<PAGE>

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                               ----------------

                                   FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

  For the quarterly period ended June 30, 2001

                                       OR

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

  For the transition period from                       to


                        Commission file number 000-31103

                               LEXAR MEDIA, INC.
             (Exact name of registrant as specified in its charter)

<TABLE>
      <S>                                       <C>
                      Delaware                               33-0723123
          (State or other jurisdiction of       (I.R.S. Employer Identification No.)
           incorporation or organization)

               47421 Bayside Parkway
                Fremont, California                            94538
      (Address of principal executive offices)               (Zip Code)
</TABLE>

                                 (510) 413-1200
              (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) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter 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 [X] No [_]

 Number of shares of common stock outstanding as of August 8, 2001: 60,490,973

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>

                               LEXAR MEDIA, INC.

                                   FORM 10-Q
                      FOR THE QUARTER ENDED JUNE 30, 2001

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
 <C>        <S>                                                            <C>
 PART I. FINANCIAL INFORMATION

    Item 1. Financial Statements
            Condensed Consolidated Balance Sheets as of June 30, 2001
             and December 31, 2000......................................     1
            Condensed Consolidated Statements of Operations for the
             Three-Month and Six-Month Periods Ended June 30, 2001 and
             2000.......................................................     2
            Condensed Consolidated Statements of Cash Flows for the Six
             Months Ended June 30, 2001 and 2000 .......................     3
            Notes to Unaudited Condensed Consolidated Financial
             Statements.................................................     4
    Item 2. Management's Discussion and Analysis of Financial Condition
             and Results of Operations .................................     8
    Item 3. Quantitative and Qualitative Disclosures About Market Risk..    29

 PART II. OTHER INFORMATION

    Item 1. Legal Proceedings...........................................    30
    Item 2. Changes in Securities and Use of Proceeds...................    30
    Item 3. Defaults Upon Senior Securities.............................    30
    Item 4. Submission of Matters to a Vote of Security Holders.........    31
    Item 5. Other Information...........................................    31
    Item 6. Exhibits....................................................    31

 SIGNATURES.............................................................    32
</TABLE>
<PAGE>

PART I--FINANCIAL INFORMATION

1. Financial Statements

                       LEXAR MEDIA, INC. AND SUBSIDIARIES

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                (in thousands, except share and per share data)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                         June 30,   December 31,
                                                           2001         2000
                                                         ---------  ------------
<S>                                                      <C>        <C>
                        ASSETS
                        ------
Current assets:
  Cash and cash equivalents (includes restricted cash
   of $1,250 and $1,000)...............................  $  14,041    $  8,755
  Short-term investments...............................        --       19,987
  Accounts receivable, net.............................     13,011       8,767
  Inventory............................................      9,300      27,536
  Prepaid expenses and other current assets............      1,049       1,909
                                                         ---------    --------
    Total current assets...............................     37,401      66,954
Property and equipment, net............................      3,364       3,364
Intangible assets, net.................................        343       3,544
Other assets...........................................        814         986
                                                         ---------    --------
    Total assets.......................................  $  41,922    $ 74,848
                                                         =========    ========

         LIABILITIES AND STOCKHOLDERS' EQUITY
         ------------------------------------
Current liabilities:
  Accounts payable.....................................  $  10,713    $  8,007
  Accrued liabilities..................................      9,713       8,886
  Deferred revenue.....................................      6,878         446
  Notes payable to stockholders........................        205         362
  Note payable to bank.................................        651       6,088
                                                         ---------    --------
    Total current liabilities..........................     28,160      23,789
Notes payable to stockholders, net of current portion..        --          159
Notes payable, net.....................................      2,020       1,362
                                                         ---------    --------
    Total liabilities..................................     30,180      25,310

Commitments and contingencies

Stockholders' equity:
Common stock, $0.0001 par value:
  75,000,000 shares authorized; 60,264,536 and
   60,052,462 shares issued and outstanding............          6           6
  Additional paid-in capital...........................    149,374     152,796
  Unearned stock-based compensation....................     (3,349)     (9,586)
  Notes receivable from stockholders...................     (4,992)     (5,292)
  Accumulated deficit..................................   (129,257)    (88,348)
  Accumulated other comprehensive loss.................        (40)        (38)
                                                         ---------    --------
    Total stockholders' equity.........................     11,742      49,538
                                                         ---------    --------
    Total liabilities and stockholders' equity.........  $  41,922    $ 74,848
                                                         =========    ========
</TABLE>

  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.

                                       1
<PAGE>

                       LEXAR MEDIA, INC. AND SUBSIDIARIES

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)
                                  (unaudited)

<TABLE>
<CAPTION>
                                           Three Months
                                               Ended         Six Months Ended
                                         ------------------  ------------------
                                         June 30,  June 30,  June 30,  June 30,
                                           2001      2000      2001      2000
                                         --------  --------  --------  --------
<S>                                      <C>       <C>       <C>       <C>
Revenues:
  Product revenues.....................  $ 13,579  $ 24,516  $ 29,551  $ 40,566
  License revenues.....................     3,760       250     4,009       250
                                         --------  --------  --------  --------
    Total revenues.....................    17,339    24,766    33,560    40,816
Cost of product revenues (excludes
 stock-based compensation of $23, $423,
 $51, and $766)........................    17,946    20,681    40,118    34,052
                                         --------  --------  --------  --------
Gross margin...........................      (607)    4,085    (6,558)    6,764
                                         --------  --------  --------  --------
Operating expenses:
  Research and development (excludes
   stock-based compensation of $188,
   $1,344, $706 and $2,705)............     1,612     2,014     3,206     3,551
  Sales and marketing (excludes stock-
   based compensation of $(49), $580,
   $145 and $1,185)....................     5,324     5,129    11,985     8,126
  General and administrative (excludes
   stock-based compensation of $256,
   $1,787, $1,013 and $3,512)..........     3,871     3,402     7,671     5,860
  Goodwill impairment..................       --        --      2,854       --
  Restructuring charge.................     2,086       --      2,086       --
  Stock-based compensation.............       418     4,134     1,915     8,168
                                         --------  --------  --------  --------
    Total operating expenses...........    13,311    14,679    29,717    25,705
                                         --------  --------  --------  --------
Loss from operations...................   (13,918)  (10,594)  (36,275)  (18,941)
Other income and expense:
  Interest and other expense...........    (1,984)     (380)   (3,356)     (509)
  Interest and other income............        64       181       322       351
                                         --------  --------  --------  --------
    Total other income (expense).......    (1,920)     (199)   (3,034)     (158)
                                         --------  --------  --------  --------
Loss before income taxes...............   (15,838)  (10,793)  (39,309)  (19,099)
                                         --------  --------  --------  --------
Foreign tax expense....................     1,600       --      1,600       --
                                         --------  --------  --------  --------
    Net loss...........................  $(17,438) $(10,793) $(40,909) $(19,099)
                                         ========  ========  ========  ========
Net loss per common share--basic and
 diluted...............................  $  (0.30) $  (1.27) $  (0.71) $  (2.29)
                                         ========  ========  ========  ========
Shares used in net loss per common
 share calculation--basic and diluted..    57,864     8,575    57,595     8,471
                                         ========  ========  ========  ========
</TABLE>

  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.

                                       2
<PAGE>

                       LEXAR MEDIA, INC. AND SUBSIDIARIES

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                            Six Months Ended
                                                            ------------------
                                                            June 30,  June 30,
                                                              2001      2000
                                                            --------  --------
<S>                                                         <C>       <C>
Cash flows from operating activities:
  Net Loss................................................  $(40,909) $(19,099)
  Adjustments to reconcile net loss to net cash used in
   operating activities:
    Depreciation and amortization.........................     1,081       853
    Goodwill impairment...................................     2,854       --
    Restructuring charge..................................     2,086       --
    Amortization of stock-based compensation..............     1,915     8,168
    Imputed and other non-cash interest...................     2,724        89
    Change in operating assets and liabilities:
      Accounts receivable, net............................    (4,244)       28
      Inventory...........................................    18,236    (2,501)
      Prepaid expenses and other assets...................       428    (1,220)
      Accounts payable and accrued liabilities............     1,447     3,620
      Deferred revenue....................................     6,632       902
                                                            --------  --------
        Net cash used in operating activities.............    (7,750)   (9,160)
                                                            --------  --------
Cash flows from investing activities:
  Purchase of property and equipment......................      (728)   (1,488)
  Cash used in acquisition of Impact Peripherals, Ltd. ...       --        (64)
  Cash acquired upon acquisition of Printroom.com, Inc. ..       --         49
  Proceeds from short-term investments....................    19,987     3,896
                                                            --------  --------
        Net cash provided by investing activities.........    19,259     2,393
                                                            --------  --------
Cash flows from financing activities:
  Issuance of stock under employee stock purchase plan....       167       --
  Exercise of stock options...............................        45       301
  Repayment of notes payable..............................    (6,425)      (38)
  Proceeds from notes payable.............................       --       2037
  Proceeds from notes payable to stockholders.............       --     11,775
  Repurchase of stock.....................................        (8)      (11)
                                                            --------  --------
        Net cash provided by (used in) financing
         activities.......................................    (6,221)   14,064
                                                            --------  --------
  Effect of exchange rates on cash and cash equivalents...        (2)      --
                                                            --------  --------
Net increase in cash and cash equivalents.................     5,286     7,297
Cash and cash equivalents at beginning of period..........     8,755     6,495
                                                            --------  --------
Cash and cash equivalents at end of period................  $ 14,041  $ 13,792
                                                            ========  ========
Supplemental disclosure of non-cash financing and
 investing activities:
  Re-pricing of warrants in connection with amended credit
   facility agreement.....................................  $    792  $    --
  Exercise of stock options and restricted stock grants in
   exchange for full recourse notes receivable............       --      3,236
Issuance of warrants and accrual of expenses in connection
 with the Chase credit facility...........................       --      3,940
Issuance of common stock in connection with acquisition of
 Printroom.com and Impact Peripherals, Ltd. ..............       --      4,040
Repurchase of common stock by cancellation of notes
 receivable...............................................       300       --
Issuance of warrant in connection with license and royalty
 agreement................................................       206       --
Issuance of common stock for browser development..........       --        200
</TABLE>

  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.

                                       3
<PAGE>

                      LEXAR MEDIA, INC. AND SUBSIDIARIES

             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1--Basis of Presentation

   The accompanying unaudited condensed consolidated financial statements have
been prepared by Lexar Media, Inc. (the "Company"), in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all normally recurring adjustments considered necessary
for a fair presentation have been included.

   The financial statements should be read in conjunction with the audited
consolidated financial statements for the year ended December 31, 2000
included in our Annual Report on Form 10-K, as filed with the Securities and
Exchange Commission on April 2, 2001. The condensed consolidated balance sheet
data as of December 31, 2000 was derived from the audited financial
statements.

   The results of operations for the three and six months ended June 30, 2001
are not necessarily indicative of results that may be expected for any other
future period, including the fiscal year ending December 31, 2001.

Note 2--Summary of Selected Accounting Policies

 Revenue recognition

   The Company's customers include distributors, retailers, original equipment
manufacturers and end users. Certain customers have return and price
protection rights. The Company recognizes revenue where there is a contract or
purchase order, upon shipment or delivery depending on the terms of sale, and
where collectibility of the resulting receivable is reasonably assured. The
Company provides for estimated future returns and price protection based on
historical experience at the time revenue is recognized. At the time of sale,
the Company also provides for the estimated costs of meeting product warranty
obligations. For certain customers where the Company is unable to reasonably
estimate the level of returns or where the customers do not take title to the
product on delivery, revenues and the costs of revenues are deferred until
these customers have sold the product to their customers.

 Accounting for stock-based compensation

   The Company accounts for employee stock-based compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees," and Financial Accounting
Standards Board Interpretation ("FIN") No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans," and
complies with the disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." Under
APB No. 25, compensation expense is based on the difference, if any, on the
date of grant, between the estimated fair value of the Company's common stock
and the exercise price of the option. SFAS No. 123 defines a "fair value"
based method of accounting for an employee stock option or similar equity
investment. The Company accounts for equity instruments issued to non-
employees in accordance with the provisions of SFAS No. 123 and the Emerging
Issues Task Force ("EITF") 96-18, "Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services."

 Accounting for derivative instruments and hedging activities

   The Company adopted SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," which

                                       4
<PAGE>

                      LEXAR MEDIA, INC. AND SUBSIDIARIES

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

establish accounting and reporting standards for derivative instruments and
hedging activities. SFAS No. 133 and SFAS No. 138 require that an entity
recognize all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. The accounting for changes in the
fair value of a derivative depends on the intended use of the derivative and
the resulting designation.

   For a derivative designated as a fair value hedge, the gain or loss is
recognized in earnings in the period of change together with the offsetting
loss or gain on the hedged item attributed to the risk being hedged. For a
derivative designated as a cash flow hedge, the effective portion of the
derivative's gain or loss is initially reported as a component of other
comprehensive income and subsequently reclassified into earnings when the
hedged exposure affects earnings. The ineffective portion of the gain or loss
is reported in earnings immediately. For a derivative not designated as a
hedging instrument, the gain or loss is recognized in earnings in the period
of change.

   A majority of the Company's revenues and costs are denominated in United
States dollars, and to date the Company has not entered into any derivative
contracts. The Company adopted SFAS No. 133 and SFAS No. 138 on January 1,
2001. The adoption did not have any impact on the Company's consolidated
financial statements.

 Recent accounting developments

   In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for
business combinations initiated after June 30, 2001, and eliminates the
pooling-of-interests method. The Company believes that the adoption of SFAS
141 will not have a significant impact on its financial statements.

   In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS 142
requires, among other things, the discontinuance of goodwill amortization. In
addition, the standard includes provisions upon adoption for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill
and the testing for impairment of existing goodwill and other intangibles. The
Company is currently assessing but has not yet determined the impact of SFAS
142 on its financial position and results of operations.

 Shipping and handling costs

   Shipping and handling costs are included in selling and marketing expenses
in the Company's condensed consolidated statements of operations. These costs
were $0.5 million and $0.2 million for the three months ended June 30, 2001
and June 30, 2000, respectively, and $1.0 million and $0.5 million for the six
months ended June 30, 2001 and June 30, 2000, respectively.

Note 3--Balance Sheet Detail (in thousands)

<TABLE>
<CAPTION>
                                                           June 30, December 31,
                                                             2001       2000
                                                           -------- ------------
   <S>                                                     <C>      <C>
   Inventories:
     Raw materials........................................  $1,283    $ 4,897
     Controllers..........................................   1,527      1,483
     Flash memory products................................   5,508     19,183
     Ancillary products...................................     982      1,973
                                                            ------    -------
     Inventory............................................  $9,300    $27,536
                                                            ======    =======
</TABLE>

                                       5
<PAGE>

                      LEXAR MEDIA, INC. AND SUBSIDIARIES

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 4--Net Loss Per Common Share (in thousands, except per share data)

<TABLE>
<CAPTION>
                                          Three Months
                                              Ended         Six Months Ended
                                        ------------------  ------------------
                                        June 30,  June 30,  June 30,  June 30,
                                          2001      2000      2001      2000
                                        --------  --------  --------  --------
<S>                                     <C>       <C>       <C>       <C>
Numerator:
  Net loss............................. $(17,438) $(10,793) $(40,909) $(19,099)
  Accretion of mandatorily redeemable
   convertible preferred stock.........      --       (139)      --       (278)
                                        --------  --------  --------  --------
  Net loss after accretion of
   mandatorily redeemable convertible
   preferred stock..................... $(17,438) $(10,932) $(40,909) $(19,377)
                                        ========  ========  ========  ========
Denominator:
  Weighted average common shares
   outstanding.........................   60,256    14,867    60,225    14,576
  Weighted average unvested common
   shares subject to repurchase........   (2,392)   (6,292)   (2,630)   (6,105)
                                        --------  --------  --------  --------
  Denominator for basic and diluted
   calculations........................   57,864     8,575    57,595     8,471
                                        ========  ========  ========  ========
  Net loss per common share, basic and
   diluted............................. $  (0.30) $  (1.27) $  (0.71) $  (2.29)
                                        ========  ========  ========  ========
</TABLE>

   All outstanding shares under options, warrants and convertible preferred
stock during each period have been excluded since they are anti-dilutive.

Note 5--Interest Expense

   Interest expense for the second quarter of 2001 includes imputed interest
and other non-cash interest of $1.6 million associated primarily with the
amortization of the value of the warrants issued and fees paid in connection
with The Chase Manhattan Bank and Access Technology Partners credit
facilities. The Chase loan was for a term of one year and was repaid at the
end of the second quarter of 2001. Interest expense for the six-month period
ended June 30, 2001 includes imputed and other non-cash interest of $2.7
million and includes a charge of $0.7 million, which, in the first quarter of
2001, was added to the principal balance of the notes payable to Access in
connection with the forbearance agreement the Company entered into with Access
in February 2001.

Note 6--Restructuring

   At the end of the second quarter of fiscal 2001, the Company decided to
implement a 27% reduction in its work force and to discontinue its
Printroom.com operations. These actions were taken to allow the Company to
focus on its core competitive strengths and position itself for revenue growth
and near term profitability. In connection with these decisions, the Company
recognized a $2.1 million restructuring charge in the second quarter of fiscal
2001 for estimated severance costs related to organizational changes and the
planned reduction in work force, to reduce property and equipment to its
estimated realizable value and to provide for consolidation of excess
facilities and other charges related to the discontinuance of its operation of
Printroom.

                                       6
<PAGE>

                      LEXAR MEDIA, INC. AND SUBSIDIARIES

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


   No restructuring activity had taken place as of June 30, 2001. The
reduction of staff by approximately 40 employees, which included personnel
from all business functions, was implemented in July and August 2001, and is
substantially completed. The discontinuance of Printroom was effected as of
August 3, 2001. The following table represents the restructuring as of June
30, 2001:

<TABLE>
     <S>                                                                 <C>
     Reduction in workforce............................................. $1,052
     Asset write-offs ..................................................    554
     Excess facilities and related costs................................    368
     Other .............................................................    112
                                                                         ------
                                                                         $2,086
                                                                         ======
</TABLE>

Note 7--Notes Payable

   In the first quarter of 2001, we were in default of covenants related to
our term loan with Access Technology Partners ("Access"). In February 2001,
Access agreed to forbear from exercising its rights and remedies against that
default. The forbearance period extends until the earlier of (i) December 31,
2001 or (ii) the date any additional default occurs, at which time Access may,
at its option, exercise any and all rights or remedies in connection with the
aforementioned default.

   At June 30, 2001, the Company was in default of certain covenants in
relation to its term loan with Access. In July 2001, Access issued a waiver of
this default.

                                       7
<PAGE>

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.

   The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our condensed
consolidated financial statements and related notes included elsewhere in this
report. In addition to historical information, this discussion contains
certain forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those anticipated by these
forward-looking statements due to factors, including, but not limited to,
those set forth under "Risks That Could Affect Future Results" and elsewhere
in this report. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. We
undertake no obligation to update these forward-looking statements to reflect
events or circumstances occurring after the date hereof.

Overview

   We design, develop and market high-performance digital film and
connectivity products for the digital photography market. Our products and
services allow customers to capture digital images and download them quickly
to a personal computer for editing, distributing and printing. We also license
our proprietary controller technology and sell controllers to other
manufactures of flash storage media to address markets adjacent to digital
photography.

   Our broad line of high-performance digital film offers removable and
reusable storage devices that capture images from a digital camera. During the
second quarter of 2001, digital film and other product sales comprised
approximately 78.3% of our revenues. Our digital film combines flash memory
from leading suppliers with our patented technology to address the needs of
professional, commercial and consumer photographers. Our digital film is
compatible with substantially all digital cameras, including those
manufactured by Agfa, Canon, Casio, Epson, Fuji, Hewlett-Packard, Kodak,
Konica, Minolta, Nikon, Olympus, Polaroid, Ricoh, Sony and Yashica. We offer
digital film in the three primary media formats currently used by digital
cameras: CompactFlash, SmartMedia and Memory Stick, as well as in the
MultiMedia Card and Secure Digital Card formats, which are flash memory
products used in digital cameras and other electronic devices. We also offer
digital film in the PC Card format, but are in the process of phasing out our
PC Card digital film products.

   Our digital film reader/writers are products that facilitate the transfer
of digital images to personal computers and other devices without a direct
connection to the digital camera. Our JumpShot cable connects the universal
serial bus, or USB, port to our USB-enabled CompactFlash digital film to
quickly and easily transfer images.

   In addition to digital photography, our technology can be applied to a
variety of consumer electronic applications such as digital music players,
laptop computers, personal digital assistants, telecommunication and network
devices and digital video recorders. In order to extend our technology into
these adjacent markets, we have selectively licensed our technology to third
parties. As one example, we entered into an agreement with Sony in 2000 to
combine our proprietary controller technology with their Memory Stick media
format and include the Memory Stick as one of our digital film products. The
Memory Stick is used in a wide variety of consumer electronic products,
including camcorders, personal computers, portable music players, cameras and
video recorders.

   In April 2001, we finalized our supply agreement and our license agreement
with Samsung Electronics Co., Ltd. Under the supply agreement, we purchase a
substantial portion of our flash memory needs from Samsung at an agreed upon
pricing formula. Samsung has also guaranteed a certain allocation of flash
memory production capacity to us. Samsung also has the right to purchase our
flash memory controllers. Under the license agreement, Samsung entered into a
royalty-bearing license for our technology for some of their products. We
received the first payment under the license agreement in April 2001.

   In April 2001, we entered into a license agreement with Olympus Optical
Co., Ltd. and Olympus Promarketing, Inc., which we collectively refer to as
Olympus. Under the license agreement, we granted Olympus a non-exclusive
license to our technology, agreed that Olympus would bundle our Lexar-branded
digital

                                       8
<PAGE>

film with all Olympus cameras distributed in Japan, gave Olympus exclusive
rights to distribute our Lexar-branded digital film in Japan and agreed to
jointly develop next generation digital film for use in Olympus cameras. We
received the first payment under the license agreement in June 2001.

   In June 2001, we formed Lexar Media International, Ltd., a subsidiary based
in Dublin, Ireland, for the purpose of reducing operational and other costs by
centralizing certain activities related to supporting our European markets and
our technology licensing activities.

   Revenues. We generate revenues primarily from the sale of digital film and
connectivity products to end-users through mass market, photo and original
equipment manufacturer channels. In 2000, we began generating revenues from
the licensing of our technology to Sony. In the second quarter of 2001 we
began generating licensing revenues under our recently signed agreements with
Samsung and Olympus. During the second quarter of 2001, we also generated
revenues from the sales of our controllers to flash storage manufacturers.

   Our customers include distributors, retailers, original equipment
manufacturers and end users. Certain customers have return and price
protection rights. We recognize revenue where there is a contract or purchase
order, upon shipment or delivery depending on the term of sale, and when
collectibility of the resulting receivable is reasonably assured. We provide
for estimated future returns and price protection based on historical
experience at the time revenue is recognized. At the time of sale, we also
provide for the estimated costs of meeting product warranty obligations. For
certain customers, including where we are unable to reasonably estimate the
level of returns or where the customers do not take title to the product on
delivery, revenues and the costs of revenues are deferred until the customers
have sold the product to their customers.

   A majority of our sales have been to a limited number of customers. Our top
10 customers accounted for 63.8% of our gross revenues for the six months
ended June 30, 2001 and 79.1% of our gross revenues for the six months ended
June 30, 2000. We expect that sales to a limited number of customers will
continue to account for a substantial portion of our revenues for at least the
next several years. Domestic sales account for the majority of our revenues.
Product revenues in the United States represented 65.1% of our revenues for
the six months ended June 30, 2001 and 62.6% of our revenues for the six
months ended June 30, 2000.

   Cost of Revenues. Our cost of revenues consists primarily of materials
costs, with flash memory accounting for most of those costs. We maintain
relationships with key suppliers, which we believe will be able to provide us
with sufficient quantities of flash memory during 2001. We have an agreement
with Samsung Electronics under which it has become our primary supplier of
flash memory and has guaranteed that we have access to a portion of its
available production capacity. The price we have historically paid for flash
memory has fluctuated considerably and decreased significantly in 2000 and in
the first half of 2001. We expect to continue to see price declines through
the remainder of 2001. In addition, cost of revenues includes expenses related
to materials procurement, inventory management and adjustments and
manufacturing. In accordance with our settlement agreement with SanDisk,
beginning in the second quarter of 2001, we began incurring royalty expenses
related to domestic sales of our CompactFlash digital film that utilizes our
previous generation controller technology. We do not owe royalties on sales
made outside of the U.S. or on digital film that includes our next generation
controller technology.

   Research and Development. Our research and development expenses include
salaries and related expenses for research and development personnel, fees for
outside consultants, patent costs and prototype development and materials
costs. We believe that continued investment in research and development is
important to attain our strategic objectives and expect research and
development expenses in the third quarter of 2001 to be consistent with our
research and development expenses in the second quarter of 2001.

   Sales and Marketing. Our sales and marketing expenses include salaries and
related expenses for sales and marketing personnel, advertising, customer
service, technical support, distribution and travel and trade show expenses.
We expect sales and marketing expenses to decrease in the third quarter of
2001 as compared with the second quarter of 2001 due to the recent
restructuring of our business.

   General and Administrative. Our general and administrative expenses include
salaries and related expenses for executive, administrative and operational
personnel, fees for professional services and other

                                       9
<PAGE>

corporate expenses. We expect our general and administrative expenses to
decrease in the third quarter as compared with the second quarter due to the
recent restructuring of our business.

   Stock-based Compensation. Stock-based compensation related to options
granted to employees represents the aggregate difference, at the date of
grant, between the deemed fair market value of the stock underlying options
and the exercise prices of these options. Stock-based compensation related to
options granted to consultants is revalued as it vests using the Black-Scholes
option-pricing model. Stock-based compensation is amortized over the vesting
period of the underlying options based on an accelerated vesting method.

   Restructuring. At the end of the second quarter of fiscal 2001, we decided
to implement a 27% reduction in our work force and to discontinue our
Printroom.com operations. These actions were taken to allow us to focus on our
core competitive strengths and position us for future revenue growth and near
term profitability.

Our History of Losses

   We have incurred significant losses to date. As of June 30, 2001, we had an
accumulated deficit of approximately $129.3 million. We intend to continue to
expend significant financial and management resources on developing additional
products and services, improving our technologies and expanding our
operations. As a result, we expect to continue to incur additional losses and
negative cash flow through most of 2001. In view of the rapidly changing
nature of our market and our limited operating history, we believe that
period-to-period comparisons of our revenues and other operating results are
not necessarily meaningful and should not be relied upon as indications of
future performance. Our historic revenue growth rates are not necessarily
indicative of our future growth.

Results of Operations

   The following table sets forth our statement of operations data expressed
as a percentage of net sales for the periods indicated:

<TABLE>
<CAPTION>
                                           Three months
                                               ended         Six months ended
                                         ------------------  ------------------
                                         June 30,  June 30,  June 30,  June 30,
                                           2001      2000      2001      2000
                                         --------  --------  --------  --------
   <S>                                   <C>       <C>       <C>       <C>
   Revenues:
     Product revenues...................    78.3 %   99.0 %     88.1 %   99.4 %
     License revenues...................    21.7 %    1.0 %     11.9 %    0.6 %
                                          ------    -----     ------    -----
       Total revenues...................   100.0 %  100.0 %    100.0 %  100.0 %
   Cost of revenues.....................   103.5 %   83.5 %    119.5 %   83.4 %
                                          ------    -----     ------    -----
     Gross margin.......................    (3.5)%   16.5 %    (19.5)%   16.6 %
                                          ------    -----     ------    -----
   Operating expenses:
     Research and development...........     9.3 %    8.1 %      9.6 %    8.7 %
     Sales and marketing................    30.7 %   20.7 %     35.7 %   19.9 %
     General and administrative.........    22.3 %   13.7 %     22.8 %   14.4 %
     Goodwill impairment................     --       --         8.5 %    --
     Restructuring charge...............    12.1 %    --         6.2 %    --
     Stock-based compensation...........     2.4 %   16.7 %      5.7 %   20.0 %
                                          ------    -----     ------    -----
       Total operating expenses.........    76.8 %   59.2 %     88.6 %   63.0 %
   Loss from operations.................   (80.3)%  (42.8)%   (108.1)%  (46.4)%
   Other income (expense)...............   (11.1)%   (0.8)%     (9.0)%   (0.4)%
                                          ------    -----     ------    -----
   Loss before income taxes.............   (91.4)%  (43.6)%   (117.1)%  (46.8)%
                                          ------    -----     ------    -----
   Foreign tax expense..................     9.2 %    0.0 %      4.8 %    0.0 %
                                          ------    -----     ------    -----
       Net loss.........................  (100.6)%  (43.6)%   (121.9)%  (46.8)%
                                          ======    =====     ======    =====
</TABLE>

                                      10
<PAGE>

Revenues

   Total revenues for the second quarter of 2001 decreased $7.5 million, or
30.2%, to $17.3 million from $24.8 million for the second quarter of 2000.
Revenues for the first six months of 2001 decreased $7.2 million, or 17.6%, to
$33.6 million from $40.8 million for the first six months of 2000.

   Product revenues comprised 78.3% and 99.0% of total revenues for the second
quarters of 2001 and 2000, respectively. Product revenues for the second
quarter of 2001 decreased $10.9 million, or 44.5%, to $13.6 million from $24.5
million in the second quarter of 2000. Product revenues comprised 88.1% and
99.4% of total revenues for the first six months of 2001 and 2000,
respectively. Product revenues for the first six months of 2001 decreased
$11.0 million, or 27.2%, to $29.6 million from $40.6 million in the second
quarter of 2000. The decrease in product revenue for the three and six month
periods was primarily the result of increases in price protection and rebates,
lower shipments of our digital film and connectivity products to OEM customers
as a result of our strategy to sell controllers rather than digital film to
such customers and declining average selling prices. The decline in average
selling prices was due to increased price competition resulting from declining
flash memory costs and a change in product mix. In the second quarter of 2001,
we derived product revenues of 50.8%, 16.3% and 9.7% from customers in the
United States, Europe and Asia, respectively. In the second quarter of 2000,
we derived product revenues of 61.6%, 25.3% and 10.6% from customers in the
United States, Asia and Europe, respectively. Two customers accounted for
20.6% and 11.1% of our gross product revenues in the second quarter of 2001.
Three customers accounted for 21.0%, 20.2%, and 11.2% of our product revenues
in the second quarter of 2000. In the first six months of 2001, we derived
product revenues of 65.1%, 16.3% and 5.3% from customers in the United States,
Europe and Asia, respectively. In the first six months of 2000, we derived
product revenues of 62.6%, 23.1% and 12.7% from customers in the United
States, Asia and Europe, respectively. Two customers accounted for 13.4 % and
10.0% of our product revenues in the first six months of 2001. Three customers
accounted for 17.6%, 13.9%, and 12.1% of our revenues in the first six months
of 2000.

   Licensing revenues comprised 21.7% and 1.0% of total revenues for the
second quarters of 2001 and 2000, respectively. Licensing revenues for the
second quarter of 2001 increased $3.5 million, or 1404.0%, to $3.8 million
from $0.3 million in the second quarter of 2000. Licensing revenues comprised
11.9% and 0.6% of total revenues for the first six months of 2001 and 2000,
respectively. Licensing revenues for the first six months of 2001 increased
$3.8 million, or 1503.6%, to $4.0 million from $0.3 million for the first six
months of 2000. The increase in licensing revenues is a result of the
licensing agreements that we have entered into during 2001.

   In the second quarter of 2001, in addition to revenues from sales of our
digital film and connectivity products, and licensing agreements we also
recognized $0.1 million in revenue from sales of our controllers, as compared
with $0.2 million in the second quarter of 2000. In the first six months of
2001 we recognized $0.2 million in revenue from sales of our controllers, as
compared with $0.3 million in the first six months of 2000. During the second
quarter of 2001 we entered into several controller sales agreements. As a
result of these agreements we expect to recognize increased revenues from
sales of our controllers through the remainder of 2001. Revenue from the sales
of our controllers is included as part of our product revenues.

   Revenues in the second quarter of 2001 were negatively impacted by a
significant increase in sales discounts and allowances of approximately $3.7
million. In the second quarter of 2000, we incurred approximately $0.4 million
in sales discounts and allowances. For the first six months of 2001, sales
discounts and allowances were approximately $7.8 million compared to
$0.8 million for the first six months of 2000. These increases were the result
of increased price competition resulting in significant price protection and
rebates. Sales returns for the second quarter of 2001 were $1.2 million
compared with $0.6 million in the second quarter of 2000. Sales returns for
the first six months of 2001 were $2.3 million compared with $0.9 million for
the first six months of 2000. These increases were the result of an increased
percentage of business with retailers in the first half of 2001 as compared to
2000.

                                      11
<PAGE>

Cost of revenues

   Cost of revenues decreased approximately $2.7 million, or 13.2%, to $17.9
million for the second quarter of 2001 from $20.7 million for the second
quarter of 2000. The decrease in cost of revenues was driven by the decrease
in product revenue which was partially offset by an increase in inventory cost
adjustments and increased manufacturing costs. Cost of revenues increased $6.1
million, or 17.9%, to $40.1 million for the six months of 2001 from $34.0
million for the first six months of 2000. This increase was driven by an
increase in units shipped, a trend toward higher capacity products with higher
costs, and adjustments related to excess and obsolete inventory. License
revenues have no significant related costs in cost of revenues.

   Cost of revenues as a percentage of revenues for the second quarter of 2001
increased to 103.5% from 83.5% for the second quarter of 2000. Cost of
revenues as a percentage of revenues for the first six months of 2001
increased to 119.5% from 83.4% for the first six months of 2000. These
increases were due to the combination of cost factors, primarily inventory
cost adjustments and manufacturing costs in combination with the decline in
reported revenues due to the factors noted in "Revenues" above, primarily
declining average selling prices and increases in price protection and rebates
offset by increased license revenues.

Gross margin

   We expect gross margins to increase compared to the quarter ended June 30,
2001 as a result of our expected shift in mix to higher margin products and
license revenues as a result of the full implementation of our agreements with
Samsung, as well as an anticipated slowing in the rate of price protection
costs and a stabilization of inventory values and efficiencies in inventory
management. In the second quarter of 2001, we began generating licensing
revenues related to our agreements with Samsung and Olympus. In the second
quarter of 2001, we also signed a number of controller sales agreements and
saw modest revenues during the quarter of 2001 and expect to see increased
revenues associated with our controller business in the third quarter of 2001.
Partially offsetting these increases, we anticipate pressure on our gross
margins due to a number of factors, including changes in our product and
customer mix, flash memory costs, prices of competitive products and higher
costs in the introduction of new products.

   Research and Development. For the second quarter of 2001, research and
development expenses decreased 20.0% to $1.6 million, or 9.3% of revenue, from
$2.0 million, or 8.1% of revenue, for the second quarter of 2000. For the
first six months of 2001, research and development expenses decreased 9.7% to
$3.2 million, or 9.6% of revenue, as compared to $3.6 million, or 8.7% of
revenue, for the first six months of 2000. These decreases were due to
operational efficiencies.

   Sales and Marketing. Sales and marketing expenses for the second quarter of
2001 increased slightly to $5.3 million, or 30.7% of revenues, as compared to
$5.1 million, or 20.7% of revenues, for the second quarter of 2000. Sales and
marketing expenses for the first six months of 2001 increased to $12.0
million, or 35.7% of revenues, as compared to $8.1 million, or 19.9% of
revenues, for the first six months of 2000. The increase in sales and
marketing expenses for the second quarter of 2001 and the first six months of
2001 was primarily due to significant increases in marketing, advertising and
promotion costs invested during the second quarter of 2001 and first six
months of 2001. The increase in sales and marketing expenses as a percentage
of revenues during the second quarter of 2001 and the first six months of 2001
compared with the second quarter of 2000 and the first six months of 2000 was
due to the relative increase in dollars spent combined with decreased
revenues.

   General and Administrative. General and administrative expenses for the
second quarter of 2001 increased 13.8% to $3.9 million, or 22.3% of revenues,
as compared to $3.4 million, or 13.8% of revenues, for the second quarter of
2000. General and administrative expenses for the first six months of 2001
increased 30.9% to $7.7 million, or 22.8% of revenues, as compared to $5.9
million, or 14.4% of revenues, for the first six months of 2000. During the
second quarter of 2001 and the first six months of 2001, the increase in
general and administrative expenses was primarily due to an increased number
of personnel, increased occupancy and insurance costs and increased
professional fees, primarily legal fees. The increase in general and
administrative

                                      12
<PAGE>

expenses as a percentage of revenues was due to the cost factors noted
combined with relatively decreased revenue.

   Goodwill impairment. During the first quarter of 2001, a charge of $2.9
million, or 17.6% of revenue, was recognized for an other than temporary
impairment of Printroom.com goodwill in the first quarter of 2001. During the
second quarter of 2001 management decided to discontinue the Printroom.com
operation. The discontinuance of Printroom.com was completed on August 3,
2001.

   Restructuring. At the end of the second quarter of fiscal 2001, we decided
to implement a 27% reduction in our work force and to discontinue our
Printroom.com operations. These actions were taken to allow us to focus on our
core competitive strengths and position us for future revenue growth and near
term profitability. In connection with these decisions, we recognized a
$2.1 million restructuring charge in the second quarter of fiscal 2001 for
estimated severance costs related to organizational changes and the planned
reduction in work force, to reduce property and equipment to its estimated
realizable value and to provide for consolidation of excess facilities and
other charges related to the discontinuance of our operation of Printroom.

   No restructuring activity had taken place as of June 30, 2001. The
reduction of staff by approximately 40 employees, which included personnel
from all business functions, was implemented in July and August 2001, and is
substantially completed. The discontinuance of Printroom was effected as of
August 3, 2001. The following table represents the restructuring as of June
30, 2001:

<TABLE>
     <S>                                                                 <C>
     Reduction in workforce ............................................ $1,052
     Asset write-offs ..................................................    554
     Excess facilities and related costs................................    368
     Other .............................................................    112
                                                                         ------
                                                                         $2,086
                                                                         ======
</TABLE>

Stock-Based Compensation

   Stock-based compensation for the second quarter of 2001 decreased 90.0% to
$0.4 million, or 2.4% of revenues, as compared to $4.1 million, or 16.7% of
revenues, for the second quarter of 2000. Stock-based compensation for the
first six months of 2001 decreased 76.6% to $1.9 million, or 5.7% of revenues,
as compared to $8.2 million, or 20.0% of revenues, for the first six months of
2000. The decreases in both comparative periods resulted from lower
amortization under the FIN 28 model and adjustments related to employee
terminations.

Other Income and Expense

   Interest income for the three-month periods ended June 30, 2001 and 2000,
was $0.3 million and $0.2 million, respectively. For the six-month periods
ended June 30, 2001 and 2000, we recognized $0.7 million and $0.4 million,
respectively, in interest income. These increases were due primarily to
earnings from cash and cash equivalents from the proceeds of loans and our
initial public offering. Foreign exchange loss for the second quarter of 2001
was $0.2 million, or 1.2% of revenues, compared to a de mimimus amount for the
second quarter of 2000. Foreign exchange loss for the first six months of 2001
increased 300% to $0.4 million, or 1.2% of revenues, as compared to $0.1
million, or 0.2% of revenues, for the first six months of 2000. The increases
in the losses were primarily attributable to increased European sales
activities and fluctuations in European currency and the Japanese yen.

   Interest expense for the second quarter of 2001 increased 422.1% to $2.0
million, or 11.4% of revenues, compared to $0.4 million or 1.5% of revenues
for the second quarter of 2000. Interest expense for the first six months of
2001 increased 559.3% to $3.4 million, or 10.0% of revenues, as compared to
$0.5 million, or 1.2% of revenues, for the first six months of 2000. Interest
expense for the second quarter of 2001 includes imputed

                                      13
<PAGE>

interest of $1.6 million, associated primarily with the amortization of the
value of the warrants issued and fees paid in connection with The Chase
Manhattan Bank and Access Technology Partners credit facilities, the write-off
of the remaining balances related to fees on the Chase loan that was repaid
and the write-off of the warrants issued to Chase. The Chase loan was for a
term of one year and was repaid at the end of the second quarter of 2001. The
imputed and other non-cash interest for the first six months of 2001 was $2.7
million and includes a charge of $0.7 million, which, in the first quarter of
2001, was added to the principal balance of the notes payable to Access in
connection with the forbearance agreement we entered into with Access in
February 2001.

Income Taxes

   Income tax expense for the second quarter of 2001 was $1.6 million, or 9.2%
of revenues. We recognized no income tax expense in the second quarter of
2000. Income tax expense for the first six months of 2001 was $1.6 million, or
4.8% of revenues. We recognized no income tax expense in the first six months
of 2000. This increase represents foreign taxes withheld on payments from
foreign licensees. These taxes are recoverable only as a credit against
federal income taxes. No credit for the recoverability has been recorded. As
of June 30, 2001, we believe we have sufficient tax loss carryforward balances
to offset any federal or state liability related to our operations for the
three and six months ended June 30, 2001. We had recorded losses for the same
periods ended June 30, 2000. We have established a 100% valuation allowance
since it is more likely than not that no benefit will be realized for our
deferred tax assets.

Liquidity and Capital Resources

   From our inception until the completion of our initial public offering in
August 2000, we financed our operations primarily through private sales of our
common stock and preferred stock, and, to a lesser degree, through debt
financings. As of June 30, 2001, we had approximately $14.0 million in cash
and cash equivalents.

   Net cash used in operating activities was $7.8 million and $9.2 million for
the six months ended June 30, 2001 and June 30, 2000, respectively. For the
six months ended June 30, 2001, net cash used in operating activities resulted
primarily from our net loss of $40.9 million and an increase of $4.2 million
in accounts receivable, partially offset by an $18.2 million decrease in
inventory, a $6.6 million increase in deferred revenue, a $2.9 million non-
cash charge related to the write off of Printroom.com goodwill, $2.7 million
in imputed and other non-cash interest charges, a $2.1 million restructuring
charge, $1.9 million in amortization of stock-based compensation and a $1.4
million increase in accounts payable and accrued liabilities. The $18.2
million decrease in inventory was accomplished through stricter inventory
controls, and the write down of certain items to the lower of cost or market.
The $6.6 million increase in deferred revenues was primarily the result of
cash received in relation to licensing agreements for which the revenue
recognition criteria has not been met. For the six months ended June 30, 2000,
net cash used in operating activities resulted primarily from a $19.1 million
net loss, a $2.5 million increase in net inventory and a $1.2 million increase
in prepaid and other assets, which was partially offset by $8.1 million in
amortization of stock-based compensation, an increase of $3.6 million in
accounts payable and other accrued liabilities, and an increase of $0.9
million in deferred revenue.

   Net cash provided by investing activities was $19.3 million and $2.4
million for the six months ended June 30, 2001 and June 30, 2000,
respectively. For the six months ended June 30, 2001 and June 30, 2000, net
cash provided by investing activities was primarily attributable to proceeds
from short-term investments of $20.0 million and $3.9 million, respectively,
and was partially offset by purchases of property and equipment of $0.7
million and $1.5 million, respectively.

   Net cash used by financing activities was $6.2 million for the six months
ended June 30, 2001 and consisted primarily of $6.4 million in repayment of
notes payable under our credit facililty with Chase. Net cash provided by
financing activities was $14.1 million for the six months ended June 30, 2000.
The primary source of cash was the proceeds from notes payable to stockholders
and others.

                                      14
<PAGE>

   As of June 30, 2001, there was $4.7 million outstanding, before debt
discount of $2.0 million, under the Access term loan. These borrowings are
collateralized by all of our assets, and we are required to comply with
financial and other covenants contained in the loan agreements. In the first
quarter of 2001, we were in default of covenants related to our term loan with
Access Technology Partners ("Access"). In February 2001, Access agreed to
forbear from exercising its rights and remedies against that default. The
forbearance period extends until the earlier of (i) December 31, 2001 or (ii)
the date any additional default occurs, at which time Access may, at its
option, exercise any and all rights or remedies in connection with the
aforementioned default. At June 30, 2001, the Company was in default of
covenants in relation to its term loan with Access. In July 2001, Access
issued a waiver of this default.

   We anticipate that the $14.0 million in cash and cash equivalents as of
June 30, 2001, which includes our Access term loan, together with the receipt
of licensing payments and the operational efficiencies we have implemented as
part of our restructuring will be sufficient to meet our projected needs for
working capital and capital expenditures through the end of 2001. However, the
timing of cash requirements during the quarter could deplete our cash balances
to levels which may impede our ability to maintain or increase our current
level of business. We have taken measures to conserve cash by reducing
headcount and the discontinuation of operations of Printroom.com and are
looking at ways to further reduce our operating expenses in the future. In
addition, we are actively pursuing financing alternatives to fund anticipated
future growth and may need to raise additional funds prior to the expiration
of this period if, for example, our license revenues or sales of our
controllers and other higher margin products, which each have significantly
higher margins than sales of our digital film products, do not increase as
much as we anticipate, we do not remain in compliance with the provisions of
our term loan and our lender declares us to be in default or we experience
operating losses that exceed our current expectations. Our term loan also
contains covenants that restrict our ability to incur additional indebtedness.
Additional financing may be difficult to obtain on favorable terms if
required, or at all.

Recent accounting developments

   In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for
business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. The Company believes that the adoption of SFAS
141 will not have a significant impact on its financial statements.

   In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS 142
requires, among other things, the discontinuance of goodwill amortization. In
addition, the standard includes provisions upon adoption for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill
and the testing for impairment of existing goodwill and other intangibles. The
Company is currently assessing but has not yet determined the impact of SFAS
142 on its financial position and results of operations.

                                      15
<PAGE>

                    RISKS THAT COULD AFFECT FUTURE RESULTS

   The factors discussed below are cautionary statements that identify
important factors that could cause actual results to differ materially from
those anticipated in the forward-looking statements in this Quarterly Report
on Form 10-Q.

Risks Related to Our Business

 We have a history of losses, anticipate incurring additional losses and may
 never become profitable.

   We incurred a net loss of approximately $40.9 million for the six months
ended June 30, 2001, compared to $19.1 million for the six months ended June
30, 2000. As of June 30, 2001, we had an accumulated deficit of approximately
$129.3 million. We expect to incur additional losses this year. The size of
our future losses and our ability to become profitable substantially depend on
the rate of growth of the market for digital cameras and digital film, the
extent to which our products and services are accepted by this market and
purchased by consumers, and our ability to reduce our operating expenses from
their current level. In addition, we must generate substantially increased
revenues from selling higher margin products as well as licensing our
proprietary controller technology and selling our controllers on a stand-alone
basis to third parties, as these products have significantly higher margins
than our standard digital film. We also must reduce the costs of manufacturing
and selling our digital film products, as well as reduce our internal and
channel inventory. Some customers are also requesting that we sell our digital
film to them on consignment, which would negatively impact our cash needs. In
addition, we incurred non-cash deferred charges of $1.9 and $8.2 million
through June 30, 2001 and June 30, 2000, respectively, relating to stock-based
compensation. At June 30, 2001, $3.3 million of deferred stock-based
compensation charges remained to be charged against our future operations. If
we are unsuccessful in increasing overall revenues, and in particular those
generated from sales of our higher margin products and from licensing our
technology, as well as reducing our operating expenses, we will not become
profitable by the end of 2001 and may never become profitable. Even if we do
achieve profitability, we may not be able to sustain or increase profitability
on a quarterly or an annual basis.

 If we are unable to obtain additional financing for our future capital needs,
 we may be unable to develop or enhance our products, expand our operations,
 respond to competitive pressures or continue our operations.

   We currently anticipate that our available capital, together with our term
loan and our licensing revenues, will be sufficient to meet our anticipated
needs for working capital and capital expenditures through the end of 2001.
However, the timing of cash requirements during the quarter could deplete our
cash balances to levels which may impede our ability to maintain or increase
our current level of business. We are actively pursuing financing alternatives
to fund anticipated future growth and may need to raise additional funds prior
to the expiration of this period if, for example, our licensing revenues or
sales of our controllers or other higher margin products do not increase to
the degree we anticipate, we do not remain in compliance with the provisions
of our term loan and our lender declares us to be in default, we are unable to
sufficiently reduce our operating expenses, or we experience operating losses
that exceed our current expectations. Our term loan also contains covenants
that restrict our ability to incur additional indebtedness. It may be
difficult to obtain additional financing on favorable terms, if at all. We may
try to obtain additional financing by issuing shares of our common stock,
which could dilute our existing stockholders. However, the trading price of
our common stock and the downturn in the U.S. economy may make it more
difficult for us to obtain financing through the issuance of equity or debt
securities. If we cannot raise needed funds on acceptable terms, or at all, we
may not be able to develop or enhance our products, respond appropriately to
competitive pressures or continue our operations.

                                      16
<PAGE>

 If we default under our credit agreement, or if it is not renewed, we may
 experience a cash shortfall.

   In June 2000, we entered into a $10 million credit agreement with Access
Technology Partners, L.P. We granted Access a security interest in
substantially all of our assets as collateral for amounts that we borrow under
this agreement. As of June 30, 2001, we had borrowings of approximately $4.7
million outstanding under this agreement. The agreement provides that any of
the following events, as well as others specified in the agreement, may
constitute a default by us under the agreement:

  .  failure to make payments under this agreement on time;

  .  failure to comply with the requirements and restrictions imposed on us
     by this agreement;

  .  default under our other obligations;

  .  any person or group becomes the beneficial owner of 20% or more of our
     outstanding common stock; and

  .  other events which could have a material adverse effect on our company.
     If we default under this agreement, and the default is not cured by us
     or waived by Access, it may elect to accelerate all amounts due and
     terminate the term loan, foreclose on the collateral subject to a
     security interest under this agreement and sue us for other amounts due
     and other damages. Any of these results could result in a shortfall of
     cash for us or force us to cease operations. Moreover, the maturity date
     of the term loan is June 2003. If we do not achieve and sustain
     profitability before the maturity date, we may need to pursue additional
     financing to support our operations.

   In the first quarter of 2001, we were in default of covenants related to
our term loan with Access Technology Partners ("Access"). In February 2001,
Access agreed to forbear from exercising its rights and remedies against that
default. The forbearance period extends until the earlier of (i) December 31,
2001 or (ii) the date any additional default occurs, at which time Access may,
at its option, exercise any and all rights or remedies in connection with the
aforementioned default.

 Our quarterly operating results and gross margins declined significantly in
 the fourth quarter of 2000 and the first and second quarters of 2001, as
 compared to the first two quarters of 2000, may fluctuate significantly in
 the future and are difficult to predict. If our future results are below the
 expectations of investors or securities analysts, the market price of our
 common stock could decline significantly.

   Our quarterly operating results and gross margins declined significantly in
the fourth quarter of 2000 and the first and second quarters of 2001, as
compared to the first two quarters of 2000, and are likely to vary
significantly in the future based on a number of factors related to our
industry and the markets for our products. We will have little or no control
over many of these factors and any of these factors could cause the price of
our common stock to fluctuate significantly. These factors include, among
others:

  .  the rate of growth of the market for digital cameras and digital film;

  .  competitive pricing pressures;

  .  fluctuation in demand for our products;

  .  price protection, volume incentive rebates, discounts, market
     development funds, cooperative advertising payments and other
     concessions and discounts that may need to be provided to some customers
     due to increasing competitive pricing;

  .  the timing and amount of expenses related to obsolescence and disposal
     of excess inventory;

  .  the timing and amount of any reductions in the average selling prices of
     our products and services;

  .  the difficulty of forecasting and managing our inventory levels;

  .  the difficulty of forecasting sell-through rates of our products and
     their impact on inventory levels at our distributors and customers,
     which may result in additional orders being delayed or reduced and
     inventory being returned;

                                      17
<PAGE>

  .  price reductions in key components, such as flash memory, could result
     in reduced margins when selling products that include previously
     purchased components held in inventory;

  .  increases in costs charged by our component suppliers, particularly our
     flash memory suppliers;

  .  the availability and pricing of flash memory, particularly high-
     performance flash memory with increased memory capacity;

  .  seasonal demand for our products and the volumes and timing of potential
     retail customer and distributor orders;

  .  the timing and amount of orders and cancellations from existing and new
     retailers, distributors and original equipment manufacturer customers;

  .  the announcement or introduction of products and technologies by
     competitors;

  .  changes in our customers and product mix;

  .  commencement of or involvement in litigation;

  .  potential product quality problems which could raise return or rework
     costs;

  .  whether we can sell controllers in the volumes and at the prices we
     anticipate;

  .  the amount we will have to pay in royalties to SanDisk for selling
     products using our old controller; and

  .  whether we can migrate our entire product line to our new controller.

   In addition, as a result of our limited operating history and the emerging
nature of our market, we may be unable to accurately forecast our revenues and
gross margins. We incur expenses based predominantly on operating plans and
estimates of future revenues. Our expenses are to a large extent fixed and we
may not be able to adjust them quickly to meet a shortfall in revenues during
any particular quarter. We also plan inventory levels based on anticipated
revenues. Any significant shortfall in revenues in relation to our expenses
and planned inventories would decrease our net income or increase our
operating losses and would also harm our financial condition. Declines in our
operating results or gross margins may cause us to fail to meet the
expectations of investors or securities analysts. If this were to happen, the
market price for our common stock would likely decline significantly.

 We primarily market our digital film on the basis of its superior technology.
 If we are unable to achieve or maintain technology leadership, our gross
 margins and revenues will decline significantly.

   We primarily market our digital film on the basis of its performance and
technology advantage over our competitors' products. In doing so, we have
emphasized our speed advantage over our competitors' products and have tried
to establish ourselves as the brand of choice among professional
photographers. We label our CompactFlash products for write speed performance
in which 1x is equal to a write speed of 150 kilobytes per second,
nomenclature similar to that used in the CD-ROM industry. For example, our 4x
CompactFlash digital film is capable of sustained write speeds of at least 600
kilobytes per second. Currently, we offer CompactFlash with write speeds
ranging from 4x to 12x. Our highest capacity card is currently 320-megabytes.
From time to time our competitors have introduced products for which they have
claimed high sustained write speeds, but none have marketed their products on
the basis of their write speeds. If we are unable to design and manufacture
products that are technologically superior to those of our competitors or if
we lose our status as a brand preferred by professional photographers, we will
be unable to achieve a premium price for our products. If this were to occur,
our revenues and gross margins would likely decline significantly.

 If our customers elect to compete with us in the digital film market, our
 revenues would likely decline significantly.

   We have recently decided to emphasize sales of our CompactFlash
controllers. Other companies, including our competitors, could use our
controllers to manufacture CompactFlash products that are comparable in
performance to our own. Many of these customers are large companies that have
longer operating histories and

                                      18
<PAGE>

greater brand recognition, greater access to flash memory, substantially
greater financial, technical, marketing and other resources and longer
standing relationships with customers. If these companies were to choose to
compete directly with us in the digital film market, our revenues would likely
decline significantly.

 Our products are characterized by average selling prices that have
 historically declined over relatively short time periods. If we are unable to
 effectively manage our inventories, reduce our costs, introduce new products
 with higher average selling prices or increase our sales volumes, our gross
 margins will continue to be negatively impacted.

   Although consumers have recently begun to purchase digital cameras in
volume, they still exert pressure on digital camera manufacturers and on us to
lower prices of digital photography products, like our digital film, to prices
comparable to those of traditional photography products. Our competitors also
impose pricing pressures on us. In addition, because a large percentage of our
sales are to a small number of customers that are primarily retail consumer
chains, distributors and large original equipment manufacturers, these
customers have exerted, and we expect they will continue to exert, pressure on
us to make price concessions. In 2000 and in the first and second quarters of
2001, we significantly reduced the prices of many of our digital photography
products, and may need to do so in the future to remain competitive. Any
reduction in prices by us will negatively impact our gross margins, unless we
can manage our internal and channel inventories to minimize such price
declines and reduce our costs. In addition, some customers are now requesting
that we sell our digital film to them on a consignment basis. If we agree to
such arrangements, we will have to carry higher levels of inventory. If we are
unable to reduce our costs to offset declines in average selling prices or
increase the sales volume of our existing products, our gross margins will be
adversely affected. We anticipate that our average selling prices will
continue to decline for the foreseeable future.

 Because we protect many of our retail customers and distributors against the
 effects of price decreases on their inventories of our products, we may
 continue to incur large price protection charges if we reduce our prices when
 there are large quantities of our products in our distribution channel.

   More than half of our sales in the second quarter of 2001 were made through
distributors and retailers to which we have provided price protection. In the
second quarter of 2001, we incurred approximately $3.2 million in price
protection charges, and we anticipate that we will continue to incur
significant price protection charges for the remainder of 2001 due to
increased competitive pricing pressures.

 Because many of our retail customers and distributors have rights of return,
 we may be required to take back large quantities of unsold inventory, which
 could reduce our revenues.

   Substantially all of our sales to end-users are made through distributors
and retailers. Our sales through these channels often include rights to return
unsold inventory. For sales of some of our products, we recognize revenue upon
shipment of our products, although we establish reserves for estimated
returns. Additionally, we permit some of our customers to return products in
their inventory for credit or in exchange for new products. If there are
significant inventories of old products in our distribution channel when a new
product is released, or if these distributors and retailers are unsuccessful
in selling our products, there could be substantial product returns. If our
reserves are insufficient to account for these returns or if we are unable to
resell these products on a timely basis at similar prices, our revenues may be
reduced. Because the market for our products is rapidly evolving, we may not
be able to resell returned products at attractive prices or at all.

 We have recently expanded our distribution of products into international
 markets. If we are unable to anticipate demand and pricing of our products in
 those regions or if we are unable to effectively manage the distributor
 channels and relationships in those regions, our operating results will be
 harmed and our stock price will likely decline.

   We do not have a long history of managing international distribution of our
products. We experienced a slower than forecast rollout of our products in
retail stores in Japan in the fourth quarter of 2000, which

                                      19
<PAGE>

contributed to our significantly reduced revenues for that quarter. If we are
unable to accurately anticipate demand and pricing of products in
international markets, or if we cannot work effectively with our distribution
partners to create demand, develop effective marketing programs, manage
inventory levels and collect receivables in a timely fashion, our operating
results will be harmed and our stock price will likely decline.

 We have granted Olympus the exclusive right to sell our Lexar-branded digital
 film in Japan. If Olympus does not aggressively promote and distribute these
 products, our revenues will be negatively impacted.

   We have recently entered into a license agreement with Olympus Optical Co.,
Ltd. and Olympus Promarketing, Inc. in which we have given Olympus the
exclusive right to distribute our Lexar-branded digital film in Japan. Under
our agreement, we will primarily recognize revenues on digital film on sales
in Japan from royalties that Olympus will pay us on all Lexar-branded digital
film that it sells in Japan. If Olympus does not aggressively promote our
product, or if Olympus chooses to promote its own brand at the expense of the
Lexar brand, our revenue will be negatively impacted.

 Because we have a limited operating history and because we operate in a new
 and rapidly evolving market, you may have difficulty assessing our business
 and future prospects.

   We were organized in September 1996 and have a short operating history.
Because we have only recently introduced many of our products and services and
have limited historical financial data, it is difficult to evaluate our
business and future prospects. In addition, because of our limited operating
history and because the market for digital cameras and digital film is still
in an emerging stage and is characterized by an increasing number of
competitors and competing technologies and formats, we have limited insight
into trends that may emerge and affect our business. Our business will not
succeed if we are unable to execute our business strategy or if we do not
successfully address the risks we face.

 We will primarily depend upon a single source of flash memory, and if it is
 unable to provide us with sufficient quantities of flash memory in a timely
 manner and remain technologically and price competitive, we would not be able
 to manufacture and deliver digital film to our customers in accordance with
 their volume, price and schedule requirements.

   We have historically purchased substantially all of our flash memory from
Toshiba America Electronic Corporation and Samsung Semiconductor, Inc. As a
result of our recent agreement with Samsung, it has become our primary
supplier of flash memory, which is the primary component of our digital film.
We expect that the demand for flash memory over the next several years will be
substantially greater than in past periods due to the increasing acceptance of
digital cameras and other digital consumer products. If we are unable to
obtain sufficient quantities of flash memory from Samsung or, if necessary
from another flash memory supplier in a timely manner, we would not be able to
manufacture and deliver digital film to satisfy our customers' requirements.
In addition, if Samsung is unable to ensure that its flash memory is
technologically and price competitive, we may also be unable to satisfy our
customers' requirements. If we are not able to satisfy the requirements of our
customers, they may reduce any future orders or eliminate us as a supplier.
Our reputation would likely also be harmed and we may not be able to replace
any lost business with new customers. Because we will obtain most of our flash
memory from Samsung, our relationships with other flash suppliers may not be
as strong as they had been in the past. Other flash suppliers may not be able
to supply our flash memory needs if we cannot obtain adequate supplies from
Samsung. Even if we are able to obtain flash memory in sufficient volume and
on schedules that permit us to satisfy our delivery requirements, we cannot
assure you that the prices charged by these suppliers will enable us to
compete effectively in our market. Samsung and many other potential suppliers
of flash memory are located in Asia, a region that has been, and in the future
may be, affected by economic and political instability that could adversely
affect the price and supply of flash memory. If we are unable to obtain flash
memory at economical prices, our margins would decline unless we could raise
the prices of our products in a commensurate manner. The existing competitive
conditions may not permit us to do so, in which case we may suffer increasing
losses or reduced profits.

                                      20
<PAGE>

   If we are unable to continue to license our controller technology for
application in other products and sell our controllers on a stand-alone basis
to third parties, our gross margins will be negatively impacted and we will
have difficulty achieving profitability. We have historically derived
substantially all of our revenues from the sale of our digital film and
connectivity products. We believe, however, that our future growth and ability
to become profitable may depend on our ability to license our proprietary
controller technology for use in new digital photography applications or
applications in other markets, such as music and video, and to generate
increased revenues from the sales of our controllers. If we fail to generate
significant licensing revenue from these activities or increase the revenue we
derive from our controller sales, we may not grow our revenues and margins as
planned and we will have difficulty achieving profitability.

 We depend on a few key customers and the loss of any of them could
 significantly reduce our revenues.

   Historically, a small number of our customers have accounted for a
significant portion of our product revenues. In the second quarter of 2001,
sales to the 10 customers from which we received the greatest revenues
accounted for approximately 70.9% of our revenues. Our revenues could decline
if one or more of these customers were to significantly reduce, delay or
cancel their orders, decide to purchase digital film manufactured by one of
our competitors, develop and manufacture their own digital film or cease
operations due to the downturn in the nation's economy or otherwise. In the
second quarter 2001, sales to our major OEM customers continued to decline
relative to first quarter due to our strategy to sell controllers rather than
digital film to such customers. In addition, any difficulty in collecting
outstanding amounts due from our customers, particularly customers that place
larger orders or experience financial difficulties, would also reduce our
revenues. Because our sales are made by means of standard purchase orders
rather than long-term contracts, we cannot assure you that these customers
will continue to purchase quantities of our products at current levels, or at
all.

   Furthermore, our revenues include sales to OEMs, some of which may in the
future decide to compete against us in the digital film market. We expect our
operating results for at least the next several years to continue to depend on
sales to a relatively small number of customers.

 If we are unable to develop and introduce, on a timely basis, new products or
 services that are accepted by our customers and consumers, we will not be
 able to compete effectively in our market.

   We operate in an industry that is subject to evolving industry standards,
rapid technological changes, rapid changes in consumer demands and the rapid
introduction of new, higher performance products that shorten product life
cycles and tend to decrease average selling prices. To remain competitive in
this demanding market, we must continually design, develop and introduce new
products and services that meet the performance and price requirements of our
customers and consumers. Any significant delay or failure in releasing new
products or services would harm our reputation, provide a competitor a first-
to-market opportunity or allow a competitor to achieve greater market share.
Also, we cannot assure you that any products or services we do introduce will
gain market acceptance. The introduction of new products is inherently risky
because it is difficult to foresee advances in technology and the adoption of
new standards, to coordinate our technical personnel and strategic
relationships and to identify and eliminate design and products flaws. We may
not be able to recoup research and development expenditures if our new
products or services are not widely accepted.

 If we are unable to develop or maintain the strategic relationships necessary
 to develop, sell and market products that are commercially viable and widely
 accepted, the growth and success of our business may be limited.

   We may not be able to develop and sell products that are commercially
viable and widely accepted if we are unable to anticipate market trends and
the price, performance and functionality requirements of digital camera and
flash memory manufacturers. We must continue to collaborate closely with our
customers, digital camera manufacturers, flash memory manufacturers and other
suppliers to ensure that critical development, marketing and distribution
projects proceed in a coordinated manner. This collaboration is also important
because our ability

                                      21
<PAGE>

to anticipate trends and plan our development activities depends to a
significant degree upon our continued access to information derived from
strategic relationships we currently have with digital camera and flash memory
manufacturers. This collaboration can be difficult because many of these
companies are located overseas. If any of our current relationships terminate
or otherwise deteriorate, or if we are unable to enter into future alliances
that provide us with comparable insight into market trends, we will be
hindered in our product development efforts.

 We expect to increase our reliance on retailers to sell our digital film
 products.

   In recent quarters, we have begun to sell a greater percentage of our
digital film products to retailers, most notably Best Buy, CompUSA and Wal-
Mart, rather than through original equipment manufacturer and distributor
channels. Because we expect to continue to increase the portion of our
products that we sell to retailers, we are subject to many risks, including
the following:

  .  loss of market share if the retailers that carry our products do not
     grow as quickly and sell as many digital film products as the retailers
     that carry the digital film products of our competitors;

  .  product returns could increase as a result of our strategic interest in
     assisting retailers in balancing their inventories;

  .  reduced ability to forecast sales;

  .  reduction of gross margins, delays in collecting receivables and
     increased inventory levels due to the increasing tendency for some
     retailers to require products on a consignment basis;

  .  retailers may emphasize our competitors' products or decline to carry
     our products; and

  .  continued downward pricing pressure in the retail channel could continue
     to necessitate price protection of the inventories of our products that
     many of our customers carry.

 If we are unable to adequately protect our intellectual property, our
 competitors may gain access to our technology, which could harm our ability
 to successfully compete in our market.

   We regard our intellectual property as critical to our success. If we are
unable to protect our intellectual property rights, we may be unable to
successfully compete in our market.

   We rely on a combination of patent, copyright, trademark and trade secret
laws, as well as confidentiality agreements and other methods to protect our
proprietary technologies. We have been granted patents in the United States
and other countries and have a number of pending United States and foreign
patent applications. We cannot assure you, however, that:

  .  any of our existing or future patents will not be invalidated;

  .  patents will be issued for any of our pending applications;

  .  any claims allowed from existing or pending patents will have sufficient
     scope or strength; or

  .  our patents will be issued in the primary countries where our products
     are sold.

   It may also be possible for a third party to copy or otherwise obtain and
use our products or technology without authorization, develop similar
technology independently or design around our patents.

 We may become subject to additional intellectual property claims that could
 divert management's time and attention, could be time-consuming and expensive
 to defend and could limit our access to important technology.

   We have become a party to litigation with third parties to protect our
intellectual property or as a result of an alleged infringement of others'
intellectual property. These lawsuits could subject us to significant
liability for

                                      22
<PAGE>

damages or invalidate our proprietary rights. For example, in the fourth
quarter of 2000, we entered into a settlement agreement with our primary
competitor, SanDisk Corporation, under which we agreed to remit to SanDisk
$6.0 million in net payments and make certain royalty payments to SanDisk. Any
future lawsuits, regardless of their outcome, would likely be time-consuming
and expensive to resolve and would divert management's time and attention. Any
potential intellectual property litigation also could force us to do one or
more of the following:

  .  stop selling products or using technology that contain the allegedly
     infringing intellectual property;

  .  attempt to obtain a license to the relevant intellectual property, which
     license may not be available on reasonable terms or at all; and

  .  attempt to redesign those products that contain the allegedly infringing
     intellectual property.

   If we are forced to take any of the foregoing actions, we may incur
additional costs or be unable to manufacture and sell our products.

 Because we depend on single suppliers for some key components and do not have
 long-term supply contracts with those suppliers, we are exposed to the risks
 of a potential inability to obtain an adequate supply of components, price
 increases, late deliveries and poor component quality.

   ZETEX Semiconductors is the sole manufacturer of transistors for our
CompactFlash, PC Card and connectivity products. Because we depend on a single
supplier for these key components, and do not have a long-term supply contract
with this supplier, we face the risk of inadequate component supply, price
increases, late deliveries and poor component quality. ZETEX may terminate its
relationship with us or pursue other relationships with our competitors, and
if we were to lose our relationship with this single supplier, the lead time
required to qualify new suppliers could be as long as three months. Also, if
we lose our single supplier or this supplier is otherwise unable to satisfy
our volume and delivery schedule requirements, it may be difficult to locate
any suppliers who have the ability to develop, manufacture and deliver the
specialized components we need for our products. If we are unable to
accurately predict our supply needs, or if our supply of components is
disrupted, our reputation may be harmed and we may lose existing customers or
be unable to attract new customers.

 We depend on a single third-party wafer foundry to manufacture all of our
 controllers, and if we are unable to obtain sufficient quantities of
 controllers at acceptable quality, yields and prices, and in a timely manner,
 we may not be able to meet customer demand for our products, which could
 limit the growth and success of our business.

   We do not own or operate a semiconductor fabrication facility. Instead, we
rely on a single outside foundry, United Microelectronics Corporation, or UMC,
of Taiwan to produce all of our controller products. Our reliance on an
independent foundry involves a number of significant risks, including:

  .  reduced control over delivery schedules, quality assurance,
     manufacturing yields and production costs;

  .  lack of guaranteed production capacity or product supply; and

  .  unavailability of, or delayed access to, next-generation or key process
     technologies.

   We do not have a long-term supply agreement with UMC and instead obtain
manufacturing services on a purchase order basis. UMC has no obligation to
supply products to us for any specific period, in any specific quantity or at
any specific price, except as set forth in a particular purchase order. Our
requirements represent a small portion of the total production capacity of
UMC, and UMC may reallocate capacity to other customers on short notice, even
during periods of high demand for our products. If UMC were to become unable
or unwilling to continue manufacturing our controllers in the required
volumes, at acceptable quality, yields and prices, and in a timely manner, we
might not be able to meet customer demand for our products, which could limit
the growth and success of our business. Although we have attempted to
diversify our sources of controllers by

                                      23
<PAGE>

qualifying Taiwan Semiconductor Manufacturing Co. Ltd., we cannot assure you
that it will have sufficient capacity to accommodate our demand at any
particular time.

   In addition, if competition for foundry capacity increases, we may incur
significant expenses to secure access to manufacturing services, which in turn
may cause our product costs to increase substantially. We expect that the
demand for capacity at these facilities will change in the near future due to
fluctuating demand for consumer electronic and industrial products that depend
on semiconductors manufactured at these facilities. All of these foundries are
located in an area of the world that may be subject to political and economic
instability, especially in light of the results of the national election in
Taiwan, and natural disasters, particularly earthquakes. While the last
earthquake in Taiwan did not have a significant impact on deliveries to us
from UMC, a similar event in the future at one of their foundries could have a
significant impact.

 We depend solely on third-party subcontractors for assembly and testing of
 our digital film products, which could result in product shortages or delays
 or increase our costs of manufacturing, assembling or testing our products.

   Substantially all of our CompactFlash digital film is currently assembled
and tested by Venture Manufacturing in the United States and Singapore and
Flash Electronics, Inc. in Fremont, California. We do not have long-term
agreements with Venture Manufacturing or Flash Electronics and typically
obtain services from them on a per order basis. Additionally, our controllers
are assembled, tested and packaged primarily by Advanced Semiconductor
Engineering, Inc. in Taiwan and Multitech Design & Test, Inc. in Sunnyvale,
California. Our reliance on these subcontractors involves risks such as
reduced control over delivery schedules, quality assurance, inventory levels
and costs. These risks could result in product shortages or increase our costs
of manufacturing, assembling or testing our products. If these subcontractors
are unable or unwilling to continue to provide assembly and test services and
deliver products of acceptable quality, at acceptable costs and in a timely
manner, we would have to identify and qualify additional substitute
subcontractors. This could be time-consuming and difficult and result in
unforeseen operations problems.

 Our failure to successfully promote our brand and achieve strong brand
 recognition in target markets could limit or reduce the demand for our
 products and services.

   We believe that brand recognition will be important to our ability to be
successful as the digital photography market develops. We plan to continue to
invest in marketing programs to create and maintain prominent brand awareness.
If we fail to promote our brand successfully, or the expenses associated with
doing so become increasingly high, our business may not grow as we anticipate.
In addition, if our products exhibit poor performance or other defects, our
brand may be significantly diluted, which would inhibit our ability to attract
or retain customers.

 The solid-state storage market is evolving and future digital film formats
 may not use our core technology or we may be forced to pay a royalty to sell
 digital film in these formats.

   Our products may become less useful to our customers if we are unable to
respond to technological advances in our industry or as innovative products
become available to our customers. Although many digital cameras currently use
Compact Flash, Memory Stick or Smart Media Cards, future digital cameras may
use other digital film formats, such as compact discs, rotating media, micro-
optical or magneto-optical storage, which may not use our controller
technology. If these other digital film formats were to gain broad consumer
acceptance, demand for our controller technology would decline, which would
negatively impact our gross margins and operating results. In addition, we may
have to obtain a license to manufacture some digital film formats. For
example, a consortium led by SanDisk, Matsushita and Toshiba recently
introduced the Secure Digital Card format. In addition, DataPlay has recently
introduced a low cost micro-optical device. We may be unable to secure
licensing arrangements for these or other future technologies at reasonable
rates or at all.

                                      24
<PAGE>

 If we encounter difficulties in attracting and retaining qualified personnel,
 we may not be able to successfully execute our business strategy and we may
 need to grant large stock-based incentives that could be dilutive to our
 stockholders and may be required to pay significant salaries which would
 increase our general and administrative costs.

   Our future success will depend to a significant extent on the continued
services of our key employees, including Eric B. Stang, our President and
Chief Executive Officer, and Petro Estakhri, our Chief Technology Officer and
Executive Vice President of Engineering. Our success will also depend on our
ability to attract and retain qualified technical, sales, marketing, finance
and managerial personnel. If we are unable to find, hire and retain qualified
individuals, we may have difficulty implementing portions of our business
strategy in a timely manner, or at all. Petro Estakhri, Eric B. Stang, and
Mike Assar, our Senior Vice President, Technology, are the only employees with
whom we have entered into employment agreements. In addition, we do not
maintain key man life insurance on the members of our senior management team,
other than John H. Reimer, Chairman of our Board, and Mr. Estakhri.

   We have experienced, and may continue to experience, difficulty in hiring
and retaining candidates with appropriate qualifications, especially in light
of the significant decline of our stock price since our initial public
offering in August 2000. To attract and retain qualified personnel, we may be
required to grant large option or other stock-based incentive awards, which
may be highly dilutive to existing stockholders. We may also be required to
pay significant base salaries and cash bonuses to attract and retain these
individuals, which could harm our operating results. If we do not succeed in
hiring and retaining candidates with appropriate qualifications, we will not
be able to grow our business.

 If our products contain defects, we may incur unexpected and significant
 operating expenses to correct the defects, we may be required to pay damages
 to third parties and our reputation may suffer serious harm.

   Although our digital film products are tested after they are assembled,
these products are extremely complex and may contain defects. These defects
are particularly likely when new versions or enhancements are released. The
sale of products with defects or reliability, quality or compatibility
problems may damage our reputation and our ability to retain existing
customers and attract new customers. For example, if there are defects in our
products that cause loss of data, customers may lose their digital images
stored on our digital film. In addition, product defects and errors could
result in additional development costs, diversion of technical and management
resources, delayed product shipments, increased product returns, and product
liability claims against us which may not be fully covered by insurance.

 Our significant sales outside the United States and our brand launch in Japan
 subject us to increasing foreign political and economic risks, including
 foreign currency fluctuations.

   Sales outside of the United States accounted for 49.2% of our revenues for
the three months ended June 30, 2001. We generated a majority of our
international revenues from licensing agreements in Asia and product sales in
Europe. The European market is intensely competitive. One of our principal
growth strategies is to expand our presence in this and other international
markets both through increased international sales and strategic
relationships. We also anticipate conducting transactions in the euro, and are
expanding distribution of our products into Latin America. Consequently, we
anticipate that sales outside of the United States will continue to account
for a significant portion of our revenue in future periods. Accordingly, we
are subject to international risks, including:

  .  foreign currency exchange fluctuations;

  .  political and economic instability, particularly in light of recent
     economic volatility encountered by Japan;

  .  delays in meeting customer commitments due to difficulties associated
     with managing an international distribution system;


                                      25
<PAGE>

  .  increased time to collect receivables caused by slower payment practices
     that are common in many international markets, particularly in Latin
     America;

  .  difficulties associated with managing export licenses, tariffs and other
     regulatory issues pertaining to international trade;

  .  increased effort and costs associated with the protection of our
     intellectual property in foreign countries;

  .  natural disasters, political uncertainties and changing regulator
     environments in foreign countries; and

  .  difficulties in hiring and managing employees in foreign countries.

   The sales of our products are denominated primarily in United States
dollars. As a result, increases in the value of the United States dollar
relative to foreign currencies could cause our products to become less
competitive in international markets and could result in a reduction in sales
and profitability. As a result of our European subsidiary, Lexar Media,
Europe, we have product sales denominated in British pounds and anticipate
that future sales will also be denominated in the Euro and other foreign
currencies. In addition, we have sales to customers denominated in Canadian
dollars and Japanese yen, and anticipate having some sales in Latin American
currencies in 2001. To the extent our prices are denominated in foreign
currencies, particularly the British pound and Japanese yen, we will be
exposed to increased risks of currency fluctuations. We have no hedging
policies in place to mitigate these potential risks, and we cannot assure you
that any policies or techniques implemented in the future will be successful
or that our business and financial condition will not be harmed by exchange
rate fluctuations.

Risks Related to Our Industry

 Our business will not succeed unless the digital photography market continues
 to grow and is accepted by professional, commercial and consumer users.

   We currently depend on sales of digital film and connectivity products for
substantially all of our revenues, which exposes us to substantial risk in the
event the digital photography market does not grow rapidly. The digital
photography market is in an early stage of development and is rapidly
evolving. The success of this market depends on many factors, including:
  .  the ability of digital cameras to take high-quality photographs;

  .  the availability of digital cameras at prices and with performance
     characteristics comparable to traditional cameras;

  .  the availability of digital film that meet users' requirements with
     respect to price, speed, connectivity, capacity and compatibility;

  .  the speed at which digital cameras are able to take successive
     photographs;

  .  the ease with which digital files can be transferred to a personal
     computer or printer;

  .  the availability of digital image prints comparable in quality and price
     to traditional photographs; and

  .  market conditions in the industry and the economy as a whole.

                                      26
<PAGE>

   In addition to the above factors related to the digital photography market
as a whole, we believe the following additional factors will affect the
successful adoption of digital photography by consumers:

  .  marketing campaigns that increase brand awareness in end-user markets,
     both domestically and internationally;

  .  increased association between brand names and attractive price and
     performance characteristics; and

  .  heightened consumer confidence in digital photography technology.

   If the digital photography market does not continue to grow and be accepted
by professional, commercial and consumer users, our business will not succeed.

 Increased competition in the digital film market has led, and may continue to
 lead, to a decrease in revenues and market share.

   We currently compete in an industry characterized by intense competition,
rapid technological change, evolving industry standards, declining average
selling prices and rapid product obsolescence. Our existing competitors
include many large domestic and international companies that have longer
operating histories and greater brand name recognition, greater access to
flash memory, substantially greater financial, technical, marketing and other
resources, broader product lines and longer standing relationships with
customers. As a result, these competitors may be able to better absorb price
declines, adapt more quickly to new or emerging technologies or devote greater
resources to the promotion and sale of their products than we may. This has
led, and may continue to lead to, a decrease in sales and market share.

   Our primary competitors are companies that sell digital film into the
consumer and original equipment manufacturer digital film markets. These
companies are primarily manufacturers with both controller and flash memory
capabilities, such as SanDisk, Toshiba and Hitachi. SanDisk and Toshiba now
jointly develop and manufacture high-performance flash memory. Because flash
memory represents a significant portion of the cost of digital film, SanDisk
may have a competitive advantage in that it will have access to high-capacity
flash memory at prices that may be substantially below the prices that Samsung
will charge.

   We also compete with manufacturers, package or card assemblers and
resellers that combine controllers and flash memory developed by others, such
as Hitachi, into flash memory cards, including Kingston Technology, Simple
Technology, Smart Modular Technologies and Viking. Additionally, Hitachi and
Samsung, as well as flash controller developers such as Feiya Technology,
Pretec, Solid State System Co. Ltd. (3System) and Hyperstone, compete with our
controller and card sales.

   Kodak and Fuji are the largest and best known manufacturers of traditional
film products. Kodak and Fuji recently entered the U.S. digital film market,
but do not yet manufacture their own digital film. Kodak recently announced
that it plans to build on its digital strategy with investments and purchases
as it aims to be the number one player in digital photography. It further
stated that it would fund its digital plans from at least $6 billion in free
cash flow between 2001 and 2005. With their resources and worldwide brand
recognition, either Kodak or Fuji would be formidable competitors for our core
business. We also expect to face competition from existing or future
competitors that design and market similar or alternative data storage
solutions that may be less costly or provide additional features. If a
manufacturer of digital cameras or other consumer electronic devices designs
one of these alternative competing standards into its products, our digital
film as currently configured will not be compatible with that product and our
revenues may decline.

 General economic conditions and reduced demand for digital film and related
 products may prevent us from achieving targeted revenues and profitability.

   Our revenues and our ability to achieve and sustain profitability depends
significantly on the overall demand for digital film and related products. Our
customers' decisions to purchase our products are largely discretionary. The
slowdown in the U.S. and global economy may cause customers to defer or alter
purchasing decisions, and

                                      27
<PAGE>

accordingly could reduce demand for our products. Softening demand for these
products caused by worsening economic conditions has resulted and may result
in decreased revenues in the future. As a result, there is uncertainty with
respect to our expected revenues for the balance of 2001, and further delays
or reductions in spending on digital film and related products could have a
material adverse effect on our revenues and operating results.

 Our stock price and those of other technology companies have experienced
 extreme price and volume fluctuations, and, accordingly, our stock price may
 continue to be volatile which could negatively affect your investment.

   The trading price of our common stock has fluctuated significantly since
our initial public offering in August 2000 and is significantly below the
original offering price of $8 per share. An active public market for our
common stock may not be sustained in the future. Many factors could cause the
market price of our common stock to fluctuate, including:

  .  variations in our quarterly operating results;

  .  announcements of technological innovations by us or by our competitors;

  .  introductions of new products or new pricing policies by us or by our
     competitors;

  .  departure of key personnel;

  .  the gain or loss of significant orders or customers;

  .  changes in the estimates of our operating performance or changes in
     recommendations by securities analysts; and

  .  market conditions in our industry and the economy as a whole.

   In addition, stocks of technology companies have experienced extreme price
and volume fluctuations that often have been unrelated or disproportionate to
these companies' operating performance. Public announcements by companies in
our industry concerning, among other things, their performance, accounting
practices or legal problems could cause fluctuations in the market for stocks
of these companies. These fluctuations could lower the market price of our
common stock regardless of our actual operating performance.

   In the past, securities class action litigation has often been brought
against a company following a period of volatility in the market price of its
securities. We may in the future be the target of similar litigation.
Securities litigation could result in substantial costs and divert
management's attention and resources, which could harm our operating results
and our business.

 If digital camera manufacturers do not develop and promote products that are
 able to take advantage of our fastest digital film products, the growth and
 success of our business may be limited.

   We depend on the research and development, marketing and sales efforts of
digital camera manufacturers in developing, marketing and selling digital
cameras that can use our more advanced existing and future products. Most of
the digital cameras currently available on the market do not incorporate
technologies that can take advantage of the speed available in our fastest
digital film products. If digital camera manufacturers do not successfully
develop, market and sell digital cameras that take full advantage of our most
advanced products, from which we realize higher gross margins, the growth and
success of our business may be limited.

 The manufacturing of our products is complex and subject to yield problems,
 which could decrease available supply and increase costs.

   The manufacture of flash memory and controllers is a complex process, and
it is often difficult for companies to achieve acceptable product yields.
Reduced flash memory yields could decrease available supply and increase
costs. Controller yields depend on both our product design and the
manufacturing process technology unique to the semiconductor foundry. Because
low yields may result from either design defects or process difficulties, we
may not identify yield problems until well into the production cycle, when an
actual product exists and can be analyzed and tested. In addition, many of
these yield problems are difficult to diagnose and time consuming or expensive
to remedy.

                                      28
<PAGE>

Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk.

   Foreign currency risk. We sell our products primarily to customers in the
U.S. and, to a lesser extent, Japan, Canada and Europe. Most of our sales are
currently denominated in U.S. dollars; however, we anticipate an increasing
amount of our sales will be denominated in British pounds, the Japanese yen
and possibly the euro and Latin American currencies. As a result, it is
possible that our future financial results could be directly affected by
changes in foreign currency exchange rates, and the prices of our products
would become more expensive in a particular foreign market if the value of the
U.S. dollar rises in comparison to the local currency, which may make it more
difficult to sell our products in that market. We will continue to face
foreign currency exchange risk in the future. Approximately 34.1% of our
revenues for the six months ended June 30, 2001 were derived from countries
other than the United States. Therefore, our financial results could be
directly affected by weak economic conditions in foreign markets. These risks
may change if we acquire businesses outside the U.S. or if we sell in non-U.S.
dollar denominated currencies.

   Interest rate risk. Our exposure to market risk for changes in interest
rates relates primarily to the increase or decrease in the amount of interest
expense we must pay on our outstanding debt instruments. The risk associated
with fluctuating interest expense is limited to the exposure related to those
debt instruments and credit facilities that are tied to market rates. At June
30, 2001 we had no outstanding debt instruments which were tied to market
rates. We do not plan to use derivative financial instruments in our
investment portfolio. We plan to ensure the safety and preservation of our
invested principal funds by limiting default risk and market risk. We plan to
mitigate default risk by investing in investment-grade securities. We have
historically invested in investment-grade, short-term securities that we have
held until maturity to limit our market risk.

                                      29
<PAGE>

                          PART II--OTHER INFORMATION

Item 1. Legal Proceedings.

   On April 6, 2001, Memtek Products, Inc. sued us seeking declaratory relief
that its products do not infringe our U.S. Patent Nos. 5,907,856, 5,930,815
and 5,845,313. This suit was filed in the United States District Court for the
Central District of California. On July 16, 2001, the Court granted our motion
to dismiss this case and transfer the litigation to the Northern District of
California where we have a complaint pending against Memtek Products, Inc.

   On April 13, 2001, we filed an amended complaint in our litigation with
Pretec Electronics Corporation, naming Memtek Products, Inc., as an additional
defendant. On June 26, the court allowed us to file our second amended
complaint in our litigation with Pretec Electronics Corporation, naming C-One
as an additional defendant and adding our U.S. Patent No. 5,479,638 against
all of the defendants In this action we allege that Memtek Products, Inc. and
the other defendants infringe our U.S. Patent Nos. 5,479,638, 5,818,781,
5,907,856, 5,930,815 and 6,145,051. This suit is pending in the United States
District Court for the Northern District of California. We are seeking
injunctive relief and damages against all of the defendants.

   On May 10, 2001, SanDisk sued Viking Components Inc. for the manufacture
and sale of flash cards using Lexar's 1140, 1145, 1175 and 1250 flash memory
controllers. These flash memory controllers were the subject of the SanDisk v.
Lexar litigation which was settled in November 2000. SanDisk is seeking an
injunction and damages against Viking Components. We have agreed to indemnify
Viking in its defense of this litigation.

Item 2. Changes in Securities and Use of Proceeds.

   (c) Recent Sales of Unregistered Securities.

   On April 3, 2001, we issued a warrant to purchase 200,000 shares of our
common stock to Olympus Japan and a warrant to purchase 300,000 shares of our
common stock to Olympus Japan Co., Ltd., each at an exercise price of $1.13
per share, in connection with an OEM and technology licensing agreement we
entered into with Olympus Optical Co.

   (d) Use of Proceeds.

   On August 14, 2000, the Securities and Exchange Commission declared
effective our registration statement on Form S-1 (No. 333-30556) relating to
the initial public offering of our common stock.

   The net offering proceeds to us from our initial public offering, after
deducting underwriting discounts and commissions and offering expenses, were
approximately $53.3 million. A portion of the proceeds have been used to fund
continuing operations, to repay bridge financing notes totaling $13.3 million
and to pay $6.0 million in net payments to SanDisk in settlement of patent
litigation with SanDisk in November 2000. As of June 30, 2001, we had
approximately $14.0 million in proceeds remaining from our initial public
offering, which are being used to support our business operations and to
provide working capital.

Item 3. Defaults Upon Senior Securities.

   During the second quarter of 2001, the Company repaid the entire balance of
$6.1 million outstanding against the Chase revolving credit line.

   At June 30, 2001, the Company was in default of covenants in relation to
its term loan with Access Technology Partners. In July 2001, Access Technology
Partners issued a waiver of this default.

                                      30
<PAGE>

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

   The 2001 Annual Meeting of Stockholders was held on June 5, 2001 at the
Fremont Marriott, 46100 Landing Parkway, Fremont, California. At the meeting,
our stockholders voted upon the following matters: (1) The election of two
Class I directors, John A. Rollwagen and William J. Stewart, each for a term
of three years and until his successor has been elected and qualified or until
his earlier resignation, death or removal, and (2) the ratification of the
selection of PricewaterhouseCoopers LLP as our independent accountants for the
fiscal year ending December 31, 2001. The results of each proposal are as
follows.

   In Proposal No. 1, our stockholders elected two Class I directors to serve
for a three-year term expiring at the Annual Meeting of Stockholders in 2004
was approved by our stockholders. The nominees received the following votes:

<TABLE>
<CAPTION>
                                                                For     Withheld
                                                             ---------- --------
       <S>                                                   <C>        <C>
       John A. Rollwagen.................................... 38,116,547  27,500
       William J. Stewart................................... 38,116,547  27,500
</TABLE>

   In Proposal No. 2, our stockholders ratified the appointment of
PricewaterhouseCoopers LLP as our independent auditors for the fiscal year
ending December 31, 2001. This proposal received the following votes:

<TABLE>
<CAPTION>
                                                                        Votes
                                                                      ----------
       <S>                                                            <C>
       For........................................................... 38,113,707
       Against.......................................................     23,550
       Abstain.......................................................      6,700
</TABLE>

Item 5. Other Information.

   None.

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

   A. Exhibits

   None.

   B. Reports on Form 8-K

   No reports were filed on Form 8-K for the quarter ended June 30, 2001.

                                      31
<PAGE>

                                   SIGNATURES

   Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                          LEXAR MEDIA, INC.

                                                 /s/ Michael J. Perez
                                          -------------------------------------
                                                    Michael J. Perez
                                           Chief Financial Officer (Principal
                                             Financial Officer and Principal
                                                   Accounting Officer)

Date: August 14, 2001

                                       32