<PAGE>   1

                                    FORM 10-Q

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

 (Mark one)

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

               FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1998.

[ ]     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 0-22015

                                  ARTECON, INC.
             (Exact name of registrant as specified in its charter)


           DELAWARE                                           77-032-4887
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                            Identification Number)

6305 El Camino Real                                              92009
Carlsbad, CA                                                  (Zip Code)
(Address of principal
executive offices)

                                 (760) 931-5500
              (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. [X] Yes [ ] No

As of December 31, 1998, there were 21,602,441 shares of the Registrant's Common
Stock outstanding.


                                       1

<PAGE>   2



                                 ARTECON, INC.
                                FORM 10-Q INDEX

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

Item 1. Financial Statements

               Consolidated Balance Sheets as of December 31, 1998
               (unaudited) and March 31, 1998 ............................................ 3
               Consolidated Statements of Operations (unaudited)
               for the Three Months and Nine Months Ended December 31,1998
               and 1997................................................................... 5

               Consolidated Statements of Cash Flows (unaudited)
               for the Nine Months Ended December 31, 1998 and 1997....................... 6

               Notes to Consolidated Financial Statements (unaudited)..................... 8

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

Item 3.        Quantitative and Qualitative Disclosure About Market Risk..................16


PART II.       OTHER INFORMATION

Item 1.        Legal Proceedings..........................................................16
Item 2.        Change in Securities and Use of Proceeds...................................16
Item 3.        Defaults Upon Senior Securities............................................16
Item 4.        Submission of Matters to a Vote of Security Holders........................16
Item 5.        Other Information..........................................................17
Item 6.        Exhibits and Reports on Form 8-K...........................................17
Signatures     ...........................................................................18

Exhibit Index ............................................................................19
</TABLE>


                                       2

<PAGE>   3


                          PART I. FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

                                  ARTECON, INC.
                           CONSOLIDATED BALANCE SHEET
                                 (In thousands)

<TABLE>
<CAPTION>
                                                               December 31,   March 31,
                                                                  1998          1998
                                                              -------------   ---------
                                                              (unaudited)
<S>                                                           <C>            <C>     
ASSETS
CURRENT ASSETS
  Cash and cash equivalents                                     $  1,389      $  7,992
  Accounts receivable, less allowance for doubtful
    accounts and sales returns of $839 at December 31, 1998
    and $801 at March 31, 1998                                    15,144        18,415
  Inventories, net                                                13,334        12,354
  Deferred income taxes                                            3,510         3,510
  Prepaid expenses and other                                       1,299         1,654
                                                                --------      --------

    Total current assets                                          34,676        43,925

Property and Equipment
Machinery and equipment                                            4,760         4,474
Tooling molds                                                        975         1,158
Furniture and fixtures                                               150           105
Computer software                                                    400           347
                                                                --------      --------

                                                                   6,285         6,084
Less: accumulated depreciation                                    (4,234)       (2,358)
                                                                --------      --------

    Property and equipment, net                                    2,051         3,726

Other Assets                                                           2           133

Goodwill, net                                                      4,168         4,668

Other Intangible Assets, net                                       1,763         3,291

Deferred Income Taxes                                              1,521         1,602
                                                                --------      --------


                                                                $ 44,181      $ 57,345
                                                                ========      ========

</TABLE>

           See accompanying notes to consolidated financial statements


                                       3

<PAGE>   4


<TABLE>
<CAPTION>
                                                                                  December 31,    March 31,
                                                                                      1998           1998
                                                                                  -------------   ---------
                                                                                   (Unaudited)
<S>                                                                               <C>             <C>     

LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities
Accounts payable                                                                     $ 10,467      $ 14,161
Accrued compensation                                                                    1,509         2,431
Accrued merger liabilities                                                                569         5,406
Other accrued liabilities                                                               3,662         4,317
Short-term borrowings                                                                      --            35
Current portion of long-term debt                                                         474           756
                                                                                     --------      --------
Total current liabilities                                                              16,681        27,106

Long-term Liabilities                                                                     142            13

Borrowings Under Lines of Credit                                                       12,296         7,899

Long-term Debt                                                                          1,475         2,585

Minority Interest                                                                          51            63
                                                                                     --------      --------

    Total Liabilities                                                                  30,645        37,666

Shareholders' Equity
Convertible preferred Series A shares, $.005 par value, 10,000 shares
  authorized, 2,494 shares issued and outstanding at December 31, 1998 
  and March 31, 1998;
  Liquidation Preference of $4,988                                                         12            12
Common shares, $.005 par value, 40,000 shares authorized;
  21,588 and 21,387 shares issued and outstanding
  at December 31, 1998 and March 31, 1998, respectively                                   108           107
Additional paid-in capital                                                             39,376        39,148
Accumulated other comprehensive income:
  Foreign currency translation adjustment                                                 (25)          (97)
Accumulated deficit                                                                   (25,935)      (19,491)
                                                                                     --------      --------
  Total shareholders' equity                                                           13,536        19,679
                                                                                     --------      --------

                                                                                     $ 44,181      $ 57,345
                                                                                     ========      ========

</TABLE>

           See accompanying notes to consolidated financial statements


                                       4
<PAGE>   5



                                  ARTECON, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)
                      (In thousands, except per share data)

<TABLE>
<CAPTION>
                                                 Three Months Ended          Nine Months Ended
                                              December 31,  December 31,  December 31,   December 31,
                                                 1998          1997          1998          1997
                                              -----------   ------------  ------------   ------------
<S>                                           <C>           <C>           <C>           <C>     

NET REVENUES                                   $ 19,639      $ 22,401      $ 77,552      $ 52,601

COST OF SALES                                    13,554        16,070        50,139        36,980
RESTRUCTURE EXPENSES                                403            --           403            --
                                               --------      --------      --------      --------

GROSS MARGIN                                      5,682         6,331        27,010        15,621

OPERATING EXPENSES:
Selling & service                                 7,105         3,872        20,666         8,270
General & administrative                          1,574           963         4,034         2,720
Research and development                          1,825           948         5,989         2,391
Restructure expenses                              1,404            --         1,404            --
Impairment of intangible assets                     580            --           580            --
Acquired in-process research
  and development costs                              --            --            --         3,700
                                               --------      --------      --------      --------
    Total operating expenses                     12,488         5,783        32,673        17,081

OPERATING INCOME (LOSS)                          (6,806)          548        (5,663)       (1,460)

OTHER EXPENSE:
Other income (expense), net                          10           (82)           15           (77)
Loss on foreign currency transactions, net           (1)         (149)          (25)         (185)

Interest, net                                      (282)         (172)         (754)         (465)
                                               --------      --------      --------      --------

    Total other expense                            (273)         (403)         (764)         (727)

INCOME (LOSS) BEFORE INCOME                      (7,079)          145        (6,427)       (2,187)
  TAX PROVISION                                

INCOME TAX PROVISION (BENEFIT)                     (284)          298            17          (573)
                                               --------      --------      --------      --------

NET LOSS                                       $ (6,795)     $   (153)     $ (6,444)     $ (1,614)
                                               ========      ========      ========      ========

BASIC NET LOSS PER SHARE                       $  (0.32)     $  (0.03)     $  (0.30)     $  (0.29)
                                               ========      ========      ========      ========

WEIGHTED AVERAGE SHARES USED
  TO CALCULATE BASIC NET LOSS
  PER SHARE                                      21,595         6,041        21,515         5,619
                                               ========      ========      ========      ========

DILUTED NET LOSS PER SHARE                     $  (0.32)     $  (0.03)     $  (0.30)     $  (0.29)
                                               ========      ========      ========      ========

WEIGHTED AVERAGE SHARES USED
  TO CALCULATE DILUTED NET LOSS
  PER SHARE                                      21,595         6,041        21,515         5,619
                                               ========      ========      ========      ========
</TABLE>


           See accompanying notes to consolidated financial statements



                                       5
<PAGE>   6


                ARTECON,INC.CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
                                 (In thousands)

<TABLE>
<CAPTION>
                                                        December 31,  December 31,
                                                           1998          1997
                                                        ------------  ------------
<S>                                                     <C>           <C>      

CASH FLOW FROM OPERATING ACTIVITIES
Net loss                                                 $ (6,444)     $ (1,614)
Adjustments to reconcile net loss to net cash
  Used in operating activities
  Depreciation and amortization                             3,388           635
  Compensation expense related to stock issuances              --           699
  Acquired in-process research and development costs           --         3,700
  Provision for doubtful accounts and sales returns            38          (457)
  Deferred Income taxes                                        --        (1,933)
  Impairment of intangible assets                             880            --
  Changes in operating assets and liabilities
    Accounts Receivable                                     3,233        (1,913)
    Inventories                                              (980)           67
    Prepaid expenses and other assets                         601            36
    Accounts payable                                       (3,694)       (2,051)
    Accrued compensation                                     (922)          280
    Accrued merger liabilities                             (4,837)           --
    Other accrued liabilities                                (667)         (596)
    Income taxes payable                                       --           568
    Long-term liabilities                                     129          (104)
                                                         --------      --------

      Net cash used by operating activities                (9,275)       (2,683)

CASH FLOW FROM INVESTING ACTIVITIES
Purchase of property and equipment                           (599)         (440)
Cash paid for acquisition, net of cash acquired                --          (432)
                                                         --------      --------
      Net cash used by investing activities                  (599)         (872)

CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from bank borrowings                              40,754        24,208
Payments on bank borrowings                               (37,784)      (21,571)
Issuance of common shares                                     229            17
                                                         --------      --------

      Net cash provided by financing activities             3,199         2,654

EFFECT OF EXCHANGE RATE CHANGES ON CASH                        72           155

NET DECREASE IN CASH                                       (6,603)         (746)

CASH, beginning of period                                   7,992           746
                                                         --------      --------

CASH, end of period                                      $  1,389            $-
                                                         ========      ========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION - Cash paid during the period
  for:
  Interest                                               $    554      $    400
                                                         ========      ========
  Income taxes                                           $     11      $    761
                                                         ========      ========

</TABLE>


                                       6
<PAGE>   7



<TABLE>
<CAPTION>
                                                        December 31,     December 31,
                                                            1998             1997
                                                        ------------     ------------
<S>                                                     <C>              <C>  
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND                        
  FINANCING ACTIVITIES                                                
  Issuance of common shares for accrued liability                         $    122
                                                                          ========
  Issuance of common shares for preferred share                       
    repurchase agreement                                                  $    125
                                                                          ========
DETAIL OF BUSINESS ACQUIRED IN PURCHASE                               
BUSINESS COMBINATION On August 21, 1997,                              
  the Company acquired certain                                        
    assets of Falcon Systems, Inc.                                    
  A summary of the transaction is as follows:                         
    Fair value of other assets acquired                                   $ 10,232
    Acquired in-process research and development costs                       3,700
    Other intangible assets                                                    420
    Goodwill                                                                   127
    Acquired developed technology                                               91
    Note to Falcon shareholder                                              (2,500)
    Cash paid for acquisition, net of cash acquired                           (432)
                                                                          --------
    Liabilities assumed                                                   $ 11,638
                                                                          ========
</TABLE>

           See accompanying notes to consolidated financial statements



                                       7
<PAGE>   8


                                  ARTECON, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

1.      BASIS OF PRESENTATION

        The accompanying unaudited consolidated financial statements included
herein have been prepared by Artecon, Inc. (the "Company") pursuant to the rules
and regulations of the Securities and Exchange Commission (the "SEC").
Accordingly, they do not include all of the information and disclosures required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments and reclassifications considered
necessary for a fair and comparable presentation have been included and are of a
normal recurring nature. The unaudited consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended March 31, 1998. The results of operations for the three months and nine
months ended December 31, 1998, are not necessarily indicative of the results
which may be reported for any other interim period or for the year ending March
31, 1999.


2.      INVENTORIES

        Inventories, net of reserves, consist of (in thousands):

<TABLE>
<CAPTION>
                                 December 31, March 31,
                                   1998        1998
                                  -------     -------
<S>                               <C>         <C>    
Purchased parts and materials     $ 9,158     $ 6,972
Work-in-process                        40       1,599
Finished goods                      4,136       3,783
                                  -------     -------
                                  $13,334     $12,354
                                  =======     =======
</TABLE>

        During the quarter ended December 31, 1998, the Company recorded a
charge of approximately $2.1 million for write-offs of inventory. These
write-offs were related to excess and obsolete inventory and customer service
inventory reserves. In addition, approximately $416,000 of inventory was written
off for discontinued product lines as part of the restructuring expenses.

3.      BORROWINGS UNDER LINE OF CREDIT

        In May 1998, the Company entered into a revolving credit facility with
LaSalle National Bank (the "Line of Credit") which permits borrowings of up to
$15,000,000. Under the terms of the Line of Credit, borrowings are
collateralized by substantially all of the Company's assets and mature in May
2001 unless otherwise renewed. Borrowings under the Line of Credit bear interest
either at the bank's prime rate, or at the LIBOR rate plus 1.75%. Monthly
payments consist of interest only, with the principal due at maturity. As of
December 31, 1998, the total outstanding balance under the Line of Credit was
$12.3 million. The line of credit agreement requires that the Company comply
with certain covenants, including minimum net income and tangible net worth. The
Company is currently not in compliance with these covenants, and has obtained
waivers regarding its non-compliance with these covenants.

4.     EARNINGS PER SHARE

     In February 1997, the Financial Accounting Standards Board issued Statement



                                       8
<PAGE>   9

No. 128, "Earnings Per Share" ("FAS 128"). This statement establishes standards
for computing and presenting earnings per share ("EPS"). Basic EPS excludes
dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding during the respective
periods. Diluted net EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. FAS 128 requires restatement of all prior-period
EPS data presented. The computation of diluted net loss per share for the three
and nine month periods ended December 31, 1998 and 1997, respectively, excludes
the effect of the diluted securities, conversion of preferred stock and stock
options since the effect would be antidilutive.

5.    EMPLOYEE STOCK PLANS

        A total of 3,000,000 shares of common stock are currently reserved for
issuance pursuant to the 1996 Stock Option Plan (the "1996 Plan"). During the
first nine months of the fiscal year ending March 31, 1999, the Company granted
options to purchase 1,867,500 shares of common stock at exercise prices ranging
from $1.50 to $3.75 per share. Additionally, options to purchase 217,500 shares
of common stock with exercise prices ranging from $5.13 to $7.00 per share were
cancelled and re-granted at an exercise price of $3.38 per share. As of December
31, 1998, options to purchase 1,720,367 shares of common stock were outstanding
under the 1996 Plan and 1,279,633 shares of common stock remained available for
issuance under the 1996 Plan.

        A total of 400,000 shares of Common Stock are currently reserved for
issuance under the 1996 Employee Stock Purchase Plan (the "Purchase Plan"). As
of December 31, 1998, a total of 218,545 shares of Common Stock had been
purchased under the Purchase Plan, and 181,455 shares remained available for
purchase under the Purchase Plan.

6.      CHANGES IN ACCOUNTING PRINCIPLES

        As of April 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
This statement requires the Company to report comprehensive income and its
components, including foreign currency translation adjustments. SFAS 130 also
requires the Company to restate financial statements for earlier periods
provided for comparative purposes. The Company's total comprehensive income is
as follows:

<TABLE>
<CAPTION>
                                           Three Months Ended                 Nine Months Ended
                                     December 31,     December 31,      December 31,       December 31,
                                        1998              1997              1998              1997
                                     ------------     ------------      ------------       ------------
<S>                                  <C>              <C>               <C>                <C>     

Net Loss                              $(6,795)          $  (153)          $(6,444)          $(1,641)

Foreign currency translation
(loss) gain                              (291)              (19)               72               155
                                      -------           -------           -------           -------

Total Comprehensive Loss              $(7,086)          $  (172)          $(6,372)          $(1,486)
                                      =======           =======           =======           =======
</TABLE>

7.      RECENT ACCOUNTING PRONOUNCEMENTS

        In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information"("SFAS 131"), which is effective for
fiscal years beginning after December 15, 1997. SFAS 131 establishes standards
for the manner in which public business enterprises report information about



                                       9
<PAGE>   10

operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments. Additionally,
in February 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 132 ("SFAS 132"), "Employer's Disclosure
about Pensions and Other Post Retirement Benefits". Effective for the fiscal
year ending March 31, 1999, the Company will adopt SFAS 131 and SFAS 132. The
Company does not anticipate that the adoption of SFAS 131 and SFAS 132 will have
a significant effect on the Company's financial statements.

        In June 1998, FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"), which is effective for fiscal years beginning after June 15, 1999. SFAS
133 will require the Company to record all derivatives on the balance sheet at
fair value. For derivatives that are hedges, changes in the fair value of
derivatives will be offset by the change in fair value of the hedged assets,
liabilities, or firm commitments. The Company believes the impact of adopting
SFAS 133 will not be material to results from continuing operations or equity.

8.      RESTRUCTURING AND IMPAIRMENT OF INTANGIBLE ASSETS

        During the quarter ended December 31, 1998, the Company recognized
approximately $1.8 million in restructuring charges. These charges were related
to a formal decision by the Board of Directors to consolidate one of its
engineering facilities, eliminate low-volume, low-profit product lines,
discontinue a certain product development project, and to consolidate sales and
service facilities.

        During the quarter ended December 31, 1998, the Company recognized an
$880,000 impairment of intangible assets. This asset impairment related to a
revaluation of other assets associated with the reduction of the related
workforce. Of the total impairment of intangible assets, $300,000 has been
included as a component of restructuring expenses, as the impairment was a
direct result of employee terminations associated with the restructuring
activities.

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

        This Form 10-Q contains forward-looking statements, which are subject to
a number of risks and uncertainties. Such forward-looking statements include
statements regarding the Company's position as a leader in the markets within
which it operates, anticipated growth in sales to various customer bases,
efficiencies resulting from consolidation of operations and restructuring and
the adequacy of the Company's capital resources to meet capital commitments and
operating requirements. The Company's actual results may differ materially from
those discussed here. Factors that could cause or contribute to such differences
can be found in the following discussion as well as the Company's Annual Report
on Form 10-K for the year ended March 31, 1998.

        The Company designs, manufactures, markets and supports a broad range of
scalable, fully integrated data storage products for the open-systems computing
environment. The Company has established itself as a leader in the design,
manufacture and sale of third-party mass storage and enhancement products in the
Sun Microsystems, UNIX and PC-LAN markets, offering both host-attached and
network-attached storage solutions for a broad range of customers. The Company
offers a wide range of products and services in four principal areas: enterprise
storage, workstation and server rack solutions, telecommunications and disk and
tape storage systems.



                                       10
<PAGE>   11

        On March 31, 1998, the Company (then known as Storage Dimensions, Inc.)
entered into a merger transaction with Artecon, Inc., a California corporation
("Artecon California"), in a stock-for-stock transaction accounted for as a
purchase of the Company by Artecon California but in which the Company was the
surviving entity (the "Storage Dimensions Merger"). In connection with the
Storage Dimensions Merger, the Company changed its name from Storage Dimensions,
Inc. to Artecon, Inc. As a result of the Storage Dimensions Merger, the Company
is one of the world's largest third-party storage companies serving the combined
PC-LAN and UNIX open systems network computer markets. On June 25, 1998, Artecon
California was merged with and into the Company.

        On August 21, 1997, Artecon California acquired substantially all of the
assets and liabilities of Falcon Systems, Inc. ("Falcon"), a network-attached
storage server integrator and storage peripherals reseller, in a transaction
accounted for as a purchase of Falcon by Artecon California (the "Falcon
Acquisition"). The Falcon Acquisition has enabled the Company to achieve several
important strategic objectives, including the acquisition of the AerREAL(TM)
real-time specialized file server software and other complementary products to
better serve the Company's existing customers, the expansion of the Company's
customer base in the UNIX, Windows NT and Windows 95 markets and a significant
expansion of the Company's revenue base.

        The Company's financial results referred to in this Report for periods
prior to the closing of the Storage Dimensions Merger or the Falcon Acquisition
do not include financial results for Storage Dimensions or Falcon, respectively,
for such periods. Financial information for the Falcon business is included in
the financial results since August 21, 1997, the effective date of the Falcon
Acquisition.

        Fluctuations in quarterly and annual results may occur as a result of a
number of risk factors, including: the level of competition; the size, timing,
cancellation or rescheduling of significant orders; product configuration and
mix; general economic, market conditions and buyer purchasing trends; market
acceptance of new products and product enhancements; new product announcements
or introductions by competitors; deferrals of customer orders in anticipation of
new products or product enhancements; changes in pricing by the Company or its
competitors; the impact of price protection measures and return privileges
granted by the Company to its distributors and VARs; the ability of the Company
to develop, introduce and market new products and product enhancements on a
timely basis; hardware component costs and availability, particularly with
respect to hardware components obtained from sole sources; hardware supply
constraints; the company's success in expanding its sales and marketing
programs; technological changes in the network storage system market, in
particular the PC-LAN and UNIX storage system markets; the mix of sales among
the Company's sales channels; levels of expenditures on research and
development; changes in the Company's strategy; personnel changes; and general
economic trends and other factors. Due to such fluctuations, historical results
and percentage relationships are not necessarily indicative of the operating
results for any future period.

RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS AND NINE MONTHS ENDED DECEMBER 31, 1998 AND 1997

        Net Revenues. Net revenues reflect invoiced amounts for products
shipped, less reserves for estimated returns. Net revenues decreased $2.8
million, or 12.3%, to $19.6 million for the quarter ended December 31, 1998
compared to $22.4 million for the three months ended December 31, 1997. Net
revenues decreased $11.4 million in the quarter ended December 31, 1998 compared
to the second quarter ended September 30, 1998. The decrease in revenues is
primarily 



                                       11
<PAGE>   12

attributable to lower than expected orders from key customer segments including
financial services and energy customers, slower than expected production ramp up
by some of the Company's telecommunications and OEM customers, and less than
expected government spending patterns.

        Net revenues increased $25.0 million, or 47.4%, to $77.6 million for the
nine-month period ended December 31, 1998 compared to $52.6 million for the same
period last year. This increase in net revenues is primarily attributable to
revenue from the Storage Dimensions product lines, which represented $35.7
million of this increase. This increase was offset by a $12.7 million decrease
in revenues from the Falcon product lines.

        Gross Margin. Gross margin as a percentage of net revenues for the
three- and nine-month periods ended December 31, 1998 were 28.9% and 34.8% of
net revenues, respectively, compared to 28.3% and 29.7% of net revenues,
respectively, for the three- and nine-month periods ended December 31, 1997.
These increases in gross margin as a percentage of net revenues were primarily
attributable to efficiencies gained due to the consolidation of Storage
Dimensions and Artecon product lines. Gross margin as a percentage of net
revenues for the quarter ended December 31, 1998 decreased to 28.9% compared to
35.8% for the quarter ended September 30, 1998. This decrease is primarily
attributable to two factors: a $1.1 million write-off of inventory for excess
and obsolete inventory, and $403,000 related to restructuring expenses.

        Selling and Services Expenses. Selling and service expenses are
comprised primarily of salaries, commissions, and marketing costs. Selling and
service expenses in the three and nine months ended December 31, 1998 were $7.1
million, or 36.2% of net revenues, and $20.7 million, or 26.6% of net revenues,
respectively, compared to $3.9 million, or 17.3% of net revenues, and $8.3
million, or 15.7% of net revenues, for the comparable periods ended December 31,
1997. These increases in selling expenses as a percentage of net revenues were
primarily attributable to two factors: lower than expected revenues and an
approximate $896,000 write-off of excess and obsolete and service inventory.

        General and Administrative Expenses. General and administrative ("G &
A") expenses are comprised of overhead costs associated with the Company's
finance and administrative staff. G & A expenses in the three-and nine-month
periods ended December 31, 1998 were $1.6 million, or 8.0% of net revenues, and
$4.0 million, or 5.2% of net revenues, respectively, compared to $1.0 million,
or 4.3% of net revenues, and $2.7 million, or 5.2% of net revenues,
respectively, for the same periods a year ago. The increase in G & A expenses
for the quarter ended December 31, 1998 as a percentage of revenues compared to
the prior fiscal year is primarily attributable to the lower sales revenue.

        Research and Development Expenses. Research and development expenses are
comprised primarily of prototype expenses, salaries for employees directly
engaged in research and other costs associated with product development.
Research and development expenses in the three- and nine-month periods ended
December 31, 1998 were $1.8 million, or 9.3% of net revenues, and $6.0 million,
or 7.7% of net revenues, respectively, compared to $0.9 million, or 4.2% of net
revenues, and $2.4 million, or 4.5% of net revenues, respectively, for the same
periods ended December 31, 1997. The increase in research and development
expenses compared to the prior fiscal year is attributable to management's
decision to initially maintain the combined Storage Dimensions and Artecon
engineering staff, which has subsequently been reduced as part of the
restructuring. The increase in research and development expenses as a percentage
of revenues compared to the prior fiscal year is attributable to the lower than
expected sales revenues.



                                       12
<PAGE>   13

        Restructuring Expenses and Impairment of Intangible Assets. During the
quarter ended December 31, 1998, the Company recognized approximately $1.8
million in restructuring charges. These charges were related to a formal
decision by the Board of Directors to consolidate one of its engineering
facilities, eliminate low-volume, low-profit product lines, discontinue a
certain product development project, and to consolidate sales and service
facilities. These restructuring expenses are comprised of severance and
workforce reduction expenses of $554,000, inventory write-off for discontinued
product lines of $416,000, sales office leases and other office closure expenses
of $714,000, and write-off of $123,000 of tooling costs associated with a
certain product development project.

        During the quarter ended December 31, 1998, the Company recognized an
$880,000 impairment of intangible assets. This asset impairment is related to a
revaluation of other intangible assets associated with the reduction of the
related workforce. Of the total impairment of intangible assets, $300,000 has
been included as a component of restructuring expenses, as the impairment was a
direct result of employee terminations associated with the restructuring
activities.

        Acquired in-process research and development costs. In the quarter ended
September 27, 1997, the Company recognized an additional charge against earnings
of $3.7 million for in-process research and development costs relating to the
Falcon Acquisition. These costs represented certain hardware and software
products acquired that had not established technological feasibility and are
deemed to have no future alternative use based on management assumptions.

        Total Other Expense. Total other expense is comprised of interest,
taxes, foreign currency gains and losses, and other expenses, if any, relating
to the periods presented. Total other expenses for the three- and nine-month
periods ended December 31, 1998 were $273,000 and $764,000, respectively,
compared to $403,000 and $727,000 for the comparable periods ended December 31,
1997. This increase in other expenses is primarily attributable to increases in
interest expense for borrowings under the Line of Credit offset by a decrease in
losses on foreign currency transactions.

LIQUIDITY AND CAPITAL RESOURCES

        Since inception, the Company has financed its operations primarily
through a combination of cash generated from operations, bank borrowings, and
sales of its capital stock. At December 31, 1998, the Company had $1.4 million
in cash and cash equivalents, compared to $8.0 million at March 31, 1998, a
decrease of $6.6 million. This decrease was primarily attributable to net cash
used in operations of $9.0 million which included payment of $4.8 million for
transaction costs related to the Storage Dimensions Merger, a decrease in
accounts payable of $3.6 million, offset by a $3,2 million decrease in
accounts receivable. Financing activities and proceeds from the Company's 1996
Stock Option Plan and Stock Purchase Plan provided $3.0 million and $229,000,
respectively.

        Cash and cash equivalents at December 31, 1998 decreased $1.3 million to
$1.4 million from a $2.7 million balance at September 30, 1998. This decrease
was primarily attributable to a paydown of the Line of Credit and accounts
payable.

        The Company had approximately $15.1 million of accounts receivable at
December 31, 1998 compared to $18.4 million at March 31, 1998, a decrease of
$3.3 million. This decrease is primarily attributable to more aggressive
collection efforts and lower sales revenue in the quarter ended December 31,
1998. At December 31, 1998, the Company had $13.3 million in net inventory



                                       13
<PAGE>   14

compared to $12.4 million at March 31, 1998. This increase is primarily
attributable to the Storage Dimensions Merger offset by a $2.1 million write
down of inventories during the quarter ended December 31, 1998.

        In May 1998, the Company entered into a Line of Credit with LaSalle
National Bank that permits borrowings of up to $15,000,000. Under the terms of
the Line of Credit, borrowings are collateralized by substantially all of the
Company's assets and mature in May 2001 unless otherwise renewed. Borrowings
under the Line of Credit bear interest either at the bank's prime rate, or at
the LIBOR rate plus 1.75%. Monthly payments consist of interest only, with the
principal due at maturity. As of December 31, 1998, the total outstanding
balance under the Line of Credit was $12.3 million. The line of credit agreement
requires that the Company comply with certain covenants, including minimum net
income and tangible net worth. The Company is currently not in compliance with
these covenants and has obtained waivers regarding its non-compliance with these
covenants.

        The Company's Japanese subsidiary has three lines of credit with a
Japanese bank for borrowings of up to an aggregate of 50 million Yen
(approximately US $441,000 at December 31, 1998) at interest rates ranging from
1.8% to 2.5%. Interest is due monthly, with principal due and payable on various
dates through November 2003. Borrowings are secured by the inventories of the
Japanese subsidiary. As of December 31, 1998, the total amount outstanding under
the three credit lines was 49 million Yen (approximately US $434,000 at December
31, 1998).

        The Company's management believes that its expected cash resources from
operations and amounts available under the Line of Credit are sufficient to meet
its current capital commitments and the operating requirements of its existing
business for at least the next twelve months. However, there can be no assurance
that the Company will not need to obtain additional capital before such time.
The actual amount and timing of working capital and capital expenditures that
the Company may incur in future periods may vary significantly and will depend
upon numerous factors, including the amount and timing of the receipt of
revenues from continued operations, the increase in manufacturing capabilities,
the timing and extent of the introduction of new products and services, and
growth in personnel and operations.

CERTAIN RISKS

Year 2000 Compliance.

        Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. Beginning in the
year 2000 ("Y2K"), these date code fields will need to accept four digit entries
to distinguish 21st century dates from 20th century dates. As a result, in less
than one year, computer systems and/or software used by many companies may need
to be upgraded to comply with such Y2K requirements.

        State of readiness

        The Company has defined Y2K compliance in accordance with the British
Standards Institute (BSI). According to the BSI DISC PD2000, Y2K conformity
shall mean that neither performance nor functionality is affected by dates prior
to, during and after Y2K. Y2K compliance is based on the following factors: 1)
during the normal operation, the value for the current date will not cause any
interruption in operation; 2) date-based functionality must behave consistently
for dates prior to, during and after Y2K; 3) in all interfaces and data storage,
the century in any date must be specified either explicitly or by unambiguous
algorithms or inferencing rules; and 4) Y2K must be recognized as a leap year.



                                       14
<PAGE>   15

        In 1996, the Company started a comprehensive Y2K program for its data
storage products. This program includes verification testing of existing
products, implementation of date code programming policies, and the integration
of compliance tests for all enhancements and future products. The Company
established certain criteria to obtain Y2K compliance, expanding year fields to
four digits, windowing, date encoding techniques, and absence of date code
dependency. The Company's technology generally lends itself to being Y2K
compliant based on the absence of date dependencies in the hardware, software,
and firmware code. The Company certifies to its customers that the hardware,
software, and firmware developed, manufactured and distributed by the Company is
Y2K compliant. In addition, the Company's products also recognize Y2K as a leap
year. To date, approximately 95% of the Company's data storage products are Y2K
compliant, and the Company anticipates having the remaining products Y2K
compliant by the end of March 1999.

        In 1997, the Company implemented a Y2K assessment program for its
internal processing systems. The program currently includes an inventory and
assessment of information systems, testing and implementation. The Company has
identified the major systems that will require modification to make them Y2K
compliant and anticipates completion of the process by the end of March 1999. To
date, approximately 60% of these internal processing systems are Y2K compliant,
and the Company anticipates having the remaining internal processing systems Y2K
compliant by the first quarter of calendar 1999 with any additional testing of
such systems to be completed by the second quarter of calendar 1999.

        The Company may include software from third party vendors as a part of
its data storage products. The Company has received compliance statements from
such software vendors and has conducted internal testing to verify their Y2K
compliance statements. Additionally, the Company is the process of distributing
questionnaires to its other major suppliers and other third party vendors to
determine their state of readiness for Y2K issues. The Company is assessing the
effect the Y2K issues may have on its suppliers and cannot determine the impact
it may have on the Company's operations.

        Costs to address the Company's Y2K issues.

        While it is difficult to quantify the total cost to the Company of Y2K
compliance activities, the Company's best estimate of resources that are
allocated to this program is approximately $500,000. However, there can be no
assurance that Y2K issues will not have a material adverse impact on the
Company's business, results of operations or financial condition.

        Risks of the Company's Y2K issues

        The Company believes that the Y2K issue may affect the purchasing
patterns of customers and potential customers in a variety of ways. Many
companies are expending significant resources to correct or patch their current
software systems for Y2K compliance. These expenditures may result in reduced
funds available to purchase products such as those offered by the Company.
Conversely, Y2K issues may cause other companies to accelerate purchases,
thereby causing an increase in short-term demand and consequent decrease in
long-term demand for products. Additionally, Y2K issues could cause a
significant number of companies, including current customers, to reevaluate
their current information system needs, and as result consider switching to
other systems or suppliers. Any of the foregoing could result in a material
adverse effect on the Company's business, operating results and financial
condition.



                                       15
<PAGE>   16


        The Company's contingency plan

        The Company currently does not have a contingency plan in place if any
of the systems, processes, or third party suppliers mentioned is not Y2K
compliant. Currently, the Company is in the process of preparing a contingency
plan for Y2K compliance issues, and anticipates having such a contingency plan
in place by the end of the first quarter of calendar 1999.

The Euro Conversion

        On January 1, 1999, eleven of the fifteen member countries of the
European Union established fixed conversion rates between their existing
sovereign currencies and the euro. These countries have agreed to adopt the euro
as their common legal currency on that date. The euro will then trade on
currency exchanges and be available for non-cash transactions. These countries
will issue sovereign debt exclusively in euro and will re-denominate outstanding
sovereign debt. Effective on this date, these countries will no longer control
their own monetary policies by directing independent interest rates for the
legacy currencies. Instead, the authority to direct monetary policy, including
money supply and official interest rates for the euro, will be exercised by the
new European Central Bank.

        Following introduction of the euro, the legacy currencies are scheduled
to remain legal tender in these countries as a denominations of the euro between
January 1, 1999 and January 1, 2002 (the "transition period"). During the
transition period, public and private parties may pay for goods and services
using either the euro or the country's legacy currency on a "no compulsion, no
prohibition" basis. However, conversion rates no longer will be computed
directly from one legacy currency to another. Instead a "triangulation" process
will be applied whereby an amount denominated in one legacy currency first will
be converted into an amount denominated in euro, and the resultant
euro-denominated amount is converted into the second legacy currency.

        The Company is the process of evaluating the impact this conversion of
the euro will have on its financial condition and results of operations. The
company does not anticipate that the conversation to the euro will have a
significant impact on the Company's financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

        Not applicable

                           PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

        None

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

        None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

        None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        None



                                       16
<PAGE>   17

ITEM 5. OTHER INFORMATION

        None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits 

Exhibit 27.1 - Financial Data Schedule

(b) Reports on Form 8-K.

        None



                                       17
<PAGE>   18


                                   SIGNATURES

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



                           ARTECON, INC. (Registrant)



Date:   February 16, 1999          /s/ James L. Lambert
                                   ------------------------------------------
                                   James L. Lambert
                                   President and Chief Executive Officer
                                   and Director (Principal Executive Officer)

Date:   February 16, 1999          /s/ Victor Hart Powers
                                   ------------------------------------------
                                   Victor Hart Powers
                                   Chief Financial Officer and Treasurer
                                   (Principal Financial and Accounting Officer)




                                       18
<PAGE>   19


                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER              DESCRIPTION
------              -----------
<S>            <C>

27.1           Financial Data Schedule

</TABLE>



                                       19