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 March 31, 2000

                                       OR

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

              For the transition period from ____________ to ____________

                        COMMISSION FILE NUMBER: 000-27257

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


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

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

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


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

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:

As of April 30, 2000, there were 17,375,621 shares of the Registrant's Common
Stock outstanding, par value $ 0.001.


<PAGE>


                              SMARTDISK CORPORATION

                                      INDEX

                                                                            PAGE
                                                                            ----
PART I.           FINANCIAL INFORMATION

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

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

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

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


PART II.          OTHER INFORMATION

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

     Item 6.      Exhibits and Reports on Form 8-K............................37


SIGNATURES....................................................................38

                                       2
<PAGE>
PART I - FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                              SMARTDISK CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS

                                                                        DECEMBER 31,               MARCH 31,
                                                                            1999                      2000
                                                                   ---------------------     ---------------------
                                                                                                  (Unaudited)
<S>                                                                   <C>                        <C>
ASSETS
Current assets:
   Cash and cash equivalents                                          $    19,079,542            $    4,325,879
   Restricted cash                                                          1,050,000                 1,050,000
   Short-term investments                                                  26,640,401                17,740,915
   Accounts receivable, net                                                 3,865,781                11,528,253
   Notes receivable                                                         6,302,439                 3,610,133
   Inventories, net                                                         1,474,613                14,730,237
   Prepaid expenses and other current assets                                1,353,235                 2,948,155
                                                                   ---------------------     ---------------------
                  Total current assets                                     59,766,011                55,933,572
Property and equipment, net                                                 2,623,629                 3,567,712
Goodwill and other intangible assets, net                                     882,699                91,340,493
Deposits and other assets                                                     171,855                   402,341
                                                                   ---------------------     ---------------------
Total Assets                                                            $  63,444,194            $  151,244,118
                                                                   =====================     =====================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                                    $    5,329,804         $     11,993,921
   Bank line of credit and discounted notes                                 4,894,672                1,884,156
   Income taxes payable                                                     1,110,537                1,719,809
   Deferred research and development contract revenue                         307,874                        -
   Other accrued liabilities                                                2,014,765                3,848,901
                                                                   ---------------------     ---------------------
                  Total current liabilities                                13,657,652               19,446,787

Deferred income taxes and other                                                     -               13,247,943

Commitments and contingencies                                                       -                         -

Stockholders' equity:
   Preferred stock, $.001 par value; 5,000,000 shares
     authorized; none issued                                                        -                         -
   Common stock, $.001 par value; 60,000,000 shares authorized;
     16,072,399 issued and 15,991,422 outstanding at December
     31, 1999; 17,210,955 issued and 17,129,978 outstanding at
     March 31, 2000                                                            16,072                   17,211
   Capital in excess of par value                                          71,246,592              140,800,596
   Treasury  stock,  80,977 shares at December 31, 1999 and March
     31, 2000, at cost                                                        (58,304)                 (58,304)
   Accumulated other comprehensive income                                     711,954                  629,036
   Notes receivable from officers/employees                                  (387,454)                (593,868)
   Accumulated deficit                                                    (21,742,318)             (22,245,283)
                                                                   ---------------------     ---------------------
                  Total stockholders' equity                               49,786,542              118,549,388
                                                                   ---------------------     ---------------------
Total Liabilities and Stockholders' Equity                              $  63,444,194           $  151,244,118
                                                                   =====================     =====================
</TABLE>

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                       3
<PAGE>
<TABLE>
<CAPTION>
                              SMARTDISK CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

                                                                                THREE MONTHS ENDED
                                                                                     MARCH 31,
                                                                   ----------------------------------------------
                                                                           1999                     2000
                                                                   ---------------------    ---------------------
<S>                                                                        <C>                    <C>
Revenues:
     Product sales                                                         $5,430,711             $ 16,194,501
     Research and development revenue                                               -                1,148,178
     Royalties                                                                 76,788                   40,806
                                                                   ---------------------    ---------------------
         Total revenues                                                     5,507,499               17,383,485

Cost of revenues                                                            4,671,096               11,330,878
                                                                   ---------------------    ---------------------

Gross profit                                                                  836,403                6,052,607

Operating expenses:
     Research and development                                                 880,940                2,004,297
     Sales and marketing                                                      384,596                  807,833
     General and administrative                                             1,565,709                2,168,608
     Amortization of goodwill and other intangible assets                           -                2,238,423
                                                                   ---------------------    ---------------------
         Total operating expenses                                           2,831,245                7,219,161
                                                                   ---------------------    ---------------------

Operating loss                                                             (1,994,842)              (1,166,554)
Interest and other income, net                                                 54,953                  717,488
Interest expense                                                               (9,063)                 (46,150)
                                                                   ---------------------    ---------------------

Net loss before income taxes                                               (1,948,952)                (495,216)
Income tax expense                                                             17,352                    7,749
                                                                   ---------------------    ---------------------

Net loss                                                               $   (1,966,304)           $    (502,965)
                                                                   =====================    =====================

Net loss per share - basic and diluted                                 $        (0.22)           $       (0.03)
                                                                   =====================    =====================

Shares used in per share computation                                        8,964,555               16,004,537
                                                                   =====================    =====================
</TABLE>

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

                                       4
<PAGE>
<TABLE>
<CAPTION>
                              SMARTDISK CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

                                                                                     THREE MONTHS ENDED
                                                                                         MARCH 31,
                                                                        ---------------------------------------------
                                                                                1999                    2000
                                                                        -------------------     ---------------------
<S>                                                                          <C>                        <C>
Cash flows from operating activities:
   Net loss                                                                  $ (1,966,304)              $ (502,965)
   Adjustments to reconcile net loss to
     net cash used in operating activities:
       Depreciation                                                                71,227                  393,268
       Amortization                                                               176,593                2,411,059
       Foreign currency gain                                                            -                  (20,951)
       Bad debt expense                                                                 -                   13,173
       Provision for inventory obsolescence                                         7,000                  181,151
       Employee stock option expense                                               76,500                        -
       Deferred income tax benefit                                                (34,269)                (431,443)
       Changes in assets and liabilities:
         (Increase) decrease in assets:
         Accounts receivable                                                   (2,559,232)              (3,123,869)
         Notes receivable                                                        (337,407)               2,692,306
         Inventories                                                            1,333,556                  590,836
         Prepaid expenses and other current assets                                (59,753)                 376,223
         Deposits and other assets                                                (53,340)                (230,487)
         Increase (decrease) in liabilities:
         Accounts payable                                                       1,377,269                  505,759
         Income taxes payable                                                           -                 (838,878)
         Deferred research and development contract revenue                        57,801                 (307,874)
         Other accrued liabilities                                                658,605                 (308,571)
                                                                        -------------------     ---------------------
Net cash provided by (used in) operating activities                            (1,251,754)               1,398,737

Cash flows from investing activities:
   Purchases of property and equipment, net of minor disposals                 (1,404,582)                (181,279)
   Acquisition of VST Technologies, Inc., net of cash acquired                          -              (17,628,210)
   Purchases of short-term investments                                                  -               (9,116,526)
   Sales and maturities of short-term investments                                       -               17,914,198
                                                                        -------------------     ---------------------
Net cash used in investing activities                                          (1,404,582)              (9,011,817)

Cash flows from financing activities:
   Net borrowings (repayments) under line of credit                               739,928               (7,253,828)
   Collections on notes receivable from officers/employees                              -                    3,580
   Proceeds from sale of common stock                                             785,582                        -
   Proceeds from exercise of stock options                                              -                   13,294
   Purchase of treasury stock                                                        (540)                       -
                                                                        -------------------     ---------------------
Net cash provided by (used in) financing activities                             1,524,970               (7,236,954)
Effect of exchange rate fluctuations on cash                                       25,672                   96,371
                                                                        -------------------     ---------------------
Decrease in cash                                                               (1,105,694)             (14,753,663)
Cash and cash equivalents at beginning of period                                2,919,728               19,079,542
                                                                        -------------------     ---------------------
Cash and cash equivalents at end of period                                   $  1,814,034             $  4,325,879
                                                                        ===================     =====================
Significant non-cash activities:
   Notes receivable obtained for stock option exercise                       $          -              $   209,994
   Issuance of common stock for license                                      $          -              $   240,000
</TABLE>

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                       5
<PAGE>
                              SMARTDISK CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 MARCH 31, 2000

NOTE 1. BASIS OF PRESENTATION

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

         The unaudited interim consolidated financial statements should be read
in conjunction with the audited consolidated financial statements of the Company
and the notes thereto included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1999, filed with the Securities and Exchange
Commission.

NOTE 2. INVENTORY

         Inventories are stated at the lower of cost or market with cost being
determined on a first-in, first-out basis. Inventories consist of the following:
<TABLE>
<CAPTION>

                                           DECEMBER 31,           MARCH 31,
                                               1999                  2000
                                        -------------------    -----------------
<S>                                         <C>                  <C>
         Finished goods                     $ 1,561,213          $   8,387,224
         Work in-progress                             -              1,429,485
         Raw materials                                -              5,121,444
                                        -------------------    -----------------
         Total inventories                    1,561,213             14,938,153
         Allowance for obsolescence             (86,600)              (207,916)
                                        -------------------    -----------------
         Net inventory                      $ 1,474,613           $ 14,730,237
                                        ===================    =================
</TABLE>

                                       6
<PAGE>


NOTE 3. NET LOSS PER SHARE

         For the three months ended March 31, 1999 and 2000, potential common
shares totaling 865,268 and 2,816,153, respectively, were excluded from the
computation of net loss per share because they were anti-dilutive. Potential
common shares includes stock options and shares of non-vested stock.

                                       7
<PAGE>

NOTE 4. COMPREHENSIVE LOSS

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

                                                                               THREE MONTHS ENDED
                                                                                   MARCH 31,
                                                                   -------------------------------------------
                                                                          1999                    2000
                                                                   -------------------     -------------------
<S>                                                                   <C>                      <C>
Net loss                                                              $ (1,966,304)            $  (502,965)
Other comprehensive income (expense):
  Foreign currency translation adjustment                                  117,032                 (64,952)
  Unrealized loss on short-term investments, net of tax                          -                 (17,966)
                                                                   -------------------     -------------------

Total comprehensive loss                                              $ (1,849,272)            $  (585,883)
                                                                   ===================     ===================
</TABLE>


NOTE 5. SEGMENT INFORMATION

         SmartDisk designs, develops, manufactures and markets digital
connectivity products and personal storage systems that allow consumers to
easily access and exchange digital data. The Company operates in the United
States, Japan and Europe in one reportable business segment. There have been no
significant changes in our operating segments or in the geographic location of
our long-lived assets since December 31, 1999, the date of our most recent
audited financial statements included in out Annual Report of Form 10-K.

                                       8
<PAGE>

NOTE 6. ACQUISITION

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

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

                                              Purchase Price

              Cash                                                                    $16,434
              Common stock                                                                  1
              Capital in excess of par                                                 49,299
              Value of SmartDisk options issued                                        19,792
              Transaction costs                                                         2,975
                                                                           -------------------
              Total purchase price                                                    $88,501
                                                                           ===================

                                            Net Assets Acquired

              Book value of net tangible assets of VST                                 $9,551
              Intangible assets:
                    Non-compete agreements                                             21,300
                    Distributions channels                                              4,900
                    VST trade name                                                      4,800
                    Patents                                                             2,200
                    Workforce in place                                                  1,000
              Deferred income taxes                                                   (13,680)
              Goodwill                                                                 58,430
                                                                           -------------------
              Net assets acquired                                                     $88,501
                                                                           ===================
</TABLE>

                                       9
<PAGE>

NOTE 6. ACQUISITION (CONTINUED)

     The following unaudited pro forma financial information reflects the VST
acquisition as if it had occurred on January 1, 1999 after giving effect to
certain adjustments including amortization of goodwill and other intangible
assets. The pro forma financial information does not purport to represent what
the Company's actual results of operations would have been had the acquisition
occurred as of January 1, 1999 and may not be indicative of operating results
for any future periods.
<TABLE>
<CAPTION>

                                                                             THREE MONTHS ENDED
                                                                                 MARCH 31,
                                                               -----------------------------------------------
                                                                      1999                       2000
                                                               -------------------        --------------------
<S>                                                                <C>                        <C>
Revenues                                                           $14,015,255                $23,420,829
Net loss                                                           $(1,522,505)               $  (730,953)

Loss per share - basic and diluted                                 $     (0.15)               $     (0.05)
                                                               ===================        ====================
</TABLE>

NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS

         In December 1999, the Securities and Exchange Commission issued Staff
issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition." This
bulletin established guidelines for revenue recognition and is effective for
periods beginning after March 15, 2000. We do not expect the adoption of the
guidelines required by SAB No. 101 to have a material impact on our financial
condition or results of operations.

         In June 1999, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of FASB
Statement No. 133," which defers the effective date of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" to all fiscal quarters of all fiscal years beginning after June 15,
2000. SFAS No. 133 establishes accounting and reporting standards for derivative
instruments and hedging activities. SFAS No. 133 will require the Company to
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. Because
SmartDisk currently holds no derivative instruments and does not engage in
hedging activities, we expect that the adoption of SFAS No. 133 will have no
material impact on our financial position, results of operations or cash flows.

                                       10
<PAGE>

NOTE 8. SUBSEQUENT EVENTS

         On April 20, 2000, the Company completed its acquisition of
substantially all of the intellectual property of El Gato Software LLC, a
California limited liability company, for approximately $755,000 in cash and
approximately 37,000 shares of SmartDisk common stock. El Gato develops and
markets USB and FireWire drivers, applications and firmware support for leading
personal storage systems.

         On April 28, 2000, the Company also acquired all of the capital stock
of Impleo Limited, an English corporation, for approximately $200,000 in cash
and approximately 125,000 shares of SmartDisk common stock. Impleo manufactures
and markets digital connectivity products and personal storage systems under the
Datawise brand.

                                       11

<PAGE>

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

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

         CERTAIN STATEMENTS CONTAINED IN THIS REPORT ON FORM 10-Q ARE
FORWARD-LOOKING IN NATURE WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933 AND SECTION 21E OF THE SECURITIES AND EXCHANGE ACT OF 1934. THESE
FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING
STATEMENTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT, WHICH ARE BASED ON
INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF. THE COMPANY MAKES NO
COMMITMENT TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS OR TO DISCLOSE ANY
FACTS, EVENTS, OR CIRCUMSTANCES AFTER THE DATE HEREOF THAT MAY AFFECT THE
ACCURACY OF ANY FORWARD-LOOKING STATEMENT. READERS SHOULD CAREFULLY REVIEW THE
RISKS DESCRIBED IN OTHER DOCUMENTS WE FILE FROM TIME TO TIME WITH THE SECURITIES
AND EXCHANGE COMMISSION, INCLUDING THE COMPANY'S ANNUAL REPORT ON FORM 10-K AND
AMENDMENT NO. 1 TO OUR REGISTRATION STATEMENT ON FORM S-1 FILED ON MAY 9, 2000.

OVERVIEW

         We design, develop, manufacture and market digital connectivity
products and personal storage systems that allow consumers to easily access and
exchange digital data. As a result, our products provide consumers with a user
friendly way to transfer, store, manage and share digital photographs, video,
music, voice and data among digital appliances, personal computers and the
Internet. With the growth of digital appliances, such as digital cameras,
digital video camcorders, voice recorders and music players, consumers are
increasingly using the PC as the "multimedia center" of the home or office.
These digital appliances capture digital data on high capacity, reusable flash
memory cards that appeal to consumers because of their small size, versatility
and portability. Our digital connectivity products and personal storage systems
are designed to provide an easy way to transfer, store, manage and share digital
data. Our products are designed to cross PC platforms, support most leading
media types and use high performance PC interfaces, such as USB and FireWire.
Our patented digital connectivity products, such as our FlashPath products for
the Toshiba SmartMedia card, SanDisk MultimediaCard and Sony Memory Stick, as
well as Smarty, allow consumers to use the familiar 3.5 inch floppy drive --
found on most PCs worldwide -- to simplify the exchange of images, music, voice
and other digital data between PCs and digital appliances. Our latest digital
connectivity product, the Tri-Media Reader, utilizes a USB cable interface to
exchange digital data and is intended to address an expanding installed base of
PCs with USB cable interfaces. Our personal storage systems include high
performance external portable hard disk drives and floppy disk drives for
desktop and notebook PCs utilizing USB and FireWire interfaces with the PC, as
well as expansion bay disk drives for notebooks. Substantially all of our
personal storage systems are compatible with Windows and Macintosh operating
systems.

                                       12
<PAGE>

         Our principal digital connectivity products, our FlashPath family of
products, are used primarily to transfer images to PCs from digital cameras. We
develop and market three FlashPath products, one for each of three different
flash memory cards: SanDisk's MultiMediaCard, Sony's Memory Stick and Toshiba's
SmartMedia card. These flash memory cards are used in cameras and video
camcorders made by a number of leading camera manufacturers, including FujiFilm,
JVC, Olympus, Panasonic, Sanyo, Sharp, Sony and Toshiba. During the year ended
December 31, 1999, we sold over one million FlashPaths for the SmartMedia card.
During the fourth quarter of 1999, we completed development of our first
FlashPath product for the Memory Stick and began full-scale production and
shipping to Sony for distribution. In the fourth quarter of 1999, we also
shipped working samples of our FlashPath product for the MultiMediaCard. We
began volume production of FlashPath for the MultiMediaCard in the first quarter
of 2000. In the first quarter of 2000, we also introduced a follow-on FlashPath
product for new models of Sony's Mavica digital still camera. In January 2000,
we introduced a USB Tri-Media Reader which reads and writes to SmartMedia cards,
CompactFlash cards and rotations media, such as a 1.44 Mega-byte floppy disk,
all in a single USB cable-powered device for both Windows and Macintosh systems.
We believe that as consumers embrace the digital lifestyle, the number of
applications for flash memory cards will grow. These flash memory cards are
designed for applications in "smart" cellular phones, digital still cameras and
camcorders, digital audio players, digital voice recorders and video game
devices. In addition to our product development efforts with Sony and SanDisk,
we also have strategic relationships with a number of key electronics industry
participants, including Hitachi, NEC, and Toshiba.

         Our personal storage systems enhance the user's ability to store and
manage digital data. Our personal storage systems are compatible with both
Windows and Macintosh operating systems and support very high transfer rates
and 100 Gigabytes of capacity. Since 1992, we have worked with Apple as an Apple
developer. Through this relationship, Apple has provided us access to selected
product road maps which has allowed us to focus on new opportunities in the
development and engineering of many FireWire and USB systems. Through our
strategic relationship with Iomega, we build Iomega Zip drive products for
Apple, IBM and Fujitsu. In 1999, we were one of the first companies to ship
FireWire personal storage systems for both Macintosh and Windows operating
systems, as well as FireWire Zip drives. In the first quarter of 2000, we
introduced one of the first 100 Gigabyte portable FireWire RAID arrays.

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

RECENT DEVELOPMENTS

         On March 6, 2000, we completed our acquisition of VST Technologies,
Inc. VST designs, develops, manufactures and markets USB-based flash memory
readers and USB and FireWire-based high performance personal storage systems for
Windows and Macintosh platforms. Our acquisition of VST will expand our product
lines to include advanced FireWire and USB technologies and additionally expand
our access to the rapidly growing digital video and digital music markets. In
addition, we expect that the acquisition of VST will position us to


                                       13
<PAGE>

participate in the market for Apple products. VST's product line includes
expansion bay storage devices, such as the Zip 100 drive for Apple, IBM and
Fujitsu notebooks, SuperDisk drives for select Apple and IBM notebooks, USB
floppy drives, portable FireWire hard drives and a dual flash memory card and
rotational media reader, as well as a recently introduced 100 Gigabyte FireWire
RAID array.

         We acquired VST for approximately $16.4 million in cash, approximately
1.1 million shares of our common stock. In addition, we issued options to
acquire approximately 443,000 shares of our common stock with exercise prices
ranging from $0.90 to $4.45, in exchange for outstanding vested options to
acquire shares of VST common stock. VST, a Delaware corporation whose
predecessor was incorporated in 1993, is located near Boston, Massachusetts. For
the year ended December 31, 1999, VST had gross revenues of approximately $61.5
million, operating income of approximately $6.5 million and net income of
approximately $6.2 million. We have accounted for the VST acquisition under the
purchase method of accounting. Because of the significant amount of goodwill and
other intangible assets which we recognized in respect of the VST acquisition
(approximately $93.2 million), the acquisition was dilutive to our stockholders.
We will amortize goodwill over five years and the various components of other
intangible assets over lives ranging from two to four years.

         In April 2000, we completed our acquisition of El Gato Software LLC. El
Gato, a California limited liability company, is located near San Jose,
California. El Gato develops and markets USB and FireWire drivers, applications
and firmware support for leading personal storage systems, including SmartMedia,
CompactFlash, hard drives, Zip drives, floppy drives and optical drives. We use
El Gato drivers in our FireWire hard drives, FireWire Zip drives and USB-based
products, including our Tri-Media Reader. We acquired substantially all of the
intellectual property of El Gato for approximately $755,000 in cash and
approximately 37,000 shares of our common stock. We also retained the services
of El Gato's staff of five software developers under two-year consulting
agreements.

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

RESULTS OF OPERATIONS

         REVENUES. Total revenues were approximately $17.4 million for the three
months ended March 31, 2000 compared to approximately $5.5 million for the three
months ended March 31, 1999. This increase was primarily attributable to higher
sales of our FlashPath for SmartMedia product, sales of our newest products,
FlashPath for the Sony Memory Stick, which we commercially introduced in the
fourth quarter of 1999, and FlashPath for the SanDisk MultiMediaCard, which we
commercially introduced in the first quarter of 2000, and sales of personal
storage systems subsequent to the VST acquisition on March 6, 2000.

                                       14
<PAGE>

         Our product revenues from the sale of FlashPath increased from
approximately $5.1 million for the three months ended March 31, 1999 to
approximately $9.4 million for the three months ended March 31, 2000. Our
product revenues from the sale of personal storage systems for the period from
March 6, 2000 through March 31, 2000 were approximately $5.4 million. Our
product revenues are recognized when title and risk of loss are tranferred to
customers, which is generally at the time of shipment.

         Fiscal year 1999 was the first year that we have had revenues from our
research and development efforts. During the fourth quarter of 1999, we entered
into a research and development agreement with a customer, which was completed
during the quarter ended March 31, 2000. Our research and development revenue is
recognized upon final customer acceptance of our work performed under the terms
of the agreement. Our revenues from research and development agreements were
approximately $1.1 million for the three months ended March 31, 2000. We had no
research and development revenues for the three months ended March 31, 1999.

         Our royalty revenues consist of royalties earned on the sales of our
first product, SafeBoot, which is licensed to and sold by Fischer International,
an affiliate. As our FlashPath revenues continue to increase, these royalties
represent a smaller portion of our total revenues and have decreased to
approximately 0.2% of our total revenues for the three months ended March 31,
2000. Our royalty revenues from the sale of our SafeBoot product decreased to
$41,000 in the three months ended March 31, 2000 as compared to $77,000 in the
three months ended March 31, 1999.

         COST OF REVENUES. Cost of revenues includes the purchased cost of
product, packaging, storage, freight, scrap, inventory and warranty provisions
and royalties for some of our FlashPath products. Cost of revenues increased to
approximately $11.3 million for the three months ended March 31, 2000 compared
to approximately $4.7 million for the three months ended March 31, 1999. This
increase in costs was due primarily to the increase in sales of our FlashPath
product and the inclusion of VST. With the acquisition of VST, we expect that
our cost of revenues will increase significantly in 2000 as we add
infrastructure to expand our product offerings, particularly for FireWire and
USB products, and support anticipated sales growth.

         GROSS PROFIT. Our gross profit for the three months ended March 31,
2000 increased to approximately $6.1 million or 35% of total revenue, compared
to approximately $800,000 or 15% of total revenue for the three months ended
March 31, 1999. These increases in the gross profit and gross profit percentage
are primarily the result of revenue growth and improved margins on our FlashPath
product. The improved FlashPath product margins achieved in 2000 are a result of
our efforts to reduce our costs per unit. The improved margins also resulted
from a favorable mix associated with higher shipments to customers other than
our largest OEMs, which we intend to continue. Because we expect OEMs to
continue to account for a large portion of our sales, we expect gross margins on
our FlashPath products to remain relatively consistent with the current level.
However, our largest OEM customers may seek price concessions, which could cause
a reduction in our gross margins. Another contributor to our improved gross
profit in 2000 was the research and development revenue earned under the
research and development agreement we have with one of our customers. Without
the research and development revenue, our gross margin would be approximately
30% of total revenue. Our improved gross profit


                                       15
<PAGE>

percentage was partially offset by the inclusion of VST, which we acquired on
March 6, 2000. With the acquisition of VST, we expect the actual amount of our
gross profit to increase this year, however, we anticipate our gross margin
percentage will decrease.

         RESEARCH AND DEVELOPMENT EXPENSES. Our research and development
expenses consist primarily of salaries and payroll-related expenses for our
design and development engineers, as well as prototype supplies and contract or
professional services. These expenses increased to approximately $2.0 million,
or 12% of total revenues, for the three months ended March 31, 2000 compared to
approximately $900,000, or 16% of total revenues, for the three months ended
March 31, 1999. This increase was the result of hiring additional technical
personnel, including salaries and related payroll expenses, costs incurred in
conjunction with one of our research and development contracts and the
outsourcing of product development, as well as the inclusion of VST.

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

         SALES AND MARKETING EXPENSES. Sales and marketing expenses include
salaries, benefits and travel expenses for our sales, marketing and product
management personnel in the United States and Japan. These expenses also include
other selling and marketing expenditures for items such as trade shows,
marketing and promotional programs. Sales and marketing expenses increased by
approximately $400,000 to approximately $800,000 for the three months ended
March 31, 2000 compared to the three months ended March 31, 1999. The change
from 1999 to 2000 is primarily attributable to the inclusion of VST. In
connection with the VST acquisition we added a number of new products to
our existing product lines, significantly increasing the sales and marketing
expenses related to these new products.

         GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses include the salaries and related expenses of our executive management,
finance, information systems, human resources, legal and administrative
functions, as well as lease rental expense, utilities, maintenance expenses,
taxes, insurance, legal and accounting professional fees, depreciation and
amortization. General and administrative expenses increased to approximately
$2.2 million in the three months ended March 31, 2000 compared to approximately
$1.6 million in the same period in 1999. This increase is primarily due to
increases in professional services, legal fees and


                                       16
<PAGE>

personnel related costs including salaries, bonuses and relocation expenses, as
well as the inclusion of VST, which had 46 employees at March 6, 2000.

         INTEREST AND OTHER INCOME. The primary components of interest and other
income are interest earned on cash, cash equivalents and short-term investments
and gains or losses on foreign exchange. The most significant component of these
items, for the three months ended March 31, 2000, is interest earned of
approximately $600,000 on the proceeds from our initial public offering in
October 1999.

         INTEREST EXPENSE. Interest expense is incurred on the bank line of
credit in Japan and VST's line of credit. We repaid VST's line of credit, in
full, on March 31, 2000.

         PROVISION FOR INCOME TAXES. We are subject to tax in Japan and a number
of other jurisdictions where we do business, including the United States and
United Kingdom. These jurisdictions have different marginal tax rates. For the
three months ended March 31, 2000, income tax expense totaled approximately
$468,000, associated with income earned in Japan and royalty income from the
Japan branch. This amount was offset by an income tax benefit of approximately
$460,000 resulting from amortization expense on certain intangible assets
related to the VST acquisition. Taxable income earned in the United States was
offset by net operating loss carryforwards. A valuation allowance is provided
to reduce deferred tax assets to the amount that will more likely than not be
realized.

LIQUIDITY AND CAPITAL RESOURCES

         On October 6, 1999, we completed our initial public offering. We
realized net proceeds of approximately $39.14 million from the sale of 3,450,000
shares of our common stock, including 450,000 shares issued upon the exercise of
the underwriters' over allotment option, at an initial public offering price of
$13.00 per share after deducting underwriting discounts and commissions of
approximately $3.14 million and offering expenses of approximately $2.57
million.

         The net proceeds from our initial public offering have been invested in
cash, cash equivalents and short-term investments. In March 2000, in connection
with the acquisition of VST, we paid, or have set aside to be paid, a total of
approximately $18.28 million in purchase consideration and other acquisition
related costs. In March 2000, we also repaid a line of credit that VST
maintained which had an outstanding balance of approximately $4.28 million. To
date, we have funded VST's operations with approximately $3.75 million, which
includes the $755,000 cash portion of the consideration for the acquisition of
El Gato. We plan to use the remaining net proceeds from our initial public
offering for general corporate purposes, including working capital and capital
expenditures, as well as potential acquisitions of technology and businesses.
The use of the proceeds from our initial public offering does not represent a
material change in the use of proceeds described in our prospectus dated October
5, 1999.

                                       17
<PAGE>

         We maintain a line of credit under which we may borrow up to $5
million. Any amounts borrowed under this line of credit bear interest at 2% over
the 30-day LIBOR rate and are secured by substantially all of our assets. This
line of credit expires on December 15, 2000. We have not borrowed against this
line of credit and we have no current plans to borrow any amounts under this
line of credit.

         VST has a line of credit secured by a security interest in
substantially all of its assets, including all of its intellectual property. As
of March 31, 2000, no amounts were outstanding under this line of credit.

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

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

         Net cash provided by operating activities was approximately $1.4
million for the three months ended March 31, 2000 compared to cash used in
operations of approximately $1.3 million for the three months ended March 31,
1999. Net cash provided by operating activities in the first quarter of 2000
reflected a net loss of approximately $500,000 offset by approximately $2.8
million in depreciation and amortization. In addition, there were decreases in
notes receivable of approximately $2.7 million, inventory of approximately
$600,000, prepaid expenses and other current assets of approximately $400,000
and an increase in accounts payable of approximately $500,000. These amounts
were partially offset by an increase in accounts receivable of approximately
$3.1 million and decreases in income taxes payable of approximately $800,000,
deferred income taxes of approximately $400,000, other accrued expenses of
approximately $300,000 and deferred research and development revenues of
approximately $300,000.

         Net cash used in investing activities was approximately $9.0 million
for the first quarter of 2000. The most significant use of cash in the first
quarter of 2000 was approximately $17.6 million in connection with the
acquisition of VST in March 2000. This amount was partially offset with proceeds
from the sale of short-term investments, net of purchases, of approximately $8.8
million. Cash was also used for capital expenditures, primarily the acquisition
of development and production equipment.

                                       18
<PAGE>

         Net cash used in financing activities was approximately $7.2 million in
the first quarter of 2000. This was attributable to approximately $3.0 million
in net repayments under our line of credit with a Japanese bank and
approximately $4.3 million used to repay the outstanding balance under VST's
line of credit. These amounts were partially offset by proceeds from option
exercises and collections on notes receivable from officers/employees.

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

YEAR 2000 ISSUES

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

         In 1999, we completed our remediation and testing of hardware and
software systems to assess their Year 2000 readiness. Our costs associated with
Year 2000 compliance have been minimal, and, therefore, these costs have not
been accounted for separately. To date, we have not experienced any material
adverse effect on our business or operations as a result of any Year 2000
Issues. In addition, we have not deferred any material information technology
projects or equipment purchases as a result of our Year 2000 activities.
However, we believe that it is not possible to determine with complete certainty
that all Year 2000 Issues affecting us have been identified or corrected. If we,
our customers, our providers of hardware and software or our third-party
computer network providers fail to remedy any Year 2000 Issues, the reasonably
likely worst case scenario would be a disruption in the supply of our products
from our subcontractors or an interruption of our research programs, which could
have a material adverse affect on our business, financial conditions and results
of operations. Presently we are unable to quantitatively estimate the duration
and extent of any such disruption or interruption, or estimate the effect such
disruption or interruption may have on our future revenue. However, we believe
that the impact of any Year 2000 Issue on the supply of our products or on our
research programs will be limited to our ongoing operations. We do not expect
that any historical data will be affected.

                                       19
<PAGE>

FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

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

WE HAVE INCURRED NET LOSSES AND CANNOT GUARANTEE THAT WE WILL BE ABLE TO SUSTAIN
OUR PROFITABILITY.

         Except for the third and fourth quarter of 1999, we have incurred net
losses on a quarterly basis since inception. We had net income of approximately
$1.0 million during 1999 (a net loss of approximately $17.7 million on a pro
forma basis after giving effect to the VST acquisition). We had a net loss of
approximately $503,000 in the first quarter of 2000. In addition, as of March
31, 2000, we had an accumulated deficit of approximately $22.2 million. In light
of our loss history and the VST acquisition, we cannot assure you that we will
be able to sustain profitability in the future.

WE HAVE A LIMITED OPERATING HISTORY ON WHICH TO BASE AN INVESTMENT DECISION.

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

OUR MANAGEMENT TEAM HAS ONLY RECENTLY BEEN ASSEMBLED AND MAY NOT BE ABLE TO WORK
TOGETHER AS A COHESIVE UNIT.

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

WE MAY NOT BE ABLE TO SELL SUFFICIENT QUANTITIES OF OUR PRODUCTS TO SUSTAIN A
VIABLE BUSINESS IF THE MARKET FOR DIGITAL CONNECTIVITY PRODUCTS DOES NOT
CONTINUE TO DEVELOP OR IF A COMPETING TECHNOLOGY DISPLACES THESE PRODUCTS.

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

                                       20
<PAGE>

WE MAY NOT BE ABLE TO SELL SUFFICIENT QUANTITIES OF OUR FLASHPATH PRODUCTS TO
SUSTAIN OUR CURRENT BUSINESS IF A SINGLE STANDARD FOR FLASH MEMORY CARDS
EMERGES.

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

A REDUCTION IN THE USE OF THE 3.5 INCH FLOPPY DISK DRIVE BY CONSUMERS AND
MANUFACTURERS WOULD LEAD TO A REDUCTION IN DEMAND FOR OUR FLASHPATH PRODUCTS.

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

SINCE OUR FLASHPATH PRODUCTS WORK ONLY IN CONJUNCTION WITH THE 3.5 INCH FLOPPY
DISK DRIVE, ADVANCES IN FLASH MEMORY CARDS MAY MAKE THESE PRODUCTS LESS
COMPETITIVE BECAUSE OF THE INCREASED TIME NEEDED TO TRANSFER DATA USING THE 3.5
INCH FLOPPY DISK DRIVE.

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

WE MAY NOT BE ABLE TO SELL SUFFICIENT QUANTITIES OF OUR PERSONAL STORAGE SYSTEMS
TO SUSTAIN OUR FUTURE GROWTH IF PC MANUFACTURERS DO NOT ADOPT IEEE 1394 AS A
HIGH-SPEED PERIPHERAL INTERFACE OR IF A COMPETING CPU INTERFACE DISPLACES OR
PREVENTS THE WIDESPREAD ADOPTION OF IEEE 1394.

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


                                       21
<PAGE>

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

WE MAY NOT BE ABLE TO SELL SUFFICIENT QUANTITIES OF OUR PERSONAL STORAGE SYSTEMS
TO SUPPORT OUR BUSINESS IF SUPPLIERS OF OUR DRIVES DEVELOP NATIVE FIREWIRE-BASED
PERSONAL STORAGE SYSTEMS THAT DO NOT REQUIRE OUR FIREWIRE CONVERSION TECHNOLOGY.

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

MOST OF OUR REVENUES ARE DERIVED FROM ONLY A FEW MAJOR PRODUCTS AND OUR BUSINESS
WILL BE SERIOUSLY HARMED IF DEMAND FOR THOSE PRODUCTS DECLINES.

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

WE MUST DEVELOP NEW PRODUCTS AND INTRODUCE THEM IN A TIMELY MANNER IN ORDER TO
REMAIN COMPETITIVE.

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


                                       22
<PAGE>

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

WE MAY NOT BE ABLE TO DEVELOP OR MAINTAIN THE STRATEGIC RELATIONSHIPS NECESSARY
TO PROVIDE US WITH THE INSIGHT WE NEED TO DEVELOP COMMERCIALLY VIABLE PRODUCTS.

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

WE MAY NOT BE ABLE TO SUSTAIN OUR RELATIONSHIP WITH APPLE COMPUTER WHICH WOULD
GREATLY HINDER OUR ABILITY TO TIMELY DEVELOP PRODUCTS WHICH ARE COMPATIBLE WITH
MACINTOSH OPERATING SYSTEMS.

         Historically, Apple has provided us, as an Apple developer, access to
selected product road maps, which has allowed us to timely develop and engineer
many of our current products, including our current FireWire and USB storage
systems. As a result of this collaborative relationship, we have received a
substantial portion of our historical revenues from direct sales to Apple and
Apple users. Moreover, we anticipate that a significant portion of our product
revenues will continue to be derived from sales of our Apple compatible products
in the future. If Apple were to terminate our status as an Apple developer or if
there were a material deterioration of our relationship, we would not be able to
timely develop new technologies which 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


                                       23
<PAGE>

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

A DECLINE IN THE DEMAND FOR APPLE PRODUCTS WOULD REDUCE THE MARKET FOR MANY OF
OUR PRODUCTS.

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

OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY AND MAY FLUCTUATE
SIGNIFICANTLY IN THE FUTURE, WHICH COULD LEAD TO DECREASES IN OUR STOCK PRICE.

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

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

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

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

         o        The timing and amount of research and development
                  expenditures;

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

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

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

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

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

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

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

                                       24
<PAGE>

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

WE MAY FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY AND, THEREFORE, LOSE
OUR COMPETITIVE ADVANTAGE.

         Our proprietary technology with respect to 3.5 inch floppy disk drive
interfaces and USB and FireWire source codes is critical to our future growth.
We rely in part on patent, trade secret, trademark and copyright law to protect
our intellectual property. However, the patents issued to us may not be adequate
to protect our proprietary rights, to deter misappropriation or to prevent an
unauthorized third party from copying our technology, designing around the
patents we own or otherwise obtaining and using our products, designs or other
information. We have, in fact, filed a complaint against one of our former
patent attorneys for improperly copying one of our patent applications and
filing a patent application without our consent naming himself as a co-inventor.
This matter was settled with no materially adverse consequences to SmartDisk. In
addition, we may not receive trademark protection for our "SmartDisk" name. We
have filed for trademark registration of the name "SmartDisk," but this has not
yet been granted. We are aware of a trademark application for the name
"SmartDisk" that was filed by another company. Our application could be denied
and we could be prohibited from using the "SmartDisk" name. In that event, we
would be required to incur substantial costs to establish new name recognition.

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

WE MAY FACE COMPETITION FROM INTEL IF IT DECIDES TO UTILIZE ITS COMPETING
PATENT.

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

                                       25
<PAGE>

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 which 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 to obtain a better understanding of its claim and have agreed to retain a
mediator to review the facts and to help us resolve this dispute through
mediation. Although we believe that we do not infringe upon this third party's
patent, we cannot guarantee that the mediation will avoid litigation, or that
the outcome of any such litigation will be favorable to SmartDisk. In another
instance, we received a letter from SanDisk stating that SanDisk held two
patents which it believes might apply to our products. Although we subsequently
obtained a non-exclusive worldwide license for a 10-year period for all of
SanDisk's intellectual property rights in connection with multimedia floppy disk
interfaces, if the license terminates or expires, we could face a potential
conflict with SanDisk regarding the scope of those patents. 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.
While none of these claims has resulted in litigation at this time, future
claims may. In addition, we license a portion of the intellectual property
included in our products from third parties, which may increase our exposure to
infringement actions because we rely upon those third parties for information
about the origin and ownership of the licensed intellectual property. We may
also lose our license rights with respect to the intellectual property for which
infringement is claimed. Further, if our customers are required to obtain a
license on other than commercially reasonable terms, our business could be
jeopardized.

WE MAY HAVE PARTICULAR DIFFICULTY PROTECTING OUR INTELLECTUAL PROPERTY RIGHTS
OVERSEAS.

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

BECAUSE MOST OF OUR SALES ARE TO A RELATIVELY SMALL NUMBER OF CUSTOMERS THE LOSS
OF ANY OF OUR KEY CUSTOMERS WOULD SERIOUSLY HARM OUR BUSINESS.

         Our business will be seriously harmed if we lose any of our significant
customers, particularly Olympus, FujiFilm or Ingram Micro, or suffer a
substantial reduction in or cancellation of orders from these customers. Our
current distribution strategy results, and will continue to result, in sales to
only a limited number of customers. Some of our products are sold as stand-alone
products by OEMs and, to a lesser extent, are bundled together and sold with


                                       26
<PAGE>

systems manufactured by third party OEMs. We currently sell to ten OEMs, sales
to which collectively accounted for approximately 57% of our revenues for 1999
on a pro forma basis after giving effect to the VST acquisition. More
specifically, on a pro forma basis after giving effect to the VST acquisition,
Olympus, Fuji Film and Ingram Micro accounted for approximately 11%, 11% and 22%
of our revenues and our top five customers collectively accounted for
approximately 58% of our revenues for fiscal 1999. Furthermore, we expect to
continue to depend on sales of our products to relatively few customers, which
will continue to account for a significant portion of our net revenues, for the
foreseeable future.

OUR CUSTOMERS COULD STOP PURCHASING OUR PRODUCTS AT ANY TIME BECAUSE WE DO NOT
HAVE LONG-TERM PURCHASE CONTRACTS WITH THEM.

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

OUR ABILITY TO SELL OUR PRODUCTS WILL BE LIMITED IF THE OEMS' PRODUCTS DO NOT
ACHIEVE MARKET ACCEPTANCE OR IF THE OEMS DO NOT ADEQUATELY PROMOTE OUR PRODUCTS.

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

A NEW OR COMPETING DATA TRANSFER SOLUTION THAT ACHIEVES SIGNIFICANT MARKET SHARE
OR RECEIVES SIGNIFICANT SUPPORT FROM FLASH MEMORY CARD OR DIGITAL APPLIANCE
MANUFACTURERS WOULD JEOPARDIZE OUR BUSINESS.

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

                                       27
<PAGE>

SINCE WE SELL OUR PRODUCTS TO A LIMITED NUMBER OF LARGE CUSTOMERS, WE EXPECT
THAT THOSE CUSTOMERS MAY PRESSURE US TO MAKE PRICE CONCESSIONS, WHICH WOULD
REDUCE OUR FUTURE GROSS MARGINS.

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

WE EXPECT TO CONTINUE OUTSOURCING KEY OPERATIONAL FUNCTIONS AND OUR ABILITY TO
DO SO WILL BE IMPAIRED IF WE ARE UNABLE TO MAINTAIN OUR STRATEGIC RELATIONSHIPS.

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

WE MUST OVERCOME GEOGRAPHIC AND CULTURAL DIFFERENCES IN ORDER TO MAINTAIN OUR
STRATEGIC RELATIONSHIPS.

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

OUR SALES AND EXPENSES ARE GEOGRAPHICALLY CONCENTRATED IN JAPAN, AND, THEREFORE,
WE COULD SUFFER FROM EXCHANGE RATE FLUCTUATIONS AND ECONOMIC AND POLITICAL
DIFFICULTIES.

         On a pro forma basis after giving effect to the VST acquisition,
approximately 31% of our revenues for 1999 were attributable to sales to
Japanese customers, and we expect that sales to Japanese customers will continue
to account for a significant portion of our total revenues for the foreseeable
future. All of our Japanese sales, as well as the related expenses, are
denominated in yen. Fluctuations in exchange rates between the yen and the U.S.
dollar, particularly with respect to Japanese transactions denominated in a
currency other than the yen, could adversely impact our financial results. Some
transactions and accounts of our Japanese subsidiary are U.S. dollar
denominated. Since the Japanese subsidiary's accounting records are


                                       28
<PAGE>

kept in yen, those U.S. dollar denominated transactions are accounted for in yen
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 Japanese subsidiary
are translated to the U.S. dollar for financial reporting purposes and resulting
adjustments are made to stockholders equity. The value of the yen may
deteriorate against the dollar, which would impair the value of stockholders'
investment in us. Deterioration of the yen against the dollar has occurred in
recent years, resulting in a foreign currency loss of approximately $48,000 and
a foreign currency translation adjustment to equity of approximately $290,000
for 1998. In 1999, we had a foreign currency gain of approximately $30,000 and a
foreign currency transaction adjustment to equity of approximately $277,000.
Further, we do not currently hedge against foreign currency exposure. In the
future, we could be required to denominate our product sales in other
currencies, which would make the management of currency fluctuations more
difficult and expose us to greater currency risks.

OUR SALES ARE GEOGRAPHICALLY CONCENTRATED IN JAPAN, AND, THEREFORE, WE COULD
SUFFER FROM ECONOMIC AND POLITICAL DIFFICULTIES.

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

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

OUR FOREIGN OEM CUSTOMERS MAY CHOOSE TO WORK WITH A LOCAL COMPETITOR, WHICH
WOULD ADVERSELY IMPACT OUR SALES.

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

WE DEPEND ON A LIMITED NUMBER OF CONTRACT AND OFFSHORE MANUFACTURERS, AND IT MAY
BE DIFFICULT TO FIND REPLACEMENT MANUFACTURERS IF OUR EXISTING RELATIONSHIPS ARE
IMPAIRED.

         We contract with offshore manufacturers to produce our products and our
dependence on a limited number of contract manufacturers exposes us to a variety
of risks, including shortages of manufacturing capacity, reduced control over
delivery schedules, quality assurance, production yield and costs. For example,
Yamaichi, Hitachi and Mitsumi are the sole manufacturers of our FlashPath
products. We do not have contracts with any of Yamaichi, Hitachi or Mitsumi. If
Yamaichi, Hitachi or Mitsumi terminates production or cannot meet our production
requirements, we may have to rely on other contract manufacturing sources or
identify and qualify new contract manufacturers. The lead time required to
qualify a new manufacturer could


                                       29
<PAGE>

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

TOSHIBA INTRODUCED US TO ONE OF OUR MANUFACTURERS AND WE MAY NOT BE ABLE TO
RETAIN THE SERVICES OF THE MANUFACTURER IF OUR RELATIONSHIP WITH TOSHIBA IS
IMPAIRED.

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

OUR DEPENDENCE ON FOREIGN MANUFACTURING AND INTERNATIONAL SALES EXPOSES US TO
DIFFICULTIES OFTEN NOT ENCOUNTERED BY EXCLUSIVELY DOMESTIC COMPANIES.

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

         o        Difficulties in monitoring production;

         o        Transportation delays and interruptions;

         o        Unexpected changes in regulatory requirements;

         o        Currency exchange risks;

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

         o        Difficulties in staffing and managing disparate branch
                  operations;

         o        Political or economic instability;

         o        Compliance with foreign laws;

         o        Difficulties in protecting intellectual property rights in
                  foreign countries;

         o        Exchange controls; and

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

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



                                       30
<PAGE>

WE HAVE A LIMITED NUMBER OF SUPPLIERS OF KEY COMPONENTS AND OUR ABILITY TO
PRODUCE FINISHED PRODUCTS WILL BE IMPAIRED IF WE ARE UNABLE TO OBTAIN SUFFICIENT
QUANTITIES OF SOME COMPONENTS.

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

OUR CURRENT AND POTENTIAL COMPETITORS HAVE SIGNIFICANTLY GREATER RESOURCES THAN
WE DO, AND INCREASED COMPETITION COULD HARM SALES OF OUR PRODUCTS.

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

OUR BUSINESS MAY SUFFER IF WE ARE UNABLE TO MANAGE OUR GROWTH.

         Failure to effectively manage our growth could impair our ability to
execute our business strategy. Our business has grown substantially in recent
periods, with revenues increasing from approximately $15.3 million in 1998 to
approximately $102 million in 1999, on a pro forma basis after giving effect to
the VST acquisitions. 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 125 as of March 31, 2000.
We expect to continue to increase the number of employees as our business grows,
and may expand operations to locations other than those in which we currently
operate.

                                       31
<PAGE>

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

WE MAY NOT BE ABLE TO INTEGRATE THE BUSINESS OF COMPANIES WE ACQUIRE AND
THEREFORE THESE ACQUISITIONS MAY NOT PROVIDE ADDITIONAL VALUE TO OUR
STOCKHOLDERS.

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

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

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

         o        Establish a common corporate culture; and

         o        Integrate geographically distant facilities, systems and
                  employees.

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

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

OUR GROWTH PROSPECTS WILL BE REDUCED IF WE CANNOT SUCCESSFULLY MARKET AND SELL
OUR NEW FIREWIRE RAID ARRAY PRODUCT.

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


                                       32
<PAGE>

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

OUR GROWTH PROSPECTS WILL BE REDUCED IF THE SMART CARD MARKET DOES NOT DEVELOP.

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

WE HAVE INDEMNIFICATION OBLIGATIONS RELATED TO OUR INTELLECTUAL PROPERTY, WHICH
MAY REQUIRE US TO PAY DAMAGES.

         Our arrangements with SanDisk, Iomega, Sony, Toshiba and others require
us to indemnify them for any damages they may suffer if a third party claims
that we are violating their intellectual property rights. While, to date, we
have not received indemnification claims, there may be future claims. Any
indemnification claim may require us to pay substantial damages, which could
negatively impact our financial condition.

OUR PRODUCTS MAY BE RETURNED TO US BY OUR CUSTOMERS IF PROJECTED CONSUMER DEMAND
DOES NOT MATERIALIZE, WHICH WOULD LEAD TO A REDUCTION IN OUR REVENUES.

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

WE COULD BE HELD LIABLE FOR PRODUCT DEFECTS, WHICH COULD REQUIRE US TO PAY
SUBSTANTIAL DAMAGES AND HARM OUR REPUTATION WITH OUR CUSTOMERS.

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


                                       33
<PAGE>

and customers. This could result in additional development costs, loss of, or
delays in, market acceptance, diversion of technical and other resources from
our other development efforts, claims by our customers or others against us or
the loss of credibility with our current and prospective customers.

OUR EXECUTIVE OFFICERS AND KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND THESE
OFFICERS AND PERSONNEL MAY NOT REMAIN WITH US IN THE FUTURE.

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

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

         All of our short-term investments are fixed rate instruments. The
aggregate fair value of our short-term investments as of March 31, 2000 is
$17,740,915. The weighted average interest rate of our short-term investments is
6.44%.

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

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


                                       34
<PAGE>

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

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

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

PART II.      OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

         Between January 1, 2000 and March 31, 2000, we issued approximately
15,000 shares of common stock to employees, directors and consultants. Such
shares were issued upon exercise of stock options with exercise prices ranging
from $0.72 to $35.00 per share. All of such shares were purchased by cash except
Timothy Tomlinson, one of our directors, paid the par value in cash and the
balance by delivery of a full recourse promissory note in the principal amount
of $209,994.

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

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

                                       35
<PAGE>

         On October 6, 1999, we completed our initial public offering. The
shares of common stock sold in the initial public offering were registered under
the Securities Act of 1933, as amended on a registration statement on Form S-1
(No. 333-82793). The Securities and Exchange Commission declared the
registration statement effective on October 5, 1999. We realized net proceeds of
approximately $39.14 million from the sale of 3,450,000 shares of common stock
(including 450,000 shares issued upon the exercise of the underwriters' over
allotment option) at an initial public offering price of $13.00 per share after
deducting underwriting discounts and commissions of approximately $3.14 million
and offering expenses of approximately $2.57 million.

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

         The net proceeds from our initial public offering have been invested in
cash, cash equivalents and short-term investments. In March 2000, in connection
with the acquisition of VST, we paid, or have set aside to be paid, a total of
approximately $18.28 million in purchase consideration and other acquisition
related costs. In March 2000, we also paid-down a line of credit that VST
maintained which had an outstanding balance of approximately $4.28 million. To
date, we have funded VST's operations with approximately $3.75 million, which
includes the $755,000 cash portion of the consideration for the acquisition of
El Gato. We plan to use the remaining net initial public offering proceeds for
general corporate purposes, including working capital and capital expenditures,
as well as potential acquisitions of technology and businesses. The use of the
proceeds from the initial public offering does not represent a material change
in the use of proceeds described in our prospectus dated October 5, 1999.

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

                                       36
<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

         (a)      Exhibits:

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

           27.1       Financial Data Schedule (available in EDGAR format only)


         (b)      Reports on Form 8-K:

         FORM 8-K, FILED MARCH 21, 2000, LISTING ITEMS 2 AND 7 AS THEY RELATED
         TO THE COMPANY'S ACQUISITION OF VST TECHNOLOGIES, INC.

                                       37
<PAGE>

                                   SIGNATURES

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

                           SMARTDISK CORPORATION



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



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




Dated:    May 15, 2000

                                       38
<PAGE>

                                 EXHIBIT INDEX


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

           27.1       Financial Data Schedule (available in EDGAR format only)