<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 September 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)

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

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

                                (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 October 31, 2001: 59,759,448

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

<PAGE>

                               LEXAR MEDIA, INC.

                                   FORM 10-Q
                   FOR THE QUARTER ENDED SEPTEMBER 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 September 30, 2001 and
              December 31, 2000...............................................................   1
            Condensed Consolidated Statements of Operations for the Three-Month and Nine-Month
              Periods Ended September 30, 2001 and 2000.......................................   2
            Condensed Consolidated Statements of Cash Flows for the Nine-Months Ended
              September 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...................................................  31
   Item 4.  Submission of Matters to a Vote of Security Holders...............................  31
   Item 5.  Other Information.................................................................  31
   Item 6.  Exhibits and Reports on Form 8-K..................................................  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>
                                                                              September 30, December 31,
                                                                                  2001          2000
                                                                              ------------- ------------
                                   ASSETS
                                   ------
<S>                                                                           <C>           <C>
Current assets:
   Cash and cash equivalents (includes restricted cash of $2,333 and $1,000).   $  14,980     $  8,755
   Short-term investments....................................................          --       19,987
   Accounts receivable, net..................................................       9,586        8,767
   Inventory.................................................................       6,545       27,536
   Prepaid expenses and other current assets.................................       1,138        1,909
                                                                                ---------     --------
       Total current assets..................................................      32,249       66,954
Property and equipment, net..................................................       2,622        3,364
Intangible assets, net.......................................................         291        3,544
Other assets.................................................................         863          986
                                                                                ---------     --------
       Total assets..........................................................   $  36,025     $ 74,848
                                                                                =========     ========
<CAPTION>

                    LIABILITIES AND STOCKHOLDERS' EQUITY
                    ------------------------------------
<S>                                                                           <C>           <C>
Current liabilities:
   Accounts payable..........................................................   $   7,102     $  8,007
   Accrued liabilities.......................................................       8,162        8,886
   Deferred revenue..........................................................       7,080          446
   Notes payable to stockholders.............................................         187          362
   Notes payable to banks....................................................       4,909        6,088
                                                                                ---------     --------
       Total current liabilities.............................................      27,440       23,789
Notes payable to stockholders, net of current portion........................          --          159
Notes payable, net...........................................................          --        1,362
                                                                                ---------     --------
       Total liabilities.....................................................      27,440       25,310

Stockholders' equity:
Common stock, $0.0001 par value:
   75,000,000 shares authorized; 59,754,929 and 60,052,462 shares issued and
     outstanding.............................................................           6            6
   Additional paid-in capital................................................     147,611      152,796
   Unearned stock-based compensation.........................................      (2,567)      (9,586)
   Notes receivable from stockholders........................................      (3,593)      (5,292)
   Accumulated deficit.......................................................    (132,750)     (88,348)
   Accumulated other comprehensive loss......................................        (122)         (38)
                                                                                ---------     --------
       Total stockholders' equity............................................       8,585       49,538
                                                                                ---------     --------
       Total liabilities and stockholders' equity............................   $  36,025     $ 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           Nine Months Ended
                                                     --------------------------  --------------------------
                                                     September 30, September 30, September 30, September 30,
                                                         2001          2000          2001          2000
                                                     ------------- ------------- ------------- -------------
<S>                                                  <C>           <C>           <C>           <C>
Revenues:
   Product revenues.................................    $14,319      $ 30,724      $ 43,870      $ 71,290
   License and royalty revenues.....................      3,829           250         7,838           500
                                                        -------      --------      --------      --------
       Total revenues...............................     18,148        30,974        51,708        71,790
Cost of product revenues (excludes stock-based
  compensation of $(16), $(475), $35, and $291).....     12,942        25,852        53,061        59,904
                                                        -------      --------      --------      --------
Gross margin........................................      5,206         5,122        (1,353)       11,886
                                                        -------      --------      --------      --------
Operating expenses:
   Research and development (excludes stock-based
     compensation of $322, $1,018, $1,028 and
     $3,724)........................................      1,215         1,701         4,421         5,252
   Sales and marketing (excludes stock-based
     compensation of $87, $499, $232 and
     $1,685)........................................      4,167         5,957        16,151        14,083
   General and administrative (excludes stock-based
     compensation of $(459), $1,723, $554 and
     $5,233)........................................      2,500         3,769        10,171         9,629
   Goodwill impairment..............................         --            --         2,854            --
   Restructuring charge.............................         --            --         2,086            --
   Stock-based compensation.........................        (66)        2,765         1,849        10,933
                                                        -------      --------      --------      --------
       Total operating expenses.....................      7,816        14,192        37,532        39,897
                                                        -------      --------      --------      --------
Loss from operations................................     (2,610)       (9,070)      (38,885)      (28,011)
Other income and expense:
   Interest and other expense.......................       (545)       (6,067)       (3,911)       (6,545)
   Interest and other income........................        144           615           868           992
   Foreign exchange gain (loss).....................        194           250          (198)          193
                                                        -------      --------      --------      --------
       Total other expense..........................       (207)       (5,202)       (3,241)       (5,360)
                                                        -------      --------      --------      --------
Loss before income taxes............................     (2,817)      (14,272)      (42,126)      (33,371)
Income tax expense..................................        676            --         2,276            --
                                                        -------      --------      --------      --------
       Net loss.....................................    $(3,493)     $(14,272)     $(44,402)     $(33,371)
                                                        =======      ========      ========      ========
Net loss per common share--basic and diluted........    $ (0.06)     $  (0.46)     $  (0.77)     $  (2.12)
                                                        =======      ========      ========      ========
Shares used in net loss per common share
  calculation--basic and diluted....................     58,547        30,985        57,912        15,976
                                                        =======      ========      ========      ========
</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>
                                                                                                      Nine Months Ended
                                                                                                 --------------------------
                                                                                                 September 30, September 30,
                                                                                                     2001          2000
                                                                                                 ------------- -------------
<S>                                                                                              <C>           <C>
Cash flows from operating activities:
    Net loss....................................................................................   $(44,402)     $(33,371)
    Adjustments to reconcile net loss to net cash used in operating activities:
       Depreciation and amortization............................................................      1,461         1,376
       Issuance of warrants and stock to non-employees..........................................         51           167
       Goodwill impairment......................................................................      2,854            --
       Restructuring charge.....................................................................      1,590            --
       Loss on disposition of fixed assets......................................................          6            --
       Amortization of stock-based compensation.................................................      1,849        10,933
       Imputed and other non-cash interest......................................................      2,991         5,647
       Change in operating assets and liabilities:
          Accounts receivable, net..............................................................       (819)       (6,139)
          Inventory.............................................................................     20,991        (3,244)
          Prepaid expenses and other assets.....................................................        264        (2,052)
          Accounts payable and accrued liabilities..............................................     (3,676)        4,928
          Deferred revenue......................................................................      6,834           885
                                                                                                   --------      --------
             Net cash used in operating activities..............................................     (9,014)      (20,870)
                                                                                                   --------      --------
Cash flows from investing activities:
    Purchase of property and equipment..........................................................       (856)       (2,035)
    Cash used in acquisition of Impact Peripherals, Ltd.........................................         --           (64)
    Cash acquired upon acquisition of Printroom.com, Inc........................................         --            49
    Purchase of short-term investments..........................................................         --       (19,692)
    Proceeds from sale of short-term investments................................................     19,987         3,896
                                                                                                   --------      --------
             Net cash provided by (used in) investing activities................................     19,131       (17,846)
                                                                                                   --------      --------
Cash flows from financing activities:
    Proceeds from initial public offering, net of issuance costs................................         --        53,350
    Issuance of stock under employee stock purchase plan........................................        392            --
    Exercise of stock options and warrants......................................................         45           754
    Repayment of notes payable..................................................................     (6,445)      (18,486)
    Proceeds from notes payable.................................................................      2,000        12,125
    Repayment of notes receivable from stockholders.............................................        220            --
    Proceeds from notes payable to stockholders.................................................         --        13,275
    Repurchase of stock.........................................................................        (20)          (19)
                                                                                                   --------      --------
             Net cash (used in) provided by financing activities................................     (3,808)       60,999
                                                                                                   --------      --------
    Effect of exchange rates on cash and cash equivalents.......................................        (84)          (25)
                                                                                                   --------      --------
Net increase in cash and cash equivalents.......................................................      6,225        22,258
Cash and cash equivalents at beginning of period................................................      8,755         6,495
                                                                                                   --------      --------
Cash and cash equivalents at end of period......................................................   $ 14,980      $ 28,753
                                                                                                   ========      ========
Supplemental disclosure of non-cash financing and investing activities:
    Conversion of note payable into common stock................................................   $     --      $  2,000
    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.................................................................................         --      $  3,536
    Issuance of warrants in relation to credit facilities.......................................         --      $  3,140
    Issuance of common stock in connection with acquisition of Printroom.com, Inc. and
     Impact Peripherals, Ltd....................................................................         --      $  4,040
    Repurchase of common stock by cancellation of notes receivable..............................   $  1,479      $    190
    Issuance of warrant in connection with license and royalty agreement........................   $    206            --
    Issuance of common stock for browser development............................................         --      $    200
    Conversion of preferred stock into common stock.............................................         --      $ 53,415
</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. In addition, certain reclassifications have been made to
prior year balances in order to conform to the current year presentation.

   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 nine months ended September 30,
2001 are not necessarily indicative of results that may be expected for any
other future period, including the full fiscal year.

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," Financial Accounting
Standards Board Interpretation ("FIN") No. 44, "Accounting for Certain
Transactions Involving Stock Compensation" an Interpretation of APB 25," the
Emerging Issues Task Force ("EITF") 00-23, "Issues Related to the Accounting
for Stock Compensation under APB Opinion No. 25 and FIN No. 44," and 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
EITF 96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services."

                                      4

<PAGE>

                      LEXAR MEDIA, INC. AND SUBSIDIARIES

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Recent accounting developments

   In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS141 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.

   In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." SFAS No. 144 applies to all long-lived assets
(including discontinued operations) and consequently amends APB No. 30,
"Reporting the Results of Operations--Reporting the Effects of Disposal of a
Division of a Business." SFAS No. 144 develops one accounting model for
long-lived assets that are to be disposed of by sale and requires the
measurement to be at the lower of book value or fair value, less the cost to
sell the assets. Additionally, SFAS No. 144 expands the scope of discontinued
operations to include all components of an entity with operations that (1) can
be distinguished from the rest of the entity and (2) will be eliminated from
the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001. The provisions of
SFAS No. 144 are not expected to have a significant impact on the Company's
financial position or operating results.

  Shipping and handling costs

   Shipping and handling costs associated with our product revenues are
included in selling and marketing expenses in the Company's condensed
consolidated statements of operations. These costs were $0.5 million and $0.3
million for the three months ended September 30, 2001 and September 30, 2000,
respectively, and $1.4 million and $0.8 million for the nine months ended
September 30, 2001 and September 30, 2000, respectively.

Note 3--Balance Sheet Detail (in thousands)

<TABLE>
<CAPTION>
                                        September 30, December 31,
                                            2001          2000
                                        ------------- ------------
              <S>                       <C>           <C>
              Inventories:
                 Raw materials.........    $  873       $ 4,897
                 Controllers...........       693         1,483
                 Flash memory products.     3,983        19,183
                 Ancillary products....       996         1,973
                                           ------       -------
                                           $6,545       $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 date)

<TABLE>
<CAPTION>
                                                Three Months Ended           Nine Months Ended
                                            --------------------------  --------------------------
                                            September 30, September 30, September 30, September 30,
                                                2001          2000          2001          2000
                                            ------------- ------------- ------------- -------------
<S>                                         <C>           <C>           <C>           <C>
Numerator:
   Net loss................................    $(3,493)     $(14,272)     $(44,402)     $(33,371)
   Accretion of mandatorily redeemable
     convertible preferred stock...........         --           (72)           --          (423)
                                               -------      --------      --------      --------
   Net loss after accretion of mandatorily
     redeemable convertible preferred
     stock.................................    $(3,493)     $(14,344)     $(44,402)     $(33,794)
                                               =======      ========      ========      ========
Denominator:
   Weighted average common shares
     outstanding...........................     60,420        36,200        60,290        21,785
   Weighted average unvested common
     shares subject to repurchase..........     (1,873)       (5,215)       (2,378)       (5,809)
                                               -------      --------      --------      --------
   Denominator for basic and diluted
     calculations..........................     58,547        30,985        57,912        15,976
                                               =======      ========      ========      ========
   Net loss per common share, basic and
     diluted...............................    $ (0.06)     $  (0.46)     $  (0.77)     $  (2.12)
                                               =======      ========      ========      ========
</TABLE>

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

Note 5--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. The Company recognized a $2.1 million restructuring
charge in the second quarter of 2001 related to this restructuring. The
restructuring was effected in the third quarter of fiscal 2001 and is
substantially complete. The disposition of Printroom.com was implemented
through a sale of the Printroom.com assets to a company owned by the management
of Printroom.com.

   The following table depicts the restructuring and other activity through
September 30, 2001:

<TABLE>
<CAPTION>
                                         Accrued                        Accrued
                                        Balance at                    Balance at
                                         June 30,    Cash   Non-cash September 30,
                                           2001    Payments Charges      2001
                                        ---------- -------- -------- -------------
<S>                                     <C>        <C>      <C>      <C>
Reduction in workforce.................   $1,052    $(448)   $  --      $  604
Asset write-offs.......................      554       --     (536)         18
Excess facilities and related costs....      368      (28)      --         340
Other..................................      112      (20)      --          92
                                          ------    -----    -----      ------
                                          $2,086    $(496)   $(536)     $1,054
                                          ======    =====    =====      ======
</TABLE>

   Remaining expenditures relating to workforce reductions and termination
agreements will be substantially paid in the fourth quarter of 2001 and the
first quarter of 2002. Amounts related to excess facilities and related costs
are expected to be paid over the lease terms which expire in 2004.

                                      6

<PAGE>

                      LEXAR MEDIA, INC. AND SUBSIDIARIES

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 6--Notes Payable

   During September 2001, the Company established a new asset based credit
facility with Greater Bay Bancorp "GBB." The Company borrowed $2.0 million
under this facility at the end of the third quarter. The new facility bears
interest at an annual rate of 9.6%, plus administrative charges, has a term of
one year and is renewable from year to year thereafter. In addition, the
Company issued to GBB a warrant to purchase 250,000 shares of the Company's
common stock at an exercise price of $1.26 per share. The warrant was valued
using the Black-Scholes model at $0.1 million and recognized as an expense
during the third quarter. This facility may be terminated by either party, at
any time, upon 30 days notice.

   In October 2001, the Company elected to repay the outstanding balance on the
Access Technology Partners credit facility. Under the terms of the credit
facility, the repayment of the initial borrowing of $4.0 million was due in
June 2003. The principal payment made in October 2001 was $4.7 million, and the
Company wrote off the related unamortized warrant value and fees totaling $2.0
million.

Note 7--Comprehensive Loss

   Other comprehensive loss for the third quarter and first nine months of 2001
was $82,000 and $84,000, respectively. This loss was attributable to foreign
currency translation. There was no other comprehensive income or loss for the
third quarter and first nine months of 2000.

                                      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
third quarter of 2001, digital film and other product sales comprised
approximately 78.9% 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.

   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

                                      8

<PAGE>

Olympus a non-exclusive license to our technology, agreed that Olympus would
bundle our Lexar-branded digital 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 third quarter and first nine months 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 62.0% of our gross revenues for the nine months
ended September 30, 2001 and 81.1% of our gross revenues for the nine months
ended September 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 product sales account for the majority of our revenues. Product
revenues in the United States represented 63.2% of our revenues for the nine
months ended September 30, 2001 and 63.7% of our revenues for the nine months
ended September 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 for at least the next 12 months. 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 nine months of 2001. We expect to continue to see
price declines through the remainder of 2001 and into 2002. In addition, cost
of revenues includes expenses related to materials procurement, inventory
management, adjustments and manufacturing. In accordance with our settlement
agreement with SanDisk, 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 latest 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. In the fourth quarter of 2001, we
expect research and development expenses to be consistent with our research and
development expenses in the third quarter of 2001.

                                      9

<PAGE>

   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. In
the fourth quarter of 2001, we expect sales and marketing expenses to decline
compared with sales and marketing expenses in the third quarter of 2001 due to
our continuing focus on expense reductions in this area.

   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 corporate expenses. In the
fourth quarter of 2001, we expect general and administrative expenses to
decline compared with general and administrative in the third quarter of 2001
due to our continuing focus on expense reductions in this area.

   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. The restructuring was effected in the third quarter of
2001 and is substantially complete.

Our History of Losses

   We have incurred significant losses to date. As of September 30, 2001, we
had an accumulated deficit of approximately $132.8 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 may to continue to incur additional losses and
negative cash flow through the remainder 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.

                                      10

<PAGE>

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           Nine months ended
                                     -------------------------   -------------------------
                                     September 30, September 30, September 30, September 30,
                                         2001          2000          2001          2000
                                     ------------- ------------- ------------- -------------
<S>                                  <C>           <C>           <C>           <C>
Revenues:
   Product revenues.................      78.9 %        99.2 %        84.8 %        99.3 %
   License and royalty revenues.....      21.1 %         0.8 %        15.2 %         0.7 %
                                         -----         -----         -----         -----
       Total revenues...............     100.0 %       100.0 %       100.0 %       100.0 %
Cost of product revenues............      71.3 %        83.5 %       102.6 %        83.4 %
                                         -----         -----         -----         -----
   Gross margin.....................      28.7 %        16.5 %        (2.6)%        16.6 %
                                         -----         -----         -----         -----
Operating expenses:
   Research and development.........       6.7 %         5.5 %         8.6 %         7.3 %
   Sales and marketing..............      23.0 %        19.2 %        31.2 %        19.7 %
   General and administrative.......      13.8 %        12.2 %        19.7 %        13.4 %
   Goodwill impairment..............        --            --           5.5 %          --
   Restructuring charge.............        --            --           4.0 %          --
   Stock-based compensation.........      (0.4)%         8.9 %         3.6 %        15.2 %
                                         -----         -----         -----         -----
       Total operating expenses.....      43.1 %        45.8 %        72.6 %        55.6 %
                                         -----         -----         -----         -----
Loss from operations................     (14.4)%       (29.3)%       (75.2)%       (39.0)%
Other income and expense:
   Interest and other expense.......      (3.0)%       (19.6)%        (7.6)%        (9.1)%
   Interest and other income........       0.8 %         2.0 %         1.7 %         1.4 %
   Foreign exchange gain (loss).....       1.1 %         0.8 %        (0.4)%         0.2 %
                                         -----         -----         -----         -----
       Total other expense..........      (1.1)%       (16.8)%        (6.3)%        (7.5)%
                                         -----         -----         -----         -----
Loss before income taxes............     (15.5)%       (46.1)%       (81.5)%       (46.5)%
                                         -----         -----         -----         -----
Income tax expense..................       3.7 %         0.0 %         4.4 %         0.0 %
                                         -----         -----         -----         -----
       Net loss.....................     (19.2)%       (46.1)%       (85.9)%       (46.5)%
                                         =====         =====         =====         =====
</TABLE>

Revenues

   Total revenues for the third quarter of 2001 decreased $12.8 million, or
41.4%, to $18.1 million from $31.0 million for the third quarter of 2000.
Revenues for the first nine months of 2001 decreased $20.1 million, or 28.0%,
to $51.7 million from $71.8 million for the first nine months of 2000.

   Product revenues comprised 78.9% and 99.2% of total revenues for the third
quarters of 2001 and 2000, respectively. Product revenues for the third quarter
of 2001 decreased $16.4 million, or 53.4%, to $14.3 million from $30.7 million
in the third quarter of 2000. Product revenues comprised 84.8% and 99.3% of
total revenues for the first nine months of 2001 and 2000, respectively.
Product revenues for the first nine months of 2001 decreased $27.4 million, or
38.5%, to $43.9 million from $71.3 million for the first nine months of 2000.
The decrease in product revenue for the three and nine month periods was
primarily the result of declining average selling prices, and increases in
price protection and rebates, and for the nine-month period, lower shipments of
our digital film and connectivity products to OEM customers. The decline in OEM
product sales was driven by our strategy to focus on selling higher margin
products and licensing our proprietary controller technology. The decline in
average product selling prices was due to declining flash memory costs and
increased price competition. In the third quarter of 2001, we derived 59.0%,
13.5% and 4.6%, respectively, of our total revenues

                                      11

<PAGE>

from product sales to customers in the United States, Europe and Asia. In the
third quarter of 2000, we derived 65.2%, 9.9% and 22.8%, respectively, of our
total revenues from product sales to customers in the United States, Europe and
Asia. Two customers accounted for 13.6% and 13.4% of our gross product revenues
in the third quarter of 2001. Four customers accounted for 21.7%, 20.9%, 13.0%
and 10.2% of our gross product revenues in the third quarter of 2000. In the
first nine months of 2001, we derived 63.2%, 15.3% and 5.0%, respectively, of
our total revenues from product sales to customers in the United States, Europe
and Asia. In the first nine months of 2000, we derived 63.7%, 11.5% and 23.0%,
respectively, of our total revenues from product sales to customers in the
United States, Europe and Asia. One customer accounted for 11.1% of our gross
product revenues in the first nine months of 2001. Three customers accounted
for 19.4%, 15.9%, and 13.5% of our gross product revenues in the first nine
months of 2000.

   License and royalty revenues comprised 21.1% and 0.8% of total revenues for
the third quarters of 2001 and 2000, respectively. Licensing and royalty
revenues for the third quarter of 2001 increased $3.5 million, or 1,431.6%, to
$3.8 million from $0.3 million in the third quarter of 2000. License and
royalty revenues comprised 15.2% and 0.7% of total revenues for the first nine
months of 2001 and 2000, respectively. License and royalty revenues for the
first nine months of 2001 increased $7.3 million, or 1,467.6%, to $7.8 million
from $0.5 million for the first nine months of 2000. The increase in license
and royalty revenues is a result of the license and royalty agreements that we
have entered into during 2001.

Cost of product revenues

   Cost of product revenues decreased 49.9% to $12.9 million for the third
quarter of 2001 from $25.9 million for the third quarter of 2000. The decrease
in cost of product revenues was primarily driven by the decline in flash memory
pricing and a decrease in assembly costs; these decreases were partially offset
by a trend toward manufacture of higher capacity products which use more flash
memory, and by adjustments related to excess and obsolete inventory. Cost of
product revenues decreased $6.8 million, or 11.4%, to $53.1 million for the
first nine months of 2001 from $59.9 million for the first nine months of 2000.
This decrease was primarily driven by the decline in flash memory pricing and a
decrease in assembly costs; these decreases were partially offset by a trend
toward manufacture of higher capacity products, which use more flash memory, by
an increase in units sold and by adjustments related to excess and obsolete
inventory. Cost of revenues related to license and royalty revenues is
insignificant.

Gross margin

   Gross margins for product revenues in the third quarter of 2001 decreased to
9.6%, compared to 15.9% in the third quarter of 2000. Gross margins for product
revenues in the nine months ended September 30, 2001 decreased to (20.9%),
compared to 16.0% in the nine months ended September 30, 2000. These declines
were primarily related to the significant decreases in average selling prices,
increases in price protection and rebates, and inventory adjustments, which
were partially offset by decreases in product material and assembly costs as
well as improved inventory control.

   We expect gross margins to increase modestly compared to the quarter ended
September 30, 2001, primarily as a result of a shift to sales of higher margin
products, including our newly released 16x products, a continuing increase in
sales of Memory Stick and controller sales, and decreases in costs due to
increased efficiencies in inventory management. In addition, we expect flash
memory costs to continue to decrease in the near term as a result of continued
overcapacity in the flash memory manufacturing industry. Partially offsetting
these increases, we expect to experience continued pricing pressures on our
products due to continuing decreases of flash memory costs and competition,
which we believe will result in declining average selling prices.

Operating expenses

   Research and Development. For the third quarter of 2001, research and
development expenses decreased to $1.2 million, or 6.7% of revenues, from $1.7
million, or 5.5% of revenues, for the third quarter of 2000. For

                                      12

<PAGE>

the first nine months of 2001, research and development expenses decreased to
$4.4 million, or 8.6% of revenues, as compared to $5.3 million, or 7.3% of
revenues, for the first nine months of 2000. The decreases in research and
development expenses were primarily due to the divestiture of Printroom.com and
lower patent, project, and computer related costs over the comparable periods.
The increases in research and development expenses, as a percentage of
revenues, were primarily due to the decrease in revenue that was only partially
offset by the expense reductions.

   Sales and Marketing. Sales and marketing expenses for the third quarter of
2001 decreased to $4.2 million, or 23.0% of revenues, as compared to $6.0
million, or 19.2% of revenues, for the third quarter of 2000. This decrease in
sales and marketing expenses was due to a reduction of employee compensation
related costs in marketing and a reduction in spending on advertising. The
increase in sales and marketing expenses as a percentage of revenues during the
third quarter of 2001 compared with the third quarter of 2000 was primarily due
to the decreased revenues and partially offset by the relative decrease in
dollars spent. Sales and marketing expenses for the first nine months of 2001
increased to $16.2 million, or 31.2% of revenues, as compared to $14.1 million,
or 19.7% of revenues, for the first nine months of 2000. The increase in
expenses during the first nine months of 2001 was primarily due to significant
increases in marketing, advertising and promotion costs invested during the
first half of 2001. The increase in sales and marketing expenses as a
percentage of revenues during the first nine months of 2001 compared with the
first nine months of 2000 was due to the increase in dollars spent combined
with decreased revenues.

   General and Administrative. General and administrative expenses for the
third quarter of 2001 decreased to $2.5 million, or 13.8% of revenues, as
compared to $3.8 million, or 12.2% of revenues, for the third quarter of 2000.
The decrease in general and administrative costs in the third quarter of 2001
was primarily due to lower legal fees. General and administrative expenses for
the first nine months of 2001 increased to $10.2 million, or 19.7% of revenues,
as compared to $9.6 million, or 13.4% of revenues, for the first nine months of
2000. During the first nine 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 accounting and auditing
expenses, which were partially offset by reduced legal fees. The increase in
general and administrative expenses as a percentage of revenues was due to the
cost factors noted combined with decreased revenue.

   Goodwill impairment. During the first quarter of 2001, a charge of $2.9
million, or 5.5% of revenues, was recognized for Printroom.com goodwill. At the
end of the second quarter of 2001 management also decided to divest the
Printroom.com operation. The divestiture of Printroom.com was completed during
the third quarter of 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 divest our Printroom.com
operations. We recognized a $2.1 million restructuring charge related to this
restructuring. The restructuring was implemented in the third quarter of fiscal
2001 and is substantially complete. The divestiture of Printroom.com was
implemented through a sale of the Printroom assets to a company owned by the
management of Printroom.com.

   The following table depicts the restructuring and other activity through
September 30, 2001:

<TABLE>
<CAPTION>
                                                   Accrued                        Accrued
                                                  balance at                    balance at
                                                   June 30,    Cash   Non-cash September 30,
                                                     2001    payments charges      2001
                                                  ---------- -------- -------- -------------
<S>                                               <C>        <C>      <C>      <C>
Reduction in workforce...........................   $1,052    $(448)   $  --      $  604
Asset write-offs.................................      554       --     (536)         18
Excess facilities and related costs..............      368      (28)      --         340
Other............................................      112      (20)      --          92
                                                    ------    -----    -----      ------
                                                    $2,086    $(496)   $(536)     $1,054
                                                    ======    =====    =====      ======
</TABLE>

                                      13

<PAGE>

   Remaining expenditures relating to workforce reductions and termination
agreements will be substantially paid in the fourth quarter of 2001 and the
first quarter of 2002. Amounts related to excess facilities and related costs
will be paid over the lease terms through 2004.

Stock-Based Compensation

   Stock-based compensation for the third quarter of 2001 decreased to $(0.1)
million, or (0.4)% of revenues, as compared to $2.8 million, or 8.9% of
revenues, for the third quarter of 2000. Stock-based compensation for the first
nine months of 2001 decreased 83.1% to $1.9 million, or 3.6% of revenues, as
compared to $10.9 million, or 15.2% of revenues, for the first nine months of
2000. The decreases in both comparative periods resulted from lower
amortization under FIN No. 28 and adjustments related to employee terminations.

Other Income and Expense

   Interest and other income for the third quarter of 2001 decreased to $0.1
million, or 0.8% of revenues, as compared to $0.6 million, or 2.0% of revenues,
for the third quarter of 2000. Interest income for the first nine months of
2001, decreased to $0.8 million, or 1.6% of revenues, compared to $1.0 million,
or 1.4% of revenues, for the first nine months of 2001. These decreases are due
to lower cash and short-term investment balances in 2001.

   Foreign exchange gain for the third quarter of 2001, was flat at $0.2
million, or 1.1% of revenue compared to $0.3 million or 0.8% of revenue for the
third quarter of 2000. Foreign exchange loss for the first nine months of 2001
was $0.2 million, or 0.4% of revenues, as compared to a gain of $0.2 million,
or 0.2% of revenues, for the first nine months of 2000. These changes were
primarily attributable to European and Japanese sales activities and
fluctuations in the British pound and the Japanese yen.

   Interest and other expense for the third quarter of 2001 decreased to $0.5
million, or 3.0% of revenues, compared to $6.0 million, or 19.6% of revenues,
for the third quarter of 2000. Interest expense for the third quarter of 2001
includes imputed interest of $0.3 million, associated primarily with the
amortization of the value of the warrants issued and fees paid in connection
with the Access Technology Partners credit facility. Interest expense for the
first nine months of 2001 decreased to $3.9 million, or 7.6% of revenues, as
compared to $6.5 million, or 9.1% of revenues, for the first nine months of
2000. The imputed and other non-cash interest for the first nine months of 2001
was $3.0 million, which is comprised of imputed interest of $2.3 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 in the second quarter of 2000, the
write-off of the warrants issued to Chase, and 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. The decreases in interest expense were due to
lower debt balances in the comparable periods.

Income Taxes

   Income tax expense for the third quarter of 2001 was $0.7 million, or 3.7%
of revenues. We recognized no income tax expense in the third quarter of 2000.
Income tax expense for the first nine months of 2001 was $2.3 million, or 4.4%
of revenues. We recognized no income tax expense in the first nine months of
2000. This increase is primarily the result of foreign taxes related to foreign
license revenues. These taxes are recoverable only as a credit against federal
income taxes. No credit for the recoverability has been recorded. As of
September 30, 2001, we believe we have sufficient tax loss carry-forward
balances to offset any federal or state liability related to our operations for
the three and nine months ended September 30, 2001. We had recorded losses for
the same periods ended September 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.

                                      14

<PAGE>

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 September 30, 2001, we had approximately $14.9 million in
cash and cash equivalents.

   Net cash used in operating activities was $9.0 million and $20.9 million for
the nine months ended September 30, 2001 and September 30, 2000, respectively.
For the nine months ended September 30, 2001, net cash used in operating
activities resulted primarily from our net loss of $44.4 million and a decrease
of $3.2 million in accounts payable and accrued liabilities, partially offset
by an $21.0 million decrease in inventory, a $6.8 million increase in deferred
revenue, $3.0 million in imputed and other non-cash interest charges, a $2.9
million non-cash charge related to the write off of Printroom.com goodwill, a
$2.1 million restructuring charge, $1.8 million in amortization of stock-based
compensation and $1.5 million in depreciation and amortization. The $21.0
million decrease in inventory was accomplished primarily through stricter
inventory management. The $6.8 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 nine months
ended September 30, 2000, net cash used in operating activities resulted
primarily from a $33.4 million net loss, a $6.1 million increase in accounts
receivable, a $3.2 million increase in net inventory and a $2.1 million
increase in prepaid and other assets, which was partially offset by $10.9
million in amortization of stock-based compensation, $5.6 million in imputed
and other non-cash interest charges, an increase of $4.9 million in accounts
payable and other accrued liabilities, $1.4 million in depreciation and
amortization and an increase of $0.9 million in deferred revenue.

   Net cash provided by investing activities was $19.1 million for the first
nine months of 2001 compared to $17.8 million used during the first nine months
of 2000. For the first nine months of 2001, net cash provided by investing
activities was primarily attributable to proceeds from the sale of short-term
investments of $20.0 million, and was partially offset by purchases of property
and equipment of $0.9 million. For the first nine months of 2000, net cash used
in by investing activities was primarily attributable to the net purchase of
short-term investments of $15.8 million, and purchases of property and
equipment of $2.0 million.

   Net cash used by financing activities was $3.8 million for the first nine
months of September 30, 2001 and consisted primarily of $6.4 million in
repayment of notes payable under our credit facility with Chase, partially
offset by $2.0 million in proceeds from our credit facility with Greater Bay
Bancorp, or "GBB". Net cash provided by financing activities was $61.0 million
for the first nine months of September 30, 2000 and consisted of $53.4 million
in proceeds from our initial public offering and $13.3 million in proceeds from
notes payable to stockholders and was partially offset by $6.4 in net
repayments of notes payable.

   During September 2001, we established a new asset based credit facility with
GBB. We borrowed $2.0 million under this facility at the end of the third
quarter. The facility bears interest at an annual rate of 9.6%, plus
administrative charges, has a term of one year and is renewable from year to
year after that. In addition, we issued to GBB a warrant to purchase 250,000
shares of our common stock at an exercise price of $1.26 per share. The
facility may be terminated by either party, at any time, upon 30 days written
notice.

   As of September 30, 2001, there was $4.7 million outstanding under the
Access term loan, and $2.0 million outstanding under the GBB loan. We repaid
the Access term loan in October 2001.

   We anticipate that the $14.9 million in cash and cash equivalents as of
September 30, 2001, which includes our Access term loan that we subsequently
repaid in October 2001 and the GBB 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 for at least the next 12 months. However, the
timing of cash requirements during the quarter could deplete our cash balances
to levels

                                      15

<PAGE>

that may impede our ability to increase our current level of business. We have
taken measures to conserve cash by reducing headcount 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 or we do not
attain operating profitability according to plan. 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." SFAS141 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.

   In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." SFAS No. 144 applies to all long-lived assets
(including discontinued operations) and consequently amends Accounting
Principles Board Opinion No. 30, "Reporting the Results of
Operations--reporting the Effects of Disposal of a Division of a Business."
SFAS No. 144 develops one accounting model for long-lived assets that are to be
disposed of by sale and requires the measurement to be at the lower of book
value or fair value, less the cost to sell the assets . Additionally, SFAS No.
144 expands the scope of discontinued operations to include all components of
an entity with operations that (1) can be distinguished from the rest of the
entity and (2) will be eliminated from the ongoing operations of the entity in
a disposal transaction. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001. The provisions of SFAS No. 44 are not expected to have
a significant impact on our financial position or operating results.

                                      16

<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 $44.4 million for the nine months
ended September 30, 2001, compared to $33.4 million for the nine months ended
September 30, 2000. As of September 30, 2001, we had an accumulated deficit of
approximately $132.8 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 charges of $1.8 million and $10.9 million
through September 30, 2001 and September 30, 2000, respectively, relating to
stock-based compensation. At September 30, 2001, $2.6 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 reach operating profitability 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 new
credit facility 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 are unable to sufficiently reduce our
operating expenses, or we experience operating losses that exceed our current
expectations. 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.

  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, which improved in the
third quarter of 2001, declined significantly in the fourth quarter of 2000 and
the first and second quarters of 2001, as compared to the first two

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<PAGE>

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,
notwithstanding the improvement achieved in the third quarter of 2001. 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;

   .   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; and

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

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<PAGE>

  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 16x. Our
highest capacity card is currently 512-megabytes. From time to time our
competitors have introduced products for which they have claimed high sustained
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 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 nine months 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 product sales in the third quarter of 2001 were made
through distributors and retailers to which we have provided price protection.
In the third quarter of 2001, we incurred approximately $2.7 million in

                                      19

<PAGE>

price protection charges, and we anticipate that we will continue to incur
significant price protection charges for the remainder of 2001 and into 2002
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 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., which we collectively refer to as Olympus,
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.
Olympus has not yet agreed to market any of our digital film products in the
Japanese market. If Olympus does not aggressively promote our products, or if
Olympus chooses to promote its own brand at the expense of the Lexar brand, our
revenues 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.

                                      20

<PAGE>

  We primarily depend upon a single source of flash memory, and if this source
  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 flash memory products 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. As one example, Samsung is emphasizing smaller flash
geometries over multi-level cell technology. If multi-level cell technology can
be manufactured in volume at high yields, it could offer significant cost
advantages over single-level cell technologies. 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 likely 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.

  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 revenues from these activities or
increase the revenues 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 third quarter of 2001,
sales to the 10 customers from which we received the greatest revenues
accounted for approximately 66.3% of our gross 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 global economy or otherwise. 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.

                                      21

<PAGE>

   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 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 has and could
       continue to necessitate price protection of the inventories of our
       products that many of our customers carry.

                                      22

<PAGE>

  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 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

                                      23

<PAGE>

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 qualifying Taiwan Semiconductor Manufacturing Co. Ltd., we have
not yet completed this process and 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 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. We do
not have long-term agreements with Venture Manufacturing 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.

                                      24

<PAGE>

  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.

  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. 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 of Directors, 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.

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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 40.9% of our revenues for
the quarter ended September 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;

   .   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. We have product sales denominated in British pounds and
other European currencies as well as the Japanese yen. In addition, we
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.

  The recent terrorist attacks in New York City and Washington, D.C has created
  uncertainty regarding demand for our products and may affect our ability to
  timely ship our products.

   The generally uncertain economic conditions resulting from the terrorist
attacks in New York City and Washington, D.C. on September 11, 2001 have
created increased uncertainty regarding demand for our products. Reductions in
end-user demand would likely cause our operating results to suffer. If we are
unable to increase

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our product revenues in the fourth quarter, we will not be able to achieve
positive cash flow from operations in the fourth quarter. Furthermore, our
ability to effectively manage our supply chain and deliver products on a timely
basis to our customers may be adversely affected by the reduced flight
schedules of many commercial airlines and delivery services, and increased
security precautions and customs scrutiny instituted in response to these
terrorist actions. Changes in flight schedules and additional security measures
may negatively affect our ability to accurately predict the delivery times of
our products or to deliver products on time. Our inability to accurately
predict delivery times could negatively affect our relationships with our
customers.

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.

   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 our 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 retailers, OEMs
and end users. 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.

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   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, Ritek, Dane-Elec 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 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;

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   .   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.

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 36.8% of our revenues for the nine
months ended September 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. In addition, a strengthening of
the U.S. dollar could make our products less competitive in foreign markets.
These risks could become more significant if we expand business outside the
U.S. or if we increase sales in non-U.S. dollar denominated currencies.

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   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
September 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.

                          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 September 28, 2001, we filed a motion for a preliminary injunction
against Memtek Products, Inc. Our motion is scheduled to be heard on November
20, 2001. No trial date has yet been set.

   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 sought an
injunction and damages against Viking Components. We agreed to indemnify Viking
in its defense of this litigation.

   On October 9, 2001, Viking won a summary judgment against SanDisk in which
the court ruled that all controllers sold by Lexar to Viking prior to December
31, 2001 were covered by the settlement in the SanDisk v. Lexar litigation
which was signed in November 2000. As Viking had purchased only a small number
of controllers after December 31, 2001, this ruling was largely dispositive of
this action and the litigation settled for a nominal amount. Final judgment was
entered and the case was dismissed on October 9, 2001.

Item 2. Changes in Securities and Use of Proceeds.

   (c) Recent Sales of Unregistered Securities.

   On September 28, 2001, we issued a warrant to purchase 250,000 shares of our
common stock to GBB at an exercise price of $1.26 per share, in connection with
the establishment of an asset based credit facility.

   (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.

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   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. The proceeds have been used to fund $34.0 million
of continuing operations, to repay bridge financing notes totaling $13.3
million and to make $6.0 million in net payments to SanDisk in settlement of
patent litigation with SanDisk in November 2000. As of September 30, 2001, we
had completely exhausted these proceeds.

Item 3. Defaults Upon Senior Securities.

   None.

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

   None.

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 September 30, 2001.

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                                  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: November 13, 2001

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