company from claims, damages, lossesand costs which may arise from the alleged infringement by its products ofthird-party patents, trademarks or other proprietary rights.  After initially agreeing to indemnify andassume the Company’s defense, I-O Data has failed to assume the Company’sdefense.  As a result, SimpleTech hasfiled an answer to Lexar Media’s counter claim and filed a Third-PartyComplaint against I-O Data asking for indemnification.  This lawsuit is in the early stage ofdiscovery and the court has set a trial for April 2004.  Because of the preliminary stage of thiscase, an estimate of potential damages, if any, would be premature and speculative,and the Company has not made any such estimate at this time.

 

**StaktekCorporation—Patent Infringement**

 

On July 30, 2003, theCompany filed a lawsuit against Staktek Corporation in the United StatesDistrict Court for the Central District of California for infringement of theCompany’s IC Tower stacking patent, U.S. Patent No. Re. 36,916.  The Company is seeking monetary damages inan amount to be stated later, an injunction against further infringement of theCompany's patent, attorneys' fees and trebled damages.  No court dates have been set.

 

8

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**Other LegalProceedings**

 

The Company is currently nota party to any other material legal proceedings. However, the Company isinvolved in other suits and claims in the ordinary course of business, and the Companymay from time to time become a party to other legal proceedings arising in theordinary course of business, including, but not limited to, employee, customerand vendor disputes and intellectual property litigation.

 

As is common in theindustry, the Company currently has in effect a number of agreements in whichthe Company has agreed to defend, indemnify and hold harmless certain of itssuppliers and customers from damages and costs which may arise from theinfringement by the Company’s products of third-party patents, trademarks orother proprietary rights. The scope of such indemnity varies, but may, in someinstances, include indemnification for damages and expenses, includingattorneys’ fees. The Company’s insurance does not cover intellectual propertyinfringement.

** **

**Other Commitments**

** **

The Company is subject to repurchaseagreements with various financial institutions in connection with wholesaleinventory financing.  Under theseagreements, the Company may be required to repurchase inventory upon customerdefault with a financing institution and then resell the inventory throughnormal distribution channels.  As ofJune 30, 2003, the Company has not been required to repurchase inventory inconnection with the customer default agreements noted above.  However, it may be possible that the Companywill be required to repurchase inventory, upon customer default, in thefuture.  Sales under such agreementswere approximately $276,000 and $510,000 in the second quarter and first halfof 2003, respectively, compared to $177,000 and $366,000 in the second quarterand first half of 2002, respectively.

 

**Note 6 – Segment Information**

 

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

 

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

 

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

 
|                           |   | **Three Months Ended June 30, 2003**     |   | **Six Months Ended June 30, 2003**     |       |
|--------------------------------|--------|-----------------------------------------------|--------|---------------------------------------------|------------|
| **(in thousands)**             |   | **Commercial**                                |   | **Industrial**                              | ** ** | **Subtotal** | ** ** | **Xiran** | ** ** | **Consolidated** | ** ** | **Commercial** | ** ** | **Industrial** | ** ** | **Subtotal** | ** ** | **Xiran** | ** ** | **Consolidated** | ** ** |
| Net  revenues                  |   | $                                             | 36,072 |                                        | $          | 8,673 |   | $ | 44,745 |   | $ | 0 |   | $ | 44,745 |   | $ | 67,843 |   | $ | 17,820 |   | $ | 85,663 |   | $ | 0 |   | $ | 85,663 |   |
| Cost  of revenues              |   | 30,164                                        |   | 6,857                                       |       | 37,021 |   | 0 |   | 37,021 |   | 57,589 |   | 13,419 |   | 71,008 |   | 0 |   | 71,008 |   |
| Gross  profit                  |   | $                                             | 5,908  |                                        | $          | 1,816 |   | 7,724 |   | 0 |   | $ | 7,724 |   | $ | 10,254 |   | $ | 4,401 |   | 14,655 |   | 0 |   | $ | 14,655 |   |
| Operating  expenses            |   |                                          |   |                                        |       | 7,390 |   | 1,984 |   | 9,374 |   |   |   |   |   | 15,519 |   | 3,858 |   | 19,377 |   |
| Income  (loss) from operations |   |                                          |   |                                        |       | $ | 334 |   | $ | (1,984 | ) | $ | (1,650 | ) |   |   |   |   | $ | (864 | ) | $ | (3,858 | ) | $ | (4,722 | ) |
|                           |   |                                          |   |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                           |   | **Three  Months Ended****June 30, 2002** |   | **Six  Months Ended****June 30, 2002** |       |
|                           |   | **Commercial**                                |   | **Industrial**                              | ** ** | **Subtotal** | ** ** | **Xiran** | ** ** | **Consolidated** | ** ** | **Commercial** | ** ** | **Industrial** | ** ** | **Subtotal** | ** ** | **Xiran** | ** ** | **Consolidated** | ** ** |
| Net  revenues                  |   | $                                             | 29,791 |                                        | $          | 13,510 |   | $ | 43,301 |   | $ | 0 |   | $ | 43,301 |   | $ | 73,416 |   | $ | 20,837 |   | $ | 94,253 |   | $ | 0 |   | $ | 94,253 |   |
| Cost  of revenues              |   | 27,556                                        |   | 9,611                                       |       | 37,167 |   | 0 |   | 37,167 |   | 61,953 |   | 14,690 |   | 76,643 |   | 0 |   | 76,643 |   |
| Gross  profit                  |   | $                                             | 2,235  |                                        | $          | 3,899 |   | 6,134 |   | 0 |   | 6,134 |   | $ | 11,463 |   | $ | 6,147 |   | 17,610 |   | 0 |   | 17,610 |   |
| Operating  expenses            |   |                                          |   |                                        |       | 7,470 |   | 1,440 |   | 8,910 |   |   |   |   |   | 16,129 |   | 3,947 |   | 20,076 |   |
| Income  (loss) from operations |   |                                          |   |                                        |       | $ | (1,336 | ) | $ | (1,440 | ) | $ | (2,776 | ) |   |   |   |   | $ | 1,481 |   | $ | (3,947 | ) | $ | (2,466 | ) |

 

For the three months ended June 30, 2003 and 2002, internationalsales comprised 21% and 13%, of the Company’s revenues.  For the six months ended June 30, 2003 and2002, international sales comprised 21% and 13%, of the Company’srevenues.  During these periods, nosingle foreign country accounted for more than 10% of total revenues.  For the three and six months endedJune 30, 2003, Europe accounted for 11% and 12%, respectively, of theCompany's total revenues.  Other thanEurope in the three and six months ended June 30, 2003, no other foreigngeographical area accounted for more than 10% of the Company's total revenuesin each of the second quarters and first halves of 2003 and 2002.  All international sales during these periodswere shipped from the Company’s domestic warehouse to foreign customers.

 

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

 

**Cautionary Statement**

 

Certain statements in this report, includingstatements regarding the Company’s strategy, financial performance and revenuesources, are forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995, Section 21E of the SecuritiesExchange Act of 1934, as amended, and Section 27A of the Securities Act of1933, as amended, and are subject to the safe harbors created by thosesections.  These forward-lookingstatements are based on our current expectations,

 

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estimatesand projections about our industry, management’s beliefs, and certainassumptions made by us. Such statements are not guarantees of futureperformance and are subject to certain risks, uncertainties and assumptionsthat are difficult to predict. Therefore, our actual results could differmaterially and adversely from those expressed in any forward-looking statementsas a result of various factors. The section entitled “Risk Factors” set forthin this Form 10-Q and similar discussions in filings with the Securities andExchange Commission made from time to time, including other quarterly reportson Form 10-Q, our Annual Reports on Form 10-K, and in our other SEC filings,discuss some of the important risk factors that may affect our business,results of operations and financial condition.

 

The following discussion should be read in conjunction with theCompany’s consolidated financial statements and notes thereto.

 

#### **Overview**

#### ** **

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

** **

**Afterexperiencing year-over-year revenue growth of 57.5% from 1998 to 1999 and 60.1%from 1999 to 2000, revenues declined 46.7% in 2001 and increased 7.5% in2002.  Revenues in 2001 and 2002 werenegatively impacted due to softening macro-economic conditions, severe declinesin the price of DRAM and Flash components and significantly reduced sales tocustomers in the communications and networking markets.  These negative conditions continued in thefirst quarter of 2003, but began to improve through the second quarter of2003.  Demand for DRAM and Flashproducts increased during the second quarter of 2003 and into July 2003particularly in the retail channel. DRAM and Flash component prices began to stabilize during the early partof the second quarter of 2003 and increased during June andJuly 2003.  Based on these trendsat the end of the second quarter of 2003, we are more optimistic about thedemand and pricing outlook in the second half of 2003.**

** **

**As aresult of increased demand for Flash-based consumer electronics and industrialapplications in which solid-state Flash-based storage displaces traditionalstorage, our Flash memory products as a percentage of our revenues increasedsteadily from 12.9%, or $24.9 million, in 1999 to 31.0%, or $54.7 million, in2002.  As a result of stronger thanexpected demand in the retail and direct marketer channels, Flash memoryproducts increased from 38.1% of revenues, or $15.6 million, in the firstquarter of 2003 to 44.3% of revenues, or $19.8 million in the second quarter of2003, compared to 28.2% of our revenues in the second quarter of 2002. Flashmemory product unit shipments grew 39.3% from 389,000 units shipped in thefirst quarter of 2003 to 542,000 units shipped in the second quarter of2003.  In November 2002, SemicoResearch Corporation projected data storage Flash industry revenues to grow ata compounded annual growth rate of 41% from 2001 to 2004.  Our Flash memory products revenue grew 62.4%in the second quarter of 2003 compared to the same period in 2002.**

** **

**In thefirst half of 2003 and 2002, our highest margin division was our IndustrialDivision.  In the first half of 2003 and2002, our highest profit margin product line was our IC Tower stacking productline.  We track revenues and grossmargins for our Industrial and Commercial Divisions.  We do not track separately, and do not intend to trackseparately, operating expenses for our Industrial and CommercialDivisions.  Conversely, we do trackoperating expenses for our Xiran Division. Although our Xiran Division is expected to ship prototype units topotential customers in the third quarter of 2003, it is not expected togenerate revenues until 2004.**

** **

**Historically,a small number of customers have accounted for a significant percentage of ourrevenues.  Our ten largest customersaccounted for an aggregate of 55.2% of our total revenues in the first half of2003, compared to 56.6% of our total revenues in the first half of 2002. CDW Computer Centers accounted for 20.6% of our total revenues in the firsthalf of 2003, compared to 21.2% of our total revenues in the first half of2002. Other than CDW Computer Centers, no customer accounted for more than10.0% of our total revenues in the first half of 2003 or 2002.  The composition of our major customer basechanges from quarter to quarter as the market demand for our products changesand we expect this variability will continue in the future. We expect thatsales of our products to a small number of customers will continue tocontribute materially to our revenues in the foreseeable future.  The loss of, or a significant**

** **

**10**

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** **

**reduction in purchases by any of our major customers, couldharm our business, financial condition and results of operations.  See Risk Factors**- “Sales to asmall number of customers represent a significant portion of our revenues andthe loss of any key customer would materially reduce our sales.”

** **

**Internationalsales of our products constituted 21.4% of our total revenues for the firsthalf of 2003, compared to 12.7% of our total revenues for the first half of2002.  Except for Europe, whichaccounted for 12.2% of our revenues in the first half of 2003, no other foreigngeographical area or single foreign country accounted for more than 10.0% ofour revenues in the first half of 2003 or 2002. During the first half of 2003and 2002, over 95.0% of our international sales were denominated in U.S.dollars.  In addition, our purchases ofIC components are currently denominated in U.S. dollars.  However, we do face risks associated withdoing business in foreign countries. See Risk Factors - “We face risks associated with doing business inforeign countries, including foreign currency fluctuations and trade barriers,that could lead to a decrease in demand for our products or an increase in thecost of the components used in our products.”**

** **

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

** **

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

** **

**Results ofOperations – Comparison of the Second Quarter of 2003 to the Second Quarter of2002**

 

*Net Revenues.*  Our revenues were$44.7 million in the second quarter of 2003, compared to $43.3 million in thesame period in 2002.  Revenues increased 3.2% in the second quarter of2003 due to an 11% increase in units shipped, partially offset by a 6% declinein average sales price.  The decrease inour average sales price resulted from lower DRAM and Flash component prices inthe second quarter of 2003 compared to the second quarter of 2002.  Unitshipment growth was comprised of unit volume increases of 57% for Flashproducts and 27% for IC Tower stacking products, partially offset by a decreaseof 70% for non-DRAM, non-Flash products such as SRAM, hard drive upgrade kitsand connectivity products.  Non-stackedDRAM memory product units shipped were relatively flat in the second quartersof 2003 and 2002.  The mix of productssold varies from quarter to quarter and may vary in the future, affecting ouroverall average sales prices and gross margins.

 

Our Industrial Divisionrevenues decreased 35.6% from $13.5 million in the second quarter of 2002 to$8.7 million in the second quarter of 2003. The decrease in Industrial Divisionrevenues was due to a 27% decrease in Industrial Division unit volume and a 12%decrease in Industrial Division average sales price in the second quarter of2003.  Our Commercial Division revenues increased 21.1% from $29.8 millionin the second quarter of 2002 to $36.1 million in the second quarter of 2003.Commercial Division revenues increased in the second quarter of 2003 due to a27% increase in Commercial Division unit volume, partially offset by a 6%decline in Commercial Division average sales price.  Commercial Division unit volume grew primarily due to asignificant increase in the sale of Flash memory products in the retail anddirect marketer channels.  The decreasein average sales price resulted primarily from lower DRAM and Flash componentprices in the second quarter of 2003 compared to the second quarter of 2002.

 

Sales of our products aremade under short-term cancelable purchase orders. We include in our backlogonly those customer orders for which we have accepted purchase orders and towhich we have assigned shipment dates within the upcoming six months. Since ordersconstituting our backlog are subject to change due to, among other things,customer cancellations and reschedulings, and our ability to procure necessarycomponents, backlog is not necessarily an indication of future revenues. Inaddition, there can be no assurance that current backlog will necessarily leadto revenues in any future period.  Ourcombined backlog was $5.5 million as of June 30, 2003, compared to $4.9million as of June 30, 2002.  OurIndustrial Division backlog was $2.7 million as of June 30, 2003, comparedto $3.8 million as of June 30, 2002. Our Commercial Division backlog was $2.8 million as of June 30,2003, compared to $1.1 million as of June 30, 2002.

 

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Commercial Division backlog is typically nominal sincesubstantially all commercial orders are filled on a same-day or next-day basis.Our ability to predict future sales is limited because a majority of ourquarterly product revenues come from orders that are received and fulfilled inthe same quarter.  We believe that ourstronger than expected results in the second quarter of 2003, recent increasesin DRAM and Flash demand along with the stabilization and increase of componentprices towards the end of the second quarter of 2003 may indicate a turnaroundfor our sector.

 

*Gross Profit.*  Our gross profit was$7.7 million in the second quarter of 2003, compared to $6.1 million in thesame period in 2002.  Gross profit as a percentage of revenues was 17.2%in the second quarter of 2003, compared to 14.1% in the same period in2002.  Gross profit for our IndustrialDivision as a percentage of Industrial Division revenues was 20.9% in thesecond quarter of 2003, compared to 28.9% in the second quarter of 2002. This decrease in gross profit as a percentage of revenues for our IndustrialDivision resulted primarily from a 27% decrease in unit shipments resulting ina higher absorption of production labor and overhead costs.  Gross profitfor our Commercial Division as a percentage of Commercial Division revenues was16.4% in the second quarter of 2003, compared to 7.5% in the second quarter of2002.  Our gross profit for our Commercial Division as a percentage ofCommercial Division revenues for the second quarter of 2002 was negatively affectedby the impact of significant DRAM component price declines on our inventoryheld in stock.

 

*Sales and Marketing.*  Sales and marketingexpenses are primarily comprised of personnel costs and travel expenses for ourdomestic and international sales and marketing employees, commissions paid tointernal salespersons and independent manufacturers’ representatives, shippingcosts and marketing programs. Sales and marketing expenses were $5.0 million inthe second quarter of 2003, compared to $4.2 million in the same period in2002. Sales and marketing expenses as a percentage of revenues were 11.2% inthe second quarter of 2003, compared to 9.7% in the same period in 2002.  Sales and marketing expenses increased due primarilyto increased sales and marketing efforts for the Xiran Division and expandedCommercial Division marketing programs in the second quarter of 2003.

 

*General and Administrative.*  General andadministrative expenses are primarily comprised of personnel costs for ourexecutive and administrative employees, professional fees and facilitiesoverhead. General and administrative expenses were $2.4 million in the secondquarter of 2003, compared to $2.7 million in the same period in 2002. Generaland administrative expenses as a percentage of revenues were 5.4% in the secondquarter of 2003 and 6.2% in the second quarter of 2002.  General and administrative expensesdecreased due primarily to a $265,000 reduction in legal fees.

 

*Research and Development.*  Research anddevelopment expenses are primarily comprised of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses were $2.1 million in the second quarter of 2003, comparedto $2.0 million in the same period in 2002. Research and development expensesas a percentage of revenues were 4.7% in the second quarter of 2003, comparedto 4.6% in the same period in 2002. Research and development expenses were relatively flat in the secondquarters of 2003 and 2002.

 

*Interest Income, Net.*  Interest income, netwas $125,000 in the second quarter of 2003 and $187,000 in the second quarterof 2002.  Interest income is comprisedof interest earned on our cash, cash equivalents and marketable securities.  Interest income was $125,000 in the secondquarter of 2003 and $211,000 in the second quarter of 2002.  This decreasein interest income resulted from lower interest rates and a reduced averagecash balance in the second quarter of 2003 compared to the second quarter of2002.  Interest expense is comprised of interest related to equipmentfinancing. Interest expense was $0 in the second quarter of 2003 and $24,000 inthe second quarter of 2002.

 

*Benefit for Income Taxes.*Benefit for income taxes was$661,000 in the second quarter of 2003. Benefit for income taxes was $1.9 million in the second quarter of2002.  As a percentage of income before benefit for income taxes, benefitfor income taxes was 43.3% and 72.3% in the second quarter of 2003 and 2002,respectively.  The percentage of incomebefore benefit for income taxes for the second quarter of 2002 was high due toa research and development income tax benefit of approximately $800,000.

 

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*Net Loss. *Net loss was $864,000 and$716,000 in the second quarters of 2003 and 2002, respectively.

 

**Results ofOperations – Comparison of the First Half of 2003 to the First Half of 2002**

 

*Net Revenues.*  Our revenues were$85.7 million in the first half of 2003, compared to $94.3 million in the sameperiod in 2002.  Revenues decreased 9.1% in the first half of 2003 due toa 15% decline in average sales price, partially offset by a 5% increase inunits shipped.  The decrease in ouraverage sales price resulted from lower DRAM and Flash component prices in the firsthalf of 2003 compared to the first half of 2002.  Unit shipments growthwas comprised of unit volume increases of 51% for IC Tower stacking productsand 44% for Flash products, partially offset by decreases of 74% for non-DRAM,non-Flash products such as SRAM, hard drive upgrade kits and connectivityproducts and 5% for non-stacked DRAM memory products.  The mix of products sold varies from quarter to quarter and mayvary in the future, affecting our overall average sales price and grossmargins.

 

Our Industrial Divisionrevenues decreased 14.4% from $20.8 million in the first half of 2002 to $17.8million in the first half of 2003. The decrease in Industrial Division revenuewas due to a 5% decrease in Industrial Division unit volume during this periodand a 10% decrease in Industrial Division average sales price in the first halfof 2003.  Our Commercial Divisionrevenues decreased 8.3% from $73.4 million in the first half of 2002 to $67.8million in the first half of 2003. Commercial Division revenues decreased inthe first half of 2003 due to a 15% decline in Commercial Division averagesales price, partially offset by a 9% increase in Commercial Division unitvolume.  Commercial Division unit volumegrew primarily due to a significant increase in the sale of Flash memoryproducts in the retail and direct marketer channels.  The decrease in average sales price resulted primarily from lowerDRAM and Flash component prices in the first half of 2003 compared to the firsthalf of 2002.  We believe that ourstronger than expected results in the second quarter of 2003, recentincreases in DRAM and Flash demand along with the stabilization and increase ofcomponent prices towards the end of the second quarter of 2003 mayindicate a turnaround for our sector.

 

*Gross Profit.*  Our gross profit was$14.7 million in the first half of 2003, compared to $17.6 million in the sameperiod in 2002.  Gross profit as a percentage of revenues was 17.2% in thefirst half of 2003, compared to 18.7% in the same period in 2002.  Gross profit for our Industrial Division asa percentage of Industrial Division revenues was 24.7% in the first half of2003, compared to 29.5% in the first half of 2002.  This decrease in grossprofit as a percentage of revenues for our Industrial Division resultedprimarily from a 5% decrease in unit shipments resulting in a higher absorptionof production labor and overhead costs and a negative shift in productmix.  Gross profit for our Commercial Division as a percentage ofCommercial Division revenues was 15.1% in the first half of 2003, compared to15.6% in the first half of 2002.  Gross profit for our Commercial Divisionas a percentage of Commercial Division revenues for the first half of 2003 and2002 was relatively flat.

 

*Sales and Marketing.*  Sales and marketingexpenses are primarily comprised of personnel costs and travel expenses for ourdomestic and international sales and marketing employees, commissions paid tointernal salespersons and independent manufacturers’ representatives, shipping costsand marketing programs. Sales and marketing expenses were $10.3 million in thefirst half of 2003, compared to $9.1 million in the same period in 2002. Salesand marketing expenses as a percentage of revenues were 12.0% in the first halfof 2003, compared to 9.7% in the same period in 2002.  Sales and marketing expenses increased due primarily to increasedsales and marketing efforts for the Xiran Division and expanded CommercialDivision marketing programs in the first half of 2003.

 

*General and Administrative.*  General andadministrative expenses are primarily comprised of personnel costs for ourexecutive and administrative employees, professional fees and facilitiesoverhead. General and administrative expenses were $4.9 million in the firsthalf of 2003, compared to $5.7 million in the same period in 2002. General andadministrative expenses as a percentage of revenues were 5.7% in the first halfof 2003 and 6.0% in the first half of 2002. General and administrative expenses decreased due primarily to a$450,000 reduction in legal fees.

 

*Research and Development.*  Research anddevelopment expenses are primarily comprised of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses were $4.2 million in the first half of 2003, compared to$3.9 million in the same period in 2002. Research and development expenses as apercentage of revenues were 4.9% in the first half of 2003,

 

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compared to 4.1% in the same period in 2002.  The increase in research and developmentexpenses in the first half of 2003 resulted from a $505,000 increase inexpenditures related to our Xiran Division, partially offset by a $212,000decrease in expenditures related to our Commercial and Industrial Divisions.

 

*Non-recurring In-process Research and Development.*  Wedid not have non-recurring in-process research and development expenses in thefirst half of 2003.  Non-recurring in-process research and development expenseswere $1.4 million in the first half of 2002 and related to our acquisition ofthe assets of Irvine Networks (Xiran Division) in January 2002.

 

*Interest Income, Net.*  Interest income, netwas $276,000 in the first half of 2003 and $396,000 in the first half of2002.  Interest income is comprised ofinterest earned on our cash, cash equivalents and marketable securities.  Interest income was $276,000 in the firsthalf of 2003 and $449,000 in the first half of 2002.  This decrease ininterest income resulted from lower interest rates and a reduced average cashbalance in the first half of 2003 compared to the first half of 2002. Interest expense is comprised of interest related to equipment financing.Interest expense was $0 in the first half of 2003 and $53,000 in the first halfof 2002.

 

*Benefit for Income Taxes.*Benefit for income taxes was$1.9 million in the first half of 2003, compared to $1.7 million in the firsthalf of 2002.  As a percentage of income before benefit for income taxes,benefit for income taxes was 43.2% and 80.5% in the first half of 2003 and2002, respectively.  The percentage ofincome before benefit for income taxes for the first half of 2002 was high dueto a research and development income tax benefit of approximately $800,000.

 

*Net Loss. *Net loss was $2.5 millionand $403,000 in the first halves of 2003 and 2002, respectively.

 

**Liquidity and CapitalResources**

 

As ofJune 30, 2003, we had working capital of $57.9 million, including $34.0million of cash and cash equivalents and $10.0 million in marketablesecurities, compared to working capital of $60.4 million, including $34.0million of cash and cash equivalents and $10.0 million in marketable securitiesas of December 31, 2002.  Currentassets were 3.7 times current liabilities at June 30, 2003, compared to3.9 times current liabilities at December 31, 2002.

 

Net cashprovided by operating activities was $609,000 for the first half of 2003 andresulted primarily from a  $2.4 milliondecrease in accounts receivable, net of allowances, $2.1 million in non-cashdepreciation and amortization, a $2.0 million increase in accounts payable anda $1.1 million decrease in income taxes receivable, partially offset by a netloss of $2.5 million, a $1.7 million increase in deferred income tax assets, a$1.3 million decrease in inventory, a $1.1 million decrease in accrued andother liabilities and a $450,000 increase in other assets.

 

Net cash usedin investing activities was $719,000 for the first half of 2003, attributableto $823,000 in purchases of furniture, fixtures and equipment, partially offsetby $104,000 in proceeds from the sale of furniture, fixtures andequipment.  We expect to spendapproximately $3.0 to $5.0 million on capital expenditures during the next24 months, primarily for the purchase of manufacturing, testing andengineering equipment.

 

Net cashprovided by financing activities was $154,000 for the first half of 2003 andresulted from the receipt of $267,000 in proceeds from the issuance of commonstock related to stock option exercises and purchases of stock by employeesthrough the employee stock purchase plan, partially offset by payments of$113,000 related to equipment capital lease obligations.

 

In prior years, we enteredinto several capital leases to finance manufacturing and testing equipment. Ourobligations under capital leases were paid down to zero as of June 30,2003 and had a balance of $113,000 at December 31, 2002, with interestrates ranging from 8.1% to 9.6% per annum.

 

We believe that our current assets, including cash and cashequivalents, and expected cash flow from operations will be sufficient to fundour operations for at least the next twelve months.  However, it is possible that we may need or elect to raiseadditional funds to fund our activities beyond the next year or to consummateacquisitions 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 need additionalfunds, we may still elect to sell additional equity securities or obtain credit

 

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facilities forother reasons.  We cannot assure youthat we will be able to obtain additional funds on commercially favorableterms, or at all.  If we raiseadditional funds by issuing additional equity or convertible debt securities,the ownership percentages of existing shareholders would be reduced.  In addition, the equity or debt securitiesthat we issue may have rights, preferences or privileges senior to those of theholders of our common stock.

 

Although we believe we have sufficient capital to fund our activitiesfor at least the next twelve months, our future capital requirements may varymaterially from those now planned.  Theamount of capital that we will need in the future will depend on many factors,including:

 

•                  themarket acceptance of our products;

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

•                  pricediscounts on our products to our customers;

•                  ourbusiness, product, capital expenditure and research and development plans andproduct and technology roadmaps;

•                  thelevels of inventory and accounts receivable that we maintain;

•                  capitalimprovements to new and existing facilities;

•                  technologicaladvances;

•                  ourcompetitors’ response to our products;

•                  ourpursuit of strategic transactions; and

•                  ourrelationships with suppliers and customers.

 

**Inflation**

** **

**Inflationwas not a material factor in either revenue or operating expenses during thesecond quarters or first half of 2003 and 2002.**

** **

**RecentlyIssued Accounting Standards**

** **

In January2003, the FASB issued Interpretation No. 46, “Consolidation of VariableInterest Entities – an interpretation of ARB No. 51.”  The objective ofFIN 46 is to improve financial reporting by companies involved with variableinterest entities.  This new model for consolidation applies to an entityin which either (1) the powers or rights of the equity holders do not give themsufficient decision making powers or (2) the equity investment at risk isinsufficient to finance that entity’s activities without receiving additionalsubordinated financial support from other parties.  FIN 46 requires avariable interest entity to be consolidated into the company that is subject toa majority of the risk of loss from the variable entity's activities or that isentitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interestentities created after January 31, 2003.  For entities created on or priorto January 31, 2003, the consolidation requirements apply in the first fiscalyear or interim period beginning after June 15, 2003.  For variableinterest entities created prior to January 31, 2003, we are currentlyevaluating the impact of the adoption of FIN 46 for these entities, and thusare not able to disclose the impact on our results of operations, financialposition or cash flows.

** **

**Critical Accounting Policies and Estimates**

 

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

 

•*Reserves for inventory excess, obsolescence and lowerof market values compared to costs*—We generally purchase rawmaterials in quantities that we anticipate will be fully used in the near term.Changes in operating strategy, customer demand and unpredictable fluctuationsin market values of raw materials can limit our ability to effectively utilizeall of the raw materials purchased and sold through resulting finished goods tocustomers for a profit.  We regularly monitor potential inventory excess,obsolescence and lower market values compared to costs and, when necessary,reduce the carrying amount of our inventory to its market value.

 

•*Allowances for doubtful accounts and price protection*—Wemaintain allowances for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments.  Additionally,we maintain allowances for limited price protection rights for inventories ofour products held by our customers as a result of recent sales transactions tothem.

 

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

 

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

 

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

 

•*Litigation andother contingencies*—Management regularly evaluates our exposure tothreatened or pending litigation and other business contingencies. Because ofthe uncertainties related to the amount of loss from litigation and otherbusiness contingencies, 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.

 

•*Valuation oflong-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.

 

**Risk Factors**

 

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

** **

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

 

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

 

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•                  Fluctuatingmarket demand for and declines in the average sales prices of our products;

•                  Overproductionby suppliers of the components used in our products;

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

•                  Theeffects of litigation;

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

•                  Marketacceptance of new and enhanced versions of our products;

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

•                  Inventoryobsolescence, product returns and price protections;

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

•                  Expensesassociated with acquisitions.

 

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

 

In addition, the tradingprice of our common stock may materially decline regardless of our operatingperformance.  The market price of our common stock has been subject to significantfluctuations since our initial public offering in September 2000. The stock market has experienced significant price and volume fluctuations thathave affected the market prices of securities, particularly securities oftechnology companies. In the past, following periods of volatility in themarket price of a particular company’s securities, securities class actionlitigation has often been brought against that company. We may become involvedin this type of litigation in the future. Litigation of this type is oftenexpensive and can divert management’s attention and resources.

 

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

 

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

 

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

 

We are dependent on a smallnumber of suppliers to supply Flash IC and DRAM IC devices. We have nolong-term DRAM IC device supply contract and only have a limited supplycontract with Renesas, formerly Hitachi Semiconductor, for Flash ICdevices.  Although we have a limited contract with Renesas, there can beno assurance that Renesas can or will agree to supply the quantities of FlashIC devices we may need to meet our production goals.  IC devices representapproximately 95% of our component costs. Our dependence on a small number ofsuppliers and our limited number of long-term supply contracts expose us toseveral risks, including the inability to obtain an adequate supply ofcomponents, price increases, late deliveries and poor component quality.Renesas and Samsung supply substantially all of the IC devices used in ourFlash memory products. In addition, Elpida, Micron and Samsung currently supplya majority of the DRAM IC devices used in our DRAM memory products. Adisruption in or termination of our supply relationship with any of thesesignificant suppliers by natural disaster or otherwise, or our inability todevelop relationships with new suppliers, if required, would cause delays,disruptions or reductions in product shipments or require product redesignswhich could damage relationships with our customers, and would increase ourcosts and/or prices. In particular, if our supply relationships with

 

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Renesas or Samsung are disrupted or terminated, our abilityto manufacture and sell our Flash products would be harmed and our Flashbusiness would be adversely affected.

 

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

 

The semiconductor industry,including the memory markets in which we compete, is highly cyclical andcharacterized by constant and rapid technological change, rapid productobsolescence and price erosion, evolving standards, short product life cyclesand wide fluctuations in product supply and demand. The industry hasexperienced significant downturns often connected with, or in anticipation of,maturing product cycles of both semiconductor companies’ and their customers’products and declines in general economic conditions. These downturns have beencharacterized by diminished product demand, production overcapacity, highinventory levels and accelerated erosion of average selling prices. In the pasttwo and a half years, a semiconductor downturn has negatively impacted ouraverage selling prices, revenues and earnings. Any future downturns could havea material adverse effect on our business and operating results.

 

**We may be unableto maintain a steady supply of components.**

 

The electronics industry hasexperienced in the past, and may experience in the future, shortages in ICdevices, including DRAM and Flash memory. We have experienced and may continueto experience delays in component deliveries and quality problems, which havecaused and could in the future cause delays in product shipments. In addition,we have required and could in the future require the redesign of some of ourproducts. From time to time, industry capacity has become constrained such thatsome vendors have placed their customers, ourselves included, on componentallocation. This means that while we may have customer orders, we may not beable to obtain the materials that we need to fill those orders in a timelymanner which could have a material adverse effect on our business and operatingresults.

 

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

 

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

 

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

 

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

 

• Problemsassimilating the purchased operations, technologies or products;

 

• Costsassociated with the acquisition;

 

• Adverseeffects on existing business relationships with suppliers and customers;

 

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

 

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• Potentialloss of key employees of purchased organizations; and

 

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

 

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

 

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

 

**Ourdependence on a small number of customers means that the loss of a majorcustomer or any reduction in orders by a major customer would materially reduceour revenues. Historically, a relatively small number of customers haveaccounted for a significant percentage of our revenues. Our ten largestcustomers accounted for an aggregate of 54.2% and 55.2% of our total revenuesin the second quarter and first half of 2003, respectively, compared to 56.6%and 56.6% of our total revenues in the second quarter and first half of 2002,respectively.**

** **

**Ourten largest Industrial Division customers accounted for an aggregate of 69.5%and 67.4% of our Industrial Division revenues, or 13.5% and 14.0% of our totalrevenues, in the second quarter and first half of 2003, respectively, and 81.6%and 80.4% of our Industrial Division revenues, or 23.9% and 18.0% of our totalrevenues, in the second quarter and first half of 2002, respectively.  Ourten largest Commercial Division customers accounted for an aggregate of 60.5%and 61.6% of our Commercial Division revenues, or 48.8% and 48.8% of our totalrevenues, in the second quarter and first half of 2003, respectively, and 60.7%and 60.1% of our Commercial Division revenues, or 42.9% and 46.6% of our totalrevenues, in the second quarter and first half of 2002, respectively. Ourlargest Commercial Division customer in each of the second quarter and firsthalf of 2003 and 2002, CDW Computer Centers, accounted for 23.8% and 26.0% ofour Commercial Division revenues, or 19.2% and 20.6% of our total revenues, inthe second quarter and first half of 2003, respectively, and 30.0% and 27.3% ofour Commercial Division revenues, or 21.2% and 21.2% of our total revenues, inthe second quarter and first half of 2002, respectively. In addition, Sam’sClub accounted for 14.5% of our Commercial Division revenues, or 11.7% of ourtotal revenues in the second quarter of 2003 and Unisys accounted for 47.0% ofour Industrial Division revenues, or 13.8% of our total revenues in the secondquarter of 2002.  Other than CDWComputer Centers, Sam’s Club and Unisys, no customer accounted for more than10.0% of our total revenues in each of the second quarters or first halves of2003 or 2002.**

** **

Consolidation in some of ourcustomers’ industries may result in increased customer concentration and thepotential loss of customers as a result of acquisitions. In addition, thecomposition of our major customer base changes from quarter to quarter as themarket demand for our customers’ products changes, and we expect this variabilitywill continue in the future. We expect that sales of our products to a smallnumber of customers will continue to contribute materially to our revenues inthe foreseeable future.  The loss of, or a significant reduction inpurchases by any of our major customers, could harm our business, financialcondition and results of operations.

 

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

 

Manouch Moshayedi, MikeMoshayedi and Mark Moshayedi, each of whom is an executive officer and directorof SimpleTech, are brothers and beneficially own approximately 78.8% of ourcommon stock at June 30, 2003. As a result, they have the ability tocontrol all matters requiring approval by our shareholders, including theelection and removal of directors, approval of significant corporatetransactions and the ability to control the decision of whether a change incontrol will occur.

 

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

 

The semiconductor industryis characterized by vigorous protection and pursuit of intellectual propertyrights. We believe that it may be necessary, from time to time, to initiatelitigation against one or more third parties to preserve our intellectualproperty rights. In addition, from time to time, we have

 

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received, and may continue to receive in the future, noticesthat claim we have infringed upon, misappropriated or misused other parties’proprietary rights, which claims could result in litigation. Such litigationwould likely result in significant expense to us and divert the efforts of ourtechnical and management personnel. In the event of an adverse result in suchlitigation, we could be required to pay substantial damages, cease themanufacture, use and sale of certain products, expend significant resources todevelop non-infringing technology, discontinue the use of certain processes orobtain licenses to use the infringed technology. Such a license may not beavailable on commercially reasonable terms, if at all. Our failure to obtain alicense or our failure to obtain a license on commercially reasonable termscould cause us to incur substantial costs and suspend manufacturing productsusing the infringed technology. If we obtain a license, we would likely berequired to make royalty payments for sales under the license. Such paymentswould increase our costs of revenues and reduce our gross profit.  Inaddition, any litigation, whether as plaintiff or as defendant, would likelyresult in significant expense to us and divert the efforts of our technical andmanagement personnel, whether or not such litigation is ultimately determinedin our favor. In addition, the results of any litigation are inherentlyuncertain.

 

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

 

We are currently a party tofour lawsuits regarding intellectual property as further described under “LegalProceedings.” The outcome of litigation is inherently uncertain and we cannotpredict the outcome of these lawsuits with certainty. These lawsuits havediverted, and are expected to continue to divert, the efforts and attention ofour key management and technical personnel. In addition, we have incurred, andexpect to continue to incur, substantial legal fees and expenses in connectionwith these lawsuits. As a result, our defense of these lawsuits, regardless oftheir eventual outcomes, has been, and will continue to be, costly and timeconsuming. In addition, if our IC Tower stacking patent is found to be invalid,our ability to exclude competitors from making, using or selling the same orsimilar products to our IC Tower stacking products would cease. In addition, ifwe are found to infringe valid patents of others, we may be excluded from usingthe infringed technology without a license, which may not be available oncommercially reasonable terms, if at all.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

• preventthe challenge, invalidation or circumvention of our existing patents;

 

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

 

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

 

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

 

• provideadequate protection for our intellectual property rights;

 

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

 

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

 

• result inpatents from any of our pending applications.

 

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

 

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

 

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

 

We currently have in effecta number of agreements in which we have agreed to defend, indemnify and holdharmless certain of our customers and suppliers from damages and costs whichmay arise from the infringement by our products of third-party patents,trademarks or other proprietary rights. We may periodically have to respond toclaims and litigate these types of indemnification obligations. Any

 

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such indemnification claims could require us to paysubstantial damages. Our insurance does not cover intellectual propertyinfringement.

 

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

 

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

 

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

 

To the extent we manufactureproducts in anticipation of future demand that does not materialize, or in theevent a customer cancels outstanding orders, we could experience anunanticipated increase in our inventory. A lack of consumer demand for ourproducts may also cause increased product returns. A majority of our salesthrough commercial channels include limited rights to return unsold inventory.In addition, while we may not be contractually obligated to accept returnedproducts, we may determine that it is in our best interest to accept returns inorder to maintain good relations with our customers. Product returns wouldincrease our inventory and reduce our revenues.  We have had to write-downinventory in the past for reasons such as obsolescence, excess quantities anddeclines in market value below our costs. These inventory write-downs wereapproximately $170,000 and $195,000 in the second quarter and first half of2003, respectively, compared to $122,000 and $477,000 in the second quarter andfirst half of 2002, respectively. In addition, we offer some of our CommercialDivision customers limited price protection rights for inventories of ourproducts held by them. If we reduce the list price of our products, thesecustomers may receive credits from us. We incurred price protection charges ofapproximately $166,000 and $680,000 in the second quarter and first half of2003, respectively, compared to $490,000 and $787,000 in the second quarter andfirst half of 2002, respectively.  We also offer rebate programs throughsome of our Commercial Division customers to end-users.  We incurredrebate charges of $366,000 and $720,000 in the second quarter and first half of2003, respectively, compared to $218,000 and $569,000 in the second quarter andfirst half of 2002, respectively.

 

We are also subject torepurchase agreements with various financial institutions in connection withwholesale inventory financing. Under these agreements, we may be required torepurchase inventory upon customer default with a financing institution andthen resell the inventory through normal distribution channels. As ofJune 30, 2003, we have not been required to repurchase inventory inconnection with the customer default agreements noted above. However, it may bepossible that we will be required to repurchase inventory, upon customerdefault, in the future. Sales under such agreements were approximately $276,000and $510,000 in the second quarter and first half of 2003, respectively,compared to $177,000 and $366,000 in the second quarter and first half of 2002,respectively.

 

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

 

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

 

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

 

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

 

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

 

**Terroristactivities and resulting military and other actions could adversely affect ourbusiness.**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The volatility of generaleconomic conditions and fluctuations in currency exchange rates affect theprices of our products and the prices of the components used in our products.International sales of our products accounted for 21.2% and 21.4% of ourrevenues in the second quarter and first half of 2003, respectively, and 13.3%and 12.7% of our revenues in the second quarter and first half of 2002,respectively.  Except for Europe, which accounted for 11.3% and 12.2%,respectively, of our revenues for the second quarter and first half of 2003, noother foreign geographical area or single foreign country accounted for morethan 10.0% of our revenues in the second quarters or first half of 2003 or2002.  For the second quarters and first halves of 2003 and 2002, morethan 95.0% of our international sales were denominated in U.S. dollars.However, if there is a significant devaluation of the currency in a specificcountry, the prices of our products will increase relative to that country’scurrency and our products may be less competitive in that country. In addition,we cannot be sure that our international customers will continue to be willingto place orders denominated in U.S. dollars. If they do not, our revenues andresults of operations will be subject to foreign exchange fluctuations, whichcould harm our business. We do not hedge against foreign currency exchange raterisks.

 

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

 

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

 

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

 

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

 

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

 

We are subject to a varietyof environmental laws and regulations governing, among other things, airemissions, waste water discharge, waste storage, treatment and disposal, andremediation of releases of hazardous materials. Our failure to comply withpresent and future requirements could harm our ability to continuemanufacturing our products. Such requirements could require us to acquirecostly equipment or to incur other significant expenses to comply withenvironmental regulations. The imposition of additional or more stringentenvironmental requirements, the results of future testing at our facilities, ora determination

 

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that we are potentially responsible for remediation at othersites where problems are not presently known to us, could result in expenses inexcess of amounts currently estimated to be required for such matters.

 

**Failure to complywith governmental laws and regulations could harm our business.**

 

Our businessis subject to regulation by various federal and state governmentalagencies.  Such regulation includes theradio frequency emission regulatory activities of the Federal CommunicationsCommission, the anti-trust regulatory activities of the Federal TradeCommission and Department of Justice, the consumer protection laws of theFederal Trade Commission, the import/export regulatory activities of the Departmentof Commerce, the product safety regulatory activities of the Consumer ProductsSafety Commission, the regulatory activities of the Occupational Safety andHealth Administration, the environmental regulatory activities of theEnvironmental Protection Agency, the labor regulatory activities of the EqualEmployment Opportunity Commission and tax and other regulations by avariety of regulatory authorities in each of the areas in which we conductbusiness. We are also subject to regulation in other countries where weconducts business. In certain jurisdictions, such regulatory requirements maybe more stringent than in the United States. We are also subject to a variety of federal and state employment andlabors laws and regulations, including the Americans with Disabilities Act, theFederal Fair Labors Standards Act, the WARN Act and other regulations relatedto working conditions, wage-hour pay, over-time pay, employee benefits,anti-discrimination, and termination of employment.

 

Noncompliancewith applicable regulations or requirements could subject us to investigations,sanctions, mandatory product recalls, enforcement actions, disgorgement ofprofits, fines, damages, civil and criminal penalties, or injunctions. Inaddition from time to time we have received, and expect to continue to receive,correspondence from former employees terminated by us who threaten to bringclaims against us that stem from their termination or allegations thatwe have violated one or more labor and employment regulations.  In certain of these instances the formeremployee has brought claims against us and we expect that we will encountersimilar actions against us in the future. An adverse outcome in any such litigation could require us to paycontractual damages, compensatory damages, punitive damages, attorneys’ feesand costs.

 

Theseenforcement actions could have a material adverse effect on our business,financial condition, results of operations and cash flows.  If any governmental sanctions are imposed,or if we were not to prevail in civil or criminal litigation, our business,financial condition, results of operations and cash flows could be materiallyadversely affected. In addition, responding to any action will likely result ina significant diversion of management’s attention and resources and an increasein professional fees.

 

**ITEM3****.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

**InterestRate Risk**

** **

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

 

At June 30, 2003, ourcash and cash equivalents were $34.0 million. At June 30, 2003, our cash and cash equivalents included $24.2million invested in money market and other interest bearing accounts and $9.8million invested in securities, which represents investments in corporatebonds, auction rate securities and commercial paper with maturities of less thanthree months.  At June 30, 2003, our investments in securities withmaturities of less than three months had a weighted-average time to maturity of19.5 days.

 

At June 30, 2003, ourinvestment in marketable securities was $10.0 million.  The marketable securitiesconsist primarily of $100,000 certificates of deposit with an original maturityof one year at 100 different financial institutions.  At June 30,2003, these marketable securities had a weighted-average time to maturity ofapproximately 262.0 days. Marketable securities represent investments with anoriginal 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.

 

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If interest rates were todecrease 1%, the result would be an annual decrease in our interest incomerelated to our cash and cash equivalents of approximately $340,000. However, due to the uncertainty of the actions that would be taken and theirpossible effects, this analysis assumes no such action.  Further, thisanalysis does not consider the effect of the change in the level of overalleconomic activity that could exist in such an environment.

 

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

 

**ITEM 4**.  CONTROLS AND PROCEDURES

** **

**(a) *Evaluation of Disclosure Controls and Procedures*.  An evaluation as of the end of the periodcovered by this report was carried out under the supervision and with theparticipation of our management, including our principal executive officer andprincipal financial officer, of the effectiveness of our disclosure controlsand procedures, as such term is defined under Rule 13a-15(e) and Rule 15d –15promulgated under the Securities Exchange Act of 1934, as amended (the“Exchange Act”).  Based on theirevaluation, our principal executive officer and principal financial officerconcluded that our disclosure controls and procedures are effective to ensurethat we record, process, summarize, and report information required to bedisclosed by us in our quarterly reports filed under the Securities ExchangeAct within the time periods specified by the Securities and ExchangeCommission’s rules and forms.**

** **

**(b) *Changes in Internal Controls*.  During the quarterly period covered by this report, there havenot been any changes in our internal controls over financial reporting (asdefined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that havematerially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.**

 

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**PART II**

**OTHERINFORMATION**

 

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

### ** **

**DPACTechnologies, Inc.—Patent Infringement**

 

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

 

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

 

We received notice onNovember 26, 2001, that the Lemelson Medical, Education & ResearchFoundation, LLP (“Lemelson Foundation”) filed a complaint on November 13,2001, against us and other defendants.  The complaint was filed in theDistrict Court of Arizona and alleges that our manufacturing processes infringeseveral patents that the Lemelson Foundation allegedly owns.  Thecomplaint also states that these allegedly infringed patents relate to machinevision technology and bar coding technology.  On March 7, 2002, wewere served with the Lemelson Foundation complaint.  Thereafter, the casewas stayed pending the outcome of related cases against parties involving thesame patents.  Because of the preliminary stage of this case, an estimateof potential damages, if any, would be premature and speculative, and we havenot made any such estimate at this time.

 

**Lexar Media, Inc.— Unfair Trade Practice and Patent Infringment**

 

On October 1, 2002, wefiled a lawsuit against Lexar Media, Inc. in the Superior Court of OrangeCounty, California for trade libel, libel per se, intentional interference withprospective economic advantage and California unfair competition, seekingunspecified damages, including punitive and trebled damages.  The lawsuit arose from correspondence sentby Lexar Media to one of the our customers that alleged that certain of ourproducts infringe Lexar Media’s patents.  On October 30, 2002, LexarMedia filed a notice of removal, which removed the matter from the OrangeCounty Superior Court to the United States District Court for the CentralDistrict of California.  OnNovember 14, 2002, we amended our complaint to add violation of theSherman Antitrust Act, violation of the California Unfair Trade Practices Actand common law unfair competition as causes of action.  On November 6, 2002, Lexar Media fileda motion to dismiss our complaint.  On January 8, 2003, the Courtdenied Lexar’s motion as to the initial four causes of actions and dismissedthe violation of the Sherman Antitrust Act, violation of the California UnfairTrade Practices Act and common law unfair competition causes of actions againstLexar Media.

 

On July 21, 2003, Lexarfiled a motion for summary judgment seeking dismissal of our amended complaintand a Rule 11 motion requesting sanctions against us for filing the amendedcomplaint. On August 11, 2003, the Court ruled on Lexar's motion for summaryjudgment on our underlying causes of action. According to the Court's ruling, there was not clear and convincingevidence that Lexar's actions were conducted in bad faith. As a result, theCourt granted Lexar's motion for summary judgment, but denied Lexar's Rule 11motion.

 

On March 20, 2003,Lexar Media filed a counter claim against us alleging that the Memory Stickproducts sold by us violate Lexar Media’s U.S. patent No. 5,479,638. Lexar Media is seeking monetary damages in an amount to be stated later, aninjunction against further infringement of its patent, attorneys’ fees andtrebled damages.  We purchase our Memory Stick products from I-OData.  Under the terms of the distribution agreement with I-O Data, I-OData has agreed to indemnify, defend and hold us harmless from claims, damages,losses and costs which may arise from the alleged infringement by its productsof third-party patents, trademarks or other proprietary rights.  Afterinitially agreeing to indemnify us and assume our defense, I-O Data has failedto assume our defense.  As a result, wefiled an answer to Lexar Media’s counter claim and filed a Third PartyComplaint against I-O Data asking for indemnification.  This lawsuit is in the early stage ofdiscovery and the court has set a trial for April 2004.  Because ofthe preliminary stage of this case, an estimate of potential damages, if any,would be premature and speculative, and we have not made any such estimate atthis time.

 

**StaktekCorporation—Patent Infringement**

 

On July 30, 2003, wefiled a lawsuit against Staktek Corporation in the United States District Courtfor the Central District of California for infringement of our IC Towerstacking patent, U.S. Patent No. Re. 36,916. We are seeking monetary damages in an amount to be stated later, aninjunction against further infringement of our patent, attorneys' fees andtrebled damages.  No court dates havebeen set.

 

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We are notcurrently involved in any other material legal proceedings. We are not aware ofany other material legal proceedings threatened or pending against us. Fromtime to time, however, we may become subject to additional legal proceedings,claims, and litigation arising in the ordinary course of business, including,but not limited to, employee, customer and vendor disputes. In addition, in thepast we have received, and we may continue to receive in the future, lettersalleging infringement of patent or other intellectual property rights. Ourmanagement believes that these letters generally are without merit and intendto contest them vigorously.

 

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

 

None.

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

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

 

We held our2003 Annual Meeting of Shareholders as further discussed below:

 

(a)                                  Our 2003 Annual Meeting ofShareholders was held on May 14, 2003 in Irvine, California.

 

(b)                                 Proxies for the Annual Meeting weresolicited pursuant to Regulation 14 under the Securities Exchange Act of 1934,as amended, there was no solicitation in opposition to the management’snominees as listed in the proxy statement, and all of such nominees wereelected.

 

(c)                                  At the Annual Meeting, the followingmatters were considered and voted upon:

 

(i) Theelection of seven directors to our board of directors.  Our board of directors currently consists ofseven persons.  All seven positions onour board of directors were to be elected at our Annual Meeting.  At the Annual Meeting, our shareholderselected each of the following director nominees as directors, to serve on ourboard of directors until the next Annual Meeting of Shareholders or until theirsuccessors are duly elected and qualified. The vote for each director was asfollows: 

 
| **Name**          |   | **For**    |   | **Withheld** |   |
|-------------------|--------|------------|--------|--------------|--------|
| Manouch Moshayedi |   | 36,334,207 |   | 1,773,417    |   |
| Mike Moshayedi    |   | 36,334,207 |   | 1,773,417    |   |
| Mark Moshayedi    |   | 36,334,207 |   | 1,773,417    |   |
| Dan Moses         |   | 36,334,207 |   | 1,773,417    |   |
| F. Michael Ball   |   | 37,633,107 |   | 474,517      |   |
| Mark R. Hollinger |   | 37,633,107 |   | 474,517      |   |
| James J. Peterson |   | 37,633,107 |   | 474,517      |   |

 

(ii) To ratify the appointment of PricewaterhouseCoopers LLP as ourindependent auditors for the fiscal year ending December 31, 2003.  At the Annual Meeting, our shareholdersapproved this proposal by the votes indicated below:

 
|        |   | **Shares** |   |
|-------------|--------|------------|--------|
| **For**     |   | 38,054,552 |   |
| **Against** |   | 25,879     |   |
| **Abstain** |   | 27,193     |   |

 

(d)                                 Notapplicable.

 

**Item5.  Other Information**

 

None.

 

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

 

(a)  Exhibits.

 
| **Exhibit  Number** |   | **Description**                                                                                                                                     |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                |
| 31.1                |   | Section 302 Certification of Chief Executive Officer                                                                                                |
| 31.2                |   | Section 302 Certification of Chief Financial Officer                                                                                                |
| 32.1*               |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |
| 32.2*               |   | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |

 

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* The information in Exhibits 32.1 and 32.2shall not be deemed  “filed” forpurposes of Section 18 of the Securities Exchange Act of 1934, as amended (the“Exchange Act”), or otherwise subject to the liabilities of that section, norshall they be deemed incorporated by reference in any filing under theSecurities Act of 1933, as amended, or the Exchange Act (including thisReport), unless SimpleTech specifically incorporates the foregoing informationinto those documents by reference.

 

(b)  Reports on Form 8-K.

 

(i)                                     ACurrent Report on Form 8-K was furnished by SimpleTech with the Securities andExchange Commission on April 29, 2003, to report under Item 12 the pressrelease issued to the public on April 29, 2003 reporting the results ofthe first quarter ended March 31, 2003. In accordance with General Instruction B.6 of Form 8-K, the informationin the Form 8-K and the exhibit attached thereto was not “filed” for purposesof Section 18 of the Exchange Act, or otherwise subject to the liabilities ofthat section, nor shall it be deemed incorporated by reference in any filingunder the Securities Act of 1933, as amended, or the Exchange Act (includingthis Report), unless SimpleTech specifically incorporates the foregoinginformation into those documents by reference.

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

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

 

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### **SIMPLETECH, INC.**

### **Index to Exhibits**

### ** **

| **Exhibit  Number** |   | **Description**                                                                                                                                      |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1                |   | Section 302 Certification of Chief  Executive Officer                                                                                                |
| 31.2                |   | Section 302 Certification of Chief  Financial Officer                                                                                                |
| 32.1*               |   | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 32.2*               |   | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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* The information in Exhibits 32.1 and 32.2 shall not be deemed  “filed” for purposes of Section 18 of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwisesubject to the liabilities of that section, nor shall they be deemedincorporated by reference in any filing under the Securities Act of 1933, as amended,or the Exchange Act (including this Report), unless SimpleTech specificallyincorporates the foregoing information into those documents by reference.

 

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