<PAGE>

--------------------------------------------------------------------------------
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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

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

                                   FORM 10-Q

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

    For the quarterly period ended June 30, 2001

                                       OR

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

    For the transition period from to

                       Commission File Number: 000-27257

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

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

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

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

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

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

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

   As of July 31, 2001, there were 17,725,350 shares of the Registrant's Common
Stock outstanding, par value $0.001.

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

                             SMARTDISK CORPORATION

                                     INDEX

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

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

    1)   Condensed Consolidated Balance Sheets as of December 31, 2000
         and June 30, 2001..............................................     3

    2)   Condensed Consolidated Statements of Operations for the three
         and six months ended June 30, 2000 and 2001....................     4

    3)   Condensed Consolidated Statements of Cash Flows for the six
         months ended June 30, 2000 and 2001............................     5

    4)   Notes to Condensed Consolidated Financial Statements...........     6

 Item 2. Management's Discussion and Analysis of Financial Condition and
         Results of Operations..........................................    10

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

                        PART II. OTHER INFORMATION

 Item 1. Legal Proceedings..............................................    28

 Item 2. Changes in Securities and Use of Proceeds......................    28

 Item 4. Submission of Matters to a Vote of Security Holders............    29

 Item 6. Exhibits and Reports on Form 8-K...............................    29

 SIGNATURES..............................................................   30
</TABLE>

                                       2
<PAGE>

                         PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

                             SMARTDISK CORPORATION

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                        (in thousands, except par value)

<TABLE>
<CAPTION>
                                                       December 31,  June 30,
                                                           2000        2001
                                                       ------------ -----------
                                                                    (Unaudited)
<S>                                                    <C>          <C>
                        ASSETS
                        ------

Current assets:
  Cash and cash equivalents...........................   $ 12,833    $ 10,807
  Restricted cash.....................................      1,671         141
  Short-term investments..............................      6,001       6,607
  Accounts and notes receivable, net..................      7,204       8,218
  Inventories.........................................     16,666       9,756
  Prepaid expenses and other current assets...........      3,262       2,648
                                                         --------    --------
    Total current assets..............................     47,637      38,177
Property and equipment, net...........................      3,265       2,689
Goodwill and other intangible assets, net.............     75,098      60,128
Deposits and other assets.............................        309         239
                                                         --------    --------
TOTAL ASSETS..........................................   $126,309    $101,233
                                                         ========    ========

         LIABILITIES AND STOCKHOLDERS' EQUITY
         ------------------------------------

Current liabilities:
  Accounts payable....................................   $  9,125    $  5,047
  Bank line of credit.................................      1,907       1,364
  Income taxes payable................................        878         623
  Deferred revenue....................................        725         --
  Other accrued liabilities...........................      4,865       5,548
                                                         --------    --------
    Total current liabilities.........................     17,500      12,583
Deferred income taxes and other.......................      8,494       5,106

Commitments and contingencies

Stockholders' equity:
  Preferred stock, $0.001 par value; 5,000 shares
   authorized; none issued............................        --          --
  Common stock, $0.001 par value; 60,000 shares
   authorized; 17,596 issued and 17,509 outstanding at
   December 31, 2000; 17,812 issued and 17,724
   outstanding at June 30, 2001.......................         18          18
  Capital in excess of par value......................    146,388     146,685
  Treasury stock, 87 shares at December 31, 2000 and
   88 shares at June 30, 2001, at cost................        (89)        (89)
  Accumulated other comprehensive income (loss).......        315        (209)
  Notes receivable from officers/employees............       (336)       (303)
  Unearned compensation...............................        --          (12)
  Accumulated deficit.................................    (45,981)    (62,546)
                                                         --------    --------
    Total stockholders' equity........................    100,315      83,544
                                                         --------    --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............   $126,309    $101,233
                                                         ========    ========
</TABLE>

           See notes to condensed consolidated financial statements.

                                       3
<PAGE>

                             SMARTDISK CORPORATION

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                        Three Months Ended    Six Months Ended
                                             June 30,             June 30,
                                        --------------------  -----------------
                                          2000       2001      2000      2001
                                        ---------  ---------  -------  --------
<S>                                     <C>        <C>        <C>      <C>
REVENUE
 Net product sales....................  $  30,837  $  20,208  $47,032  $ 37,040
 Research and development.............         61        100    1,209       100
 License fees and royalties...........         30        367       71       797
                                        ---------  ---------  -------  --------
   Total revenue......................     30,928     20,675   48,312    37,937
COST OF REVENUE.......................     21,480     15,433   32,811    27,862
                                        ---------  ---------  -------  --------
GROSS PROFIT..........................      9,448      5,242   15,501    10,075
OPERATING EXPENSES
 Research and development.............      2,543      2,454    4,548     4,963
 Sales and marketing..................      1,757      2,041    2,565     4,316
 General and administrative...........      2,897      3,109    5,065     5,992
 Amortization of goodwill and other
  acquisition related intangible
  assets..............................      7,396      7,525    9,634    15,075
                                        ---------  ---------  -------  --------
   Total operating expenses...........     14,593     15,129   21,812    30,346
                                        ---------  ---------  -------  --------
OPERATING LOSS........................     (5,145)    (9,887)  (6,311)  (20,271)
Interest and other income, net........        295        259    1,013       706
Interest expense......................        (41)        (6)     (88)      (13)
                                        ---------  ---------  -------  --------
Net loss before income taxes..........     (4,891)    (9,634)  (5,386)  (19,578)
Income tax benefit....................       (619)    (1,450)    (612)   (3,013)
                                        ---------  ---------  -------  --------
NET LOSS..............................  $  (4,272) $  (8,184) $(4,774) $(16,565)
                                        =========  =========  =======  ========
Loss per share--basic and diluted.....  $   (0.25) $   (0.47) $ (0.29) $  (0.95)
                                        =========  =========  =======  ========
Shares used in per share computation..     17,043     17,543   16,524    17,436
                                        =========  =========  =======  ========
</TABLE>




           See notes to condensed consolidated financial statements.

                                       4
<PAGE>

                             SMARTDISK CORPORATION

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)
                                 (in thousands)

<TABLE>
<CAPTION>
                                                             Six Months Ended
                                                                 June 30,
                                                             ------------------
                                                               2000      2001
                                                             --------  --------
<S>                                                          <C>       <C>
Cash flows from operating activities:
  Net loss.................................................. $ (4,774) $(16,565)
  Adjustments to reconcile net loss to net cash provided by
   (used in) operating activities:
    Depreciation and amortization...........................   10,874    16,352
    Provision for uncollectible accounts, sales returns and
     other credits..........................................      155       517
    Provision for inventory obsolescence....................      410       456
    Deferred income taxes...................................   (2,219)   (3,380)
    Other...................................................      (21)     (363)
    Changes in assets and liabilities:
      Accounts and notes receivable.........................   (2,021)   (1,531)
      Inventories...........................................     (133)    6,454
      Prepaid expenses and other current assets.............     (377)      606
      Deposits and other assets.............................     (104)       71
      Accounts payable......................................    1,143    (4,078)
      Income taxes payable..................................     (962)     (255)
      Deferred revenue......................................     (308)     (725)
      Other accrued liabilities.............................     (447)      684
                                                             --------  --------
        Net cash provided by (used in) operating
         activities.........................................    1,216    (1,757)
Cash flows from investing activities:
  Purchases of property and equipment, net of disposals.....     (741)     (487)
  Cash paid for acquisitions, net of cash acquired..........  (18,079)      --
  Cash paid for intellectual property.......................     (755)     (250)
  Decrease in restricted cash...............................      --      1,529
  Purchases of short-term investments.......................   (9,117)   (5,600)
  Sales and maturities of short-term investments............   22,910     5,007
                                                             --------  --------
        Net cash (used in) provided by investing
         activities.........................................   (5,782)      199
Cash flows from financing activities:
  Net repayments under lines of credit......................   (7,119)     (542)
  Collections on notes receivable from officers/employees...        6        33
  Proceeds from exercise of stock options...................      149       191
  Proceeds from stock issued under ESPP.....................      371        88
  Purchase of treasury stock................................      --         (1)
                                                             --------  --------
Net cash used in financing activities.......................   (6,593)     (231)
Effect of exchange rate fluctuations on cash................       33      (237)
                                                             --------  --------
Decrease in cash and cash equivalents.......................  (11,126)   (2,026)
Cash and cash equivalents at beginning of period............   19,080    12,833
                                                             --------  --------
Cash and cash equivalents at end of period.................. $  7,954  $ 10,807
                                                             ========  ========
Significant non-cash activities:
  Issuance of common stock for intellectual property........ $    240  $    --
  Note receivable obtained for stock option exercise........ $    210  $    --
</TABLE>

           See notes to condensed consolidated financial statements.

                                       5
<PAGE>

                             SMARTDISK CORPORATION

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

Note 1. Basis of Presentation

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

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

   The unaudited interim condensed consolidated financial statements should be
read in conjunction with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in this report and the audited
consolidated financial statements and accompanying notes included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2000,
filed with the Securities and Exchange Commission.

Note 2. Inventories

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

<TABLE>
<CAPTION>
                                                           December 31, June 30,
                                                               2000       2001
                                                           ------------ --------
                                                              (in thousands)
   <S>                                                     <C>          <C>
   Finished goods.........................................   $ 6,147     $5,564
   Raw materials..........................................    10,519      4,192
                                                             -------     ------
     Total inventories....................................   $16,666     $9,756
                                                             =======     ======
</TABLE>

Note 3. Net Loss Per Share

   For the three months ended June 30, 2000 and 2001, potential common shares
totaling approximately 1,458,000 and 246,000, respectively, were excluded from
the computation of net loss per share because their effect was anti-dilutive.
For the six months ended June 30, 2000 and 2001, potential common shares
totaling approximately 1,585,000 and 386,000, respectively, were excluded from
the computation of net loss per share because their effect was anti-dilutive.
Potential common shares include stock options and shares of non-vested stock.

                                       6
<PAGE>

                             SMARTDISK CORPORATION

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Note 4. Comprehensive Loss

   Other comprehensive income (loss) refers to revenue, expenses, gains, and
losses that under accounting principles generally accepted in the United States
are included in comprehensive loss but are excluded from net loss as these
amounts are recorded directly as an adjustment to stockholders' equity, net of
tax. SmartDisk's other comprehensive income (loss) is composed of unrealized
gains and losses on available-for-sale securities and foreign currency
translation adjustments. The following table sets forth the computation of
comprehensive loss for the periods indicated:

<TABLE>
<CAPTION>
                                       Three Months Ended    Six Months Ended
                                            June 30,             June 30,
                                       --------------------  -----------------
                                         2000       2001      2000      2001
                                       ---------  ---------  -------  --------
                                                  (in thousands)
<S>                                    <C>        <C>        <C>      <C>
Net loss.............................. $  (4,272) $  (8,184) $(4,774) $(16,565)
Other comprehensive income (loss):
  Unrealized gain (loss) on short-term
   investments, net of tax............        13         (1)      (4)       (2)
  Foreign currency translation
   adjustment.........................         8        (99)     (57)     (522)
                                       ---------  ---------  -------  --------
    Total comprehensive loss.......... $  (4,251) $  (8,284) $(4,835) $(17,089)
                                       =========  =========  =======  ========
</TABLE>

Note 5. Acquisitions

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

Note 6. Segment Information

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

                                       7
<PAGE>

                             SMARTDISK CORPORATION

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


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

<TABLE>
<CAPTION>
                                                 Three Months     Six Months
                                                Ended June 30,  Ended June 30,
                                                --------------- ---------------
                                                 2001    2000    2001    2000
                                                ------- ------- ------- -------
                                                        (in thousands)
<S>                                             <C>     <C>     <C>     <C>
Digital connectivity products:
  Revenue...................................... $14,227 $ 9,507 $24,439 $15,709
                                                ======= ======= ======= =======
  Gross profit................................. $ 5,305 $ 2,728 $ 8,750 $ 4,789
                                                ======= ======= ======= =======
Personal storage products:
  Revenue...................................... $16,610 $10,701 $22,593 $21,331
                                                ======= ======= ======= =======
  Gross profit................................. $ 4,052 $ 2,196 $ 5,471 $ 4,697
                                                ======= ======= ======= =======
Other:
  Revenue...................................... $    91 $   467 $ 1,280 $   897
                                                ======= ======= ======= =======
  Gross profit................................. $    91 $   318 $ 1,280 $   589
                                                ======= ======= ======= =======
Total
  Revenue...................................... $30,928 $20,675 $48,312 $37,937
                                                ======= ======= ======= =======
  Gross profit................................. $ 9,448 $ 5,242 $15,501 $10,075
                                                ======= ======= ======= =======
</TABLE>

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

Note 7. Recent Accounting Pronouncements

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

   In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. SFAS No. 141 also
specifies criteria intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be
accounted for separately. The requirements of SFAS No. 141 are effective for
any business combination accounted for by the purchase method that is completed
after June 30, 2001. Under SFAS No. 142, goodwill and intangible assets with
indefinite useful lives are no longer amortized, but are reviewed annually, or
more frequently if impairment indicators arise, for impairment. SFAS No. 142
will also require that intangible assets with definite useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with SFAS No. 121,
Accounting for the Impairment of

                                       8
<PAGE>

                             SMARTDISK CORPORATION

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The amortization
provisions of SFAS No. 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and intangible assets acquired
prior to July 1, 2001, the amortization provisions of SFAS No. 142 are
effective upon adoption of SFAS No. 142. Companies are required to adopt SFAS
No. 142 in their fiscal year beginning after December 15, 2001 (i.e., January
1, 2002 for calendar year companies).

   Because of the extensive effort required to comply with the adoption of SFAS
No. 141 and SFAS No. 142, it is not practicable to reasonably estimate the
impact of adopting these Statements on the Company's financial statements at
the date of this report, including whether any transitional impairment losses
will be required to be recognized as the cumulative effect of a change in
accounting principle. However, for the three and six months ended June 30,
2001, the Company recognized $3.3 million and $6.7 million of goodwill
amortization, respectively.

Note 8. Contingencies

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

   On June 26, 2000, a party filed a complaint in the Central District Federal
Court of the State of California alleging SmartDisk's infringement of a patent.
On November 20, 2000, the Company prevailed in moving the venue for such action
from the State of California to the Middle District of Florida. The Company
considers this claim to be wholly without merit and SmartDisk will vigorously
defend against such claim. Accordingly, a contingent loss has not been accrued
by the Company as of June 30, 2001.

Note 9. Subsequent Events

   Subsequent to June 30, 2001, a securities class action suit was filed
against SmartDisk, the following executive officers and directors: Addison M.
Fischer, Michael S. Battaglia and Michael R. Mattingly, and the following
underwriters of SmartDisk's initial public offering: BancBoston Robertson
Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. The
suit was filed in the United States District Court for the Southern District of
New York on behalf of all persons who acquired SmartDisk securities between
October 6, 1999 and December 6, 2000. The complaint charges defendants with
violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and
Section 10(b) of the Securities Exchange Act of 1934 (and Rule 10b-5
promulgated thereunder), for issuing a Registration Statement and Prospectus
("Prospectus") that contained material misrepresentations and/or omissions. The
complaint alleges that the Prospectus was false and misleading because it
failed to disclose (i) the agreements between BancBoston Robertson Stephens,
Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain
investors to provide them with significant amounts of restricted SmartDisk
shares in the initial public offering ("IPO") in exchange for excessive and
undisclosed commissions; and (ii) the agreements between BancBoston Robertson
Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and
certain customers under which the underwriters would allocate shares in the IPO
to those customers in exchange for the customers' agreement to purchase
SmartDisk shares in the after-market at pre-determined prices. The complaint
seeks an undisclosed amount of damages, as well as attorney fees. SmartDisk
considers this claim, as it relates to the Company, to be wholly without merit
and SmartDisk will vigorously defend against such claim.

                                       9
<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
interim condensed consolidated financial statements and the notes thereto
included in Item 1 of this Quarterly Report.

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

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

Overview

   We design, develop, manufacture and market a range of consumer electronic
products and software solutions that are enabling the digital age and
simplifying the digital lifestyle. Our products help users transfer, store,
manage and share digital music, video, pictures and data. Our digital
connectivity products enable the easy and convenient sharing of information
stored on flash media cards between digital appliances and PCs. Our personal
storage products and related software are designed to provide an easy way to
store, organize and retrieve digital data on portable, high-speed, high-
capacity disk drives. Our innovative software will offer consumers the ability
to create multimedia CDs that combine their digital music, videos and pictures
and then share them with or without using a PC.

   Our digital connectivity products are designed to work across all popular PC
platforms, support all leading flash memory media types and use high
performance PC interfaces, such as Universal Serial Bus (USB). Our patented
FlashPath products allow consumers to use the familiar 3.5-inch floppy drive--
found on most PCs worldwide--to simplify the exchange of images and other
digital data between PCs and digital appliances. We market three FlashPath
products that support four different flash memory cards: the SanDisk
MultiMediaCard, the Sony Memory Stick, the Toshiba SmartMedia card and the
SanDisk, Toshiba and Matsushita Secure Digital (SD) Card. These flash memory
cards are used in various digital appliances including digital still cameras,
digital video cameras, digital audio players and personal digital assistants
made by a number of

                                       10
<PAGE>

leading electronics manufacturers, including FujiFilm, JVC, Olympus, Palm,
Panasonic, Sanyo, Sharp, Sony and Toshiba. Our high-speed Dual Media Reader and
Tri-Media Reader address an expanding installed base of PCs with USB cable
interfaces and are compatible with both Windows and Macintosh operating
systems. During the second quarter, we introduced a new line of USB-based flash
media readers that enable quicker transfer of digital files to PCs that include
photo editing and management software. We believe that as consumers embrace the
digital lifestyle, the number of applications for flash memory cards will
continue to grow.

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

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

Recent Developments

   Closing of Acton Facility. On May 31, 2001, we announced our intention to
close our Acton, Massachusetts facility and move those operations to our
Naples, Florida headquarters. We anticipate these actions will allow us to
centralize our operations, marketing and development efforts, improve
efficiencies and increase our effectiveness. In connection with this closing,
we recognized approximately $0.5 million in severance costs in the quarter
ended June 30, 2001. We expect the closing to be substantially complete by
September 30, 2001. As a result, we anticipate incurring additional costs
during the third quarter associated with employee separation costs, excess
facility costs and the disposal of fixed assets.

Results of Operations

   Revenue. Total revenue was approximately $20.7 million for the three months
ended June 30, 2001 compared to approximately $30.9 million for the three
months ended June 30, 2000. Total revenue was approximately $37.9 million for
the six months ended June 30, 2001 compared to approximately $48.3 million for
the six months ended June 30, 2000. These decreases primarily resulted from a
decline in demand for our FlashPath products and various personal storage
products and a decline in R&D revenue.

   Product revenue is recognized when title and risk of loss are transferred to
customers, which is generally at the time of shipment. We defer recognition of
revenue on shipments to certain distributors until the distributors have resold
the products. We record a provision for estimated product returns at the time
the related revenue is recognized on sales to certain resellers that have
rights of return. Product revenue at our Japanese subsidiary is recognized upon
acceptance by the customer.

   Revenue from the sale of digital connectivity products decreased from
approximately $14.2 million for the three months ended June 30, 2000 to
approximately $9.5 million for the three months ended June 30, 2001. Product
revenue from the sale of digital connectivity products decreased from
approximately $24.4 million for the six months ended June 30, 2000 to
approximately $15.7 million for the six months ended June 30, 2001. These
decreases were primarily attributable to the anticipated decline in the use of
the 3.5-inch floppy drive as a flash memory card interface, as consumers move
towards devices with higher transfer speeds, such as our USB-based flash media
readers. This is contributing to the decline in sales of our FlashPath
products. We

                                       11
<PAGE>

expect this trend to continue during the remainder of 2001, resulting in
revenue from digital connectivity products being lower than the 2000 revenue
associated with these products.

   Revenue from the sale of personal storage products decreased from
approximately $16.6 million for the three months ended June 30, 2000 to
approximately $10.7 million for the three months ended June 30, 2001. Product
revenue from the sale of personal storage products decreased from approximately
$22.6 million for the six months ended June 30, 2000 to approximately $21.3
million for the six months ended June 30, 2001. These decreases were primarily
attributable to a decline in demand for our USB- and FireWire-based products
arising from the continued weakness in the U.S. economy, as well as a decline
in demand for expansion bay products due to the redesign of Apple laptop
computers, which no longer contain expansion bay capabilities. In addition, we
decreased the sale prices of various personal storage products in order to
promote sales of excess and aging inventory. With improvement in the technology
segment and the overall economy, we expect this trend to improve.

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

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

   Cost of Revenue. Cost of revenue includes the purchased cost of product,
packaging, freight, scrap, and inventory write downs, as well as royalties for
some of our digital connectivity products and personal storage products. Cost
of revenue decreased to approximately $15.4 million for the three months ended
June 30, 2001 compared to approximately $21.5 million for the three months
ended June 30, 2000. Cost of revenue decreased to approximately $27.9 million
for the six months ended June 30, 2001 compared to approximately $32.8 million
for the six months ended June 30, 2000. These decreases in cost were due
primarily to lower sales volume of our FlashPath products and certain personal
storage products.

   Gross Profit. Our gross profit for the three months ended June 30, 2001
decreased to approximately $5.2 million or 25% of total revenue, compared to
approximately $9.5 million or 31% of total revenue for the three months ended
June 30, 2000. Our gross profit for the six months ended June 30, 2001
decreased to approximately $10.1 million or 27% of total revenue, compared to
approximately $15.5 million or 32% of total revenue for the six months ended
June 30, 2000. These decreases in the amount of gross profit are primarily
attributable to a decline in demand for our FlashPath products, various aging
personal storage products with declining margins and the decrease of research
and development revenue.

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

   Research and Development Expenses. Our research and development expenses
consist primarily of salaries and payroll-related expenses for our design and
development engineers, as well as prototype supplies and contract or
professional services. These expenses were approximately $2.5 million, or 12%
of total revenue, for the three months ended June 30, 2001 compared to
approximately $2.5 million, or 8% of total revenue, for the three months ended
June 30, 2000. Research and development expenses increased to approximately
$5.0 million, or 13% of total revenue, for the six months ended June 30, 2001
compared to approximately $4.5 million, or 9% of total revenue, for the six
months ended June 30, 2000. The increase for the six months ended June 30, 2001
was primarily attributable to the inclusion of VST's results for the six months
ended June 30, 2001 compared to the period from March 6, 2000 to June 30, 2000
in the preceding year.

                                       12
<PAGE>

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

   Sales and Marketing Expenses. Sales and marketing expenses include salaries,
benefits and travel expenses for our sales, marketing and product management
personnel in the United States, Japan and the United Kingdom. These expenses
also include other selling and marketing expenditures for items such as trade
shows, advertising, marketing and other promotional programs. Sales and
marketing expenses for the three and six months ended June 30, 2001 increased
by approximately $0.3 million and $1.8 million to approximately $2.0 million
and $4.3 million compared to the three and six months ended June 30, 2000,
respectively. These increases were primarily attributable to the inclusion of
VST's results for the six months ended June 30, 2001 compared to the period
from March 6, 2000 to June 30, 2000 in the preceding year. In connection with
the VST acquisition in March 2000, we added a number of new products to our
existing product lines, significantly increasing our total sales and marketing
expenses. These added products require more catalog and magazine advertising
than we have needed in the past due to our OEM relationships. In addition, we
have increased our sales and marketing personnel to support the launch of new
products and broadening of our distribution into more traditional consumer
electronic and mass retail channels. We expect our sales and marketing expenses
to increase in the future as we continue to support new product introductions
and retail distribution initiatives.

   General and Administrative Expenses. General and administrative expenses
include the salaries and related expenses of our executive management, finance,
information systems, operations, human resources, legal and administrative
functions, as well as lease rental expense, utilities, maintenance expenses,
taxes, insurance, legal and accounting professional fees, depreciation and
amortization. General and administrative expenses increased to approximately
$3.1 million and $6.0 million for the three and six months ended June 30, 2001
compared to approximately $2.9 million and $5.1 million for the three and six
months ended June 30, 2000. The increase for the six months ended June 30, 2001
is primarily due to the inclusion of VST's results for the six months ended
June 30, 2001 compared to the period from March 6, 2000 to June 30, 2000 in the
preceeding year, as well as, increases in professional services, legal fees and
personnel related costs. We expect the closing of our Acton, Massachusetts
facility and the relocation of those operations to our Naples, Florida
headquarters to be substantially complete by September 30, 2001. As a result,
we anticipate incurring additional costs during the third quarter associated
with employee separation costs, excess facility costs and the disposal of fixed
assets. We expect our general and administrative expenses to decrease
subsequent to the closing.

   Amortization of Goodwill and Other Acquisition Related Intangible
Assets. Amortization of goodwill and other acquisition related intangible
assets includes the amortization of the purchase price allocated to separately
identified intangible assets acquired in the acquisition of VST Technologies,
Inc. and Impleo Limited and from El Gato Software LLC. The separately
identified intangible assets acquired consist of non-compete agreements,
distribution channels, trade names, patents, and workforce in place. These
intangible assets have lives ranging from one to five years from the date of
acquisition. Purchase price not allocated to separately identified intangible
assets was allocated to goodwill. Goodwill is amortized over a five-year life
from the date of acquisition. For the three and six months ended June 30, 2001,
amortization of goodwill and other acquisition related intangible assets
totaled approximately $7.5 million and $15.1 million, respectively, compared to
approximately $7.4 million and $9.6 million for the three and six months ended
June 30, 2000. The increase for the six months ended June 30, 2001 is
attributable to the inclusion of the amortization associated with the
acquisitions of VST and Impleo for the six months ended June 30, 2001 compared
to the period from March 6, 2000 to June 30, 2000 for VST and April 28, 2000 to
June 30, 2000 for Impleo.

   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.

                                       13
<PAGE>

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

   Provision for Income Taxes. We are subject to tax in the United States,
Japan, Switzerland and the United Kingdom. These jurisdictions have different
marginal tax rates. For the three and six months ended June 30, 2001, income
tax expense totaled approximately $ 0.2 million and $0.4 million, respectively.
These amounts were offset by income tax benefits of approximately $1.7 million
and $3.4 resulting from amortization expense on certain intangible assets
related to the VST and Impleo acquisitions. A valuation allowance is provided
to reduce deferred tax assets to the amount that will more likely than not be
realized.

Liquidity and Capital Resources

   Cash and cash equivalents decreased to approximately $10.8 million at June
30, 2001 from approximately $12.8 million at December 31, 2000. In addition to
cash and cash equivalents, we have approximately $6.6 million in short-term
investments and approximately $0.1 million in restricted cash.

   During the six months ended June 30, 2001, we used approximately $1.8
million and $0.2 million in operating and financing activities, respectively,
offset in part by approximately $0.2 provided by investing activities.

   Net cash used in operating activities was approximately $1.8 million for the
six months ended June 30, 2001 compared to cash provided by operating
activities of approximately $1.2 million for the six months ended June 30,
2000. Our net loss of approximately $16.6 million primarily included non-cash
charges of approximately $16.4 million for depreciation and amortization and
approximately $1.0 million for provisions for uncollectible accounts, sales
returns and other credits and inventory obsolescence offset by a decrease in
deferred income taxes of approximately $3.4 million. We also used cash through
changes in our operating assets and liabilities. We decreased accounts payable
by approximately $4.1 million and increased accounts receivable by
approximately $1.5 million. These amounts were offset by a decrease in
inventories of approximately $6.5 million. Our accounts payable decreased
primarily as a result of lower purchases of inventory. Our accounts receivable
increased due to an increase in revenue for the three months ended June 30,
2001 compared to the three months ended December 31, 2000. Our inventories
decreased as a result of lower purchases of inventory along with the sale of
the inventory acquired in previous quarters.

   Net cash provided by investing activities was approximately $0.2 million for
the six months ended June 30, 2001 compared to cash used in investing
activities of approximately $5.8 million for the six months ended June 30,
2000. The most significant contributors of cash from investing activities in
the first half of 2001 were approximately $5.0 million in connection with the
sale of short-term investments and a decrease in restricted cash of
approximately $1.5 million. These amounts were partially offset by purchases of
short-term investments of approximately $5.6 million and approximately $0.7
million primarily used for the acquisition of the intellectual property of
Multimedia Technology Center and equipment used in research, development,
operational and administrative activities.

   Net cash used in financing activities was approximately $0.2 million and
$6.6 million for the six months ended June 30, 2001 and 2000, respectively.
Cash used in financing activities in the first half of 2001 was primarily
attributable to net repayments under our lines of credit in Japan and the
United Kingdom. During the first half of 2000, we used approximately $4.3
million to pay off the line of credit assumed as part of the acquisition of VST
and $3.0 million to repay credit facilities in Japan.

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

   As of June 30, 2001, our Japanese subsidiary had a line of credit with a
maximum borrowing capacity of approximately $1.2 million, which was secured by
accounts receivable of specified trade customers and a time

                                       14
<PAGE>

deposit. The outstanding balance under the line of credit was approximately
$1.2 million as of June 30, 2001. The line of credit was renewed in July 2001
with a maximum borrowing capacity of $0.8 million and expires in October 2001.
The interest rate on borrowings under the new credit facility is 1.375% per
year.

   As of June 30, 2001, our Japanese subsidiary also had a loan payable of
approximately $0.2 million, which will be repaid in August 2001. This loan
bears interest at an annualized rate of 1.375%.

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

   We believe our cash and cash equivalents, short-term investments, credit
facilities and the remaining net proceeds of our initial public offering in
October 1999, will be sufficient to meet our working capital and anticipated
capital expenditure needs for at least the next 12 months. We may need to raise
additional capital if we expand more rapidly than currently planned, to develop
and market new or enhanced products and/or services, to respond to competitive
pressures or to acquire complementary products, businesses or technologies. The
capital, if needed, may not be available or may not be available on terms
acceptable to us.

Recent Accounting Pronouncements

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

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

   Because of the extensive effort needed to comply with adopting SFAS No. 141
and SFAS No. 142, it is not practicable to reasonably estimate the impact of
adopting these Statements on our financial statements at the date of this
report, including whether any transitional impairment losses will be required
to be recognized as the cumulative effect of a change in accounting principle.
However, for the three and six months ended June 30, 2001, we recognized $3.3
million and $6.7 million of goodwill amortization, respectively.

                                       15
<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 profitable
 in the future.

   Except for the third and fourth quarters of 1999, we have incurred net
losses on a quarterly basis since inception. We had a net loss of
approximately $16.6 million for the six months ended June 30, 2001, primarily
as a result of $11.7 million in amortization of goodwill and other intangible
assets from the VST and Impleo acquisitions, net of tax. In addition, as of
June 30, 2001, we had an accumulated deficit of approximately $62.5 million.
In light of our loss history and the amortization of goodwill and other
intangible assets from the VST and Impleo acquisitions, we cannot assure you
that we will be profitable in the future.

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

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

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

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

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

   Our current FlashPath products only work in conjunction with the standard
3.5-inch floppy disk drive. While the 3.5-inch floppy disk drive is found
today in most PCs, a number of newer PC models do not have this device and new
industry standards may emerge that render the 3.5-inch floppy disk drive
obsolete. Advances in input devices such as CD-ROM and external data storage
disk drives, such as Zip drives, are reducing the need for the 3.5-inch floppy
diskette, which is contributing to the decrease in sales of our FlashPath
products. In the future, we will have to rely on our other products and
develop new products that use a different interface between personal computers
and digital appliances.

                                      16
<PAGE>

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

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

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

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

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

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

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

   To date, substantially all of our revenue has been derived from the sale of
only a few major products. While our long-term strategy is to derive revenue
from multiple products, we anticipate that the sale of our FlashPath products
and our USB and FireWire storage products will continue to represent the most
substantial portion of our net revenue through 2001. A decline in the price of
or demand for these products as a result of competition, technological change,
the introduction of new products by us or others, a failure to adequately
manage product transitions, or for other reasons, would seriously harm our
business. During the six months ended June 30, 2001, we derived approximately
76% of our product revenue from the sale of FlashPath and USB- and FireWire-
based personal storage products.

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

   We operate in an industry that is subject to evolving industry standards,
rapid technological changes, rapid changes in consumer demands and the rapid
introduction of new, higher performance products that shorten product life
cycles. To be competitive in this demanding market, we must both continue to
refine current products so that they remain competitive, and continually
design, develop and introduce, in a timely manner,

                                      17
<PAGE>

new products that meet the performance and price demands of OEMs and
consumers. Product development is inherently risky because it is difficult to
foresee developments in technology, coordinate our technical personnel and
strategic relationships, and identify and eliminate design flaws. These
development activities will require the investment of substantial resources
before revenue is derived from product sales. Any significant delay in
releasing new products would adversely affect our reputation, provide a
competitor a first-to-market opportunity or allow a competitor to achieve
greater market share. Further, we may not be able to recoup research and
development expenditures if new products are not widely commercially accepted.

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

   We may not be able to produce commercially viable products if we are unable
to anticipate market trends and the price, performance and functionality
requirements of flash memory card, PC and digital appliance manufacturers. We
must continue to collaborate closely with our customers, our OEM manufacturers
and our other contract manufacturers to ensure that critical development
projects proceed in a coordinated manner. This collaboration is also important
because our ability to anticipate trends and plan our product development
activities depends to a significant degree upon our continued access to
information derived from these strategic relationships. We currently rely on
strategic relationships with flash memory card manufacturers, such as SanDisk,
Sony and Toshiba, PC manufacturers, such as Apple, and consumer product OEMs,
such as Olympus and FujiFilm. If we cannot maintain our relationship with
these manufacturers then we may not be able to continue to develop products
that are compatible with their flash memory cards, PCs and digital appliances.
However, collaboration is more difficult because many of these companies are
located overseas. If any of our current relationships deteriorates or is
terminated, or if we are unable to enter into future alliances that provide us
with comparable insight into market trends, we will be hindered in our ability
to produce commercially viable products.

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

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

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

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

                                      18
<PAGE>

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

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

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

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

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

  . The timing and amount of research and development expenditures;

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

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

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

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

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

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

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

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

   The stock market has experienced significant price and volume fluctuations
that have particularly affected the market prices of the stocks of technology
companies. Recently, the market price of our common stock, like that of many
technology companies, has experienced significant fluctuations. For instance,
from October 6, 1999, the date of our IPO, to July 31, 2001, the reported last
sale price for our common stock ranged from $2.19 to $65.13 per share. On July
31, 2001, the reported last sale price of our common stock was $3.30 per
share.

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

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

   Our proprietary technology with respect to 3.5-inch floppy disk drive
interfaces and USB and FireWire source codes is critical to our future growth.
We rely in part on patent, trade secret, trademark and copyright law to
protect our intellectual property. However, the patents issued to us may not
be adequate to protect our proprietary rights, to deter misappropriation or to
prevent an unauthorized third party from copying our technology, designing
around the patents we own or otherwise obtaining and using our products,
designs or other information. We have, in fact, filed a complaint against one
of our former patent attorneys for improperly copying one of our patent
applications and filing a patent application without our consent naming
himself as a

                                      19
<PAGE>

co-inventor. This matter was settled with no materially adverse consequences to
SmartDisk. In addition, we may not receive trademark protection for our
"SmartDisk" name. We have filed for trademark registration of the name
"SmartDisk," but this has not yet been granted. We are aware of a trademark
application for the name "SmartDisk" that was filed by another company. Our
application could be denied and we could be prohibited from using the
"SmartDisk" name. In that event, we would be required to incur substantial
costs to establish new name recognition.

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

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

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

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

   From time to time we may receive communications from third parties asserting
that our products infringe, or may infringe, the proprietary rights of these
third parties. These claims of infringement may result in protracted and costly
litigation that could require us to pay substantial damages or have sales of
our products stopped by an injunction. Infringement claims could also cause
product shipment delays, require us to redesign our products or require us to
enter into royalty or licensing agreements, any of which could harm our
business. For example, we received communications alleging that our FlashPath
products infringed a third party's patent rights. We have met with this third
party, a non-public limited liability company, to gain a better understanding
of its claim and attempted to resolve the dispute through mediation. Such
mediation did not yield a resolution to the dispute and such party subsequently
filed a complaint in the Central District Federal Court of the State of
California. On November 20, 2000, we prevailed in moving the venue for such
action from the State of California to the Middle District of Florida. (See
Part II, Item 1. "Legal Proceedings"). While we believe that we do not infringe
upon this third party's patent and that such claim is wholly without merit, we
cannot guarantee that the effects or outcome of this litigation will be
favorable to SmartDisk. We also received correspondence alleging that our
SafeBoot product violated another third party's intellectual property rights.
We discussed this correspondence with counsel and concluded that our product
does not infringe upon the third party's rights. In addition, we license a
portion of the intellectual property included in our products from third
parties, which may increase our exposure to infringement actions because we
rely upon those third parties for information about the origin and ownership of
the licensed intellectual property. We may also lose our license rights with
respect to the intellectual property for which infringement is claimed.
Further, if our customers are required to obtain a license on other than
commercially reasonable terms, our business could be jeopardized.

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

   Our arrangements with Fuji Photo USA, Iomega, SanDisk, Sony, Toshiba and
others require us to indemnify them for any damages they may suffer if a third
party claims that we are violating their intellectual

                                       20
<PAGE>

property rights. While, to date, we have not received indemnification claims,
there may be future claims. For example, Fuji Photo USA has been named as a co-
defendant in the above referenced complaint. We have agreed to indemnify Fuji
Photo USA with respect to expenses or damages incurred by Fuji Photo USA in
connection with this matter. Any indemnification claim may require us to pay
substantial damages, which could negatively impact our financial condition.

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

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

   Recently, three class action suits were filed against one of the
underwriters in SmartDisk's initial public offering: FleetBoston Robertson
Stephens, Inc. (formerly BancBoston Robertson Stephens, Inc.). We have not been
named as a defendant in these suits. The suits were filed in the United States
District Court for the Southern District of New York on behalf of all persons
who acquired our common stock between October 6, 1999 and December 6, 2000. The
complaints allege violations of Sections 10(b) of the Securities Exchange Act
of 1934 (and Rule 10b-5 promulgated thereunder). The complaints allege that the
Registration Statement and Prospectus were false and misleading because they
failed to disclose (i) the agreements between BancBoston Robertson Stephens,
Inc. and certain investors to provide them with significant amounts of
restricted SmartDisk shares in the initial public offering (IPO) in exchange
for excessive and undisclosed commissions; and (ii) the agreements between
BancBoston Robertson Stephens, Inc. and certain customers under which the
underwriters would allocate shares in the IPO to those customers in exchange
for the customers' agreement to purchase SmartDisk shares in the after-market
at pre-determined prices. The complaints seek an undisclosed amount of damages,
as well as attorney fees. No lead plaintiff has been appointed and a
consolidated complaint has not been filed.

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

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

                                       21
<PAGE>

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

   Our business will be seriously harmed if we lose any of our significant
customers, particularly Apple, FujiFilm, Ingram Micro, Olympus or Sony, or
suffer a substantial reduction in or cancellation of orders from these
customers. Our current distribution strategy results in sales to a limited
number of customers, which account for a significant portion of our revenue.
Some of our products are sold as stand-alone products by OEMs and, to a lesser
extent, are bundled together and sold with systems manufactured by third party
OEMs. During the six months ended June 30, 2001, Apple, Sony and Ingram Micro
accounted for approximately 15%, 17% and 22% of our revenue and our top five
customers collectively accounted for approximately 64% of our revenue. We
expect sales of our products to a limited number of customers to account for a
significant portion of our net revenue through 2001. However, we expect to
reduce our reliance on a limited number of customers for a large portion of
our revenue by increasing our presence in the retail channel through newly
formed relationships with major retailers.

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

   Our reliance on sales to a limited number of large customers may expose us
to pressure for price concessions. Because of this reliance and because of our
dependence on OEMs and distributors as a significant distribution channel, we
expect that they may seek price concessions from us, which would reduce our
average selling prices and our gross margins. Since we do not manufacture our
own products, we may be unable to reduce our manufacturing costs in response
to declining average per unit selling prices. We expect to reduce our reliance
on OEMs and distributors by increasing our presence in the retail channel
through newly formed relationships with major retailers.

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

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

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

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

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

   Our products currently compete with a number of cable and non-cable
interfaces between personal computers and digital appliances, including ports,
PCMCIA slots and infrared interfaces, all of which are PC peripheral
interfaces. It is possible that one of these competing data transfer
solutions, or another existing or

                                      22
<PAGE>

new technology, could achieve a significant market presence or become
supported by a number of significant flash memory card, personal storage or
digital appliance manufacturers. Regardless of the relative benefits of our
products, if a competing product gains significant market share or significant
support of flash card manufacturers, this product would likely emerge as the
industry standard and thereby achieve a dominant market position that would
jeopardize our survival.

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

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

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

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

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

   Approximately 32% of our revenue for the six months ended June 30, 2001 was
attributable to sales to Japanese customers, and we expect that sales to
Japanese customers will continue to account for a significant portion of our
total revenue for the foreseeable future. All of our Japanese sales, as well
as the related expenses, are denominated in Japanese yen. Fluctuations in
exchange rates between the yen and the U.S. dollar, particularly with respect
to Japanese transactions denominated in a currency other than the yen, could
adversely impact our financial results. Some transactions and accounts of our
Japanese and European subsidiary are U.S. dollar denominated. Since the
foreign subsidiaries' accounting records are kept in local currency, those
U.S. dollar denominated transactions are accounted for using the local
currency at the time of the transaction. U.S. dollar denominated accounts are
remeasured at the end of the accounting period. This remeasurement results in
adjustments to income. In addition, the balance sheet accounts of our foreign
subsidiaries are translated to the U.S. dollar for financial reporting
purposes and resulting adjustments are made to stockholders equity. The value
of the Japanese yen and the British pound may deteriorate against the dollar,
which would impair the value of stockholders' investment in us. Fluctuations
in the value of the Japanese yen and the British pound against the dollar have
occurred in the six months ended June 30, 2001, resulting in a foreign
currency gain of approximately $399,000 and a foreign currency translation
adjustment to reduce equity for approximately $522,000. 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.

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

   We contract with offshore manufacturers to produce some of our products and
our dependence on a limited number of contract manufacturers exposes us to a
variety of risks, including shortages of manufacturing

                                      23
<PAGE>

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

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

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

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

   Many of our products are manufactured overseas and a significant portion of
our revenue is derived from overseas sales. Approximately 42% of our revenue
during the six months ended June 30, 2001 was derived from customers located
outside the United States, primarily in Japan. Our dependence on foreign
manufacturers and international sales poses a number of risks, including:

  . Difficulties in monitoring production;

  . Transportation delays and interruptions;

  . Unexpected changes in regulatory requirements;

  . Currency exchange risks;

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

  . Difficulties in staffing and managing disparate branch operations;

  . Political or economic instability;

  . Compliance with foreign laws;

  . Difficulties in protecting intellectual property rights in foreign
    countries;

  . Exchange controls; and

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

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

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

   Rohm is our sole provider of application specific integrated circuits, or
ASICs, for our FlashPath products. In our FlashPath products, the specific
function of these integrated circuits is the conversion of digital and analog
data. In addition, LSI Logic and Texas Instruments are our primary suppliers of
ASICs for our FireWire products. Our dependence on a limited number of
suppliers and our lack of long-term supply contracts exposes

                                       24
<PAGE>

us to several risks, including a potential inability to obtain an adequate
supply of components, price increases, late deliveries and poor component
quality. Disruption or termination of the supply of components could delay
shipments of our products. The lead-time required for orders of some of our
components is as much as six months. In addition, the lead-time required to
qualify new suppliers for our components is as much as 12 months. If we are
unable to accurately predict our component needs, or if our component supply
is disrupted, we may miss market opportunities by not being able to meet the
demand for our products. This may damage our relationships with current and
prospective customers.

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

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

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

   Failure to effectively manage our growth could impair our ability to
execute our business strategy. Our business has grown substantially in recent
periods, with revenue increasing from approximately $15.3 million in 1998 to
approximately $96.7 million in 2000. The growth of our business has placed a
strain on our management, operations and financial systems. In addition, the
number of employees has increased from 16 at January 1, 1998 to 119 as of July
31, 2001. We expect to continue to increase the number of employees as our
business grows, and may expand operations to locations other than those in
which we currently operate.

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

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

   We continually evaluate potential acquisitions of complementary businesses,
products and technologies. We acquired VST in March 2000 and Impleo in April
2000. We may not realize the desired benefits of these transactions or of
future transactions. In order to successfully integrate acquired companies we
must, among other things:

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

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

  . Establish a common corporate culture; and

  . Integrate geographically distant facilities, systems and employees.

   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

                                      25
<PAGE>

use a significant portion of our available cash. On May 31, 2001, we announced
our intention to close our Acton, Massachusetts facility and move those
operations to our Naples, Florida headquarters. We anticipate these actions
will allow us to centralize our operations, marketing and development efforts,
improve efficiencies and increase our effectiveness. In connection with this
closing, we recognized approximately $0.5 million in severance costs in the
quarter ended June 30, 2001. We expect the closing to be substantially complete
by September 30, 2001. As a result, we anticipate incurring additional costs
during the third quarter associated with employee separation costs, excess
facility costs and the disposal of fixed assets. If we are not successful in
the timely integration of this facility, we may experience a disruption in our
operations, which could have a material adverse affect on our business and
operating results.

   If an acquisition is made utilizing our securities, a significant dilution
to our stockholders and significant acquisition related charges to earnings
could occur. Our acquisitions of VST and Impleo were dilutive and we expect
that our earnings per share will remain negative for the foreseeable future as
a result of these acquisitions, primarily due to the amortization of goodwill
and intangible assets recorded under the purchase method of accounting. We may
incur additional charges in the future resulting from redundancies in product
lines, personnel and fixed assets associated with these acquisitions.
Acquisitions may also cause us to incur or assume additional liabilities or
indebtedness, including liabilities that are unknown or not fully known to us
at the time of the acquisition, which could have an adverse effect on us.
Furthermore, we cannot assure that any products we acquire in connection with
any acquisition will gain acceptance in our markets.

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

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

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

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

Item 3. Quantitative and Qualitative Disclosure About Market Risk

   Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. The primary objective of
our investment activities is to preserve our invested funds while at the same
time maximizing the income we receive from our investments without
significantly increasing risk. Some of the securities that we have invested in
may be subject to market risk. This means that a change in prevailing interest
rates may cause the principal amount of the investment to fluctuate. For
example, if we hold a security that was issued with a fixed interest rate at
the then-prevailing rate and the prevailing interest rate later rises, the
principal amount of our investment will probably decline in value. If market
interest rates were to increase immediately and uniformly by 10 percent from
levels at June 30, 2001, this would not materially

                                       26
<PAGE>

change the fair market value of our portfolio. To minimize this risk, we
maintain our portfolio of cash equivalents and short-term investments in a
variety of securities including U.S. government and government agency notes,
corporate bonds and money market funds. In general, money market funds are not
subject to interest rate risk because the interest paid on such funds
fluctuates with the prevailing interest rate. Our investment portfolio includes
marketable securities with contractual maturities of less than one year and
active secondary or resale markets to ensure portfolio liquidity.

   The aggregate fair value of our short-term investments that were subject to
market risk as of June 30, 2001 was approximately $6.6 million with a weighted-
average interest rate of 4.25%.

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

   Foreign Exchange Risk. We conduct operations and sell products in several
different countries. Some balance sheet accounts of our U.S., Japanese and
European operations are denominated in currencies other than the respective
local currency and are remeasured to the respective local currency at the end
of the accounting period. This remeasurement results in an adjustment to
income. Additionally, the balance sheet accounts of our Japanese and European
operations are translated to U.S. dollars for financial reporting purposes and
resulting adjustments are made to stockholders' equity. The value of the
respective local currency may strengthen or weaken against the U.S. dollar,
which would impact the value of stockholders' investment in our common stock.
Fluctuations in the value of the Japanese yen and the British pound against the
U.S. dollar have occurred in 2001, resulting in a realized foreign currency
gain of approximately $399,000 for the six months ended June 30, 2001. In
addition, such fluctuations resulted in an unrealized foreign currency
translation loss of approximately $522,000 for the six months ended June 30,
2001, which is included in accumulated other comprehensive income and shown in
the equity section of our balance sheet.

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

   Our operating results may be impacted by the fluctuating exchange rates of
foreign currencies, especially the Japanese yen and the British pound, in
relation to the U.S. dollar. Most of the revenue and expense items of our
Japanese and European subsidiaries are denominated in the respective local
currency. In both regions, we believe this serves as a natural hedge against
exchange rate fluctuations because although an unfavorable change in the
exchange rate of the foreign currency against the U.S. dollar will result in
lower revenue when translated into U.S. dollars, operating expenses will also
be lower in these circumstances. For example, during the six months ended June
30, 2001, a decrease in the Japanese yen to U.S. dollar of 10 percent would
have resulted in a decrease in revenue of approximately $1.2 million and a
decrease in the net loss before income tax of approximately $0.2 million. A 10
percent adverse change in the British pound against the U.S. dollar would not
have a material effect on net loss before income taxes.

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

   Intangible Asset Risk. We have a substantial amount of intangible assets.
Although at June 30, 2001 we believe our intangible assets are recoverable,
changes in the economy, the business in which we operate and our own relative
performance could change the assumptions used to evaluate intangible asset
recoverability. We continue to monitor those assumptions and their consequent
effect on the estimated recoverability of our intangible assets.

                                       27
<PAGE>

                           PART II. OTHER INFORMATION

Item 1. Legal Proceedings

   A complaint was filed on June 26, 2000 in the Central District Federal Court
of the State of California by a party alleging our infringement of that party's
patent. On November 20, 2000, we prevailed in moving the venue for such action
from the State of California to the Middle District of Florida. We consider
this claim to be wholly without merit. We intend to vigorously defend against
this claim. See "Factors That May Affect Future Results of Operations
Infringement claims by third parties could result in costly litigation and
otherwise adversely impact our business."

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

Item 2. Changes in Securities and Use of Proceeds

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

   Through June 30, 2001, we used approximately $19.0 million of the net
proceeds from the offering for the acquisitions of VST Technologies, Inc.,
Impleo Limited and the intellectual property of El Gato Software, LLC and
Multimedia Technology Center. In addition, we used $4.3 million to pay off
VST's outstanding line of credit and $9.9 million for the purchase of equipment
and funding of operations. The remaining $5.9 million has been invested in
short-term, interest-bearing, investment grade securities.

                                       28
<PAGE>

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

   (a) We held our annual stockholders' meeting on May 30, 2001.

   (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:

<TABLE>
<CAPTION>
                                                                    VOTES
                                                             -------------------
                                                                FOR     WITHHELD
                                                             ---------- --------
   <S>                                                       <C>        <C>
   D. James Bidzos.......................................... 11,630,125 668,612
   Hirotsugu Nakaiwa........................................ 11,469,025 829,712
</TABLE>

     ii. Approval of the amendment of our Amended and Restated 1999 Incentive
  Compensation Plan:

<TABLE>
<CAPTION>
                                    VOTES
   -------------------------------------------------------------------------------------------
      FOR                AGAINST                    ABSTAIN                   BROKER NON-VOTES
   ----------           ---------                   -------                   ----------------
   <S>                  <C>                         <C>                       <C>
   10,960,175           1,321,231                   17,331                       5,397,497
</TABLE>

Item 6. Exhibits and Reports on Form 8-K

   (a) Exhibits:

     None.

   (b) Reports on Form 8-K:

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

                                      29
<PAGE>

                                   SIGNATURES

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

                                          Smartdisk Corporation

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

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

Dated: August 14, 2001

                                       30