<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 March 31, 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                    (I.R.S. Employer
   of 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 April 30, 2001: 60,223,537

================================================================================
<PAGE>

                               LEXAR MEDIA, INC.
                                   FORM 10-Q
                      FOR THE QUARTER ENDED MARCH 31, 2001

                               TABLE OF CONTENTS

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

    Item 1. Financial Statements
            Condensed Consolidated Balance Sheets as of March 31, 2001
            and December 31, 2000.......................................     1
            Condensed Consolidated Statements of Operations for the
            Three Months Ended March 31, 2001 and 2000..................     2
            Condensed Consolidated Statements of Cash Flows for the
            Three Months Ended March 31, 2001 and 2000..................     3
            Notes to Condensed Consolidated Financial Statements........     4

    Item 2. Management's Discussion and Analysis of Financial Condition
            and Results of Operations...................................     7

    Item 3. Quantitative and Qualitative Disclosures About Market Risk..    26

 PART II. OTHER INFORMATION

    Item 1. Legal Proceedings...........................................    27
    Item 2. Changes in Securities and Use of Proceeds...................    27
    Item 3. Defaults Upon Senior Securities.............................    27
    Item 4. Submission of Matters to a Vote of Security Holders.........    27
    Item 5. Other Information...........................................    27
    Item 6. Exhibits and Reports on Form 8-K............................    28

 SIGNATURES..............................................................   29
</TABLE>
<PAGE>

                         PART I--FINANCIAL INFORMATION

                            1. Financial Statements

                               LEXAR MEDIA, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                 (in thousands except share and per share data)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                         March 31,  December 31,
                                                           2001         2000
                                                         ---------  ------------
                        ASSETS
<S>                                                      <C>        <C>
Current assets:
  Cash and cash equivalents (includes restricted cash
   of $1,250 and $1,000, respectively).................  $  22,066    $  8,755
  Short-term investments...............................        --       19,987
  Accounts receivable, net.............................      9,682       8,767
  Inventory, net.......................................     15,663      27,536
  Prepaid expenses and other current assets............      1,106       1,909
                                                         ---------    --------
    Total current assets...............................     48,517      66,954
Property and equipment, net............................      3,242       3,364
Intangible assets, net.................................        430       3,544
Other assets...........................................      1,038         986
                                                         ---------    --------
    Total assets.......................................  $  53,227    $ 74,848
                                                         =========    ========

         LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable.....................................  $   8,572    $  8,007
  Accrued liabilities..................................      7,732       8,886
  Deferred revenue.....................................        234         446
  Notes payable to stockholders........................        368         362
  Notes payable to banks...............................      6,769       6,088
                                                         ---------    --------
    Total current liabilities..........................     23,675      23,789
Notes payable to stockholders, net of current portion..        140         159
Notes payable, net of current portion..................        882       1,362
                                                         ---------    --------
    Total liabilities..................................     24,697      25,310

Commitments and contingencies
Stockholders' equity:
Common stock, $0.0001 par value:
  75,000,000 shares authorized; 60,212,490 and
   60,052,462 shares issued and outstanding,
   respectively........................................          6           6
  Additional paid-in capital...........................    152,596     152,796
  Unearned stock-based compensation....................     (7,216)     (9,586)
  Notes receivable from stockholders...................     (4,992)     (5,292)
  Accumulated deficit..................................   (111,818)    (88,348)
  Accumulated other comprehensive loss.................        (46)        (38)
                                                         ---------    --------
    Total stockholders' equity.........................     28,530      49,538
                                                         ---------    --------
    Total liabilities and stockholders' equity.........  $  53,227    $ 74,848
                                                         =========    ========
</TABLE>

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

                                       1
<PAGE>

                               LEXAR MEDIA, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                            Three months ended
                                                            --------------------
                                                            March 31,  March 31,
                                                              2001       2000
                                                            ---------  ---------
<S>                                                         <C>        <C>
Revenues................................................... $ 16,221    $16,050
Cost of revenues (excludes stock-based compensation of $28
 and $343, respectively)...................................   22,172     13,371
                                                            --------    -------
Gross margin...............................................   (5,951)     2,679
                                                            --------    -------
Operating expenses:
  Research and development (excludes stock-based
   compensation of $518 and $1,361, respectively)..........    1,594      1,537
  Sales and marketing (excludes stock-based compensation of
   $194 and $605, respectively)............................    6,661      2,997
  General and administrative (excludes stock-based
   compensation of $757 and $1,725, respectively)..........    3,800      2,458
  Goodwill impairment......................................    2,854        --
  Stock-based compensation.................................    1,497      4,034
                                                            --------    -------
Total operating expenses...................................   16,406     11,026
                                                            --------    -------
Loss from operations.......................................  (22,357)    (8,347)
Interest and other expense.................................   (1,553)      (165)
Interest and other income..................................      439        206
                                                            --------    -------
Total other income (expense)...............................   (1,114)        41
                                                            --------    -------
  Net loss................................................. $(23,471)   $(8,306)
                                                            ========    =======
Net loss per common share:
  Basic and diluted........................................ $  (0.41)   $ (1.01)
                                                            ========    =======
Shares used in net loss per common share calculation:
  Basic and diluted........................................   57,326      8,368
                                                            ========    =======
</TABLE>



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

                                       2
<PAGE>

                               LEXAR MEDIA, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                            Three months ended
                                                            --------------------
                                                            March 31,  March 31,
                                                              2001       2000
                                                            ---------  ---------
<S>                                                         <C>        <C>
Cash flows from operating activities:
  Net loss................................................. $(23,471)   $(8,306)
  Adjustments to reconcile net loss to net cash used in
   operating activities:
    Depreciation and amortization..........................      637        370
    Goodwill impairment....................................    2,854        --
    Amortization of stock-based compensation...............    1,497      4,034
    Imputed and other non-cash interest....................    1,078        --
Change in operating assets and liabilities:
  Accounts receivable, net.................................     (915)     1,051
  Inventory, net...........................................   11,873     (3,078)
  Prepaid expenses and other assets........................      675     (1,905)
  Accounts payable and accrued liabilities.................     (589)       898
  Deferred revenue.........................................     (212)       922
                                                            --------    -------
      Net cash used in operating activities................   (6,573)    (6,014)
                                                            --------    -------
Cash flows from investing activities:
  Purchase of property and equipment.......................     (255)      (531)
  Cash acquired upon acquisition of Printroom.com..........      --          49
  Proceeds from short-term investments.....................   19,987      1,315
                                                            --------    -------
      Net cash provided by investing activities............   19,732        833
                                                            --------    -------
Cash flows from financing activities:
  Issuance of stock under employee stock purchase plan.....      167        --
  Exercise of stock options................................       22        301
  Repayment of notes payable...............................      (23)       (14)
  Proceeds from notes payable..............................      --       2,000
  Repurchase of stock......................................       (7)       --
                                                            --------    -------
      Net cash provided by financing activities............      159      2,287
                                                            --------    -------
  Effect of exchange rates on cash and cash equivalents....       (7)       --
                                                            --------    -------
Net increase (decrease) in cash and cash equivalents.......   13,311     (2,894)
Cash and cash equivalents at beginning of period...........    8,755      6,495
                                                            --------    -------
Cash and cash equivalents at end of period................. $ 22,066    $ 3,601
                                                            ========    =======
Supplemental disclosure of non-cash transactions:
  Re-pricing of warrants in connection with amended credit
   facility agreement...................................... $    792    $   --
  Exercise of stock options and restricted stock grants in
   exchange for full recourse notes receivable.............      --       3,236
  Issuance of common stock in connection with acquisition
   of Printroom.com........................................      --       3,800
  Repurchase of common stock by cancellation of notes
   receivable..............................................      300        --
</TABLE>

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

                                       3
<PAGE>

                               LEXAR MEDIA, INC.

              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"), without audit, in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all normally recurring adjustments considered
necessary for a fair presentation have been included.

   The financial statements should be read in conjunction with our audited
consolidated financial statements for the year ended December 31, 2000 and the
notes thereto included in our Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission on April 2, 2001.

   The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the condensed
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from these
estimates.

   The results of operations and cash flows for the three months ended March
31, 2001 are not necessarily indicative of results that may be expected for any
other future period.

Note 2--Summary of Selected Accounting Policies

 Revenue recognition

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

 Accounting for stock-based compensation

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


                                       4
<PAGE>

                               LEXAR MEDIA, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

   In March 2000, the Financial Accounting Standards Board ("FASB") issued FIN
No. 44, "Accounting for Certain Transactions Involving Stock Compensation, an
Interpretation of APB Opinion No. 25." FIN 44 clarifies the application of APB
Opinion No. 25 for (a) the definition of employee, (b) the criteria for
determining whether a plan qualifies as a non-compensatory plan, (c) the
accounting consequences of various modifications to the terms of a previously
fixed stock option or award and (d) the accounting for an exchange of stock
compensation awards in a business combination. FIN 44 became effective July 1,
2000, but certain conclusions cover specific events that occurred either after
December 15, 1998 or January 12, 2000. The adoption of the provisions of FIN 44
did not have a material impact on the Company's financial statements.

 Shipping and handling costs

   Shipping and handling costs are included in sales and marketing expenses in
the Company's condensed consolidated statements of operations. These costs were
$428,000 for the three months ended March 31, 2001 and $245,000 for the three
months ended March 31, 2000.

Note 3--Balance Sheet Detail (in thousands)

<TABLE>
<CAPTION>
                                                          March 31, December 31,
                                                            2001        2000
                                                          --------- ------------
   <S>                                                    <C>       <C>
   Inventories:
     Raw materials.......................................  $ 5,336    $ 5,100
     Controllers.........................................    2,361      1,718
     Flash memory products...............................    9,888     19,520
     Ancillary products..................................    1,793      2,086
                                                           -------    -------
                                                            19,378     28,424
     Less: inventory reserve.............................   (3,715)      (888)
                                                           -------    -------
     Inventory, net......................................  $15,663    $27,536
                                                           =======    =======
</TABLE>

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

<TABLE>
<CAPTION>
                                                          March 31,  March 31,
                                                            2001       2000
                                                          ---------  ---------
   <S>                                                    <C>        <C>
   Numerator:
     Net loss............................................ $(23,471)   $(8,306)
     Accretion of mandatorily redeemable convertible
      preferred stock....................................      --        (139)
                                                          --------    -------
     Net loss after accretion of mandatorily redeemable
      convertible preferred stock........................ $(23,471)   $(8,445)
                                                          ========    =======
   Denominator:
     Weighted average common shares outstanding..........   60,193     14,287
     Weighted average unvested common shares subject to
      repurchase.........................................   (2,867)    (5,919)
                                                          --------    -------
     Denominator for basic and diluted calculations......   57,326      8,368
                                                          --------    -------
     Net loss per common share, basic and diluted........ $  (0.41)   $ (1.01)
                                                          ========    =======
</TABLE>

   All outstanding shares under options, warrants and convertible preferred
stock during each period have been excluded due to their antidilutive effect.


                                       5
<PAGE>

                               LEXAR MEDIA, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 5--Notes, Payable to Banks

   At December 31, 2000, the Company was in default of certain of the covenants
contained in the credit agreement with The Chase Manhattan Bank and Access
Technology Partners. These covenants are related to its consolidated revenue,
EBlTDA and debt to capital ratio. During the first quarter of 2001, the Company
entered into an amended credit agreement with Chase, effective as of December
31, 2000, which revised these financial covenants. Consequently, the Company
was in compliance with the revised covenants as of December 31, 2000. In
addition, the Company entered into a forbearance agreement with Access under
which Access agreed not to exercise its rights and remedies as a result of the
defaults under the loan agreements existing at December 31, 2000 until the
earlier of December 31, 2001 or the date any additional default may occur. In
connection with these agreements, the Company incurred a $0.7 million interest
charge and re-priced the warrants issued in connection with the credit
facilities from $8.00 to $1.44 per share. The increase in the value of the
warrants related to the re-pricing is being amortized over the life of the
loan. At March 31, 2001, the Company was in default of the EBITDA covenant of
the amended agreements as a result of the significant non-cash charges
recognized in the three months then ended. Chase and Access have amended the
EBITDA covenant effective March 31, 2001 to address the treatment of the non-
cash charges. As a result of the amendment, the Company was in compliance with
the revised covenants as of March 31, 2001.

Note 6--Interest Expense

   Interest expense for the first quarter of 2001 includes imputed interest
charges of $0.4 million, associated primarily with amortization of the value of
the warrants issued in connection with The Chase Manhattan Bank and Access
Technology Partners credit facilities. It also includes a charge of $0.7
million, which was added to the principal balance of the notes payable to
Access in connection with the forbearance agreement.

Note 7--Comprehensive Loss

   Other comprehensive loss for the three months ended March 31, 2001 was
$8,000. This loss was attributable to foreign currency translation. There was
no other comprehensive income or loss for the three months ended March 31,
2000.


                                       6
<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 objective is to establish our
products and associated services as the industry standard solution for
capturing, storing, viewing, editing and distributing digital images. Our
products and services allow customers to capture digital images and download
them quickly to a personal computer for editing, distributing and printing. As
a means of addressing markets adjacent to digital photography, we also license
our proprietary controller technology and sell controllers to other
manufactures of flash storage media.

   Our broad line of high-performance digital film offers removable and
reusable storage devices that capture images from a digital camera. During the
first quarter of 2001, digital film related sales comprised approximately 98.2%
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
applications. We also offer digital film in the PC Card format, but are in the
process of phasing out our PC Card digital film products.

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

   In addition to digital photography, our digital film 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 digital
film technology into these adjacent markets we have selectively licensed our
products and technology to third parties. 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 September 2000, we introduced Shoot & Share, an easy-to-use image manager
that simplifies digital photo organization, naming, editing and sharing. Shoot
& Share also features a link to Printroom.com, an online photo finishing
service enabling users to upload and order high-quality prints from their
digital images. In September 2000, Lexar also launched its digital imaging
educational website SayCheese.com where consumers and professionals can find
information on digital photography, product reviews and how-to-tips and advice.

   In April 2001, we finalized our supply agreement and our license agreement
with Samsung Electronics Co., Ltd. Under the supply agreement, we anticipate
purchasing a substantial portion of our flash memory

                                       7
<PAGE>

needs from Samsung at an agreed upon pricing formula. Samsung has also
guaranteed a certain allocation of flash memory to us and has agreed to provide
our flash memory on consignment. 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. Under the license agreement, we granted
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.

   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 agreement with Samsung.
During the second quarter of 2001, we expect to begin generating revenues under
our recently signed Olympus agreement. During the second quarter of 2001, we
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 86.2% of our revenues for the three months ended
March 31, 2000 and 67.1% of our revenues for the three months ended March 31,
2001. We expect that sales to a limited number of customers will continue to
account for a substantial portion of our revenues for at least the next several
years. Domestic sales account for the majority of our revenues. Product
revenues in the United States represented 64.0% of our revenues for the three
months ended March 31, 2000 and 80.5% of our revenues for the three months
ended March 31, 2001. We expect that international sales will become a larger
percentage of our revenues in the future.

   Cost of Revenues. Our cost of revenues consists primarily of materials
costs, with flash memory accounting for most of those costs. We maintain
relationships with key suppliers, which we believe will be able to provide us
with sufficient quantities of flash memory during 2001. We recently entered
into an agreement with Samsung Electronics Co., Ltd. under which it agreed to
become our primary supplier of flash memory and guarantee 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. We expect to continue to see significant price declines
through at least 2001. In addition, cost of revenues includes expenses related
to materials procurement, inventory management and adjustments and
manufacturing. In accordance with our settlement agreement with SanDisk,
beginning in the second quarter of 2001, we began incurring royalty expenses
related to domestic sales of our CompactFlash digital film that utilizes our
previous generation controller technology. We do not owe royalties on sales
made outside of the U.S. or on digital film that includes our next generation
controller technology.

   Research and Development. Our research and development expenses include
salaries and related expenses for research and development personnel, fees for
outside consultants, patent costs and prototype development and materials
costs. We believe that continued investment in research and development is
important to attain our strategic objectives, but expect research and
development expenses to decrease slightly

                                       8
<PAGE>

in the second quarter of 2001 as compared with the first quarter of 2001 due to
increased operational efficiencies.

   Sales and Marketing. Our sales and marketing expenses include salaries and
related expenses for sales and marketing personnel, advertising, customer
service, technical support, distribution and travel and trade show expenses. We
expect sales and marketing expenses to decrease slightly in the second quarter
of 2001 as compared with the first quarter of 2001 due to increased operational
efficiencies and reduced headcount.

   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. We
expect our legal expenses will continue to decrease in 2001, despite the patent
litigation that we have initiated against Pretec, Feiya, PNY, and, more
recently against Memtek Products, Inc.

   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.

Our History of Losses

   We have incurred significant losses to date. As of March 31, 2001, we had an
accumulated deficit of approximately $111.8 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 expect to continue to incur additional losses and negative cash
flow through most of 2001. In view of the rapidly changing nature of our market
and our limited operating history, we believe that period-to-period comparisons
of our revenues and other operating results are not necessarily meaningful and
should not be relied upon as indications of future performance. Our historic
revenue growth rates are not necessarily indicative of our future growth.

Results of Operations

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

<TABLE>
<CAPTION>
                                                           Three months ended
                                                           ---------------------
                                                           March 31,   March 31,
                                                             2001        2000
                                                           ---------   ---------
   <S>                                                     <C>         <C>
   Revenues...............................................   100.0 %     100.0 %
   Cost of revenues.......................................   136.7 %      83.3 %
                                                            ------       -----
     Gross margin.........................................   (36.7)%      16.7 %
                                                            ------       -----
   Operating expenses:
     Research and development.............................     9.8 %       9.6 %
     Sales and marketing..................................    41.1 %      18.7 %
     General and administrative...........................    23.4 %      15.3 %
     Goodwill impairment..................................    17.6 %       --
     Stock-based compensation.............................     9.2 %      25.1 %
                                                            ------       -----
       Total operating expenses...........................   101.1 %      68.7 %
                                                            ------       -----
   Loss from operations...................................  (137.8)%     (52.0)%
                                                            ------       -----
   Other income (expense).................................    (6.9) %      0.2 %
                                                            ------       -----
   Net loss...............................................  (144.7)%     (51.8)%
                                                            ------       -----
</TABLE>

                                       9
<PAGE>

 Revenues

   Revenues for the first quarter of 2001 increased slightly to $16.2 million
from $16.1 million for the first quarter of 2000. This increase was primarily
the result of continued increases in shipments of our digital film and
connectivity products, offset by declining average selling prices and increases
in price protection and rebates. The decline in average selling prices was due
to increased price competition resulting from declining flash memory costs and
a change in product mix toward lower cost per megabyte products. In the first
quarter of 2001, we derived product revenues of 80.5% and 16.2% from customers
in the United States and Europe, respectively. In first quarter of 2000, we
derived product revenues of 64.0%, 19.8% and 15.8% from customers in the
United States, Japan and Europe, respectively. Two customers accounted for
22.2% and 10.8% of our product revenues in the first quarter of 2001. Four
customers accounted for 18.2%, 14.6%, 12.5% and 11.6% of our revenues in the
first quarter of 2000.

   In the first quarter of 2001, in addition to revenues from sales of our
digital film and connectivity products, we also recognized licensing revenue of
$249,000 from our agreement with Sony. We anticipate that licensing revenues
will increase significantly in the future as a result of the agreements we
recently entered into with Samsung and Olympus. We also recognized $142,000 in
revenue in the first quarter of 2001 from sales of our controllers, as compared
with $129,000 in the first quarter of 2000. We expect to recognize increased
revenues from sales of our controllers in 2001.

   Revenues in the first quarter of 2001 were negatively impacted by a
significant increase in sales discounts and allowances to $4.1 million. In the
quarter ended March 31, 2000, we incurred approximately $0.4 million in sales
discounts and allowances. The increase for the first quarter of 2001 was
primarily the result of increased price competition resulting in significant
price protection and rebates. Sales returns for the first quarter of 2001 were
$1.1 million compared with $0.4 million in the first quarter of 2000, which
resulted from an increased percentage of business with retailers in the first
quarter of 2001 compared with the first quarter of 2000.

 Cost of revenues

   Cost of revenues increased $8.8 million, or 65.8%, to $22.2 million for the
first quarter of 2001 from $13.4 million for the first quarter of 2000. The
increase in cost of revenues was driven by a significant increase in units
shipped a trend toward higher capacity products with a higher cost and
adjustments related to excess and obsolete inventory. Cost of revenues as a
percentage of revenues for the first quarter of 2001 increased to 136.7% from
83.3% for the first quarter of 2000. This increase is due to the cost factors
noted above in combination with relatively flat revenue growth.

   Overall, we expect gross margins to increase significantly compared to the
quarter ended March 31, 2001 as a result of our anticipated increases in
technology licensing and controller revenues. In the second quarter of 2001, we
began generating licensing revenues related to our recently signed agreement
with Samsung. In addition, during the second quarter of 2001, we anticipate
generating revenues related to the recently signed agreement with Olympus.
Partially offsetting these increases, we anticipate pressure on our gross
margins due to a number of factors, including changes in our product and
customer mix, flash memory costs, prices of competitive products and higher
costs in the introduction of new products.

 Research and Development

   For the first quarter of 2001, research and development expenses were flat
at $1.6 million, or 9.8% of revenue, as compared to $1.5 million, or 9.6% of
revenue, for the first quarter of 2000. We expect a decline in research and
development costs in the near term due to increased operational efficiencies.

                                       10
<PAGE>

 Sales and Marketing

   Sales and marketing expenses for the first quarter of 2001 were $6.7
million, or 41.1% of revenues, as compared to $3.0 million, or 18.7% of
revenues, for the first quarter of 2000. The increase in sales and marketing
expenses was primarily due to increased number of employees and significant
increases in marketing, advertising and promotion costs. The increase in sales
and marketing expenses as a percentage of revenues during the first quarter of
2001 was due to increased expenses combined with flat revenues.

 General and Administrative

   General and administrative expenses for the first quarter of 2001 were $3.8
million, or 23.4% of revenues, as compared to $2.5 million, or 15.3% of
revenues, for the first quarter of 2000. The increase in general and
administrative expenses was primarily due to an increased number of personnel,
increased occupancy and insurance costs and increased professional fees,
primarily legal fees. The increase in general and administrative expenses as a
percentage of revenues during the first quarter of 2001 as compared to the
first quarter of 2000 was due to the cost factors noted combined with
relatively flat revenue growth.

 Goodwill impairment

   A charge of $2.9 million, or 17.6% of revenue, was recognized for an other
than temporary impairment of Printroom.com goodwill in the first quarter of
2001. Printroom.com's current results and projected cash flows do not justify
retaining the goodwill related to the operation.

 Stock-Based Compensation

   During the three months ended March 31 2001, we recognized $1.5 million in
stock-based compensation compared to $4.0 million for the comparable period in
2000. The decrease resulted from lower amortization under the FIN28 model and
adjustments related to employee terminations.

 Income Taxes

   We did not record a provision for federal or state income tax for the three-
month periods ended March 31, 2001 and 2000, respectively. As of March 31,
2001, we believe that we have sufficient tax losses carryforward balances to
offset any federal or state tax liability related to the operations of the
first quarter of 2001. We had recorded losses for the same period ended March
31, 2000. The company has established a 100% valuation allowance since it is
more likely than not that no benefit will be realized for it's deferred tax
assets. At March 31, 2001, foreign tax liabilities were insignificant.

 Other Income and Expense

   Interest income for the first quarter of 2001 was $0.4 million as compared
to $0.2 million for the first quarter of 2000. The increase in interest income
in the first quarter of 2001 was primarily due to earnings from cash and cash
equivalents from the proceeds of loans and our initial public offering.

   Interest expense for the first quarter of 2001 was $1.4 million as compared
to $0.1 million for the first quarter of 2000. Interest expense for the first
quarter of 2001 includes imputed interest charges of $0.4 million, associated
primarily with amortization of the value of the warrants issued in connection
with The Chase Manhattan Bank and Access Technology Partners credit facilities.
It also includes a charge of $0.7 million, which was added to the principal
balance of the notes payable to Access in connection with the forbearance
agreement.

                                       11
<PAGE>

   Our foreign exchange loss the first quarter of 2001 was $171,000 compared to
$36,000 for the first quarter of 2000. The change was primarily attributable to
increased European sales activity and fluctuations in European currency.

 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 March 31, 2001, we had approximately $22.1 million in cash
and cash equivalents.

   Net cash used in operating activities was $6.6 million and $6.0 million for
the three months ended March 31, 2001 and March 31, 2000, respectively. For the
quarter ended March 31, 2001, net cash used in operating activities resulted
primarily from our net loss of $23.5 million, partially offset by an $11.9
million decrease in inventory, a $2.9 million non-cash charge related to the
write off of Printroom.com goodwill, $1.5 million in amortization of stock-
based compensation and $1.1 million in imputed and other non-cash interest
charges. The $11.9 million decrease in inventory was accomplished through
stricter inventory controls, increases in reserves for slow moving and excess
material and the write down of certain items to the lower of cost or market.
For the quarter ended March 31, 2000, net cash used in operating activities
resulted primarily from an $8.3 million net loss, a $3.1 million increase in
net inventory and a $1.9 million increase in prepaid and other assets, which
was partially offset by $4.0 in amortization of stock-based compensation and a
$1.1 decrease in net accounts receivable, an increase of $0.9 million in
accounts payable and other accrued liabilities, and an increase of $0.9 million
in deferred revenue.

   Net cash provided by investing activities was $19.7 million and $833,000 for
the three months ended March 31, 2001 and March 31, 2000, respectively. Net
cash provided by investing activities was primarily attributable to proceeds
from short-term investments of $20.0 million and $1.3 million, and was
partially offset by purchases of property and equipment of $255,000 and
$531,000 for the quarters ended March 31, 2001 and March 31, 2000,
respectively.

   Net cash provided by financing activities was $159,000 and $2.3 million for
the three months ended March 31, 2001 and March 31, 2000, respectively. For the
quarter ended March 31, 2001, the primary source of cash was the issuance of
stock under our employee stock purchase plan. For the quarter ended March 31,
2000, the primary sources of cash were $2.0 million from the issuance of notes
payable and $301,000 from the exercise of stock options.

   As of March 31, 2001, there was $6.1 million outstanding under the Chase
credit facility and $4.7 million outstanding under the Access term loan. These
borrowings are collateralized by all of our assets, and we are required to
comply with financial and other covenants contained in the loan agreements.

   We anticipate that the $22.1 million in cash and cash equivalents as of
March 31, 2001, together with our term loan, revolving credit facility and the
receipt of licensing payments, will be sufficient to meet our projected needs
for working capital and capital expenditures through the end of 2001. We have
taken measures to conserve cash by reducing headcount, primarily in
Printroom.com, and are looking at ways to further reduce our operating expenses
in the future. We may need to raise additional funds prior to the expiration of
this period if, for example, our licensing revenues or sales of our
controllers, which each have significantly higher margins than sales of our
digital film products, do not increase as much as we anticipate, we do not
remain in compliance with the provisions of our credit facilities and our
lenders declare us to be in default or we experience operating losses that
exceed our current expectations. Our credit facilities also contain covenants
that restrict our ability to incur additional indebtedness. Additional
financing may be difficult to obtain on favorable terms if required, or at all.

                                       12
<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 $23.5 for the three months ended
March 31, 2001, compared to $8.3 for the three months ended March 31, 2000. As
of March 31, 2001, we had an accumulated deficit of approximately $111.8
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
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 digital film. We also must reduce the costs of
manufacturing and selling our digital film products, as well as reduce our
internal inventory. Some customers are also requesting that we sell our digital
film to them on consignment, which would negatively impact our cash needs. In
addition, we incurred non-cash deferred charges of $1.5 and $4.0 million
through March 31, 2001 and March 31, 2000, respectively, relating to stock-
based compensation. At March 31, 2001, $7.2 million of deferred stock-based
compensation charges remained to be charged against our future operations. If
we are unsuccessful in increasing overall revenues, and in particular those
generated from sales of our higher margin products and from licensing our
technology, as well as reducing our operating expenses, we will not become
profitable by the end of 2001 and may never become profitable. Even if we do
achieve profitability, we may not be able to sustain or increase profitability
on a quarterly or an annual basis.

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

   We currently anticipate that our available capital, together with our term
loan, revolving credit facility and licensing revenues, will be sufficient to
meet our anticipated needs for working capital and capital expenditures through
the end of 2001. We may need to raise additional funds prior to the expiration
of this period if, for example, our licensing revenues or sales of our
controllers do not increase to the degree we anticipate, we do not remain in
compliance with the provisions of our credit facilities and our lenders declare
us to be in default, we are unable to sufficiently reduce our operating
expenses, or we experience operating losses that exceed our current
expectations. Our credit facilities also contain covenants that restrict our
ability to incur additional indebtedness. It may be difficult to obtain
additional financing on favorable terms, if at all. We may try to obtain
additional financing by issuing shares of our common stock, which could dilute
our existing stockholders. 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 first quarter of 2001, may fluctuate significantly
in the future and are difficult to predict. If our future results are below the
expectations of investors or securities analysts, the market price of our
common stock could decline significantly.

   Our quarterly operating results and gross margins declined significantly in
the fourth quarter of 2000 and the first quarter of 2001 and are likely to vary
significantly in the future based on a number of factors related to our
industry and the markets for our products. We will have little or no control
over many of these factors and

                                       13
<PAGE>

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;

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

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

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

                                       14
<PAGE>

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

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

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

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

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

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

                                       15
<PAGE>

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 one-third of our sales in the first quarter of 2001 were made
through distributors and retailers to which we have provided price protection.
In the first quarter of 2001, we incurred more than $3 million in price
protection charges, and we anticipate that we will continue to incur
significant price protection charges for the remainder of 2001 due to increased
competitive pricing pressures.

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

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

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

   We do not have a long history of managing international distribution of our
products. We recently 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.

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.

                                       16
<PAGE>

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

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

If we are unable to continue to license our controller technology for
application in other products and sell our controllers on a stand-alone basis
to third parties, our gross margins will be negatively impacted and we will
have difficulty achieving profitability

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

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

   Historically, a small number of our customers have accounted for a
significant portion of our product revenues. In the first quarter of 2001,
sales to the 10 customers from which we received the greatest revenues
accounted for approximately 67.1% of our revenues. Our revenues could decline
if one or more of these customers were to significantly reduce, delay or cancel
their orders, decide to purchase digital film manufactured by one of our
competitors, develop and manufacture their own digital film or cease operations
due to the downturn in the nation's economy or otherwise. In the first quarter
2001, sales to our major OEM customers continued to decline somewhat relative
to fourth quarter due to excess inventories on the part of our customers and
downward pricing pressures that among other effects has discouraged OEMs from
bundling digital film with their cameras. 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

                                       17
<PAGE>

contracts, we cannot assure you that these customers will continue to purchase
quantities of our products at current levels, or at all.

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

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

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

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

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

   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;

                                       18
<PAGE>

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

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

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, we recently
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

                                       19
<PAGE>

relationships with our competitors, and if we were to lose our relationship
with this single supplier, the lead time required to qualify new suppliers
could be as long as three months. Also, if we lose our single supplier or this
supplier is otherwise unable to satisfy our volume and delivery schedule
requirements, it may be difficult to locate any suppliers who have the ability
to develop, manufacture and deliver the specialized components we need for our
products. If we are unable to accurately predict our supply needs, or if our
supply of components is disrupted, our reputation may be harmed and we may lose
existing customers or be unable to attract new customers

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

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

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

  . lack of guaranteed production capacity or product supply; and

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

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

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

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

   Substantially all of our CompactFlash digital film is currently assembled
and tested by Flash Electronics, Inc. in Fremont, California and Venture
Manufacturing in the United States and Singapore. We do not have long-term
agreements with Flash Electronics or 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

                                       20
<PAGE>

to provide assembly and test services and deliver products of acceptable
quality, at acceptable costs and in a timely manner, we would have to identify
and qualify additional substitute subcontractors. This could be time-consuming
and difficult and result in unforeseen operations problems.

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

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

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

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

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

   The competition for qualified personnel is particularly intense in our
industry and in northern California, where there is a high concentration of
established and emerging growth technology companies. This competition makes it
more difficult to retain our key personnel and to recruit new highly qualified
personnel. 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. 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. If we do not succeed in
hiring and retaining candidates with appropriate qualifications, we will not be
able to grow our business.

                                       21
<PAGE>

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

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

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

   Sales outside of the United States accounted for 17.8% of our revenues for
the three months ended March 31, 2001. We generated a majority of our
international revenues from 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 regulatory
    environments in foreign countries; and

  . difficulties in hiring and managing employees in foreign countries.

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

                                       22
<PAGE>

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 revenues and market share.

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

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

   We also compete with manufacturers, package or card assemblers and resellers
that combine controllers and flash memory developed by others, such as Hitachi,
into flash memory cards, including Kingston

                                       23
<PAGE>

Technology, Simple Technology, Smart Modular Technologies and Viking.
Additionally, Hitachi and Samsung, as well as flash controller developers such
as Feiya Technology, Pretec, Solid State System Co. Ltd. (3System) and
Hyperstone, compete with our controller and card sales.

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

Competition in the Internet photofinishing market is intense, and we may not be
able to maintain or expand our customer base, which may make it difficult for
us to generate revenues and establish market share.

   We are faced with growing competition in the area of Internet photofinishing
that could make it difficult for us to generate revenues and establish market
share. Our primary competitors in these areas are Internet digital
photofinishing companies such as EZ Prints, Kodak, Ofoto, PhotoAccess,
PhotoWorks.com, Shutterfly, Snapfish and Wolf Camera, which process digital
images transferred to them by customers over the Internet and mail finished
prints to them. These companies also provide traditional prints from scanned
traditional photographs, or digital camera images and photo-image management
services allowing consumers to archive, edit and share uploaded images and
create online photo albums. Additionally, digital imaging kiosks, such as those
from Kodak, Fuji, Pixel Magic and Telepix, allow consumers to scan traditional
images or download digital images for processing and output. Traditional film
processors with strong brand recognition such as Kodak will pose a significant
challenge if they begin to focus their efforts on direct digital-to-paper
photofinishing processing and leverage their advantage in brand recognition.
Indeed, Ofoto was recently purchased by Kodak, which suggests that Kodak may be
intensifying its efforts to compete in this space. Moreover, Internet photo-
image archiving and sharing services such as Club Photo, PhotoIsland, PhotoLoft
and Zing present additional competition through their current and potential
alliances with digital photo labs to directly compete with the services we
offer. We will continue to review our expenditures in Printroom.com in light of
our goal of obtaining profitability this year.

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;

                                       24
<PAGE>

  . 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.

                                       25
<PAGE>

Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk

   Foreign currency risk. We sell our products primarily to customers in the
U.S. and to a lesser extent Japan, Canada and Europe. Most of our sales are
currently denominated in U.S. dollars; however, we anticipate an increasing
amount of our sales will be denominated in British pounds, the Japanese yen and
possibly the euro and Latin American currencies. As a result, it is possible
that our future financial results could be directly affected by changes in
foreign currency exchange rates, and the prices of our products would become
more expensive in a particular foreign market if the value of the U.S. dollar
rises in comparison to the local currency, which may make it more difficult to
sell our products in that market. We will continue to face foreign currency
exchange risk in the future. Approximately 17.8% of our revenues for the three
months ended March 31, 2001 were derived from countries other than the United
States. Therefore, our financial results could be directly affected by weak
economic conditions in foreign markets. These risks may change if we acquire
businesses outside the U.S. or if we sell in non-U.S. dollar denominated
currencies.

   Interest rate risk. Our exposure to market risk for changes in interest
rates relates primarily to the increase or decrease in the amount of interest
expense we must pay on our outstanding debt instruments. The risk associated
with fluctuating interest expense is limited to the exposure related to those
debt instruments and credit facilities that are tied to market rates.
Accordingly, our interest rate risk is comprised of our $20.0 million revolving
credit line from Chase. Interest is payable on borrowings against this line is
at a rate of PRIME plus 2.0% per year, which was 10.00% at March 31, 2001. 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.

                                       26
<PAGE>

                           PART II--OTHER INFORMATION

Item 1. Legal Proceedings.

   On April 6, 2001, Memtek Products, Inc. sued us seeking declaratory relief
that its products do not infringe our U.S. Patent Nos. 5,907,856, 5,930,815 and
5,845,313. This suit is pending in the United States District Court for the
Central District of California.

   On April 13, 2001, we filed an amended complaint in our litigation with
Pretec Electronics Corporation, naming Memtek Products, Inc., as an additional
defendant. In the action, we allege that Memtek Products, Inc. and the other
defendants infringe our U.S. Patent Nos. 5,818,78, 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.

Item 2. Changes in Securities.

   (d) Use of Proceeds.

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

   The net offering proceeds to us from our initial public offering, after
deducting underwriting discounts and commissions and offering expenses, were
approximately $53.3 million. A portion of the proceeds have been used to fund
continuing operations, to repay bridge financing notes totaling $13.3 million
and to pay $6.0 million in net payments to SanDisk in settlement of patent
litigation with SanDisk in November 2000. As of March 31, 2001, we had
approximately $22.1 million in proceeds remaining from our initial public
offering, which are being used to support our business operations and to
provide working capital.

Item 3. Defaults Upon Senior Securities.

   At December 31, 2000, the Company was in default of certain of the covenants
contained in the credit agreement with The Chase Manhattan Bank and Access
Technology Partners. These covenants related to its consolidated revenue,
EBITDA and debt to capital ratio. During the first quarter of 2001, the Company
entered into an amended credit agreement with Chase, effective as of December
31, 2000, which revised these financial covenants and consequently, the Company
was in compliance with the revised covenants as of December 31, 2000. In
addition, the Company entered into a forbearance agreement with Access under
which Access agreed not to exercise its rights and remedies as a result of the
defaults under the loan agreements existing at December 31, 2000 until the
earlier of December 31, 2001 or the date any additional default may occur. In
connection with these agreements, the Company incurred a $0.7 million interest
charge and re-priced the warrants issued in connection with the credit
facilities from $8.00 to $1.44 per share. The increase in the value of the
warrants related to the re-pricing is being amortized over the life of the
loan. At March 31, 2001, the company was in default of the EBITDA covenant of
the amended agreements as a result of the significant non-cash charges
recognized in the three months then ended. Chase and Access have amended the
EBITDA covenant effective March 31, 2001 to address the treatment of the non-
cash charges. As a result of the amendment, the Company was in compliance with
the revised covenants as of March 31, 2001.

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

   None.

Item 5. Other Information.

   None.

                                       27
<PAGE>

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

A. Exhibits

<TABLE>
<CAPTION>
 Exhibit
   No.   Description
 ------- -----------
 <C>     <S>
 10.1*   Patent License Agreement between Lexar Media, Inc. and Samsung
         Electronics Co., Ltd. dated as of March 29, 2001.

 10.2*   Purchase and Supply Agreement between Lexar Media, Inc. and Samsung
         Electronics Co., Ltd. dated as of March 29, 2001.
</TABLE>
--------
* Confidential treatment has been requested for portions of this agreement.

B. Reports on Form 8-K

   No reports were filed on Form 8-K for the quarter ended March 31, 2001.

                                       28
<PAGE>

                                   SIGNATURES

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

                                          Lexar Media, Inc.

                                                  /s/ Ronald H. Bissinger
                                          _____________________________________
                                                    Ronald H. Bissinger
                                            Chief Financial Officer (Principal
                                              Financial Officer and Principal
                                                    Accounting Officer)

Date: May 15, 2001

                                       29
<PAGE>

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
 Exhibit
   No.                               Description
 -------                             -----------
 <C>     <S>
 10.1*   Patent License Agreement between Lexar Media, Inc. and Samsung
         Electronics Co., Ltd. dated as of March 29, 2001.

 10.2*   Purchase and Supply Agreement between Lexar Media, Inc. and Samsung
         Electronics Co., Ltd. dated as of March 29, 2001.
</TABLE>
--------
* Confidential treatment has been requested for portions of this agreement.