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 June 30, 2000

                                       OR

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

         For the transition period from _____________ to _____________.

                        COMMISSION FILE NUMBER: 000-27257

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


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

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

                                 (941) 436-2500
                                 --------------
              (Registrant's telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ].

As of July 31, 2000, there were 17,437,397 shares of the Registrant's Common
Stock outstanding, par value $0.001.

<PAGE>

                              SMARTDISK CORPORATION

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

     Item 1.   Financial Statements............................................................... 3

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

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

     Item 3.   Quantitative and Qualitative Disclosure About Market Risk..........................34


PART II.       OTHER INFORMATION

     Item 1.   Legal Proceedings..................................................................35

     Item 2.   Changes in Securities and Use of Proceeds..........................................35

     Item 4.   Submission of Matters to a Vote of Security Holders................................37

     Item 6.   Exhibits and Reports on Form 8-K...................................................38


SIGNATURES........................................................................................39
</TABLE>


                                        2
<PAGE>

PART I - FINANCIAL INFORMATION

                              SMARTDISK CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                      December 31,       June 30,
                                                                          1999            2000
                                                                      -----------      -----------
                                                                    (in thousands, except par value)
<S>                                                                   <C>              <C>
Assets
Current assets:
   Cash and cash equivalents                                          $    19,080      $     7,954
   Restricted cash                                                          1,050            1,050
   Short-term investments                                                  26,640           12,768
   Accounts receivable, net                                                 3,866           16,883
   Notes receivable                                                         6,302              215
   Inventories, net                                                         1,475           15,682
   Prepaid expenses and other current assets                                1,353            3,745
                                                                      -----------      -----------
                  Total current assets                                     59,766           58,297
Property and equipment, net                                                 2,623            3,739
Goodwill and other intangible assets, net                                     883           89,935
Deposits and other assets                                                     172              276
                                                                      -----------      -----------
Total Assets                                                          $    63,444      $   152,247
                                                                      ===========      ===========

Liabilities and Stockholders' Equity
Current liabilities:
   Accounts payable                                                   $     5,330      $    13,687
   Bank line of credit and discounted notes                                 4,895            2,019
   Income taxes payable                                                     1,110            1,614
   Deferred research and development contract revenue                         308               --
   Other accrued liabilities                                                2,015            3,513
                                                                      -----------      -----------
                  Total current liabilities                                13,658           20,833

Deferred income taxes and other                                                --           11,739

Commitments and contingencies

Stockholders' equity:
   Preferred stock, $0.001 par value; 5,000 shares authorized;
     none issued                                                               --               --
   Common stock, $0.001 par value; 60,000 shares authorized;
     16,072 issued and 15,991 outstanding at December 31, 1999;
     17,513 issued and 17,432 outstanding at June 30, 2000                     16               17
   Capital in excess of par value                                          71,246          146,174
   Treasury stock, 81 shares at December 31, 1999 and June 30,
     2000, at cost                                                            (58)             (58)
   Accumulated other comprehensive income                                     712              651
   Notes receivable from officers/employees                                  (387)            (592)
   Accumulated deficit                                                    (21,743)         (26,517)
                                                                      -----------      -----------
                  Total stockholders' equity                               49,786          119,675
                                                                      -----------      -----------
Total Liabilities and Stockholders' Equity                            $    63,444      $   152,247
                                                                      ===========      ===========
</TABLE>

See notes to condensed consolidated financial statements


                                        3
<PAGE>

                              SMARTDISK CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                       Three Months Ended                Six Months Ended
                                                             June 30,                        June 30,
                                                  ----------------------------      ----------------------------
                                                      1999             2000            1999              2000
                                                  -----------      -----------      -----------      -----------
                                                              (in thousands, except per share data)
<S>                                               <C>              <C>              <C>              <C>
Revenues:
     Product sales                                $     8,366      $    30,837      $    13,797      $    47,032
     Research and development revenue                      --               61               --            1,209
     Royalties                                            119               30              196               71
                                                  -----------      -----------      -----------      -----------
         Total revenues                                 8,485           30,928           13,993           48,312

Cost of revenues                                        5,600           21,480           10,271           32,811
                                                  -----------      -----------      -----------      -----------
Gross profit                                            2,885            9,448            3,722           15,501

Operating expenses:
     Research and development                           1,523            2,543            2,404            4,548
     Sales and marketing                                  394            1,757              779            2,565
     General and administrative                         1,120            2,897            2,686            5,065
     Amortization of goodwill and other
        acquisition related intangible assets              --            7,396               --            9,634
                                                  -----------      -----------      -----------      -----------
         Total operating expenses                       3,037           14,593            5,869           21,812

Operating loss                                           (152)          (5,145)          (2,147)          (6,311)
Interest and other income, net                             27              295               82            1,013
Interest expense                                          (14)             (41)             (23)             (88)
                                                  -----------      -----------      -----------      -----------
Net loss before income taxes                             (139)          (4,891)          (2,088)          (5,386)

Income tax expense (benefit)                               51             (619)              68             (612)
                                                  -----------      -----------      -----------      -----------
Net loss                                          $      (190)     $    (4,272)     $    (2,156)     $    (4,774)
                                                  ===========      ===========      ===========      ===========
Loss per share
         Basic and diluted                        $     (0.02)     $     (0.25)     $     (0.24)     $     (0.29)
                                                  ===========      ===========      ===========      ===========
Shares used in per share computation                    9,181           17,043            9,043           16,524
                                                  ===========      ===========      ===========      ===========
</TABLE>

See notes to condensed consolidated financial statements


                                       4
<PAGE>

                              SMARTDISK CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                           Six Months Ended
                                                                               June 30,
                                                                    ----------------------------
                                                                        1999            2000
                                                                    -----------      -----------
                                                                           (in thousands)
<S>                                                                 <C>              <C>
Cash flows from operating activities:
   Net loss                                                         $    (2,156)     $    (4,774)
   Adjustments to reconcile net loss to
     net cash used in operating activities:
       Depreciation                                                         471              922
       Amortization                                                         251            9,952
       Foreign currency gain                                                (29)             (21)
       Bad debt expense                                                      39              155
       Provision for inventory obsolescence                                  33              410
       Employee stock option expense                                         77               --
       Deferred income tax benefit                                          (67)          (2,219)
       Changes in assets and liabilities:
         (Increase) decrease in assets:
             Accounts receivable                                         (5,248)          (8,109)
             Notes receivable                                                --            6,088
             Inventories                                                  1,280             (133)
             Prepaid expenses and other current assets                     (760)            (377)
             Deposits and other assets                                       73             (104)
         Increase (decrease) in liabilities:
             Accounts payable                                               940            1,143
             Income taxes payable                                            --             (962)
             Deferred research and development contract revenue             968             (308)
             Other accrued liabilities                                      699             (447)
                                                                    -----------      -----------
Net cash (used in) provided by operating activities                      (3,429)           1,216

Cash flows from investing activities:
   Purchases of property and equipment, net of disposals                 (1,746)            (741)
   Cash paid for acquisitions, net of cash acquired                          --          (18,079)
   Cash paid for intellectual property                                       --             (755)
   Purchases of short-term investments                                       --           (9,117)
   Sales and maturities of short-term investments                            --           22,910
                                                                    -----------      -----------
Net cash used in investing activities                                    (1,746)          (5,782)

Cash flows from financing activities:
   Net borrowings (repayments) under lines of credit                      2,207           (7,119)
   Collections on notes receivable from officers/employees                   --                6
   Proceeds from sale of common stock                                     1,100               --
   Proceeds from exercise of stock options                                  176              149
   Proceeds from stock issued under ESPP                                     --              371
   Proceeds from sale of stock by SDL                                        65               --
   Purchase of treasury stock                                                (1)              --
                                                                    -----------      -----------
Net cash provided by (used in) financing activities                       3,547           (6,593)
Effect of exchange rate fluctuations on cash                                 43               33
                                                                    -----------      -----------
Decrease in cash                                                         (1,585)         (11,126)
Cash and cash equivalents at beginning of period                          2,920           19,080
                                                                    -----------      -----------
Cash and cash equivalents at end of period                          $     1,335      $     7,954
                                                                    ===========      ===========
Significant non-cash activities:
   Note receivable obtained for stock option exercise               $        --      $       210
   Issuance of common stock for license                             $       300      $       240
   Contribution/conversion of stockholder loan to capital           $       648      $        --
</TABLE>

See notes to condensed consolidated financial statements


                                        5
<PAGE>

                              SMARTDISK CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 2000

Note 1. Basis of Presentation

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

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

Note 2. Inventory

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

                                                   December 31,      June 30,
                                                      1999            2000
                                                 --------------  -------------

         Finished goods                              $  1,561      $   6,306
         Work in process                                    -          1,627
         Raw materials                                      -          8,185
                                                 --------------  -------------
         Total inventories                              1,561         16,118
         Allowance for obsolescence                       (86)          (436)
                                                 --------------  -------------
         Net inventory                               $  1,475       $ 15,682
                                                 ==============  =============


                                        6
<PAGE>

Note 3. Net Loss Per Share

         For the three months ended June 30, 1999 and 2000, potential common
shares totaling 591,252 and 1,457,622, respectively, were excluded from the
computation of net loss per share because they were anti-dilutive. For the six
months ended June 30, 1999 and 2000, potential common shares totaling 570,223
and 1,585,449, respectively, were excluded from the computation of net loss per
share because they were anti-dilutive. Potential common shares include stock
options and shares of non-vested stock.

Note 4. Comprehensive Loss

         Comprehensive loss includes all changes in equity that result from
transactions and other economic events during the period other than transactions
with stockholders. The significant components of other comprehensive expense for
the Company include equity adjustments resulting from the translation of the
balance sheet for the Japanese branch and the European subsidiary and realized
losses on short-term investments. The following table sets forth the computation
of comprehensive loss for the periods indicated (in thousands):
<TABLE>
<CAPTION>
                                                          Three Months Ended              Six Months Ended
                                                               June 30,                       June 30,
                                                     ---------------------------    ---------------------------
                                                         1999            2000          1999            2000
                                                     -----------     -----------    ----------    -------------
<S>                                                   <C>             <C>            <C>           <C>
Net loss                                              $  (190)        $ (4,272)      $ (2,156)     $ (4,774)
Other comprehensive income (expense):
     Unrealized loss on short-term investments,
         net of tax                                         -               13              -            (4)
     Foreign currency translation adjustment               66                8             (5)          (57)
                                                     -----------     -----------    ----------    -------------
Total comprehensive loss                              $  (124)        $ (4,251)      $ (2,161)     $ (4,835)
                                                     ===========     ===========    ==========    =============
</TABLE>

Note 5. Acquisition

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


                                        7
<PAGE>

Note 5. Acquisition (continued)

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

              <S>                                                              <C>
              Cash                                                             $  16,433
              Common stock                                                             1
              Capital in excess of par                                            49,792
              Value of SmartDisk options issued                                   19,792
              Transaction costs                                                    2,916
                                                                           --------------
              Total purchase price                                             $  88,934
                                                                           ==============

                                            Net Assets Acquired

              Book value of net tangible assets of VST                         $   9,551
              Intangible assets:
                    Non-compete agreements                                        21,300
                    Distributions channels                                         4,900
                    VST trade name                                                 4,800
                    Patents                                                        2,200
                    Workforce in place                                             1,000
              Deferred income taxes                                              (13,680)
              Goodwill                                                            58,863
                                                                           --------------
              Net assets acquired                                              $  88,934
                                                                           ==============
</TABLE>

         The following unaudited pro forma financial information reflects the
VST acquisition as if it had occurred on January 1, 1999 after giving effect to
certain adjustments including amortization of goodwill and other intangible
assets. The pro forma financial information does not purport to represent what
the Company's actual results of operations would have been had the acquisition
occurred as of January 1, 1999 and may not be indicative of operating results
for any future periods.
<TABLE>
<CAPTION>
                                                   Three Months Ended                   Six Months Ended
                                                        June 30,                            June 30,
                                             ------------------------------     ---------------------------------
                                                 1999             2000               1999               2000
                                             -------------    -------------     --------------    ---------------
                                                           (in thousands, except per share data)
<S>                                           <C>              <C>               <C>               <C>
Revenues                                      $   21,152       $   30,928        $    35,168       $    54,349
Net loss                                      $   (8,356)      $   (4,272)       $   (18,992)      $   (10,832)

Loss per share
         Basic and diluted                    $    (0.81)      $    (0.25)       $     (1.87)      $     (0.61)
                                             =============    =============     ==============    ===============
</TABLE>


                                        8
<PAGE>

Note 5. Acquisition (continued)

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

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

Note 6. Segment Information

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


                                        9
<PAGE>

Note 6. Segment Information (continued)

         The following table presents information about the Company's reportable
segments (in thousands):
<TABLE>
<CAPTION>
                                            Three Months Ended             Six Months Ended
                                                  June 30,                     June 30,
                                         ------------------------     ------------------------
                                             1999          2000           1999          2000
                                         -----------     --------     -----------     --------
      <S>                                <C>             <C>          <C>             <C>
      Digital connectivity products:
            Revenues                     $     8,366     $ 14,227     $    13,797     $ 24,439
                                         ===========     ========     ===========     ========
            Gross profit                 $     2,766     $  5,305     $     3,526     $  8,750
                                         ===========     ========     ===========     ========

      Personal storage systems:
            Revenues                     $        --     $ 16,610     $        --     $ 22,593
                                         ===========     ========     ===========     ========
            Gross profit                 $        --     $  4,052     $        --     $  5,471
                                         ===========     ========     ===========     ========

      Other:
            Revenues                     $       119     $     91     $       196     $  1,280
                                         ===========     ========     ===========     ========
            Gross profit                 $       119     $     91     $       196     $  1,280
                                         ===========     ========     ===========     ========

      Total
            Revenues                     $     8,485     $ 30,928     $    13,993     $ 48,312
                                         ===========     ========     ===========     ========
            Gross profit                 $     2,885     $  9,448     $     3,722     $ 15,501
                                         ===========     ========     ===========     ========
</TABLE>

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

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

Note 7. Reclassifications

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

Note 8. Recent Accounting Pronouncements

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


                                       10
<PAGE>

Note 8. Recent Accounting Pronouncements (continued)

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


                                       11
<PAGE>

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

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

         Certain statements contained in this report on Form 10-Q are
forward-looking in nature within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. These
forward-looking statements involve risks and uncertainties that could cause
actual results to differ materially from those in such forward-looking
statements. Readers are cautioned not to place undue reliance on the
forward-looking statements included in this document, which are based on
information available to the Company on the date hereof. The Company makes no
commitment to update any such forward-looking statements or to disclose any
facts, events, or circumstances after the date hereof that may affect the
accuracy of any forward-looking statement. Readers should carefully review the
risks described below under "Factors That May Affect Future Results of
Operations" and in other documents we file from time to time with the Securities
and Exchange Commission, including the Company's Annual Report on Form 10-K.

Overview

         We design, develop, manufacture and market digital connectivity
products and personal storage systems that allow consumers to easily access and
exchange digital data. As a result, our products provide consumers with a
user-friendly way to transfer, store, manage and share digital photographs,
video, music, voice and data among digital appliances, personal computers and
the Internet.

         With the growth of digital appliances, such as digital cameras, digital
video camcorders, voice recorders and music players, consumers are increasingly
using the PC as the "multimedia center" of the home or office. These digital
appliances capture digital data on high capacity, reusable flash memory cards
that appeal to consumers because of their small size, versatility and
portability. Our digital connectivity products enable the easy and convenient
sharing of the information on the cards between the digital appliance, PCs and
the Internet. Our personal storage systems and related software are designed to
provide an easy way to store and manage this digital data on one's PC.

         Our products are designed to work across all popular PC platforms,
support all leading flash memory media types and use high performance PC
interfaces, such as USB and FireWire. Our patented digital connectivity
products, such as our FlashPath products for the Toshiba SmartMedia card,
SanDisk MultimediaCard and Sony Memory Stick, as well as Smarty, allow consumers
to use the familiar 3.5 inch floppy drive -- found on most PCs worldwide -- to
simplify the exchange of images, music, voice and other digital data between PCs
and digital appliances. Our latest digital connectivity product, the Tri-Media
Reader, represents our first product for the CompactFlash market. CompactFlash
is the leading flash memory card in the


                                       12
<PAGE>

world. The Tri-Media Reader utilizes a USB cable interface to exchange digital
data and it addresses an expanding installed base of PCs with USB cable
interfaces.

         Our USB- and FireWire-based personal storage systems include high
performance, portable hard disk drives and floppy disk drives for desktop and
notebook PCs, as well as expansion bay disk drives for notebooks. Substantially
all of our personal storage systems are compatible with Windows and Macintosh
operating systems.

         Our principal digital connectivity products, our FlashPath family of
products, are used primarily to transfer images to PCs from digital cameras. We
develop and market three FlashPath products, one for each of three different
flash memory cards: SanDisk's MultiMediaCard, Sony's Memory Stick and Toshiba's
SmartMedia card. These flash memory cards are used in cameras and video
camcorders made by a number of leading camera manufacturers, including FujiFilm,
JVC, Olympus, Panasonic, Sanyo, Sharp, Sony and Toshiba. During the year ended
December 31, 1999, we sold over one million FlashPaths for the SmartMedia card.
During the fourth quarter of 1999, we completed development of our first
FlashPath product for the Memory Stick and began full-scale production and
shipping to Sony for distribution. In the fourth quarter of 1999, we also
shipped working samples of our FlashPath product for the MultiMediaCard.

         We began volume production of FlashPath for the MultiMediaCard in the
first quarter of 2000. In the first quarter of 2000, we also introduced a
follow-on FlashPath product for new models of Sony's Mavica digital still
camera. In January 2000, we introduced a USB Tri-Media Reader which reads and
writes to SmartMedia cards, CompactFlash cards and rotational media, such as a
1.44 Mega-byte floppy disk, all in a single USB cable-powered device for both
Windows and Macintosh systems.

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

         Our personal storage systems and related software enhance the user's
ability to store and manage digital data. These systems are compatible with both
Windows and Macintosh operating systems, support very high transfer rates and
offer up to 100 Gigabytes of capacity.

         Since 1992, we have worked with Apple as an Apple preferred partner and
developer. Through this relationship, Apple has provided us access to product
road maps that have allowed us to focus on new opportunities in the development
and engineering of many FireWire and USB systems. Through our strategic
relationship with Iomega, we build Iomega Zip drive products for Apple, IBM and
Fujitsu. In 1999, we were one of the first companies to ship FireWire personal
storage systems for both Macintosh and Windows operating systems, as well as
FireWire Zip drives. In the first quarter of 2000, we introduced one of the
first 100 Gigabyte portable FireWire RAID arrays.


                                       13
<PAGE>

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

Recent Developments

         In April 2000, we acquired substantially all of the intellectual
property of El Gato Software LLC, a California-based company located near San
Jose, California, for approximately $0.8 million in cash and approximately
37,000 shares of our common stock. We also retained the services of El Gato's
staff of five software developers under two-year consulting agreements. El Gato
develops and markets USB and FireWire drivers, applications and firmware support
for leading personal storage systems, including SmartMedia, CompactFlash, hard
drives, Zip drives, floppy drives and optical drives. We use El Gato's drivers
in our FireWire hard drives, FireWire Zip drives and USB-based products,
including our Tri-Media Reader.

         In April 2000, we also completed our acquisition of Impleo Limited.
Impleo, an English corporation established in November 1999, is based in
England. Impleo manufactures and markets digital connectivity products and
personal storage systems under the Datawise brand. We plan to use Impleo as our
primary European distributor. We acquired all of the capital stock of Impleo for
approximately $200,000 in cash and approximately 125,000 shares of our common
stock. The consolidated financial statements include the operating results of
Impleo from the date of acquisition.

Results of Operations

         Revenues. Total revenues were approximately $30.9 million for the three
months ended June 30, 2000 compared to approximately $8.5 million for the three
months ended June 30, 1999. Total revenues were approximately $48.3 million for
the six months ended June 30, 2000 compared to approximately $14.0 million for
the six months ended June 30, 1999. These increases were primarily attributable
to sales of personal storage systems subsequent to the acquisition of VST in
March 2000 and higher sales of our newest products, FlashPath for the Sony
Memory Stick, which we commercially introduced in the fourth quarter of 1999,
and FlashPath for the SanDisk MultiMediaCard, which we commercially introduced
in the first quarter of 2000.

         Our product revenues from the sale of FlashPath increased from
approximately $8.2 million for the three months ended June 30, 1999 to
approximately $13.0 million for the three months ended June 30, 2000. Our
product revenues from the sale of FlashPath increased from approximately $13.3
million for the six months ended June 30, 1999 to approximately $22.5 million
for the six months ended June 30, 2000. Our product revenues from the sale of
personal storage systems for the three months ended June 30, 2000 were
approximately $16.6 million. Our product revenues are recognized when title and
risk of loss are transferred to customers, which is generally at the time of
shipment. Product revenues at our Japanese branch are recognized upon acceptance
by the customer.


                                       14
<PAGE>

         Fiscal year 1999 was the first year that we had revenues from our
research and development efforts. During the fourth quarter of 1999, we entered
into a research and development agreement with a customer, which was completed
during the quarter ended March 31, 2000. Our research and development revenue is
recognized upon final customer acceptance of our work performed under the terms
of the agreement. Our revenues from research and development agreements were
approximately $0.1 million and $1.2 million for the three and six months ended
June 30, 2000, respectively. We had no research and development revenues for the
three and six months ended June 30, 1999.

         Our royalty revenues consist of royalties earned on the sales of our
first product, SafeBoot, which is licensed to and sold by Fischer International,
an affiliate. As a result of increases in our product revenues, royalty revenue
represents less than one percent of our total revenues for the three and six
months ended June 30, 2000.

         Cost of Revenues. Cost of revenues includes the purchased cost of
product, packaging, storage, freight, scrap, inventory and warranty provisions,
as well as royalties for some of our FlashPath products. Cost of revenues
increased to approximately $21.5 million for the three months ended June 30,
2000 compared to approximately $5.6 million for the three months ended June 30,
1999. Cost of revenues increased to approximately $32.8 million for the six
months ended June 30, 2000 compared to approximately $10.3 million for the six
months ended June 30, 1999. These increases in cost were due primarily to sales
of personal storage systems subsequent to the acquisition of VST and an increase
in sales of our FlashPath product. With the acquisition of VST, we expect that
our cost of revenues will increase significantly in 2000 as we expand our
product offerings, particularly for FireWire and USB products, and support
anticipated sales growth.

         Gross Profit. Our gross profit for the three months ended June 30, 2000
increased to approximately $9.5 million or 31% of total revenue, compared to
approximately $2.9 million or 34% of total revenue for the three months ended
June 30, 1999. Our gross profit for the six months ended June 30, 2000 increased
to approximately $15.5 million or 32% of total revenue, compared to
approximately $3.7 million or 27% of total revenue for the six months ended June
30, 1999. These increases in the amount of gross profit are primarily
attributable to sales of personal storage systems subsequent to the acquisition
of VST in March 2000, which caused the decrease in our gross margin percentage
in the current quarter since the gross margin on personal storage products is
typically less than on digital connectivity products. The increase in our gross
margin percentage in the first half of 2000 compared to the first half of 1999
was due to improved FlashPath product margins as a result of our efforts to
reduce our costs per unit. The improved margins also resulted from a favorable
mix associated with higher shipments to customers other than our largest OEMs.
Because we expect OEMs to continue to account for a large portion of our sales,
we expect gross margins on our FlashPath products to remain relatively
consistent with the current level. However, our largest OEM customers may seek
price concessions, which could cause a reduction in our gross margins. Another
contributor to our improved gross margin in the first half of 2000 was the
revenue earned under the research and development agreement we have with one of
our customers. Without the research and development revenue, our gross margin
would be approximately 30% of total revenue for the three and six months ended
June 30, 2000. With the acquisition of VST, we expect the actual


                                       15
<PAGE>

amount of our gross profit to increase this year, however, we anticipate our
gross margin percentage will decrease since the gross margin on personal storage
products is typically less than on digital connectivity products.

         Research and Development Expenses. Our research and development
expenses consist primarily of salaries and payroll-related expenses for our
design and development engineers, as well as prototype supplies and contract or
professional services. These expenses increased to approximately $2.5 million,
or 8% of total revenues, for the three months ended June 30, 2000 compared to
approximately $1.5 million, or 18% of total revenues, for the three months ended
June 30, 1999. Research and development expenses increased to approximately $4.5
million, or 9% of total revenues, for the six months ended June 30, 2000
compared to approximately $2.4 million, or 17% of total revenues, for the six
months ended June 30, 1999. These increases in expenditures were the result of
hiring additional technical personnel, including salaries and related payroll
expenses, costs incurred in conjunction with one of our research and development
contracts and the outsourcing of product development, as well as the inclusion
of VST. We believe that the continued introduction of new products with an
emphasis on being first-to-market is essential to our growth and will require
increases in research and development expenditures.

         Research and development expenses related to digital connectivity
products, were incurred to support our development of enhanced versions of our
existing FlashPath and Smarty products, as well as our development of our new
FlashPath products designed to work with the Sony Memory Stick and the SanDisk
MultiMediaCard. We expect that our research and development expenses will
continue to increase in connection with the enhancement of our existing
FlashPath products and the expansion of the FlashPath line to support additional
flash memory card formats. In addition, we expect to incur additional costs as
we develop other digital connectivity products to conveniently transfer digital
data from competing flash memory cards to existing, non-PC technologies, such as
our recently-announced FlashTrax(R) product, and other products that support
computer interfaces other than the 3.5 inch floppy disk drive, such as our
recently-introduced USB Tri-Media Reader. Including personal storage products,
we expect our consolidated research and development expenses to increase but
represent a decreasing percentage of our total product revenues.

         Sales and Marketing Expenses. Sales and marketing expenses include
salaries, benefits and travel expenses for our sales, marketing and product
management personnel in the United States and Japan. These expenses also include
other selling and marketing expenditures for items such as trade shows,
advertising, marketing and other promotional programs. Sales and marketing
expenses for the three and six months ended June 30, 2000 increased by
approximately $1.4 million and $1.8 million to approximately $1.8 million and
$2.6 million compared to the three and six months ended June 30, 1999,
respectively. The change from 1999 to 2000 is primarily attributable to the
inclusion of VST. In connection with the VST acquisition in March 2000, we added
a number of new products to our existing product lines, significantly increasing
our total sales and marketing expenses.

         General and Administrative Expenses. General and administrative
expenses include the salaries and related expenses of our executive management,
finance, information systems, human


                                       16
<PAGE>

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 $2.9 million and $5.1 million in the three
and six months ended June 30, 2000, respectively, compared to approximately $1.1
million and $2.7 million in the three and six months ended June 30, 1999. These
increases are primarily due to the inclusion of VST, as well as, increases in
professional services, legal fees and personnel related costs including
salaries, bonuses and relocation 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. The most significant component of these
items, for the three and six months ended June 30, 2000, is interest earned of
approximately $0.3 million and $0.9 million, respectively, on the proceeds from
our initial public offering in October 1999.

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

         Provision for Income Taxes. We are subject to tax in the United States,
Japan and the United Kingdom. These jurisdictions have different marginal tax
rates. For the three and six months ended June 30, 2000, income tax expense
totaled approximately $1.1 million and $1.6 million, respectively. These amounts
were offset by income tax benefits of approximately $1.7 million and $2.2
million resulting from amortization expense on certain intangible assets related
to the VST and Impleo acquisitions. Taxable income earned in the United States
was partially offset by net operating loss and credit carryforwards. A valuation
allowance is provided to reduce deferred tax assets to the amount that will more
likely than not be realized.

Liquidity and Capital Resources

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

         The net proceeds from our initial public offering have been invested in
cash, cash equivalents and short-term investments. In March 2000, in connection
with the acquisition of VST, we paid, or have set aside to be paid, a total of
approximately $18.2 million in purchase consideration and other acquisition
related costs. In March 2000, we also repaid a line of credit that VST
maintained which had an outstanding balance of approximately $4.3 million. To
date, we have funded VST's operations with approximately $5.0 million. We also
used approximately $0.8 million for the acquisition of substantially all of the
intellectual property of El Gato. We plan to use the remaining net proceeds from
our initial public offering for general corporate purposes, including working
capital and capital expenditures, as well as potential acquisitions of


                                       17
<PAGE>

technology and businesses. The use of the proceeds from our initial public
offering does not represent a material change in the use of proceeds described
in our prospectus dated October 5, 1999.

         We maintain a line of credit 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 substantially all of our assets. This
line of credit expires on December 15, 2000. We have not borrowed against this
line of credit and we have no current plans to borrow any amounts under this
line of credit.

         Our Japanese branch has a line of credit with maximum borrowing
capacity of approximately $2.8 million, or 295 million yen. The facility, which
has no fixed term, is secured by a time deposit and accounts receivable. The
branch maintains a time deposit with the bank that had a balance at June 30,
2000 of approximately $1.0 million. We may borrow up to 90% of this amount. The
credit agreement corresponding to the time deposit collateral is renewable
automatically on May 31, 2000. In addition, accounts receivable of up to $1.9
million, or 200 million yen, of specified trade customers may be used as
additional collateral. The credit agreement corresponding to the accounts
receivable collateral is renewable automatically on January 31, 2001. The
interest rate on borrowings under the credit facility is 1.38% per year. The
outstanding balance under the line of credit was approximately $1.9 million or
200 million yen as of June 30, 2000 compared to approximately $2.0 million at
December 31, 1999.

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

         Our UK subsidiary has a line of credit with maximum borrowing capacity
of approximately $0.8 million, or 500,000 British pounds. The credit facility
expires in October 2000. The interest rate on borrowings under the credit
facility is 5.5% per year. The outstanding balance under the line of credit as
of June 30, 2000 was approximately $0.1 million or approximately 80,000 British
pounds.

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

         Net cash provided by operating activities was approximately $1.2
million for the six months ended June 30, 2000 compared to cash used in
operations of approximately $3.4 million for the six months ended June 30, 1999.
Net cash provided by operating activities in the first six months of 2000
reflected a net loss of approximately $4.8 million offset by approximately $10.9
million in depreciation and amortization. In addition, there was a decrease in
notes receivable of approximately $6.1 million and an increase in accounts
payable of approximately $1.1 million. These amounts were partially offset by
increases in accounts receivable of approximately $8.1 million, prepaid and
other current assets of approximately $0.4 million and decreases in income taxes
payable of approximately $1.0 million, deferred income taxes of approximately

                                       18
<PAGE>

$2.2 million and other accrued expenses of approximately $0.4 million.

         Net cash used in investing activities was approximately $5.8 million
for the first six months of 2000. The most significant use of cash in the first
six months of 2000 was approximately $18.2 million in connection with the
acquisition of VST in March 2000. This amount was partially offset with proceeds
from the sale of short-term investments, net of purchases, of approximately
$13.8 million. Cash was also used for capital expenditures, primarily the
acquisition of development and production equipment.

         Net cash used in financing activities was approximately $6.6 million in
the first six months of 2000. This was attributable to approximately $2.8
million in net repayments under our line of credit with a Japanese bank and
approximately $4.3 million used to repay the outstanding balance under VST's
line of credit. These amounts were partially offset by proceeds from option
exercises and collections on notes receivable from officers/employees.

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

Year 2000 Issues

         The "Year 2000 Issue" refers generally to the problems that some
software may have in determining the correct century of the year. Many existing
electronic systems, including computer systems, use only the last two digits to
refer to a year. Therefore, these systems may recognize a date using "00" as
1900 rather than the year 2000. If not corrected, these electronic systems could
fail or create erroneous results when addressing dates on and after January 1,
2000.

         In 1999, we completed our remediation and testing of hardware and
software systems to assess their Year 2000 readiness. Our costs associated with
Year 2000 compliance have been minimal, and, therefore, these costs have not
been accounted for separately. To date, we have not experienced any material
adverse effect on our business or operations as a result of any Year 2000
Issues.


                                       19
<PAGE>

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 able to sustain
our profitability.

         Except for the third and fourth quarter of 1999, we have incurred net
losses on a quarterly basis since inception. We had net income of approximately
$1.0 million during 1999 (a net loss of approximately $17.7 million on a pro
forma basis after giving effect to the VST acquisition). We had a net loss of
approximately $4.8 million in the first six months of 2000. In addition, as of
June 30, 2000, we had an accumulated deficit of approximately $26.5 million. In
light of our loss history and the VST acquisition, we cannot assure you that we
will be able to sustain profitability in the future.

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

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

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

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

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

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


                                       20
<PAGE>

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

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

A reduction in the use of the 3.5 inch floppy disk drive by consumers and
manufacturers would lead to a reduction in demand for our FlashPath products.

         Our current FlashPath products only work in conjunction with the
standard 3.5 inch floppy disk drive. While the 3.5 inch floppy disk drive is
today found in most PCs, a number of newer PC models, such as the Apple iMac and
the Apple G3 desktop, do not have this device and new industry standards may
emerge that render the 3.5 inch floppy disk drive obsolete. Advances in input
devices such as CD-ROM and removable data storage disk drives, such as Zip
drives, may reduce or eliminate the need for the 3.5 floppy diskette, which will
lead to a corresponding reduction in demand for our FlashPath products. We would
then have to rely on our other products or develop new products that use a
different interface between personal computers and digital appliances. We may
not be able to redesign our FlashPath products to fit the new interface and
demonstrate technological feasibility of those products on a timely basis, if at
all, or in a cost effective manner.

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

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

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

         A substantial portion of our business depends on the adoption of
Institute of Electrical and Electronics Engineering, or IEEE, 1394 technology by
PC manufacturers. IEEE 1394 is a high speed PC interface that is replacing Small
Computer System Interface, or SCSI, and parallel interfaces. If these
manufacturers do not include a IEEE 1394 interface on their PCs or notebook
computers, then we may not be able to sell sufficient quantities of our FireWire
personal storage


                                       21
<PAGE>

systems to support our future growth. FireWire is Apple's trade name for IEEE
1394. For example, a new, competing high speed interface, such as Universal
Serial Bus, or USB, 2.0, could be developed and emerge as an industry standard,
thus limiting the demand for our FireWire technology and related personal
storage systems.

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

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

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

         To date, substantially all of our revenue has been derived from the
sale of only a few major products. While our long-term strategy is to derive
revenue from multiple products, we anticipate that the sale of our FlashPath
products and our USB and FireWire storage systems will continue to represent the
most substantial portion of our revenues through at least 2001. A decline in the
price of or demand for these products as a result of competition, technological
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. On a pro forma basis after giving effect to the VST
acquisition, for the year ended December 31, 1999, we derived approximately 36%
of our product revenues from the sale of FlashPath, 19% from the sale of our
USB-based personal storage systems, 20% from the sale of our Zip drives, and 8%
from the sale of our FireWire-based personal storage systems.

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

         We operate in an industry that is subject to evolving industry
standards, rapid technological changes, rapid changes in consumer demands and
the rapid introduction of new, higher performance products that shorten product
life cycles. To be competitive in this demanding market, we must both continue
to refine current products so that they remain competitive, and continually
design, develop and introduce, in a timely manner, new products that meet the
performance and price demands of OEMs and consumers. These development
activities will require the investment of substantial resources before revenues
are derived from product sales. Any significant delay in releasing new products
would adversely affect our reputation, provide a competitor a first-to-market
opportunity or allow a competitor to achieve greater market share. Product
development is inherently risky because it is difficult to foresee developments
in technology, coordinate our technical personnel and strategic relationships,
and identify and eliminate design flaws. If we are unable to develop and sell
new products, we will


                                       22
<PAGE>

not be able to continue our strategy of maintaining media neutrality, and our
target market will be limited. Further, we may not be able to recoup research
and development expenditures if new products are not widely commercially
accepted.

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

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

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

         Historically, Apple has provided us, as an Apple developer, access to
selected product road maps, which has allowed us to timely develop and engineer
many of our current products, including our current FireWire and USB storage
systems. As a result of this collaborative relationship, we have received a
substantial portion of our historical revenues from direct sales to Apple and
Apple users. Moreover, we anticipate that a significant portion of our product
revenues will continue to be derived from sales of our Apple compatible products
in the 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


                                       23
<PAGE>

a Macintosh CPU. While we do not anticipate any change in this arrangement,
Apple is not contractually obligated to offer our products on their website.

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

         Our continued growth depends to a large extent on both our strategic
relationship with Apple and the continued resurgence of demand for Apple
products. This dependence is due primarily to the fact that, to date, Apple has
been the principal PC manufacturer using the USB and FireWire interface
technologies on which many of our products are based. If the demand for Apple
products declines or Apple suffers a material change in its business, the market
for many of our products would be negatively impacted.

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

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

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

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

     o    Reductions in consumer demand for our customers' products generally or
          for our products in particular;

     o    The timing and amount of research and development expenditures;

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

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

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

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

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

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

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


                                       24
<PAGE>

         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.

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 SmartDisk. In
addition, we may not receive trademark protection for our "SmartDisk" name. We
have filed for trademark registration of the name "SmartDisk," but this has not
yet been granted. We are aware of a trademark application for the name
"SmartDisk" that was filed by another company. Our application could be denied
and we could be prohibited from using the "SmartDisk" name. In that event, we
would be required to incur substantial costs to establish new name recognition.

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

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

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

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

         From time to time we may receive communications from third parties
asserting that our products infringe, or may infringe, the proprietary rights of
these third parties. These claims of


                                       25
<PAGE>

infringement may result in protracted and costly litigation that could require
us to pay substantial damages or have sales of our products stopped by an
injunction. Infringement claims could also cause product shipment delays,
require us to redesign our products or require us to enter into royalty or
licensing agreements, any of which could harm our business. For example, we
received communications alleging that our FlashPath products infringed a third
party's patent rights. We have met with this third party, a non-public limited
liability company, to gain a better understanding of its claim and attempted to
resolve the dispute through mediation. Such mediation did not yield a resolution
to the dispute and such party subsequently filed a complaint in the Central
District Federal Court of the State of California. See Part II, Item 1. "Legal
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 we
will avoid litigation, or that the effects or outcome of any such litigation
will be favorable to SmartDisk. We also received correspondence alleging that
our SafeBoot product violated another third party's intellectual property
rights. We discussed this correspondence with counsel and concluded that our
product does not infringe upon the third party's rights. In addition, we license
a portion of the intellectual property included in our products from third
parties, which may increase our exposure to infringement actions because we rely
upon those third parties for information about the origin and ownership of the
licensed intellectual property. We may also lose our license rights with respect
to the intellectual property for which infringement is claimed. Further, if our
customers are required to obtain a license on other than commercially reasonable
terms, our business could be jeopardized.

We 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 much of our business is conducted
overseas, primarily Japan, 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 Olympus, FujiFilm or Ingram Micro, or suffer a
substantial reduction in or cancellation of orders from these customers. Our
current distribution strategy results, and will continue to result, in sales to
only a limited number of customers. Some of our products are sold as stand-alone
products by OEMs and, to a lesser extent, are bundled together and sold with
systems manufactured by third party OEMs. We currently sell to ten OEMs, sales
to which collectively accounted for approximately 57% of our revenues for 1999
on a pro forma basis after giving effect to the VST acquisition. More
specifically, on a pro forma basis after giving effect to the VST acquisition,
Olympus, Fuji Film and Ingram Micro accounted for approximately 11%,


                                       26
<PAGE>

11% and 22% of our revenues and our top five customers collectively accounted
for approximately 58% of our revenues for fiscal 1999. Furthermore, we expect to
continue to depend on sales of our products to relatively few customers, which
will continue to account for a significant portion of our net revenues, for the
foreseeable future.

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

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

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

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

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

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


                                       27
<PAGE>

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

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

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

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

         There are inherent difficulties in developing and maintaining
relationships with foreign entities. Language and cultural differences often
impair relationships, and geographical distance, at times, is also an
impediment. We must overcome these difficulties. 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.

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

         On a pro forma basis after giving effect to the VST acquisition,
approximately 31% of our revenues for 1999 were attributable to sales to
Japanese customers, and we expect that sales to Japanese customers will continue
to account for a significant portion of our total revenues for the foreseeable
future. All of our Japanese sales, as well as the related expenses, are
denominated in 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 subsidiary are U.S. dollar
denominated. Since the Japanese subsidiary's accounting records are kept in yen,
those U.S. dollar denominated transactions are accounted for in yen at the time
of the transaction. U.S.


                                       28
<PAGE>

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 Japanese subsidiary are translated to the U.S. dollar for
financial reporting purposes and resulting adjustments are made to stockholders
equity. The value of the yen may deteriorate against the dollar, which would
impair the value of stockholders' investment in us. Deterioration of the yen
against the dollar has occurred in recent years, resulting in a foreign currency
loss of approximately $48,000 and a foreign currency translation adjustment to
equity of approximately $290,000 for 1998. In 1999, we had a foreign currency
gain of approximately $30,000 and a foreign currency transaction adjustment to
equity of approximately $277,000. 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.

Our digital connectivity product sales are geographically concentrated in Japan,
and, therefore, we could suffer from economic and political difficulties.

         We are also subject to risks associated with a significant amount of
sales of our digital connectivity products being made to one geographical area.
An economic downturn in Asia generally, and Japan in particular, could lead to a
reduced demand for our digital connectivity products. In recent years, Japan has
been subject to political and economic instability and, while that instability
has not yet adversely impacted us, if it continues, sales of our digital
connectivity products in Japan may be adversely affected.

         Given our dependence on sales of our digital connectivity products to
Japanese customers, we must develop and maintain alliances in Japan to help with
the promotion and distribution of our digital connectivity products. We may not
be able to develop or maintain these alliances.

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

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

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

         We contract with offshore manufacturers to produce 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, Hitachi and Mitsumi are the sole manufacturers of our FlashPath
products. We do not have contracts with any of Yamaichi, Hitachi or Mitsumi. If
Yamaichi, Hitachi or Mitsumi terminates production or cannot meet our production
requirements, we may have to rely on other contract manufacturing sources or
identify and


                                       29
<PAGE>

qualify new contract manufacturers. The lead time required to qualify a new
manufacturer could range from approximately three to six months. Despite efforts
to do so, we may not be able to identify or qualify new contract manufacturers
in a timely manner and these new manufacturers may not allocate sufficient
capacity to us in order to meet our requirements. Any significant delay in our
ability to obtain adequate quantities of our products from our current or
alternative contract manufacturers would cause our sales to decline.

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

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

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

         Many of our products are manufactured overseas and a substantial
portion of our revenues is derived from overseas sales. On a pro forma basis
after given effect to the VST acquisition, approximately 38% of our revenues in
1999 were derived from customers located outside the United States, primarily in
Japan. Our dependence on foreign manufacturers and international sales poses a
number of risks, including:

     o    Difficulties in monitoring production;

     o    Transportation delays and interruptions;

     o    Unexpected changes in regulatory requirements;

     o    Currency exchange risks;

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

     o    Difficulties in staffing and managing disparate branch operations;

     o    Political or economic instability;

     o    Compliance with foreign laws;

     o    Difficulties in protecting intellectual property rights in foreign
          countries;

     o    Exchange controls; and

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

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


                                       30
<PAGE>

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

         Rohm is our sole provider of application specific integrated circuits,
or ASICs, for our FlashPath products and we purchase ASICs for Smarty from Rohm
and Atmel. In our products, the specific function of these integrated circuits
is the conversion of digital and analog data. In addition, Iomega is a sole
source supplier of Zip drives, and LSI Logic is our primary supplier of ASICs
for our FireWire products. Our dependence on a limited number of suppliers and
our lack of long-term supply contracts exposes us to several risks, including a
potential inability to obtain an adequate supply of components, price increases,
late deliveries and poor component quality. Disruption or termination of the
supply of components could delay shipments of our products. The lead time
required for orders of some of our components is as much as six months. In
addition, the lead time required to qualify new suppliers for our components is
as much as 12 months. If we are unable to accurately predict our component
needs, or if our component supply is disrupted, we may miss market opportunities
by not being able to meet the demand for our products. This may damage our
relationships with current and prospective customers. For example, in 1997 and
1998 we experienced a nine-month delay in the shipment of our first notebook Zip
drives resulting from delays in deliveries of Zip mechanisms from our sole
supplier. We suffered additional costs as a result of these delays that
adversely affected our gross margin.

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

         Increased competition is likely to result in price reductions, reduced
operating margins and loss of market share. Many of our current and potential
competitors have significantly greater financial, technical, marketing,
purchasing and other resources than we do. As a result, our competitors may be
able to respond more quickly to new or emerging technologies or standards and to
changes in customer requirements. Our competitors may also be able to devote
greater resources to the development, promotion and sale of products, and may be
able to deliver competitive products at a lower end-user price. Current and
potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of our prospective customers. Therefore, it
is possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.

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

         Failure to effectively manage our growth could impair our ability to
execute our business strategy. Our business has grown substantially in recent
periods, with revenues increasing from approximately $15.3 million in 1998 to
approximately $102 million in 1999, on a pro forma basis after giving effect to
the VST acquisition. 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 128 as of June 30, 2000.
We expect to continue to increase the number of employees as our business grows,
and may expand operations to locations other than those in which we currently
operate.


                                       31
<PAGE>

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

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

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

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

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

     o    Establish a common corporate culture; and

     o    Integrate geographically distant facilities, systems and employees.

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

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

Our growth prospects will be reduced if we cannot successfully market and sell
our new FireWire RAID array product.

         We recently introduced a 100 Gigabyte FireWire RAID array. We do not
know whether this product will achieve any significant level of consumer
acceptance. In addition, because this product is more expensive than our other
products, we cannot distribute this product though our normal sales channels. If
we are not be able to develop the marketing and sales infrastructure necessary
to successfully distribute this product, our growth prospects will be reduced.

                                       32
<PAGE>

Finally, our ability to exploit this technology in the future depends on our
continued renewal of an exclusive license of source codes from a third party.

Our growth prospects will be reduced if the smart card market does not develop.

         Our future growth and operating results will depend, in part, on
whether our Smarty family of smart card readers achieves significant sales. A
smart card reader retrieves information from a card that uses a microprocessor
or memory chip for security and data storage purposes. The current primary use
for Smarty is as a smart card token-based security application designed to
provide protection from unauthorized access to digital information. However, the
market for network and electronic commerce security applications is still
emerging and the smart card may not become the industry standard for these
applications. Similarly, the market for other smart card applications may not
develop, or may develop more slowly than we expect. If the market for the Smarty
family of products fails to develop or develops more slowly than expected, or if
any of the standards supported by us do not achieve or sustain market
acceptance, our growth prospects would be reduced.

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

         Our arrangements with SanDisk, Iomega, 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. Any
indemnification claim may require us to pay substantial damages, which could
negatively impact our financial condition.

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

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

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

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


                                       33
<PAGE>

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. To minimize this risk, we
maintain our portfolio of short-term investments in a variety of securities
including government and government agency notes, corporate bonds and notes and
asset-backed securities with contractual maturities of less than two years. Our
investment portfolio includes only marketable securities with active secondary
or resale markets to ensure portfolio liquidity. We do not expect any material
loss from our marketable security investments and, therefore, believe that our
potential interest rate exposure is not material.

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

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

         Foreign Exchange Risk. We are exposed to currency exchange fluctuations
since we sell our products internationally. We are also exposed to currency
fluctuations associated with our Japanese branch, however, revenue and expense
items of the Japanese branch are denominated in yen. Changes in foreign exchange
rates impact the results of operations of the Japanese branch when translated
into U.S. dollars. While most of the transactions of our United States and
Japanese operations are dollar or yen denominated, some transactions are
denominated in other currencies. Since the accounting records of our Japanese
operations are kept in yen, any non-yen denominated transactions are accounted
for in yen at the time of the transaction. Upon settlement of such a
transaction, any foreign currency gain or loss results in an adjustment to
income. We could be required to denominate our product sales in currencies other
than yen in the future,


                                       34
<PAGE>

which would make the management of currency fluctuations more difficult and
expose us to greater currency risk.

         Some accounts of our U.S. and Japanese operations are denominated in
currencies other than the dollar or yen and are remeasured to the dollar or yen
at the end of the accounting period. This remeasurement also results in an
adjustment to income. Additionally, the balance sheet accounts of our Japanese
operations are translated to dollars for financial reporting purposes and
resulting adjustments are made to stockholders' equity. The value of the yen may
strengthen or weaken against the dollar, which would impact the value of
stockholders' investment in our common stock. The strengthening of the yen
against the U.S. dollar in the three months ended March 31, 2000 contributed the
most significant portion of the foreign currency translation gain adjustment
during that period. This amount is included in accumulated other comprehensive
income and shown in the equity section of our balance sheet.

         We do not currently hedge against foreign currency exposure. The lack
of a hedging program exposes us to foreign currency gains and losses. We have
not incurred significant realized losses on exchange transactions. If realized
losses on foreign transactions were to become significant, we would evaluate
appropriate strategies, including the possible use of foreign exchange
contracts, to reduce such losses.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 2. Changes in Securities and Use of Proceeds

         Between January 1, 2000 and June 30, 2000, we issued approximately
108,000 shares of common stock to employees, directors and consultants. Such
shares were issued upon exercise of stock options with exercise prices ranging
from $0.72 to $35.00 per share. All of such shares were purchased by cash except
Timothy Tomlinson, one of our directors, paid the par value in cash and the
balance by delivery of a full recourse promissory note in the principal amount
of $209,994.

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


                                       35
<PAGE>

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

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

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

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

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

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

         We believe our cash and cash equivalents, short-term investments,
credit facility and the net proceeds of the initial public offering, will be
sufficient to meet our working capital and anticipated capital expenditure needs
for at least the next 12 months. We may need to raise


                                       36
<PAGE>

additional capital if we expand more rapidly than initially planned, to develop
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.

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

(a) We held our annual stockholders' meeting on May 23, 2000.

(b) Not applicable.

(c) The matters voted on at the annual stockholders' meeting and the tabulation
of votes are as follows:

   i)  Election of the following to the Board of Directors:

                                                          VOTES
 -------------------------------------------------------------------------------
                                               FOR                   WITHHELD
 -------------------------------------------------------------------------------
   Michael S. Battaglia                     11,093,614                10,133

   Timothy Tomlinson                        11,093,614                10,133

   Joseph M. Tucci                          11,093,614                10,133


   ii) Approval of the amendment of our 1999 Incentive Compensation Plan:

                                      VOTES
 -------------------------------------------------------------------------------
     FOR                 AGAINST               ABSTAIN         BROKER NON-VOTES
 -----------           -----------            ---------       ------------------
  8,688,271             1,417,784               2,880              994,812


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<PAGE>

Item 6. Exhibits and Reports on Form 8-K

          (a)     Exhibits:

        Exhibit         Description
          No.
    ---------------    ----------------------------------------------------

         10.3          1999 Incentive Compensation Plan, as amended

         10.25         Agreement for the exchange of the whole of the
                       issued share capital of Impleo Limited dated April
                       28, 2000 among SmartDisk Corporation and the
                       stockholders of Impleo Limited.

         27.1          Financial Data Schedule (available in EDGAR format only)


          (b)     Reports on Form 8-K:

         The following reports were filed on Form 8-K or Form 8-K/A during the
quarter ended June 30, 2000:

          o    Current Report on Form 8-K dated May 4, 2000 was filed on May 5,
               2000 pursuant to Item 5 - Other Events, and Item 7 - Financial
               Statements, Pro Forma Financial Information and Exhibits.
          o    Amended Current Report on Form 8-K/A dated May 4, 2000 was filed
               on May 8, 2000 pursuant to Item 5 - Other Events, and Item 7 -
               Financial Statements, Pro Forma Financial Information and
               Exhibits.
          o    Amended Current Report on Form 8-K/A dated March 6, 2000 was
               filed on May 11, 2000 pursuant to Item 7 - Financial Statements,
               Pro Forma Financial Information and Exhibits.


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<PAGE>

                                   SIGNATURES

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

                                       SMARTDISK CORPORATION



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



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



Dated:    August 11, 2000



                                       39
<PAGE>

                                  Exhibit Index


Exhibit No.        Exhibit Description
-----------        ------------------

   10.3            1999 Incentive Compensation Plan, as amended

   10.25           Agreement for the exchange of the whole of the issued share
                   capital of Impleo Limited dated April 28, 2000 among
                   SmartDisk Corporation and the stockholders of Impleo Limited.

   27.1            Financial Data Schedule (available in EDGAR format only)