**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

----

**FORM 10-K**

**FOR ANNUAL AND TRANSITIONREPORTS PURSUANT TO SECTIONS 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**(MarkOne)**

| ý |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|--------|--------|-------------------------------------------------------------------------------------------|

**For the fiscal year endedDecember 31, 2002**

**OR**

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

**For the transition periodfrom          to**

**Commission file number000-31623**

**SIMPLETECH,INC.**

(Exact Name of Registrant as Specified in Its Charter)

----

| ****California****                                                   |   | **33-0399154**                       |   |
|----------------------------------------------------------------------|--------|--------------------------------------|--------|
| (State or Other Jurisdiction  of Incorporation or Organization) |   | (I.R.S. Employer Identification No.) |   |
|                                                                 |   |                                 |   |
| **3001  Daimler Street Santa Ana, California 92705-5812**            |   |
| (Address of principal  executive offices, including zip code)        |   |
|                                                                 |   |
| **(949) 476-1180**                                                   |   |
| Registrant’s Telephone Number, Including Area Code:             |   |

 

----

 
| ****Securities registered pursuant to Section 12(b) of  the Act:  None Securities registered  pursuant to Section 12(g) of the Act:**** |
|----------------------------------------------------------------------------------------------------------------------------------------------|

 

| ****Title of each class****             |   | ****Name of each exchange on which registered**** |
|-----------------------------------------|--------|---------------------------------------------------|
| ****Common  Stock, $0.001 par value**** |   | ****The  Nasdaq National Market****               |

 

Indicate by checkmark whether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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 ý    No o

Indicate by acheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  ý

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange ActRule 12b-2). Yes o No ý

As of June 28,2002, the last business day of the registrant’s most recently completed secondfiscal quarter, the approximate aggregate market value of voting and non-votingcommon stock held by non-affiliates of the registrant was $25,647,000 (basedupon the last closing price for shares of the registrant’s common stock asreported by The National Market System of the National Association ofSecurities Dealers Automated Quotation System as of that date). Shares ofcommon stock held by each officer, director, and holder of 10% or more of theoutstanding common stock have been excluded in that such persons may be deemedto be affiliates. This determination of affiliate status is not necessarily aconclusive determination for other purposes.

As of March 1,2003, there were approximately 38,900,883 shares of common stock outstanding.

**Documents Incorporated By Reference**

Certaininformation required in Part III hereto is incorporated by reference to theProxy Statement for the Registrant’s 2003 Annual Meeting of Shareholders to befiled with the Securities and Exchange Commission pursuant to Regulation 14Anot later than 120 days after the end of the fiscal year covered by this Form10-K.

** **

----

**SIMPLETECH,INC.FORM 10–K ANNUAL REPORTTABLE OF CONTENTS**
| PART I    |                                                                                             |
|-----------|--------------------------------------------------------------------------------------------------|
| ITEM 1.   | BUSINESS                                                                                         |
| ITEM 2.   | PROPERTIES                                                                                       |
| ITEM  3.  | LEGAL  PROCEEDINGS                                                                               |
| ITEM  4.  | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                             |
|      |                                                                                             |
| PART II   |                                                                                             |
| ITEM  5.  | MARKET  FOR THE REGISTRANT’S COMMON STOCK AND RELATED SHAREHOLDER MATTERS                   |
| ITEM 6.   | SELECTED FINANCIAL  DATA                                                                         |
| ITEM  7.  | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      |
| ITEM  7A. | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                      |
| ITEM  8.  | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                     |
| ITEM  9.  | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE            |
|      |                                                                                             |
| PART III  |                                                                                             |
| ITEM  10. | DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT                                              |
| ITEM 11.  | EXECUTIVE COMPENSATION                                                                           |
| ITEM  12. | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS |
| ITEM  13. | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                  |
| ITEM 14.  | CONTROLS AND  PROCEDURES                                                                         |
|      |                                                                                             |
| PART IV   |                                                                                             |
| ITEM 15.  | EXHIBITS, FINANCIAL STATEMENT  SCHEDULES AND REPORTS ON FORM 8-K                            |

 

 

**ABOUT THIS ANNUAL REPORT**

** **

**In this Report, “SimpleTech,” “we,”“us” and “our” refer to SimpleTech, Inc., a California corporation, andour subsidiaries. We own or have rights to product names and trademarks that weuse in conjunction with the sale of our products, including Simple®,SimpleTech®, IC TowerTM and CompactFlashTM. The CompactFlash Association makesthe CompactFlash name and logo available royalty-free to its member companies.References in this Report to CompactFlash are references only to our productsunless otherwise indicated. This report also contains other product names,trade names and trademarks that belong to other organizations.**

 

----

**ThisAnnual Report on Form 10-K, including information incorporated herein byreference, contains “forward-looking statements” within the meaning of Section27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. These statements relate toexpectations concerning matters that are not historical facts. Words such as“projects,” “believes,” “anticipates,” “will,” “estimate,” “plans,” “expects,”“intends,” and similar words and expressions are intended to identifyforward-looking statements. Although we believe that such forward-lookingstatements are reasonable, we cannot assure you that such expectations willprove to be correct. Important language regarding factors which could causeactual results to differ materially from such expectations are disclosed inthis Report, including without limitation under the caption “Risk Factors” in***this Report.***All forward-looking statements attributable to SimpleTech are expresslyqualified in their entirety by such language. We do not undertake any obligation to update any forward-lookingstatements.**

 

# **PART I**.

## **ITEM1.**                                                     BUSINESS

**Overview**

SimpleTech designs,manufactures and markets a comprehensive line of over 2,500 memory and storageproducts, as well as a range of connectivity products. Our memory solutions arebased on dynamic random access memory, or DRAM, static random access memory, orSRAM, and Flash memory technologies. Our products are used in consumerelectronics, high-performance computing, defense and aerospace, networking andcommunications and industrial applications. Examples of these applicationsinclude digital cameras, MP3 digital audio players, personal digitalassistants, or PDAs, digital video recorders, desktop and notebook computers,military subsystems, in-flight information systems, servers, routers, switches,casino gaming systems, embedded controls and medical instruments. Our patentedIC Tower stacking technology allows multiple memory chips to be stackedtogether to increase the capacities of memory modules without increasing theproduct footprint. Our small form factor Flash cards, including CompactFlash,Secure Digital, or SD, and MultiMedia cards, increase storage capacities inportable digital devices, such as digital cameras, MP3 digital audio playersand PDAs.  Our design, manufacturing, testingand logistics expertise, along with our proprietary technologies, enable us tocustomize solutions for specific applications and respond to our customers’rapidly changing product and service requirements. We provide our customerswith timely access to high-speed and high-density memory products, increasingtheir ability to bring products to market quickly and decreasing their capitalrequirements and production and inventory costs.

We offer our productsthrough our Industrial and Commercial Divisions.  Commercial Division channels include value added resellers, orVARs, direct marketers, commercial and industrial distributors and mass marketretailers. We believe our comprehensive line of products allows our customersto efficiently manage their inventory purchases by consolidating their sourcesfor memory, storage and connectivity products. Our Industrial Division sellsprimarily custom memory products for newly manufactured systems, with mostsales based on a coordinated design effort between our design team and theengineers from our Industrial Division customers.  Our Commercial Division designs and manufactures industryaccepted memory storage and connectivity products used as upgrades in orenhancements to computing systems and consumer electronics.  CDW Computer Centers accounted for more than10.0% of our total revenues in 2002, and CDW Computer Centers and Unisysaccounted for more than 10.0% of our total revenues in 2001.  No other customer accounted for more than10.0% of our total revenues in 2002 and 2001.

SimpleTech was originallyincorporated in California in March 1990 as Simple Technology, Inc.  Our name was then changed to SimpleTech,Inc. in May 2001. Our principal executive offices are

1

----

 

located at 3001Daimler Street, Santa Ana, California 92705-5812.  Our telephone numberis (949) 476-1180.  We maintain a WorldWide Web site at http://www.simpletech.com.  We make available, free of charge, throughour web site copies of our annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and amendments to these reports, as soonas reasonably practicable after such material is electronically filed with, orfurnished to, the Securities and Exchange Commission.  The information on our web site should not be considered part ofthis Report.

**Industry Background**

The DRAM industryexperienced explosive growth from 1990 through 1995 fueled by Microsoft’sintroduction of the memory-intensive Windows operating system for desktop PCsand notebook computers. After DRAM industry revenues reached approximately $41billion in 1995, desktop PC and notebook computer growth rates slowed and theindustry entered a period of overcapacity. As a result of consolidation, the number of major DRAM manufacturersdecreased from more than ten in 1995 to approximately four in 2002.  The oversupply environment waned briefly in1999 and the first nine months of 2000, driven in part by significant increasesin IT spending due to Y2K upgrades, the build-out of the Internetinfrastructure and spending by Internet companies.  The combination of a massive build-up of semiconductorinventories, the overhang left by the passing of Y2K and deterioration of theInternet economy resulted in the return of oversupply conditions in late2000.  We expect industry conditions tocontinue to be challenging in the foreseeable future, with most or allmanufacturers of DRAM currently selling components at or below their productioncost. Since we rely on these market participants for our raw components, ourDRAM revenues will continue to be volatile.

The Flash industry isdivided into two primary segments: data storage, or NAND, and code storage, orNOR.  Data storage Flash products arecommonly used for storing large volumes of data in small form factors and inenvironments characterized by high levels of shock, vibration or temperaturefluctuation.  Alternatively, codestorage Flash products are typically used in less memory-intensiveapplications.  Substantially all of ourFlash product revenues are derived from the sale of data storage Flashproducts.

 

The data storage Flash industry is still in the earlystages of development.  The industryexperienced explosive growth from 1997 to 2000 led by consumers embracing anumber of Flash-based devices, such as digital cameras, MP3 digital audioplayers and PDAs.  Growth in Flashindustry revenues stalled in 2001 and 2002 as a result of worldwide economicweakness.  In November 2002, however,Semico Research Corporation projected data storage Flash industry revenues togrow at a compounded annual growth rate of 41% from 2001 to 2004.

 

The DRAM and Flash memorysupply chain consists of numerous players from semiconductor manufacturers tothird-party module and card designers and manufacturers to a variety ofdistributors who sell to end-users. Historically, semiconductor manufacturers have focused on large-volumeopportunities, producing modules and cards as base-level memory for only thetop original equipment manufacturers, or OEMs, of desktop PCs, notebookcomputers, digital cameras, cell phones and other mass markets.  In contrast to serving the base-level memoryneeds of these OEMs, third-party module and card manufacturers, such asSimpleTech, specialize in providing industry-accepted upgrades to theaftermarket and customized solutions for systems in which standard modules andcards are not adequate.  As purchasersof semiconductor components from large-scale semiconductor manufacturers,third-party module and card producers provide design, assembly, test anddistribution expertise, as well as technical support and quality assurance, toend customers.

 

2

----

 

**The SimpleTech Solution**

SimpleTech designs,manufactures and markets a comprehensive line of memory, storage andconnectivity products used in consumer electronics, high-performance computing,defense and aerospace, networking and communications and industrialapplications.

***Product Features***

•                  *High degree of customization. *Products sold to our Industrial Division customers aretypically customized to meet our customers’ specific design requirements.

•                  *High density*. Our patented IC Tower stackingtechnology allows us to design and manufacture Flash cards and DRAM memorymodules in which multiple memory chips are stacked together to increase thecapabilities of memory modules without increasing the product footprint. Insome cases, our IC Tower stacking memory technology allows us to createsolutions that are otherwise not currently available in the market usingstandard modules.

•                  *Compact size*. We are able to manufacture high-densityDRAM and Flash memory products with some of the smallest footprints on themarket.  As component chips increase incapacity, our ability to increase density in the same footprint also increases.

•                  *High performance andreliability*. Ourmemory products are built utilizing sophisticated error detection andcorrection processes to provide high data reliability and integrity. Inaddition, our memory products are designed to withstand high levels of shockand vibration as well as extreme temperature fluctuations typically associatedwith mobile computing and industrial applications.

•                  *Low power consumption*. During read and write operations, ourFlash memory products use less power than most rotating disk drives. At allother times during system operation, our Flash memory products require nopower. This low-power consumption translates into longer battery life for manymobile computing and consumer electronic devices.

***Industrial Division***

We offer our IndustrialDivision customers a comprehensive technology solution from concept to designto the creation of prototypes through high volume production and testing. Webelieve our quick-turn design capabilities and automated manufacturing and testprocesses allow our Industrial Division customers to quickly andcost-effectively bring products to market. In addition, our capabilities allowour  Industrial Division customers tofocus their resources on activities and technologies in which they add thegreatest value, such as system design, sales, marketing and distribution. Webelieve our technical capabilities and manufacturing strengths allow ourIndustrial Division customers to cost-effectively design and implement advancedmemory chip technology in high volume product applications.

***Commercial Division***

Our Commercial Divisioncustomers include VARs, direct marketers, commercial and industrialdistributors and mass market retailers. We believe our comprehensive line ofproducts allows our Commercial Division customers to efficiently manage theirinventory purchases by consolidating their sources for memory, storage andconnectivity products. We are able to strengthen our relationships with theseCommercial Division customers and develop the SimpleTech brand name throughvarious marketing programs. We also provide ongoing customer support, includingon-line pricing and navigation tools, toll-free technical support and accountmanager training programs. For further details regarding our various marketingprograms, see “Business—Sales and Marketing.”

3

----

 

***Xiran Division***

In January 2002, weacquired Irvine Networks, LLC, including its intellectual propertyportfolio.  Subsequently, IrvineNetworks was renamed as our Xiran Division. By retaining Irvine Networks’ engineering staff, we have addedsignificant expertise in content delivery and storage system design.  Our Xiran Division is developing a universalsolution to accelerate the delivery of content between network and storage. TheXiran Division received its ASIC from its fabrication partner, IBM, in December2002 and is currently integrating the ASIC into board and system levelproducts. We expect our Xiran Division to begin generating revenues in 2004.

While the Xiran Division received its ASIC in December2002 and expects to generate revenue in 2004, there can be no assurance thatthe efforts focused thus far will result in future profitability of the XiranDivision.  In addition, the success ofthe Xiran Division will depend in significant part upon the ability to develop,introduce and sell its products on a timely and cost-effective basis, and torespond to changing customer requirements.

 

For additional financial information about each of ourdivisions, please see Note 12 to our Consolidated Financial Statement.

 

**Design, Manufacturing and TestEngineering**

*Design and production*.  The typical production cycle consists ofa design stage followed by a prototype stage and ends with full production ofthe final product. The length of the design stage has been reduced due to rapidimprovements in technology. In recent years customers have demanded shorterdesign and production cycles. In response, we have developed quick-turn designand manufacturing services. By working with our Industrial Division customersearly in the design and prototype stages, we are able to resolve criticaldesign issues effectively and efficiently, thus shortening the time fromprototype design to volume manufacturing. In addition, working closely with ourIndustrial Division customers throughout the design and production stagesallows us to gain important insights into their future product requirements. Webelieve our quick-turn design and manufacturing services also allows us tointroduce upgrade products to the aftermarket on a timely basis to coincidewith new product releases by these customers.

*Manufacturing.*  Our manufacturing processes are highlyautomated and involve the use of specialized equipment for the production ofmemory products. Our manufacturing systems have been optimized to support theplacement of a large number of IC devices on each memory board. We believe weare able to achieve a high manufacturing yield and minimize direct labor costsas a result of our design efficiencies, high level of automation and generalmanufacturing expertise. Because our manufacturing systems can be easilyconfigured for different memory products, we have the ability to offer ourcustomers short manufacturing and test cycles on small and large projects. Wealso have developed an automated method of manufacturing our IC Tower stackingproducts which we believe results in further manufacturing efficiencies. Ourmanufacturing process is ISO 9001 certified.

*Test engineering.*  An important aspect of our manufacturingoperations is our focus on test engineering. We test all of our memory productsupon completion of manufacturing, which results in lower returns due to productdefects. We believe our test engineering expertise will continue to grow inimportance as the speed and complexity of memory products increase. Our testengineering group develops proprietary processes which, together with ourcontinued investment in advanced testing equipment, enable us to consistentlyproduce high-quality products.

4

----

 

**Research and Development**

Our research anddevelopment efforts are focused on developing reliable, high-performance andcost-effective memory products to address the needs of traditional and emergingmemory applications. We believe the timely development of new products isessential to maintaining our competitive position. Our engineering staff worksclosely with our Industrial Division customers and provides services throughoutthe production cycle, including component selection, schematic design, layout,manufacturing and test engineering expertise. We design our products to becompatible with existing industry standards and, where appropriate, develop andpromote new standards. An important aspect of our research and developmenteffort is to understand the challenges presented by our Industrial Divisioncustomers’ custom design requirements and satisfy them by utilizing ourproprietary technologies and our technical expertise. In the course of meetingour customers’ challenges, we are often required to develop new technologiesand processes, which are later added to our design library. Our design libraryconsists of over 1,000 designs that are available for a wide variety of customand industry-accepted product configurations.

We focus primarily on newhigh speed memory modules, improvements in manufacturing processes andtechnologies, and improvements in test routines and related software. We planto continue to direct our research and development efforts toward the design ofnew memory products which address the requirements of our Industrial andCommercial Division customers.  Our ICTower stacking technology is a critical component of our research anddevelopment effort as it allows us to design solutions that are continuallymigrating to higher densities for our customers.  In response to the growth in Flash-based applications, we haveaccelerated our design of new Flash solutions that provide improved storagecapacities, higher speed read and write capabilities, smaller sizes and newinterfaces.

In January 2002, weacquired Irvine Networks, LLC, including its intellectual propertyportfolio.  Subsequently, IrvineNetworks was renamed as our Xiran Division. By retaining Irvine Network’s engineering staff, we have addedsignificant expertise in content delivery and storage system design.  The Xiran Division is developing a universalsolution to accelerate the delivery of content between network and storage. TheXiran Division received its ASIC from its fabrication partner, IBM, in December2002 and is currently integrating the ASIC into board and system levelproducts.

**Products**

We design, manufactureand market a comprehensive line of more than 2,500 memory, storage andconnectivity products using our proprietary design and manufacturingtechnologies. Substantially all of our DRAM, SRAM and Flash memory productscomply with industry standards and are based on a variety of industryarchitectures. Sales of memory products accounted for 93.2% of our totalrevenues in 2002, 90.2% of our total revenues in 2001 and 91.0% of our totalrevenues in 2000.

***DRAM Products***

We offer DRAM productsincluding a wide range of single in-line memory modules, or SIMMs, dual in-linememory modules, or DIMMs, and small outline dual in-line memory modules, or SODIMMs. Our standard DRAM products are available in various configurationsof up to 184 pins and densities of up to 4 gigabytes. We also offer many ofthese products in 3.3 volt or 5.0 volt configurations utilizing different DRAMarchitectures such as DDR, SDRAM, RDRAM, EDO and FPM.

5

----

 

The following table describes certain of ournon-stacking DRAM products as of March 1, 2003: 
| **DRAM Product Family**              |   | **Density** |   | **Architecture** |   | **Speed  (MHz)** |   |
|--------------------------------------|--------|-------------|--------|------------------|--------|------------------|--------|
| 184-pin DIMM                         |   | 64MB-4GB    |   | DDR              |   | 100-200          |   |
| 200-pin SODIMM                       |   | 64MB-1GB    |   | DDR              |   | 100-200          |   |
| Rambus DIMM                          |   | 64-512MB    |   | RDRAM            |   | 600-1066         |   |
| 168-pin and  184-pin Registered DIMM |   | 64MB-2GB    |   | DDR, SDRAM       |   | 66-200           |   |
| 168-pin DIMM                         |   | 16-256MB    |   | EDO, FPM         |   | 100-133          |   |
| 144-pin SO DIMM                      |   | 16MB-1GB    |   | SDRAM, EDO, FPM  |   | 100-133          |   |
| 100-pin DIMM                         |   | 16-64MB     |   | SDRAM, EDO, FPM  |   | 100-133          |   |
| 72-pin SO DIMM                       |   | 16-64MB     |   | EDO, FPM         |   | 50 ns            |   |
| 72-pin SIMM                          |   | 16-128MB    |   | EDO, FPM         |   | 60 ns            |   |

 

***Flash Products***

We manufacture Flashproducts for data storage and code storage. Our data storage Flash products arecommonly used for storing large volumes of data in small form factors inenvironments characterized by high levels of shock, vibration or temperaturefluctuation.  Conversely, our Flashmodules and Linear Flash PC Cards are commonly used in less memory-intensiveprogram and code storage applications. Substantially all of our Flash product revenues are derived from thesale of data storage Flash products.

*Data storage Flash products.*  We offer a broad line of data storageFlash products in various capacities, sizes and operating voltages andtemperatures. Our data storage Flash products are compatible with a majority oftoday’s industry-standard consumer electronic devices, computing systems andcommunications systems and include:

*CompactFlash.*  Our CompactFlash productsprovide full PC Card ATA functionality but are only one-fourth the size of astandard PC Card. CompactFlash’s small size, durability, low-power consumptionand ability to operate at either 3.3 volts or 5.0 volts make it well-suited fora range of current and next-generation, small size consumer applications suchas audio recorders, digital cameras, MP3 digital audio players and PDAs.CompactFlash products provide interoperability with systems based on the PCCard ATA standard by using a low-cost passive adapter.

*Secure Digital and MultiMedia FlashCards.*  Our Secure Digital and MultiMedia FlashCards are used in storage, data backup and data logging applications and areabout the size of a postage stamp. Their slim, compact design makes them an ideal removable storagesolution for designs ranging from pocket-sized cellular phones, audio playersand digital cameras, to PDAs and set-top boxes as well as other compact ormulti-function digital products.

*BonzaiFlash Drives.*OurBonzai USB Flash Drives are portable, pocket-sized storage devices used tostore, transfer and carry personal files and allow access to files via anydesktop PC, notebook computer or other device with a USB port.  Bonzai Flash Drives store data on our

6

----

 

Secure Digital or MultiMedia Flash Cards, which can be removed from thedrive enabling the use of multiple Flash cards on the same Bonzai, upgrade ofthe Bonzai to higher storage capacities and the use of a single Flash cardamong multiple devices.

*ATA Flash PC Cards.*  Our ATA Flash PC Cards areused in storage, data backup and data logging applications. Our products areavailable in PC Card Type II and III form factors.

*Solid-State Flash Drives.*  Our solid-state Flash drivesare available in 2.5 inch and 3.5 inch hard disk form factors and are targetedat applications that require embedded data storage devices. Our solid-stateFlash drives offer rugged, portable, low-power data storage and are compatiblereplacements for rotating hard drives, making them ideal for industrializednotebook computers, communication devices, and networking and communicationsapplications requiring embedded storage.

*Flash Disk Modules.*  Our Flash Disk Moduleproducts offer a transparent design, replacing or augmenting conventional IDEhard disk drives by leveraging from a miniature module footprint that allowsthese products to be used as components in embedded systems. Specifically, theproduct line is available in a 44-pin configuration, which addresses similarfunctionality to a 2.5 inch hard disk drive, a 40-pin configuration whichaddresses similar functionality to 3.5 inch hard disk drive.

The following table describes certain of our datastorage Flash products as of March 1, 2003: 
| **Data Storage Flash Product Family**      |   | **Density** |   | **Form  Factor**                    |   |
|--------------------------------------------|--------|-------------|--------|-------------------------------------|--------|
| CompactFlash                               |   | 32-640MB    |   | Type I (36.4mm x 42.8mm x 3.3mm)    |
| Secure Digital  and MultiMedia Flash Cards |   | 16-512MB    |   | 7 and 9-pin                         |
| Bonzai                                     |   | 64-512MB    |   | USB mini drive                      |
| ATA Flash PC  Cards                        |   | 32MB-3.6GB  |   | Type II (54.0mm x 85.6mm x 5.0mm)   |
|                                       |   | 4.0GB       |   | Type III (54.0mm x 85.6mm x 10.0mm) |
| Solid-state  Flash drives                  |   | 32MB-16GB   |   | 2.5 inch and 3.5 inch               |
| Flash Disk  Modules - 40-pin               |   | 32-512MB    |   | 40-pin vertical & horizontal    |
| Flash Disk  Modules - 44-pin               |   | 32MB-1GB    |   | 44-pin horizontal                   |

 

*Flash modules.*  We offer standard, custom andapplication-specific Flash modules, including 168-pin Asynchronous DIMMs,144-pin SO DIMM, 80-pin Asynchronous SIMMs and 72-pin DRAM/Flashcombination SIMMs. Our Flash modules are available in densities of up to256 megabytes. We offer additional options such as on-board active resetcontrol and system reset. Many of these products are available in 3.3 volt or5.0 volt configurations.

*Linear Flash PC Cards.*  We offer standard, custom andapplication-specific Linear Flash PC Cards, with densities ranging from 512kilobytes to 256 megabytes.

7

----

 

***Stacked DRAM and Flash Card Products***

    *DRAM modules and Flash card products.*  Weoffer custom and application-specific stacked DRAM modules including a widerange of DIMMs and SO DIMMs. Our stacked DRAM modules are availablein various configurations of up to 200-pins and densities of up to 1 gigabyte.We also offer many of these modules in both 3.3 volt and 5.0 voltconfigurations utilizing different DRAM architectures such as DDR, SDRAM, EDOand FPM. Our IC Tower stacking technology has enabled us to offer a 1 gigabyte,Type II CompactFlash card, which is one of the highest capacity CompactFlashcards currently available.

    The following table describescertain of our stacking DRAM and Flash card products as of March 1, 2003: 
| **Stacked DRAM Product Family**      |   | **Density** |   | **Architecture** |   | **Speed  (MHz)** |   |
|--------------------------------------|--------|-------------|--------|------------------|--------|------------------|--------|
| 200-pin  Registered DIMM             |   | 512MB-1GB   |   | SDRAM            |   | 66-133           |   |
| 168-pin and  184-pin Registered DIMM |   | 1GB-4GB     |   | DDR, SDRAM       |   | 66-133           |   |
| 168-pin DIMM                         |   | 512MB-2GB   |   | EDO, FPM, SDRAM  |   | 10-133           |   |
| 144-pin and  200-pin SO DIMM         |   | 128MB-1GB   |   | DDR, SDRAM       |   | 66-133           |   |

 
| **Stacked Flash Card Product Family** |   | **Density** |   | **Form  Factor**                            |
|---------------------------------------|--------|-------------|--------|---------------------------------------------|
| CompactFlash                          |   | 1GB         |   | Type II (36.4mm × 42.8mm × 5.0mm) |

 

* IC Tower stacked components.*  Our patented IC Towerstacking technology is a high-density memory design architecture that usesstandard DRAM IC devices to create high-capacity components. We offer a wideselection of stacked components to be used on memory modules and on ourcustomers’ specific applications. This technology is used in complex,high-capacity module designs and systems and offers chip densities that areless expensive than non-stacked components on a per megabit basis.

The following table describes certain of our IC Towerstacked components as of March 1, 2003:

 
| **IC Tower Stacked Component Product Family** |   | **Density** |   | **Architecture**   |   | **Speed  (MHz)** |   |
|-----------------------------------------------|--------|-------------|--------|--------------------|--------|------------------|--------|
| DDR                                           |   | 128-512MB   |   | 2 High

(64-256MB) |   | 200-266          |   |
| SDRAM                                         |   | 128-512MB   |   | 2 High

(64-256MB) |   | 66-133           |   |
| EDO/FPM                                       |   | 128MB       |   | 2 High

(64MB)     |   | 10-33            |   |

 

8

----

 

***SRAM Products***

We offer a comprehensiveline of standard, custom and application-specific SRAM modules and PC Cards,including synchronous, asynchronous and battery backup low-power SRAM devices.Our SRAM products are available in densities of up to 32 megabytes. Many ofthese products are available in 3.3 volt or 5.0 volt configurations.

The following table describes certain of our SRAMproducts as of March 1, 2003: 

| **SRAM Product Family** |   | **Density** |   | **Speed  (MHz)** |   |
|-------------------------|--------|-------------|--------|------------------|--------|
| Custom ZBT              |   | 4-8 MB      |   | 133-200          |   |
| Custom Late  Write      |   | 16-32 MB    |   | 133-200          |   |
| PC Card                 |   | 512KB-6MB   |   | 66-100           |   |
| 72-pin SIMM             |   | 2-8MB       |   | 66-100           |   |
| 64-pin SIMM             |   | 1MB         |   | 66-83            |   |

 

***Other Products***

*Harddrive upgrade kits and external hard drives*.  We offer hard drive upgrade kits for manymajor brands of notebook PCs. Our products range from 20 to 60 gigabytes. Theprimary use of these products is to enhance the storage capacity of notebookPCs. We also offer USB data transfer/backup kits for desktop and notebook PCs.

*Connectivityproducts.  *We offer connectivity products that connect PC Cards, CompactFlashcards and hard drive upgrade kits to a PC’s parallel port or USB port. Theseproducts allow the user to move information from their PC Card, CompactFlashcard or hard drive to their desktop or notebook PC.

**Customers**

We sell our productsthrough our Industrial and Commercial Divisions.  We have no long-term sales contracts with our customers.  Our Industrial Division markets our productsto OEMs leveraging our custom design capabilities to offer custom memorysolutions to address their specific needs. Our Commercial Division sells our products through a variety ofdistribution channels, including VARS, direct marketers, commercial andindustrial distributors and mass market retailers.

***Industrial Division***

In 2002, our IndustrialDivision sold to over 150 customers, including sales through industrialdistributors and contract manufacturers who incorporate our products intosystems they assemble for our Industrial Division customers. We define ourIndustrial Division customers as OEMs who have purchased our products directlyor ordered our products from industrial distributors and contractmanufacturers.  Our Industrial Divisioncustomers make the purchasing decisions on substantially all of the products wesell

9

----

 

through industrialdistributors and contract manufacturers. In 2001, Unisys accounted for 37.6% of our Industrial Division revenuesor 11.0% of our total revenues. No other Industrial Division customer accountedfor more than 10.0% of our total revenues in 2002 or 2001.

***Commercial Division***

In 2002, our CommercialDivision sold to over 1,000 customers through VARs, direct marketers,commercial and industrial distributors and mass market retailers. In addition,through our commercial distribution arrangements, we supply certain of ourproducts to e-commerce companies for their sale of these products on theInternet.  CDW Computer Centers was ourlargest Commercial Division customer for both 2002 and 2001. CDW ComputerCenters accounted for 27.1% of our Commercial Division revenues or 21.1% of ourtotal revenues in 2002, and 27.9% of our Commercial Division revenues or 19.7%of our total revenues in 2001. No other Commercial Division customer accountedfor more than 10.0% of our total revenues in 2002 and 2001.

We expect that sales ofour products to a small number of customers will continue to contributematerially to our revenues for the foreseeable future and believe that ourfinancial results will depend in significant part upon the success of ourcustomers’ businesses.  We have alsoexperienced changes in the composition of our major customer base from quarterto quarter as the market demand for our customers’ products changes and weexpect this variability will continue in the future.

International sales ofour products accounted for 14.8%, 16.0% and 13.4% of the our total revenues in2002, 2001 and 2000, respectively. During these periods, no single foreign country accounted for more than10% of our total revenues. Substantially all of our international sales areexport sales, which are shipped domestically to our foreign customers.  For additional information regarding ourinternational sales, see Note 11 to our Consolidated Financial Statements andBusiness – Risk Factors – “We face risks associated with doing business in foreigncountries, including foreign currency fluctuations and trade barriers, thatcould lead to a decrease in demand for our products or an increase in the costof the components used in our products.”

**Sales and Marketing**

***Industrial Division***

Our Industrial Divisionuses an internal direct sales force complemented by an external sales force ofmanufacturers’ representatives and industrial distributors for sales toIndustrial Division customers in the United States and internationally. Wepursue our customer base on both a geographic and account-specific basis. Webelieve these combined sales forces have the local presence, market knowledgeand strategic insight to allow us to more effectively market our products to alarger number of industrial customers. In addition, as part of our sales andmarketing efforts, our experienced applications engineers work closely with ourIndustrial Division customers in designing our products into their systems.

***Commercial Division***

We ship SimpleTech brand-name products directly toVARs, direct marketers, commercial and industrial distributors and mass marketretailers. As of March 1, 2003, our products were available in more than 2,000stores in the United States. In addition to in-house sales representatives, oursales efforts in the commercial channel are supported by manufacturers’representatives. For the direct market and mass market retailer channels, weadvertise in magazines and newspapers as a way of bringing end-users to ourcustomers’ locations. Some of our Commercial Division customers also featureour products in their advertisements in exchange for a fee. We offer certainVARs volume rebates and work with their customers to qualify our products fortheir information system departments. Volume rebates are used to

10

----

 

incentivizecertain resellers, rewarding them with a rebate for our products sold. Forcommercial distributors, we purchase corporate image advertising, offer volumerebates and joint marketing programs, and generate leads at electronicstradeshows and refer those potential customers to our distributors. Throughjoint marketing programs, we work together with resellers to incorporate theSimpleTech brand in the resellers’ existing marketing plans, such as catalogsand web banner ads. In addition, we have developed direct advertising programswith certain of our commercial distributors’ e-commerce customers in which wemarket our products on their websites. We also offer account managerincentives, which include sales contests and reward programs designed tosustain reseller loyalty while also creating excitement for increased salesactivity.

**Customer Service and Support**

We provide our customerswith comprehensive product service and support. We work closely with ourIndustrial Division customers to monitor the performance of their productdesigns and to provide application design and support. This also provides uswith insight into defining their subsequent generations of products. Ourstandard Industrial Division customer support package is generally offered withall product sales and includes full technical documentation and applicationdesign assistance. During our Industrial Division customers’ production phase,we provide extensive support which includes training, system-level design,implementation and integration support. We believe that tailoring our technicalsupport to our Industrial Division customers’ needs is essential for thesuccess of our product introductions and customer satisfaction. Our CommercialDivision customers receive technical support on an unlimited, toll-free basisand are assigned a dedicated technician familiar with their account. We alsotrain the account managers of certain Commercial Division customers to keepthem informed about changes in our product lines. In addition, we offerCommercial Division customers on-line pricing and navigation tools, and apersonalized web page available through our extranet which featurespersonalized information such as promotions, new products and contactinformation.

**Competition**

We conduct business in anindustry characterized by intense competition, rapid technological change,evolving industry standards, declining average sales prices and rapid productobsolescence. Our competitors include many large domestic and internationalcompanies that have substantially greater financial, technical, marketing,distribution and other resources, broader product lines, lower cost structures,greater brand recognition and longer-standing relationships with customers andsuppliers.

Our primary competitorsin the third-party memory module industry include:  Crucial Memory, a division of Micron, DPAC Technologies, KingstonTechnology, Lexar Media, M-Systems, PNY Technologies, SanDisk, and Smart Modular,a division of Solectron.

We expect to facecompetition from existing competitors and new and emerging companies that mayenter our existing or future markets that have similar or alternative products,which may be less costly or provide additional features. In addition, some ofour significant suppliers, including Micron and Samsung, are also ourcompetitors. These suppliers have the ability to manufacture competitiveproducts at lower costs as a result of their higher levels of integration. Wealso face competition from current and prospective customers that evaluate ourcapabilities against the merits of manufacturing products internally.Competition also may arise due to the development of cooperative relationshipsamong our current and potential competitors or third parties to increase theability of their products to address the needs of our prospective customers.Accordingly, it is possible that new competitors or alliances among competitorsmay emerge and rapidly acquire significant market share.

We compete in our targetmarkets based primarily on quality, design and manufacturing technology, priceand responsiveness to our customers’ needs. We expect our competitors willcontinue to

11

----

improve theperformance of their current products, reduce their current product salesprices and introduce new products that may offer greater performance andimproved pricing, any of which could cause a decline in sales or loss of marketacceptance of our products.

To remain competitive, wemust, among other things:

•                  Provide best-of-class design, manufacturing and testengineering services;

•                  Maintain quality levels;

•                  Provide technologically advanced products;

•                  Successfully protect our intellectual property rights;

•                  Accurately anticipate and prepare for newtechnological trends and standards in the industry;

•                  Compete favorably on the basis of price;

•                  Offer flexible delivery schedules; and

•                  Deliver finished products on a timely basis insufficient volume to satisfy our customers’ requirements.

 

The Flash memory marketis in the early stages of development. There is currently an absence of asingle Flash memory standard. It is possible that Flash memory standards otherthan those to which our products conform will emerge as the industry standard.If we are unable to anticipate and adequately allocate our resources in atimely and efficient manner toward the production and development ofindustry-standard Flash memory products, we may experience significant delaysin releasing new and commercially viable products. In addition, if a competingtechnology replaces or takes significant market share from the Flash memorymarket, we would not be able to sell our Flash products.

**Suppliers**

IC devices representapproximately 95.0% of our component costs. We purchase these IC devices from asmall number of suppliers. In 2002, our significant suppliers of IC devicesincluded:
| **DRAM IC Device Suppliers** |   | **Flash IC  Device Suppliers** |   |
|------------------------------|--------|--------------------------------|--------|
| •Elpida                 |   | •Hitachi                  |   |
| •Micron                 |   | •Samsung                  |   |
| •Samsung                |   |                           |   |

 

We are dependent on a small number of suppliers tosupply Flash IC and DRAM IC devices.  Wehave no long-term DRAM IC device supply contract and only have a limited supplycontract with Hitachi for Flash IC devices. Although we have a limited contract with Hitachi, there can be noassurance that Hitachi can or will agree to supply the quantities of Flash ICdevices we may need to meet our production goals.  Accordingly, we periodically review opportunities to developalternative sources for our Flash IC and DRAM IC device needs.  Hitachi and Samsung supply substantially allof the IC devices used in our Flash memory products. In addition, Elpida,Micron and Samsung currently supply a majority of the DRAM IC devices used in ourDRAM memory products. We have executed IC device consignment inventoryagreements with some of our major DRAM and Flash memory suppliers.  As a result of the agreements, our inventoryrisk has decreased significantly as we are not financially obligated for theinventory until it enters the production process.  For risks associated with our supplier relationships, seeBusiness - Risk Factors -“Because we depend on a small number of suppliers for IC devices, anydisruption in our supply relationships could harm our ability to fulfillorders” and Business - Risk Factors - “Wemay be unable to maintain a steady supply of components.”

12

----

 

**Seasonality**

 

In the past, we have been impacted by seasonalpurchasing patterns resulting in lower sales in the first and second quartersof each year.  Other factors, includingcomponent price fluctuations, may distort the effect of seasonality. Ourability to adjust our short-term operating expenses in response to fluctuationsin revenues is limited. As a result, should revenues decrease to a level lowerthan expected in any given period, our results of operations could be harmed.

 

**Backlog**

Sales of our memoryproducts are made under short-term cancelable purchase orders. We include inour backlog only those customer orders for which we have accepted purchaseorders and to which we have assigned shipment dates within the upcoming sixmonths. Since orders constituting our backlog are subject to change due to,among other things, customer cancellations and reschedulings, and our abilityto procure necessary components, backlog is not necessarily an indication offuture revenues. In addition, there can be no assurance that current backlogwill necessarily lead to revenues in any future period. Our combined backlogwas $5.8 million as of December 31, 2002, compared to $4.5 million as ofDecember 31, 2001. Our Industrial Division backlog was $4.3 million as ofDecember 31, 2002, compared to $3.8 million as of December 31, 2001.  Our Commercial Division backlog increasedfrom $721,000 as of December 31, 2001, to $1.5 million as of December 31, 2002,as a result of increased Commercial Division orders booked in the fourthquarter of 2002 compared to the fourth quarter of 2001. Commercial Divisionbacklog is typically nominal since substantially all commercial orders arefilled on a same-day or next-day basis. Our ability to predict future sales islimited because a majority of our quarterly product revenues come from ordersthat are received and fulfilled in the same quarter.

**Intellectual Property Rights**

We regard our patents,trademarks, trade secrets and other intellectual property as critical to oursuccess. We rely on patents, trademarks, copyrights and trade secret laws,confidentiality procedures, and employee disclosure and invention assignmentagreements to protect our intellectual property rights.

As of March 1, 2003, weowned 10 U.S. patents, including U.S. Patent No. Re. 36,916 related to our ICTower stacking products, and 12 additional patent applications were pending. Wehave two agreements to license our technology to two different third parties.In addition, we have entered into two licensing agreements to license thetechnology of others.  In late 2001, weentered into a license agreement with Acticon Technologies to make, use andsell certain PCMCIA-based telephone modems and PCMCIA-based Ethernet networkingconnectors and cards with respect to certain Acticon patents.  In a second licensing matter, Micron agreedon August 22, 2000, to dismiss the lawsuit it filed against us on April 6,2000. In return for Micron’s dismissal, we agreed to a settlement agreement,which included a licensing agreement between Micron and us. License feesrelated to the Acticon and Micron license agreements were immaterial for allperiods presented in the financial statements included in this report.

Although we consider thepatents currently held by us to be critical to our success, there can be noassurance that any patents currently held by us or any patents which may begranted to us in the future will not be challenged, invalidated orcircumvented, or that rights granted thereunder will provide meaningfulprotection or other commercial advantage to us. There can be no assurance thatthird parties will not develop similar products, duplicate our products ordesign around the patents currently owned by us or which may be granted to usin the future. Because we view intellectual property rights as critical to oursuccess, we intend to pursue future patents and other intellectual property rightsin the U.S. There can be no assurance that we will be successful in theseendeavors. In addition there can be no assurance that our trade secrets andknow-how may not become known to third parties, or become part of the publicdomain, which in either case would harm our financial performance and businessoperations.

13

----

 

We have on at least oneoccasion applied for and may in the future apply for patent protection inforeign countries. The laws of foreign countries, however, may not adequatelyprotect our intellectual property rights. Many U.S. companies have encountered substantial infringement problemsin some foreign countries.  Because wesell some of our products overseas, we have exposure to foreign intellectualproperty risks.

The semiconductorindustry is characterized by vigorous protection and pursuit of intellectualproperty rights. We believe that it may be necessary to initiate litigationagainst one or more third parties to preserve our intellectual property rights.In addition, from time to time, third parties may bring suits against us. Fordetails regarding our pending intellectual property lawsuits, see “LegalProceedings” and Business - Risk Factors - “Weare involved from time to time in claims and litigation over intellectualproperty rights, which may adversely affect our ability to manufacture and sellour products.”

As is common in theindustry, we currently have in effect a number of agreements in which we haveagreed to defend, indemnify and hold harmless certain of our suppliers andcustomers from damages and costs which may arise from the infringement by ourproducts of third-party patents, trademarks or other proprietary rights. Thescope of such indemnity varies, but may, in some instances, includeindemnification for damages and expenses, including attorneys’ fees. We mayfrom time to time be engaged in litigation as a result of such indemnificationobligations. In addition, our insurance does not cover intellectual property infringement.

In our efforts tomaintain the confidentiality and ownership of trade secrets and otherconfidential information, all of our employees are required to sign employeenon-disclosure and invention assignment agreements. This agreement requires ouremployees to disclose, document and assign their interest in all inventions,patents and copyrights developed while employed with us. Our employees furtheragree to preserve all of our confidential information including trade secrets,customer information, know-how and other business information. There can be noassurance that these agreements will provide meaningful protection of our tradesecrets or other confidential information in the event of unauthorized use ordisclosure of such information. See “Risk Factors - Ourproprietary technology and intellectual property may not be adequatelyprotected, which could harm our competitive position.”

**Employees**

As ofDecember 31, 2002, we had 368 full-time employees, consisting of 165 inmanufacturing (including test, quality assurance and material management), 100in sales and marketing, 46 in finance and administration and 57 in design andproduct development.  Our employees arenot represented by any collective bargaining agreements and we have neverexperienced a work stoppage.

14

----

**RISKFACTORS**

*You should carefully consider the following risks before youdecide to buy shares of our common stock. The risks and uncertainties describedbelow are not the only ones facing us. Additional risks and uncertainties,including those risks set forth in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” below, may also adversely impactand impair our business. If any of the following risks actually occur, ourbusiness, results of operations or financial condition would likely suffer. Insuch case, the trading price of our common stock could decline, and you maylose all or part of the money you paid to buy our stock.*

*This Report contains forward-looking statements based on thecurrent expectations, assumptions, estimates and projections about our industryand us. These forward-looking statements involve risks and uncertainties. Ouractual results could differ materially from those discussed in theseforward-looking statements as a result of certain factors, as more fullydescribed in this section and elsewhere in this Report. We do not undertake toupdate publicly any forward-looking statements for any reason, even if newinformation becomes available or other events occur in the future.*

**Our quarterly operating results may fluctuate in future periods and, as a result, we may fail to meet expectations of investors and analysts, causing our stock price to fluctuate or decline.**

 

                    Our quarterly operating results have fluctuated in the past and we believe they will continue to do so in the future. Our future results of operations will depend on many factors including:

 

•                  Fluctuating market demand for and declines in the average sales prices of our products;

•                  Overproduction by suppliers of the components used in our products;

•                  Our ability to procure required components or fluctuations in the cost of such components;

•                  The effects of litigation;

•                  Changes in our product and sales mix as well as seasonal demand for our products;

•                  Market acceptance of new and enhanced versions of our products;

•                  The timing of the introduction of new products or components and enhancements to existing products or components by us, our competitors or our suppliers;

•                  Inventory obsolescence, product returns and price protections;

•                  Manufacturing inefficiencies associated with the start-up of new products and volume production; and

•                  Expenses associated with acquisitions.

 

Due to the abovefactors, quarterly revenues and results of operations are difficult toforecast, and we believe that period-to-period comparisons of our operatingresults are neither meaningful nor predictive of future performance.  In one or more future quarters our resultsof operations may fall below the expectations of securities analysts andinvestors. In that event, the trading price of our common stock would likelydecline.

In addition, thetrading price of our common stock may materially decline regardless of ouroperating performance.  The market priceof our common stock has been subject to significant fluctuations since ourinitial public offering in September 2000. The stock market has experienced significant price and volumefluctuations that have affected the market prices of securities, particularlysecurities of technology companies. In the past, following periods ofvolatility in the market price of a particular company’s securities, securitiesclass action litigation has often been brought against that company. We maybecome involved in this type of litigation in the future. Litigation of thistype is often expensive and diverts management’s attention and resources.

15

----

 

**Declines in our average sales pricesmay result in declines in our revenues and gross profit.**

During the substantialmajority of 2001 and 2002, overcapacity in the memory product market resultedin significant declines in component prices, which negatively impacted ouraverage selling prices, revenues and gross profit.  Declines in semiconductor prices could also affect the valuationof our inventory, which could harm our business. During periods ofovercapacity, our ability to maintain or increase revenues will depend upon ourability to increase unit sales volumes of existing products and to introduceand sell new products in quantities sufficient to offset declines in salesprices. Our efforts to reduce costs and develop new products to offset theimpact of further declines in average sales prices may not be successful.Declines in average sales prices also would result in more memory being builtinto products by OEMs, which would favor our largest competitors and reduce thedemand for our Commercial Division memory products.

**Because we depend on a small numberof suppliers for IC devices, any disruption in our supply relationships couldharm our ability to fulfill orders.**

We are dependent on asmall number of suppliers to supply Flash IC and DRAM IC devices. We have nolong-term DRAM IC device supply contract and only have a limited supplycontract with Hitachi for Flash IC devices. Although we have a limited contract with Hitachi, there can be noassurance that Hitachi can or will agree to supply the quantities of Flash ICdevices we may need to meet our production goals.  IC devices represent approximately 95% of our component costs.Our dependence on a small number of suppliers and our limited number oflong-term supply contracts expose us to several risks, including the inabilityto obtain an adequate supply of components, price increases, late deliveriesand poor component quality. Hitachi and Samsung supply substantially all of theIC devices used in our Flash memory products. In addition, Elpida, Micron andSamsung currently supply a majority of the DRAM IC devices used in our DRAMmemory products. A disruption in or termination of our supply relationship withany of these significant suppliers by natural disaster or otherwise, or ourinability to develop relationships with new suppliers, if required, would causedelays, disruptions or reductions in product shipments or require productredesigns which could damage relationships with our customers, and wouldincrease our costs and/or prices. In particular, if our supply relationshipswith Hitachi or Samsung are disrupted or terminated, our ability to manufactureand sell our Flash products would be harmed and our Flash business would beadversely affected.

**We are subject to the cyclical natureof the semiconductor industry and a significant and prolonged downturn couldcontinue to adversely affect our business.**

The semiconductorindustry, including the memory markets in which we compete, is highly cyclicaland characterized by constant and rapid technological change, rapid productobsolescence and price erosion, evolving standards, short product life cyclesand wide fluctuations in product supply and demand. The industry hasexperienced significant downturns, such as the one we are currently in, oftenconnected with, or in anticipation of, maturing product cycles of both semiconductorcompanies’ and their customers’ products and declines in general economicconditions. These downturns have been characterized by diminished productdemand, production overcapacity, high inventory levels and accelerated erosionof average selling prices. In the past two and a half years, a semiconductordownturn has negatively impacted our average selling prices, revenues andearnings. Any future downturns, or a worsening of the current downturn, couldhave a material adverse effect on our business and operating results.

**We may be unable to maintain a steadysupply of components.**

The electronics industryhas experienced in the past, and may experience in the future, shortages in ICdevices, including DRAM, SRAM and Flash memory. We have experienced and maycontinue to experience delays in component deliveries and quality problems,which have caused and could in the future cause delays in product shipments. Inaddition, we have required and could in the future require the

16

----

 

redesign of someof our products. From time to time, industry capacity has become constrainedsuch that some vendors have placed their customers, ourselves included, oncomponent allocation. This means that while we may have customer orders, we maynot be able to obtain the materials that we need to fill those orders in atimely manner which could have a material adverse effect on our business andoperating results.

**Increased worldwide production of DRAM orFlash components could lead to further declines in average selling prices.**

The transition to smaller geometries and the use of 300 millimeter wafersby semiconductor manufacturers, which is expected to accelerate over the nextfive years, could lead to a significant increase in the worldwide supply ofDRAM and Flash components.  Increases inthe worldwide supply of DRAM and Flash components could also result from fabcapacity expansions.  Increases inworldwide supply of DRAM and Flash components, if not offset by increases indemand, could lead to further declines in the average selling prices of ourproducts and have a material adverse effect on our business and operatingresults.

**Our limited experience in acquiring otherbusinesses, product lines and technologies may make it difficult for us toovercome problems encountered in connection with any acquisitions we mayundertake.**

We intendto pursue selective acquisitions to complement our internal growth. If we makeany future acquisitions, we couldissue stock that would dilute our shareholders’ percentage ownership, incursubstantial debt, reduce our cash reserves or assume contingent liabilities.Although we completed the acquisition of assets of Irvine Networks, LLC,renamed our Xiran Division, in January 2002, our experience in acquiring otherbusinesses, product lines and technologies is limited. In addition, theattention of our small management team may be diverted from our core businessif we undertake an acquisition. Potential acquisitions also involve numerousrisks, including, among others:

• Problems assimilating the purchasedoperations, technologies or products;

• Costs associated with the acquisition;

• Adverse effects on existing businessrelationships with suppliers and customers;

• Risks associated with entering marketsin which we have no or limited prior experience;

• Potential loss of key employees ofpurchased organizations; and

• Potential litigation arising from the acquired company’s operationsbefore the acquisition.

Ourinability to overcome problems encountered in connection with such acquisitionscould divert the attention of management,utilize scarce corporate resources and harm our business. In addition, we areunable to predict whether or when any prospective acquisition candidate willbecome available or the likelihood that any acquisition will be completed.

**Sales to a small number of customersrepresent a significant portion of our revenues and the loss of any keycustomer would materially reduce our sales.**

Our dependence on a small number of customers means thatthe loss of a major customer or any reduction in orders by a major customerwould materially reduce our revenues. Historically, a relatively small numberof customers have accounted for a significant percentage of our revenues. Ourten largest customers accounted for an aggregate of 55.5% of our total revenuesin 2002  and 56.3% of our total revenues

17

----

 

in 2001.  Ourten largest Industrial Division customers accounted for an aggregate of 78.4%of our Industrial Division revenues or 18.4% of our total revenues in 2002 and71.0% of our Industrial Division revenues or 20.8% of our total revenues in2001.  In 2001, Unisys accounted for37.6% of our Industrial Division revenues or 11.0% of our total revenues.  No other Industrial Division customeraccounted for more than 10.0% of our total revenues in 2002 or 2001.

Our ten largestCommercial Division customers accounted for an aggregate of 60.1% of ourCommercial Division revenues or 46.0% of our total revenues in 2002 and 61.6%of our Commercial Division revenues or 43.6% of our total revenues in 2001.  Our largest Commercial Division customer in2001 and 2002, CDW Computer Centers, accounted for 27.6% of our Commercial Divisionrevenues or 21.1% of our total revenues in 2002 and 27.9% of our Commercial Divisionrevenues or 19.7% of our total revenues in 2001.  No other Commercial Division customer accounted for more than10.0% of our total revenues in 2002 or 2001.

Consolidation in some ofour customers’ industries may result in increased customer concentration andthe potential loss of customers as a result of acquisitions. In addition, thecomposition of our major customer base changes from quarter to quarter as themarket demand for our customers’ products changes, and we expect thisvariability will continue in the future. We expect that sales of our productsto a small number of customers will continue to contribute materially to ourrevenues in the foreseeable future.  Theloss of, or a significant reduction in purchases by any of our major customers,could harm our business, financial condition and results of operations.

**Threeof our beneficial shareholders have substantial influence over our operationsand can significantly influence matters requiring shareholder approval.**

Manouch Moshayedi, MikeMoshayedi and Mark Moshayedi, each of whom is an executive officer and directorof SimpleTech, are brothers and beneficially own approximately 79.1% of ourcommon stock at December 31, 2002. As a result, they have the ability tocontrol all matters requiring approval by our shareholders, including theelection and removal of directors, approval of significant corporatetransactions and the ability to control the decision of whether a change incontrol will occur.

**Weare involved from time to time in claims and litigation over intellectualproperty rights, which may adversely affect our ability to manufacture and sellour products.**

Thesemiconductor industry is characterized by vigorous protection and pursuit of intellectualproperty rights. We believe that it may be necessary, from time to time, toinitiate litigation against one or more third parties to preserve ourintellectual property rights. In addition, from time to time, we have received,and may continue to receive in the future, notices that claim we have infringedupon, misappropriated or misused other parties’ proprietary rights, whichclaims could result in litigation. Such litigation would likely result insignificant expense to us and divert the efforts of our technical andmanagement personnel. In the event of an adverse result in such litigation, wecould be required to pay substantial damages, cease the manufacture, use andsale of certain products, expend significant resources to develop non-infringingtechnology, discontinue the use of certain processes or obtain licenses to usethe infringed technology. Such a license may not be available on commerciallyreasonable terms, if at all. Our failure to obtain a license or our failure toobtain a license on commercially reasonable terms could cause us to incursubstantial costs and suspend manufacturing products using the infringedtechnology. If we obtain a license, we would likely be required to make royaltypayments for sales under the license. Such payments would increase our costs ofrevenues and reduce our gross profit. In addition, any

18

----

 

litigation,whether as plaintiff or as defendant, would likely result in significantexpense to us and divert the efforts of our technical and management personnel,whether or not such litigation is ultimately determined in our favor. Inaddition, the results of any litigation are inherently uncertain.

In the event we desire toincorporate third-party technology into our products or our products are foundto infringe on others’ patents or intellectual property rights, we may berequired to license such patents or intellectual property rights. If we obtainlicenses from third parties, we may be required to pay license fees or makeroyalty payments, which could reduce our gross margins. If we are unable toobtain a license from a third party for technology, we could incur substantialliabilities or be required to expend substantial resources redesigning ourproducts to eliminate the infringement. There can be no assurance that we wouldbe successful in redesigning our products or that we could obtain licenses oncommercially reasonable terms, if at all. In addition, any development orlicense negotiations could require substantial expenditures of time and otherresources by us.

We arecurrently a party to two lawsuits regarding intellectual property as furtherdescribed under “Legal Proceedings.” The outcome of litigation is inherentlyuncertain and we cannot predict the outcome of these lawsuits with certainty.These lawsuits have diverted, and are expected to continue to divert, theefforts and attention of our key management and technical personnel. Inaddition, we have incurred, and expect to continue to incur, substantial legalfees and expenses in connection with these lawsuits. As a result, our defenseof these lawsuits, regardless of their eventual outcomes, has been, and willcontinue to be, costly and time consuming. In addition, if our IC Towerstacking patent is found to be invalid, our ability to exclude competitors frommaking, using or selling the same or similar products to our IC Tower stackingproducts would cease. In addition, if we are found to infringe valid patents ofothers, we may be excluded from using the infringed technology without alicense, which may not be available on commercially reasonable terms, if atall.

**If industry sales of products usingFlash memory do not grow, our revenues, gross margins and profitability wouldbe harmed.**

The market for consumerelectronics incorporating data storage Flash memory is relatively new andemerging. The success of our Flash business will depend largely on the level ofconsumer interest in new and emerging consumer electronics utilizing Flashmemory. If sales of products using Flash memory do not increase, we will beunable to grow our Flash business. In addition, if we are unable to anticipateand fulfill customer demand for our products, we may lose sales to ourcompetitors.

**Demand for our products would declineif the market for Flash memory does not develop, or if a competing technologydisplaces Flash memory.**

There is currently anabsence of a single Flash memory standard. It is possible that Flash memorystandards other than those to which our products conform will emerge as theindustry standard. If we are unable to anticipate and adequately allocate ourresources in a timely and efficient manner toward the production anddevelopment of industry-standard Flash memory products, we may experiencesignificant delays in releasing new and commercially viable products. Thesedelays would provide a competitor a first-to-market opportunity and allow acompetitor to achieve greater market share. Some of our competitors are in abetter financial and marketing position from which to influence industryacceptance of a particular Flash memory standard or competing technology thanwe are. In particular, a primary source of competition may come from companiesthat offer alternative technologies such as ferroelectric random access memoryproducts. If a competing technology replaces or takes significant market sharefrom the Flash memory market, we would not be able to sell our Flash products.

**The execution of our growth strategydepends on our ability to retain key personnel, including our executiveofficers, and to attract qualified personnel.**

19

----

 

Competition for employeesin our industry is intense. We have had and may continue to have difficultyhiring the necessary engineering, sales and marketing and management personnelto support our growth. The successful implementation of our business model andgrowth strategy depends on the continued contributions of our senior managementand other key research and development, sales and marketing and operationspersonnel, including Manouch Moshayedi, our Chief Executive Officer, MikeMoshayedi, our President, and Mark Moshayedi, our Chief Operating Officer,Chief Technical Officer and Secretary. The loss of any key employee, the failureof any key employee to perform in his or her current position, or the inabilityof our officers and key employees to expand, train and manage our employee basewould prevent us from executing our growth strategy.

**Our proprietary technology and intellectualproperty may not be adequately protected, which could harm our competitiveposition.**

Ourproprietary technology and other intellectual property are critical to oursuccess. We protect our intellectual property rights through patents,trademarks, copyrights and trade secret laws, confidentiality procedures andemployee disclosure and invention assignment agreements. It is possible thatour efforts to protect our intellectual property rights may not:

• prevent the challenge, invalidation orcircumvention of our existing patents;

• result in patents that lead tocommercially viable products or provide competitive advantages for ourproducts;

•prevent our competitors fromindependently developing similar products, duplicating our products ordesigning around the patents owned by us;

• prevent third-party patents from havingan adverse effect on our ability to do business;

• provide adequate protection for ourintellectual property rights;

• prevent disputes with third partiesregarding ownership of our intellectual property rights;

• prevent disclosure of our trade secretsand know-how to third parties or into the public domain; and

• result in patents from any of ourpending applications.

As part ofour confidentiality procedures, we enter into non-disclosure and inventionassignment agreements with all of our employees and attempt to control accessto and distribution of our technology, documentation and other proprietaryinformation. However, if such agreements are found to be unenforceable, we maybe unable to adequately protect our intellectual property rights. In addition,despite these procedures, third parties could copy or otherwise obtain and makeunauthorized use of our technologies or independently develop similartechnologies.

We have notapplied and do not expect to apply for patent protection in foreign countries.In addition, the laws of foreign countries may not adequately protect ourintellectual property rights. Many U.S. companies have encountered substantialinfringement problems in some foreign countries. Because we sell some of ourproducts overseas, we have exposure to foreign intellectual property risks.

**Our indemnification obligations for theinfringement by our products of the intellectual property rights of otherscould require us to pay substantial damages.**

Wecurrently have in effect a number of agreements in which we have agreed todefend, indemnify and hold harmless certain of our customers and suppliers fromdamages and costs which may

20

----

 

arise from the infringementby our products of third-party patents, trademarks or other proprietary rights.We may periodically have to respond to claims and litigate these types ofindemnification obligations. Any such indemnification claims could require usto pay substantial damages. Our insurance does not cover intellectual propertyinfringement.

**Our indemnification obligations to ourcustomers and suppliers for product defects could require us to pay substantialdamages.**

A number ofour product sales and product purchase agreements provide that we will defend,indemnify and hold harmless our customers and suppliers from damages and costswhich may arise from product warranty claims or claims for injury or damageresulting from defects in our products. We maintain insurance to protectagainst certain claims associated with the use of our products, but ourinsurance coverage may not be adequate to cover all or any part of the claimsasserted against us. A successful claim brought against us that is in excessof, or excluded from, our insurance coverage could substantially harm ourbusiness, financial condition and results of operations.

**Product returns, order cancellations,inventory write-downs, price protection and rebates could adversely affect ourresults of operations.**

To the extent wemanufacture products in anticipation of future demand that does notmaterialize, or in the event a customer cancels outstanding orders, we couldexperience an unanticipated increase in our inventory. A lack of consumerdemand for our products may also cause increased product returns. A majority ofour sales through commercial channels include limited rights to return unsoldinventory. In addition, while we may not be contractually obligated to acceptreturned products, we may determine that it is in our best interest to acceptreturns in order to maintain good relations with our customers. Product returnswould increase our inventory and reduce our revenues.  We have had to write-down inventory in the past for reasons suchas obsolescence, excess quantities and declines in market value below ourcosts. These inventory write-downs were approximately $304,000 in 2002 comparedto $759,000 in 2001. In addition, we offer some of our Commercial Division customerslimited price protection rights for inventories of our products held by them.If we reduce the list price of our products, these customers may receivecredits from us. We incurred price protection charges of approximately $1.3million in 2002 compared to $1.8 million in 2001.  We also offer rebate programs through some of our CommercialDivision customers to end-users.  Weincurred rebate charges of $1.1 million in 2002 compared to $839,000 in 2001.

We are also subject torepurchase agreements with various financial institutions in connection withwholesale inventory financing. Under these agreements, we may be required torepurchase inventory upon customer default with a financing institution andthen resell the inventory through normal distribution channels. As of December31, 2002, we have not been required to repurchase inventory in connection withthe customer default agreements noted above. However, it may be possible thatwe will be required to repurchase inventory, upon customer default, in thefuture. Sales under such agreements were approximately $876,000 in 2002compared to $1.1 million in 2001.

We have no long-termvolume commitments from our customers. Sales of our products are made throughindividual purchase orders and, in certain cases, are made under masteragreements governing the terms and conditions of the relationships. Customersmay change, cancel or delay orders with limited or no penalties. We haveexperienced cancellations of orders and fluctuations in order levels fromperiod-to-period and we expect to continue to experience similar cancellationsand fluctuations in the future, which could result in fluctuations in ourrevenues.

**We may not be able to maintain orimprove our competitive position because of the intense competition in thememory industry.**

21

----

 

We conduct business in anindustry characterized by intense competition, rapid technological change,evolving industry standards, declining average sales prices and rapid productobsolescence. Our competitors include many large domestic and internationalcompanies that have substantially greater financial, technical, marketing,distribution and other resources, broader product lines, lower cost structures,greater brand recognition and longer-standing relationships with customers andsuppliers. As a result, our competitors may be able to respond better to new oremerging technologies or standards and to changes in customer requirements. Ourcompetitors may also be able to devote greater resources to the development,promotion and sale of products, and may be able to deliver competitive productsat a lower price.

We expect to facecompetition from existing competitors and new and emerging companies that mayenter our existing or future markets with similar or alternative products,which may be less costly or provide additional features. In addition, some ofour significant suppliers are also our competitors, many of whom have theability to manufacture competitive products at lower costs as a result of theirhigher levels of integration. We also face competition from current andprospective customers that evaluate our capabilities against the merits ofmanufacturing products internally. Competition may arise due to the developmentof cooperative relationships among our current and potential competitors orthird parties to increase the ability of their products to address the needs ofour prospective customers. Accordingly, it is possible that new competitors oralliances among competitors may emerge and rapidly acquire significant marketshare.

We expect our competitorswill continue to improve the performance of their current products, reducetheir prices and introduce new products that may offer greater performance andimproved pricing, any of which could cause a decline in sales or loss of marketacceptance of our products. In addition, our competitors may developenhancements to or future generations of competitive products that may renderour technology or products obsolete or uncompetitive.

**Terrorist activities and resultingmilitary and other actions could adversely affect our business.**

 

The September 11, 2001terrorist attacks in the United States and recent terrorist attacks in otherparts of the world, as well as continued threats of global terrorism, currentand future military response to them and the current United States militaryaction against Iraq have created many economic and political uncertainties thatmake it extremely difficult for us, our customers and our suppliers toaccurately forecast and plan future business activities. This reducedpredictability challenges our ability to operate profitably or to grow ourbusiness. In particular, it is difficult to develop and implement strategies,sustainable business models and efficient operations, and effectively managecontract manufacturing and supply chain relationships. In addition, thecontinued threats of terrorism and the heightened security measures in responseto such threats have and may continue to cause significant disruption to commercethroughout the world. Disruption in air transportation in response to thesethreats or future attacks may result in transportation and supply-chaindisruptions, increase our costs for both receipt of inventory and shipment ofproducts to our customers, and cause customers to defer their purchasingdecisions. Disruptions in commerce could also cause consumer confidence andspending to decrease or result in increased volatility in the United States andworldwide financial markets and economy. They also could result in economicrecession in the United States or abroad. Any of these occurrences could have asignificant impact on our operating results, revenue and costs and may resultin the volatility of the market price for our common stock and on the futureprice of our common stock.

 

**We may lose our competitive positionif we fail to develop new and enhanced products and introduce them in a timelymanner.**

22

----

 

The high-performancecomputing, networking and communications, consumer electronics and industrialmarkets are subject to rapid technological change, product obsolescence,frequent new product introductions and enhancements, changes in end-userrequirements and evolving industry standards. Our ability to compete in thesemarkets will depend in significant part upon our ability to successfullydevelop, introduce and sell new and enhanced products on a timely andcost-effective basis, and to respond to changing customer requirements.

We have experienced, andmay in the future experience, delays in the development and introduction of newproducts. Our product development is inherently risky because it is difficultto foresee developments in technology, coordinate our technical personnel, andidentify and eliminate design flaws. Defects or errors found in our productsafter commencement of commercial shipments could result in delays in marketacceptance of these products. Delays in developing, manufacturing or marketingnew or enhanced products could give our competitors an advantage, hurt ourreputation and harm our business, financial condition and results ofoperations. Such products, even if introduced, may not gain market acceptance.In addition, we may not be able to respond effectively to new technologicalchanges or new product announcements by others.

**Obtaining additional capital to fundour operations and finance our growth could impair the value of yourinvestment.**

If we expand more rapidlythan currently anticipated or if our working capital needs exceed our currentexpectations, we may need to raise additional capital through public or privateequity offerings or debt financings. Our future capital requirements depend onmany factors including our research, development, sales and marketingactivities. We do not know whether additional financing will be available ifneeded, or will be available on terms favorable to us. If we cannot raiseneeded funds on acceptable terms, we may not be able to develop or enhance ourproducts, take advantage of future opportunities or respond to competitivepressures or unanticipated requirements. To the extent we raise additionalcapital by issuing equity securities, our shareholders may experiencesubstantial dilution and the new equity securities may have greater rights,preferences or privileges than our existing common stock.

**We face risks associated with doingbusiness in foreign countries, including foreign currency fluctuations andtrade barriers, that could lead to a decrease in demand for our products or anincrease in the cost of the components used in our products.**

The volatility of generaleconomic conditions and fluctuations in currency exchange rates affect theprices of our products and the prices of the components used in our products.International sales of our products accounted for 14.8% and 16.0% of ourrevenues in 2002 and 2001, respectively. No single foreign country accounted for more than 10.0% of our revenuesin 2002 or 2001.  For 2002 and 2001,more than 95.0% of our international sales were denominated in U.S. dollars.However, if there is a significant devaluation of the currency in a specificcountry, the prices of our products will increase relative to that country’scurrency and our products may be less competitive in that country. In addition,we cannot be sure that our international customers will continue to be willingto place orders denominated in U.S. dollars. If they do not, our revenues andresults of operations will be subject to foreign exchange fluctuations, whichcould harm our business. We do not hedge against foreign currency exchange raterisks.

In addition, we purchasesubstantially all of the IC devices used in our products from localdistributors of foreign suppliers. Although our purchases of IC devices arecurrently denominated in U.S. dollars, devaluation of the U.S. dollar relativeto the currency of a foreign supplier would likely result in an increase in ourcost of IC devices.

23

----

 

Our international salesalso are subject to certain other risks, including regulatory risks, tariffsand other trade barriers, timing and availability of export licenses, politicaland economic instability, difficulties in accounts receivable collections,difficulties in managing distributors, lack of a local sales presence,difficulties in obtaining governmental approvals, compliance with a widevariety of complex foreign laws and treaties and potentially adverse taxconsequences. In addition, the United States or foreign countries may implementquotas, duties, taxes or other charges or restrictions upon the importation orexportation of our products, leading to a reduction in sales and profitabilityin that country.

**Disruption of our operations in ourSanta Ana, California, manufacturing facility would substantially harm ourbusiness.**

All of our manufacturingoperations are located in our facility in Santa Ana, California. Due to thisgeographic concentration, a disruption of our manufacturing operations,resulting from sustained process abnormalities, human error, governmentintervention or natural disasters, including earthquakes, fires or floods,could cause us to cease or limit our manufacturing operations and consequentlyharm our business, financial condition and results of operations.

**Compliance with environmental lawsand regulations could harm operating results.**

We are subject to avariety of environmental laws and regulations governing, among other things,air emissions, waste water discharge, waste storage, treatment and disposal,and remediation of releases of hazardous materials. Our failure to comply withpresent and future requirements could harm our ability to continuemanufacturing our products. Such requirements could require us to acquirecostly equipment or to incur other significant expenses to comply withenvironmental regulations. The imposition of additional or more stringentenvironmental requirements, the results of future testing at our facilities, ora determination that we are potentially responsible for remediation at other siteswhere problems are not presently known to us, could result in expenses inexcess of amounts currently estimated to be required for such matters.

**ITEM 2.     ****PROPERTIES**

** **

We occupy two leasedfacilities of approximately 24,500 and 48,600 square feet in Santa Ana,California, in which our executive offices, manufacturing, engineering,research and development and testing operations are located. We lease the24,500 square foot facility from MDC Land LLC, a limited liability companyowned by Manouch Moshayedi, Mike Moshayedi and Mark Moshayedi, each of whom isan executive officer, director and major shareholder of SimpleTech. This leaseexpires in March 2005 and the base rent is approximately $17,000 per month. Wealso lease the 48,600 square foot facility from MDC Land LLC. This leaseexpires in May 2005, and the base rent is approximately $33,000 per month. Inaddition, we lease a 12,000 square foot research and development facility inIrvine, California. This lease expires in July 2005 and the base rent is approximately$18,000 per month.  We also leasevarious small facilities for our sales offices and storage. We believe that ourexisting leased space is adequate for our current operations and that suitablereplacement and additional spaces will be available in the future oncommercially reasonable terms.

**ITEM 3.     LEGAL PROCEEDINGS**

 

**DPAC Technologies, Inc.—PatentInfringement**

On September 23,1998, we filed a lawsuit against DPAC Technologies, Inc., formerly Dense-PacMicrosystems, Inc. (“DPAC”) in the United States District Court for theCentral District of California for infringement of our IC Tower stackingpatent, U.S. Patent No. 5,514,907. On March 29, 2001, the court enteredfinal judgment finding DPAC did not infringe our patent and that we did notinfringe DPAC’s

 

24

----

 

patent. Theappeals court affirmed the final judgment on March 7, 2002.  On September3, 2002, we filed a petition for ceritiori with the U.S. Supreme Court.  On October 7, 2002, the petition to theSupreme Court was granted and the matter was remanded to the Circuit Court ofAppeals.  DPAC filed a motion forsummary affirmance with the Circuit Court of Appeals.  The Court of Appeals denied the motion and remanded the matterfor trial to the United States District Court for the Central District ofCalifornia.  No trial date has been setby the District Court.

**Lemelson Medical, Education &Research Foundation, LLP — Patent Infringement**

We receivednotice on November 26, 2001, that the Lemelson Medical, Education &Research Foundation, LLP (“Lemelson Foundation”) filed a complaint on November13, 2001, against us and other defendants.  The complaint was filed in theDistrict Court of Arizona and alleges that our manufacturing processes infringeseveral patents that the Lemelson Foundation allegedly owns.  Thecomplaint also states that these allegedly infringed patents relate to machinevision technology and bar coding technology.  On March 7, 2002, we wereserved with the Lemelson Foundation complaint.  Thereafter, the case wasstayed pending the outcome of related cases against parties involving the samepatents.  Because of the preliminarystage of this case, an estimate of potential damages, if any, would bepremature and speculative, and we have not made any such estimate at this time.

**LexarMedia, Inc. — Unfair Trade Practice**

 

                On October 1, 2002, we filed a lawsuit against LexarMedia, Inc. in the Superior Court of Orange County, California for unfair tradepractices and are seeking unspecified damages, including punitive and trebleddamages.  Our complaint sets forthvarious causes of actions against Lexar Media, including trade libel, libel perse, interference with business opportunities, violation of the CaliforniaUnfair Competition Act, and violation of the California Unfair Trade PracticesAct.  On October 30, 2002, Lexar Mediafiled a notice of removal, which removed the matter from the Orange CountySuperior Court to the United States District Court for the Central District ofCalifornia.  This lawsuit is in theearly stages of discovery.

                We are notcurrently involved in any other material legal proceedings. We are not aware ofany other material legal proceedings threatened or pending against us. Fromtime to time, however, we may become subject to additional legal proceedings,claims, and litigation arising in the ordinary course of business. In addition,in the past we have received, and we may continue to receive in the future,letters alleging infringement of patent or other intellectual property rights.Our management believes that these letters generally are without merit andintend to contest them vigorously.

## **ITEM 4.**                 SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS

## ** **

None.

25

----

 

# **PART II.**

**ITEM 5.****       ****MARKET FOR THE REGISTRANT’S COMMONSTOCK AND RELATED SHAREHOLDER MATTERS**

 

**Market Information**

Our common stock has traded on The Nasdaq National Market under thesymbol “STEC.”  Our initial publicoffering of stock occurred on September 29, 2000.  Prior to that time, there was no public market for our commonstock. The following table sets forth the range of high and low intra-day salesprices reported on The Nasdaq National Market for our common stock for theperiods indicated.

 

 
|                           |   | **Price range  of Common Stock** |   |
|--------------------------------|--------|----------------------------------|--------|
|                           |   | **High**                         |   | **Low** |   |
| Year Ended  December 31, 2002: |   |                             |   |   |   |
| First Quarter                  |   | $                                | 8.99   |   | $ | 2.86 |   |
| Second Quarter                 |   | $                                | 10.44  |   | $ | 3.20 |   |
| Third Quarter                  |   | $                                | 4.28   |   | $ | 2.05 |   |
| Fourth Quarter                 |   | $                                | 4.15   |   | $ | 1.80 |   |

 

 
|                           |   | **Price  range of Common Stock** |   |
|--------------------------------|--------|----------------------------------|--------|
|                           |   | **High**                         |   | **Low** |   |
| Year Ended  December 31, 2001: |   |                             |   |   |   |
| First Quarter                  |   | $                                | 6.00   |   | $ | 2.50 |   |
| Second Quarter                 |   | $                                | 3.49   |   | $ | 2.20 |   |
| Third Quarter                  |   | $                                | 3.15   |   | $ | 1.03 |   |
| Fourth Quarter                 |   | $                                | 3.60   |   | $ | 1.30 |   |

 

**Recent Share Prices**

The following table setsforth the closing sales prices per share of our common stock on The NasdaqNational Market on (i) December 31, 2002 and (ii) February 27, 2003.  Because the market price of our common stockis subject to fluctuation, the market value of the shares of our common stockmay increase or decrease.
|               |   | **Closing  Price** |   |
|--------------------|--------|--------------------|--------|
|               |   |               |   |
| December 31,  2002 |   | $                  | 3.02   |   |
| February 27,  2003 |   | $                  | 2.05   |   |

** **

**Holders**

As of February 27, 2003,there were 54 holders of record of our common stock.

**Dividend Policy**

We were originallyincorporated as an S corporation in March 1990 and converted to a C corporationin September 2000.  Since becoming a Ccorporation, we have not declared or paid any cash dividends on our commonstock and do not expect to do so in the foreseeable future. We currently intend

26

----

 

to retain allavailable funds for use in the operation and expansion of our business. Anyfuture determination to pay dividends will be at the discretion of our board ofdirectors and will depend principally upon our results of operations, financialconditions, capital requirements, contractual and legal restrictions and otherfactors the board deems relevant.

**Recent Sales of UnregisteredSecurities**

None

**Use of Proceeds from Sales ofRegistered Securities**

On October 4, 2000, wecompleted the initial public offering of our common stock pursuant to ourRegistration Statement on Form S-1 (File No. 333-32478) that was declaredeffective by the Securities and Exchange Commission on September 28, 2000.There has been no material change with respect to our use of proceeds from ourinitial public offering to the information discussed in our Quarterly Report onForm 10-Q for the nine months ended September 30, 2000.

## **ITEM 6.**                SELECTED FINANCIAL DATA

## ** **

You should read thefollowing selected consolidated financial data in conjunction with ourconsolidated financial statements and related notes and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”appearing elsewhere in this Report. The consolidated statement of operationsdata for the years ended December 31, 2000 through 2002 and the consolidatedbalance sheet data at December 31, 2001 and 2002 were derived from ourconsolidated financial statements that have been audited byPricewaterhouseCoopers LLP, independent accountants, and are included elsewherein this Report. The consolidated statement of operations data for the yearsended December 31, 1998 and 1999 and the consolidated balance sheet data atDecember 31, 1998 through 2000 were derived from our audited consolidatedfinancial statements and are not included in this Report.

27

----

 

 
|                                                          |   | **Year Ended  December 31,**                        |    |
|---------------------------------------------------------------|--------|-----------------------------------------------------|---------|
|                                                          |   | **1998**                                            |    | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|                                                          |   | **(in thousands, except share and per share data)** |    |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| **Consolidated  Statement of Operations Data:**               |   |                                                |    |   |   |   |   |   |   |   |   |
| Net revenues                                                  |   | $                                                   | 122,288 |   | $ | 192,593 |   | $ | 308,316 |   | $ | 164,241 |   | $ | 176,531 |   |
| Cost of revenues                                              |   | 97,930                                              |    | 152,743 |   | 239,964 |   | 127,691 |   | 143,582 |   |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Gross profit                                                  |   | 24,358                                              |    | 39,850 |   | 68,352 |   | 36,550 |   | 32,949 |   |
| Operating  expenses                                           |   |                                                |    |   |   |   |   |   |   |   |   |
| Sales and  marketing                                          |   | 13,340                                              |    | 14,150 |   | 21,588 |   | 18,078 |   | 18,151 |   |
| General and  administrative                                   |   | 9,381                                               |    | 9,755 |   | 11,853 |   | 11,564 |   | 10,354 |   |
| Research and  development                                     |   | 2,180                                               |    | 1,832 |   | 3,745 |   | 4,426 |   | 8,805 |   |
| Non-recurring  expense                                        |   | —                                              |    | — |   | 1,810 |   | — |   | 1,360 |   |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Total operating  expenses                                     |   | 24,901                                              |    | 25,737 |   | 38,996 |   | 34,068 |   | 38,670 |   |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| (Loss) income  from operations                                |   | (543                                                | )       | 14,113 |   | 29,356 |   | 2,482 |   | (5,721 | ) |
| Interest expense  (income), net                               |   | 1,597                                               |    | 2,128 |   | 1,158 |   | (1,395 | ) | (778 | ) |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| (Loss) income  before (benefit) provision for income taxes    |   | (2,140                                              | )       | 11,985 |   | 28,198 |   | 3,877 |   | (4,943 | ) |
| (Benefit)  provision for                                      |   |                                                |    |   |   |   |   |   |   |   |   |
| income taxes                                                  |   | 23                                                  |    | (518 | ) | 2,838 |   | 1,537 |   | (3,637 | ) |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Net (loss)  income                                            |   | $                                                   | (2,163  | ) | $ | 12,503 |   | $ | 25,360 |   | $ | 2,340 |   | $ | (1,306 | ) |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| **Pro  Forma Data (1):**                                      |   |                                                |    |   |   |   |   |   |   |   |   |
| (Loss) income  before (benefit) provision for income taxes    |   | $                                                   | (2,140  | ) | $ | 11,985 |   | $ | 28,198 |   |   |   |   |   |
| Pro forma  (benefit) provision for income taxes               |   | (813                                                | )       | 4,554 |   | 10,883 |   |   |   |   |   |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Pro forma net  (loss) income                                  |   | $                                                   | (1,327  | ) | $ | 7,431 |   | $ | 17,315 |   |   |   |   |   |
|                                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Net (loss)  income per share (pro forma in years 1998 - 2000) |   |                                                |    |   |   |   |   |   |   |   |   |
| Basic                                                         |   | $                                                   | (0.04   | ) | $ | 0.24 |   | $ | 0.53 |   | $ | 0.06 |   | $ | (0.03 | ) |
| Diluted                                                       |   | $                                                   | (0.04   | ) | $ | 0.23 |   | $ | 0.50 |   | $ | 0.06 |   | $ | (0.03 | )  |
| Weighted average  shares outstanding (2)                      |   |                                                |    |   |   |   |   |   |   |   |   |
| Basic                                                         |   | 30,601,027                                          |    | 30,601,027 |   | 32,393,218 |   | 38,126,687 |   | 38,515,825 |   |
| Diluted                                                       |   | 30,601,027                                          |    | 32,657,993 |   | 34,593,678 |   | 39,435,505 |   | 38,515,825 |   |

 
|                                  |   | **December  31,**   |   |
|---------------------------------------|--------|---------------------|--------|
|                                  |   | **1998**            |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|                                  |   | **(in  thousands)** |   |
| **Consolidated  Balance Sheet Data:** |   |                |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents            |   | $                   | 817    |   | $ | 3,779 |   | $ | 33,747 |   | $ | 51,831 |   | $ | 33,992 |   |
| Marketable  securities                |   | —              |   | — |   | — |   | — |   | 9,980 |   |
| Working capital                       |   | 11,283              |   | 22,855 |   | 64,300 |   | 64,543 |   | 60,433 |   |
| Total assets                          |   | 40,087              |   | 55,131 |   | 103,286 |   | 89,250 |   | 94,461 |   |
| Long-term  portion of debt and        |   |                |   |   |   |   |   |   |   |   |   |
| capital lease  obligations            |   | 18,132              |   | 15,681 |   | 1,642 |   | 384 |   | — |   |
| Total  shareholders’ equity      |   | 4,760               |   | 15,780 |   | 69,913 |   | 73,873 |   | 73,815 |   |
|                                       |        |                     |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1) From our formation in March 1990 to September 26,2000, we elected for federal and state income tax purposes to be treated as anS corporation under Subchapter S of the Internal Revenue Code of 1986 andcomparable state tax laws and filed our federal and state income tax returns onthat basis. Accordingly, no provision has been made for federal or certainstate income taxes. Pro forma net (loss) income has been computed using an effectivetax rate of 38% to reflect the estimated income tax (benefit) expense as if wehad been fully subject to federal and state income taxes as a C corporation forall periods presented. Subsequent to the termination of our S corporationstatus on September 26, 2000, we have paid federal and state corporate-levelincome taxes as a C corporation.

 

(2) Reflects a 5.07 for 1 stock split of our commonstock in September 2000.  All share andper share amounts have been adjusted to give retroactive effect to the stocksplit.

 

28

----

 

 

## **ITEM 7.**                 MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

*The following discussion of our financial condition andresults of operations should be read in conjunction with our financialstatements and the related notes to suchfinancial statements included elsewhere in this Report beginning on pageF-1. The following discussion contains forward-looking statements thatinvolve risks and uncertainties.  Thestatements are based on current expectations and actual results could differmaterially from those discussed herein. Factors that could cause or contribute to the differences are discussedin “Business – Risk Factors” and elsewhere in this Report.*

**Overview**

Simple Technology, Inc.,incorporated in March 1990 and renamed SimpleTech, Inc. in May 2001, is atechnology solutions provider offering products based on DRAM, SRAM and Flashmemory technologies. Headquartered in Santa Ana, California, the company is aleader in the design, development, manufacturing and marketing of memorysolutions.

After experiencingyear-over-year revenue growth of 57.5% from 1998 to 1999 and 60.1% from 1999 to2000, revenues declined 46.7% in 2001 and increased 7.5% in 2002.  Revenues in 2001 and 2002 were negativelyimpacted due to softening macro-economic conditions, severe declines in theprice of DRAM and Flash components and significantly reduced sales to customersin the communications and networking markets.

As a result of increaseddemand for Flash-based consumer electronics and industrial applications inwhich solid-state Flash-based storage displaces traditional storage, our Flashmemory products as a percentage of total revenues increased steadily from 12.9%for 1999 to 31.0% for 2002.  For thefourth quarter of 2002, Flash memory products as a percentage of total revenuesreached 44.0%.  In November 2002, SemicoResearch Corporation projected data storage Flash industry revenues to grow ata compounded annual growth rate of 41% from 2001 to 2004.

In 2001 and 2002, ourhighest profit margin division was our Industrial Division. In 2002, ourhighest profit margin product line was our IC Tower stacking product line.  We track revenues and gross margins for our Industrialand Commercial Divisions.  We do nottrack separately, and do not intend to track separately, operating expenses forour Industrial and Commercial Divisions. Conversely, we do track operating expenses for our Xiran Division, whichis not expected to generate revenues until 2004.

Historically, a smallnumber of customers have accounted for a significant percentage of ourrevenues. Our ten largest customers accounted for an aggregate of 55.5% of ourtotal revenues in 2002, 56.3% of our total revenues in 2001 and 55.8% of ourtotal revenues in 2000.  In 2002, CDWComputer Centers accounted for 21.1% of our total revenues.  In 2001, CDW Computer Centers and Unisysaccounted for 19.7% and 11.0% of our total revenues, respectively.  In 2000, Cisco Systems and CDW ComputerCenters accounted for 14.6% and 16.8% of our total revenues, respectively.  Other than CDW Computer Centers, CiscoSystems and Unisys, no customer accounted for more than 10.0% of our totalrevenues between 2000 and 2002.  Thecomposition of our major customer base changes from quarter to quarter as themarket demand for our products changes and we expect this variability willcontinue in the future. We expect that sales of our products to a small numberof customers will continue to contribute materially to our revenues in theforeseeable future.  The loss of, or asignificant reduction in purchases by any of our major customers, could harmour business, financial condition and results of operations.  See Business - RiskFactors - “Salesto a small number of customers represent a significant portion of our revenuesand the loss of any key customer would materially reduce our sales.”

29

----

 

International sales ofour products constituted 14.8% of our total revenues in 2002, 16.0% of ourtotal revenues in 2001 and 13.4% of our total revenues in 2000. No singleforeign country accounted for more than 10.0% of our revenues between 2000 and2002. Over 95.0% of our international sales were denominated in U.S. dollars between 2000 and 2002. In addition, ourpurchases of IC devices are currently denominated in U.S. dollars.  However, we do face risks associated withdoing business in foreign countries. See Business - Risk Factors - “We face risksassociated with doing business in foreign countries, including foreign currencyfluctuations and trade barriers, that could lead to a decrease in demand forour products or an increase in the cost of the components used in ourproducts.”

In the past, we have beenimpacted by seasonal purchasing patterns resulting in lower sales in the firstand second quarters of each year.  Otherfactors, including component price fluctuations, may distort the effect ofseasonality. Our ability to adjust our short-term operating expenses inresponse to fluctuations in revenues is limited. As a result, should revenuesdecrease to a level lower than expected in any given period, our results ofoperations could be harmed.

Revenues are recognizedat the time of shipment. We face risks associated with declines in the marketvalue of our products, product returns, inventory obsolescence, priceprotection and rebates.  See Business - RiskFactors - “Product returns, order cancellations,inventory write-downs, price protection and rebates could adversely effect ourresults of operations.”

From our formation inMarch 1990 through September 26, 2000, we elected for federal and state incometax purposes to be treated as an S corporation under Subchapter S of theInternal Revenue Code of 1986 and comparable state tax laws and filed ourfederal and state income tax returns during that period on that basis.Subsequent to our S corporation termination on September 26, 2000, we have paidfederal and state corporate-level income taxes as a C corporation.

**Results of Operations**

The following table setsforth, for the periods indicated, certain consolidated statement of operationsdata reflected as a percentage of revenues.
|                                                       |   | **Year Ended  December 31,** |   |
|------------------------------------------------------------|--------|------------------------------|--------|
|                                                       |   | **2002**                     |   | **2001** |   | **2000** |   |
|                                                       |   |                         |   |   |   |   |   |
| Net revenues                                               |   | 100.0                        | %      | 100.0 | % | 100.0 | % |
| Cost of revenues                                           |   | 81.3                         |   | 77.7 |   | 77.8 |   |
|                                                       |   |                         |   |   |   |   |   |
| Gross profit                                               |   | 18.7                         |   | 22.3 |   | 22.2 |   |
| Operating  expenses                                        |   |                         |   |   |   |   |   |
| Sales and  marketing                                       |   | 10.3                         |   | 11.0 |   | 7.0 |   |
| General and  administrative                                |   | 5.8                          |   | 7.0 |   | 3.9 |   |
| Research and  development                                  |   | 5.0                          |   | 2.7 |   | 1.2 |   |
| Non-recurring  expense                                     |   | 0.8                          |   | 0.0 |   | 0.6 |   |
|                                                       |   |                         |   |   |   |   |   |
| Total operating  expenses                                  |   | 21.9                         |   | 20.7 |   | 12.7 |   |
|                                                       |   |                         |   |   |   |   |   |
| Loss (income)  from operations                             |   | (3.2                         | )      | 1.6 |   | 9.5 |   |
| Interest  (income) expense, net                            |   | (0.4                         | )      | (0.8 | ) | 0.4 |   |
|                                                       |   |                         |   |   |   |   |   |
| (Loss) income  before (benefit) provision for income taxes |   | (2.8                         | )      | 2.4 |   | 9.1 |   |
| (Benefit)  provision for income taxes [1]                  |   | (2.1                         | )      | 1.0 |   | 3.5 |   |
|                                                       |   |                         |   |   |   |   |   |
| Net (loss)  income [1]                                     |   | (0.7%                        | )      | 1.4 | % | 5.6 | % |

----

[1]  Pro formain 2000.

 

30

----

 

**Comparison of the years endedDecember 31, 2002 and 2001**

*Net Revenues*.  Our revenuesincreased 7.5% from $164.2 million in 2001 to $176.5 million in 2002.  Sales of memory products accounted for 93.2%of our revenues in 2002 compared to 90.2% of our revenues in 2001.  The increase in revenues from 2001 to 2002was primarily due to a 24.1% increase in units shipped from 2.9 million unitsin 2001 to 3.6 million units in 2002, partially offset by a 12.3% decline inour average sales price from 2001 to 2002. The increase in unit volume resulted from unit volume increases of 93.2%for Flash products, 81.6% for IC Tower stacking products and 81.8% fornon-DRAM, non-Flash products such as SRAM, hard drive upgrade kits andconnectivity products, partially offset by a unit volume decrease of 12.1% forstandard memory products.  The increasein Flash product units shipped resulted primarily from an increase in sales ofFlash products to consumers for applications such as digital camera, MP3players and PDA through direct marketers and mass market retailers.  The decrease in standard memory unitsshipped resulted primarily from continued weakness in the personal computermarket.  The decrease in our averagesales price resulted primarily from a steady decline of Flash component pricesduring 2002, partially offset by a marginal increase in overall DRAM componentprices in 2002.  The mix of productssold varies from quarter to quarter and may vary in the future, affecting ouroverall average sales price and gross margin.

Our Industrial Divisionrevenues decreased 13.5% from $48.0 million in 2001 to $41.5 million in2002.  Our Industrial Division revenueswere negatively impacted in 2002 due to reduced sales to customers in thenetworking and communications markets. Commercial Division revenues increased 16.2% from $116.2 million in 2001to $135.0 million in 2002 primarily due to a 50.4% increase in Flashproducts.  We also expect to begingenerating revenues from our Xiran Division in 2004.

Our combined backlog was$5.8 million as of December 31, 2002, compared to $4.5 million as of December31, 2001. Our Industrial Division backlog was $4.3 million as of December 31,2002, compared to $3.8 million as of December 31, 2001.  Our Commercial Division backlog increasedfrom $721,000 as of December 31, 2001, to $1.5 million as of December 31, 2002,as a result of increased Commercial Division orders booked in the fourthquarter of 2002 compared to the fourth quarter of 2001.

*Gross Profit*.  Our grossprofit decreased 10.1% from $36.6 million in 2001 to $32.9 million in 2002.Gross profit as a percentage of revenues decreased from 22.3% in 2001 to 18.7%in 2002.  Gross profit as a percentageof revenues declined from 2001 to 2002 primarily due to sharp declines in DRAMpricing during the second quarter of 2002, which resulted in a 14.2% grossprofit as a percentage of revenue in that quarter.  We believe the sharp decline in DRAM pricing during the secondquarter of 2002 resulted from failed consolidation discussions between Micronand Hynix, two of the largest DRAM manufacturers in the industry.  Gross profit as a percentage of revenues wasrelatively flat for our Industrial Division at 30.1% in 2002 and 29.6% in2001.  Gross profit as a percentage ofrevenues for our Commercial Division decreased to 15.1% in 2002 from 19.2% in2001 primarily due to the impact of DRAM price declines for the second quarterof 2002 on DRAM inventory held in stock. As a result of our Industrial Division selling a larger percentage ofhigher margin, higher capacity DRAM, Flash memory and IC Tower stackingproducts, gross profit as a percentage of revenues for our Industrial Divisionis typically higher than our Commercial Division.

*Sales and Marketing*.  Sales andmarketing expenses are comprised primarily of personnel costs and travelexpenses for our domestic and international sales and marketing employees,commissions paid to internal salespersons and independent manufacturers’representatives, shipping costs and marketing programs.  Sales and marketing expenses remained flatat $18.2 million in 2002 compared to $18.1 million in 2001.  Sales and marketing expenses as a percentageof revenues remained relatively flat at 10.3% in 2002 compared to 11.0% in2001.

*General and Administrative*.  General andadministrative expenses are comprised primarily of personnel costs for ourexecutive and administrative employees, professional fees and facilitiesoverhead.

31

----

 

General andadministrative expenses decreased 10.3% from $11.6 million in 2001 to $10.4million in 2002.  The decline in generaland administrative expenses was primarily due to reductions in legal expense ofapproximately $600,000, bad debt expense of approximately $400,000 and payrollexpense of approximately $100,000. General and administrative expenses as a percentage of revenuesdecreased from 7.0% in 2001 to 5.8% in 2002 primarily due to reduced legal, baddebt and payroll expenses and increased revenues.

*Research and Development*.  Research anddevelopment expenses are comprised primarily of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses increased 100.0% from $4.4 million in 2001 to $8.8 millionin 2002. Research and development expenses as a percentage of revenuesincreased from 2.7% in 2001 to 5.0% in 2002. Research and development expenses increased year-over-year from 2001 to2002 due to a significant expansion of our research and development staff toserve our growing Industrial Division customer base and to develop new productlines. In January 2002, we completed a $2.3 million acquisition of the assets,including intellectual property, of Irvine Networks, LLC, and hired theirengineering staff. Irvine Networks, renamed our Xiran Division, is developing auniversal solution to accelerate the delivery of content between network andstorage. Operating costs for the Xiran Division were approximately $6.5 millionin 2002, excluding a $1.4 million non-recurring in-process research and developmentcharge related to the acquisition, and are expected to increase toapproximately $9 million in 2003.  TheXiran Division received its ASIC, the key component in its universal solution,from its fabrication partner, IBM, in December 2002 and is currentlyintegrating the ASIC into board and system level products.  We expect to begin generating revenues fromthe Xiran Division in 2004.

*Non-Recurring Expenses*.  We did not have non-recurring expenses in2001.  Non-recurring expenses were $1.4million in 2002 and were comprised of in-process research anddevelopment expenses related to the acquisition of Irvine Networks in January2002.

*Interest (Income) Expense, Net*. Interest (income) expense, net iscomprised primarily of interest income from our cash and cash equivalents andinterest expense related to our line of credit and equipment financing.  Interest (income) expense, net was ($778,000)in 2002 compared to ($1.4) million in 2001. Interest income was $855,000 in 2002 and $1.6 million in 2001. Interestincome decreased from 2001 to 2002 primarily due to lower interest rates.  Interest expense was $77,000 in 2002 and$200,000 in 2001.  Interest expensedecreased from 2001 to 2002 due to the maturation and pay down of a portion ofour equipment loans and capital leases.

*(Benefit) provision for income taxes. *(Benefit) provision forincome taxes was ($3.6) million in 2002 and $1.5 million in 2001.  (Benefit) provision for income taxes as apercentage of (loss) income before (benefit) provision for income taxes was73.3% in 2002 compared to 39.6% in 2001. The increase in the effective rate in 2002 resulted from the applicationof state net operating loss carryforwards, prior year research and developmentand state enterprise zone hiring credits of approximately $927,000 taken in2002 and current year research and development and state enterprise zone hiringcredits of approximately $934,000.

 

*Net (Loss) Income*.  Net (loss) income was ($1.3) million in 2002 and$2.3 million in 2001.

**Comparison of the years endedDecember 31, 2001 and 2000**

*Net Revenues*.  Our revenuesdecreased 46.7% from $308.3 million in 2000 to $164.2 million in 2001.  Sales of memory products accounted for 90.2%of our revenues in 2001 and 91.0% of our revenues in 2000.  The decrease in revenues from 2000 to 2001was primarily due to a 54.4% decrease in our average sales price from 2000 to2001, offset partially by a 16.0% increase in units shipped from 2.5 millionunits in 2000 to 2.9 million units in 2001. The decrease in our average sales price resulted from

32

----

 

significantdeclines in DRAM and Flash component prices from October 2000 through November2001.  The increase in unit volumeresulted from unit volume increases of 37.7% for standard memory products and29.7% for Flash products, partially offset by unit volume decreases of 68.4%for IC Tower stacking products and 41.2% for non-DRAM, non-Flash products suchas SRAM, hard drive upgrade kits and connectivity products.  Increases in Flash and standard memory unitsshipped resulted primarily from market share gains achieved during 2001 in themass market retailer channel.  Decreasesin IC Tower stacking units shipped resulted from excess Industrial Divisioncustomer inventory levels throughout 2001. The mix of products sold varies fromquarter to quarter and may vary in the future, affecting our overall averagesales price and gross margin.

Our Industrial Divisionrevenues decreased 66.7% from $144.2 million in 2000 to $48.0 million in 2001.Our Commercial Division revenues decreased 29.2% from $164.1 million in 2000 to$116.2 million in 2001.  Both ourIndustrial and Commercial Division revenues were negatively impacted in 2001due to softening macro-economic conditions and severe declines in the price ofDRAM and Flash components, which resulted in significantly lower averageselling prices.  Our Industrial Divisionrevenues were further impacted by a build-up of inventory by our communicationsand networking customers during 2000.

Our combined backlog was$4.5 million as of December 31, 2001 compared to $22.4 million as of December31, 2000. Our Industrial Division backlog was $3.8 million as of December 31,2001 compared to $21.4 million as of December 31, 2000.  Our Commercial Division backlog was $721,000as of December 31, 2001 compared to $1.0 million as of December 31, 2000.  From 2000 to 2001, the decrease inIndustrial Division backlog resulted from a build-up of inventory by ourIndustrial Division customers, which led to a significant reduction oforders.  Commercial Division backlog istypically nominal since substantially all commercial orders are filled on asame-day or next-day basis.

*Gross Profit*.  Our grossprofit decreased 46.5% from $68.4 million in 2000 to $36.6 million in 2001.Gross profit as a percentage of revenues remained flat at 22.3% in 2001compared to 22.2% in 2000.  Gross profitas a percentage of revenues for our Industrial Division increased to 29.6% in2001 from 26.7% in 2000.  Gross profitas a percentage of revenues for our Commercial Division increased to 19.2% in2001 from 18.2% in 2000 primarily due to a positive shift in customer mix. As aresult of our Industrial Division selling a larger percentage of higher margin,higher capacity DRAM, Flash memory and IC Tower stacking products, gross profitas a percentage of revenues for our Industrial Division is typically higherthan our Commercial Division.

*Sales and Marketing*.  Sales andmarketing expenses are comprised primarily of personnel costs and travel expensesfor our domestic and international sales and marketing employees, commissionspaid to internal salespersons and independent manufacturers’ representatives,shipping costs and marketing programs. Sales and marketing expenses decreased 16.2% from $21.6 million in 2000to $18.1 million in 2001 primarily due to reduced commissions and channelmarketing expenses related to lower revenues. Sales and marketing expenses as a percentage of revenues increased from7.0% in 2000 to 11.0% in 2001 primarily due to reduced revenues.

*General and Administrative*.  General andadministrative expenses are comprised primarily of personnel costs for ourexecutive and administrative employees, professional fees and facilitiesoverhead. General and administrative expenses remained relatively flat at $11.6million in 2001 compared to $11.9 million in 2000.  General and administrative expenses as a percentage of revenuesincreased from 3.8% in 2000 to 7.0% in 2001 primarily due to reduced revenues.

*Research and Development*.  Research anddevelopment expenses are comprised primarily of personnel costs for ourengineering and design staff and the cost of prototype supplies. Research anddevelopment expenses increased 19.0% from $3.7 million in 2000 to $4.4 millionin 2001. Research and development expenses as a percentage of revenuesincreased from 1.2% in 2000 to 2.7% in 2001. Research and

33

----

 

developmentexpenses increased year-over-year from 2000 to 2001 due to a significant expansionof our research and development staff to serve our growing Industrial Divisioncustomer base and to develop new product lines.

*Non-Recurring Expenses*.  We did not have non-recurring expenses in2001.  Non-recurring expenses were $1.8million in 2000 and were comprised of expenses related to a litigationsettlement with Interactive Flight Technologies, Inc.  The settlement payment was made in January 2001.

*Interest (Income) Expense, Net*. Interest (income) expense, net iscomprised primarily of interest income from our cash and cash equivalents andinterest expense related to our line of credit and equipment financing.  Interest (income) expense, net was ($1.4)million in 2001 compared to $1.2 million in 2000.  Interest income was $1.6 million in 2001 and $406,000 in 2000.Interest income increased in 2001 compared to 2000 due to a higher average cashbalance resulting primarily from initial public offering proceeds received inOctober 2000 and positive cash flow from operations in each quarter from thefourth quarter of 2000 through the fourth quarter of 2001.  Interest expense was $200,000 in 2001 and$1.6 million in 2000.  Interest expensedecreased significantly from 2000 to 2001 primarily due to the reduction of ourline of credit balance to zero in October 2000.

*Provision for income taxes. *Provision for income taxes was $1.5 million in 2001.  Pro forma provision from income taxes was$10.9 million in 2000.  Provision forincome taxes as a percentage of income before provision for income taxes was 39.6%in 2001. Pro forma provision for income taxes as a percentage of income beforeprovision for income taxes was 38.6% in 2000.

*Net Income*.  Net income was $2.3 million in 2001.  Assuming the termination of our Scorporation status, pro forma net income would have been $17.3 million in 2000.

**Liquidity and Capital Resources**

As of December 31, 2002,we had working capital of $60.4 million, including $34.0 million of cash andcash equivalents and $10.0 million in marketable securities, compared toworking capital of $64.5 million, including $51.8 million of cash and cashequivalents, as of December 31, 2001. Our cash and cash equivalents balancedecreased over the 2002 period primarily due to an investment in marketsecurities of $10.0 million and purchases of furniture, fixtures and equipmentof $5.4 million.  We had no outstandingprincipal balance under our $27.5 million line of credit with Comerica Bank atDecember 31, 2001 and the line of credit expired in August 2002 and was notrenewed. Current assets were 3.9 times current liabilities at the end of 2002,compared to 5.3 times current liabilities at the end of 2001.

Net cash used byoperating activities was $217,000 in 2002. Net cash used by operating activities resulted primarily from anincrease in net accounts receivable of $6.4 million and an increase in netinventory of $4.3 million, partially offset by an increase in accounts payableof $6.1 million and non-cash depreciation of $3.6 million. Net inventory, netaccounts receivable and accounts payable growth resulted from a 28.7% increasein revenues in the fourth quarter of 2002 compared to the fourth quarter of2001.

Net cash provided byoperating activities was $24.2 million in 2001. Net cash provided by operatingactivities in 2001 resulted primarily from net income of $2.3 million, adecrease in net accounts receivable of $15.6 million and a decrease in netinventory of $21.2 million, partially offset by a decrease in accounts payableof $15.6 million.  Inventory andaccounts payable decreased primarily due to the implementation of consignmentinventory programs with our three largest component suppliers during 2001 and asharp decline in DRAM and Flash pricing during the year.  Accounts receivable decreased due to thedecline in overall revenues.

34

----

 

Net cash used ininvesting activities was $16.9 million in 2002 compared to $5.4 million in2001. In 2002, net cash used in investing activities resulted primarily from aninvestment in marketable securities of $10.0 million, purchases of furniture,fixtures and equipment of $5.4 million and an acquisition of a business for$2.3 million. In 2001, net cash used in investing activities was attributableprimarily to purchases of furniture, fixtures and equipment.  Although we had no material capital expensecommitments as of December 31, 2002, we expect to spend up to approximately$3.0 million to $5.0 million during the next 24 months, primarily formanufacturing, testing and engineering equipment.

Net cash used infinancing activities totaled $681,000 in 2002 and $674,000 in 2001. Net cashused in financing activities in 2002 resulted from the repayment of borrowingsfrom banks and capital lease obligations of $1.5 million, partially offset bythe issuance of common stock for proceeds of $772,000 related to our employeestock purchase plan and stock option exercises. Net cash used in financingactivities in 2001 resulted primarily from the repayment of borrowings frombanks and capital lease obligations of $1.6 million, partially offset by theissuance of common stock for proceeds of $1.1 million related to our employeestock purchase plan and stock option exercises. In 2001, we also repurchased atotal of 72,500 shares of our common stock under our authorized stockrepurchase program at an average price of approximately $1.25 per share,resulting in a total cash payment of approximately $92,000.

In prior years, weentered into several capital leases and loans to finance manufacturing andtesting equipment. Our obligations under capital leases were $113,000 onDecember 31, 2002 and $554,000 on December 31, 2001, with interest ratesranging from 8.1% to 9.6% per annum. Our equipment financing loan balances were paid down to zero at December31, 2002 and had a balance of $1.0 million on December 31, 2001, with interestrates ranging from 7.5% to 9.1% per annum.

Prior to our conversionfrom an S corporation to a C corporation in September 2000, we made cashdistributions of a portion of our S Corporation earnings to our shareholders ofrecord as of September 20, 2000, for reasons including payment of their overallpersonal income taxes. On September 26, 2000, we distributed to ourshareholders of record as of September 20, 2000, in proportion to theirownership of our shares, notes in an aggregate principal amount of $25.1million, equal to our undistributed earnings from the date of our formationthrough September 26, 2000. We used a portion of the net proceeds from ourinitial public offering to payoff the principal amount of these undistributedearnings notes on October 6, 2000 and November 3, 2000.

We believe that ourexisting assets, cash, cash equivalents and investments on hand, together withcash that we expect to generate from our operations, will be sufficient to meetour capital needs for at least the next twelve months. However, it is possiblethat we may need or elect to raise additional funds to fund our activitiesbeyond the next year or to consummate acquisitions of other businesses,products or technologies. We could raise such funds by selling more stock tothe public or to selected investors, or by borrowing money. In addition, eventhough we may not need additional funds, we may still elect to sell additionalequity securities or obtain credit facilities for other reasons. We cannotassure you that we will be able to obtain additional funds on commerciallyfavorable terms, or at all. If we raise additional funds by issuing additionalequity or convertible debt securities, the ownership percentages of existingstockholders would be reduced. In addition, the equity or debt securities thatwe issue may have rights, preferences or privileges senior to those of theholders of our common stock.

Although we believe wehave sufficient capital to fund our activities for at least the next twelvemonths, our future capital requirements may vary materially from those nowplanned. The amount of capital that we will need in the future will depend onmany factors, including:

•                  the market acceptance of our products;

 

35

----

 

•                  the levels of promotion and advertising that will berequired to launch our new products and achieve and maintain a competitiveposition in the marketplace;

•                  price discounts on our products to our customers;

•                  our business, product, capital expenditure andresearch and development plans and product and technology roadmaps;

•                  the levels of inventory and accounts receivable thatwe maintain;

•                  capital improvements to new and existing facilities;

•                  technological advances;

•                  our competitors’ response to our products;

•                  our pursuit of strategic alternatives, includingfuture market opportunities; and

•                  our relationships with suppliers and customers.

 

In addition, we mayrequire additional capital to accommodate planned growth, hiring,infrastructure and facility needs or to consummate acquisitions of otherbusinesses, products or technologies.

**Inflation**

Inflation was not amaterial factor in either revenue or operating expenses during the past threefiscal years ended December 31, 2002, 2001 and 2000.

 

**CriticalAccounting Policies and Estimates**

 

Our discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamount of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amount ofrevenues and expenses for each period. The following represents a summary of our critical accounting policies,defined as those policies that we believe are: (a) the most important to theportrayal of our financial condition and results of operations, and (b) thatrequire management’s most difficult, subjective or complex judgments, often asa result of the need to make estimates about the effects of matters that areinherently uncertain.

 

•*Reservesfor inventory excess, obsolescence and lower of market values over costs*—Wegenerally purchase raw materials in quantities that we anticipate will be fullyused in the near term. Changes in operating strategy, customer demand andunpredictable fluctuations in market values of raw materials can limit ourability to effectively utilize all of the raw materials purchased and soldthrough resulting finished goods to customers for a profit.  We regularly monitor potential inventoryexcess, obsolescence and lower market values compared to costs and, whennecessary, reduce the carrying amount of our inventory to its market value.

 

•*Allowancesfor doubtful accounts and price protection*—We maintain allowancesfor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. Additionally, we maintain allowances for limited price protection rightsfor inventories of our products held by our customers as a result of recentsales transactions to them.

 

36

----

 

If we reduce the list price of our products, thesecustomers may receive a credit from us. We estimate the impact of such pricing changes on a regular basis andadjust our allowances accordingly.

 

• *Product returns*—Weoffer a majority of our customers that purchase products through our commercialchannels limited rights to return unsold inventory.  In addition, while we may not be contractually obligated toaccept returned products, we may determine that it is in our best interest toaccept returns in order to maintain good relationships with our customers. Weprovide for estimated future returns of inventory at the time of sale based onhistorical experience, and actual results have been within our expectations.

 

• *Income taxes*—Aspart of the process of preparing our consolidated financial statements, we arerequired to estimate our income taxes in each of the jurisdictions in which weoperate. The process incorporates an assessment of the current tax exposuretogether with temporary differences resulting from different treatment oftransactions for tax and financial statement purposes. Such differences resultin deferred tax assets and liabilities, which are included within the consolidatedbalance sheet.  The recovery of deferredtax assets from future taxable income must be assessed and, to the extent thatrecovery is not likely, we establish a valuation allowance. Increases invaluation allowances result in the recording of additional tax expense.Further, if our ultimate tax liability differs from the periodic tax provisionreflected in the consolidated statements of operations, additional tax expensemay be recorded.

 

• *Litigation andother contingencies*—Management regularly evaluates our exposure tothreatened or pending litigation and other business contingencies. Because ofthe uncertainties related to the amount of loss from litigation and otherbusiness contingencies, the recording of losses relating to such exposures requiressignificant judgment about the potential range of outcomes.  As additional information about current orfuture litigation or other contingencies becomes available, our management willassess whether such information warrants the recording of additional expenserelating to our contingencies. We base our estimates on historical experienceand on various other assumptions that are believed to be reasonable. Theresults of these estimates form the basis for making judgments about thecarrying values of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates under differentassumptions or conditions.

 

• *Valuation of long-lived assets*—Weassess the potential impairment of long-lived tangible and intangible assetswhenever events or changes in circumstances indicate that the carrying valuemay not be recoverable. Changes in our operating strategy can significantlyreduce the estimated useful life of such assets.

 

## **ITEM 7A.**       QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

## ** **

**Interest Rate Risk**

 

At any time, fluctuationsin interest rates could affect interest earnings on our cash and cashequivalents and interest expense on our existing variable rate debt.  Webelieve that the effect, if any, of reasonably possible near term changes ininterest rates on our financial position, results of operations and cash flowswould not be material.  Currently, we donot hedge these interest rate exposures.  The primary

37

----

 

objective of ourinvestment activities is to preserve capital. We have not used derivativefinancial instruments in our investment portfolio.

At December 31, 2002, ourcash and cash equivalents were $34.0 million. Our variable rate equipment debtwas paid down to zero at December 31, 2002, and our floating rate debt underthe revolving credit facility expired in August 2002 and was not renewed.  At December 31, 2002, our cash and cashequivalents included $25.4 million invested in money market and other interestbearing accounts and $8.6 million invested in securities, which representsinvestments in corporate bonds, auction rate securities and commercial paperwith maturities of less than three months. At December 31, 2002, our investments in securities with maturities ofless than three months had a weighted-average time to maturity of 23.3 days.

At December 31, 2002, ourinvestment in marketable securities was $10.0 million.  The marketable securities consist primarilyof $100,000 certificates of deposit with an original maturity of one year at100 different financial institutions. At December 31, 2002, these marketable securities had a weighted-averagetime to maturity of approximately 77 days. Marketable securities representinvestments with an original maturity of greater than three months. Thesesecurities are classified as held to maturity because we have the intention andability to hold the securities to maturity. Gross unrealized gains and losseson held-to-maturity marketable securities have historically not been material.

If interest rates were todecrease 1%, the result would be an annual decrease in our interest incomerelated to our cash and cash equivalents of approximately $340,000. Conversely, if interest rates were to increase 1%, the result would be anannual increase in our interest expense related to our variable rate debt ofapproximately $10,000.  However, due to the uncertainty of the actionsthat would be taken and their possible effects, this analysis assumes no such action. Further, this analysis does not consider the effect of the change in the levelof overall economic activity that could exist in such an environment.

More than 95.0% of ourinternational sales are denominated in U.S. dollars.  Consequently, if the value of the U.S. dollar increases relativeto a particular foreign currency, our products could become relatively moreexpensive.  In addition, we purchasesubstantially all of our IC devices from local distributors of Japanese, Koreanand Taiwanese suppliers.  Fluctuationsin the currencies of Japan, Korea or Taiwan could have an adverse impact on thecost of our raw materials.  To date, wehave not entered any derivative instruments to manage risks related to interestrate or foreign currency exchange rates.

## **ITEM 8.**                 FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

 

SimpleTech, Inc.,consolidated financial statements, schedule and supplementary data required bythis item are included in Part IV, Item 15 of this Report.

## **ITEM 9.**                 CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

38

----

 

# **PART III.**

## **ITEM 10.**          DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT

 

The informationrequired by this Item is included in “Proposal 1: Elections of Directors”“Management”, and “Section 16(a) Beneficial Ownership Reporting Compliance”sections of our Proxy Statement to be filed in connection with our 2003 AnnualMeeting of Shareholders and is incorporated herein by reference.

## **ITEM 11.**         EXECUTIVE COMPENSATION

 

The information required by this Item is included in the “ExecutiveCompensation and Related Information” and "Management" sections ofour Proxy Statement to be filed in connection with our 2003 Annual Meeting ofShareholders and is incorporated herein by reference.

 

## **ITEM 12.**         SECURITY OWNERSHIPOF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information required by this Item is included in the “SecurityOwnership of Certain Beneficial Owners and Management” and “Equity CompensationPlan Information” sections of our Proxy Statement to be filed in connectionwith our 2003 Annual Meeting of Shareholders and is incorporated herein byreference.

 

## **ITEM 13.**          CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

 

The information required by this Item is included in the “CompensationCommittee Interlocks and Insider Participation” and “Certain Transactions”sections of our Proxy Statement to be filed in connection with our 2003 AnnualMeeting of Shareholders and is incorporated herein by reference.

## ** **

## **ITEM 14.**         CONTROLS AND PROCEDURES

 

*(a)Evaluation of Disclosure Controls and Procedures.*****Under the supervision and with theparticipation of our management, including our principal executive officer andprincipal financial officer, we conducted an evaluation of our disclosurecontrols and procedures, as such term is defined under Rule 13a-14(c) and Rule15d-14(c) promulgated under the Securities Exchange Act of 1934, as amended(the “Exchange Act”), within 90 days of the filing date of this Annual Reporton Form 10-K. Based on their evaluation, our principal executive officer andprincipal accounting officer concluded that our disclosure controls andprocedures are effective.

 

*(b)Changes in Internal Controls.*****There have been no significant changes (includingcorrective actions with regard to significant deficiencies or materialweaknesses) in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of the evaluationreferenced in paragraph (a) above.

39

----

**PART IV.**

## **ITEM 15.**                                              EXHIBITS,FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

### **(a)   Documents filed aspart of this Report:**

1.  **FinancialStatements.  **The following financial statements ofSimpleTech, Inc. are included in a separate section of this Annual Reporton Form 10-K commencing on the pages referenced below: 
|                                                                                                                          |   | **Page** |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|
| **SimpleTech, Inc. Consolidated  Financial Statements**                                                                       |   |     |   |
| Report of  Independent Accountants                                                                                            |   | F-2      |   |
| Consolidated Balance  Sheets at December 31, 2002 and 2001                                                                    |   | F-3      |   |
| Consolidated  Statements of Operations for each of the three years in the period ended  December 31, 2002                |   | F-4      |   |
| Consolidated  Statements of Shareholders’ Equity for each of the three years in the period  ended December 31, 2002 |   | F-5      |   |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2002                |   | F-6      |   |
| Note to  Consolidated Financial Statements                                                                                    |   | F-8      |   |

 

2.  **FinancialStatement Schedule.  **The following financial statementschedule is included in a separate section of this Annual Report onForm 10-K commencing on the pages referenced below. All other scheduleshave been omitted because they are not applicable, not required, or theinformation is included in the consolidated financial statements or notesthereto. 
|                                                                            |   | **Page** |   |
|---------------------------------------------------------------------------------|--------|----------|--------|
| Report of  Independent Accountants on Financial Statement Schedule              |   | S-1      |   |
| Schedule II –  Consolidated Valuation and Qualifying Accounts and Reserves |   | S-2      |   |

 

3.  **Exhibits.  **TheExhibits filed as part of this Annual Report are listed in Item 14(c) of thisAnnual Report on Form 10-K.

### **(b)   Reports onForm 8-K:**

None

### **(c) Exhibits.**

The following exhibitsare filed as part of, or are incorporated by reference in, this Report: 
| **Number** |   | **Description**                                                                                                                                                               |   |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 3.1        | *      | Amended and Restated Articles of Incorporation                                                                                                                                |   |
| 3.1.1      | *      | Certificate of Amendment to the Amended and Restated  Articles of Incorporation, dated August 31, 2000                                                                   |   |
| 3.1.2      | ‡ | Certificate of Amendment to the Amended and Restated  Articles of Incorporation, dated May 1, 2001                                                                            |   |
| 3.2        | *      | Amended and Restated Bylaws                                                                                                                                                   |   |
| 4.1        |   | See Exhibits 3.1 and 3.2 for provisions of the  Articles of Incorporation and Bylaws for SimpleTech, Inc. defining the rights  of holders of common stock of SimpleTech, Inc. |   |

 

40

----

 
| 4.2  | *        | Specimen Stock Certificate                                                                                                                                                      |
|------|----------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1 | *        | Amended and Restated Real Estate Lease, dated April  1, 2000, by and between MDC Land LLC and SimpleTech, Inc.                                                                  |
| 10.2 | *        | Amended and Restated Real Estate Lease, dated June  1, 2000, by and between MDC Land LLC and SimpleTech, Inc.                                                                   |
| 10.3 | **† | 2000 Stock Incentive Plan (as amended and restated)                                                                                                                             |
| 10.4 | **† | 2000 Employee Stock Purchase Plan (as amended and  restated)                                                                                                                    |
| 10.5 | *        | Form of Indemnification Agreement between  SimpleTech, Inc. and each of its directors and officers                                                                              |
| 10.6 | *†  | Form of Employment Agreement for Executive Officers  of SimpleTech, Inc. (including a schedule of substantially identical  agreements)                                          |
| 10.7 | *        | Distribution and Tax Indemnity Agreement, dated  September 26, 2000, by and between SimpleTech, Inc. and each of the  shareholders of SimpleTech, Inc.                          |
| 10.8 | *        | License Agreement, dated August 22, 2000, by and  between Micron Electronics and SimpleTech, Inc.                                                                               |
| 10.9 | †   | Employment Agreement, dated November 11, 2002, by  and between SimpleTech, Inc. and Thomas A. Beaver                                                                            |
| 21.1 | +        | List of Subsidiaries of SimpleTech, Inc.                                                                                                                                        |
| 23.1 |     | Consent of PricewaterhouseCoopers LLP                                                                                                                                           |
| 99.1 |     | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

----

*              This exhibit was previously filed as an exhibit to theCompany’s Registration Statement on Form S-1 declared effectiveSeptember 28, 2000 (File No. 333-32478), and is incorporated byreference herein.

‡              This exhibit was previously filed as an exhibit to theCompany’s Quarterly Report on Form 10-Q for the Quarterly Period Ended March31, 2001, filed with the Securities and Exchange Commission on May 14, 2001,and is incorporated by reference herein.

**           This exhibit was previously filed as an exhibit to theCompany’s Registration Statement on Form S-8 with the Securities andExchange Commission on February 9, 2001, and is incorporated by referenceherein.

†              Management contractor compensatory plan or arrangement required to be filed as an exhibit pursuantto Item 15(c) of Form 10-K.

 

+              This exhibit waspreviously filed as an exhibit to the Company's Annual Report on Form 10-K forthe fiscal year ended December 31, 2001, filed with the Securities and ExchangeCommission on March 20, 2002, and is incorporated by reference herein.

 

### **(d) Financial Statement Schedule:**

The financial statementschedule for SimpleTech, Inc. is set forth in (a)(2) of Item 14 above.

41

----

**SIMPLETECH, INC.**

**INDEX TO CONSOLIDATED FINANCIALSTATEMENTS**
|                                                                                                                          |   | **Page** |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|
| Report of  Independent Accountants                                                                                            |   | F-2      |   |
| Consolidated  Balance Sheets at December 31, 2002 and 2001                                                                    |   | F-3      |   |
| Consolidated  Statements of Operations for each of the three years in the period ended  December 31, 2002                |   | F-4      |   |
| Consolidated  Statements of Shareholders’ Equity for each of the three years in the period  ended December 31, 2002 |   | F-5      |   |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended  December 31, 2002                |   | F-6      |   |
| Notes to  Consolidated Financial Statements                                                                                   |   | F-8      |   |

 

F-1

----

**Reportof Independent Accountants**

The Shareholders and Board of Directors of

SimpleTech, Inc.

 

In our opinion,the accompanying consolidated balance sheets and the related consolidatedstatements of operations, shareholders’ equity and cash flows present fairly,in all material respects, the financial position of SimpleTech, Inc. and itssubsidiaries (the “Company”) at December 31, 2002 and 2001, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2002 in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are the responsibility of the Company’smanagement; our responsibility is to express an opinion on these financialstatements based on our audits.  Weconducted our audits of these statements in accordance with auditing standardsgenerally accepted in the United States of America, which require that we planand perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

PricewaterhouseCoopers LLP

Orange County, California

January 31, 2003,except for Note 10, as to which the date is February 26, 2003

F-2

----

**SimpleTech, Inc.**

**Consolidated Balance Sheets**

**(in thousands, except  share and per share amounts)**

 
|                                                                                                                                                                                                 |   | **December  31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|
|                                                                                                                                                                                                 |   | **2002**          |   | **2001** |   |
| **ASSETS:**                                                                                                                                                                                          |   |              |   |   |   |
| CURRENT ASSETS:                                                                                                                                                                                      |   |              |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                           |   | $                 | 33,992 |   | $ | 51,831 |   |
| Marketable  securities                                                                                                                                                                               |   | 9,980             |   | — |   |
| Accounts  receivable, net of allowances of $782 and $540 at December 31, 2002 and 2001,  respectively                                                                                                |   | 19,019            |   | 12,602 |   |
| Inventory, net                                                                                                                                                                                       |   | 14,141            |   | 9,843 |   |
| Deferred income  taxes                                                                                                                                                                               |   | 28                |   | 786 |   |
| Other current  assets                                                                                                                                                                                |   | 3,919             |   | 4,474 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| Total current  assets                                                                                                                                                                                |   | 81,079            |   | 79,536 |   |
| Furniture,  fixtures and equipment, net                                                                                                                                                              |   | 10,169            |   | 9,127 |   |
| Goodwill                                                                                                                                                                                             |   | 835               |   | — |   |
| Deferred income  taxes                                                                                                                                                                               |   | 2,378             |   | 587 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| Total assets                                                                                                                                                                                         |   | $                 | 94,461 |   | $ | 89,250 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY:**                                                                                                                                                      |   |
| CURRENT  LIABILITIES:                                                                                                                                                                                |   |              |   |   |   |
| Accounts payable                                                                                                                                                                                     |   | $                 | 16,381 |   | $ | 10,320 |   |
| Current  maturities of long-term debt                                                                                                                                                                |   | —            |   | 741 |   |
| Current  maturities of capital lease obligations                                                                                                                                                     |   | 113               |   | 441 |   |
| Accrued and  other liabilities                                                                                                                                                                       |   | 4,152             |   | 3,491 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| Total current  liabilities                                                                                                                                                                           |   | 20,646            |   | 14,993 |   |
| Long-term debt                                                                                                                                                                                       |   | —            |   | 271 |   |
| Capital lease  obligations                                                                                                                                                                           |   | —            |   | 113 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| Total  liabilities                                                                                                                                                                                   |   | 20,646            |   | 15,377 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| Commitments and  contingencies (Note 10)                                                                                                                                                             |   |              |   |   |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| SHAREHOLDERS’  EQUITY:                                                                                                                                                                          |   |              |   |   |   |
| Preferred stock,  $0.001 par value, 20,000,000 shares authorized, no shares issued and  outstanding                                                                                                  |   | —            |   | — |   |
| Common stock,  $0.001 par value, 100,000,000 shares authorized, 38,725,800 shares issued and  outstanding as of December 31, 2002; 38,272,050 shares issued and outstanding  as of December 31, 2001 |   | 39                |   | 38 |   |
| Additional  paid-in capital                                                                                                                                                                          |   | 66,716            |   | 65,484 |   |
| Unearned stock  based compensation                                                                                                                                                                   |   | —            |   | (15 | ) |
| Retained  earnings                                                                                                                                                                                   |   | 7,060             |   | 8,366 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| Total  shareholders’ equity                                                                                                                                                                     |   | 73,815            |   | 73,873 |   |
|                                                                                                                                                                                                 |   |              |   |   |   |
| Total  liabilities and shareholders’ equity                                                                                                                                                     |   | $                 | 94,461 |   | $ | 89,250 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-3

----

 

 

**SimpleTech, Inc.**

**Consolidated Statements of Operations**

**(in thousands, except share and pershare amounts)**

 

 
|                                                                |   | **Year Ended  December 31,** |    |
|---------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                |   | **2002**                     |    | **2001** |   | **2000** |   |
|                                                                |   |                         |    |   |   |   |   |
| Net revenues                                                        |   | $                            | 176,531 |   | $ | 164,241 |   | $ | 308,316 |   |
| Cost of revenues                                                    |   | 143,582                      |    | 127,691 |   | 239,964 |   |
|                                                                |   |                         |    |   |   |   |   |
| Gross profit                                                        |   | 32,949                       |    | 36,550 |   | 68,352 |   |
| Sales and  marketing                                                |   | 18,151                       |    | 18,078 |   | 21,588 |   |
| General and  administrative                                         |   | 10,354                       |    | 11,564 |   | 11,853 |   |
| Research and  development                                           |   | 8,805                        |    | 4,426 |   | 3,745 |   |
| In-process  research and development (Note 6)                       |   | 1,360                        |    | — |   | — |   |
| Non-recurring  legal settlement (Note 10)                           |   | —                       |    | — |   | 1,810 |   |
|                                                                |   |                         |    |   |   |   |   |
| Total operating  expenses                                           |   | 38,670                       |    | 34,068 |   | 38,996 |   |
|                                                                |   |                         |    |   |   |   |   |
| (Loss) income  from operations                                      |   | (5,721                       | )       | 2,482 |   | 29,356 |   |
| Interest income                                                     |   | (855                         | )       | (1,595 | ) | (406 | ) |
| Interest expense                                                    |   | 77                           |    | 200 |   | 1,564 |   |
|                                                                |   |                         |    |   |   |   |   |
| (Loss) income  before (benefit) provision for income taxes          |   | (4,943                       | )       | 3,877 |   | 28,198 |   |
| (Benefit)  provision for income taxes                               |   | (3,637                       | )       | 1,537 |   | 2,838 |   |
| Net (loss)  income                                                  |   | $                            | (1,306  | ) | $ | 2,340 |   | $ | 25,360 |   |
|                                                                |   |                         |    |   |   |   |   |
| Pro forma data  (Note 2):  Income before provision for income taxes |   |                         |    |   |   | $ | 28,198 |   |
| Provision for  income taxes                                         |   |                         |    |   |   | 10,883 |   |
|                                                                |   |                         |    |   |   |   |   |
| Net income                                                          |   |                         |    |   |   | $ | 17,315 |   |
| Net (loss)  income per share:                                       |   |                         |    |   |   |   |   |
| Basic                                                               |   | $                            | (0.03   | ) | $ | 0.06 |   | $ | 0.53 (a | ) |
| Diluted                                                             |   | $                            | (0.03   | ) | $ | 0.06 |   | $ | 0.50 (a | ) |
|                                                                |   |                         |    |   |   |   |   |
|                                                                |   |                         |    |   |   |   |   |
| Weighted average  shares outstanding:                               |   |                         |    |   |   |   |   |
| Basic                                                               |   | 38,515,825                   |    | 38,126,687 |   | 32,393,218 |   |
| Diluted                                                             |   | 38,515,825                   |    | 39,435,505 |   | 34,593,678 |   |

----

(a) Pro forma (Note 2).

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-4

----

**SimpleTech, Inc.**

**Consolidated Statements of Shareholders’Equity**

**(in thousands, except share amounts)**

 
|                                                          |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    | **Accumulated  Other Comprehensive Loss** |                                 |                     |   |
|---------------------------------------------------------------|--------|-------------------|--------|------------|-----------------------------------------------------------------|--------------------------------------|--------|---------------------------------------------|--------|---------|---------------------------------------------------------|-------------------------------------------|--------------------------------------|--------------------------|--------|
|                                                          |   |              |   |       |                                                            | **Additional  Paid-In**

**Capital** |   | **Unearned  Stock Based**

**Compensation** |   |    |                                                    |                                      | **Total  Shareholders’ Equity** |                     |
|                                                          |   | **Common  Stock** |   |       |                                                            |                                 |   | **Retained  Earnings**                      |   |    |                                                    |                                      |                                 |
|                                                          |   | **Shares**        |   | **Amount** |                                                            |                                 |   |                                        |   |    |
|                                                          |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    |                                      |                                 |                     |   |
| Balances,  December 31, 1999                                  |   | 30,601,027        |   | $          |      30                                     |                                 | $      |     3,283               |   | $       |       (141                     | )                                         | $                                    |    12,705      |   | $ |        (97 | ) | $ |   15,780 |   |
| Comprehensive  income:                                        |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    |                                      |                                 |                     |   |
| Net income                                                    |   |              |   |       |                                                            |                                 |   |                                        |   | 25,360  |                                                    |                                      |                                 | 25,360                   |   |
| Foreign currency  translation adjustment                      |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    | 97                                        |                                 | 97                       |   |
|                                                          |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    |                                      |                                 |                     |   |
| Total  comprehensive income                                   |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    |                                      |                                 | 25,457                   |   |
| Compensation  related to stock options vesting                |   |              |   |       |                                                            |                                 |   | 79                                          |   |    |                                                    |                                      |                                 | 79                       |   |
| Change in par  value of common stock                          |   |              |   | 1          |                                                            | (1                                   | )      |                                        |   |    |                                                    |                                      |                                 | —                   |   |
| Distributions to  shareholders                                |   |              |   |       |                                                            | (3,000                               | )      |                                        |   | (32,039 | )                                                       |                                      |                                 | (35,039                  | )      |
| Issuance of  common shares                                    |   | 6,364,000         |   | 6          |                                                            | 62,726                               |   |                                        |   |    |                                                    |                                      |                                 | 62,732                   |   |
| Exercise of  stock options                                    |   | 607,640           |   | 1          |                                                            | 671                                  |   |                                        |   |    |                                                    |                                      |                                 | 672                      |   |
| Tax benefit from  exercises of stock options                  |   |              |   |       |                                                            | 232                                  |   |                                        |   |    |                                                    |                                      |                                 | 232                      |   |
|                                                          |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    |                                      |                                 |                     |   |
| Balances,  December 31, 2000                                  |   | 37,572,667        |   | 38         |                                                            | 63,911                               |   | (62                                         | )      | 6,026   |                                                    | —                                    |                                 | 69,913                   |   |
| Net income                                                    |   |              |   |       |                                                            |                                 |   |                                        |   | 2,340   |                                                    |                                      |                                 | 2,340                    |   |
| Compensation  related to stock options vesting                |   |              |   |       |                                                            |                                 |   | 47                                          |   |    |                                                    |                                      |                                 | 47                       |   |
| Issuance of  common shares under employee stock purchase plan |   | 99,826            |   |       |                                                            | 327                                  |   |                                        |   |    |                                                    |                                      |                                 | 327                      |   |
| Stock buyback                                                 |   | (72,500           | )      |       |                                                            | (92                                  | )      |                                        |   |    |                                                    |                                      |                                 | (92                      | )      |
| Exercise of  stock options                                    |   | 672,057           |   |       |                                                            | 729                                  |   |                                        |   |    |                                                    |                                      |                                 | 729                      |   |
| Tax benefit from  exercises of stock options                  |   |              |   |       |                                                            | 609                                  |   |                                        |   |    |                                                    |                                      |                                 | 609                      |   |
|                                                          |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    |                                      |                                 |                     |   |
| Balances,  December 31, 2001                                  |   | 38,272,050        |   | 38         |                                                            | 65,484                               |   | (15                                         | )      | 8,366   |                                                    | —                                    |                                 | 73,873                   |   |
| Net loss                                                      |   |              |   |       |                                                            |                                 |   |                                        |   | (1,306  | )                                                       |                                      |                                 | (1,306                   | )      |
| Compensation  related to stock options vesting                |   |              |   |       |                                                            | 48                                   |   | 15                                          |   |    |                                                    |                                      |                                 | 63                       |   |
| Issuance of  common shares under employee stock purchase plan |   | 94,833            |   |       |                                                            | 222                                  |   |                                        |   |    |                                                    |                                      |                                 | 222                      |   |
| Exercise of  stock options                                    |   | 358,917           |   |  1    |                                                            | 549                                  |   |                                        |   |    |                                                    |                                      |                                 | 550                      |   |
| Tax benefit from  exercises of stock options                  |   |              |   |       |                                                            | 413                                  |   |                                        |   |    |                                                    |                                      |                                 | 413                      |   |
|                                                          |   |              |   |       |                                                            |                                 |   |                                        |   |    |                                                    |                                      |                                 |                     |   |
| Balances,  December 31, 2002                                  |   | 38,725,800        |   | $          |            39 |                                 | $      |    66,716                         |   | $       |          — |                                      | $                                    |     7,060 |   | $ |          — |   | $ |   73,815 |   |
|                                                               |        |                   |        |            |                                                                 |                                      |        |                                             |        |         |                                                         |                                           |                                      |                          |        |  |  |  |  |  |  |  |  |

 

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-5

----

 

**SimpleTech, Inc.**

**Consolidated Statements of Cash Flows**

**(in thousands)**

 

 

 
|                                                                                                 |   | **Year Ended  December 31,** |   |
|------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                                 |   | **2002**                     |   | **2001** |   | **2000** |   |
| Cash flows from  operating activities:                                                               |   |                         |   |   |   |   |   |
| Net (loss)  income                                                                                   |   | $                            | (1,306 | ) | $ | 2,340 |   | $ | 25,360 |   |
| Adjustments to  reconcile net (loss) income to net cash (used in) provided by operating  activities: |   |                         |   |   |   |   |   |
| Depreciation and  amortization                                                                       |   | 3,602                        |   | 3,152 |   | 3,406 |   |
| Loss on sale of  furniture, fixtures and equipment                                                   |   | 122                          |   | 50 |   | 42 |   |
| Accounts  receivable provisions                                                                      |   | 1,463                        |   | 2,003 |   | 1,253 |   |
| Inventory excess  and obsolescence expense                                                           |   | 304                          |   | 759 |   | 2,940 |   |
| Deferred income  taxes                                                                               |   | (1,033                       | )      | 1,016 |   | (1,571 | ) |
| Compensation  related to stock options vesting                                                       |   | 63                           |   | 47 |   | 79 |   |
| Tax benefit from  exercises of stock options                                                         |   | 413                          |   | 609 |   | 232 |   |
| In-process  research and development                                                                 |   | 1,360                        |   | — |   | — |   |
| Other                                                                                                |   | —                       |   | — |   | 97 |   |
| Change in  operating assets and liabilities:                                                         |   |                         |   |   |   |   |   |
| Accounts  receivable                                                                                 |   | (7,880                       | )      | 13,498 |   | (5,651 | ) |
| Inventory                                                                                            |   | (4,602                       | )      | 20,450 |   | (15,715 | ) |
| Other assets                                                                                         |   | 555                          |   | (3,405 | ) | (524 | ) |
| Accounts payable                                                                                     |   | 6,061                        |   | (15,630 | ) | 5,917 |   |
| Accrued and  other liabilities                                                                       |   | 661                          |   | (728 | ) | 2,215 |   |
|                                                                                                 |   |                         |   |   |   |   |   |
| Net cash (used  in) provided by operating activities                                                 |   | (217                         | )      | 24,161 |   | 18,080 |   |
|                                                                                                 |   |                         |   |   |   |   |   |
| Cash flows from  investing activities:                                                               |   |                         |   |   |   |   |   |
| Purchase of  marketable securities                                                                   |   | (9,980                       | )      | — |   | — |   |
| Purchase of  furniture, fixtures and equipment                                                       |   | (5,383                       | )      | (5,796 | ) | (2,635 | ) |
| Proceeds from  sale of furniture, fixtures and equipment                                             |   | 717                          |   | 393 |   | 229 |   |
| Acquisition of  business                                                                             |   | (2,295                       | )      | — |   | — |   |
|                                                                                                 |   |                         |   |   |   |   |   |
| Net cash used in  investing activities                                                               |   | (16,941                      | )      | (5,403 | ) | (2,406 | ) |
|                                                                                                 |   |                         |   |   |   |   |   |
|                                                                                                 |   |                         |   |   |   |   |   |
| Cash flows from  financing activities:                                                               |   |                         |   |   |   |   |   |
| Repayments of  line of credit, net                                                                   |   | —                       |   | — |   | (12,479 | ) |
| Repayments of  borrowings from banks                                                                 |   | (1, 012                      | )      | (832 | ) | (697 | ) |
| Payments on  capital lease obligations                                                               |   | (441                         | )      | (806 | ) | (935 | ) |
| Repayment of  loans to related parties, net                                                          |   | —                       |   | — |   | 40 |   |
| Proceeds from  exercise of stock options                                                             |   | 550                          |   | 729 |   | 672 |   |
| Stock buyback                                                                                        |   | —                       |   | (92 | ) | — |   |
| Distributions to  shareholders                                                                       |   | —                       |   | — |   | (35,039 | ) |
| Proceeds from  issuance of common stock                                                              |   | 222                          |   | 327 |   | 65,104 |   |
| Cost of equity  issuance                                                                             |   | —                       |   | — |   | (2,371 | ) |
|                                                                                                 |   |                         |   |   |   |   |   |
| Net cash (used  in) provided by financing activities                                                 |   | (681                         | )      | (674 | ) | 14,295 |   |
|                                                                                                 |   |                         |   |   |   |   |   |
| Net (decrease)  increase in cash                                                                     |   | (17,839                      | )      | 18,084 |   | 29,969 |   |
| Cash and cash  equivalents at beginning of period                                                    |   | 51,831                       |   | 33,747 |   | 3,778 |   |
|                                                                                                 |   |                         |   |   |   |   |   |
| Cash and cash  equivalents at end of period                                                          |   | $                            | 33,992 |   | $ | 51,831 |   | $ | 33,747 |   |

 

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-6

----

**SimpleTech, Inc.**

**Consolidated Statements of CashFlows, Continued**

**(in thousands)**

 
|                                               |   | **Year Ended  December 31,** |   |
|----------------------------------------------------|--------|------------------------------|--------|
|                                               |   | **2002**                     |   | **2001** |   | **2000** |   |
| Supplemental  disclosure of cash flow information: |   |                         |   |   |   |   |   |
| Cash paid during  the year:                        |   |                         |   |   |   |   |   |
| Income taxes                                       |   | $                            | 10     |   | $ | 4,025 |   | $ | 3,927 |   |
| Interest                                           |   | $                            | 78     |   | $ | 197 |   | $ | 1,567 |   |

 

 

The accompanying notesare an integral part of these consolidated financial statements.

 

F-7

----

 

**SimpleTech, Inc.Notes to Consolidated Financial Statements**

**1.             CompanyOrganization:**

    SimpleTechnology, Inc., incorporated in March 1990 and renamed SimpleTech, Inc. inMay 2001, designs, manufactures and markets a comprehensive line of memory andstorage products, as well as connectivity products that connect memory cardsand hard drive upgrade kits to PCs. The Company’s memory and storage productsare based on dynamic random access memory, or DRAM, static random accessmemory, or SRAM, and Flash memory technologies. These products are used inconsumer electronics, high-performance computing, defense and aerospace,networking and communications and industrial applications.  The Company offers its products through itsIndustrial and Commercial Divisions. Commercial Division channels include value added resellers, directmarketers, commercial and industrial distributors and mass marketretailers.  The Industrial Divisionsells primarily custom memory products for newly manufactured systems, withmost sales based on a coordinated effort between the Company’s design team andthe engineers of the Industrial Division customers.

**2.****                                     ****Summary of Significant Accounting Policies:**

*Basis of Consolidation:*

The accompanyingconsolidated financial statements include the accounts of SimpleTech, Inc.and its subsidiaries in California, Canada and Scotland (collectively, the“Company”). All significant intercompany accounts and transactions have beeneliminated in consolidation.

*Cash and Cash Equivalents:*

 Cash and cashequivalents consist primarily of cash in banks and money market funds. Allhighly liquid investments with a maturity date of three months or less whenacquired are considered to be cash equivalents. Cash and cash equivalents arecarried at cost, which approximates market.

*MarketableSecurities:*

                Marketable securities consistprimarily of $100,000 certificates of deposit with an original maturity of oneyear at 100 different financial institutions. These securities are classified as held-to-maturity because the Companyhas the intent and ability to hold the securities to maturity.  The securities are stated at cost and thegross unrealized gains and losses on held-to-maturity securities havehistorically not been material.

*Accounts Receivable:*

 

Accounts receivable consist of trade receivablesrecorded upon recognition of revenue for product sales, reduced by reserves forthe estimated amount deemed uncollectible due to bad debt, price protectionsand sales returns.  The amount chargedto operations for amounts deemed uncollectible as a result of bad debt arebased on the sum of (i) the actual amounts incurred during the year and (ii)the Company’s estimate of the amount needed on those ending accounts receivablebalances, relating to the identification of specific accounts.  Amounts charged to operations for amountspursuant to price protection and sales returns are based on the sum of (i) theactual amounts incurred during the year and (ii) the Company’s estimate of theamounts required, but not yet incurred, relating to the identification ofspecific accounts for price

 

F-8

----

 

protection and current and historical information for salesreturns.  For the years ended December31, 2002, 2001, and 2000, amounts charged to operations for uncollectibleaccounts for bad debt, price protection and sales returns were approximately$1,463,000, $2,003,000, and $1,253,000, respectively.

 

*Inventory:*

Inventory is stated atthe lower of cost or market, with cost being determined on the first-in,first-out (“FIFO”) method of accounting.

*Furniture, Fixtures and Equipment:*

Furniture, fixtures andequipment are stated at cost and depreciated using the straight-line method.The Company’s estimated useful lives of the assets, other than leaseholdimprovements, range from four to five years for equipment and seven years forfurniture and fixtures. Leasehold improvements and assets under capital leasesare amortized using the straight-line method over the shorter of the lease termor the estimated useful life of the assets.

Expenditures for majorrenewals and betterments are capitalized, while minor replacements, maintenanceand repairs, which do not extend the asset lives, are charged to operations asincurred. Upon sale or disposition, the cost and related accumulateddepreciation are removed from the accounts and any gain or loss is included inoperations.

The Company continuallymonitors events and changes in circumstances that could indicate that thecarrying balances of its furniture, fixtures and equipment may not berecoverable in accordance with the provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 144, “Disposal of Long-Lived Assets.”When such events or changes in circumstances are present, the Company assessesthe recoverability of long-lived assets by determining whether the carryingvalue of such assets will be recovered through undiscounted expected futurecash flows. If the total of the future cash flows is less than the carryingamount of those assets, the Company recognizes an impairment loss based on theexcess of the carrying amount over the fair value of the assets.

*Goodwill:*

 

Goodwill, which represents the excess of the purchaseprice over the fair value of net assets acquired, is not amortized inaccordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”  SFAS No. 142 requires the Company to assessthe goodwill for impairment on an annual basis and when there is reason tosuspect that the value has been diminished or impaired with any correspondingwrite-downs recognized as necessary.

 

*Long-Term Debt:*

The fair values of theCompany’s long-term debt have been estimated based on current rates offered tothe Company for debt of the same remaining maturities. The carrying amounts ofthe Company’s loans approximate their fair values.

*Revenue Recognition:*

Product sales and relatedcost of sales are recognized upon the shipment of product to customers providedthe Company has received a purchase order, the price is fixed or

F-9

----

 

determinable,collectibility of the resulting receivable is reasonably assured, returns arereasonably estimable and there are no remaining obligations. The terms ofsubstantially all product sales are FOB shipping point. A substantial portionof the Company’s sales through its Commercial Division includes limited rightsto return unsold inventory. In addition, some customers have limited priceprotection rights for inventories of the Company’s products held by them. Ifthe Company reduces the list price of their products, these customers may be entitledto receive credits from the Company. The Company provides for estimated futurereturns of inventory, limited price protection arrangements and the estimatedcosts of warranty at the time of sale based on historical experience. Actualresults have been within management’s expectations.

*Shipping and Handling Costs:*

Shipping and handlingcosts incurred in a sales transaction to ship products to a customer areincluded in sales and marketing. For the years ended December 31, 2002,2001 and 2000, shipping and handling costs were approximately $2,200,000,$2,400,000 and $2,100,000, respectively.

*Advertising Costs:*

Advertising costs, whichrelate primarily to various print media expenditures, are expensed as incurred.For the years ended December 31, 2002, 2001 and 2000, advertising costswere approximately $2,469,000, $2,914,000 and $3,599,000, respectively.

*Research and Development:*

Research and developmentcosts, which primarily relate to payroll-related costs, consulting fees andrent expense for office space, are expensed as incurred.

*Income Taxes:*

Deferred income taxes arerecognized for the tax consequences in future years of differences between thetax basis of assets and liabilities and their financial reporting amounts ateach year-end based on enacted tax laws and statutory rates applicable to theperiods in which the differences are expected to affect taxable income.Valuation allowances are established, when necessary, to reduce deferred incometax assets to the amount expected to be realized. The provision for incometaxes represents the tax payable for the year and the change during the year indeferred income tax assets and liabilities.

*Stock-Based Compensation:*

SFAS No. 123,“Accounting for Stock-Based Compensation,” encourages, but does not require,companies to record compensation cost for stock-based employee compensationplans at fair value. The Company has elected to continue to account forstock-based compensation using the intrinsic value method prescribed inAccounting Principles Board Opinion (“APB”) No. 25, “Accounting for StockIssued to Employees,” and related interpretations. Accordingly, compensationcost for stock options is measured as the excess, if any, of the estimatedmarket price of the Company’s underlying stock at the date of grant over theexercise price of the option, amortized over the vesting period. The Companyhas adopted the disclosure-only provisions of SFAS No. 123.

F-10

----

 

*Per Share Information:*

Basic earnings per shareis computed by dividing net income by the weighted average number of sharesoutstanding. In computing diluted earnings per share, the weighted averagenumber of shares outstanding is adjusted to additionally reflect the effect ofpotentially dilutive securities.

For the years endedDecember 31, 2001 and 2000, potentially dilutive securities consistedsolely of options and resulted in potential common shares of 1,308,818 and2,200,460, respectively.  For the yearended December 31, 2002, no potential common shares were included in thediluted per share amount as the effect would have been anti-dilutive.

In September 2000,the Company effected a 5.07 for 1.0 stock split of all outstanding common stockand common stock options. All share and per share amounts have been adjusted togive retroactive effect to the stock split for all periods presented.

*Pro Forma Net Income (unaudited):*

For the year endedDecember 31, 2000, pro forma net income was computed using an effective taxrate of 38% to reflect the estimated income tax expense of the Company as if ithad been subject to C corporation federal and state income taxes for theperiod, instead of S corporation income taxes.

*Segment Reporting:*

The Company reportsinformation about operating segments based on the manner in which managementorganizes and evaluates the internal organization to make operating decisionsand assess performance.

*Risks and Uncertainties:*

Financial instruments,which potentially subject the Company to a concentration of credit risk,principally consist of cash and cash equivalents and accounts receivable. As ofDecember 31, 2002 and 2001, approximately 15% and 37%, respectively, ofaccounts receivable were concentrated with one and three customers,respectively. For the years ended December 31, 2002, 2001 and 2000, salesto CDW Computer Centers comprised 21%, 20% and 17%, respectively, of theCompany’s revenues. For the year ended December 31, 2001, sales to Unisysaccounted for 11% of the Company’s revenues. For the year ended December 31,2000, sales to Cisco Systems accounted for 15% of the Company’s revenues. Noother single customer accounted for more than 10% of accounts receivable orrevenues at December 31, 2002 and 2001, or for each of the three years inthe period ended December 31, 2002. The Company generally does not requirecollateral on accounts receivable as the majority of the Company’s customersare large,

F-11

----

 

well-establishedcompanies. Historically, bad debt provisions have been consistent withmanagement’s expectations.

At December 31, 2002and 2001, the Company had amounts on deposit with financial institutions thatwere in excess of the federally insured limit of $100,000.

The manufacturingoperations of the Company are concentrated in a facility located in Santa Ana,California. As a result of this geographic concentration, a disruption in themanufacturing process resulting from a natural disaster or other unforeseenevent could have a material adverse effect on the Company’s financial positionand results of operations.

Certain of the Company’sproducts utilize components that are purchased from a small number of sourceswith whom the Company has no long-term contracts. An inability to obtain suchcomponents in the amounts needed on a timely basis or at commerciallyreasonable prices could result in delays in product introductions,interruptions in product shipments or increases in product costs, which couldhave a material adverse effect on the Company’s financial position and resultsof operations.

*Management Estimates:*

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

* *

*Reclassifications:*

 

Certain amounts in the prior year consolidatedfinancial statements have been reclassified to conform to the current yearpresentation.

 

**3.             RelatedParty Transactions:**

The Company occupies twoleased facilities of approximately 24,500 and 48,600 square feet in Santa Ana,California, in which its executive offices, manufacturing, engineering,research and development and testing operations are located. The Company leasesboth facilities from MDC Land LLC (“MDC”), a limited liability company owned byManouch Moshayedi, Mike Moshayedi and Mark Moshayedi, each of whom is anexecutive officer, director and major shareholder of SimpleTech. MDC has nooperations other than leasing transactions with the Company. An operating leasewith MDC for the 24,500 square foot facility was signed in April 2000. Thelease term was decreased from 26 years to 5 years, expiring inMarch 2005, and the monthly base rent was changed from approximately$19,000 to approximately $17,000. An operating lease with MDC for the 48,600square foot facility was signed in June 2000. The 48,600 square foot facilitylease expires in May 2005, and the base rent is approximately $33,000 permonth. Building rent expense for these two facilities for the years ended December 31,2002, 2001 and 2000, amounted to $603,000, $603,000 and $446,000,respectively.  At December 31,2002, 2001 and 2000, there was no outstanding facility rent owed to MDC.

F-12

----

 

In 1996 and 1997, theCompany entered into equipment leases with MDC Land Corporation, a corporationowned by Manouch Moshayedi, Mike Moshayedi and Mark Moshayedi. In December2001, the Company exercised its purchase option under the capital leases bypurchasing all of the related equipment for approximately $21,000.  Equipment lease payments amounted to $0 in2002, $385,000 in 2001 and $574,000 in 2000. At December 31, 2002, 2001and 2000, there was no outstanding equipment lease payments owed to MDC.

**4.             Inventory:**

Inventory consistsof the following:

|                  |   | **December  31,** |       |
|-----------------------|--------|-------------------|------------|
|                  |   | **2002**          |       | **2001** |   |
| Raw materials         |   | $                 | 6,325,000  |   | $ | 5,421,000 |   |
| Work-in-progress      |   | 364,000           |       | 927,000 |   |
| Finished goods        |   | 8,256,000         |       | 4,785,000 |   |
|                  |   | 14,945,000        |       | 11,133,000 |   |
| Valuation  allowances |   | (804,000          | )          | (1,290,000 | ) |
|                  |   | $                 | 14,141,000 |   | $ | 9,843,000 |   |

 

**5.             Furniture,Fixtures and Equipment:**

Furniture,fixtures and equipment consist of the following:

|                                       |   | **December  31,** |       |
|--------------------------------------------|--------|-------------------|------------|
|                                       |   | **2002**          |       | **2001** |   |
| Furniture and  fixtures                    |   | $                 | 325,000    |   | $ | 299,000 |   |
| Equipment                                  |   | 24,643,000        |       | 21,557,000 |   |
|                                       |   | 24,968,000        |       | 21,856,000 |   |
| Accumulated  depreciation and amortization |   | (14,799,000       | )          | (12,729,000 | ) |
|                                       |   | $                 | 10,169,000 |   | $ | 9,127,000 |   |

 

For the years endedDecember 31, 2002, 2001 and 2000, the Company recorded depreciation andamortization expense of approximately $3,602,000, $3,152,000 and $3,406,000,respectively.

At December 31, 2002and 2001, furniture, fixtures and equipment included approximately $1,978,000of assets under capital leases with associated accumulated amortization ofapproximately $1,881,000 and $1,486,000, respectively.

**6.             Acquisition of Business**

 

In January 2002, the Company acquired substantiallyall the assets, including intellectual property, of Irvine Networks, LLC for$2.3 million in cash.  The Companyretained the engineering staff of Irvine Networks, LLC, which was subsequentlyrenamed the Xiran Division.  Inconnection with the acquisition, approximately $1.4 million of the purchaseprice was allocated to in-process research and development (“IPR&D”).  The amount attributed to IPR&D wasexpensed at the date of acquisition as the IPR&D projects had not reachedtechnological feasibility nor had any alternative use.  In addition, approximately $835,000 and$100,000 of the purchase price was allocated to goodwill and fixed assets,respectively.

 

F-13

----

 

The acquisition added significant expertise in contentdelivery and storage system design.  TheXiran Division is developing a universal solution to accelerate the delivery ofcontent between network and storage. The Xiran Division received its ASIC fromits fabrication partner, IBM, in December 2002 and is currently integrating theASIC into board and system level products. Revenues from the Xiran Division are expected during 2004.  While the Xiran Division received its ASIC,the key component in its universal solution, in December 2002 and expectsrevenue in 2004, there can be no assurance that the efforts focused thus farwill result in future profitability of the Xiran Division.  In addition, the success of the product andthe Xiran Division will depend in significant part upon the ability to develop,introduce and sell the product on a timely and cost-effective basis, and torespond to changing customer requirements.

 

**7.             Line of Credit:**

Effective August 3,1999, the Company entered into a line of credit agreement, as amended. The lineof credit balance was reduced to zero in October 2000.  There were no borrowings on this line ofcredit from the pay down in October 2000 to the expiration of the line in August2002.  The line of credit was notrenewed after expiration.

**8.             Long-TermDebt:**

Long-term debt consistsof the following:

|                                                                                                                                                                                                                |   | **December 31,** |      |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|-----------|
|                                                                                                                                                                                                                |   | **2001**              |      |
| Equipment notes  payable, principal and interest payable in monthly installments of $70,671,  maturing at various dates through December 2004, collateralized by equipment,  interest ranging between 8.4% and 9.1% |   | $                     | 1,012,000 |   |
| Less current  portion                                                                                                                                                                                               |   | (741,000              | )         |
|                                                                                                                                                                                                                |   | $                     | 271,000   |   |

                The equipment notes payable werepaid off during 2002.

**9.             IncomeTaxes:**

From formation in March1990 to September 26, 2000, the Company had elected for U.S. federalincome tax purposes to be treated as an S corporation underSubchapter S of the Internal Revenue Code. Under this election, theCompany’s shareholders, rather than the Company, were subject to federal incometaxes on their respective share of the Company’s taxable income. The Companyhad also elected similar treatment for California franchise tax purposes, whichalso requires a state income tax at the Company-level of 1.5%. On September 26,2000, the Company terminated its Subchapter S election. Subsequent to thetermination, the Company has paid federal and state corporate-level incometaxes. In 2000, pro forma net income has been computed as if the Company hadbeen fully subject to federal and state income taxes as a C corporationfor all periods presented.

F-14

----

 

The (benefit) provisionfor income taxes consists of the following: 

|                                        |   | **December  31,** |       |
|---------------------------------------------|--------|-------------------|------------|
|                                        |   | **2002**          |       | **2001** |   | **2000** |   |
| Current                                     |   |              |       |   |   |   |   |
| Federal                                     |   | $                 | (2,793,000 | ) | $ | 527,000 |   | $ | 3,544,000 |   |
| State                                       |   | 189,000           |       | (6,000 | ) | 496,000 |   |
| Foreign                                     |   | —            |       | — |   | 369,000 |   |
|                                        |   | (2,604,000        | )          | 521,000 |   | 4,409,000 |   |
| Deferred                                    |   |              |       |   |   |   |   |
| Federal                                     |   | 1,058,000         |       | 948,000 |   | (1,752,000 | ) |
| State                                       |   | (2,091,000        | )          | 68,000 |   | 181,000 |   |
|                                        |   | (1,033,000        | )          | 1,016,000 |   | (1,571,000 | ) |
| Total (benefit)  provision for income taxes |   | $                 | (3,637,000 | ) | $ | 1,537,000 |   | $ | 2,838,000 |   |

 

 

For 2002, the differencebetween the effective rate and the expected U.S. federal tax rate is due to anincrease in deferred tax assets as a result of prior year and current yearresearch and development tax credits recorded in 2002.  For 2001, the difference between theeffective rate and the expected U.S. federal tax rate is due primarily to statetaxes and other permanent differences between tax and financial reportingincome.  For 2000, the differencebetween the effective tax rate and the expected U.S. federal tax rate is dueprimarily to an increase in deferred tax assets as a result of terminating theCompany’s S corporation status and income taxed at the shareholder level.

The (benefit) provisionfor income taxes differs from the amount that would result from applying thefederal statutory rate as follows:
|                                                                              |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Statutory  regular federal income tax                                             |   | (35.0    | )%     | 35.0     | %      | 35.0     | %      |
| State taxes  (including state tax credits in 2002), net of federal benefit        |   | (25.0    | )      | 1.1      |   | 2.3      |   |
| Income taxed at  shareholder level prior to termination of S-Corporation election |   | —   |   | —   |   | (21.9    | )      |
| Increase in  deferred tax benefits from termination of S-corporation election     |   | —   |   | —   |   | (5.9     | )      |
| Tax credits                                                                       |   | (14.3    | )      |     |   |     |   |
| Other                                                                             |   | 1.0      |   | 3.5      |   | 0.6      |   |
|                                                                              |   | (73.3    | )%     | 39.6     | %      | 10.1     | %      |

 

F-15

----

 

The components ofdeferred tax assets and (liabilities) are as follows: 
|                                           |   | **December  31,** |      |
|------------------------------------------------|--------|-------------------|-----------|
|                                           |   | **2002**          |      | **2001** |   |
| Current deferred  tax assets (liabilities):    |   |              |      |   |   |
| Financial  statement allowances                |   | $                 | 645,000   |   | $ | 798,000 |   |
| Accrued expenses                               |   | 191,000           |      | 137,000 |   |
| State taxes                                    |   | (880,000          | )         | (149,000 | ) |
| Other                                          |   | 72,000            |      | — |   |
| Total current                                  |   | 28,000            |      | 786,000 |   |
| Noncurrent  deferred tax assets (liabilities): |   |              |      |   |   |
| Depreciation and  amortization                 |   | (189,000          | )         | 430,000 |   |
| Operating loss  carryforwards                  |   | 1,214,000         |      | 715,000 |   |
| Credit  carryforwards                          |   | 2,327,000         |      | 147,000 |   |
| Other                                          |   | 9,000             |      | 10,000 |   |
|                                           |   | 3,361,000         |      | 1,302,000 |   |
| Valuation  allowance                           |   | (983,000          | )         | (715,000 | ) |
| Total noncurrent                               |   | 2,378,000         |      | 587,000 |   |
|                                           |   | $                 | 2,406,000 |   | $ | 1,373,000 |   |

 

At December 31, 2002, theCompany had state net operating loss carryforwards of approximately $2,614,000,which begin to expire in 2013.  OnSeptember 11, 2002, the Governor of California signed into law new taxlegislation that suspends the use of net operating loss carryforwards into taxyears beginning on or after January 1, 2002 and 2003.  Should the Company have taxable income for the year endingDecember 31, 2003, it may not look to California net operating losses generatedin prior years to offset taxable income. This suspension will not apply to tax years beginning after 2003.

At December 31, 2002, theCompany has federal research and development credit carryforwards ofapproximately $419,000 which begin to expire in 2022.  In addition, the Company had the following state credits:  research and development creditcarryforwards of approximately $853,000, which carryforward indefinitely;enterprise zone credit carryforwards of approximately $941,000, whichcarryforward indefinitely; and manufacturer’s investment credit carryforwardsof approximately $430,000, which begin to expire in 2009.

For income tax purposes,the Company’s foreign subsidiary, Simple Technology Limited, is treated as aseparate entity and, therefore, is not subject to U.S. taxation.

The Company’s foreignsubsidiary, SimpleTech Europe, is treated as a branch partnership for incometax purposes and, therefore, is subject to U.S. taxation. At December 31,2002 and 2001, this entity had U.K. net operating loss carryforwards of$3,200,000 and $2,300,000, respectively. The losses carry over indefinitely,unless certain changes in business operations, as defined, occur during thecarryover period. The Company has established a valuation allowance againstthese deferred tax assets since it cannot be established that this foreignsubsidiary’s U.K. net operating loss carryforwards will be fully utilized.

**10.          Commitmentsand Contingencies:**

**DPAC Technologies, Inc.—PatentInfringement**

OnSeptember 23, 1998, the Company filed a lawsuit against DPAC Technologies,Inc., formerly Dense-Pac Microsystems, Inc. (“DPAC”), in the United StatesDistrict Court for the Central District of California for infringement of theCompany’s IC Tower stacking patent, U.S. Patent No. 5,514,907. On March 29,2001, the court entered final judgment finding DPAC did not infringe theCompany’s patent and that the Company did not infringe DPAC’s patent. Theappeals court affirmed the final judgment on March 7, 2002.  On September 3, 2002, the Company filed apetition for certiori with the U.S. Supreme Court.  On October 7, 2002, the petition to the Supreme Court was grantedand the matter was remanded to the Circuit Court of Appeals.  DPAC filed a motion for summary affirmancewith the Court of Appeals.  On February26, 2003, the Court of Appeals denied DPAC's motion and remanded the matter fortrial to the United States District Court for the Central District ofCalifornia.  No trial date has been setby the District Court.

F-16

----

 

OnOctober 17, 2000, the U.S. Patent and Trademark Office granted the Companya reissue patent on the Company’s IC Tower stacking patent. The reissue patentis U.S. Patent No. Re. 36,916.

On February 21,2001, the Company filed a new lawsuit against DPAC in the United StatesDistrict Court for the Central District of California for infringement of thereissue patent. The Company is seeking damages and an injunction againstfurther infringement. On March 13, 2001, DPAC filed an answer to theCompany’s complaint denying infringement and asserted a defense of patentinvalidity. In addition, DPAC counterclaimed alleging the Companymisappropriated unspecified DPAC technology and allegedly used that unspecifiedtechnology in the Company’s IC Tower products. On September 9, 2002, the Company and DPAC agreed to dismiss thislawsuit without prejudice.  Although adismissal without prejudice allows for the potential refiling of the lawsuit inthe future, the Company has not pursued a refiling.

**Lemelson Medical, Education & ResearchFoundation, LLP – Patent Infringement**

 The Company received notice on November 26,2001 that the Lemelson Medical, Education & Research Foundation, LLP(“Lemelson Foundation”) filed a complaint on November 13, 2001 against theCompany and other defendants.  The complaint was filed in the DistrictCourt of Arizona and alleges that the Company’s manufacturing processesinfringe several patents that the Lemelson Foundation allegedly owns.  Thecomplaint also states that these allegedly infringed patents relate to machinevision technology and bar coding technology.  On March 7, 2002, the Companywas served with the Lemelson Foundation complaint.  Thereafter, the casewas stayed pending the outcome of related cases against other parties involvingthe same patents.  Because of thepreliminary stage of this case, an estimate of potential damages, if any, wouldbe premature and speculative, and the Company has not made any such estimate atthis time.

**LexarMedia, Inc. – Unfair Trade Practice**

 

On October1, 2002, the Company filed a lawsuit against Lexar Media, Inc. in the SuperiorCourt of Orange County, California for unfair trade practices and is seekingunspecified damages, including punitive and trebled damages.  The Company’s complaint sets forth variouscauses of actions against Lexar Media, including trade libel, libel per se,interference with business opportunities, violation of the California UnfairCompetition Act, and violation of the California Unfair Trade PracticesAct.  On October 30, 2002, Lexar Mediafiled a notice of removal, which removed the matter from the Orange CountySuperior Court to the United States District Court for the Central District ofCalifornia.  This lawsuit is in theearly stage of discovery.

**Interactive FlightTechnologies, Inc.**

On June 8, 1998,Interactive Flight Technologies, Inc. filed a lawsuit againstAvnet, Inc. in the Superior Court of Maricopa County, Arizona seeking anaward for direct and consequential damages arising from the Company’s sale ofallegedly defective hard disk drives to Avnet for inclusion in an in-flightentertainment system manufactured by Interactive Flight. The Company purchasedthe hard disk drives from Integral Peripherals, Inc., the manufacturer,through its distributor, Bell Microsystems, Inc. Integral has sincedeclared bankruptcy and was not a party to this lawsuit. On June 8, 1999,Avnet filed a cross claim against the Company seeking indemnification.

F-17

----

 

    Allparties entered into a settlement agreement that settled all claims betweenthem. Under the terms of the settlement, the Company made a total payment of$1,810,000 to Interactive Flight and the other parties in 2001. OnJanuary 23, 2001, the court entered its Order of Dismissal dismissing allremaining claims between the parties.

**Other Legal Proceedings**

The Company is currentlynot a party to any other material legal proceedings. However, the Company isinvolved in other suits and claims in the ordinary course of business, and theCompany may from time to time become a party to other legal proceedings arisingin the ordinary course of business.

As is common in theindustry, the Company currently has in effect a number of agreements in whichthe Company has agreed to defend, indemnify and hold harmless certain of itssuppliers and customers from damages and costs which may arise from the infringementby the Company’s products of third-party patents, trademarks or otherproprietary rights. The scope of such indemnity varies, but may, in someinstances, include indemnification for damages and expenses, includingattorneys’ fees. The Company’s insurance does not cover intellectual propertyinfringement.

**Lease Commitments**

As discussed inNote 3, the Company leases its corporate office facilities from affiliatesof Manouch Moshayedi, Mike Moshayedi and Mark Moshayedi, each of whom is anexecutive officer, director and major shareholder of the Company. In addition,the Company leases manufacturing equipment from an unaffiliated third partyunder capital leases with initial noncancelable lease terms ranging from 4 to5 years with an interest rate of 8.11% per annum. The Company also leasesa 12,000 square foot office space for research and development and varioussmall facilities for sales offices and storage from unaffiliated third partiesunder operating leases with initial noncancelable lease terms ranging from 2 to4 years.  Future scheduled minimumannual lease payments for the years ending December 31 are as follows: 
|                                                                        |   | **Capital  Leases** |    | **Operating  Leases (Related Party)** |      | **Operating  Leases (Third Party)** |   |
|-----------------------------------------------------------------------------|--------|---------------------|---------|---------------------------------------|-----------|-------------------------------------|--------|
| 2003                                                                        |   | $                   | 115,000 |                                  | $         | 603,000                             |   | $ | 301,000 |   |
| 2004                                                                        |   | —              |    | 603,000                               |      | 222,000                             |   |
| 2005                                                                        |   | —              |    | 217,000                               |      | 111,000                             |   |
| Net minimum  lease payments                                                 |   | 115,000             |    | $                                     | 1,423,000 |                                | $      | 634,000 |   |
| Less, amounts  representing interest                                        |   | (2,000              | )       |                                  |      |                                |   |
| Present value of  future minimum capital lease obligations, current portion |   | $                   | 113,000 |                                  |      |                                |   |   |

 

F-18

----

 

Rent expense forthe years ended December 31, 2002, 2001 and 2000 was approximately$1,030,000, $783,000 and $772,000, respectively, inclusive of related partybalances.

**Repurchase Agreements**

The Company iscontingently liable at December 31, 2002, to various financialinstitutions on repurchase agreements in connection with wholesale inventoryfinancing. In general, inventory would be repurchased by the Company uponcustomer default with a financing institution and then resold through normaldistribution channels. The amount of potential product returns is estimated andprovided for in the period of the sale for financial reporting purposes. As ofDecember 31, 2002, the Company has never been required to repurchaseinventory in connection with the customer default agreements noted above.However, there can be no assurance that the Company will not be required torepurchase inventory, upon customer default, in the future. Sales under suchagreements were approximately $876,000, $1,100,000 and $2,700,000 for the yearsended December 31, 2002, 2001 and 2000, respectively.

**401(k) Plan**

    TheCompany has a 401(k) profit sharing plan covering employees with at least sixmonths of service. Employees may make voluntary contributions of up to 20% oftheir annual pre-tax compensation to the plan, subject to the maximum limitallowed by the IRS guidelines. The Company makes matching contributions equalto one-half of each participating employee’s matchable contributions to theplan, which cannot exceed 10% of their salary. The Company’s matchingcontributions to the plan are subject to vesting at the rate of 20% per yearbeginning after the employee’s second year of employment. For the years ended December 31,2002, 2001 and 2000, the Company made matching contributions of approximately$492,000, $424,000 and $369,000, respectively.

**CompanyStock Buy Back**

In September 2001, theCompany’s Board of Directors authorized a stock repurchase program under whichthe Company could repurchase up to 1,800,000 shares of the Company’s commonstock over an 18-month period. The shares may be purchased from time to time,at prevailing market prices, through open market or unsolicited negotiatedtransactions, depending on market conditions and other considerations, untilMarch 31, 2003.  During fiscal 2001, theCompany repurchased 72,500 shares of its common stock for a total of $92,000under this program. During 2002, the Company did not repurchase any shares ofits common stock under this program. Shares of common stock repurchased have been returned to the status ofauthorized but unissued shares of common stock and may be issued by the Companyin the future.

**11.          StockOption Plan:**

The 2000 Stock IncentivePlan (the “Plan”) is intended to serve as the successor equity incentiveprogram to the 1996 Stock Option Plan (the “Predecessor Plan”). The Plan wasadopted by the Company’s board of directors and approved by its shareholders inJune 2000. In September 2000, the Plan became effective, and alloutstanding options under the Predecessor Plan were transferred into the Plan.No further option grants will be made under the Predecessor Plan. Thetransferred options will continue to be governed by their existing terms, unlessthe compensation committee of the Board of Directors elects to extend one ormore features of the Plan to those options.

The Plan provides for thedirect sale of shares and the grant of options to purchase shares of theCompany’s common stock to officers and other employees, non-employee boardmembers

F-19

----

 

and consultants.Under the Plan, eligible participants may be granted options to purchase sharesof common stock at an exercise price not less than 100% of the fair marketvalue of those shares on the grant date. The compensation committee of theBoard of Directors has the authority to determine the time or times at whichoptions become exercisable under the Plan. Options expire within a period of notmore than ten years from the date of grant.

On October 29, 2001, the compensation committee of theBoard of Directors authorized the Company to implement an option exchangeprogram pursuant to which the Company’s current employees, including executiveofficers, were given the opportunity to exchange their outstanding options topurchase shares of the Company’s common stock for new stock options for thesame number of shares to be granted to them at a later date.  At the conclusion of the option exchange programon December 20, 2001, the Company accepted for exchange and canceled options topurchase an aggregate of 2,309,500 shares of the Company’s common stock.  On June 24, 2002, the Company issuedreplacement options to purchase an aggregate of 2,202,500 shares of theCompany’s common stock at an exercise price of $5.75, which was the closingprice per share of the Company’s common stock on the grant date.  Options to purchase an aggregate of 107,000shares of the Company’s common stock were exchanged and canceled, but notreplaced, as a result of terminations of employees between the exchange dateand the replacement grant date.

 

At December 31,2002, the Plan provided for the issuance of up to 10,066,792 shares of commonstock, including 2,777,471 shares subject to options transferred from thePredecessor Plan. The number of shares of common stock reserved for issuanceunder the Plan will automatically increase on the first trading day in Januaryin each calendar year by an amount equal to 4% of the total number of shares ofcommon stock outstanding on the last trading day in December of the priorcalendar year, but in no event will exceed 2,500,000 shares.

   Asummary of the option activity under the Plan is as follows:
|                     |   | **Shares  Under Option** |   | **Weighted  Average Exercise Price** |   |
|--------------------------|--------|--------------------------|--------|--------------------------------------|--------|
| Balances at  12/31/99    |   | 3,385,061                |   | $                                    | 1.08   |   |
| Granted                  |   | 3,569,000                |   | $                                    | 10.97  |   |
| Exercised                |   | (607,641                 | )      | $                                    | 1.11   |   |
| Canceled                 |   | (77,949                  | )      | $                                    | 11.00  |   |
|                     |   |                     |   |                                 |   |
| Balances at  12/31/00    |   | 6,268,471                |   | $                                    | 6.58   |   |
| Granted                  |   | 1,583,550                |   | $                                    | 2.60   |   |
| Exercised                |   | (672,057                 | )      | $                                    | 1.08   |   |
| Canceled                 |   | (3,434,850               | )      | $                                    | 9.95   |   |
|                     |   |                     |   |                                 |   |
| Balances at  12/31/01    |   | 3,745,114                |   | $                                    | 2.78   |   |
| Granted                  |   | 4,678,900                |   | $                                    | 5.29   |   |
| Exercised                |   | (358,917                 | )      | $                                    | 1.53   |   |
| Canceled                 |   | (1,311,445               | )      | $                                    | 5.34   |   |
|                     |   |                     |   |                                 |   |
| Balances at  12/31/02    |   | 6,753,652                |   | $                                    | 4.05   |   |
|                     |   |                     |   |                                 |   |
| Exercisable at  12/31/00 |   | 2,658,820                |   | $                                    | 1.07   |   |
| Exercisable at  12/31/01 |   | 2,044,720                |   | $                                    | 1.80   |   |
| Exercisable at  12/31/02 |   | 1,980,862                |   | $                                    | 1.93   |   |

 

F-20

----

 

At December 31, 2002,1,674,526 options were available for grant under the Plan. 
| **Options  Outstanding**     |   | **Exercisable**       |   |
|------------------------------|--------|-----------------------|--------|
| **Range of Exercise Prices** |   | **Number of  Shares** |   | **Weighted  Average Exercise Price** |   | **Weighted  Average Remaining Life (Years)** |   | **Number of  Shares** |   | **Weighted  Average Exercise Price** |   |
| $1.06 to $1.18               |   | 1,606,337             |   | $ | 1.06 |   | 3.52 |   | 1,606,337 |   | $ | 1.06 |   |
| $1.50 to $2.51               |   | 444,640               |   | 1.80 |   | 9.13 |   | 52,520 |   | 1.64 |   |
| $2.74                        |   | 593,125               |   | 2.74 |   | 8.33 |   | 114,705 |   | 2.74 |   |
| $2.81 to $4.83               |   | 619,450               |   | 3.47 |   | 9.53 |   | 33,300 |   | 3.38 |   |
| $5.00 to $5.31               |   | 678,300               |   | 5.02 |   | 9.10 |   | — |   | — |   |
| $5.75 to $6.10               |   | 2,389,100             |   | 5.76 |   | 9.48 |   | — |   | — |   |
| $6.50 to $11.00              |   | 422,700               |   | 9.30 |   | 8.25 |   | 174,000 |   | 9.25 |   |
|                         |   | 6,753,652             |   |   |   |   |   | 1,980,862 |   |   |   |
|                              |        |                       |        |  |  |  |  |  |  |  |  |  |  |

 

With respect to optionsgranted to employees in 1999, there were 446,459 shares under options grantedin January 1999 with an estimated fair market value of $1.58 per share,65,910 granted in April 1999 and 6,591 granted in May 1999 with anestimated fair market value of $2.37 per share, all of which were granted at anexercise price of $1.18 per share. The difference between the exercise priceand the fair market value at the date of grant of $262,000 is accounted for asunearned compensation and is being amortized to expense over the relatedservice period. In 2002, the Company recorded additional compensation expenseof $48,000 as a result of accelerated vesting of stock options for a terminatedemployee. The Company recorded a total of approximately $63,000, $47,000 and$79,000 as compensation expense for the years ended December 31, 2002,2001 and 2000, respectively, related to options granted to employees.

Pursuant to SFASNo. 123, “Accounting for Stock-Based Compensation,” the Company haselected to continue the intrinsic value method of accounting for stock optionsgranted to employees and directors in accordance with APB Opinion No. 25and related interpretations in accounting for stock option plans. Accordingly,no compensation cost has been recognized for its Plan other than that describedabove. Had compensation cost been determined based on the fair value at thegrant dates for stock options under the Plan consistent with the methodpromulgated by SFAS No. 123, the Company’s net income for the years endedDecember 31, 2002, 2001 and 2000 would have resulted in the pro formaamounts below:
|                                                                 |   | **Year Ended  December 31,** |       |
|----------------------------------------------------------------------|--------|------------------------------|------------|
|                                                                 |   | **2002**                     |       | **2001** |   | **2000** |   |
|                                                                 |   |                         |       |   |   |   |   |
| (Loss) income  before income taxes, as reported                      |   | $                            | (4,943,000 | ) | $ | 3,877,000 |   | $ | 28,198,000 |   |
| Additional  compensation expense per SFAS No. 123                    |   | (3,614,000                   | )          | (3,992,000 | ) | (946,000 | ) |
| Pro forma (loss)  income before (benefit) provision for income taxes |   | (8,557,000                   | )          | (115,000 | ) | 27,252,000 |   |
| Pro forma  (benefit) provision for income taxes                      |   | (5,010,000                   | )          | (45,000 | ) | 10,524,000 |   |
| Pro forma net  (loss) income                                         |   | $                            | (3,547,000 | ) | $ | (70,000 | ) | $ | 16,728,000 |   |
| Net (loss)  income as reported                                       |   | $                            | (1,306,000 | ) | $ | 2,340,000 |   | $ | 17,315,000 |  (a) |
| Basic net (loss)  income per share:                                  |   |                         |       |   |   |   |   |
| Pro forma                                                            |   | $                            | (0.09      | ) | $ | — |   | $ | 0.52 |   |
| As reported                                                          |   | $                            | (0.03      | ) | $ | 0.06 |   | $ | 0.53 |  (a) |
| Diluted net  (loss) income per share:                                |   |                         |       |   |   |   |   |
| Pro forma                                                            |   | $                            | (0.09      | ) | $ | — |   | $ | 0.48 |   |
| As reported                                                          |   | $                            | (0.03      | ) | $ | 0.06 |   | $ | 0.50 |  (a) |
| Weighted average  shares outstanding:                                |   |                         |       |   |   |   |   |
| Basic                                                                |   | 38,515,825                   |       | 38,126,687 |   | 32,393,218 |   |
| Diluted                                                              |   | 38,515,825                   |       | 39,435,505 |   | 34,593,678 |   |

----

(a) Pro forma (Note 2).

 

 

F-21

----

 

The fair value of eachoption grant under the Predecessor Plan was estimated on the date of the grantusing the minimum value method as the Company was a nonpublic entity while thisplan was in effect. This value was the current stock price less the presentvalue of the exercise price for a stock that does not pay dividends. Theassumptions used for the period from January 1, 2000 through the date ofthe Company’s initial public offering on September 28, 2000 were asfollows: the risk-free interest rate ranged from 4.39% to 6.41%; generally theexercise price was equal to the fair market value of the underlying commonstock at the grant date after consideration of any related unearnedcompensation recorded in the consolidated financial statements; the expectedlife of the option is 5 years; the forfeiture rate is estimated at 8.0%;and the common stock is not expected to pay dividends.

The fair value of eachoption grant under the Plan and subsequent to the Company’s 2000 initial publicoffering was estimated on the date of the grant using the Black-Scholesoption-pricing model. The assumptions used for the period fromSeptember 28, 2000 through December 31, 2002, were as follows: therisk-free interest rate ranged from 2.67% to 5.92%; generally the exerciseprice was equal to the fair market value of the underlying common stock at thegrant date; the expected life of the option is 5 years; the forfeiturerate is estimated at 8.0%; expected volatility ranged from 63% to 65% and thecommon stock is not expected to pay dividends.

The weighted averagegrant date fair value per share of shares under option was $2.47, $1.47 and$5.32 for the years ended December 31, 2002, 2001 and 2000, respectively.

**12.          SegmentInformation:**

Historically, the Companyhas reported financial results for two reportable operating segments,Industrial and Commercial.  In January2002, the Company acquired Irvine Networks, which was subsequently renamed theXiran Division, and will report the Division’s operating results as a thirdoperating segment.

The accounting policiesfor each of the reportable operating segments are the same as those describedin Note 2 and reflect the information used by the Company’s management to

F-22

----

 

evaluate theperformance of its segments. For the Industrial and Commercial segments, theCompany tracks separately net sales and gross profit, but does not trackseparately operating expenses, interest or income taxes.  For the Xiran segment, which is not expectedto produce revenues until 2004, the Company currently tracks operating expensesonly.  The Company does not maintainseparate records to identify assets by operating segment.

Summarized financialinformation regarding the Company’s three reportable segments is shown in thefollowing table:

 
|                           |   | **Year Ended  December 31, 2002** |       |
|--------------------------------|--------|-----------------------------------|------------|
|                           |   | **Industrial**                    |       | **Commercial** |   | **Subtotal** |   | **Xiran** |   | **Consolidated** |   |
|                           |   |                              | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Net revenues                   |   | $                                 | 41,536,000 |   | $ | 134,995,000 |   | $ | 176,531,000 |   | $ | 0 |   | $ | 176,531,000 |   |
| Cost of revenues               |   | 29,016,000                        |       | 114,566,000 |   | 143,582,000 |   | 0 |   | 143,582,000 |   |
| Gross profit                   |   | $                                 | 12,520,000 |   | $ | 20,429,000 |   | 32,949,000 |   | 0 |   | 32,949,000 |   |
| Operating  expenses            |   |                              |       |   |   | 30,802,000 |   | 7,868,000 |   | 38,670,000 |   |
| Income (loss)  from operations |   |                              |       |   |   | $ | 2,147,000 |   | $ | (7,868,000 | ) | $ | (5,721,000 | ) |

 
|                   |   | **Year Ended December 31, 2001** |       |
|------------------------|--------|----------------------------------|------------|
|                   |   | **Industrial**                   |       | **Commercial** |   | **Subtotal** |   | **Xiran** |   | **Consolidated** |   |
| Net revenues           |   | $                                | 48,037,000 |   | $ | 116,204,000 |   | $ | 164,241,000 |   | $ | 0 |   | $ | 164,241,000 |   |
| Cost of revenues       |   | 33,818,000                       |       | 93,873,000 |   | 127,691,000 |   | 0 |   | 127,691,000 |   |
| Gross profit           |   | $                                | 14,219,000 |   | $ | 22,331,000 |   | 36,550,000 |   | 0 |   | 36,550,000 |   |
| Operating expenses     |   |                             |       |   |   | 34,068,000 |   | 0 |   | 34,068,000 |   |
| Income from operations |   |                             |       |   |   | $ | 2,482,000 |   | $ | 0 |   | $ | 2,482,000 |   |

 
|                   |   | **Year Ended December 31, 2000** |        |
|------------------------|--------|----------------------------------|-------------|
|                   |   | **Industrial**                   |        | **Commercial** |   | **Subtotal** |   | **Xiran** |   | **Consolidated** |   |
| Net revenues           |   | $                                | 144,178,000 |   | $ | 164,138,000 |   | $ | 308,316,000 |   | $ | 0 |   | $ | 308,316,000 |   |
| Cost of revenues       |   | 105,650,000                      |        | 134,314,000 |   | 239,964,000 |   | 0 |   | 239,964,000 |   |
| Gross profit           |   | $                                | 38,528,000  |   | $ | 29,824,000 |   | 68,352,000 |   | 0 |   | 68,352,000 |   |
| Operating expenses     |   |                             |        |   |   | 38,996,000 |   | 0 |   | 38,996,000 |   |
| Income from operations |   |                             |        |   |   | $ | 29,356,000 |   | $ | 0 |   | $ | 29,356,000 |   |

 

For the years ended December 31, 2002, 2001 and 2000,international sales comprised 15%, 16% and 13% of the Company’s revenues, respectively.  During these periods, no single foreigncountry accounted for more than 10% of total revenues. Substantially all of theCompany’s international sales are export sales, which are shipped domesticallyto the Company’s foreign customers.

 

**13.          SelectedQuarterly Financial Data (unaudited):**
|                                     |   | **Quarter  Ended** |       |
|------------------------------------------|--------|--------------------|------------|
|                                     |   | **Mar. 31,  2002** |       | **Jun. 30,  2002** |   | **Sept.  30, 2002** |   | **Dec. 31,  2002** |   |
| **Fiscal  Year Ended December 31, 2002** |   |               |       |   |   |   |   |   |   |
| Net revenues                             |   | $                  | 50,952,000 |   | $ | 43,301,000 |   | $ | 36,501,000 |   | $ | 45,777,000 |   |
| Gross profit                             |   | 11,476,000         |       | 6,134,000 |   | 6,590,000 |   | 8,749,000 |   |
| Income (loss)  from operations           |   | 310,000            |       | (2,776,000 | ) | (2,294,000 | ) | (961,000 | ) |
| Net income  (loss)                       |   | $                  | 313,000    |   | $ | (716,000 | ) | $ | (1,056,000 | ) | $ | 153,000 |   |
| Net income  (loss) per share:            |   |               |       |   |   |   |   |   |   |
| Basic                                    |   | $                  | 0.01       |   | $ | (0.02 | ) | $ | (0.03 | ) | $ | 0.00 |   |
| Diluted                                  |   | $                  | 0.01       |   | $ | (0.02 | ) | $ | (0.03 | ) | $ | 0.00 |   |

 

F-23

----

 
|                                     |   | **Quarter  Ended** |       |
|------------------------------------------|--------|--------------------|------------|
|                                     |   | **Mar. 31,  2001** |       | **Jun. 30,  2001** |   | **Sept.  30, 2001** |   | **Dec. 31,  2001** |   |
|                                     |   |               |       |   |   |   |   |   |   |
| **Fiscal  Year Ended December 31, 2001** |   |               |       |   |   |   |   |   |   |
| Net revenues                             |   | $                  | 58,715,000 |   | $ | 36,768,000 |   | $ | 33,177,000 |   | $ | 35,581,000 |   |
| Gross profit                             |   | 15,462,000         |       | 5,619,000 |   | 5,651,000 |   | 9,818,000 |   |
| Income (loss)  from operations           |   | 6,149,000          |       | (3,589,000 | ) | (1,744,000 | ) | 1,666,000 |   |
| Net income  (loss)                       |   | $                  | 3,959,000  |   | $ | (1,934,000 | ) | $ | (843,000 | ) | $ | 1,158,000 |   |
| Net income  (loss) per share:            |   |               |       |   |   |   |   |   |   |
| Basic                                    |   | $                  | 0.10       |   | $ | (0.05 | ) | $ | (0.02 | ) | $ | 0.03 |   |
| Diluted                                  |   | $                  | 0.10       |   | $ | (0.05 | ) | $ | (0.02 | ) | $ | 0.03 |   |

** **
|                                     |   | **Quarter  Ended** |       |
|------------------------------------------|--------|--------------------|------------|
|                                     |   | **Mar. 31,  2000** |       | **Jun. 30,  2000** |   | **Sept.  30, 2000** |   | **Dec. 31,  2000** |   |
| **Fiscal  Year Ended December 31, 2000** |   |               |       |   |   |   |   |   |   |
| Net revenues                             |   | $                  | 57,835,000 |   | $ | 75,136,000 |   | $ | 84,879,000 |   | $ | 90,466,000 |   |
| Gross profit                             |   | 12,822,000         |       | 16,913,000 |   | 18,470,000 |   | 20,147,000 |   |
| Income from operations                   |   | 5,171,000          |       | 7,001,000 |   | 7,640,000 |   | 9,544,000 |   |
| Pro forma net  income                    |   | $                  | 3,029,000  |   | $ | 4,019,000 |   | $ | 4,324,000 |   | $ | 5,943,000 |   |
| Pro forma net  income per share:         |   |               |       |   |   |   |   |   |   |
| Basic                                    |   | $                  | 0.10       |   | $ | 0.13 |   | $ | 0.14 |   | $ | 0.16 |   |
| Diluted                                  |   | $                  | 0.10       |   | $ | 0.12 |   | $ | 0.13 |   | $ | 0.15 |   |

 

F-24

----

**REPORT OF INDEPENDENT ACCOUNTANTS ONCONSOLIDATEDFINANCIAL STATEMENT SCHEDULE**

The Shareholdersand Board of Directors ofSimpleTech, Inc.

Our audits of theconsolidated financial statements of SimpleTech, Inc. referred to in ourreport dated January 31, 2003, except for Note 10, as to which the date isFebruary 26, 2003, appearing in this Annual Report on Form 10-K also includedan audit of the consolidated financial statement schedule listed inItem 15 (a) (2) of this Form 10-K. In our opinion, thisfinancial statement schedule presents fairly, in all material respects, theinformation set forth therein when read in conjunction with the relatedconsolidated financial statements.

PricewaterhouseCoopers LLPOrange County, California

January 31, 2003, except for Note 10, as to whichthe date is February 26, 2003

 

S-1

----

 

**SimpleTech, Inc.**

**Schedule II-Consolidated Valuationand Qualifying Accounts and Reserves**

**For the Years Ended December 31,2000, 2001 and 2002**
|                        |   | **Accounts  Receivable Allowances** |    | **Inventory  Valuation Allowances** |   |
|-----------------------------|--------|-------------------------------------|---------|-------------------------------------|--------|
| Balance,  December 31, 1999 |   | $                                   | 772,000 |                                | $      | 2,080,000 |   |
| Charged to  operations      |   | 1,253,000                           |    | 2,940,000                           |   |
| Write-offs                  |   | (1,053,000                          | )       | (893,000                            | )      |
| Balance,  December 31, 2000 |   | 972,000                             |    | 4,127,000                           |   |
| Charged to  operations      |   | 2,003,000                           |    | 759,000                             |   |
| Write-offs                  |   | (2,435,000                          | )       | (3,596,000                          | )      |
| Balance,  December 31, 2001 |   | 540,000                             |    | 1,290,000                           |   |
| Charged to  operations      |   | 1,463,000                           |    | 304,000                             |   |
| Write-offs                  |   | (1,221,000                          | )       | (790,000                            | )      |
| Balance,  December 31, 2002 |   | $                                   | 782,000 |                                | $      | 804,000 |   |

 

S-2

----

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this AnnualReport on Form 10-K to be signed on its behalf by the undersigned, thereuntoduly authorized, in the City of Santa Ana, State of California, on the 21st dayof March, 2003.
|   | **SimpleTech,  Inc.**               |
|--------|-------------------------------------|
|   |                                |
|   | By:                                 | /s/ Manouch Moshayedi |
|   | Name:                               | Manouch Moshayedi |
|   | Title:                              | Chief Executive Officer  and |
|   | Chairman of the Board  of Directors |
|        |                                     |  |

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned by the following persons in the capacities and on the dates indicated:

 

 
| **Signature**          | **Title**                                                                          | **Date**        |
|------------------------|------------------------------------------------------------------------------------|-----------------|
|                   |                                                                               |            |
| /s/  Manouch Moshayedi | Chief  Executive Officer and and Chairman of the Board of Directors                | March  21, 2003 |
| Manouch  Moshayedi     |                                                                               |
|                   |                                                                               |            |
|                   |                                                                               |            |
| /s/  Mike Moshayedi    | President  and Director                                                            | March  21, 2003 |
| Mike  Moshayedi        |                                                                               |            |
|                   |                                                                               |            |
| /s/  Mark Moshayedi    | Chief  Operating Officer, Chief Technical Officer, Secretary and Director          | March  21, 2003 |
| Mark  Moshayedi        |                                                                               |
|                   |                                                                               |            |
|                   |                                                                               |            |
| /s/  Dan Moses         | Chief  Financial Officer (Principal Financial and Accounting Officer) and Director | March  21, 2003 |
| Dan  Moses             |                                                                               |
|                   |                                                                               |            |
|                   |                                                                               |            |
| /s/  F. Michael Ball   | Director                                                                           | March  21, 2003 |
| F.  Michael Ball       |                                                                               |            |
|                   |                                                                               |            |
| /s/  Mark R. Hollinger | Director                                                                           | March  21, 2003 |
| Mark  R. Hollinger     |                                                                               |            |
|                   |                                                                               |            |
| /s/  James J. Peterson | Director                                                                           | March  21, 2003 |
| James  J. Peterson     |                                                                               |            |

 

----

 

**PERIODIC REPORT CERTIFICATION**

**of the Chief Executive Officer**

 

I, Manouch Moshayedi, Chief Executive Officer of SimpleTech, Inc.,certify that:

 

1.  I have reviewed this annualreport on Form 10-K of SimpleTech, Inc.;

 

2.  Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

 

4.  The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

 

(i)  Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

(ii)  Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report(“Evaluation Date”); and

 

(iii) Presented in this annual report our conclusions about the effectivenessof the disclosure controls and procedures based on our evaluation as of theEvaluation Date;

 

5.  The registrant’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of the registrant’s boardof directors (or persons performing the equivalent functions):

 

(a) All significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

(b) Any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.  The registrant’s othercertifying officers and I have indicated in this annual report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

| /s/ MANOUCH MOSHAYEDI         |
|-------------------------------|
| Manouch Moshayedi             |
| Chief Executive Officer       |
| (Principal Executive Officer) |
| March 21, 2003                |

----

 

**PERIODIC REPORT CERTIFICATION**

**of the Chief Financial Officer**

 

I, Dan Moses, Chief Financial Officer of SimpleTech, Inc., certifythat:

 

1.  I have reviewed this annualreport on Form 10-K of SimpleTech, Inc.;

 

2.  Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition, resultsof operations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.  The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

 

(i)  Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this annual report is being prepared;

 

(ii)  Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report(“Evaluation Date”); and

 

(iii) Presented in this annual report our conclusions about the effectivenessof the disclosure controls and procedures based on our evaluation as of theEvaluation Date;

 

5.  The registrant’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of the registrant’s boardof directors (or persons performing the equivalent functions):

 

(a) All significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

(b) Any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.  The registrant’s othercertifying officers and I have indicated in this annual report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

| /s/ DAN MOSES                 |
|-------------------------------|
| Dan Moses                     |
| Chief Financial Officer       |
| (Principal Financial Officer) |
| March 21, 2003                |

 

----

**EXHIBIT INDEX**

 
| **Number** |     | **Description**                                                                                                                                                                  |
|------------|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1        | *        | Amended and Restated Articles of Incorporation                                                                                                                                   |
| 3.1.1      | *        | Certificate of Amendment to the Amended and Restated  Articles of Incorporation, dated August 31, 2000                                                                      |
| 3.1.2      | ‡   | Certificate of Amendment to the Amended and Restated  Articles of Incorporation, dated May 1, 2001.                                                                              |
| 3.2        | *        | Amended and Restated Bylaws                                                                                                                                                      |
| 4.1        | *        | See Exhibits 3.1 and 3.2 for provisions of the Articles  of Incorporation and Bylaws for SimpleTech, Inc. defining the rights of  holders of common stock of SimpleTech, Inc.    |
| 4.2        | *        | Specimen Stock Certificate                                                                                                                                                       |
| 10.1       | *        | Amended and Restated Real Estate Lease, dated April  1, 2000, by and between MDC Land LLC and SimpleTech, Inc.                                                                   |
| 10.2       | *        | Amended and Restated Real Estate Lease, dated June  1, 2000, by and between MDC Land LLC and SimpleTech, Inc.                                                                    |
| 10.3       | **† | 2000 Stock Incentive Plan (as amended and restated)                                                                                                                              |
| 10.4       | **† | 2000 Employee Stock Purchase Plan (as amended and  restated)                                                                                                                     |
| 10.5       | *        | Form of Indemnification Agreement between  SimpleTech, Inc. and each of its directors and officers                                                                               |
| 10.6       | *†  | Form of Employment Agreement for Executive Officers  of SimpleTech, Inc. (including a schedule of substantially identical agreements)                                            |
| 10.7       | *        | Distribution and Tax Indemnity Agreement, dated  September 26, 2000, by and between SimpleTech, Inc. and each of the  shareholders of SimpleTech, Inc.                           |
| 10.8       | *        | License Agreement, dated August 22, 2000, by and  between Micron Electronics and SimpleTech, Inc.                                                                                |
| 10.9       | †   | Employment Agreement, dated November 11, 2002, by  and between SimpleTech, Inc. and Thomas A. Beaver                                                                             |
| 21.1       | +        | List of Subsidiaries of SimpleTech, Inc.                                                                                                                                         |
| 23.1       |     | Consent of PricewaterhouseCoopers LLP                                                                                                                                            |
| 99.1       |     | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

----

*              This exhibit was previously filed as an exhibit to theCompany’s Registration Statement on Form S-1 declared effectiveSeptember 28, 2000 (File No. 333-32478), and is incorporated byreference herein.

‡              This exhibit was previously filed as an exhibit to theCompany’s Quarterly Report on Form 10-Q for the Quarterly Period Ended March31, 2001, filed with the Securities and Exchange Commission on May 14, 2001,and is incorporated by reference herein.

**           This exhibit was previously filed as an exhibit to theCompany’s Registration Statement on Form S-8 with the Securities andExchange Commission on February 9, 2001, and is incorporated by referenceherein.

†              Management contractor compensatory plan or arrangement required to be filed as an exhibit pursuantto Item 15(c) of Form 10-K.

 

+              This exhibit waspreviously filed as an exhibit to the Company's Annual Report on Form 10-K forthe fiscal year ended December 31, 2001, filed with the Securities and ExchangeCommission on March 20, 2002, and is incorporated by reference herein.

 

----