UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-Q

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

         For the quarterly period ended September 30, 2000

                                       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: 000-27257

                              SMARTDISK CORPORATION
             (Exact name of registrant as specified in its charter)


           DELAWARE                                    65-0733580
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

                  3506 Mercantile Avenue, Naples, Florida 34104
                    (Address of principal executive offices)

                                 (941) 436-2500
              (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 [ ].

As of October 31, 2000, there were 17,479,037 shares of the Registrant's Common
Stock outstanding, par value $0.001.


<PAGE>


                              SMARTDISK CORPORATION

                                      INDEX

                                                                            Page
                                                                            ----
PART I.     FINANCIAL INFORMATION

    Item 1. Financial Statements (Unaudited).................................. 3

         1) Condensed Consolidated Balance Sheets
               as of December 31, 1999 and September 30, 2000................. 3
         2) Condensed Consolidated Statements of Operations
               for the three and nine months ended
               September 30, 1999 and 2000.................................... 4
         3) Condensed Consolidated Statements of Cash Flows
               for the nine months ended September 30, 1999 and 2000.......... 5
         4) Notes to Condensed Consolidated Financial Statements--
               September 30, 2000 ............................................ 6

    Item 2. Management's Discussion and Analysis of Financial Condition and
            Results of Operations.............................................12

    Item 3. Quantitative and Qualitative Disclosure About Market Risk.........33


PART II.    OTHER INFORMATION

    Item 1. Legal Proceedings.................................................34

    Item 2. Changes in Securities and Use of Proceeds.........................34

    Item 6. Exhibits and Reports on Form 8-K..................................36


SIGNATURES....................................................................37





<PAGE>
PART I - FINANCIAL INFORMATION

Item 1. - Financial Statements

                              SMARTDISK CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                        (in thousands, except par value)
<TABLE>
<CAPTION>
                                                                          December 31,           September 30,
                                                                              1999                     2000
                                                                          ------------           -------------
                                                                                                   (Unaudited)
<S>                                                                        <C>                      <C>
Assets
Current assets:
   Cash and cash equivalents                                               $   19,080               $    10,242
   Restricted cash                                                              1,050                     1,050
   Short-term investments                                                      26,640                    12,827
   Accounts receivable, net                                                     3,866                    18,205
   Notes receivable                                                             6,302                       193
   Inventories, net                                                             1,475                    15,312
   Prepaid expenses and other current assets                                    1,353                     4,176
                                                                           ----------                ----------
                  Total current assets                                         59,766                    62,005
Property and equipment, net                                                     2,623                     3,817
Goodwill and other intangible assets, net                                         883                    82,321
Deposits and other assets                                                         172                       240
                                                                           ----------                ----------
Total assets                                                               $   63,444                $  148,383
                                                                           ==========                ==========

Liabilities and Stockholders' Equity
Current liabilities:
   Accounts payable                                                        $    5,330                $   13,268
   Bank line of credit and discounted notes                                     4,895                     2,119
   Income taxes payable                                                         1,110                     1,718
   Deferred revenue                                                               308                     1,088
   Other accrued liabilities                                                    2,015                     4,281
                                                                           ----------                ----------
                  Total current liabilities                                    13,658                    22,474

Deferred income taxes and other                                                     -                    10,062

Commitments and contingencies

Stockholders' equity:
   Preferred stock, $0.001 par value; 5,000 shares authorized;
     none issued                                                                    -                         -
   Common stock, $0.001 par value; 60,000 shares authorized;
     16,072 issued and 15,991 outstanding at December 31, 1999;
     17,558 issued and 17,477 outstanding at September 30, 2000                    16                        18
   Capital in excess of par value                                              71,246                   146,266
   Treasury stock, 81 shares at December 31, 1999 and September
     30, 2000, at cost                                                            (58)                      (58)
   Accumulated other comprehensive income                                         712                       603
   Notes receivable from officers/employees                                      (387)                     (553)
   Accumulated deficit                                                        (21,743)                  (30,429)
                                                                           ----------                ----------
                  Total stockholders' equity                                   49,786                   115,847
                                                                           ----------                ----------
Total liabilities and stockholders' equity                                 $   63,444                $  148,383
                                                                           ==========                ==========
</TABLE>

See notes to condensed consolidated financial statements

                                       3
<PAGE>
                              SMARTDISK CORPORATION
           CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
                      (in thousands, except per share data)
<TABLE>
<CAPTION>
                                                              Three Months Ended                        Nine Months Ended
                                                                 September 30,                            September 30,
                                                         -----------------------------             ----------------------------
                                                           1999                2000                  1999               2000
                                                         ---------           ---------             ---------          ---------
<S>                                                      <C>                 <C>                   <C>                <C>
Revenues:
     Product sales                                       $  11,331           $  32,246             $  25,127          $  79,278
     Research and development revenue                            -                   -                     -              1,209
     License fee and royalty revenue                           133                 462                   329                533
                                                         ---------           ---------             ---------          ---------
         Total revenues                                     11,464              32,708                25,456             81,020

Cost of revenues                                             6,968              22,662                17,239             55,473
                                                         ---------           ---------             ---------          ---------

Gross profit                                                 4,496              10,046                 8,217             25,547

Operating expenses:
     Research and development                                1,421               2,385                 3,825              6,933
     Sales and marketing                                       315               2,222                 1,094              4,787
     General and administrative                              1,812               3,280                 4,497              8,345
     Amortization of goodwill and other
        acquisition related intangible assets                    -               7,529                     -             17,163
                                                         ---------           ---------             ---------          ---------
         Total operating expenses                            3,548              15,416                 9,416             37,228

Operating income (loss)                                        948              (5,370)               (1,199)           (11,681)

Interest and other income, net                                  30                 379                   111              1,392
Interest expense                                               (16)                 (9)                  (39)               (97)
                                                         ---------           ---------             ---------          ---------

Net income (loss) before income taxes                          962              (5,000)               (1,127)           (10,386)

Income tax (expense) benefit                                  (260)              1,088                  (327)             1,700
                                                         ---------           ---------             ---------          ---------

Net income (loss)                                           $  702           $  (3,912)            $  (1,454)         $  (8,686)
                                                         =========           =========             =========          =========

Income (Loss) per share

         Basic                                            $ 0.07             $ (0.23)              $ (0.16)           $ (0.52)
                                                         =========           =========             =========          =========
         Diluted                                          $ 0.05             $ (0.23)              $ (0.16)           $ (0.52)
                                                         =========           =========             =========          =========

Shares used in per share computation
         Basic                                               9,616              17,166                 9,234             16,734
                                                         =========           =========             =========          =========
         Diluted                                            12,766              17,166                 9,234             16,734
                                                         =========           =========             =========          =========
</TABLE>


See notes to condensed consolidated financial statements

                                       4

<PAGE>
                              SMARTDISK CORPORATION
           CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
                                 (in thousands)
<TABLE>
<CAPTION>
                                                                                      Nine Months Ended
                                                                                          September 30,
                                                                                ---------------------------------
                                                                                   1999                   2000
                                                                                ---------               ---------
<S>                                                                             <C>                     <C>
Cash flows from operating activities:
   Net loss                                                                     $  (1,454)              $  (8,686)
   Adjustments to reconcile net loss to
     net cash (used in) provided by operating activities:
       Depreciation                                                                   937                   1,538
       Amortization                                                                   387                  17,529
       Foreign currency gain                                                            -                    (101)
       Bad debt expense                                                                81                     221
       Provision for inventory obsolescence                                           101                     847
       Employee stock option expense                                                   77                       -
       Deferred income tax benefit                                                    169                  (3,891)
       Gain on sale of property and equipment                                           -                     (97)
       Loss on sale of short-term investments                                           -                      19
       Changes in operating assets and liabilities, net of acquisitions:
             Accounts receivable                                                   (3,378)                 (9,418)
             Notes receivable                                                      (3,394)                  6,110
             Inventories                                                            1,050                    (200)
             Prepaid expenses and other current assets                             (2,220)                   (861)
             Deposits and other assets                                             (2,100)                    (68)
             Accounts payable                                                       2,217                     724
             Income taxes payable                                                       -                    (858)
             Deferred revenue                                                       2,335                     779
             Other accrued liabilities                                              1,763                     447
                                                                                ---------               ---------
Net cash (used in) provided by operating activities                                (3,429)                  4,034

Cash flows from investing activities:
   Purchases of property and equipment, net of disposals                           (2,399)                 (1,446)
   Cash paid for acquisitions, net of cash acquired                                     -                 (18,221)
   Cash paid for intellectual property                                                  -                    (778)
   Purchases of short-term investments                                                  -                  (9,116)
   Sales and maturities of short-term investments                                       -                  22,960
                                                                                ---------               ---------
Net cash used in investing activities                                              (2,399)                 (6,601)

Cash flows from financing activities:
   Net borrowings (repayments) under lines of credit                                2,498                  (7,019)
   Collections on notes receivable from officers/employees                              -                      45
   Proceeds from sale of common stock                                               4,300                       -
   Proceeds from exercise of stock options                                            176                     242
   Proceeds from stock issued under ESPP                                                -                     371
   Proceeds from sale of stock by SDL                                                  65                       -
   Purchase of treasury stock                                                          (1)                      -
                                                                                ---------               ---------
Net cash provided by (used in) financing activities                                 7,038                  (6,361)
Effect of exchange rate fluctuations on cash                                           56                      90
                                                                                ---------               ---------
Increase (decrease) in cash                                                         1,266                  (8,838)
Cash and cash equivalents at beginning of period                                    2,920                  19,080
                                                                                ---------               ---------
Cash and cash equivalents at end of period                                      $   4,186               $  10,242
                                                                                =========               =========
Significant non-cash activities:
   Note receivable obtained for stock option exercise                           $       -               $     210
   Issuance of common stock for license                                         $     300               $     240
   Contribution/conversion of stockholder loan to capital                       $     648               $       -

</TABLE>
See notes to condensed consolidated financial statements

                                       5
<PAGE>
                              SMARTDISK CORPORATION
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
                               SEPTEMBER 30, 2000

Note 1. Basis of Presentation

         The accompanying unaudited condensed interim consolidated financial
statements for SmartDisk Corporation ("SmartDisk" or the "Company") have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
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 adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. The balance sheet at December 31, 1999 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. Operating results for the three and
nine-month periods ended September 30, 2000 are not necessarily indicative of
the results that may be expected for the year ended December 31, 2000.

         The unaudited condensed interim consolidated financial statements
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this report and the
audited consolidated financial statements and accompanying notes included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999, filed
with the Securities and Exchange Commission.

Note 2. Inventories

         Inventories are stated at the lower of cost or market (estimated net
realizable value) with cost being determined on a first-in, first-out basis.
Inventories consist of the following (in thousands):

                                            December 31,           September 30,
                                                1999                   2000
                                              --------              ---------
         Finished goods                       $  1,475              $   4,351
         Work in process                             -                  1,903
         Raw materials                               -                  9,058
                                              --------              ---------
         Total inventories                    $  1,475              $  15,312
                                              ========              =========

                                       6
<PAGE>

Note 3. Net Income (Loss) Per Share

         For the three months ended September 30, 2000, potential common shares
totaling 1,368,357 were excluded from the computation of net loss per share
because they were anti-dilutive. For the nine months ended September 30, 1999
and 2000, potential common shares totaling 3,063,879 and 1,487,368,
respectively, were excluded from the computation of net loss per share because
they were anti-dilutive. Potential common shares include stock options and
shares of non-vested stock.

Note 4. Comprehensive Loss

         Comprehensive loss includes all changes in equity that result from
transactions and other economic events during the period other than transactions
with stockholders. The components of other comprehensive loss for the Company
include equity adjustments resulting from the translation of the balance sheets
for the Japanese and European subsidiaries and unrealized losses on short-term
investments. The following table sets forth the computation of comprehensive
loss for the periods indicated (in thousands):
<TABLE>
<CAPTION>

                                                          Three Months Ended                Nine Months Ended
                                                             September 30,                    September 30,
                                                        -----------------------         ---------------------
                                                         1999             2000             1999         2000
                                                        -----          --------         --------     --------
<S>                                                     <C>            <C>              <C>          <C>
Net income (loss)                                       $ 702          $ (3,912)        $ (1,454)    $ (8,686)
Other comprehensive income (loss):
     Unrealized gain on short-term investments,
          net of tax                                        -                34                -           30
     Foreign currency translation adjustment              241               (82)             235         (139)
                                                        -----          --------         --------     --------
Total comprehensive income (loss)                       $ 943          $ (3,960)        $ (1,219)    $ (8,795)
                                                        =====          ========         ========     ========
</TABLE>

Note 5. Acquisition

         On March 6, 2000, SmartDisk Corporation acquired all the outstanding
shares of VST Technologies, Inc. stock in exchange for approximately 1.1 million
shares of SmartDisk common stock and approximately $16.4 million in cash. In
addition, SmartDisk issued options to purchase a total of approximately 443,000
shares of SmartDisk common stock in exchange for all issued and outstanding VST
options.

                                       7
<PAGE>

Note 5. Acquisition (continued)

         Under purchase accounting, the total purchase price was allocated to
VST's assets and liabilities based on their relative fair values as of the date
of the closing of the acquisition pending final determination of certain
acquired balances. The amounts and components of the purchase price along with
the allocation of the purchase price to net assets acquired are presented below
(in thousands).

                       Purchase Price

              Cash                                           $16,433
              Common stock                                         1
              Capital in excess of par                        49,792
              Value of SmartDisk options issued               19,792
              Transaction costs                                2,918
                                                             -------
              Total purchase price                           $88,936
                                                             =======

                       Net Assets Acquired

              Book value of net tangible assets of VST        $9,551
              Intangible assets:
                    Non-compete agreements                    21,300
                    Distributions channels                     4,900
                    VST trade name                             4,800
                    Patents                                    2,200
                    Workforce in place                         1,000
              Deferred income taxes                          (13,680)
              Goodwill                                        58,865
                                                             -------
              Net assets acquired                            $88,936
                                                             =======

         The following unaudited pro forma financial information reflects the
VST acquisition as if it had occurred on January 1, 1999 after giving effect to
certain adjustments including amortization of goodwill and other acquired
intangible assets. The pro forma financial information does not purport to
represent what the Company's actual results of operations would have been had
the acquisition occurred as of January 1, 1999 and may not be indicative of
operating results for any future periods.
<TABLE>
<CAPTION>
                                      Three Months Ended                   Nine Months Ended
                                        September 30,                         September 30,
                                  -------------------------         ---------------------------
                                     1999           2000              1999              2000
                                  ----------     ----------         ---------         ---------
                                               (in thousands, except per share data)
<S>                               <C>            <C>                <C>               <C>
Revenues                          $   29,106     $   32,708         $  64,272         $  87,057
Net loss                          $   (6,980)    $   (3,912)        $ (25,971)        $ (14,744)

Loss per share
         Basic and diluted        $    (0.65)    $    (0.23)        $   (2.52)        $   (0.83)
                                  ==========     ==========         =========         =========
</TABLE>


                                       8
<PAGE>

Note 5. Acquisition (continued)

         On April 21, 2000, the Company completed its acquisition of
substantially all of the intellectual property of El Gato Software LLC, a
California limited liability company, for approximately $755,000 in cash and
approximately 37,000 shares of SmartDisk common stock, valued at $1.0 million.
El Gato develops and markets USB and FireWire drivers, applications and firmware
support for leading personal storage systems. The purchase price of the acquired
intellectual property is being amortized over two years.

         On April 28, 2000, the Company acquired all of the capital stock of
Impleo Limited, an English corporation, for approximately $200,000 in cash and
approximately 125,000 shares of SmartDisk common stock, valued at approximately
$3.4 million. Impleo manufactures and markets digital connectivity products and
personal storage systems under the Datawise brand. Under purchase accounting,
the total purchase price was allocated to Impleo's assets and liabilities based
on their relative fair values as of the date of the closing of the acquisition
pending final determination of certain acquired balances. Amounts allocated to
identifiable assets and the residual goodwill are amortized on a straight-line
basis over periods not exceeding five years. Identifiable intangible assets
include trade name, workforce in place, distribution channel and non-compete
agreements. The consolidated financial statements include the operating results
of Impleo from the date of acquisition. Pro forma results of operations have not
been presented because the effect of this acquisition was not material.

Note 6. Segment Information

         Based on its method of internal reporting, SmartDisk has two reportable
segments: Digital connectivity products and personal storage systems. Digital
connectivity products primarily consist of our FlashPath flash memory card
readers, which support Toshiba SmartMedia, Sony Memory Stick, and SanDisk
MultiMediaCard. Personal storage systems consist of the family of Universal
Serial Bus (USB) and FireWire-based products, which include high performance,
portable hard disk drives and floppy disk drives for desktop and notebook PCs,
as well as expansion-bay disk drives for notebook PCs.

                                       9
<PAGE>

Note 6. Segment Information (continued)

         The following table presents information about the Company's reportable
segments (in thousands):
<TABLE>
<CAPTION>
                                                   Three Months Ended                Nine Months Ended
                                                       September 30,                    September 30,
                                                 ------------------------          ------------------------
                                                   1999             2000             1999             2000
                                                 --------         -------          -------          -------
<S>                                              <C>              <C>              <C>              <C>
      Digital connectivity products:
            Revenues                             $ 11,331         $11,975          $25,127          $36,414
                                                 ========         =======          =======          =======
            Gross profit                         $  4,363         $ 4,173          $ 7,888          $12,923
                                                 ========         =======          =======          =======
      Personal storage systems:
            Revenues                             $      -         $20,271          $     -          $42,864
                                                 ========         =======          =======          =======
            Gross profit                         $      -         $ 5,556          $     -          $11,027
                                                 ========         =======          =======          =======
      Other:
            Revenues                             $    133         $   462          $   329          $ 1,742
                                                 ========         =======          =======          =======
            Gross profit                         $    133         $   317          $   329          $ 1,597
                                                 ========         =======          =======          =======
      Total
            Revenues                             $ 11,464         $32,708          $25,456          $81,020
                                                 ========         =======          =======          =======
            Gross profit                         $  4,496         $10,046          $ 8,217          $25,547
                                                 ========         =======          =======          =======
</TABLE>

         SmartDisk does not allocate operating expenses, interest expense,
interest and other income, net or income tax expense or benefit to the these
segments for internal reporting purposes.

         Total assets have increased from December 31, 1999 to September 30,
2000 primarily due to the acquisition of VST in the first quarter of 2000.

Note 7. Reclassifications

         Certain amounts in the unaudited condensed interim consolidated
financial statements for the 1999 periods have been reclassified to conform to
the current period presentation.

Note 8. Recent Accounting Pronouncements

         In June 1998, the Financial Accounting Standards Board issued Statement
(SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as
amended, which is required to be adopted in years beginning after June 15, 2000.
SFAS 133, as amended, establishes accounting and reporting standards for
derivative instruments and hedging activities and will require the Company to
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. Because
SmartDisk currently holds no derivative instruments and does not engage in
hedging activities, management does not anticipate that the adoption of SFAS No.
133 will have a significant effect on the financial position, results of
operations or cash flows of the Company.

                                       10
<PAGE>

Note 8. Recent Accounting Pronouncements (continued)

         In December 1999, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements, which summarizes certain of the SEC's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
SAB 101, as amended, is required to be adopted no later than the fourth fiscal
quarter of fiscal years beginning after December 15, 1999. We do not anticipate
the adoption of the guidelines required by SAB No. 101 will have a material
impact on our financial condition or results of operations.

                                       11
<PAGE>

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

         The following discussion should be read in conjunction with the
unaudited condensed consolidated financial statements and the notes thereto
included in Item 1 of this Quarterly Report.

         Certain statements contained in this report on Form 10-Q are
forward-looking in nature within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities and Exchange Act of 1934.
Terminology such as "may," "will," "expect," "anticipate," "estimate,"
"continue," "predict," or other similar words identify forward-looking
statements. These statements discuss future expectations, contain projections of
results of operations or of financial condition or state other forward-looking
information. Forward-looking statements appear in a number of places in this
Form 10-Q and include statements regarding management's intent, belief or
current expectation about, among other things, the following: our anticipated
growth strategies, including trends in revenues, costs, gross margins and
profitability; our intention to develop, market and introduce new products;
anticipated growth of the personal computer and technology industries;
anticipated trends in our businesses, including trends in the demand for digital
appliances and, therefore, demand for our products; expectations of consumer
preferences and desires; future projections of our financial performance, future
expenditures for capital projects and research and development; the emergence of
certain competing technologies; potential uses for and applications of our
products; and our ability to continue to control costs and maintain quality.
Although management believes that the expectations reflected in these
forward-looking statements are based on reasonable assumptions, forward-looking
statements are not guarantees of future performance and involve risks and
uncertainties that could cause actual results to differ materially from those in
such forward-looking statements. Readers are cautioned not to place undue
reliance on the forward-looking statements included in this document, which are
based on information available to the Company on the date hereof. The Company
makes no commitment to update any such forward-looking statements or to disclose
any facts, events, or circumstances after the date hereof that may affect the
accuracy of any forward-looking statement. Actual results may differ materially
from those predicted in the forward-looking statements as a result of various
factors, including those set forth below under "Factors That May Affect Future
Results of Operations" and in other documents that we file from time to time
with the Securities and Exchange Commission.

Overview

         We design, develop, manufacture and market digital connectivity
products and personal storage systems that allow consumers to easily access,
exchange, organize and store digital data such as photographs, video, music,
voice and data among digital appliances, personal computers and the Internet.
With the growth of digital appliances, such as digital cameras, digital video
camcorders, voice recorders and music players, consumers are increasingly using
the PC as the "multimedia center" of the home or office. These digital
appliances capture digital data on high capacity, reusable flash memory cards
that appeal to consumers because of their small size, versatility and
portability. Our digital connectivity products enable the easy and convenient


                                       12
<PAGE>

sharing of the information on the cards between the digital appliance, PCs and
the Internet. Our personal storage systems and related software are designed to
provide an easy way to store, organize and retrieve this digital data on
portable, high-speed, high-capacity disk drives.

         Our digital connectivity products are designed to work across all
popular PC platforms, support all leading flash memory media types and use high
performance PC interfaces, such as USB. Our patented digital connectivity
products, such as our FlashPath products for the Toshiba SmartMedia card,
SanDisk MultiMediaCard and Sony Memory Stick, as well as Smarty, allow consumers
to use the familiar 3.5-inch floppy drive -- found on most PCs worldwide -- to
simplify the exchange of images, music, voice and other digital data between PCs
and digital appliances. We recently launched our new high-speed USB-based Flash
Media Reader, a dual-slot flash memory reader, for both CompactFlash and
SmartMedia cards. In early 2000, we introduced a USB Tri-Media Reader, which
reads and writes to CompactFlash and SmartMedia cards, as well as rotational
media, such as a 1.44 Mega-byte floppy disk. Our Flash Media Reader and our
Tri-Media Reader are used to exchange digital data and address an expanding
installed base of PCs with USB cable interfaces. These two products are
compatible with both Windows and Macintosh systems.

         Our FlashPath family of products is used primarily to transfer images
to PCs from digital cameras. We develop and market three FlashPath products, one
for each of three different flash memory cards: SanDisk's MultiMediaCard, Sony's
Memory Stick and Toshiba's SmartMedia card. These flash memory cards are used in
cameras and video camcorders made by a number of leading camera manufacturers,
including FujiFilm, JVC, Olympus, Panasonic, Sanyo, Sharp, Sony and Toshiba. To
date, we have sold over two million FlashPaths.

         We believe that as consumers embrace the digital lifestyle, the number
of applications for flash memory cards will grow. These flash memory cards are
designed for applications in "smart" cellular phones, digital still cameras and
camcorders, digital audio players, digital voice recorders and video game
devices. In addition to our product development efforts with Sony and SanDisk,
we also have strategic relationships with a number of key electronics industry
participants, including Hitachi, NEC, and Toshiba.

         Our USB- and FireWire-based personal storage systems include high
performance, portable hard disk drives and floppy disk drives for desktop and
notebook PCs, as well as expansion bay disk drives for notebooks. Substantially
all of our personal storage systems are compatible with Windows and Macintosh
operating systems. We believe that the substantial increase of data intensive
digital content, such as imaging, music and video has created the need and
awareness for increased personal storage. Our personal storage systems and
related software enhance the user's ability to store, organize and retrieve
digital content. These systems support very high transfer rates and offer up to
120 Gigabytes of capacity.

         Since 1992, we have worked with Apple as an Apple preferred partner and
developer. Through this relationship, Apple has provided us access to product
road maps that have allowed us to focus on new opportunities in the development
and engineering of many FireWire and USB systems. Through our strategic
relationship with Iomega, we build Iomega Zip drive products for Apple, IBM and
Fujitsu. We were one of the first companies to ship FireWire personal storage


                                       13
<PAGE>

systems for both Macintosh and Windows operating systems, as well as FireWire
Zip drives. In the third quarter of 2000, we introduced our 120 Gigabyte
portable FireWire RAID (Redundant Array of Independent Disks) product.

         Our strategic partners actively participate in the development of our
products, provide us with access to leading edge manufacturing capabilities, and
market and/or distribute our products globally.

Results of Operations

         Revenues. Our product revenues are recognized when title and risk of
loss are transferred to customers, which is generally at the time of shipment.
Product revenues at our Japanese subsidiary are recognized upon acceptance by
the customer. Total revenues were approximately $32.7 million for the three
months ended September 30, 2000 compared to approximately $11.5 million for the
three months ended September 30, 1999. Total revenues were approximately $81.0
million for the nine months ended September 30, 2000 compared to approximately
$25.5 million for the nine months ended September 30, 1999. These increases were
primarily attributable to sales of personal storage systems subsequent to the
acquisition of VST in March 2000 and an increase in sales of our digital
connectivity products.

         Our product revenues from the sale of digital connectivity products
increased from approximately $11.3 million for the three months ended September
30, 1999 to approximately $12.0 million for the three months ended September 30,
2000. Our product revenues from the sale of digital connectivity products
increased from approximately $25.1 million for the nine months ended September
30, 1999 to approximately $36.4 million for the nine months ended September 30,
2000. We are starting to see the anticipated decline in the use of the 3.5-inch
floppy drive as a flash memory card interface, as consumers move towards devices
with higher transfer speeds, such as our USB-based flash media readers. This is
contributing to the slow growth in sales of our FlashPath products.

         Our product revenues from the sale of personal storage systems for the
three months ended September 30, 2000 were approximately $20.3 million. For the
period from March 6, 2000, the date we acquired VST, through September 30, 2000,
revenues from personal storage systems were approximately $42.9 million.
Although the results for the three months ended September 30, 2000, represents a
22% increase in revenues as compared to the three months ended June 30, 2000, we
experienced slower growth in our USB- and FireWire-based products for the Apple
market, which is attributed to the recent decrease in demand for Apple products.
We are introducing various personal storage products, which previously were
limited to Apple-based systems, to the much larger Windows-based market. In
addition, we plan to pursue broader markets for our personal storage products
through our European and Japanese operations.

         Fiscal year 1999 was the first year that we had revenues from our
research and development efforts. We earned additional revenues from a research
and development agreement, which was completed during the quarter ended March
31, 2000. Our research and development revenue is recognized upon final customer
acceptance of our work performed under the terms of the agreement. Our revenues
from research and development agreements were approximately $1.2 million for the
nine months ended September 30, 2000. We had no research


                                       14
<PAGE>

and development revenues for the three months ended September 30, 2000. In the
future, we may enter into additional research and development agreements for the
development of new technologies.

         Our license fee and royalty revenues primarily consist of fees earned
from license agreements on our SafeBoot and FlashTrax intellectual property.
Currently, these revenues represent less than two percent of our total revenues
for the three and nine months ended September 30, 2000. In the future, we may
enter into additional licensing agreements for our existing and future
intellectual property.

         Cost of Revenues. Cost of revenues includes the purchased cost of
product, packaging, storage, freight, scrap, inventory and warranty provisions,
as well as royalties for some of our digital connectivity products and personal
storage systems. Cost of revenues increased to approximately $22.7 million for
the three months ended September 30, 2000 compared to approximately $7.0 million
for the three months ended September 30, 1999. Cost of revenues increased to
approximately $55.5 million for the nine months ended September 30, 2000
compared to approximately $17.2 million for the nine months ended September 30,
1999. These increases in cost were due primarily to sales of personal storage
systems subsequent to the acquisition of VST and an increase in sales of our
digital connectivity products. With the acquisition of VST, we expect that our
cost of revenues will increase significantly in 2000, compared to 1999, and as
we expand our product offerings, particularly for FireWire and USB products, and
support anticipated sales growth.

         Gross Profit. Our gross profit for the three months ended September 30,
2000 increased to approximately $10.0 million or 31% of total revenue, compared
to approximately $4.5 million or 39% of total revenue for the three months ended
September 30, 1999. Our gross profit for the nine months ended September 30,
2000 increased to approximately $25.5 million or 32% of total revenue, compared
to approximately $8.2 million or 32% of total revenue for the nine months ended
September 30, 1999. These increases in the amount of gross profit are primarily
attributable to sales of personal storage systems subsequent to the acquisition
of VST in March 2000, which contributed to the decrease in our gross margin
percentage in the current quarter since the gross margin on personal storage
products is typically less than on digital connectivity products. Because we
expect OEMs to continue to account for a large portion of our sales, we expect
gross margins on our digital connectivity products to remain relatively
consistent with the current level. However, our largest OEM customers may seek
price concessions, which could cause a reduction in our gross margins. Our gross
margin percentage for the first nine months of 2000 remained consistent with the
first nine months of 1999 because of the revenue earned under our research and
development efforts and license fees. With the acquisition of VST, we expect the
actual amount of our gross profit to increase this year, however, we anticipate
our gross margin percentage will decrease since the gross margin on personal
storage products is typically less than on digital connectivity products.

         Research and Development Expenses. Our research and development
expenses consist primarily of salaries and payroll-related expenses for our
design and development engineers, as well as prototype supplies and contract or
professional services. These expenses increased to approximately $2.4 million,
or 7% of total revenues, for the three months ended September 30, 2000


                                       15
<PAGE>

compared to approximately $1.4 million, or 12% of total revenues, for the three
months ended September 30, 1999. Research and development expenses increased to
approximately $6.9 million, or 9% of total revenues, for the nine months ended
September 30, 2000 compared to approximately $3.8 million, or 15% of total
revenues, for the nine months ended September 30, 1999. These increases in
expenditures were the result of the inclusion of VST, as well as hiring
additional technical personnel, including salaries and related payroll expenses,
costs incurred in conjunction with one of our research and development contracts
and the outsourcing of product development. We believe that the continued
introduction of new products with an emphasis on being first-to-market is
essential to our growth and will require increases in research and development
expenditures.

         Research and development expenses related to digital connectivity
products, were incurred to support our development of enhanced versions of our
existing SmartMedia FlashPath, as well as our development of our FlashPath
products designed to work with the Sony Memory Stick and the SanDisk
MultiMediaCard. We expect that our research and development expenses will
continue to increase in connection with the developement of other digital
connectivity products to conveniently transfer digital data from competing flash
memory cards to products that support computer interfaces other than the
3.5-inch floppy disk drive, such as our recently-introduced USB dual-slot flash
media reader. Including personal storage products, we expect our research and
development expenses to increase but represent a decreasing percentage of our
total product revenues.

         Sales and Marketing Expenses. Sales and marketing expenses include
salaries, benefits and travel expenses for our sales, marketing and product
management personnel in the United States and Japan. These expenses also include
other selling and marketing expenditures for items such as trade shows,
advertising, marketing and other promotional programs. Sales and marketing
expenses for the three and nine months ended September 30, 2000 increased by
approximately $1.9 million and $3.7 million to approximately $2.2 million and
$4.8 million compared to the three and nine months ended September 30, 1999,
respectively. The change from 1999 to 2000 is primarily attributable to the
inclusion of VST. In connection with the VST acquisition in March 2000, we added
a number of new products to our existing product lines, significantly increasing
our total sales and marketing expenses. We expect our sales and marketing
expenses to increase in the future as we launch new products and broaden our
markets.

         General and Administrative Expenses. General and administrative
expenses include the salaries and related expenses of our executive management,
finance, information systems, human resources, legal and administrative
functions, as well as lease rental expense, utilities, maintenance expenses,
taxes, insurance, legal and accounting professional fees, depreciation and
amortization. General and administrative expenses increased to approximately
$3.3 million and $8.3 million for the three and nine months ended September 30,
2000, respectively, compared to approximately $1.8 million and $4.5 million in
the three and nine months ended September 30, 1999. These increases are
primarily due to the inclusion of VST, as well as, increases in professional
services, legal fees and personnel related costs including salaries, bonuses and


                                       16
<PAGE>

relocation expenses. During the third quarter of 2000, we recognized a one-time
expense of approximately $0.5 million for costs associated with a withdrawn
secondary stock offering.

         Amortization of goodwill and other acquisition related intangible
assets. Amortization of goodwill and other acquisition related intangible assets
includes the amortization of the purchase price allocated to separately
identified intangible assets acquired in the acquisition of VST Technologies,
Inc. and Impleo Limited and from El Gato Software LLC. The separately identified
intangible assets acquired consist of non-compete agreements, distribution
channels, trade names, patents, and workforce in place. These intangible assets
have lives ranging from one to five years from the date of acquisition. Purchase
price not allocated to separately identified intangible assets was allocated to
goodwill. Goodwill is amortized over a five-year life from the date of
acquisition. For the three and nine months ended September 30, 2000,
amortization of goodwill and other acquisition related intangible assets totaled
approximately $7.5 million and $17.2 million, respectively.

         Interest and Other Income. The primary components of interest and other
income are interest earned on cash, cash equivalents and short-term investments
and gains or losses on foreign exchange. The most significant component of these
items, for the three and nine months ended September 30, 2000, is interest
earned on cash, cash equivalents, and short-term investments.

         Interest Expense. Interest expense is incurred on the bank line of
credit in Japan and the United Kingdom. We incurred interest expense on VST's
line of credit until it was paid in full on March 31, 2000.

         Provision for Income Taxes. We are subject to tax in the United States,
Japan, Switzerland and the United Kingdom. These jurisdictions have different
marginal tax rates. For the three and nine months ended September 30, 2000,
income tax expense totaled approximately $0.6 million and $2.2 million,
respectively. These amounts were offset by income tax benefits of approximately
$1.7 million and $3.9 million resulting from amortization expense on certain
intangible assets related to the VST and Impleo acquisitions. Taxable income
earned in the United States was partially offset by net operating loss and
credit carryforwards. A valuation allowance is provided to reduce deferred tax
assets to the amount that will more likely than not be realized.

Liquidity and Capital Resources

         On October 6, 1999, we completed our initial public offering. We
realized net proceeds of approximately $39.1 million from the sale of 3,450,000
shares of our common stock, including 450,000 shares issued upon the exercise of
the underwriters' over allotment option, at an initial public offering price of
$13.00 per share after deducting underwriting discounts and commissions of
approximately $3.1 million and offering expenses of approximately $2.6 million.

         The net proceeds from our initial public offering have been invested in
cash, cash equivalents and short-term investments. In March 2000, in connection
with the acquisition of VST, we paid approximately $18.2 million in purchase
consideration and other acquisition


                                       17
<PAGE>

related costs. In March 2000, we also repaid a line of credit that VST
maintained which had an outstanding balance of approximately $4.3 million. To
date, we have funded VST's operations with approximately $5.0 million. We also
used approximately $0.8 million for the acquisition of substantially all of the
intellectual property of El Gato. We plan to use the remaining net proceeds from
our initial public offering for general corporate purposes, including working
capital and capital expenditures, as well as potential acquisitions of
technology and businesses. The use of the proceeds from our initial public
offering does not represent a material change in the use of proceeds described
in our prospectus dated October 5, 1999.

         We maintain a line of credit in the United States under which we may
borrow up to $10.0 million. Any amounts borrowed under this line of credit bear
interest at 2% over the 30-day LIBOR rate and are secured by substantially all
of our assets. This line of credit expires on April 30, 2001. We have not
borrowed against this line of credit and we have no current plans to borrow any
amounts under this line of credit.

         Our Japanese subsidiary has a line of credit with maximum borrowing
capacity of approximately $2.7 million, or 295 million yen. The facility, which
has no fixed term, is secured by a time deposit and accounts receivable. The
subsidiary maintains a time deposit with a Japanese bank that had a balance at
September 30, 2000 of approximately $1.0 million. We may borrow up to 90% of
this amount. In addition, accounts receivable of up to $1.8 million, or 200
million yen, of specified trade customers may be used as additional collateral.
The credit agreement corresponding to the accounts receivable collateral is
renewable automatically on January 31, 2001. The interest rate on borrowings
under the credit facility is 1.5% per year. The outstanding balance under the
line of credit was approximately $1.9 million or 200 million yen as of September
30, 2000 compared to approximately $2.0 million at December 31, 1999.

         The Japanese subsidiary also discounts certain short-term promissory
notes received from certain trade customers with a bank in Japan. The branch had
no outstanding borrowings collateralized by promissory notes as of September 30,
2000. At December 31, 1999, the branch had approximately $2.9 million of bank
borrowings collateralized by promissory notes.

         Our UK subsidiary has a line of credit with maximum borrowing capacity
of approximately $0.8 million, or 500,000 British pounds. The credit facility
expires in April 2001. The interest rate on borrowings under the credit facility
is 5.5% per year. The outstanding balance under the line of credit as of
September 30, 2000 was approximately $0.3 million or approximately 182,000
British pounds.

         VST has a line of credit secured by a security interest in
substantially all of its assets, including all of its intellectual property. As
of September 30, 2000, no amounts were outstanding under this line of credit.

         Net cash provided by operating activities was approximately $4.0
million for the nine months ended September 30, 2000 compared to cash used in
operations of approximately $3.4 million for the nine months ended September 30,
1999. Net cash provided by operating activities in the first nine months of 2000
reflected a net loss of approximately $8.7 million offset by approximately $19.1
million in depreciation and amortization along with approximately $1.1


                                       18
<PAGE>

million in provisions for uncollectible accounts and inventory obsolescense. In
addition, there was a decrease in notes receivable of approximately $6.1 million
and increases in accounts payable of approximately $0.7 million and deferred
revenue of approximately $0.8 million. These amounts were partially offset by
increases in accounts receivable of approximately $9.4 million, prepaid and
other current assets of approximately $0.9 million and decreases in income taxes
payable of approximately $0.9 million and deferred income taxes of approximately
$3.9 million.

         Net cash used in investing activities was approximately $6.6 million
for the first nine months of 2000. The most significant use of cash in the first
nine months of 2000 was approximately $18.2 million in connection with the
acquisition of VST in March 2000. This amount was partially offset with proceeds
from the sale of short-term investments, net of purchases, of approximately
$13.8 million. Cash was also used for capital expenditures, primarily the
acquisition of development and production equipment.

         Net cash used in financing activities was approximately $6.4 million in
the first nine months of 2000. This was attributable to approximately $2.7
million in net repayments under our line of credit with a Japanese bank and
approximately $4.3 million used to repay the outstanding balance under VST's
line of credit. These amounts were partially offset by proceeds from the
exercise of stock options and employee share purchases.

         We believe our cash and cash equivalents, short-term investments,
credit facility and the remaining net proceeds of the initial public offering,
will be sufficient to meet our working capital and anticipated capital
expenditure needs for at least the next 12 months. We may need to raise
additional capital if we expand more rapidly than initially planned, to develop
and market new or enhanced products and/or services, to respond to competitive
pressures or to acquire complementary products, businesses or technologies. The
capital, if needed, may not be available or may not be available on terms
acceptable to us.

Factors That May Affect Future Results of Operations

         Our business, results of operations and financial condition could be
adversely affected by a number of factors, including the following:

We have incurred net losses and cannot guarantee that we will be profitable in
the future.

         Except for the third and fourth quarter of 1999, we have incurred net
losses on a quarterly basis since inception. We had net income of approximately
$1.0 million during 1999 (a net loss of approximately $17.7 million on a pro
forma basis after giving effect to the VST acquisition). We had a net loss of
approximately $8.7 million in the first nine months of 2000, primarily as a
result of $13.3 million in amortization of goodwill and other intangible assets
from the VST and Impleo acquisitions, net of tax. In addition, as of September
30, 2000, we had an accumulated deficit of approximately $30.4 million. In light
of our loss history and the amortization of goodwill and other intangible assets
from the VST and Impleo acquisitions, we cannot assure you that we will be
profitable in the future.

                                       19
<PAGE>

We have a limited operating history on which to base an investment decision.

         We were incorporated in March 1997, commenced operations in January
1998, and our predecessor corporation only conducted limited operations.
Further, commercial sales of FlashPath, one of our primary products, commenced
in mid-1998. As a result of our limited operating history, we have limited
financial data that can be used in evaluating our business and prospects and in
projecting future operating results.

We may not be able to sell sufficient quantities of our products to sustain a
viable business if the market for digital connectivity products does not
continue to develop or if a competing technology displaces these products.

         Our current FlashPath products and other flash media readers are
designed to provide connectivity between personal computers and digital
appliances that use flash memory cards. The flash memory market is in the early
stage of development and is still evolving. Our current dependence on sales of
FlashPath exposes us to a substantial risk of loss in the event that the flash
memory market does not develop or if a competing technology replaces flash
memory cards. If a competing memory storage device replaces or takes significant
market share from the flash memory cards which our digital connectivity products
support, we will not be able to sell our products in quantities sufficient to
grow our business.

We may not be able to sell sufficient quantities of our digital connectivity
products to sustain our current business if a single standard for flash memory
cards emerges.

         We believe that demand for our flash memory connectivity products is
driven, to a large extent, by the absence of a single standard for flash memory
cards. There are currently five major flash memory cards, none of which has
emerged as the industry standard. Should one of these cards or a new technology
emerge as an industry standard, flash memory card readers could be built into
PCs, eliminating the need for our current flash memory connectivity products.

A reduction in the use of the 3.5-inch floppy disk drive by consumers and
manufacturers is contributing to the slow growth in sales of our FlashPath
products.

         Our current FlashPath products only work in conjunction with the
standard 3.5-inch floppy disk drive. While the 3.5-inch floppy disk drive is
today found in most PCs, a number of newer PC models, such as the Apple iMac and
the Apple G4 desktop, do not have this device and new industry standards may
emerge that render the 3.5-inch floppy disk drive obsolete. Advances in input
devices such as CD-ROM and removable data storage disk drives, such as Zip
drives, are reducing or eliminating the need for the 3.5-inch floppy diskette,
which is contributing to the slow growth in sales of our FlashPath products. In
the future, we will then have to rely on our other products and develop new
products that use a different interface between personal computers and digital
appliances. We may not be able to redesign our FlashPath products to fit the new
interface and demonstrate technological feasibility of those products on a
timely basis, if at all, or in a cost effective manner.

                                       20
<PAGE>

Since our FlashPath products work only in conjunction with the 3.5-inch floppy
disk drive, advances in flash memory cards may make these products less
competitive because of the increased time needed to transfer data using the
3.5-inch floppy disk drive.

         Consumer acceptance of our FlashPath products will depend upon their
ability to quickly transfer information from flash memory cards to PCs. However,
the time needed to transfer information using a 3.5-inch disk drive increases as
more data is transferred. As more memory is condensed on to flash memory cards,
the time necessary to transfer all of the data from a single card will increase.
As technological advances make it possible and feasible to produce higher
density cards, our ability to create products, which quickly transfer all of the
stored information on a single card will be constrained by the inherent
limitations of the 3.5-inch disk drive. In that case, our products would be less
attractive to consumers and our sales would decline.

We may not be able to sell sufficient quantities of our personal storage systems
to sustain our future growth if PC manufacturers do not adopt IEEE 1394 as a
high-speed peripheral interface or if a competing CPU interface displaces or
prevents the widespread adoption of IEEE 1394.

         A substantial portion of our business depends on the adoption of
Institute of Electrical and Electronics Engineering, or IEEE, 1394 technology by
PC manufacturers. IEEE 1394 is a high speed PC interface that is replacing Small
Computer System Interface, or SCSI, and parallel interfaces. If these
manufacturers do not include a IEEE 1394 interface on their PCs or notebook
computers, then we may not be able to sell sufficient quantities of our FireWire
personal storage systems to support our future growth. FireWire is Apple's trade
name for IEEE 1394. For example, a new, competing high speed interface, such as
Universal Serial Bus, or USB, 2.0, could be developed and emerge as an industry
standard, thus limiting the demand for our FireWire technology and related
personal storage systems.

We may not be able to sell sufficient quantities of our personal storage systems
to support our business if suppliers of our drives develop native FireWire-based
personal storage systems that do not require our FireWire conversion technology.

         We embed conversion ASICS and integrated software drivers in the hard
disk drives and Zip drives we obtain from our suppliers, which enables our
FireWire-based personal storage systems to be used with FireWire-equipped CPUs.
We license this technology and the firmware from LSI Logic. If our suppliers
were to develop a native FireWire solution that does not require the conversion
ASICS and drivers embedded in our products, then we may not be able to sell
sufficient quantities of our FireWire personal storage systems to support our
business.

Most of our revenues are derived from only a few major products and our business
will be seriously harmed if demand for those products declines.

         To date, substantially all of our revenue has been derived from the
sale of only a few major products. While our long-term strategy is to derive
revenue from multiple products, we anticipate that the sale of our FlashPath
products and our USB and FireWire storage systems will continue to represent the
most substantial portion of our revenues through at least 2001. A decline in the
price of or demand for these products as a result of competition, technological


                                       21
<PAGE>

change, the introduction of new products by us or others, a failure to
adequately manage product transitions, or for other reasons, would seriously
harm our business. For the nine months ended September 30, 2000, we derived
approximately 41% of our product revenues from the sale of FlashPath, 16% from
the sale of our USB-based personal storage systems, and 14% from the sale of our
FireWire-based personal storage systems.

We must develop new products and introduce them in a timely manner in order to
remain competitive.

         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. To be competitive in this demanding market, we must both continue
to refine current products so that they remain competitive, and continually
design, develop and introduce, in a timely manner, new products that meet the
performance and price demands of OEMs and consumers. These development
activities will require the investment of substantial resources before revenues
are derived from product sales. Any significant delay in releasing new products
would adversely affect our reputation, provide a competitor a first-to-market
opportunity or allow a competitor to achieve greater market share. Product
development is inherently risky because it is difficult to foresee developments
in technology, coordinate our technical personnel and strategic relationships,
and identify and eliminate design flaws. If we are unable to develop and sell
new products, we will not be able to continue our strategy of maintaining media
neutrality, and our target market will be limited. Further, we may not be able
to recoup research and development expenditures if new products are not widely
commercially accepted.

We may not be able to develop or maintain the strategic relationships necessary
to provide us with the insight we need to develop commercially viable products.

         We may not be able to produce commercially viable products if we are
unable to anticipate market trends and the price, performance and functionality
requirements of flash memory card, PC and digital appliance manufacturers. We
must continue to collaborate closely with our customers, our OEM manufacturers
and our other contract manufacturers to ensure that critical development
projects proceed in a coordinated manner. This collaboration is also important
because our ability to anticipate trends and plan our product development
activities depends to a significant degree upon our continued access to
information derived from these strategic relationships. We currently rely on
strategic relationships with flash memory card manufacturers, such as Sony,
SanDisk and Toshiba, PC manufacturers, such as Apple, and consumer product OEMs,
such as Olympus and Fuji Film. For example, through our co-development efforts
with Sony, we developed our FlashPath for the Sony Memory Stick, which began
shipping in the fourth quarter of 1999, and introduced a follow-on FlashPath
product for new models of Sony's Mavica digital still camera a few months later.
If we cannot maintain our relationship with these manufacturers, like Sony, then
we may not be able to continue to develop products that are compatible with
their flash memory cards, PCs and digital appliances. However, collaboration is
more difficult because many of these companies are located overseas. If any of
our current relationships deteriorates or is terminated, or if we are unable to
enter into future alliances that provide us with comparable insight into market
trends, we will be hindered


                                       22
<PAGE>

in our ability to produce commercially viable products. For example, we depend
on our relationship with Iomega Corporation in order to produce our Zip drive
products for IBM and Apple notebook computers. If we cannot maintain our
relationship with Iomega, or if Iomega wishes to produce these products
internally, then our current market for these products will deteriorate.

We may not be able to sustain our relationship with Apple Computer, which would
greatly hinder our ability to timely develop products, which are compatible with
Macintosh operating systems.

         Historically, Apple has provided us, as an Apple developer, access to
selected product road maps, which has allowed us to timely develop and engineer
many of our current products, including our current FireWire and USB storage
systems. As a result of this collaborative relationship, we have received a
substantial portion of our historical revenues from direct sales to Apple and
Apple users. Moreover, we anticipate that a significant portion of our product
revenues will continue to be derived from sales of our Apple compatible products
in the near future. If Apple were to terminate our status as an Apple developer
or if there were a material deterioration of our relationship, we would not be
able to timely develop new technologies that are compatible with Apple's product
road maps and this would have an adverse effect on our business. Moreover, we
currently sell a number of our Apple products through the Apple Web Store, where
our products may be sold separately or may be configured and ordered along with
a Macintosh CPU. While we do not anticipate any change in this arrangement,
Apple is not contractually obligated to offer our products on their website.

A continued decline in the demand for Apple products would further
reduce the market for many of our products.

         Our continued growth depends to a large extent on both our strategic
relationship with Apple and demand for Apple products. This dependence is due
primarily to the fact that, to date, Apple has been the principal PC
manufacturer using the FireWire interface technology on which many of our
products are based. The recent decline in demand for Apple products has
contributed to the slow growth in sales of our personal storage products in the
third quarter. If the decline in the demand for Apple products continues or if
Apple suffers a material change in its business, the market for many of our
products would be further negatively impacted.

Our operating results have fluctuated significantly and may fluctuate
significantly in the future, which could lead to decreases in our stock price.

         Our operating results have fluctuated significantly in the past and we
expect that they will continue to fluctuate in the future. If our future
operating results materially fluctuate or are below the expectations of stock
market analysts, our stock price would likely decline. Future fluctuations may
result from a variety of factors including the following:

         o        The timing and amount of orders we receive from our customers,
                  which may be tied to seasonal demand for the consumer products
                  manufactured and sold by OEMs;

                                       23
<PAGE>

         o        Cancellations or delays of customer product orders, or the
                  loss of a significant customer;

         o        Reductions in consumer demand for our customers' products
                  generally, such as Apple products, or for our products in
                  particular, such as FlashPath;

         o        The timing and amount of research and development
                  expenditures;

         o        The availability of manufacturing capacity necessary to make
                  our products;

         o        General business conditions in our markets, particularly Japan
                  and Europe, as well as global economic uncertainty;

         o        Any new product introductions, or delays in product
                  introductions, by us or our competitors;

         o        Increased costs charged by our suppliers or changes in the
                  delivery of products to us;

         o        Increased competition or reductions in the average selling
                  prices that we are able to charge;

         o        Fluctuations in the value of foreign currencies, particularly
                  the Japanese yen and British Pound, against the U.S. dollar;
                  and

         o        Changes in our product mix as well as possible seasonal demand
                  for our products.

         As a result of these and other factors, we believe that
period-to-period comparisons of our historical results of operations are not a
good predictor of our future performance.

         The stock market has experienced significant price and volume
fluctuations that have particularly affected the market prices of the stocks of
technology companies. Recently, the market price of our common stock, like that
of many technology companies, has experienced significant fluctuations. For
instance, from October 6, 1999, the date of our initial public offering, to
October 31, 2000, the reported last sale price for our common stock ranged from
$5.13 to $65.13 per share. On October 31, 2000, the reported last sale price of
our common stock was $5.13 per share.

         The market price of our common stock also has been and is likely to
continue to be significantly affected by expectations of analysts and investors.
Reports and statements of analysts do not necessarily reflect our views. The
fact that we have in the past met or exceeded analyst or investor expectations
does not necessarily mean that we will do so in the future.

We may fail to adequately protect our intellectual property and, therefore, lose
our competitive advantage.

         Our proprietary technology with respect to 3.5-inch floppy disk drive
interfaces and USB and FireWire source codes is critical to our future growth.
We rely in part on patent, trade secret, trademark and copyright law to protect
our intellectual property. However, the patents issued to


                                       24
<PAGE>

us may not be adequate to protect our proprietary rights, to deter
misappropriation or to prevent an unauthorized third party from copying our
technology, designing around the patents we own or otherwise obtaining and using
our products, designs or other information. We have, in fact, filed a complaint
against one of our former patent attorneys for improperly copying one of our
patent applications and filing a patent application without our consent naming
himself as a co-inventor. This matter was settled with no materially adverse
consequences to SmartDisk. In addition, we may not receive trademark protection
for our "SmartDisk" name. We have filed for trademark registration of the name
"SmartDisk," but this has not yet been granted. We are aware of a trademark
application for the name "SmartDisk" that was filed by another company. Our
application could be denied and we could be prohibited from using the
"SmartDisk" name. In that event, we would be required to incur substantial costs
to establish new name recognition.

         We also claim copyright protection for some proprietary software and
documentation. We attempt to protect our trade secrets and other proprietary
information through agreements with our customers, employees and consultants,
and through other security measures. However, despite our efforts to protect our
intellectual property, unauthorized parties may attempt to copy aspects of our
products or obtain and use information and software that we regard as
proprietary. Those parties may have substantially greater financial resources
than we have, and we may not have the resources available to challenge their use
of our proprietary technology. If we fail to adequately protect our intellectual
property, it will be easier for our competitors to sell competing products.

We may face competition from Intel if it decides to utilize its competing
patent.

         Intel Corporation was issued a patent in 1997 disclosing and claiming
technology substantially similar to that disclosed in one of our key patents.
The Intel patent was filed four years after our effective filing date, and we do
not believe that the Intel patent can be validly applied to any of the
technology disclosed in our patent. However, given the substantial resources
available to Intel, our financial condition could suffer if we engage in a
dispute with Intel. Our business could also be harmed if Intel's patent is
determined to be valid and Intel or any licensee of Intel decides to sue our
customers or develop and commercialize products based on its patent.

Infringement claims by third parties could result in costly litigation and
otherwise adversely impact our business.

         From time to time we may receive communications from third parties
asserting that our products infringe, or may infringe, the proprietary rights of
these third parties. These claims of infringement may result in protracted and
costly litigation that could require us to pay substantial damages or have sales
of our products stopped by an injunction. Infringement claims could also cause
product shipment delays, require us to redesign our products or require us to
enter into royalty or licensing agreements, any of which could harm our
business. For example, we received communications alleging that our FlashPath
products infringed a third party's patent rights. We have met with this third
party, a non-public limited liability company, to gain a better understanding of
its claim and attempted to resolve the dispute through mediation. Such mediation
did not yield a resolution to the dispute and such party subsequently filed a
complaint in the Central District Federal Court of the State of California (See
Part II, Item 1. "Legal


                                       25
<PAGE>

Proceedings"). While we believe that we do not infringe upon this third party's
patent and that such claim is wholly without merit, we cannot guarantee that the
effects or outcome of this litigation will be favorable to SmartDisk. We also
received correspondence alleging that our SafeBoot product violated another
third party's intellectual property rights. We discussed this correspondence
with counsel and concluded that our product does not infringe upon the third
party's rights. In addition, we license a portion of the intellectual property
included in our products from third parties, which may increase our exposure to
infringement actions because we rely upon those third parties for information
about the origin and ownership of the licensed intellectual property. We may
also lose our license rights with respect to the intellectual property for which
infringement is claimed. Further, if our customers are required to obtain a
license on other than commercially reasonable terms, our business could be
jeopardized.

We have indemnification obligations related to our intellectual property, which
may require us to pay damages.

         Our arrangements with Fuji Photo USA, Iomega, SanDisk, Sony, Toshiba
and others require us to indemnify them for any damages they may suffer if a
third party claims that we are violating their intellectual property rights.
While, to date, we have not received indemnification claims, there may be future
claims. For example, Fuji Photo USA has been named as a co-defendant in the
above referenced complaint filed in the Central District Federal Court of the
State of California. SmartDisk has agreed to indemnify Fuji Photo USA with
respect to expenses or damages incurred by Fuji Photo USA in connection with
this matter. Any indemnification claim may require us to pay substantial
damages, which could negatively impact our financial condition.

We may have particular difficulty protecting our intellectual property rights
overseas.

         The laws of some foreign countries do not protect proprietary rights to
as great an extent as do the laws of the United States, and many U.S. companies
have encountered substantial infringement problems in some foreign countries.
Because many of our products are sold and a portion of our business is conducted
overseas, primarily Japan and Europe, our exposure to intellectual property
risks may be higher.

Because most of our sales are to a relatively small number of customers the loss
of any of our key customers would seriously harm our business.

         Our business will be seriously harmed if we lose any of our significant
customers, particularly Apple, FujiFilm, Ingram Micro, Olympus, or Sony, or
suffer a substantial reduction in or cancellation of orders from these
customers. Our current distribution strategy results, and will continue to
result, in sales to only a limited number of customers. Some of our products are
sold as stand-alone products by OEMs and, to a lesser extent, are bundled
together and sold with systems manufactured by third party OEMs. For the first
nine months of 2000, our top five customers collectively accounted for
approximately 54% of our revenues. Furthermore, we expect to continue to depend
on sales of our products to relatively few customers, which will continue to
account for a significant portion of our net revenues, for the foreseeable
future.

                                       26
<PAGE>

Since we sell our products to a limited number of large customers, we expect
that those customers may pressure us to make price concessions, which would
reduce our future gross margins.

         Our reliance on sales to a limited number of large customers may expose
us to pressure for price concessions. Because of this reliance and because of
our dependence on OEMs as our primary distribution channel, we expect that our
OEM customers may seek price concessions from us, which would reduce our average
selling prices and our gross margins. Since we do not manufacture our own
products, we may be unable to reduce our manufacturing costs in response to
declining average per unit selling prices.

Our customers could stop purchasing our products at any time because we do not
have long-term purchase contracts with them.

         No OEM or other customer is contractually obligated to purchase
products from us. As a result, our customers are free to cancel their orders or
stop ordering our products at any time. In addition, even if we are able to
demonstrate that our products are superior, OEMs may still choose not to bundle
our products with theirs or market and distribute our products on a stand-alone
basis. OEMs may also change their business strategies and manufacturing
practices, which could cause them to purchase fewer of our products, find other
sources for products we currently manufacture or manufacture these products
internally.

Our ability to sell our products will be limited if the OEMs' products do not
achieve market acceptance or if the OEMs do not adequately promote our products.

         We depend upon our OEM customers to market our products and we do not
have significant experience and resources devoted to independent marketing
efforts. Failure of the OEMs' products to achieve market acceptance, the failure
of the OEMs to bundle our products with theirs, or any other event causing a
decline in our sales to the OEMs could seriously harm our business. Even if
consumers buy OEMs' products, their ultimate decision to buy our products
depends on OEM packaging, distribution and sales efforts, which may not be
sufficient to maintain or increase sales of our products. If we cannot achieve
or maintain a sufficient consumer acceptance rate of our products concurrent
with their purchases of OEM products, our future sales to OEM customers will be
adversely affected.

A new or competing data transfer solution that achieves significant market share
or receives significant support from flash memory card or digital appliance
manufacturers would jeopardize our business.

         Our products currently compete with a number of cable and non-cable
interfaces between personal computers and digital appliances, including ports,
PCMCIA slots and infrared interfaces, all of which are PC peripheral interfaces.
It is possible that one of these competing data transfer solutions, or another
existing or new technology, could achieve a significant market presence or
become supported by a number of significant flash memory card or digital
appliance manufacturers. Regardless of the relative benefits of our products, if
a competing product gains significant market share or significant support of
flash card manufacturers, this product would


                                       27
<PAGE>

likely emerge as the industry standard and thereby achieve a dominant market
position that would jeopardize our survival.

We expect to continue outsourcing key operational functions and our ability to
do so will be impaired if we are unable to maintain our strategic relationships.

         We have formed strategic relationships with a number of significant
industry participants, including Apple, FujiFilm, Hitachi, Iomega, Olympus,
Rohm, SanDisk, Sony, Toshiba, Visa and Yamaichi. We depend upon these
corporations to provide technical assistance and perform key manufacturing,
marketing, distribution and other functions. For example, Yamaichi is currently
one of two manufacturers of our FlashPath products, Toshiba and Apple provide
technological assistance in the development of our products, and Olympus and
FujiFilm market our products. We expect that these and similar types of
relationships will be critical to our growth because our business model calls
for the continued outsourcing of many key operational functions and we do not
currently have the resources to perform these functions ourselves.

We must overcome geographic and cultural differences in order to maintain our
strategic relationships.

         There are inherent difficulties in developing and maintaining
relationships with foreign entities. Language and cultural differences often
impair relationships, and geographical distance, at times, is also an
impediment. If any of our current relationships is impaired, or if we are unable
to develop additional strategic relationships in the future, our product
development costs would significantly increase and our business would be
materially and adversely affected.

A portion of our sales and expenses are geographically concentrated in Japan,
and, therefore, we could suffer from exchange rate fluctuations and economic and
political difficulties.

         Approximately 34% of our revenues for the first nine months of 2000
were attributable to sales to Japanese customers, and we expect that sales to
Japanese customers will continue to account for a significant portion of our
total revenues for the foreseeable future. All of our Japanese sales, as well as
the related expenses, are denominated in Japanese yen. Fluctuations in exchange
rates between the yen and the U.S. dollar, particularly with respect to Japanese
transactions denominated in a currency other than the yen, could adversely
impact our financial results. Some transactions and accounts of our Japanese and
European subsidiary are U.S. dollar denominated. Since the foreign subsidiaries'
accounting records are kept in local currency, those U.S. dollar denominated
transactions are accounted for using the local currency at the time of the
transaction. U.S. dollar denominated accounts are remeasured at the end of the
accounting period. This remeasurement results in adjustments to income. In
addition, the balance sheet accounts of our foreign subsidiaries are translated
to the U.S. dollar for financial reporting purposes and resulting adjustments
are made to stockholders equity. The value of the Japanese yen and the British
pound may deteriorate against the dollar, which would impair the value of
stockholders' investment in us. Fluctuations in the value of the Japanese yen
and the British pound against the dollar have occurred in 2000, resulting in a
foreign currency gain of approximately $101,000 and a foreign currency
translation adjustment to reduce equity for approximately $139,000. Further, we
do not currently hedge against foreign currency exposure.


                                       28
<PAGE>

In the future, we could be required to denominate our product sales in other
currencies, which would make the management of currency fluctuations more
difficult and expose us to greater currency risks.

Our foreign OEM customers may choose to work with a local competitor, which
would adversely impact our sales.

         Our OEM customers, most of which are based in Japan and to whom a
significant portion of our sales are made, may choose to work with, and purchase
products from, a local competitor if one were able to provide a substitute
product. This may occur because of geographic distance, time differences, or for
other reasons. In that event, we may not be able to find other OEM customers and
our sales could decline.

We depend on a limited number of contract and offshore manufacturers, and it may
be difficult to find replacement manufacturers if our existing relationships are
impaired.

         We contract with offshore manufacturers to produce some of our products
and our dependence on a limited number of contract manufacturers exposes us to a
variety of risks, including shortages of manufacturing capacity, reduced control
over delivery schedules, quality assurance, production yield and costs. For
example, Yamaichi and Mitsumi are the sole manufacturers of our FlashPath
products. We do not have contracts with Yamaichi or Mitsumi. If Yamaichi or
Mitsumi terminates production, or cannot meet our production requirements, we
may have to rely on other contract manufacturing sources or identify and qualify
new contract manufacturers. The lead-time required to qualify a new manufacturer
could range from approximately three to six months. Despite efforts to do so, we
may not be able to identify or qualify new contract manufacturers in a timely
manner and these new manufacturers may not allocate sufficient capacity to us in
order to meet our requirements. Any significant delay in our ability to obtain
adequate quantities of our products from our current or alternative contract
manufacturers would cause our sales to decline.

Toshiba introduced us to one of our manufacturers and we may not be able to
retain the services of the manufacturer if our relationship with Toshiba is
impaired.

         Yamaichi, one of the manufacturers of our FlashPath products, was
introduced to us by Toshiba, which is one of our major stockholders. If our
relationship with Toshiba is impaired, we may not be able to retain the services
of Yamaichi in manufacturing our products.

Our dependence on foreign manufacturing and international sales exposes us to
difficulties often not encountered by exclusively domestic companies.

         Many of our products are manufactured overseas and a significant
portion of our revenues is derived from overseas sales. Approximately 36% of our
revenues for the first nine months of 2000 were derived from customers located
outside the United States, primarily in Japan. Our dependence on foreign
manufacturers and international sales poses a number of risks, including:

         o        Difficulties in monitoring production;


                                       29
<PAGE>

         o        Transportation delays and interruptions;

         o        Unexpected changes in regulatory requirements;

         o        Currency exchange risks;

         o        Tariffs and other trade barriers, including import and export
                  restrictions;

         o        Difficulties in staffing and managing disparate branch
                  operations;

         o        Political or economic instability;

         o        Compliance with foreign laws;

         o        Difficulties in protecting intellectual property rights in
                  foreign countries;

         o        Exchange controls; and

         o        Potential adverse tax consequences, including with respect to
                  repatriation of earnings.

         We intend to continue manufacturing our products overseas and we
anticipate that international sales will continue to account for a significant
portion of our revenues. Therefore, we expect to be subject to the risks
outlined above for the foreseeable future.

We have a limited number of suppliers of key components and our ability to
produce finished products will be impaired if we are unable to obtain sufficient
quantities of some components.

         Rohm is our sole provider of application specific integrated circuits,
or ASICs, for our FlashPath products and we purchase ASICs for Smarty from Rohm
and Atmel. In our products, the specific function of these integrated circuits
is the conversion of digital and analog data. In addition, Iomega is a sole
source supplier of Zip drives, and LSI Logic is our primary supplier of ASICs
for our FireWire products. Our dependence on a limited number of suppliers and
our lack of long-term supply contracts exposes us to several risks, including a
potential inability to obtain an adequate supply of components, price increases,
late deliveries and poor component quality. Disruption or termination of the
supply of components could delay shipments of our products. The lead-time
required for orders of some of our components is as much as six months. In
addition, the lead-time required to qualify new suppliers for our components is
as much as 12 months. If we are unable to accurately predict our component
needs, or if our component supply is disrupted, we may miss market opportunities
by not being able to meet the demand for our products. This may damage our
relationships with current and prospective customers.

Our current and potential competitors have significantly greater resources than
we do, and increased competition could harm sales of our products.

         Increased competition is likely to result in price reductions, reduced
operating margins and loss of market share. Many of our current and potential
competitors have significantly greater financial, technical, marketing,
purchasing and other resources than we do. As a result, our competitors may be
able to respond more quickly to new or emerging technologies or standards


                                       30
<PAGE>

and to changes in customer requirements. Our competitors may also be able to
devote greater resources to the development, promotion and sale of products, and
may be able to deliver competitive products at a lower end-user price. Current
and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of our prospective customers. Therefore, it
is possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.

Our business may suffer if we are unable to manage our growth.

         Failure to effectively manage our growth could impair our ability to
execute our business strategy. Our business has grown substantially in recent
periods, with revenues increasing from approximately $15.3 million in 1998 to
approximately $81 million for the first nine months of 2000. The growth of our
business has placed a strain on our management, operations and financial
systems. In addition, the number of employees has increased from 16 at January
1, 1998 to 133 as of September 30, 2000. We expect to continue to increase the
number of employees as our business grows, and may expand operations to
locations other than those in which we currently operate.

         Continued growth is likely to place a greater burden on our operating
and financial systems as well as our senior management and other personnel.
Existing and new members of management may not be able to improve existing
systems and controls or implement new systems and controls in response to
anticipated growth. Management of our operations in diverse locations may also
complicate the task of managing our growth.

We may not be able to integrate the business of companies we acquire and
therefore these acquisitions may not provide additional value to our
stockholders.

         We continually evaluate potential acquisitions of complementary
businesses, products and technologies. We acquired VST Technologies, Inc., based
in Acton, Massachusetts, in March 2000. We may not realize the desired benefits
of this transaction or of future transactions. In order to successfully
integrate acquired companies we must, among other things:

         o        Continue to attract and retain key management and other
                  personnel;

         o        Integrate the acquired products from both an engineering and
                  sales and marketing prospective;

         o        Establish a common corporate culture; and

         o        Integrate geographically distant facilities, systems and
                  employees.

         If our management's attention to day-to-day operations is diverted to
integrating acquired companies or if problems in the integration process arise,
our business could be adversely affected and we could be required to use a
significant portion of our available cash. If an acquisition is made utilizing
our securities, a significant dilution to our stockholders and significant
acquisition related charges to earnings could occur.

                                       31
<PAGE>

         Our acquisition of VST was dilutive and we expect that our earnings per
share will remain negative for the foreseeable future as a result of the VST
acquisition. We may incur additional charges in the future resulting from
redundancies in product lines, customer lists and sales channels associated with
these acquisitions. Acquisitions may also cause us to incur or assume additional
liabilities or indebtedness, including liabilities that are unknown or not fully
known to us at the time of the acquisition, which could have an adverse effect
on us. Furthermore, we cannot assure that any products we acquire in connection
with any acquisition will gain acceptance in our markets.

Some of our products may be returned to us by our OEM customers if projected
consumer demand does not materialize, which would lead to a reduction in our
revenues.

         Lack of consumer demand for our products may result in efforts by OEMs
to return products to us. While we are contractually obligated to accept
returned products from our OEMs only on a limited basis, we may determine that
it is in our best interest to accept returns in order to maintain good relations
with them. Product returns would reduce our revenues. While we have experienced
very limited product returns to date, returns may increase in the future.

We could be held liable for product defects, which could require us to pay
substantial damages and harm our reputation with our customers.

         Complex products such as ours can contain errors, defects and bugs when
first introduced or as new versions are released. Delivery of products with
production defects or reliability, quality or compatibility problems could
hinder market acceptance of our products, which could damage our reputation and
harm our ability to attract and retain customers. Errors, defects or bugs could
also cause interruption, delays or a cessation of sales to our customers, and
could subject us to warranty claims from our customers. We would have to expend
significant capital and resources to remedy these problems. Errors, defects or
bugs could be discovered in our new products after we begin commercial
production of them, despite testing by us and our suppliers and customers. This
could result in additional development costs, loss of, or delays in, market
acceptance, diversion of technical and other resources from our other
development efforts, claims by our customers or others against us or the loss of
credibility with our current and prospective customers.

Our management team has only recently been assembled and may not be able to work
together as a cohesive unit.

         Our Chief Financial Officer, Senior Vice President, Japanese
Operations, Vice President, Corporate Development and Legal Affairs, and Vice
President, Audio/Video Products, all joined us during 1999 and our Chief
Technology Officer and Senior Vice President and General Manager, Personal
Storage Systems, joined us in March 2000. There is the possibility that our
management team may not be able to work together as a cohesive unit.

                                       32
<PAGE>

Our executive officers and key personnel are critical to our business, and these
officers and personnel may not remain with us in the future.

         We depend upon the continuing contributions of our key management,
sales and product development personnel. The loss of any of those personnel
could seriously harm us. Although some of our officers are subject to employment
agreements, we cannot be sure that we will retain their services. In addition,
we have not obtained key-person life insurance on any of our executive officers
or key employees.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

         Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. The primary objective of
our investment activities is to preserve our invested funds while at the same
time maximizing the income we receive from our investments without significantly
increasing risk. Some of the securities that we have invested in may be subject
to market risk. This means that a change in prevailing interest rates may cause
the principal amount of the investment to fluctuate. To minimize this risk, we
maintain our portfolio of short-term investments in a variety of securities
including government and government agency notes, corporate bonds and notes and
asset-backed securities with contractual maturities of less than two years. Our
investment portfolio includes only marketable securities with active secondary
or resale markets to ensure portfolio liquidity. We do not expect any material
loss from our marketable security investments and, therefore, believe that our
potential interest rate exposure is not material.

         All of our short-term investments are fixed rate instruments. The
aggregate fair value of our short-term investments as of September 30, 2000 is
approximately $12.8 million. The weighted average interest rate of our
short-term investments is 6.43%.

         We do not currently hold or issue derivative securities, derivative
commodity instruments or other financial instruments for trading purposes.

         Foreign Exchange Risk. We conduct operations and sell products in
several different countries. Therefore, our operating results may be impacted by
the fluctuating exchange rates of foreign currencies, especially the Japanese
yen and the British pound, in relation to the United States dollar. Most of the
revenue and expense items of our Japanese and European subsidiaries are
denominated in the respective local currency. In both regions, we believe this
serves as a natural hedge against exchange rate fluctuations because although an
unfavorable change in the exchange rate of the foreign currency against the U.S.
dollar will result in lower revenues when translated into U.S. dollars,
operating expenses will also be lower in these circumstances.

          While most of the transactions of our United States, Japanese and
European operations are denominated in the respective local currency, some
transactions are denominated in other currencies. Since the accounting records
of our foreign operations are kept in the respective local currency, any
transactions denominated in other currencies are accounted for in the respective
local currency at the time of the transaction. Upon settlement of such a
transaction, any foreign currency gain or loss results in an adjustment to
income.

                                       33
<PAGE>

         Some balance sheet accounts of our U.S., Japanese and European
operations are denominated in currencies other than the respective local
currency and are remeasured to the respective local currency at the end of the
accounting period. This remeasurement also results in an adjustment to income.
Additionally, the balance sheet accounts of our Japanese and European operations
are translated to U.S. dollars for financial reporting purposes and resulting
adjustments are made to stockholders' equity. The value of the respective local
currency may strengthen or weaken against the U.S. dollar, which would impact
the value of stockholders' investment in our common stock. Fluctuations in the
value of the Japanese yen and the British pound against the U.S. dollar have
occurred in 2000, resulting in a foreign currency gain of approximately
$101,000. In addition, such fluctuations resulted in a foreign currency
translation loss of approximately $139,000, which is included in accumulated
other comprehensive income and shown in the equity section of our balance sheet.

         We do not currently engage in hedging activities with respect to our
foreign currency exposure; however, we continually monitor our exposure to
currency fluctuations. We have not incurred significant realized losses on
exchange transactions. If realized losses on foreign transactions were to become
significant, we would evaluate appropriate strategies, including the possible
use of foreign exchange contracts, to reduce such losses.

PART II.      OTHER INFORMATION

Item 1. Legal Proceedings

         A complaint was filed on June 26, 2000 in the Central District Federal
Court of the State of California by a party alleging our infringement of said
party's patent. We consider this claim, filed by a non-public limited liability
company, to be wholly without merit. We will vigorously defend against such
claim and seek compensation from claimant for fees and costs incurred in such
defense. See "Risk Factors--Infringement claims by third parties could result in
costly litigation and otherwise adversely impact our business."

Item 2. Changes in Securities and Use of Proceeds

         Between January 1, 2000 and September 30, 2000, we issued approximately
185,000 shares of common stock to employees, directors and consultants. Such
shares were issued upon exercise of stock options with exercise prices ranging
from $0.72 to $35.00 per share. All of such shares were purchased by cash except
Timothy Tomlinson, one of our directors, paid the par value in cash and the
balance by delivery of a full recourse promissory note in the principal amount
of $209,994.

         On March 6, 2000, we sold approximately 1,073,000 shares of common
stock to the stockholders of VST Technologies, Inc. as partial consideration for
the exchange of all of the outstanding capital stock of VST.

                                       34
<PAGE>

         On April 21, 2000, we sold approximately 37,000 shares of common stock
to the stockholders of El Gato Software LLC as partial consideration for the
acquisition of substantially all of the intellectual property of El Gato.

         On April 28, 2000, we sold approximately 125,000 shares of common stock
to the stockholders Impleo Limited as partial consideration for the acquisition
of all the capital stock of Impleo.

         The sale of the above securities was deemed to be exempt from
registration under the Securities Act in reliance upon Section 4(2) of the
Securities Act or Rule 701 promulgated under Section 3(b) of the Securities Act
as transactions by an issuer not involving any public offering or transactions
pursuant to compensation benefit plans and contracts relating to compensation as
provided under such Rule 701. The recipients of securities in each such
transaction represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof, and appropriate legends were affixed to the share
certificates issued in such transactions. All recipients had adequate access,
through their relationships with us, to information about us.

         On October 6, 1999, we completed our initial public offering. The
shares of common stock sold in the initial public offering were registered under
the Securities Act of 1933, as amended on a registration statement on Form S-1
(No. 333-82793). The Securities and Exchange Commission declared the
registration statement effective on October 5, 1999. We realized net proceeds of
approximately $39.1 million from the sale of 3,450,000 shares of common stock
(including 450,000 shares issued upon the exercise of the underwriters' over
allotment option) at an initial public offering price of $13.00 per share after
deducting underwriting discounts and commissions of approximately $3.1 million
and offering expenses of approximately $2.6 million.

         Upon the completion of our initial public offering, the 2,487,500
outstanding shares of redeemable common stock converted into nonredeemable
common stock.

         The net proceeds from our initial public offering have been invested in
cash, cash equivalents and short-term investments. In March 2000, in connection
with the acquisition of VST, we paid a total of approximately $18.2 million in
purchase consideration and other acquisition related costs. In March 2000, we
also paid-down a line of credit that VST maintained which had an outstanding
balance of approximately $4.3 million. To date, we have funded VST's operations
with approximately $5.0 million. We also paid approximately $0.8 million for the
acquisition of substantially all of the intellectual property of El Gato. We
plan to use the remaining net initial public offering proceeds for general
corporate purposes, including working capital and capital expenditures, as well
as potential acquisitions of technology and businesses. The use of the proceeds
from the initial public offering does not represent a material change in the use
of proceeds described in our prospectus dated October 5, 1999.

         We believe our cash and cash equivalents, short-term investments,
credit facility and the net proceeds of the initial public offering, will be
sufficient to meet our working capital and anticipated capital expenditure needs
for at least the next 12 months. We may need to raise additional capital if we
expand more rapidly than initially planned, to develop new or enhanced


                                       35
<PAGE>

products and/or services, to respond to competitive pressures or to acquire
complementary products, businesses or technologies. The capital, if needed, may
not be available or may not be available on terms acceptable to us.

Item 6. Exhibits and Reports on Form 8-K

         (a)      Exhibits:

       Exhibit No.     Description
       -----------     --------------------------------------------------------
           27          Financial Data Schedule (available in EDGAR format only)


         (b)      Reports on Form 8-K:

         None.

                                       36
<PAGE>

                                   SIGNATURES

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

                          SMARTDISK CORPORATION



                          By: /s/ Michael S. Battaglia
                              --------------------------------------------------
                               Michael S. Battaglia
                               President and Chief Executive Officer
                               (Principal Executive Officer)



                          By: /s/ Michael R. Mattingly
                              --------------------------------------------------
                               Michael R. Mattingly
                               Chief Financial Officer
                               (Principal Financial and Accounting Officer)




Dated:    November 13, 2000

                                       37
<PAGE>

                                 EXHIBIT INDEX

       Exhibit No.     Description
       -----------     -----------------------
           27          Financial Data Schedule