<PAGE>

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                                 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, 2001

                                       OR

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

    For the transition period from         to

                       Commission File Number: 000-27257

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

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

<TABLE>
<S>                                            <C>
                  Delaware                                       65-0733580
       (State or other jurisdiction of                       (I.R. S. Employer
       incorporation or organization)                       Identification No.)
</TABLE>

                 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, 2001, there were 17,739,817 shares of the Registrant's
Common Stock outstanding, par value $0.001.

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

                             SMARTDISK CORPORATION

                                     INDEX

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
 <C>      <S>                                                             <C>
 PART I.  FINANCIAL INFORMATION
 Item 1.  Financial Statements..........................................    3
          1) Condensed Consolidated Balance Sheets
          as of December 31, 2000 and September 30, 2001................    3
          2) Condensed Consolidated Statements of Operations
          for the three and nine months ended September 30, 2000 and
          2001..........................................................    4
          3) Condensed Consolidated Statements of Cash Flows
          for the nine months ended September 30, 2000 and 2001.........    5
          4) Notes to Condensed Consolidated Financial Statements.......    6
 Item 2.  Management's Discussion and Analysis of Financial Condition
          and Results of Operations.....................................   10
 Item 3.  Quantitative and Qualitative Disclosure About Market Risk.....   26
 PART II. OTHER INFORMATION
 Item 1.  Legal Proceedings.............................................   28
 Item 2.  Changes in Securities and Use of Proceeds.....................   28
 Item 6.  Exhibits and Reports on Form 8-K..............................   28
 SIGNATURES..............................................................  29
</TABLE>

                                       2
<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,
                                                          2000         2001
                                                      ------------ -------------
                                                                    (Unaudited)
<S>                                                   <C>          <C>
ASSETS
Current assets:
  Cash and cash equivalents.........................    $ 12,833     $ 10,539
  Restricted cash...................................       1,671           --
  Short-term investments............................       6,001        5,600
  Accounts and notes receivable, net................       7,204        7,535
  Inventories.......................................      16,666        8,861
  Prepaid expenses and other current assets.........       3,262        2,377
                                                        --------     --------
    Total current assets............................      47,637       34,912
Property and equipment, net.........................       3,265        2,104
Goodwill and other intangible assets, net...........      75,098       10,522
Deposits and other assets...........................         309          261
                                                        --------     --------
TOTAL ASSETS........................................    $126,309     $ 47,799
                                                        ========     ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..................................    $  9,125     $  6,014
  Bank line of credit...............................       1,907          837
  Income taxes payable..............................         878          638
  Deferred revenue..................................         725           --
  Other accrued liabilities.........................       4,865        5,777
                                                        --------     --------
    Total current liabilities.......................      17,500       13,266
Deferred income taxes and other.....................       8,494        1,939
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; 17,596 issued and 17,509 outstanding at
 December 31, 2000; 17,835 issued and 17,740
 outstanding at September 30, 2001..................          18           18
Capital in excess of par value......................     146,388      146,700
Treasury stock, 87 shares at December 31, 2000 and
 95 shares at September 30, 2001, at cost...........         (89)         (94)
Accumulated other comprehensive income..............         315           89
Notes receivable from officers/employees............        (336)        (302)
Unearned compensation...............................          --           (8)
Accumulated deficit.................................     (45,981)    (113,809)
                                                        --------     --------
    Total stockholders' equity......................     100,315       32,594
                                                        --------     --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..........    $126,309     $ 47,799
                                                        ========     ========
</TABLE>

           See notes to condensed consolidated financial statements.

                                       3
<PAGE>

                             SMARTDISK CORPORATION
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                      Three Months Ended   Nine Months Ended
                                        September 30,        September 30,
                                      -------------------  -------------------
                                        2000      2001       2000      2001
                                      --------  ---------  --------  ---------
<S>                                   <C>       <C>        <C>       <C>
REVENUE
  Net product sales.................. $ 32,246  $  17,323  $ 79,278  $  54,363
  Research and development...........      --         --      1,209        100
  License fees and royalties.........      462        --        533        797
                                      --------  ---------  --------  ---------
    Total revenue....................   32,708     17,323    81,020     55,260
COST OF REVENUE......................   22,662     13,833    55,473     41,695
                                      --------  ---------  --------  ---------
GROSS PROFIT.........................   10,046      3,490    25,547     13,565
OPERATING EXPENSES
  Research and development...........    2,385      1,726     6,933      6,689
  Sales and marketing................    2,222      2,803     4,787      7,119
  General and administrative.........    3,280      3,436     8,345      9,428
  Amortization of goodwill and other
   acquisition related intangible
   assets............................    7,529      7,511    17,163     22,586
  Impairment of goodwill and other
   acquisition related intangible
   assets............................      --      42,003       --      42,003
                                      --------  ---------  --------  ---------
    Total operating expenses.........   15,416     57,479    37,228     87,825
                                      --------  ---------  --------  ---------
OPERATING LOSS.......................   (5,370)   (53,989)  (11,681)   (74,260)
Interest and other income (expense),
 net.................................      379       (288)    1,392        418
Interest expense.....................       (9)        (8)      (97)       (21)
                                      --------  ---------  --------  ---------
Net loss before income taxes.........   (5,000)   (54,285)  (10,386)   (73,863)
Income tax benefit...................   (1,088)    (3,022)   (1,700)    (6,035)
                                      --------  ---------  --------  ---------
NET LOSS............................. $ (3,912) $ (51,263) $ (8,686) $ (67,828)
                                      ========  =========  ========  =========
Loss per sharebasic and diluted...... $  (0.23) $   (2.91) $  (0.52) $   (3.88)
                                      ========  =========  ========  =========
Shares used in per share
 computation.........................   17,166     17,623    16,734     17,499
                                      ========  =========  ========  =========
</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,
                                                           -------------------
                                                             2000      2001
                                                           --------  ---------
<S>                                                        <C>       <C>
Cash flows from operating activities:
  Net loss................................................ $ (8,686) $ (67,828)
  Adjustments to reconcile net loss to
   net cash provided by (used in) operating activities:
    Depreciation and amortization.........................   19,067     24,460
    Impairment of goodwill and other acquisition related
     intangible assets....................................      --      42,003
    Provision for uncollectible accounts, sales returns
     and other credits....................................      221      1,222
    Provision for inventory obsolescence..................      847      2,250
    Deferred income taxes.................................   (3,891)    (6,551)
    (Gain) loss on disposal of fixed assets...............      (97)       401
    Other.................................................      (82)      (198)
    Changes in assets and liabilities:
      Accounts and notes receivable.......................   (3,308)    (1,553)
      Inventories.........................................     (200)     5,554
      Prepaid expenses and other current assets...........     (861)       884
      Deposits and other assets...........................      (68)        48
      Accounts payable....................................      724     (3,111)
      Income taxes payable................................     (858)      (240)
      Deferred revenue....................................      779       (725)
      Other accrued liabilities...........................      447        913
                                                           --------  ---------
Net cash provided by (used in) operating activities.......    4,034     (2,471)
Cash flows from investing activities:
  Purchases of property and equipment, net of disposals...   (1,446)      (804)
  Cash paid for acquisitions, net of cash acquired........  (18,221)       --
  Cash paid for intellectual property.....................     (778)      (250)
  Decrease in restricted cash.............................      --       1,671
  Purchases of short-term investments.....................   (9,116)    (5,600)
  Sales and maturities of short-term investments..........   22,960      6,007
                                                           --------  ---------
Net cash (used in) provided by investing activities.......   (6,601)     1,024
Cash flows from financing activities:
  Net repayments under lines of credit....................   (7,019)    (1,070)
  Collections on notes receivable from
   officers/employees.....................................       45         34
  Proceeds from exercise of stock options.................      242        207
  Proceeds from stock issued under ESPP...................      371         88
  Purchase of treasury stock..............................      --          (5)
                                                           --------  ---------
Net cash used in financing activities.....................   (6,361)      (746)
Effect of exchange rate fluctuations on cash..............       90       (101)
                                                           --------  ---------
Decrease in cash and cash equivalents.....................   (8,838)    (2,294)
Cash and cash equivalents at beginning of period..........   19,080     12,833
                                                           --------  ---------
Cash and cash equivalents at end of period................ $ 10,242  $  10,539
                                                           ========  =========
Significant non-cash activities:
  Issuance of common stock for intellectual property...... $    240  $     --
  Note receivable obtained for stock option exercise...... $    210  $     --
</TABLE>

           See notes to condensed consolidated financial statements.

                                       5
<PAGE>

                             SMARTDISK CORPORATION

             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

Note 1. Basis of Presentation

  The accompanying unaudited interim condensed consolidated financial
statements for SmartDisk Corporation ("SmartDisk" or the "Company") have been
prepared in accordance with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted. The preparation of financial statements in accordance
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities at the date of the financial statements and the
reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates. In the opinion of management, all
adjustments, including normal recurring accruals, considered necessary for a
fair presentation have been included. Certain amounts in prior year's
condensed consolidated financial statements have been reclassified to conform
to the current year's presentation. The reclassifications had no effect on
previously reported net income (loss) or stockholders' equity. Operating
results for the three and nine-month periods ended September 30, 2001 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2001.

  The balance sheet at December 31, 2000 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by accounting principles generally accepted in the
United States for complete financial statements.

  The unaudited interim condensed 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, 2000,
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:

<TABLE>
<CAPTION>
                                                      December 31, September 30,
                                                          2000         2001
                                                      ------------ -------------
                                                            (in thousands)
      <S>                                             <C>          <C>
      Finished goods.................................   $ 6,147       $6,053
      Raw materials..................................    10,519        2,808
                                                        -------       ------
      Total inventories..............................   $16,666       $8,861
                                                        =======       ======
</TABLE>

Note 3. Net Loss Per Share

  For the three months ended September 30, 2000 and 2001, potential common
shares totaling approximately 1,368,000 and 194,000, respectively, were
excluded from the computation of net loss per share because their effect was
anti-dilutive. For the nine months ended September 30, 2000 and 2001,
potential common shares totaling approximately 1,487,000 and 290,000,
respectively, were excluded from the computation of net loss per share because
their effect was anti-dilutive. Potential common shares include stock options
and shares of non-vested stock.

Note 4. Comprehensive Loss

  Other comprehensive income (loss) refers to revenue, expenses, gains, and
losses that under accounting principles generally accepted in the United
States are included in comprehensive loss but are excluded from net

                                       6
<PAGE>

loss as these amounts are recorded directly as an adjustment to stockholders'
equity, net of tax. SmartDisk's other comprehensive income (loss) is composed
of unrealized gains and losses on available-for-sale securities and foreign
currency translation adjustments. The following table sets forth the
computation of comprehensive loss for the periods indicated:

<TABLE>
<CAPTION>
                                             Three Months       Nine Months
                                                Ended              Ended
                                            September 30,      September 30,
                                           -----------------  -----------------
                                            2000      2001     2000      2001
                                           -------  --------  -------  --------
                                                    (in thousands)
<S>                                        <C>      <C>       <C>      <C>
Net loss.................................. $(3,912) $(51,263) $(8,686) $(67,828)
Other comprehensive income (loss):
 Unrealized gain (loss) on short-term
  investments, net of tax.................      34        (4)      30        (6)
 Foreign currency translation adjustment..     (82)      303     (139)     (220)
                                           -------  --------  -------  --------
Total comprehensive loss.................. $(3,960) $(50,964) $(8,795) $(68,054)
                                           =======  ========  =======  ========
</TABLE>

Note 5. Acquisitions

  On March 6, 2000, SmartDisk completed its acquisition of VST Technologies,
Inc. ("VST"), a Delaware corporation, located in Acton, Massachusetts, for
approximately $16.4 million in cash, 1.1 million shares of SmartDisk common
stock and options to acquire 443,000 shares of SmartDisk common stock. On
April 28, 2000, SmartDisk completed its acquisition of Impleo Limited
("Impleo"), a corporation established under the laws of the United Kingdom,
located in Wokingham, England, for approximately $200,000 in cash and 125,000
shares of SmartDisk common stock. These acquisitions were accounted for under
the purchase method of accounting. Thus, the interim condensed consolidated
financial statements for 2000 include the operating results of VST and Impleo
from the respective dates of acquisition.

Note 6. Impairment of Goodwill and Other Acquisition Related Intangible Assets

  The Company continually evaluates the recoverability of its long-lived
assets, such as goodwill and other acquisition related intangible assets, in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of. An impairment review is performed whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors considered important which could trigger an impairment
review include, but are not limited to, significant underperformance relative
to expected historical or projected future operating results, significant
changes in the manner of use of the acquired assets or the strategy for the
overall business, a significant decline in the stock price for a sustained
period, the market capitalization relative to net book value and significant
negative industry or economic trends which indicate that this trend may
continue for an indefinite period of time. If management determines that the
carrying value may not be recoverable based upon the existence of one or more
of the above indicators of impairment, any impairment measured is based on a
projected discounted cash flow method using a discount rate commensurate with
the risk inherent in the Company's current business model.

  Based on the impairment review performed for the quarter ended September 30,
2001, the Company recorded a $42.0 million impairment charge in the third
quarter to reduce goodwill and other acquisition related intangible assets
recorded in connection with the VST acquisition. The assumptions supporting
future cash flows, including the discount rate, were determined using
management's best estimates.

Note 7. Segment Information

  Based on its method of internal reporting, SmartDisk has two reportable
segments: Digital connectivity products and personal storage products. Digital
connectivity products primarily consist of the Company's FlashPath and
Universal Serial Bus ("USB") -based flash memory card readers. Personal
storage products primarily consist of the family of IEEE 1394 ("FireWire") bus
and USB-based storage products, which include high performance, portable hard
disk drives, optical disk drives and floppy disk drives for desktop and
notebook PCs.

                                       7
<PAGE>

  The following table presents information about the Company's reportable
segments:

<TABLE>
<CAPTION>
                                                 Three Months     Nine Months
                                                     Ended           Ended
                                                 September 30,   September 30,
                                                --------------- ---------------
                                                 2000    2001    2000    2001
                                                ------- ------- ------- -------
                                                        (in thousands)
<S>                                             <C>     <C>     <C>     <C>
Digital connectivity products:
 Revenue....................................... $11,975 $ 5,629 $36,414 $21,338
                                                ======= ======= ======= =======
 Gross profit.................................. $ 4,173 $ 1,924 $12,923 $ 6,713
                                                ======= ======= ======= =======
Personal storage products:
 Revenue....................................... $20,271 $11,694 $42,864 $33,025
                                                ======= ======= ======= =======
 Gross profit.................................. $ 5,556 $ 1,566 $11,027 $ 6,263
                                                ======= ======= ======= =======
Other:
 Revenue....................................... $   462 $    -- $ 1,742 $   897
                                                ======= ======= ======= =======
 Gross profit.................................. $   317 $    -- $ 1,597 $   589
                                                ======= ======= ======= =======
Total
 Revenue....................................... $32,708 $17,323 $81,020 $55,260
                                                ======= ======= ======= =======
 Gross profit.................................. $10,046 $ 3,490 $25,547 $13,565
                                                ======= ======= ======= =======
</TABLE>

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

Note 8. Facility Closing

  On May 31, 2001, the Company announced its intention to close its Acton,
Massachusetts facility and move those operations into its Naples, Florida
headquarters. In the connection with this closing, which was substantially
completed as of September 30, 2001, the Company recognized approximately $1.2
million and $1.7 million in expenses during the three and nine months ended
September 30, 2001, respectively. Total closing expenses are comprised of $0.6
million in severance costs recorded as operating expenses, approximately $0.6
million in lease cancellation costs recorded in general and administrative
expenses and approximately $0.5 in property and equipment writedowns recorded
in other expenses. The severance costs incurred in association with the
closing of the facility relate to the 20 employees whose positions were
eliminated.

Note 9. Recent Accounting Pronouncements

  Effective January 1, 2001, the Company adopted SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133, as amended,
establishes accounting and reporting standards for derivative instruments and
hedging activities and requires the Company to recognize all derivatives as
either assets or liabilities on the balance sheet at fair value. The
accounting for gains and losses from changes in the fair value of a derivative
instrument are recorded each period in current earnings or other comprehensive
income, depending on whether the derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. Historically, the
Company has not entered into derivative contracts either to hedge existing
risks or for speculative purposes. The adoption of SFAS No. 133 did not have a
material impact on the financial position, results of operations or cash flows
of the Company.

  In April 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue No.
00-25, Vendor Income Statement Characterization of Consideration Paid to a
Reseller of the Vendor's Products. EITF Issue No. 00-25 addresses whether
consideration from a vendor to a reseller is (a) an adjustment of the selling
prices of the vendor's products and, therefore, should be deducted from
revenue when recognized in the vendor's income statement or (b) a cost
incurred by the vendor for assets or services received from the reseller and,
therefore, should be included as a cost or expense when recognized in the
vendor's income statement. EITF Issue No. 00-25 is effective for the Company
for financial statements issued for fiscal years beginning after December 15,
2001, and interim periods within those fiscal years. The adoption of EITF
Issue No.00-25 is not expected to have a material impact on the Company's
financial position, results of operations or cash flows.

                                       8
<PAGE>

  In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30,
2001. SFAS No. 141 also specifies criteria intangible assets acquired in a
purchase method business combination must meet to be recognized and reported
apart from goodwill, noting that any purchase price allocable to an assembled
workforce may not be accounted for separately. The requirements of SFAS No.
141 are effective for any business combination accounted for by the purchase
method that is completed after June 30, 2001. Under SFAS No. 142, goodwill and
intangible assets with indefinite useful lives are no longer amortized, but
are reviewed annually, or more frequently if impairment indicators arise, for
impairment. SFAS No. 142 will also require that intangible assets with
definite useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. The amortization
provisions of SFAS No. 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and intangible assets acquired
prior to July 1, 2001, the amortization provisions of SFAS No. 142 are
effective upon adoption of SFAS No. 142. Companies are required to adopt SFAS
No. 142 in their fiscal year beginning after December 15, 2001 (i.e., January
1, 2002 for calendar year companies).

  Because of the extensive effort required to comply with the adoption of SFAS
No. 141 and SFAS No. 142, it is not practicable to reasonably estimate the
impact of adopting these Statements on the Company's financial statements at
the date of this report, including whether any transitional impairment losses
will be required to be recognized as the cumulative effect of a change in
accounting principle. However, for the three and nine months ended September
30, 2001, the Company recognized $3.1 million and $9.3 million of goodwill
amortization, respectively.

  In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of. SFAS No. 144 applies to all long-lived assets (including
discontinued operations) and consequently amends APB Opinion No. 30, Reporting
the Results of Operations, Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 144 develops one accounting model for long-lived assets
that are to be disposed of by sale. SFAS No. 144 requires that long-lived
assets that are to be disposed of by sale be measured at the lower of book
value or fair value less cost to sell. Additionally SFAS No. 144 expands the
scope of discontinued operations to include all components of an entity with
operations that (1) can be distinguished from the rest of the entity and (2)
will be eliminated from the ongoing operations of the entity in a disposal
transaction. SFAS No. 144 is effective for the Company for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years. The adoption of SFAS No. 144 is not
expected to have a material impact on the Company's financial position,
results of operations or cash flows.

Note 10. Contingencies

  The Company relies on a combination of patents, trademarks, copyright and
trade secret laws, confidentiality procedures and licensing arrangements to
protect its intellectual property rights. There can be no assurance that there
will not be any disputes regarding the Company's intellectual property rights.
Specifically, there can be no assurance that any patents held by the Company
will not be invalidated, that patents will be issued for any of the Company's
pending applications or that any claims allowed from existing or pending
patents will be of sufficient scope or strength or be issued in the primary
countries where the Company's products can be sold that will provide
meaningful protection or any commercial advantage to the Company.
Additionally, competitors of the Company may be able to design around the
Company's patents.

  On June 26, 2000, a party filed a complaint in the Central District Federal
Court of the State of California alleging SmartDisk's infringement of a
patent. On November 20, 2000, the Company prevailed in moving the venue for
such action from the State of California to the Middle District of Florida.
The Company considers this

                                       9
<PAGE>

claim to be wholly without merit and will vigorously defend against such
claim. Accordingly, the ultimate loss, if any, that may result cannot be
reasonably determined and, accordingly, no accrual for this matter has been
recorded as of September 30, 2001.

  On July 26, 2001, a securities class action suit was filed against
SmartDisk, the following executive officers and directors: Addison M. Fischer,
Michael S. Battaglia and Michael R. Mattingly, and the following underwriters
of SmartDisk's initial public offering: FleetBoston Robertson Stephens, Inc.
(formerly BancBoston Robertson Stephens, Inc.), Hambrecht & Quist LLC, and
U.S. Bancorp Piper Jaffray, Inc. The suit was filed in the United States
District Court for the Southern District of New York on behalf of all persons
who acquired SmartDisk securities between October 6, 1999 and December 6,
2000. The complaint charges defendants with violations of Sections 11,
12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the
Securities Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder), for
issuing a Registration Statement and Prospectus ("Prospectus") that contained
material misrepresentations and/or omissions. The complaint alleges that the
Prospectus was false and misleading because it failed to disclose (i) the
agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist
LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain investors to provide
them with significant amounts of restricted SmartDisk shares in the initial
public offering ("IPO") in exchange for excessive and undisclosed commissions;
and (ii) the agreements between FleetBoston Robertson Stephens, Inc.,
Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain
customers under which the underwriters would allocate shares in the IPO to
those customers in exchange for the customers' agreement to purchase SmartDisk
shares in the after-market at pre-determined prices. The complaint seeks an
undisclosed amount of damages, as well as attorney fees. SmartDisk considers
this claim, as it relates to the Company, to be wholly without merit and
SmartDisk will vigorously defend against such claim.

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
interim condensed consolidated financial statements and the notes thereto
included in Item 1 of this Quarterly Report.

  Certain statements 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 Exchange Act of 1934. Terminology such as "may," "will,"
"intend," "expect," "plan," "anticipate," "estimate," "believe," "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 revenue, costs, gross margins and
profitability; our intention to develop, market and introduce new products;
anticipated growth of digital appliances and technology industries;
anticipated trends in our businesses, including trends in the demand for
personal storage and 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 our 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 us on the date hereof. We make no commitment to
update or revise 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 in "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.

  All trade names referenced in this report are either trademarks or
registered trademarks of their respective holders.

                                      10
<PAGE>

Overview

  We design, develop, manufacture and market a range of consumer electronic
products and software solutions that are enabling the digital age and
simplifying the digital lifestyle. Our products help users transfer, store,
manage and share digital music, video, pictures and data. Our digital
connectivity products enable the easy and convenient sharing of information
stored on flash media cards between digital appliances and PCs. Our personal
storage products and related software are designed to provide an easy way to
store, organize and retrieve digital data on portable, high-speed, high-
capacity disk drives. Our innovative software offers consumers the ability to
create slideshows on CDs that combine their digital music, videos and pictures
and then to share them with others by using a standard DVD player and TV.

  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 Universal Serial Bus (USB). Our patented
FlashPath products allow consumers to use the familiar 3.5-inch floppy drive--
found on most PCs worldwide--to simplify the exchange of images and other
digital data between PCs and digital appliances. We market three FlashPath
products that support four different flash memory cards: the SanDisk
MultiMediaCard, the Sony Memory Stick, the Toshiba SmartMedia card and the
SanDisk, Toshiba and Matsushita Secure Digital (SD) Card. These flash memory
cards are used in various digital appliances including digital still cameras,
digital video cameras, digital audio players and personal digital assistants
made by a number of leading electronics manufacturers, including FujiFilm,
JVC, Olympus, Palm, Panasonic, Sanyo, Sharp, Sony and Toshiba. During the
third quarter, we introduced a new line of USB-based flash media readers that
enable quicker transfer of digital files to PCs that include photo editing and
management software. We believe that as consumers embrace the digital
lifestyle, the number of applications for flash memory cards will continue to
grow and their price per megabyte will continue to fall.

  Our FireWire- and USB-based personal storage products include high
performance, portable hard disk drives, optical disk drives (CD-R/W) and
floppy disk drives for desktop and notebook PCs. Substantially all of our
personal storage products are compatible with Windows and Macintosh operating
systems. We believe that the significant increase in data intensive digital
content, such as imaging, music and video has created the need for increased
digital personal storage. Our personal storage products and related software
enhance the user's ability to transfer, store, organize and retrieve digital
content. These products support very high data transfer rates and offer up to
100 Gigabytes of capacity. During the third quarter, we introduced FireFly,
the first in our new line of hard drives that pioneer higher capacity drives
in miniature size.

  As digital applications and appliances proliferate, users are demanding
software that will allow them to collect digital images and audio files from a
variety of sources, create media shows via the PC, and then display them
anywhere, using a PC, DVD or CD player. Our software solutions include our new
MVP software application, which enables consumers and businesses to create,
organize and use digital multimedia both with and away from the PC. We began
shipping MVP to retailers during the third quarter.

Results of Operations

  Revenue. Total revenue was approximately $17.3 million for the three months
ended September 30, 2001 compared to approximately $32.7 million for the three
months ended September 30, 2000. Total revenue was approximately $55.3 million
for the nine months ended September 30, 2001 compared to approximately $81.0
million for the nine months ended September 30, 2000. These decreases
primarily resulted from a decline in demand for our FlashPath products and
various personal storage products and a decline in R&D revenue.
Product revenue is recognized when title and risk of loss are transferred to
customers, which is generally at the time of shipment. We defer recognition of
revenue on shipments to certain distributors until the distributors have
resold the products. We record a provision for estimated product returns at
the time the related revenue is recognized on sales to certain resellers that
have rights of return. Product revenue at our Japanese subsidiary is
recognized upon acceptance by the customer.

                                      11
<PAGE>

  Revenue from the sale of digital connectivity products decreased from
approximately $12.0 million for the three months ended September 30, 2000 to
approximately $5.6 million for the three months ended September 30, 2001.
Product revenue from the sale of digital connectivity products decreased from
approximately $36.4 million for the nine months ended September 30, 2000 to
approximately $21.3 million for the nine months ended September 30, 2001.
These decreases were primarily attributable to 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. In addition, our revenue suffered as a result of
the continued weakness in the worldwide economy. Both of these factors are
contributing to the decline in sales of our FlashPath products. We expect this
trend to continue during the remainder of 2001, resulting in revenue from
digital connectivity products being lower than the 2000 revenue associated
with these products.

  Revenue from the sale of personal storage products decreased from
approximately $20.3 million for the three months ended September 30, 2000 to
approximately $11.7 million for the three months ended September 30, 2001.
Product revenue from the sale of personal storage products decreased from
approximately $42.9 million for the nine months ended September 30, 2000 to
approximately $33.0 million for the nine months ended September 30, 2001.
These decreases were primarily attributable to a decline in demand for our
USB- and FireWire-based products arising from the continued weakness in the
worldwide economy, as well as a decline in demand for expansion bay products
due to the redesign of Apple laptop computers, which no longer contain
expansion bay capabilities. In addition, we decreased the sale prices of
various personal storage products in order to stimulate market demand.

  Our research and development revenue is recognized upon final customer
acceptance of our work performed under the terms of the agreement. Our revenue
from research and development agreements was $0.1 million for the nine months
ended September 30, 2001 compared to approximately $1.2 million for the nine
months ended September 30, 2000.

  Our license fee and royalty revenue primarily consist of fees earned from a
license agreement on our SafeBoot intellectual property. This agreement ended
on June 30, 2001. As opportunities arise, we intend to enter into other
licensing agreements for our existing and future intellectual property.

  Cost of Revenue. Cost of revenue includes the purchased cost of product,
packaging, freight, scrap, and inventory write downs, as well as royalties for
some of our digital connectivity products and personal storage products. Cost
of revenue decreased to approximately $13.8 million for the three months ended
September 30, 2001 compared to approximately $22.7 million for the three
months ended September 30, 2000. Cost of revenue decreased to approximately
$41.7 million for the nine months ended September 30, 2001 compared to
approximately $55.5 million for the nine months ended September 30, 2000.
These decreases in cost were due primarily to lower sales volume of our
FlashPath products and certain personal storage products offset in part by
inventory writedowns of our aging legacy storage products.

  Gross Profit. Our gross profit for the three months ended September 30, 2001
decreased to approximately $3.5 million or 20% of total revenue, compared to
approximately $10.0 million or 31% of total revenue for the three months ended
September 30, 2000. Our gross profit for the nine months ended September 30,
2001 decreased to approximately $13.6 million or 25% of total revenue,
compared to approximately $25.5 million or 32% of total revenue for the nine
months ended September 30, 2000. These decreases in the amount of gross profit
are primarily attributable to a decline in demand for our FlashPath products,
various aging personal storage products with declining margins and the
decrease of research and development revenue along with inventory writedowns
of our aging legacy storage products.

  We currently expect our gross margin percentage to improve during upcoming
quarters through reduction in component purchasing costs through Asian
procurement, launches of new products with more cost effective designs and
conversion to Asian manufacturing from U.S.-based manufacturing of personal
storage products. We also expect our overall margin percentage to improve as
the product mix begins to include our software products.

                                      12
<PAGE>

  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 were approximately $1.7 million, or 10%
of total revenue, for the three months ended September 30, 2001 compared to
approximately $2.4 million, or 7% of total revenue, for the three months ended
September 30, 2000. Research and development expenses were approximately $6.7
million, or 12% of total revenue, for the nine months ended September 30, 2001
compared to approximately $6.9 million, or 9% of total revenue, for the nine
months ended September 30, 2000. These decreases were primarily attributable
to cost savings realized during the periods as a result of the closing of our
Acton, Massachusetts facility.

  Research and development expenses related to digital connectivity and
personal storage products were incurred to support the development of new
products as well as the maintenance and refresh of existing products. In
addition, research and development expenses were incurred in support of the
development of our MVP software product and our new line of hard disk drives.
We believe that the continued introduction of new products is important to our
growth and will require increases in research and development expenditures. We
expect that our research and development expenses will increase as we invest
in the development of software applications and new and refined digital
connectivity and personal storage products to conveniently transfer, store,
manage and share digital content.

  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, Japan and the United Kingdom. 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, 2001
increased by approximately $0.6 million and $2.3 million to approximately $2.8
million and $7.1 million compared to the three and nine months ended September
30, 2000, respectively. These increases were primarily attributable to the
inclusion of VST's results for the nine months ended September 30, 2001
compared to the period from March 6, 2000 to September 30, 2000 in the
preceding year. 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. These added products
require more catalog and magazine advertising than we have needed in the past
due to our OEM relationships. In addition, we have increased our sales and
marketing personnel to support the launch of new products and broadening of
our distribution into more traditional consumer electronic and mass retail
channels. We expect our sales and marketing expenses to increase in the future
as we continue to support new product introductions and retail distribution
initiatives.

  General and Administrative Expenses. General and administrative expenses
include the salaries and related expenses of our executive management,
finance, information systems, operations, 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 $3.4 million and $9.4 million for the three and
nine months ended September 30, 2001 compared to approximately $3.3 million
and $8.3 million for the three and nine months ended September 30, 2000,
respectively. The increase for the nine months ended September 30, 2001 is
primarily due to the inclusion of VST's results for the nine months ended
September 30, 2001 compared to the period from March 6, 2000 to September 30,
2000 in the preceding year, as well as, integration expenses associated with
the closing of our Acton, Massachusetts facility and the relocation of those
operations into our Naples, Florida headquarters. We expect our general and
administrative expenses to decrease as a result of the closing of our Acton,
Massachusetts facility.

  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

                                      13
<PAGE>

three and nine months ended September 30, 2001, amortization of goodwill and
other acquisition related intangible assets totaled approximately $7.5 million
and $22.6 million, respectively, compared to approximately $7.5 million and
$17.2 million for the three and nine months ended September 30, 2000,
respectively. The increase for the nine months ended September 30, 2001 is
attributable to the inclusion of the amortization associated with the
acquisitions of VST and Impleo for the nine months ended September 30, 2001
compared to the period from March 6, 2000 to September 30, 2000 for VST and
April 28, 2000 to September 30, 2000 for Impleo.

  Impairment of Goodwill and Other Acquisition Related Intangible Assets. We
continually evaluate the recoverability of our long-lived assets, such as
goodwill and other acquisition related intangible assets, in accordance with
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.
An impairment review is performed whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors considered
important which could trigger an impairment review include, but are not
limited to, significant underperformance relative to expected historical or
projected future operating results, significant changes in the manner of use
of the acquired assets or the strategy for the overall business, a significant
decline in the stock price for a sustained period, the market capitalization
relative to net book value and significant negative industry or economic
trends which indicate that this trend may continue for an indefinite period of
time. If we determine that the carrying value may not be recoverable based
upon the existence of one or more of the above indicators of impairment, any
impairment measured is based on a projected discounted cash flow method using
a discount rate commensurate with the risk inherent in our current business
model.

  Based on the impairment review performed for the quarter ended September 30,
2001, we recorded a $42.0 million impairment charge to reduce goodwill and
other acquisition related intangible assets recorded in connection with the
VST acquisition. The charge was determined based upon estimated discounted
future cash flows. The assumptions supporting future cash flows, including the
discount rate, were determined using our best estimates.

  Closing of Acton Facility. On May 31, 2001, we announced our intention to
close our Acton, Massachusetts facility and move those operations into our
Naples, Florida headquarters. This closing allows us to centralize our
operations and marketing and development efforts, improve operational
efficiencies and otherwise increase the effectiveness of our business. In
connection with this closing, which was substantially completed as of
September 30, 2001, we recognized approximately $1.2 million and $1.7 million
in expenses during the three and nine months ended September 30, 2001,
respectively. Total closing expenses are comprised of $0.6 million in
severance costs recorded as operating expenses, approximately $0.6 million in
lease cancellation costs recorded in general and administrative expenses and
approximately $0.5 in property and equipment writedowns recorded in other
expenses.

  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.

  Interest Expense. Interest expense is incurred on the bank line of credit in
Japan and the United Kingdom.

  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, 2001,
income tax expense totaled approximately $0.1 million and $0.5 million,
respectively. These amounts were offset by income tax benefits of
approximately $3.1 million and $6.5 resulting from amortization expense and
writedown of certain intangible assets related to the VST and Impleo
acquisitions. 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

  Cash and cash equivalents decreased to approximately $10.5 million at
September 30, 2001 from approximately $12.8 million at December 31, 2000. In
addition to cash and cash equivalents, we have approximately $5.6 million in
short-term investments.

                                      14
<PAGE>

  During the nine months ended September 30, 2001, we used approximately $2.5
million and $0.7 million in operating and financing activities, respectively,
offset in part by approximately $1.0 provided by investing activities.

  Net cash used in operating activities was approximately $2.5 million for the
nine months ended September 30, 2001 compared to cash provided by operating
activities of approximately $4.0 million for the nine months ended September
30, 2000. Our net loss of approximately $67.8 million included non-cash
charges of approximately $24.5 million for depreciation and amortization,
approximately $42.0 million for writedown of goodwill and other acquisition
related intangible assets and approximately $3.5 million for provisions for
uncollectible accounts, sales returns and other credits and inventory
obsolescence offset by a decrease in deferred income taxes of approximately
$6.6 million. We also used cash through changes in our operating assets and
liabilities. Our accounts payable decreased by approximately $3.1 million and
our accounts receivable increased by approximately $1.6 million. These amounts
were offset by a decrease in inventories of approximately $5.6 million and an
increase in other accrued liabilities of approximately $0.9 million. Our
accounts payable decreased primarily as a result of lower purchases of
inventory. Our accounts receivable increased due to an increase in revenue for
the three months ended September 30, 2001 compared to the three months ended
December 31, 2000. Our inventories decreased as a result of lower purchases of
inventory, the sale of inventory acquired in previous quarters and the
recording of inventory writedowns associated with our aging legacy storage
products.

  Net cash provided by investing activities was approximately $1.0 million for
the nine months ended September 30, 2001 compared to cash used in investing
activities of approximately $6.6 million for the nine months ended September
30, 2000. The most significant contributors of cash from investing activities
for the nine months ended September 30, 2001 were approximately $6.0 million
in connection with the sale of short-term investments and a decrease in
restricted cash of approximately $1.7 million. These amounts were partially
offset by purchases of short-term investments of approximately $5.6 million
and approximately $1.1 million primarily used for the acquisition of the
intellectual property of Multimedia Technology Center and equipment used in
research, development, operational and administrative activities.

  Net cash used in financing activities was approximately $0.7 million and
$6.4 million for the nine months ended September 30, 2001 and 2000,
respectively. Cash used in financing activities for the nine months ended
September 30, 2001 was primarily attributable to net repayments under our
lines of credit in Japan and the United Kingdom. During the nine months ended
September 30, 2000, we used approximately $4.3 million to pay off the line of
credit assumed as part of the acquisition of VST and $3.0 million to repay
credit facilities in Japan.

  We maintain a line of credit in the United States under which we may borrow
up to $5.0 million. Any amounts borrowed under this line of credit bear
interest at 2% over the 30-day LIBOR rate and are secured by certain short-
term investments. As of September 30, 2001, we had not borrowed against this
line of credit. This line of credit expires in April 2002, at which time we
plan to replace or renew it.

  As of September 30, 2001, our Japanese subsidiary had a line of credit with
a maximum borrowing capacity of approximately $0.8 million, which was secured
by accounts receivable of specified trade customers. The outstanding balance
under the line of credit was approximately $0.8 million as of September 30,
2001. The line of credit was renewed in October 2001 with a maximum borrowing
capacity of $0.4 million and expires in January 2002. The balance above the
maximum borrowing capacity is being paid on various specific dates through
January 2002. The interest rate on borrowings under the new credit facility is
1.875% per year.

  As of September 30, 2001, our UK subsidiary had a line of credit with a
maximum borrowing capacity of approximately $0.5 million. The credit facility
expires in November 2001. The interest rate on borrowings under the credit
facility is 1.5% over the 30-day LIBOR rate. As of September 30, 2001, no
amounts were outstanding under this line of credit. We hope to enter into a
new credit facility after the expiration of this line.

  We believe our cash and cash equivalents, short-term investments, credit
facilities and the remaining net proceeds of our initial public offering in
October 1999, 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

                                      15
<PAGE>

we expand more rapidly than currently 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.

Recent Accounting Pronouncements

  Effective January 1, 2001, we adopted SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133, as amended,
establishes accounting and reporting standards for derivative instruments and
hedging activities and requires we to recognize all derivatives as either
assets or liabilities on the balance sheet at fair value. The accounting for
gains and losses from changes in the fair value of a derivative instrument are
recorded each period in current earnings or other comprehensive income,
depending on whether the derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. Historically, we
have not entered into derivative contracts either to hedge existing risks or
for speculative purposes. The adoption of SFAS No. 133 did not have a material
impact on our financial position, results of operations or cash flows.

  In April 2001, the Emerging Issues Task Force (EITF) issued EITF Issue No.
00-25, Vendor Income Statement Characterization of Consideration Paid to a
Reseller of the Vendor's Products. EITF Issue No. 00-25 addresses whether
consideration from a vendor to a reseller is (a) an adjustment of the selling
prices of the vendor's products and, therefore, should be deducted from
revenue when recognized in the vendor's income statement or (b) a cost
incurred by the vendor for assets or services received from the reseller and,
therefore, should be included as a cost or expense when recognized in the
vendor's income statement. EITF Issue No. 00-25 is effective for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years. The adoption of EITF Issue No.00-25
is not expected to have a material impact on our financial position, results
of operations or cash flows.

  In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30,
2001. SFAS No. 141 also specifies criteria intangible assets acquired in a
purchase method business combination must meet to be recognized and reported
apart from goodwill, noting that any purchase price allocable to an assembled
workforce may not be accounted for separately. The requirements of SFAS No.
141 are effective for any business combination accounted for by the purchase
method that is completed after June 30, 2001. Under SFAS No. 142, goodwill and
intangible assets with indefinite useful lives are no longer amortized, but
are reviewed annually, or more frequently if impairment indicators arise, for
impairment. SFAS No. 142 will also require that intangible assets with
definite useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. The amortization
provisions of SFAS No. 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and intangible assets acquired
prior to July 1, 2001, the amortization provisions of SFAS No. 142 are
effective upon adoption of SFAS No. 142. Companies are required to adopt SFAS
No. 142 in their fiscal year beginning after December 15, 2001 (i.e., January
1, 2002 for calendar year companies).

  Because of the extensive effort needed to comply with adopting SFAS No. 141
and SFAS No. 142, it is not practicable to reasonably estimate the impact of
adopting these Statements on our financial statements at the date of this
report, including whether any transitional impairment losses will be required
to be recognized as the cumulative effect of a change in accounting principle.
However, for the three and nine months ended September 30, 2001, we recognized
$3.1 million and $9.3 million of goodwill amortization, respectively.

  In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of. SFAS No. 144 applies to all long-lived assets (including
discontinued operations) and consequently amends APB Opinion No. 30, Reporting
the Results of Operations, Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 144 develops one accounting model for long-lived assets
that are to be disposed of

                                      16
<PAGE>

by sale. SFAS No. 144 requires that long-lived assets that are to be disposed
of by sale be measured at the lower of book value or fair value less cost to
sell. Additionally SFAS No. 144 expands the scope of discontinued operations
to include all components of an entity with operations that (1) can be
distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS No. 144 is
effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. The adoption
of SFAS No. 144 is not expected to have a material impact on our financial
position, results of operations or cash flows.

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 quarters of 1999, we have incurred net
losses on a quarterly basis since inception. We had a net loss of
approximately $67.8 million for the nine months ended September 30, 2001,
primarily as a result of $58.1 million in after-tax amortization and writedown
of goodwill and other acquisition related intangible assets from the VST and
Impleo acquisitions. In addition, as of September 30, 2001, we had an
accumulated deficit of approximately $113.8 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.

Reduced consumer demand for our FlashPath products may have a significant
impact on our business.

  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. 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 continue to 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.

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 depends 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, FlashPath will be constrained by the inherent limitations of
the 3.5-inch disk drive. In that case, FlashPath would be less attractive to
consumers and our sales would decline.

  A reduction in the use of the 3.5-inch floppy disk drive by consumers and
manufacturers is contributing to the decrease 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 found
today in most PCs, a number of newer PC models 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 external data storage
disk drives, such as Zip drives, are reducing the need for the 3.5-inch floppy
diskette, which is contributing to the decrease in sales of our FlashPath
products. In the future, we will have to rely on our other products and
develop new products that use a different interface between personal computers
and digital appliances.

Our sales of digital connectivity products may also be harmed if a single
standard for flash memory cards emerges.

  We believe that demand for our flash memory connectivity products is also
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

                                      17
<PAGE>

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.

We may not be able to sell sufficient quantities of our personal storage
products 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 products 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 products.

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

  We embed conversion ASICs and integrated software drivers in the hard disk
drives we obtain from our suppliers, which enables our FireWire-based personal
storage products to be used with FireWire-equipped computers. We license this
technology and the firmware from LSI Logic, Texas Instruments and other
integrated circuit suppliers. If our suppliers of drives 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 products to support our business.

Most of our revenue is 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 products will continue to represent the most
substantial portion of our net revenue through 2001 and into 2002. A decline
in the price of or demand for these products as a result of competition,
technological 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. During the nine months ended September 30, 2001,
we derived approximately 77% of our product revenue from the sale of FlashPath
and USB- and FireWire-based personal storage products.

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. 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. These development activities will
require the investment of substantial resources before revenue is 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. Further, we may not be
able to recoup research and development expenditures if new products are not
widely commercially accepted.

                                      18
<PAGE>

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 SanDisk,
Sony and Toshiba, PC manufacturers, such as Apple, and consumer product OEMs,
such as Olympus and FujiFilm. If we cannot maintain our relationship with
these manufacturers 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 in our ability
to produce commercially viable products.

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 products. As a result of this collaborative relationship, we have
received a substantial portion of our historical revenue from direct sales to
Apple and Apple users. Moreover, we anticipate that a significant portion of
our product revenue 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 computer.
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 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
decline in demand for Apple products has contributed to the recent decline in
sales of our personal storage products. 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:

  . 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;

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

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

                                      19
<PAGE>

  . The timing and amount of research and development expenditures;

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

  . General business conditions in our markets in the United States, Japan
    and Europe, as well as general economic and political conditions;

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

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

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

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

  . 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 IPO, to October 31, 2001, the reported
last sale price for our common stock ranged from $1.40 to $65.13 per share. On
October 31, 2001, the reported last sale price of our common stock was $1.54
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 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 us. 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

                                      20
<PAGE>

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. On November 20, 2000, we prevailed in moving the venue
for such action from the State of California to the Middle District of
Florida. (See Part II, Item 1. "Legal 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. 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. We have 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.

Any settlement or claim awarded against us as a result of the securities class
action suit filed against us could negatively affect our operating results and
financial condition.

  On July 26, 2001, a securities class action suit was filed against us, the
following executive officers and directors: Addison M. Fischer, Michael S.
Battaglia and Michael R. Mattingly, and the following underwriters of our
initial public offering: FleetBoston Robertson Stephens, Inc. (formerly
BancBoston Robertson Stephens, Inc.), Hambrecht & Quist LLC, and U.S. Bancorp
Piper Jaffray, Inc. The suit was filed in the United States District Court for
the Southern District of New York on behalf of all persons who acquired our
common stock between October 6, 1999 and December 6, 2000. The complaint
charges defendants with violations of Sections 11, 12(a)(2) and 15 of the
Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of
1934 (and Rule 10b-5 promulgated thereunder), for issuing a registration
statement and prospectus that contained material misrepresentations and/or
omissions. The complaint alleges that the prospectus was false and misleading
because it failed to disclose (i) the agreements between FleetBoston Robertson
Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc.
and certain investors to provide them with significant amounts of restricted
SmartDisk shares in the IPO in exchange for excessive and undisclosed
commissions; and (ii) the agreements between FleetBoston Robertson Stephens,
Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain
customers under which the underwriters would allocate shares in the IPO to
those customers in exchange for the customers' agreement to purchase SmartDisk
shares in the after-market at pre-determined

                                      21
<PAGE>

prices. The complaint seeks an undisclosed amount of damages, as well as
attorney fees. We consider this claim, as it relates to SmartDisk, to be
wholly without merit and we will vigorously defend against such claim. Any
settlement or claim awarded against us as a result of the securities class
action suit filed against us could negatively affect our operating results and
financial condition.

  Recently, three additional class action suits were filed against one of the
underwriters in our initial public offering: FleetBoston Robertson Stephens,
Inc. The suits were also filed in the United States District Court for the
Southern District of New York on behalf of all persons who acquired our common
stock between October 6, 1999 and December 6, 2000. These complaints make
similar allegations that the registration statement and prospectus violate
section 10(b) of the Exchange Act and Rule 10b-5 as a result of the
undisclosed agreements between FleetBoston Robertson Stephens and certain
inventors and customers. The complaints seek an undisclosed amount of damages,
as well as attorney fees.

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 in sales to a limited
number of customers, which account for a significant portion of our net
revenue. 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. During the nine months ended September 30, 2001, Sony,
Apple, and Ingram Micro accounted for approximately 17%, 21% and 22% of our
revenue and our top five customers collectively accounted for approximately
68% of our revenue. We expect sales of our products to a limited number of
customers to account for a significant portion of our net revenue through
2001. However, we expect to reduce our reliance on a limited number of
customers for a large portion of our revenue by increasing our presence in the
retail channel through newly formed relationships with major retailers.

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 and distributors as a significant distribution channel, we
expect that they 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. We hope to reduce our reliance
on OEMs and distributors by increasing our presence in the retail channel
through newly formed relationships with major retailers.

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.

                                      22
<PAGE>

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 certain of our products. 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 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, personal storage 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 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, Mitsumi, Olympus, Sony,
Toshiba and Yamaichi. We depend upon these corporations to provide technical
assistance and perform key manufacturing, marketing, distribution and other
functions. For example, Yamaichi and Mitsumi currently manufacture some of our
products, Toshiba and Apple provide technological assistance in the
development of our products, and Sony, Olympus and FujiFilm market certain of
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 30% of our revenue for the nine months ended September 30,
2001 was 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 revenue 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

                                      23
<PAGE>

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 the nine months ended September 30, 2001, resulting in a foreign
currency gain of approximately $0.2 million and a foreign currency translation
adjustment to reduce equity for approximately $0.2 million. Further, we do not
currently hedge against foreign currency exposure. 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.

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 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 revenue is derived from overseas sales. Approximately 41% of our revenue
during the nine months ended September 30, 2001 was 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:

  . Difficulties in monitoring production;

  . Transportation delays and interruptions;

  . Unexpected changes in regulatory requirements;

  . Currency exchange risks;

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

  . Difficulties in staffing and managing disparate branch operations;

  . Political or economic instability;

  . Compliance with foreign laws;

  . Difficulties in protecting intellectual property rights in foreign
    countries;

  . Exchange controls; and

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

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<PAGE>

We intend to continue manufacturing our products overseas and we anticipate
that international sales will continue to account for a significant portion of
our revenue. 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. In our FlashPath products, the specific
function of these integrated circuits is the conversion of digital and analog
data. In addition, LSI Logic and Texas Instruments are our primary suppliers
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.

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

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 revenue increasing from approximately $15.3 million in 1998 to
approximately $96.7 million in 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 88 as of
October 31, 2001. 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 in March 2000 and Impleo in April
2000. We may not realize the desired benefits of these transactions or of
future transactions. In order to successfully integrate acquired companies we
must, among other things:

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

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

  . Establish a common corporate culture; and

  . Integrate geographically distant facilities, systems and employees.


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  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. Our acquisitions of VST and Impleo were dilutive and we expect
that our earnings per share will remain negative for the foreseeable future as
a result of these acquisitions, primarily due to the amortization of goodwill
and intangible assets recorded under the purchase method of accounting.

  We may incur additional charges in the future resulting from redundancies in
product lines, personnel and fixed assets associated with these acquisitions.
For instance, on May 31, 2001, we announced our intention to close our Acton,
Massachusetts facility and move those operations into our Naples, Florida
headquarters. This closing will allow us to centralize our operations and
marketing and development efforts, improve operational efficiencies and
otherwise increase the effectiveness of our business. In connection with this
closing, we recognized approximately $0.5 million in severance costs in the
quarter ended June 30, 2001. The closing is substantially complete as of
September 30, 2001. As a result, we incurred additional costs of approximately
$1.2 million during this quarter associated with employee separation costs,
excess facility costs and the disposal of fixed assets. 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.

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 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. For
example, if we hold a security that was issued with a fixed interest rate at
the then-prevailing rate and the prevailing interest rate later

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rises, the principal amount of our investment will probably decline in value.
If market interest rates were to increase immediately and uniformly by 10
percent from levels at September 30, 2001, this would not materially change
the fair market value of our portfolio. To minimize this risk, we maintain our
portfolio of cash equivalents and short-term investments in a variety of
securities including U.S. government and government agency notes, corporate
bonds and money market funds. In general, money market funds are not subject
to interest rate risk because the interest paid on such funds fluctuates with
the prevailing interest rate. Our investment portfolio includes marketable
securities with contractual maturities of less than one year and active
secondary or resale markets to ensure portfolio liquidity.

  The aggregate fair value of our short-term investments that were subject to
market risk as of September 30, 2001 was approximately $5.6 million with a
weighted-average interest rate of 3.54%.

  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. 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 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 2001, resulting in a realized foreign
currency gain of approximately $0.2 million for the nine months ended
September 30, 2001. In addition, such fluctuations resulted in an unrealized
foreign currency translation loss of approximately $0.2 million for the nine
months ended September 30, 2001, which is included in accumulated other
comprehensive income and shown in the equity section of our balance sheet.

  While most of the transactions of our U.S., 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.

  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 U.S. 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 revenue when translated into U.S. dollars, operating expenses will also
be lower in these circumstances. For example, during the nine months ended
September 30, 2001, a decrease in the Japanese yen to U.S. dollar conversion
rate of 10 percent would have resulted in a decrease in revenue of
approximately $1.5 million and a decrease in the operating loss of
approximately $0.1 million. A 10 percent adverse change in the British pound
against the U.S. dollar would not have a material effect on net loss before
income taxes.

  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.

  Intangible Asset Risk. At September 30, 2001, we believe our remaining
intangible assets are recoverable, however, changes in the economy, the
business in which we operate and our own relative performance could change the
assumptions used to evaluate intangible asset recoverability. We continue to
monitor those assumptions and their consequent effect on the estimated
recoverability of our intangible assets.

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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 that
party's patent. On November 20, 2000, we prevailed in moving the venue for
such action from the State of California to the Middle District of Florida. We
consider this claim to be wholly without merit. We intend to vigorously defend
against this claim. See "Factors That May Affect Future Results of Operations
Infringement claims by third parties could result in costly litigation and
otherwise adversely impact our business."

  On July 26, 2001, a securities class action suit was filed against us, the
following executive officers and directors: Addison M. Fischer, Michael S.
Battaglia and Michael R. Mattingly, and the following underwriters of our
initial public offering: FleetBoston Robertson Stephens, Inc. (formerly
BancBoston Robertson Stephens, Inc.), Hambrecht & Quist LLC, and U.S. Bancorp
Piper Jaffray, Inc. The suit was filed in the United States District Court for
the Southern District of New York on behalf of all persons who acquired our
common stock between October 6, 1999 and December 6, 2000. The complaint
charges defendants with violations of Sections 11, 12(a)(2) and 15 of the
Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of
1934 (and Rule 10b-5 promulgated thereunder), for issuing a registration
statement and prospectus that contained material misrepresentations and/or
omissions. The complaint alleges that the prospectus was false and misleading
because it failed to disclose (i) the agreements between FleetBoston Robertson
Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc.
and certain investors to provide them with significant amounts of restricted
SmartDisk shares in the IPO in exchange for excessive and undisclosed
commissions; and (ii) the agreements between FleetBoston Robertson Stephens,
Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain
customers under which the underwriters would allocate shares in the IPO to
those customers in exchange for the customers' agreement to purchase SmartDisk
shares in the after-market at pre-determined prices. The complaint seeks an
undisclosed amount of damages, as well as attorney fees. We consider this
claim, as it relates to SmartDisk, to be wholly without merit and we will
vigorously defend against such claim.

Item 2. Changes in Securities and Use of Proceeds

  On October 6, 1999, we completed our initial public offering of 3,450,000
shares of common stock from which we realized net proceeds of approximately
$39.1 million. These shares were registered under the Securities Act of 1933,
as amended, on a registration statement on Form S-1 (No. 333-82793), which the
Securities and Exchange Commission declared effective on October 5, 1999.

  Through September 30, 2001, we used approximately $19.0 million of the net
proceeds from the offering for the acquisitions of VST Technologies, Inc.,
Impleo Limited and the intellectual property of El Gato Software, LLC and
Multimedia Technology Center. In addition, we used $4.3 million to pay off
VST's outstanding line of credit and $10.2 million for the purchase of
equipment and funding of operations. The remaining $5.6 million has been
invested in short-term, interest-bearing, investment grade securities.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits:

  None.

(b) Reports on Form 8-K:

  No reports on Form 8-K were filed by the Company during the quarter ended
September 30, 2001.

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                                   SIGNATURES

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

                                          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 14, 2001

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