<PAGE>


===============================================================================
                                  UNITED STATES


                       SECURITIES AND EXCHANGE COMMISSION


                             WASHINGTON, D.C. 20549


                                    FORM 10-Q




(Mark one)




    X         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
----------    OF THE SECURITIES EXCHANGE ACT OF 1934


FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001


              Transition Report Pursuant to Section 13 or 15(d)
-----------   of the Securities Exchange Act of 1934


For the Transition Period from ________ to ________


COMMISSION FILE NUMBER 0-21366


                              TRICORD SYSTEMS, INC.

             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


           DELAWARE                                               41-1590621
   -----------------------------                              ------------------
  (STATE OR OTHER JURISDICTION OF                             (I.R.S. EMPLOYER
  INCORPORATION OR ORGANIZATION)                             IDENTIFICATION NO.)


          2905 NORTHWEST BOULEVARD, SUITE 20, PLYMOUTH, MINNESOTA 55441
          -------------------------------------------------------------
          (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)            (ZIP CODE)

                                 (763) 557-9005
              -----------------------------------------------------
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)


     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.


                  YES          X                     NO
                           ---------                            -------

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


                                                             OUTSTANDING AT
        CLASS                                               OCTOBER 31, 2001
        -----                                               ----------------
     Common Stock,
    $0.01 par value                                            24,581,243

===============================================================================
<PAGE>
                          PART I. FINANCIAL INFORMATION

                          ITEM 1: FINANCIAL STATEMENTS

                              TRICORD SYSTEMS, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS

                                   (UNAUDITED)

<TABLE>
<CAPTION>

                                                         Three Months Ended September 30,   Nine Months Ended September 30,
                                                         --------------------------------   -------------------------------
(In thousands, except per share data)                          2001            2000            2001          2000
                                                            -------           -----         -------       -------
<S>                                                          <C>            <C>            <C>            <C>
Revenue                                                     $    110                           204              -
Cost of sales and service                                        299              -            474              -
                                                            --------         ------        -------         ------
      Gross Margin                                              (189)             -           (270)             -
                                                            --------         ------        -------         ------
Operating expenses:
      Research and development                                 2,918          1,778          8,791          4,672
      Sales and marketing                                      2,634          1,367          7,424          2,505
      General and administrative                                 941            595          2,535          2,235
      Restructuring                                              689              -            689              -
                                                            --------         ------        -------         ------
                                                               7,182          3,740         19,439          9,412
                                                            --------         ------        -------         ------
Operating loss                                                (7,371)        (3,740)       (19,709)        (9,412)
Other income (expense):
      Interest, net                                              207            352            874            644
      Other, net                                                  (5)             9              1              6
                                                            --------         ------        -------         ------
                                                                 202            361            875            650
                                                            --------         ------        -------         ------
Loss from continuing operations                               (7,169)        (3,379)       (18,834)        (8,762)
                                                            --------         ------        -------         ------
Gain on disposal of discontinued operations                       --             16              -            100
                                                            --------         ------        -------         ------
Net loss                                                      (7,169)        (3,363)       (18,834)        (8,662)
                                                            --------         ------        -------         ------
Beneficial conversion charge, Series E Preferred Stock          (525)             -         (1,185)             -
Premium on Series E Preferred Stock                             (297)             -           (693)             -
                                                            --------         ------        -------         ------
Net loss applicable to common shares                        $ (7,991)        (3,363)       (20,712)        (8,662)
                                                            ========         ======        =======         ======
Loss per common share from continuing operations -
      basic and diluted                                     $  (0.33)         (0.14)         (0.85)         (0.38)
                                                            ========         ======        =======         ======
Net loss per common share - basic and diluted               $  (0.33)         (0.14)         (0.85)         (0.38)
                                                            ========         ======        =======         ======
Weighted average common shares outstanding
      - basic and diluted                                     24,387         24,308         24,365         22,830
                                                            ========         ======        =======         ======
</TABLE>


                 See accompanying notes to financial statements.




                                       1
<PAGE>

                              TRICORD SYSTEMS, INC.

                           CONSOLIDATED BALANCE SHEETS


                                     ASSETS

<TABLE>
<CAPTION>
                                                                       September 30,              December 31,
(In thousands, except per share data)                                      2001                      2000
                                                                       -------------             ------------
                                                                        (unaudited)
<S>                                                                      <C>                          <C>
Current assets:
     Cash and cash equivalents                                           $   21,766                   16,825
     Accounts receivable, net                                                   157                       --
     Inventories                                                                530                       --
     Other current assets                                                       389                      194
                                                                         ----------                ---------
        Total current assets                                                 22,842                   17,019

Equipment and improvements, net                                               2,938                    3,114
                                                                         ----------                   ------
        Total Assets                                                     $   25,780                   20,133
                                                                         ==========                =========
</TABLE>


              LIABILITIES, CONVERTIBLE , REDEEMABLE PREFERRED STOCK

                            AND STOCKHOLDERS' EQUITY

<TABLE>
<S>                                                                       <C>                          <C>
Current liabilities:
     Accounts payable                                                     $     891                    1,521
     Accrued payroll, benefits and related taxes                              1,317                    1,065
     Deferred revenue                                                            35                       --
     Other accrued expenses                                                   1,052                      123
                                                                          ---------                ---------
        Total current liabilities                                             3,295                    2,709

Capital lease obligations                                                        98                      112

Convertible, redeemable Series E Preferred Stock,
     $1,000 par value; 25 shares authorized, 25 issued and
     outstanding (redemption value at September 30, 2001 of
     $25,693)                                                                10,930                       --

Stockholders' equity:
     Common stock, $0.01 par value; 75,000  shares
        authorized, 24,394 and 24,278 shares
        issued and outstanding                                                  244                      243
     Additional paid-in capital                                             128,184                  115,704
     Unearned compensation                                                     (653)                  (1,151)
     Accumulated deficit                                                   (116,318)                 (97,484)
                                                                          ---------                ---------
       Total stockholders' equity                                            11,457                   17,312
                                                                          ---------                ---------
        Total Liabilities, Convertible, Redeemable
          Preferred Stock and Stockholders' Equity                        $  25,780                   20,133
                                                                          =========                =========
</TABLE>

                See accompanying notes to financial statements.

                                       2
<PAGE>




                              TRICORD SYSTEMS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                 Nine Months Ended September 30,
                                                                                --------------------------------
(In thousands)                                                                   2001                      2000
---------------                                                                 ------                    ------
<S>                                                                         <C>                          <C>
Cash flows from operating activities:
     Net loss                                                               $   (18,834)                 (8,662)
     Adjustments to reconcile net loss to net
       cash used in operating activities:
        Stock compensation                                                          400                   1,975
        Depreciation and amortization                                             2,419                     275
        Loss on disposal of equipment                                                14                      --
        Provision for losses on accounts receivable                                   3                      --
        Changes in operating assets and liabilities:
           Accounts receivable                                                     (160)                     --
           Inventories                                                             (530)                     --
           Other current assets                                                    (195)                   (104)
           Accounts payable                                                        (630)                    719
           Accrued payroll, benefits and related taxes                              252                     337
           Deferred revenue                                                          35                      --
           Accrued restructuring expenses                                           689                      --
           Other accrued expenses                                                   166                      51
                                                                            -----------                  ------
              Net cash used in operating activities                             (16,371)                 (5,409)
                                                                            -----------                  ------
Cash flows from investing activities:
     Capital expenditures                                                        (2,123)                 (1,958)
                                                                            -----------                  ------
             Net cash used in investing activities                               (2,123)                 (1,958)
                                                                            -----------                  ------
Cash flows from financing activities:
     Principal payments on capital lease obligations                                (74)                     --
     Proceeds from private placement, net                                            --                  24,378
     Stock option and warrant exercises                                             109                   1,287
     Proceeds from issuance of preferred stock and warrants, net                 23,400                      --
                                                                            -----------                  ------
              Net cash provided by financing activities                          23,435                  25,665
                                                                            -----------                  ------
Net increase in cash and cash equivalents                                         4,941                  18,298
Cash and cash equivalents at beginning of period                                 16,825                   3,082
                                                                            -----------                  ------
Cash and cash equivalents at end of period                                  $    21,766                  21,380
                                                                            ===========                  ======
</TABLE>


                 See accompanying notes to financial statements.




                                       3
<PAGE>
                              TRICORD SYSTEMS, INC.

                          NOTES TO FINANCIAL STATEMENTS

1.   BASIS OF PRESENTATION

The accompanying unaudited interim statements of operations, balance sheet and
statements of cash flows reflect all adjustments of a normal recurring nature,
which are, in the opinion of management, necessary for a fair statement of the
financial position at September 30, 2001, and results of operations and cash
flows for the interim periods ended September 30, 2001 and 2000. The unaudited
financial statements should be read in conjunction with the Company's audited
financial statements for the year ended December 31, 2000, which were included
in the Company's 2000 Annual Report on Form 10-K. The year-end balance sheet
data included herein is derived from such audited financial statements, but does
not include all disclosures required by accounting principles generally accepted
in the United States of America. The results of operations for the interim
periods ended September 30, 2001 are not necessarily indicative of the results
to be expected for the full year or any future periods.

2.   REVENUE RECOGNITION

In accordance with Statement of Position ("SOP") 97-2, "Software Revenue
Recognition," the Company recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable,
collectibility is probable and vendor specific objective evidence exists to
allocate a portion of the total fee to any undelivered elements of the
arrangement. The Company records revenue when all of these elements have been
satisfied, which generally occurs when a distribution partner has delivered the
product to its customer or upon customer acceptance of products evaluated
pursuant to the Company's try-before-you-buy program. Revenues from service
subscriptions, which entitle customers to software updates and technical
services, are recognized over the terms of the related contractual periods.

3.   INVENTORIES

Inventories, which consist primarily of finished units, are stated at the lower
of cost or market. Cost is determined using weighted average costs which
approximate actual costs determined using the first-in, first-out method.
Appropriate consideration is given to deterioration, obsolescence or other
factors in the evaluation of net realizable value.

The Company has a non-exclusive integration agreement with a contract
manufacturer to manufacture, integrate and assemble the Company's Lunar
Flare(TM) NAS server appliance. Under the agreement, the manufacturer supplies
and assembles the hardware components that comprise Lunar Flare appliances,
integrates the Company's Illumina(TM) aggregation software, provides testing
services and drop-ships to the Company's channel partners and customers. All
product purchases by the Company from the manufacturer are through '


                                       4
<PAGE>

purchase orders. The Company determines the minimum number of units of server
appliances that the manufacturer builds and holds as finished goods, ready for
shipment to the Company's customers. The Company provides a non-cancelable,
non-returnable purchase order for all such finished goods inventory. In
addition, the Company provides the manufacturer with a non-cancelable,
non-returnable purchase order for unique parts (as defined by the agreement) to
be purchased by the manufacturer for integration into the Company's server
appliance. The Company is also required to reimburse the manufacturer for
obsolete, unique and excess material (as defined) and related supplier
cancellation charges because of actions by the Company, including cancellation
of a purchase order, termination of the agreement or implementation of an
engineering change order.

In the third quarter of 2001, the Company recorded a charge of $75,000 to cost
of sales and service related to excess inventory components.

As of September 30, 2001, the Company had approximately $200,000 of
component-level and finished goods purchase commitments to its contract
manufacturer.

4.   RESTRUCTURING AND OTHER CHARGES

In the third quarter of 2001, the Company recorded a restructuring charge of
$689,000 related to a workforce reduction of 50 employees. This restructuring
was implemented in September 2001 and reduced the total number of employees at
the Company to approximately 80. The restructuring charge consists of
severance-related costs including cash payments to be made of $465,000 and
non-cash charges of $224,000 for common stock to be issued to affected
employees. These severance-related costs were accrued in the third quarter of
2001, and the Company expects to make all severance-related payments and stock
distributions related to this restructuring during the fourth quarter of 2001.

In addition, the Company recorded other charges in the third quarter of 2001 of
$34,000 in research and development expenses, $525,000 in sales and marketing
expenses and $208,000 in general and administrative expenses relating primarily
to accelerated amortization associated with changes in the estimated useful
lives of certain computer software applications the Company discontinued use of
in the third quarter of 2001 or plans to discontinue use of in the fourth
quarter of 2001. The Company will also incur fourth quarter 2001 amortization
expense of $164,000 related to these changes in the estimated useful life of
computer software applications.

5.   CONVERTIBLE, REDEEMABLE SERIES E PREFERRED STOCK

On February 27, 2001 the Company closed a private placement of $25.0 million in
Series E Convertible Preferred Stock. Net cash proceeds from the placement were
approximately $23.4 million, net of approximately $1.6 million of transaction
costs. Under terms of the offering, the Company issued 25,000 shares of 4.75%
Series E Convertible Preferred Stock ("Preferred Stock"). Each share of
Preferred Stock is convertible into the number of shares of the Company's Common
Stock that is equal to


                                       5
<PAGE>
the stated value ($1,000) of each share plus accrued premium and default
payments (if any) divided by the conversion price, which is currently $9.50, but
is subject to adjustment in certain circumstances. In addition, the Company
issued warrants to the Preferred Stockholders with an 18-month term to purchase
up to 986,842 additional shares of the Company's Common Stock at $12.40 per
share, and warrants with a 24-month term to purchase up to 986,842 additional
shares of the Company's Common Stock at $14.50 per share. In addition, the
Company issued warrants to the placement agent with a five-year term to purchase
up to 110,526 shares of the Company's Common Stock at $9.50 per share.

Accounting for the preferred stock conversion feature in accordance with
Emerging Issues Task Force (EITF) issue No. 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Rates" and EITF Issue No. 00-27 "Application of Issue 98-5 to Certain
Convertible Investments" resulted in the allocation of approximately $7.9
million of the net offering proceeds to a "beneficial conversion feature". This
beneficial conversion feature was initially recorded as an increase in
additional paid-in capital and will be amortized using the effective interest
method as a non-cash charge against stockholders' equity over the shorter of
three years or the period during which the Preferred Stock remains outstanding.
These charges will also increase the carrying value of the Preferred Stock. In
addition, the Company will accrue a premium on the stated value of outstanding
Preferred Stock, which is payable to the Preferred Stockholders in additional
common stock upon conversion or in cash upon redemption of the Preferred Stock,
at an annual rate of 4.75%. This premium will also be recorded as a non-cash
charge against stockholders' equity and an increase in the carrying value of
Preferred Stock. The charges against stockholders' equity resulting from the
amortization of the beneficial conversion feature and accrual of the premium
will reduce income (increase the loss) applicable to common stockholders which
will reduce income (increase the loss) per common share reported by the Company.
If the Preferred Shares remain outstanding for their full three-year term,
without adjustment of the conversion price as described below, charges to equity
for amortization of the beneficial conversion feature and accrual of the premium
would total approximately $11.5 million. During the three and nine month periods
ended September 30, 2001, the Company recorded amortization of the beneficial
conversion feature of $525,000 and $1,185,000, respectively, and accrued premium
of $297,000 and $693,000, respectively.

The fair value of the warrants was measured using the Black-Scholes
option-pricing model. The recorded value of the warrants of approximately $5.6
million, initially recorded as an increase in additional paid-in capital,
reflects an allocation of the net proceeds of the offering based upon the
relative fair values of the Preferred Stock and the warrants issued with the
Preferred Stock.

For a complete description of the rights and preferences of the Preferred Stock,
please see the Certificate of Designation, Preferences and Rights of the
Preferred Stock and other documents attached as exhibits to the Current Report
on Form 8-K as filed by the Company on February 28, 2001. Key terms of the
Preferred Stock include the following:


                                       6
<PAGE>

Voting Rights. The holders of the Preferred Stock have no voting rights except
as may be required by Delaware law.

Dividends. The holders of Preferred Stock are not entitled to the payment of
dividends other than the 4.75% premium. The Company is prohibited from paying
dividends to any other stockholders or from repurchasing or redeeming any other
class of stock without the prior approval of the majority of the Preferred
Stockholders.

Liquidation Preference. Upon any liquidation, dissolution or winding up of the
affairs of the Company or any change in control of the Company, as defined, the
holder of each share of Preferred Stock shall be entitled to be paid $1,000 per
share plus all accrued premium amounts and any default payments due (as defined)
(the "Liquidation Preference Amount") prior and in preference to any payment to
holders of Common Stock. If the assets of the Company upon such event are
insufficient to make such payment in full, then the holders of the Preferred
Stock shall be entitled to pro rata distribution of all the assets of the
Company.

Conversion. The holders of Preferred Stock may convert such stock into shares of
common stock at any time until maturity (also see Forced Conversion at Maturity
below).

Conversion Rate. The stated value of each share of the Preferred Stock ($1,000)
plus any premium accrued at 4.75% and any default payments due (as defined) is
convertible into common stock at $9.50 per share, subject to adjustment in
certain circumstances ("Conversion Rate").

Adjustments to Conversion Rate. The Conversion Rate is subject to adjustment at
maturity or upon certain future issuances of common stock or rights to acquire
Common Stock (as defined) at a price less than $9.50 per share. Any adjustment
to the conversion rate will result in an increase in the amount ascribed to the
beneficial conversion feature discussed above.

Forced Conversion or Redemption at Maturity. Subject to certain limitations (as
defined), any Preferred Stock remaining outstanding at February 27, 2004 shall
be subject to a forced conversion unless the Company elects to redeem such
outstanding Preferred Stock for the Liquidation Preference Amount. The
conversion rate for the forced conversion shall be based upon the lowest average
trading price of the Company's common stock for 10 of the last 15 trading days
preceding February 27, 2004. Most rights, including the right to earn the 4.75%
annual premium, shall cease for any shares of Preferred Stock remaining
outstanding after February 27, 2004.

Early Forced Conversion. At any time after February 27, 2002, if the Company's
Common Stock trades at an average price of at least $19 for 20 consecutive days
and the Company has fulfilled certain registration requirements, the Company may
require the holders of the Preferred Stock to convert their shares at the
Conversion Rate.


                                       7
<PAGE>

Optional Redemption. At any time, if the Company has fulfilled certain
registration requirements, the Company may elect to redeem any outstanding
shares of Preferred Stock at a price per share equal to 115% of the Liquidation
Preference Amount.

Required Redemption. In the event of certain defaults by the Company, which such
defaults primarily relate to either a failure by the Company to issue shares of
Common Stock upon conversion of the Preferred Stock, or, beginning later in
2002, the failure of the Company to maintain the listing of its common stock on
the Nasdaq SmallCap Market (or other required trading market), the holders of
the Preferred Stock may require the Company to redeem the Preferred Stock at the
Liquidation Preference Amount or such other amount (as defined) to be determined
at the date of the redemption. Also, under certain circumstances the Company may
be required to obtain stockholders' approval to allow for issuance of additional
shares of Common Stock upon conversion of the Preferred Stock. If such approval
is not obtained, the Company may be required to redeem the portion of shares of
Preferred Stock which cannot be converted into Common Stock due to the lack of
stockholder consent.

Registration Rights. The Company was obligated to file a registration statement
with the Securities and Exchange Commission (SEC) to cover the resale of the
Company's common stock issuable upon the conversion of the Preferred Stock and
the exercise of the warrants issued with the Preferred Stock. The Company has
filed the required registration statement and it has been declared effective by
the SEC.

6.   DISCONTINUED OPERATIONS

In August 1999, the Company sold all remaining assets related to the server line
of business (sometimes referred to as the "legacy business"). The Company has
reported results of operations of the legacy business as discontinued operations
for all periods presented. Terms of the asset sale required the buyer to pay the
Company up to $200,000 of additional cash consideration based upon levels of
revenues generated from the legacy business through December 31, 2000 and any
such cash received has been reported as a gain on disposal of discontinued
operations. As of September 30, 2001, no further consideration is due to the
Company.

7.   SUPPLEMENTAL CASH FLOW INFORMATION

During the nine months ended September 30, 2001, expenses for outside directors
meeting fees of $23,000 were settled through the issuance of 5,171 shares of
common stock.

During the nine months ended September 30, 2001, the Company acquired $134,000
of equipment pursuant to terms of capital leases.

8.   INCOME (LOSS) PER SHARE

Loss per common share from continuing operations is computed by dividing loss
from continuing operations applicable to common shares by the weighted average
number of


                                       8
<PAGE>

common shares outstanding during each period. Net loss per common share is
computed by dividing net loss applicable to common shares by the weighted
average number of common shares outstanding during each period. Potentially
dilutive common shares are excluded from the calculation of loss per common
share from continuing operations and net loss per common share as their impact
is antidilutive. Loss per common share from continuing operations and net loss
per common share do not reflect common stock options and warrants ultimately
exercisable for the purchase of approximately 15,000,000 shares for the three
and nine month periods ended September 30, 2001 and approximately 10,300,000
shares for the three and nine month periods ended September 30, 2000. The net
loss per common share for the three and nine months ended September 30, 2001
does not reflect the approximately 2,700,000 common shares into which the Series
E Preferred Stock could be converted as of September 30, 2001 because the effect
would be antidilutive.

9.   COMPREHENSIVE INCOME (LOSS)

The Company has no significant comprehensive income (loss) items other than net
loss.

10.  RECENT ACCOUNTING DEVELOPMENTS

In June 2001, the Financial Accounting Standards Board (FASB) approved
Statements of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets." The
statements eliminate the pooling-of-interests method of accounting for business
combinations and require that goodwill and certain intangible assets not be
amortized. Instead, these assets will be reviewed for impairment at least
annually with any related losses recognized when incurred. SFAS No. 141 is
generally effective for business combinations completed after June 30, 2001.
SFAS No. 142 is effective January 1, 2002 for existing goodwill and intangible
assets and July 1, 2001 for business combinations completed after June 30, 2001.
The Company does not expect these statements to affect its financial position or
results of operations.

In August 2001, the FASB approved Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002. This statement will affect asset
retirement obligations upon adoption.

In October 2001, the FASB approved Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement addresses financial
accounting and reporting for the impairment of long-lived assets and for
long-lived assets to be disposed of and supercedes SFAS No. 121 and APB Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." Statement No. 144 is effective for fiscal
years beginning after December 15, 2001. The Company does not expect this
statement to affect its financial position or results of operations.



                                       9
<PAGE>
                                     ITEM 2:

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

Tricord Systems, Inc. designs, develops and markets innovative server appliances
for content-hungry applications. The core of our technology is our patented
Illumina(TM) software that aggregates multiple appliances into a cluster,
managed as a single resource. During 2000, we continued developing our
aggregation software and began beta testing our initial Lunar Flare server
appliance for the network attached storage (NAS) market segment. In December
2000, we announced our first server appliance, Lunar Flare(TM) NAS, a general
file serving storage device for Windows(R) users designed to offer seamless
growth and ease of management. During the first quarter ended March 31, 2001 and
into the second quarter of 2001, we continued testing of our initial Lunar Flare
NAS appliance. In the second quarter of 2001, we began shipping Lunar Flare NAS
in limited availability, and in late June 2001, we announced general
availability of our initial Lunar Flare NAS product. During the second quarter
ended June 30, 2001, we recognized initial revenues from the sale of Lunar Flare
NAS.

Before focusing our efforts exclusively on the development of Illumina, we had
historically engaged in the business of designing, manufacturing, marketing and
supporting high-performance enterprise servers for use in mission critical
applications principally running on Microsoft(R) Windows NT(R) and Novell(R)
NetWare(R).

See "Factors That May Affect Future Results" at the end of this section for a
discussion regarding forward-looking statements contained herein.

RESULTS OF OPERATIONS

Revenues

Revenues from sales of the Company's Lunar Flare NAS server appliances were
$110,000 and $204,000, respectively, for the third quarter and nine months ended
September 30, 2001.

Cost of Sales and Service

Cost of sales and service, which consists primarily of the costs of units sold
and costs of the Company's customer care functions, was $299,000 and $474,000
for the third quarter and nine months ended September 30, 2001. In the third
quarter of 2001, the Company also recorded a charge of $75,000 to cost of sales
and service related to excess inventory components.



                                       10
<PAGE>

Gross Margin

The Company incurred a negative gross margin ($189,000) for the third quarter of
2001 and for the nine months ended September 30, 2001 ($270,000), primarily due
to the small volume of initial sales of its Lunar Flare NAS which did not
generate sufficient revenue to absorb certain fixed components of cost of sales
and service, product discounts given to customers, and a $75,000 charge related
to excess inventory components.

Research and Development

Research and development expenses increased to $2,918,000 and $8,791,000,
respectively, for the third quarter and nine months ended September 30, 2001,
from $1,778,000 and $4,672,000, respectively, for the third quarter and nine
months ended September 30, 2000. The increase is primarily due to headcount
additions and development and testing of the Company's server appliance
products. The Company currently anticipates that research and development
expense for fourth quarter 2001 will be less than third quarter 2001 primarily
due to the restructuring and workforce reduction discussed below, but that
significant levels of research and development costs will continue to be
incurred due to ongoing product development efforts.

Sales and Marketing

Sales and marketing expenses increased to $2,634,000 and $7,424,000,
respectively, for the third quarter and nine months ended September 30, 2001
from $1,367,000 and $2,505,000, respectively, for the third quarter and nine
months ended September 30, 2000. The increase is primarily due to headcount
additions and increased expenditures related to the Company's efforts to market
and sell its initial Lunar Flare NAS server appliance, as well as the other
third quarter 2001 charges discussed below. The Company currently anticipates
that sales and marketing expense for fourth quarter 2001 will be less than third
quarter 2001 due primarily to the restructuring and workforce reduction
discussed below.

General and Administrative

General and administrative expenses increased to $941,000 and $2,535,000,
respectively, for the third quarter and nine months ended September 30, 2001
from $595,000 and $2,235,000, respectively, for the third quarter and nine
months ended September 30, 2000. The increase is primarily due to the other
charges discussed below and an increase in headcount and costs associated with
expanding the Company's general and administrative infrastructure partially
offset by a decrease in non-cash stock compensation expense related to options
granted to non-employee contractors. The Company currently anticipates that
general and administrative expense for fourth quarter 2001 will be less than
third quarter 2001 due primarily to the restructuring and workforce reduction
discussed below.



                                       11
<PAGE>

Restructuring and Other Charges

In the third quarter of 2001, the Company recorded a restructuring charge of
$689,000 related to a workforce reduction of 50 employees. This restructuring
was implemented in September 2001 and reduced the total number of employees in
the Company to approximately 80. The restructuring charge consists of
severance-related costs including cash payments to be made of $465,000 and
non-cash charges of $224,000 for common stock to be issued to affected
employees. These severance-related costs were accrued in the third quarter of
2001, and the Company expects to make all severance-related payments and stock
distributions related to this restructuring during the fourth quarter of 2001.

In addition, the Company recorded other charges in the third quarter of 2001 of
$34,000 in research and development expenses, $525,000 in sales and marketing
expenses and $208,000 in general and administrative expenses relating primarily
to accelerated amortization associated with changes in the estimated useful
lives of certain computer software applications the Company discontinued use of
in the third quarter of 2001 or plans to discontinue use of in the fourth
quarter of 2001. The Company will also incur fourth quarter 2001 amortization
expense of $164,000 related to these changes in the estimated useful life of
computer software applications.

Stock-Based Compensation

Stock-based compensation decreased to $132,000 and $400,000, respectively, for
the third quarter and nine months ended September 30, 2001 from $160,000 and
$1,975,000, respectively, for the third quarter and nine months ended September
30, 2000. The decline is primarily due to a decrease in the market value of the
Company's common stock, which resulted in a lower charge for stock compensation
related to options granted to non-employee contractors. These amounts do not
affect the Company's net stockholders' equity. These non-cash expenses increased
operating expenses, loss from continuing operations and net loss applicable to
common shares as follows:



                                       12
<PAGE>


Non-Cash Stock Compensation Expense
(in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                Three Months Ended             Nine Months ended
                                                   September 30,                 September 30,
                                             -----------------------        ----------------------
                                              2001            2000           2001          2000
                                             --------       -------        -------       -------
<S>                                          <C>            <C>            <C>           <C>
Research and development                     $   102        $   107        $   311       $   969
Sales and marketing                               12             12             36           168
General and administrative                        18             41             53           838
                                             -------        -------        -------       -------
                                             $   132        $   160        $   400       $ 1,975
                                             =======        =======        =======       =======
Impact per common  share                     $ (0.01)       $ (0.01)       $ (0.02)      $ (0.09)
                                             =======        =======        =======       =======
</TABLE>

Other Income, Net

Other income, net decreased to $202,000 for the third quarter of 2001 from
$361,000 for the third quarter of 2000, primarily due to lower interest income
as a result of lower interest rates in third quarter 2001. Other income, net
increased to $875,000 for the nine months ended September 30, 2001 from $650,000
for the nine months ended September 30, 2000, primarily due to higher interest
income as a result of investing the net proceeds from the private placements in
April 2000 and February 2001.

Series E Convertible Preferred Stock Charges

Preferred stock charges during the third quarter and nine months ended September
30, 2001 reflect charges against stockholders' equity that consist of the
beneficial conversion charge of $525,000 and $1,185,000, respectively, and the
accrual of the 4.75% premium related to the Series E Preferred Stock of $297,000
and $693,000, respectively. The beneficial conversion charge reflects
amortization of the beneficial conversion feature related to the preferred
stock. These non-cash charges reduced stockholders' equity and increased the net
loss applicable to common shares. If the preferred stock remains outstanding,
the beneficial conversion charge will be between $500,000 and $600,000 and the
premium will be approximately $300,000, for the fourth quarter of 2001. See Note
5 in Notes to Financial Statements for further discussion of the Series E
Convertible Preferred Stock Charges.

LIQUIDITY AND CAPITAL RESOURCES

The net increase in cash and cash equivalents during the first nine months of
2001 was $4,941,000, due primarily to $23,400,000 received from the net proceeds
of the private placement of Series E Convertible Preferred Stock in February
2001, partially offset by net cash used of $16,371,000 in operating activities
and capital expenditures of $2,123,000. Cash used in operating activities was
due primarily to the net loss of $18,834,000 for the first nine months of 2001.
Capital expenditures were made to



                                       13
<PAGE>
acquire equipment, expand facilities and implement systems to support the
expanding infrastructure of the Company. The Company currently anticipates that
total capital expenditures for fourth quarter of 2001 will be lower than in the
first three quarters of 2001.

As of September 30, 2001, the Company had approximately $200,000 of
component-level and finished goods purchase commitments to its contract
manufacturer.

As of September 30, 2001, the Company had $21,766,000 in cash and cash
equivalents. The Company currently believes that its cash and cash equivalents
will be sufficient to fund its operations for at least the next twelve months.
However, the Company may need to raise additional capital. If so, there can be
no assurance that the Company will be able to raise such capital when required,
or on terms acceptable to the Company.

RECENT ACCOUNTING DEVELOPMENTS

In June 2001, the Financial Accounting Standards Board (FASB) approved
Statements of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets." The
statements eliminate the pooling-of-interests method of accounting for business
combinations and require that goodwill and certain intangible assets not be
amortized. Instead, these assets will be reviewed for impairment at least
annually with any related losses recognized when incurred. SFAS No. 141 is
generally effective for business combinations completed after June 30, 2001.
SFAS No. 142 is effective January 1, 2002 for existing goodwill and intangible
assets and July 1, 2001 for business combinations completed after June 30, 2001.
The Company does not expect these statements to affect its financial position or
results of operations.

In August 2001, the FASB approved Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002. This statement will affect asset
retirement obligations upon adoption.

In October 2001, the FASB approved Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement addresses financial
accounting and reporting for the impairment of long-lived assets and for
long-lived assets to be disposed of and supercedes SFAS No. 121 and APB Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." Statement No. 144 is effective for fiscal
years beginning after December 15, 2001. The Company does not expect this
statement to affect its financial position or results of operations.

FACTORS THAT MAY AFFECT FUTURE RESULTS

This Quarterly Report on Form 10-Q contains certain forward-looking statements
within the meaning of the Private Securities Reform Act of 1995. When used in
this report, the words "anticipates," "believes," "expects," "intends,"
"forecasts," "plans," "future," "strategy," or words of similar import are
intended to identify forward-looking



                                       14
<PAGE>
statements. Other statements of the Company's plans and objectives may also be
considered to be forward-looking statements. Such statements are subject to
certain risks and uncertainties, which could cause actual results to differ
materially from those expressed in the forward-looking statements. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. The Company undertakes no obligation to
publish revised forward-looking statements to reflect the occurrence of
unanticipated events or circumstances after the date hereof. The risks and
uncertainties described below are not the only ones that we face. Additional
risks and uncertainties not presently known to us, or that are currently deemed
immaterial, may also impair our business operations. If any of these risks
actually occur, our financial condition and operating results could be
materially adversely affected. Readers are urged to carefully review and
consider the various disclosures made in this Quarterly Report by the Company as
well as the Company's other filings with the Securities and Exchange Commission.

WHILE WE HAVE GENERATED REVENUES IN THE SECOND AND THIRD QUARTERS OF 2001 FROM
SALES OF OUR FIRST LUNAR FLARE NAS SERVER APPLIANCE, WE CANNOT ASSURE YOU THAT
WE WILL BE ABLE TO GENERATE ADDITIONAL REVENUES AT A LEVEL THAT MEETS
EXPECTATIONS.

With sales of our initial Lunar Flare NAS server appliance, we generated
revenues in the second quarter of 2001 for the first time since we sold the
remaining assets associated with our server line of business in August 1999. Our
third quarter 2001 revenues were not significantly higher than those generated
in the second quarter of 2001. Although we currently anticipate additional
revenues from sales of Lunar Flare NAS, we cannot assure you that we will be
able to generate revenues at a level that meets expectations.

Further, Lunar Flare NAS utilizes Illumina, our patented clustering software,
and all other products we currently plan to develop will be designed utilizing
Illumina. Because Illumina is a new type of software technology, we cannot be
sure that we will sell a significant number of Lunar Flare NAS appliances, nor
can we be sure that anyone will buy our other Illumina-based products that we
may develop. If demand for Lunar Flare NAS or any other Illumina-based products
that we may develop fails to materialize, we will not be able to generate
revenues at a level that meets expectations, which would have a material adverse
effect on our business, financial condition and results of operations.

SOFTWARE ERRORS OR FAILURES FOUND IN OUR PRODUCTS MAY RESULT IN A DELAY IN
DELIVERY OF OUR PRODUCTS OR LOSS OF, OR DELAY IN, MARKET ACCEPTANCE OF OUR
PRODUCTS, WHICH COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS.

Software errors or failures found in our products may result in a delay in
delivery of our products. Further, even though we have performed a significant
amount of testing of our Illumina software and our Lunar Flare NAS server
appliance, they may still contain software errors or failures which are not
detected or remedied until after we ship such products, which could result in
loss of, or delay in, market acceptance, which could in turn materially
adversely affect our operating results. Similarly, other products we develop may
contain software errors or failures which may result in a delay in delivery of
such products or which are not detected or remedied until after we ship such
products. The occurrence of such errors in either the Lunar Flare NAS or other
Illumina-based products could result



                                       15
<PAGE>

in:

     o    The delay in delivery of these products;

     o    The loss of, or delay in, market acceptance and sales of these
          products;

     o    Diversion of development resources;

     o    Injury to our reputation; or

     o    Increased maintenance and warranty costs.

Moreover, because of the way customers may use our products, we may be subject
to significant liability claims if our products do not work properly. Although
the agreements we use to sell our Illumina-based products contain provisions
designed to limit our exposure to potential product liability claims, it is
possible that such limitation-of-liability provisions may not be effective as a
result of existing or future laws or unfavorable judicial decisions. If we are
found to be liable to defective product claims, such liability may have a
harmful effect on our business and financial condition.

THE SUCCESS OF OUR LUNAR FLARE NAS SERVER APPLIANCES AND OTHER ILLUMINA-BASED
PRODUCTS DEPENDS UPON MARKET ACCEPTANCE OF OUR TECHNOLOGY.

Due to the fact that we have been focusing nearly all of our resources on
developing products that utilize Illumina, our future financial performance will
be largely dependent on the acceptance of our Illumina clustering software. We
cannot assure you that the server appliance market, our target market for our
clustering software, will accept Illumina or products utilizing it. Factors that
may affect market acceptance of our products, some of which are beyond our
control, include the following:

     o    Growth and changing requirements of the server appliance market;

     o    Availability, performance, quality, price and total cost of ownership
          of our products;

     o    Availability, performance, quality, price, and total cost of ownership
          of competing products and technologies; and

     o    Successful development of our relationships with licensed
          manufacturers, original equipment manufacturers and channel partners.

If customers do not purchase Lunar Flare NAS or our other Illumina-based
products for any reason, our revenues and operating results will be adversely
affected because we currently have no other products to sell.

ECONOMIC CONDITIONS MAY NEGATIVELY IMPACT MARKET ACCEPTANCE OF OUR PRODUCTS AND
TECHNOLOGY.

General economic conditions and market conditions specific to the technology,
server appliance and network attached storage markets may negatively impact
market acceptance of our products and technology. Current economic conditions
have resulted in overall reduced IT spending and increased price and product
competition within the server appliance market. These current conditions and
possible further adverse changes



                                       16
<PAGE>

in the economy or in customer IT spending may delay or limit market acceptance
of our products and technology.

WE OPERATE IN AN EXTREMELY COMPETITIVE AND RAPIDLY CHANGING MARKETPLACE, AND
MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN US WHICH MAY ALLOW THEM TO
MORE QUICKLY REACT TO CHANGES IN THE MARKETPLACE.

We operate in an extremely competitive and rapidly changing marketplace, and we
cannot assure you that we can establish and maintain a competitive position
against current and potential competitors, especially those with greater
financial, marketing, service, support, technical and other resources. In
addition, we expect that the market for Lunar Flare NAS, our initial server
appliance targeting the network-attached storage market, will become
consolidated with larger companies possibly being in a better position than us
to compete in this rapidly changing marketplace. As the server appliance market
continues to develop, a number of companies which have greater resources than us
could attempt to increase their presence in this market by acquiring or forming
strategic alliances with our competitors or potential business partners.

IF GROWTH IN THE NETWORK-ATTACHED-STORAGE ("NAS") MARKET DOES NOT MEET OUR
EXPECTATIONS, OUR FUTURE FINANCIAL PERFORMANCE COULD BE NEGATIVELY IMPACTED.

We believe our future financial performance depends in part upon the continued
growth in the NAS market. We expect that any revenues that we are able to
generate from product sales in 2001 will come almost exclusively from
Illumina-based products that are sold in the NAS marketplace. The market for NAS
products, however, may not continue to grow at its historical rate and could
possibly decline. Long-term trends in storage technology may change and
competing technologies, such as storage area networks, may emerge as the
preferred storage solution. If the NAS market grows more slowly than anticipated
or declines, our business, financial condition and results of operations could
be materially adversely affected.

WE HAVE A HISTORY OF LOSSES AND EXPECT TO EXPERIENCE LOSSES IN THE FUTURE.

Over the last five years, we have incurred significant net losses, including net
losses of $13.6 million, $7.6 million and $2.1 million in 2000, 1999 and 1998
respectively. We also incurred a net loss of $18.8 million for the first nine
months of 2001. We expect to continue to have losses in the future. In addition,
we had an accumulated deficit of $116.3 million as of September 30, 2001. We
believe that our future growth depends upon the success and market acceptance of
Lunar Flare NAS and other Illumina-based products, as well as our ability to
develop new products and adopt successful marketing and sales strategies, all of
which will require us to incur significant product development and sales and
marketing expenses. We anticipate that we will continue to incur significant
expenses in 2001 as we:

     o    Market and sell our products;

     o    Expand our distribution channels;

     o    Continue our product development activities;

     o    Develop strategic partnerships and alliances with third parties;




                                       17
<PAGE>

     o    Create and market additional server appliance products based on
          Illumina; and

     o    Adjust our infrastructure to support our growth.

As a result of our incurring these expenses, we will need to generate
significant revenues to achieve profitability. If we do not significantly
increase our revenues or if we fail to control our costs as we implement our
business strategies, we may be unable to achieve and maintain profitability. If
we do not achieve and maintain profitability, we may be required to obtain
additional funding, which may not be available to us on commercially reasonable
terms, or at all.

WE MAY NEED ADDITIONAL CAPITAL THAT MAY NOT BE AVAILABLE TO US AND, IF RAISED,
MAY DILUTE OUR EXISTING INVESTORS' OWNERSHIP INTEREST IN US.

We may need to raise additional capital to finance our Company, including funds
to further develop or enhance our software and server appliances, fund
operations, respond to competitive pressures or acquire complementary products,
businesses or technologies. Additional financing may not be available on terms
that are acceptable to us or at all. If we raise additional funds through the
issuance of equity or convertible debt securities, the percentage ownership of
our stockholders would be reduced and these securities may have rights,
preferences and privileges senior to those of our current stockholders which may
adversely impact current stockholders. If adequate funds are not available on
acceptable terms, our ability to fund our operations, take advantage of
unanticipated opportunities, develop or enhance products or services, expand or
otherwise respond to competitive pressures would be significantly limited.

IF WE FAIL TO ESTABLISH SUFFICIENT DIRECT AND INDIRECT SALES CHANNELS FOR OUR
PRODUCTS, OUR ABILITY TO GENERATE REVENUE MAY BE LIMITED.

We currently plan to sell our products directly to end users as well as through
indirect sales channels, including value added resellers, agents and original
equipment manufacturers. In order to grow our business, it will be necessary to
further enhance and expand our recently-established direct and indirect sales
channels. We cannot assure you that we will be able to successfully market and
sell our products directly to end users or that we will be able to do so
profitably. To sell our Illumina-based products through distribution
partnerships and other indirect sales channels, we will need to establish
additional new relationships and significantly expand recently-established
relationships. Our failure to effectively establish new relationships or expand
existing relationships on acceptable terms or in sufficient numbers could
adversely affect our ability to introduce, market and sell our products
successfully. Even if we do establish such distribution relationships, using
other businesses to sell the products we are developing presents several risks
to our business. These risks include our inability to control these
distributors, our dependence upon their continued commercial success and
financial stability, our ability to provide sufficient incentives to promote and
sell our products, and the possibility that they may be unable to market or sell
our products effectively. In addition, we anticipate our agreements with
distribution partners will typically be non-exclusive, so they could carry
competing product lines, devote their efforts to other products in different
markets, reduce or discontinue sales of our products, fail to devote the
resources necessary to provide effective sales and marketing support of our
products or develop their own competing product lines.

WE FACE RISKS OF TECHNOLOGICAL CHANGES THAT MAY RENDER OUR PRODUCTS OBSOLETE.

The markets we serve are characterized by rapid technological change, changing
customer needs, frequent new product introductions and evolving industry
standards. The introduction of products embodying new technologies and the
emergence of new industry standards could render our products and software,
including Lunar Flare NAS and Illumina, obsolete and unmarketable. Our future
success will depend upon our ability to develop and introduce new products,
including new software releases and enhancements, on a timely basis that keep
pace with technological developments and emerging industry standards and address
the increasingly sophisticated needs of our customers. We cannot assure you that
we will be successful in developing and marketing new products that respond to
technological changes or evolving industry standards. If we are unable, for
technological or other reasons, to develop and introduce new products in a


                                       18
<PAGE>

timely manner in response to changing market conditions or customer
requirements, our operating results will be materially adversely affected.

OUR BUSINESS DEPENDS ON THE ACCEPTANCE OF OPERATING SYSTEM SOFTWARE FOR WHICH WE
HAVE NO RESPONSIBILITY OR CONTROL.

Our initial Lunar Flare NAS server appliance utilizes Linux as its operating
system, which is not designed or manufactured by us. We anticipate that Lunar
Flare NAS may in the future, after we further modify and enhance it, utilize
Windows NT(R) and UNIX(R) operating systems, both of which are designed and
manufactured by parties over whom we have no control. Similarly, we anticipate
future Illumina-based products may also be designed to be used with the Linux,
Windows NT(R) and UNIX(R) operating systems. Therefore, our business depends on
the market acceptance of Linux, Windows NT(R) and UNIX(R) to run computer
networks and the willingness of the manufacturers of these operating systems to
continue to offer a quality product. Because we have no control over the market
acceptance of any of this operating software or their manufacturers to continue
to offer quality products that fulfill market demand, our ability to generate
revenues will be largely dependent on the ability and desire of such
manufacturers to continue to offer quality products that fulfill market demand.

WE MAY BE UNABLE TO HIRE AND RETAIN REQUIRED, HIGHLY-SKILLED MANAGERIAL AND
TECHNICAL PERSONNEL.

Our future success depends, in significant part, upon retaining the continued
service and performance of our senior management, team members, consultants and
other key personnel as well as our continued ability to attract and recruit
qualified personnel. Losing the services of any member of our management team
could impair our ability to effectively manage our company and to carry out our
business plan. We also may need to hire additional sales, marketing,
engineering, service and administrative personnel to grow our business and
generate revenues. If we are unable to hire and retain these employees, our
business and operations would be adversely affected. Competition for people with
the skills we require is intense, and we cannot assure you that we will be able
to hire such people or that we will be able to do so without offering these
people salaries that are significantly higher than we have historically paid.
Departures of existing personnel and additions of new personnel, including
departures resulting from our third quarter 2001 restructuring actions, could
disrupt our business and may result in the departure of other employees. We also
depend on the continued service of our key personnel and even though we have
entered into employment agreements with key management personnel, these
agreements cannot prevent their departure.

WE RELY ON CONTRACT MANUFACTURERS/INTEGRATORS TO PRODUCE OUR PRODUCTS AND, IF
OUR MANUFACTURERS FAIL TO MEET OUR REQUIREMENTS, WE MAY BE UNABLE TO MEET
CUSTOMER REQUIREMENTS AND OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED.

Our arrangement with our contract manufacturer to produce our products currently
does not guarantee production levels or manufacturing prices. This manufacturer
may not have additional capacity available when we need it and they may
experience shortages in



                                       19
<PAGE>

supply of key components for an extended time, which would cause delays in the
production of our products, prevent us from satisfying our contractual
obligations and meeting customer expectations, and result in lost sales or
customers. Also, commencing volume production or expanding production to another
facility they operate may be expensive and time-consuming. In addition,
commencement of the manufacturing of our products at additional manufacturing
sites we may need in the future may cause transitional problems, including
delays and quality control issues, which could cause us to lose sales and impair
our ability to achieve profitability. We may need to find new or additional
outside manufacturers to manufacture our products in higher volume and at lower
cost to meet increased demand and competition. If we are required or choose to
change outside manufacturers, we may lose sales and our business could be
materially adversely affected.

OUR RELIANCE UPON PATENTS, DOMESTIC TRADEMARK LAWS AND CONTRACTUAL PROVISIONS TO
PROTECT OUR PROPRIETARY RIGHTS MAY NOT BE SUFFICIENT TO PROTECT OUR INTELLECTUAL
PROPERTY FROM OTHERS WHO MAY SELL SIMILAR PRODUCTS.

Our products are differentiated from those of our competitors because we utilize
Illumina, our internally developed software. If we fail to protect Illumina and
our other intellectual property, other vendors could develop and sell products
with features similar to ours, and this could reduce demand for our products. We
have been granted one U.S. patent related to Illumina and we currently have
eight additional United States patent applications pending with respect to
Illumina to protect our intellectual property rights. We also rely on a
combination of trade secret and other intellectual property law, nondisclosure
agreements and other protective measures to establish and protect our
proprietary rights in our intellectual property.

We believe that the steps we have taken to safeguard our intellectual property
afford only limited protection. Others may develop technologies that are similar
or superior to our technology or design around the patents and trade secrets we
own. Despite the precautions we have taken, laws and contractual restrictions
may not be sufficient to prevent misappropriation of our technology or deter
others from developing similar technologies.

In addition, the laws of the countries in which we may market our services and
solutions may offer little or no effective protection of our proprietary
technology. Reverse engineering, unauthorized copying or other misappropriation
of our patented, proprietary technology or disclosure as a result of the use of
open source software, could enable third parties to benefit from our technology
without paying us for it, which would significantly harm our business.

OTHERS MAY ASSERT INTELLECTUAL PROPERTY CLAIMS AGAINST US AND OUR OPERATING
RESULTS WOULD SUFFER IF WE WERE SUBJECT TO A PROTRACTED INFRINGEMENT CLAIM OR IF
WE BECOME OBLIGATED TO PAY A SIGNIFICANT DAMAGE AWARD.

Substantial litigation regarding intellectual property rights and brand names
exists in our industry. We expect that server appliance products may be
increasingly subject to third-



                                       20
<PAGE>

party infringement claims as the number of competitors in our industry segment
grows and the functionality of products in different industry segments overlaps.
We do not believe that our products employ technology that infringes any
proprietary rights of third parties. However, third parties may claim that we
infringe their intellectual property rights and such claims may be found to be
valid. Any claims, with or without merit, could:

     o    Be time-consuming to defend;

     o    Result in costly litigation;

     o    Divert our management's attention and resources;

     o    Cause product shipment delays; and

     o    Require us to enter into royalty or licensing agreements.

If we are found to be infringing upon the rights of others, we could be forced
to develop a non-infringing alternative that could be costly and time-consuming.
We may also be required, if we are found to be infringing on the intellectual
rights of others, to enter into royalty or licensing agreements with a third
party, which agreements may not be available on terms acceptable to us. A valid
claim by a third party of product infringement against us or our failure or
inability to license the infringed or similar technology could adversely affect
our business because we would not be able to sell the impacted product without
redeveloping it or incurring significant additional expenses.

OUR STOCK IS SUBJECT TO POTENTIAL DILUTION THROUGH THE CONVERSION OF SERIES E
PREFERRED STOCK, AND THE ACCOUNTING TREATMENT FOR THE SERIES E PREFERRED STOCK
CONVERSION FEATURE WILL RESULT IN SIGNIFICANT, NON-CASH CHARGES AGAINST INCOME
APPLICABLE TO COMMON STOCKHOLDERS.

The shares of Series E Preferred Stock issued in February 2001 are convertible
into shares of our common stock at a conversion price of $9.50 per share of
common stock. However, the conversion price of the Series E Preferred Stock may
be decreased in certain circumstances (which could result in an increase in the
number of shares of common stock issued upon conversion of the Series E
Preferred stock), including if we



                                       21
<PAGE>

sell shares of our common stock in certain circumstances below the initial
conversion price of $9.50 or issue securities that are convertible into shares
of common stock at an effective price of less than $9.50 per share. In addition,
if the Series E Preferred Stock is not converted to our common stock prior to
February 27, 2004 (unless the Company elects to redeem the Preferred stock), it
will automatically convert to common stock on that date, and the conversion
price will be based on the average market price of our common stock during the
fifteen trading days preceding that date. If the average market price of our
common stock is lower than $9.50 during these fifteen days, the conversion price
will be lower that $9.50 and the number of shares of common stock into which the
Series E Preferred Stock is convertible will increase, possibly by a substantial
amount, which would dilute the percentage ownership of our existing
shareholders. An increase in the number of shares issued or issuable upon
conversion of the Series E Preferred stock could have a material adverse effect
on the market price of our common stock.

Accounting for the preferred stock conversion feature in accordance with
Emerging Issues Task Force (EITF) issue No. 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Rates" and EITF Issue No. 00-27 "Application of Issue 98-5 to Certain
Convertible Investments" resulted in the allocation of approximately $7.9
million of the net offering proceeds to a "beneficial conversion feature". This
beneficial conversion feature will be amortized as a non-cash charge against
stockholders' equity over the shorter of three years or the period during which
the Preferred Stock remains outstanding. In addition, the Company will accrue a
premium on the stated value of outstanding Preferred Stock, which is payable to
the Preferred Stockholders in additional common stock upon conversion or in cash
upon redemption of the Preferred Stock, at an annual rate of 4.75%. This premium
will also be recorded as a non-cash charge against stockholders' equity. The
charges against stockholders' equity resulting from the amortization of the
beneficial conversion feature and accrual of the premium will reduce income
(increase the loss) applicable to common stockholders which will reduce income
(increase the loss) per common share reported by the Company. If the Preferred
Shares remain outstanding for their full three year term, without adjustment of
the conversion price as described above, charges to equity for amortization of
the beneficial conversion feature and accrual of the premium would total
approximately $11.5 million. If the conversion price is adjusted as described
above, an increase in the number of shares issued or issuable upon conversion of
the Series E Preferred stock could result in increased charges against income
applicable to common stockholders and could have a material adverse effect on
the market price of our Common Stock.

BEGINNING LATER IN 2002, IF WE FAIL TO MAINTAIN THE LISTING OF OUR COMMON STOCK
ON THE NASDAQ SMALLCAP MARKET OR OTHER REQUIRED TRADING MARKET, WE MAY BE
REQUIRED TO REDEEM OUR SERIES E PREFERRED STOCK AND WE MAY NOT HAVE SUFFICIENT
CASH TO REDEEM THESE SECURITIES.

Pursuant to the terms of our outstanding Series E Preferred Stock, beginning
later in 2002, we are required to maintain the listing of our common stock on
the Nasdaq Smallcap Market, the Nasdaq National Market, the New York Stock
Exchange or the American Stock Exchange. If we fail to continue to have our
common stock listed on the Nasdaq Smallcap market, or other required trading
market, for any 60 day-period any



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<PAGE>

time after August 27, 2002, then the holders of the Series E Preferred Stock
could require us to redeem our Series E Preferred Stock. Should such redemption
be required, we may not have sufficient cash to be able to redeem these
securities. Further, even if we have sufficient cash to redeem these securities,
any required redemption could have a material adverse effect on our business and
financial condition.

FAILURE TO MAINTAIN COMPLIANCE WITH NASDAQ'S LISTING REQUIREMENTS COULD RESULT
IN OUR DELISTING BY NASDAQ FROM THE NASDAQ SMALLCAP MARKET, WHICH COULD
SIGNIFICANTLY LIMIT THE ABILITY TO SELL OUR COMMON STOCK AS WELL AS
SIGNIFICANTLY LIMIT OUR ABILITY TO RAISE ADDITIONAL CAPITAL.

Our common stock is currently traded on the Nasdaq Smallcap Market. The Nasdaq
Smallcap Market has several continued listing requirements, including a
requirement that the closing bid price of our common stock must be $1.00 or
greater. If we fail to meet these listing requirements, including if the minimum
closing bid price of our common stock falls below the $1.00 threshold for 30
consecutive days, our stock could be delisted from the Nasdaq Smallcap Market.
In September 2001, the Nasdaq Smallcap Market announced that it was suspending
the $1.00 minimum closing bid requirement until January 2, 2002. After January
2, 2002, if the minimum closing bid price of our common stock falls below $1.00
for 30 consecutive days, Nasdaq would notify us that our common stock might be
delisted from the Nasdaq Smallcap Market. If the closing bid price of our common
stock does not thereafter regain compliance for a minimum of 10 consecutive
trading days during the 90 days following notification by Nasdaq, Nasdaq may
delist our common stock from trading on the Nasdaq Smallcap Market. If our stock
were delisted, the ability to sell our common stock and our ability to raise
additional capital could be significantly limited. On November 12, 2001, the
closing sales price of our common stock as reported by the Nasdaq Smallcap
Market was $1.09.

WE CURRENTLY DO NOT ANTICIPATE PAYING ANY CASH DIVIDENDS.

We currently intend to retain any future earnings for use in our business and do
not anticipate paying any cash dividends in the foreseeable future. Therefore,
any gains from your investment in our common stock will have to come from an
increase in its market price.

THE MARKET PRICE OF OUR COMMON STOCK HAS FLUCTUATED SIGNIFICANTLY IN THE PAST
AND WILL LIKELY CONTINUE TO DO SO IN THE FUTURE AND ANY BROAD MARKET
FLUCTUATIONS MAY MATERIALLY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON
STOCK.

The market price of our common stock has been volatile in the past, and several
factors could cause the price to fluctuate substantially in the future. These
factors include:

     |X|  Successful and timely development and introduction of our products or
          enhancements to our products;

     |X|  Fluctuations in our operating results;

     |X|  Fluctuations in the valuation of companies perceived by investors to
          be comparable to us;

     |X|  A shortfall in revenues or earnings compared to securities analysts'
          expectations;

     |X|  Changes in analysts' recommendations or projections;

     |X|  Announcements of new products, applications or product enhancements by
          us or our competitors; and

     |X|  Changes in our relationships with our suppliers, channel partners and
          customers.

In addition, the stock market has recently experienced volatility that has
particularly affected the market prices of equity securities of many technology
companies and that often has been unrelated to the operating results of such
companies. As a result, the market price of our common stock may fluctuate
significantly in the future and any broad market fluctuations may materially
adversely affect the market price of common stock. In the past, companies that
have experienced volatility in the market price of their stock have been the
subject of securities class action litigation. If we were the subject of
securities class action litigation, it could result in substantial costs and a
diversion of management's attention and resources.



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<PAGE>


                                     ITEM 3:

                          QUANTITATIVE AND QUALITATIVE
                          DISCLOSURES ABOUT MARKET RISK

FINANCIAL INSTRUMENTS

The Company invests excess funds not required for current operations in cash
equivalents, primarily money market funds or high-grade commercial paper. Market
risk was estimated as the potential decrease in interest income resulting from a
hypothetical one percent decrease in interest rates for the cash equivalents,
which would have resulted in a decrease in interest income for the nine months
ended September 30, 2001 of approximately $200,000.




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<PAGE>

                           PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(b)  Reports on Form 8-K

     On July 26, 2001, the Company furnished a report on Form 8-K under Item 5,
     Other, related to a press release announcing financial results for the
     second quarter ended June 30, 2001.

     On September 18, 2001, the Company furnished a report on Form 8-K under
     Item 5, Other, related to a press release announcing restructuring, expense
     reductions.



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<PAGE>




                                    SIGNATURE

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

                     TRICORD SYSTEMS, INC.

                              (REGISTRANT)

                     By:   /s/ Joan M. Wrabetz
                           -----------------------------------------
                           Joan M. Wrabetz, President and
                           Chief Executive Officer (Principal
                           Executive Officer)

                     By:   /s/ Steven E. Opdahl
                           ------------------------------------------
                           Steven E. Opdahl,
                           Chief Financial Officer
                           (Principal Financial Officer and
                           Principal Accounting Officer)

                    Date:  November 14, 2001










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