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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

for the fiscal year ended December 31, 2002

OR

for the transition period from       to       .

Commission file number: 1-11578

DISC, INC.

Registrant’s telephone number, including area code: (408) 934-7000

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value

     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  o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K. o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes  o    No  x

     The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock as of June 30, 2002 as quoted on the Nasdaq Small-Cap Market was approximately $3.3 million.

     The number of outstanding shares of the registrant’s Common Stock as of March 17, 2003 was 4,817,617.

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DISC, INC.
FORM 10-K
INDEX

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PART I

Introductory Note

     This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and we intend that such forward-looking statements are subject to the safe harbors created by those provisions. These forward-looking statements include our estimates, plans and beliefs that (i) costs of sales per product unit will decrease; (ii) research and development expenses will remain relatively constant; (iii) sales and marketing expenses will increase; (iv) general and administrative expenses will remain relatively constant; (v) we will seek additional financing from investors; (vi) we will significantly increase sales; (vii) we will continue to incur net losses; (viii) our selling efforts to large system integrators and OEMs will increase; and (ix) we will expand our current network of resellers. For this purpose, any statements contained in this Annual Report on Form 10-K except for historical information may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as “may”, “will”, “expect”, “believe”, “anticipate”, “intend”, “could”, “estimate” or “continue”, or the negative or other variations of those terms, or comparable terminology are intended to identify forward-looking statements.

     The forward-looking statements included in this Annual Report on Form 10-K are based on current expectations that involve a number of risks and uncertainties. These forward-looking statements are based on assumptions, regarding our business, which involve judgments with respect to, among other things, future economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated in forward-looking statements will be realized. In addition, our business and operations are subject to substantial risks that increase the uncertainty inherent in the forward-looking statements (see “Risk Factors that May Affect Future Operating Results” in Item 1 and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”). In light of the significant uncertainties inherent in the forward-looking information included in this Annual Report on Form 10-K, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that expectations will be realized.

Item 1. Business.

General

     DISC, Inc. was incorporated under the laws of the State of California in 1986. We operate in one business segment, the computer mass storage system business. We design, manufacture, and market a family of high-end computer nearline storage systems, which use rewritable 5.25 inch, Magneto-Optical (MO) disks, 120-millimeter Digital Versatile Discs (DVD), and Compact Discs (CD) technologies.

Products

     We spent most of 2002 continuing to redefine our product offering to address the storage requirements of today’s enterprise storage networks. Traditionally, applications for our products include federal and local government, military applications, insurance, banking, legal, multimedia, medical applications and network storage environments on a worldwide basis. Sales of our initial product line commenced in 1991 and have been primarily to distributors, value added resellers (VARs), original equipment manufacturers (OEMs) and system integrators (SIs), who combine our nearline storage systems

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with software and/or other products and resell the combination to the end-user or other members of the supply channel.

     However, to implement our new strategy and vision of delivering storage solutions for enterprise networks, we refocused our product lines and sales and marketing efforts. As the demand for storage in traditional networking environments grows at unprecedented rates, the capacity points have reached the levels of the niche markets that we have historically served. Our new product lines are built around the fact that we build storage devices that add capacity to networks for a fraction of the total cost of hard disk RAID (Redundant Array of Independent Drives). In addition to offering cost-effective nearline storage devices, we have spent a considerable amount of our resources designing and delivering network-attached storage (NAS) servers to enable seamless connectivity of our storage devices.

     Our products, which add storage capacity to networks for a fraction of the total cost of RAID, are based upon reliable and industry proven storage technologies. The underlying technologies are DVD-RAM/ROM/R and 5.25-inch MO-Rewritable/write once. With a shelf life exceeding 30 years, random access reading and writing, our family of products is suited for today’s network storage environments.

     We are currently shipping three classes of products that provide nearline storage solutions for enterprise network environments. The first class is our Orion series, an automated library system built around the magneto-optical technology. These enterprise level products scale in capacity from 180 gigabytes (GB) of storage to 9.59 terabytes (TB) of storage. The Orion D-1050 is largest of these products and provides 9.59 TB of storage in 13.75 square feet of floor space, with an end-user price per megabyte as little as 3.5 cents.

     The second class of product that we offer is the NSM Series, an automated library system built around DVD and CD technology. The NSM Series scales in capacity from 40 GB of storage to 6.5 TB of storage and gives our customers an entry-level storage solution that was not previously available. The NSM Series product line is based on a modular technology that allows the same options and upgrades to be used throughout the NSM-Series product line. The NSM Series offers some of the most cost-effective storage in the industry with an end-user cost per megabyte of less than a penny.

     The third class of products that we offer is our DISCSTOR/nas product line of network-attached storage products. These products allow all of our products to be seamlessly connected to multiple network environments. The DISCSTOR/nas product line allows users to attach our storage products to networks with a simplicity that has not previously existed. The DISCSTOR/nas product line gives us the ability to sell complete storage solutions into any networking environment and allows users to add multi-terabyte storage solutions to their networks with an unprecedented level of simplicity.

     Please see Note 11 to the Notes to Consolidated Financial Statements included in this report on Form 10-K for a description of revenues attributable to our domestic and foreign sales for 2002, 2001 and 2000. For a description of the risks attendant to our foreign operations, please see the section of this report entitled, “Risk Factors that May Affect Future Operating Results” and the heading “Because we are dependent on international sales for a substantial amount of our net revenues, we face the risks of international business and associated currency fluctuations, which might adversely affect our operating results.” In addition, please see Note 11 to the Notes to Consolidated Financial Statements included in this report for a description of revenues attributable to similar products and services sold in 2002, 2001 and 2000.

Marketing and Sales

     Over the last year we continued to make investments in sales and marketing. We have continued to strengthen our sales organization by adding sales professionals that are focused on selling solutions for data

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storage. The sales force is focused on growing our channel of storage VARs and providing them with better data storage solutions to offer their customers.

     In addition, our acquisition of NSM Storage GmbH, a German limited liability company in July 2001 has given us a presence in the international market, has broadened our product range with DVD automation technology and has strengthened our engineering and development staffs.

     Our products are installed and serviced by an international network of maintenance technicians from Eastman Kodak Co. and Anacomp, Inc. Our support staff, located strategically across the country, provides technical assistance and second-level support.

     Our sales offices are located in Northern California; Hauppauge, New York; Boston, Massachusetts; Washington, DC; Dallas, Texas; Phoenix, Arizona; Minneapolis, Minnesota; Tampa, Florida; Croydon, England; and Bingen, Germany. Our sales staff currently consists of 16 professional salespersons.

Competition

     We are currently selling nearline storage solutions for networks. While there are few direct competitors, there are many indirect competitors. The competitors include the top vendors that design, manufacture and market enterprise-level storage products. These companies are EMC, Network Appliance, Sun Microsystems, Hewlett-Packard and IBM.

     In the traditional automated library business, our competitors are Hewlett-Packard, Plasmon, Advanced Digital Information Corporation (ADIC), JVC and Pioneer.

     All of these competitors may compete with us by selling similar products for lower prices or by introducing new products that provide greater storage capacity, faster access time or other improved features, any of which could reduce demand for our products or require us to reduce our prices. This competition could have a material adverse effect on our results of operations. Many of our competitors have significantly greater financial, technical, manufacturing and marketing resources than we do, as well as significant market shares and installed customer bases in certain market areas addressed by us. As a result, we may not have the ability to keep pace with rapid competitive developments and technological advances to the same extent as its competitors.

     However, we maintain an active program of research and development in an effort to keep pace with potential competition, and we have close relationships with companies developing new high-density optical storage technologies. As end-users need to increase their pool of available storage, our products are one of the most cost-effective alternatives.

     The principal market requirements for our products are large storage capacity, low cost per megabyte, reliability, compact physical size, permanence and longevity of data and random access. While desired capabilities generally vary by product family and end user application, we believe that, because of its modular design, easy scalability, high performance and reliability, our products will compete favorably with respect to the requirements of the secondary mass data storage market.

     Further discussion relating to the competitive conditions in the computer mass storage system industry and our competitive position in the marketplace may be found in “Risk Factors that May Affect Future Operating Results” under the heading “Competition in the Computer Information Storage Market May Lead to Reduced Market Share, Declining Prices and Reduced Profits.”

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Business Combination

     On July 30, 2001 we acquired all of the outstanding shares of NSM Storage GmbH, a German limited liability company (“NSM”). Under the terms of the acquisition, we issued 965,210 shares of our common stock and paid $10,000 in cash. We also agreed to severance payments of $75,000 to each of the two managing directors and principal shareholders of NSM. The acquisition was accounted for under the purchase method of accounting.

Manufacturing and Components

     Our manufacturing operations both in the U.S. and Germany consist of final system assembly and product test activities. The majority of the parts and subassemblies in our libraries are standard, off-the-shelf components or are fabricated to our manufacturing documentation. These include power supplies, castings, motors, bearings, timing belts and electronic components. Our proprietary components, such as the frame, backplate, printed circuit assemblies and other machined and fabricated parts are subcontracted out to independent vendors.

     We purchase certain components from a single source of supply. Where we rely on single sources of supply, we generally have been able to obtain supplies of these components in a timely manner and maintain an adequate inventory of components to meet our needs. If we cannot secure components from our single-source suppliers and if we are unable to develop alternative sources of supply as required in the future, our operations will be materially adversely affected.

Research and Development

     We have focused our research and development programs to provide software storage solutions for our automated library systems. NAS server development has been the most important aspect of our development efforts over the past year. These efforts have yielded products that allow our customers to seamlessly connect our storage products to networks. Our efforts continue to be active and consist of eighteen full-time employees in the areas of mechanical and electrical engineering and software design. One of the keys to our success going forward is continued improvement of our storage connectivity solutions. We expended $2,447,000, $2,001,000 and $1,158,000 on research and development for the years ended December 31, 2002, 2001 and 2000, respectively. We have completed our major development efforts with respect to our 5.25 inch optical and CD products. We intend to continue to expand research and development activities in order to conduct on-going development of existing products and to develop new products targeted at the general storage market.

Sales and Backlog

     Our quarterly sales and operating results have been affected by seasonal trends. These trends often result in lower revenue in the first quarter of each fiscal year compared to the fourth quarter of the previous fiscal year due to customer purchasing and budgetary practices.

     Our backlog at December 31, 2002 was approximately $716,000 as compared to a backlog of approximately $486,000 at December 31, 2001. We include in backlog only those orders for products and services that are believed to be firm and that are due to be shipped or performed within 12 months. We include in backlog orders that may be canceled by customers upon payment of cancellation charges, which vary depending on the scheduled shipment date of the order. Because of the possibility of customer changes in delivery schedules or cancellation of orders, our backlog as of any particular date may not be indicative of

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actual revenues for any specific future period. Although we have never experienced material cancellation problems, no assurance can be given that we will continue to avoid cancellation problems in the future.

Patents and Other Intellectual Property

     We own U.S. and German patents covering various aspects of our technology, including the overall system design of our products. Our existing patents expire between 2007 and 2014. There can be no assurance that any subsequent patent applications will be granted. We believe that ownership of our patents is an important factor in our business, and our success depends in part on our ownership of them. However, we believe that the improvement of our existing products, reliance upon trade secrets and copyrights and reliance on unpatented proprietary know-how and innovation in the development of new products are generally as important as patent protection in establishing and maintaining our technological advantage. We believe that the value of our products is partly dependent upon our confidentiality and invention assignment agreements with our employees. While we believe that patent, copyright and trade secret laws should afford adequate protection of our proprietary technology, there can be no assurance that our proprietary technology will remain a trade secret or that others will not develop a similar technology and use that technology to compete with us. Such competition could have a material adverse effect on us. In addition, policing unauthorized use of our technology, particularly in foreign countries, may be difficult. We have not received claims from third parties alleging that our products infringe the proprietary rights of third parties or seeking indemnification against such infringements and know of no basis for any such claims. However, there can be no assurance that such claims will not be made in the future. Such claims, if asserted, may involve costly and protracted litigation and we may be required to license proprietary rights from third parties. There can be no assurance that we would be able to obtain licenses from third parties on commercially reasonable terms.

Environmental Laws

     Compliance with U.S. federal, state, local and German laws enacted for the protection of the environment has to date had no material effect upon our capital expenditures, earnings or competitive position. Although we do not anticipate any future harm to our business based on the nature of our operations and the effect of those laws, no assurance can be given that such laws, or any future laws enacted for the protection of the environment, will not have a material adverse effect on us.

Employees

     As of February 28, 2003, we employed 91 people on a full-time basis, including 15 employees in administration and accounting, 19 employees in marketing and sales, 18 employees in engineering, 27 employees in manufacturing, 1 employee in quality assurance and 11 employees in customer support. Approximately 45 employees were in international locations. Our future success is dependent, in part, on our continued ability to attract, retain and motivate highly skilled personnel. We believe that our relations with all employees are satisfactory. We have not experienced any work stoppages. Some of our employees in our location in Germany are covered by a collective bargaining agreement or employment agreements.

Customers

     Compaq Computer Corporation and Incom GmbH, two customers, accounted for 23% and 10%, respectively, of our total revenue in 2002. Compaq Computer Corporation and Ingram Micro Inc., two OEM customers, accounted for 31% and 14%, respectively, of our total revenue in 2001. Compaq Computer Corporation and Commvault Systems Inc., two OEM customers, accounted for 14% and 13%, respectively, of our total revenue in 2000.

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     No material portion of our business is subject to renegotiation of profits or contract termination at the election of the U.S. government.

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Risk Factors that May Affect Future Operating Results

     Our future operating results and stock price may be affected by a number of factors, many of which are beyond our control. These factors include the following:

We will need additional funding to continue our operations.

     To date, we have not generated enough cash from operations to fund our business, and we will need to seek additional funding in the future in order to fund our operations. We may not be able to do so on favorable terms, if at all. There also can be no assurance that funding sources will be available to us on a timely basis to fund our operations on terms acceptable to us, or at all. If we are unable to raise sufficient funding as required, the operations and prospects of our company, and its ability to continue as a going concern, will be severely harmed.

We have a history of losses and we expect to incur future losses.

     We have experienced significant operating losses since our inception, and as of December 31, 2002 had an accumulated deficit of $42,620,000. We expect to continue to incur net losses for the foreseeable future, and our ability to sustain our operations and continue as a going concern will depend on our ability to significantly increase or even maintain sales or raise significant additional debt or equity financing. There can be no assurance that we will be able to increase sales or that additional financing will be available on acceptable terms, or at all. Further, if we issue equity securities, shareholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of our existing securities. Even if we are able to increase sales, we may incur net losses for the foreseeable future based on anticipated spending levels. Even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis.

Recent terrorist and military activities could adversely affect our business.

     In response to terrorist attacks, the United States is actively using military force to pursue those behind these attacks and pursuing broader actions against global terrorism. The continued threat of terrorism within the United States and Europe, the escalation of military action and heightened security measures in response to such further threats may cause significant disruption to commerce throughout the world. To the extent that such disruptions result in further reductions in capital expenditures or spending on information technology, longer sales cycles, deferral or delay of customer orders, or an inability to effectively market our products, our revenues would decline, which would materially and adversely affect our business and results of operations.

Our quarterly revenues and operating results may fluctuate for a number of reasons, which may cause our stock price to fluctuate.

     Our quarterly operating results have varied in the past and are likely to vary significantly in the future due to several factors, including:

	•		the size and timing of significant customer orders;
	•		shifts in product or distribution channel mix;
	•		increased competition and pricing pressure;
	•		timing of new product announcements and releases by us or our competitors;

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	•		new product developments by storage device manufacturers;
	•		the rate of growth in the data storage market;
	•		market acceptance of new and enhanced versions of our products;
	•		timing and levels of our operating expenses;
	•		gain or loss of significant customers or distributors;
	•		changes in economic conditions; and
	•		personnel changes.

     Our quarterly sales and operating results have been affected by seasonal trends. These trends often result in lower revenue in the first quarter of each fiscal year compared to the fourth quarter of the previous fiscal year due to customer purchasing and budgetary practices.

     The general sales cycles for distribution of our products are similar to those of most businesses selling products designed for use as part of large systems, and range from three to six months for value added resellers and small system integrators and from one to two years for original equipment manufacturers, product integrators and large system integrators. Our variable and extended sales cycle makes it difficult to predict if or when revenue will be earned. Since our operating expenses are based on anticipated revenue levels and because a high percentage of these expenses are relatively fixed, a delay in a sale or revenue recognition for a sale could cause significant variations in our operating results from quarter to quarter and could cause unexpected results.

     Operating results in any period should not be considered indicative of the results investors can expect for any future period. Due to the forgoing and other factors related to our industry, past results are much less reliable predicators of future results than is the case in many older, more stable and less dynamic industries. We cannot assure you that we will be able to increase or even sustain our recent levels of quarterly revenue and net sales, as normalized for unusual or one-time items, or that we will attain or maintain profitability in any future period. Any unfavorable change in the factors described above or any other factors could adversely affect our operating results for a particular quarter. In addition, it is likely that in some future quarters our operating results will be below the expectations of public market analysts and investors. In any of these events, the price of our common stock would likely decline.

Because we operate with little backlog, our operating results could be adversely affected if we do not accurately anticipate future sales levels.

     Historically, we have operated with little order backlog and, due to the nature of our business, do not anticipate that we will have significant backlog in the future. Consequently, a large portion of our quarterly revenue results from orders placed during that quarter. Because of the relatively large dollar size of orders from our distributors and customers, delay in the placing of a small number of orders by a small number of purchasers could negatively affect our operating results for a particular period. In addition, our operating expense levels are, in the short term, largely fixed and are based, in part, on expectations regarding future sales. Thus, our operating results could be disproportionately affected if we do not receive the expected number of orders in a given quarter and our net sales falls below our expectations.

We depend on certain key suppliers and if we are unable to obtain adequate supplies, our sales and operating results could be significantly adversely affected.

     We do not possess proprietary optical disk, high-density disk or other storage technologies and, consequently, we depend on a limited number of third-party manufacturers to supply us with the devices that we incorporate into our products. In some cases, these manufacturers are sole-source providers of the device

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technology. Our suppliers have in the past been, and may in the future be, unable to meet our supply needs, including our needs for timely delivery, adequate quantity and high quality. We do not have long-term contracts with any of our significant suppliers. If these suppliers were to decide to pursue the disc library market directly, they may cease supplying us with disc drives and media, in which case we may be unable to obtain adequate supplies of disc drives and media at acceptable prices, if at all. The partial or complete loss of any of our suppliers could result in significant lost sales, added costs and production delays or may otherwise harm our business, financial condition, operating results and customer relationships.

We have a concentrated customer base, and therefore the loss of a single customer could negatively affect our operating results.

     The majority of our end users purchase our products from distributors, value-added resellers, original equipment manufacturers, and systems integrators. We have no long-term orders with any of our significant customers or distributors. Generally we sell products pursuant to purchase orders. In addition, our distributors carry competing product lines, which they may promote over our products. A distributor may not continue to purchase our products or market them effectively. Moreover, certain of our contracts with our distributors contain “most favored nation” pricing provisions, which mandate that we offer our products to these customers at the lowest price offered to other similarly situated customers. Our operating results could be adversely affected if any of the following factors were to occur relating to one or more of our significant resellers:

	•		the reduction, delay or cancellation of orders or the return of a significant amount of products;
	•		the loss of one or more of such resellers; or
	•		any financial difficulties of those resellers that result in their inability to pay amounts owed to us

There are substantial risks associated with the acquisition of NSM Storage GmbH.

     In connection with the acquisition of DISC GmbH, we assumed debt payable to financial institutions. To the extent DISC GmbH does not generate sufficient cash flow to meet its working capital requirements and such working capital is not available from other sources, our operations may be curtailed or otherwise adversely impacted.

     The market for DISC GmbH products may not materialize or be of sufficient size to enable us to recover our investment, resulting in the impairment of goodwill, intangible or other long lived assets. Moreover, we may not be able to accurately predict a potential impairment of the goodwill resulting from the acquisition or of the identified intangible assets, which could require us to write-off a significant portion of the goodwill or the identified intangible assets, thereby adversely affecting our operating results.

Because we are dependent on international sales for a substantial amount of our net sales, we face the risks of international business and associated currency fluctuations, which might adversely affect our operating results.

     We expect that international sales will continue to represent a significant portion of our net revenues in the foreseeable future. Doing business internationally involves greater expenses and many additional risks. For example, because the products we sell abroad and the products and services we buy abroad are priced in foreign currencies, we may be affected by fluctuating exchange rates. We might not successfully protect ourselves against currency rate fluctuations, and our financial performance could be harmed as a result. In addition, we face other risks of doing business internationally, including:

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	•		unexpected changes in regulatory requirements, taxes, trade laws and tariffs;
	•		reduced protection for intellectual property rights in some countries;
	•		differing labor regulations;
	•		compliance with a wide variety of complex regulatory requirements;
	•		changes in a country’s or region’s political or economic conditions;
	•		greater difficulty in staffing and managing foreign operations; and
	•		increased financial accounting and reporting burdens and complexities.

     Our international operations require significant attention from our management and substantial financial resources. We do not know whether our investments in other countries will produce desired levels of net revenues or profitability.

Our stock price may be extremely volatile.

     The market price of our common stock has experienced fluctuations and is likely to fluctuate significantly in the future. Our stock price can fluctuate for a number of reasons, including:

	•		announcements about us or our competitors;
	•		quarterly variations in operating results;
	•		the introduction of new technologies or products;
	•		changes in product pricing policies by us or our competitors;
	•		comments regarding us and the data storage market made on Internet bulletin boards; and
	•		changes in earnings estimates by analysts or changes in accounting policies.

     In addition, stock markets have experienced extreme price and volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many smaller public companies for reasons frequently unrelated or disproportionate to the operating performance of the specific companies. In addition, the securities of many high technology companies, including our securities, have historically been subject to extensive price and volume fluctuations that may affect the market price of their common stock. These broad market fluctuations may adversely affect the market price of our common stock.

Competition in the computer information storage market may lead to reduced market share, declining prices and reduced profits.

     The markets for data storage solutions are intensely competitive, fragmented and characterized by rapidly changing technology and evolving standards. These conditions could render our products less competitive or obsolete and could harm our business, financial condition and ability to market our products. Some of our competitors have significantly more financial, technical, manufacturing, marketing and other resources than we have. As a result, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or customer requirements. Competitors may develop products and technologies that are less expensive or technologically superior to our products. In addition, our competitors may manufacture and market their products more successfully than we do our products. Competition from computer companies and others diversifying into the field is expected to increase as the market develops. We may face substantial competition from new entrants in the industry and from established and emerging companies in related industries. There is significant price competition in the markets in which we compete, and we believe that pricing pressures are likely to continue. Certain competitors may reduce prices in order to preserve or gain market share. This pricing pressure could result in

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significant price erosion, reduced gross profit margins and loss of market share, any of which could negatively affect our business, financial condition and operating results.

The storage device market is characterized by rapid technological evolution, and our success depends on our ability to develop new products.

     The market for our products is characterized by rapidly changing technology and evolving industry standards and is highly competitive with respect to timely innovation. At this time, the data storage market is particularly subject to change with the emergence of Fibre Channel protocol and new storage solutions such as storage area networks, or SANs, and network attached storage, or NAS, devices. The introduction of new products embodying new or alternative technology or the emergence of new industry standards could render our existing products obsolete or unmarketable. Our future success will depend in part on our ability to anticipate changes in technology, to gain access to such technology for incorporation into our products and to develop new and enhanced products on a timely and cost-effective basis. Risks inherent in the development and introduction of new products include:

	•		the difficulty in forecasting customer demand accurately;
	•		the possibility that sales of new products may cannibalize sales of our current products;
	•		delays in our initial shipments of new products;
	•		competitors’ responses to our introduction of new products; and
	•		the desire by customers to evaluate new products for longer periods of time before making a purchase decision.

     In addition, we must be able to maintain the compatibility of our products with significant future device technologies, and we must rely on producers of new device technologies to achieve and sustain market acceptance of those technologies. Development schedules for high-technology products are subject to uncertainty, and we may not meet our product development schedules.

     We have in the past experienced delays in the introduction of some new products. If we are unable, for technological or other reasons, to develop products in a timely manner or if the products or product enhancements that we develop do not achieve market acceptance, our business will be harmed.

A failure to develop and maintain proprietary technology will negatively affect our business.

     Because our business depends on technology, our ability to compete effectively depends in part on our ability to develop and maintain proprietary aspects of our technology. We hold U.S. and German patents covering various aspects of our technology, including the overall system design of our products. These patents expire between 2007 and 2014. We cannot be certain that these patents will provide meaningful protection for our product innovations. We also rely on a combination of copyright, trademark, trade secret and other intellectual property laws and various contract rights to protect our proprietary rights. Such rights, however, may not preclude competitors from developing products that are substantially equivalent or superior to our products. There can be no assurance that our proprietary technology will remain a trade secret or that others will not develop a similar technology and use that technology to compete with us. In addition, many aspects of our products are not subject to intellectual property protection and can therefore be reproduced by our competitors.

     While we are not currently engaged in any intellectual property litigation or proceedings, we may become so involved in the future. An adverse outcome in litigation could subject us to significant liabilities to third parties, require us to license technology from others or require us to cease marketing or using certain products, any of which

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could negatively affect our business, financial condition and operating results. If we are required to seek licenses under patents or proprietary rights of others, we may not be able to acquire these licenses on acceptable terms, if at all. In addition, the cost of responding to an intellectual property infringement claim, in terms of legal fees and expenses and the diversion of management resources, whether or not the claim is valid, could harm our business, financial condition and operating results.

Concentration of ownership among our existing executive officers, directors and principal shareholders may prevent other investors from influencing significant corporate decisions.

     As of December 31, 2002, our executive officers, directors and principal shareholders beneficially owned approximately 91% of our outstanding common stock and preferred stock, on an as-if-converted basis. In particular, our largest shareholder beneficially owns approximately 90% of our outstanding common stock, preferred stock and warrants, on an as-if-converted basis. As a result, these shareholders, if acting together, will be able to exercise control over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership could be a disadvantage to other shareholders with interests different from those of our largest shareholder or other officers, directors and principal shareholders. For example, our largest shareholder could delay or prevent an acquisition or merger even if the transaction would benefit other shareholders.

Downturns in the computer information storage market and related markets may decrease our revenues and margins.

     The market for our products depends on economic conditions affecting the broader information technology and related markets. Downturns in these markets may cause our customers to delay or cancel information technology projects, reduce their information technology budgets or reduce or cancel orders for our products. In this environment, customers may experience financial difficulty, cease operations or fail to budget for the purchase of our products. This, in turn, may lead to longer sales cycles, delays in payment and collection, and price pressures, causing us to realize lower revenues and margins. A prolonged economic downturn would also increase our exposure to credit risk on trade receivables. In particular, capital spending in the information technology sector generally has decreased in the past 12 months, and many of our customers and potential customers have experienced declines in their revenues and operations. If capital spending in our markets continues to decline or does not increase, it may be necessary for us to gain significant market share from our competitors in order to achieve our financial goals and achieve profitability.

Undetected software or hardware errors could increase our costs and reduce our sales.

     We may not be able to adequately control and eliminate manufacturing flaws. If flaws in design, production, assembly or testing were to occur in our products or those of our vendors, we could experience a rate of failure in our products that would result in substantial repair or replacement costs and potential damage to our reputation. Continued improvement in manufacturing capabilities and control of material and manufacturing quality and costs are critical factors in our future growth. We cannot assure you that our efforts to monitor, develop and implement appropriate test and manufacturing processes for our products will be sufficient to permit us to avoid a rate of failure in our products that results in substantial shipment delays, significant repair or replacement costs and damage to our reputation. In addition, our products are combined with products from other vendors. As a result, when problems occur, it is difficult to identify the source of the problem. These problems may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems.

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We may be sued by our customers for product liability claims as a result of failures in our data storage products.

     We face potential liability for performance problems of our products because our end users employ our storage technologies for the storage and backup of important data. Although we maintain general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of our insurance coverage could harm our business.

The costs of compliance with recent developments in corporate governance regulation may affect our business, operating results and financial condition in ways that presently cannot be predicted.

     Beginning with the enactment of the Sarbanes-Oxley Act of 2002, a significant number of new corporate governance requirements have been adopted or proposed through legislation and regulation by the Securities and Exchange Commission and Nasdaq National Stock Market. We expect these developments to increase our legal compliance and accounting costs, and to make some activities more difficult, such as stockholder approval of new stock option plans. We expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These developments could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result, or the effect that these increased costs may have on our operating results.

A number of key personnel are critical to the success of our business.

     Our future success depends in large part on our ability to retain certain key executives and other personnel, some of whom have been instrumental in establishing and maintaining strategic relationships with key suppliers and customers. Our future growth and success will depend in large part on our ability to hire, motivate and retain highly qualified management, technical, operations and sales and marketing personnel. Competition for such personnel is intense in the high-technology industry, particularly in the San Francisco Bay area. We may not be able to retain our existing personnel or attract additional qualified personnel in the future. In addition, companies in our industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices. We may receive such claims in the future as we seek to hire qualified personnel, and such claims could result in litigation. Regardless of the merits of these claims, we could incur substantial costs in defending ourselves against these claims.

If our securities are delisted from NASDAQ, the trading market and prices of our securities would be harmed.

     The trading of our common stock on the NASDAQ Small Cap Market System is conditioned upon our meeting shareholders’ equity, net income, market capitalization and stock price tests. If we fail any of these tests, our common stock may be delisted from trading on the NASDAQ Small Cap Market System, it would be much more difficult to purchase or sell our stock or obtain accurate quotations as to our stock price. In addition, low-priced stocks are subject to additional risks including additional state regulatory requirements and the potential loss of effective trading markets.

Item 2. Properties.

     Our executive offices and engineering/manufacturing operations are located in approximately 17,000 square feet of space in Milpitas, California. We lease the facility pursuant to a lease that will expire on October 31, 2005. We believe that the lease can be renewed at satisfactory terms and that this facility will be sufficient to support operations for the foreseeable future. We believe that, if necessary, additional space will be available in the area for our operations. In addition, we lease approximately 16,000 square feet in Bingen, Germany, which is occupied by our German subsidiary. The lease expires on December 31, 2003, but we believe that the lease can be renewed at satisfactory terms and that the facility will be sufficient to support operations for the foreseeable future.

Item 3. Legal Proceedings.

     We are not party to any material legal proceedings.

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

     We held our Annual Meeting of Shareholders on November 21, 2002. Matters voted upon at the meeting, and the number of shares cast for, against or withheld were as follows:

1.

To elect the following directors.

2.

To increase the number of shares of common stock reserved for issuance under the 2001 Stock Plan to 1,280,700.

3.

To appoint Pricewaterhouse Coopers LLP as independent auditors for the fiscal year ending December 31, 2002.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

     Our common stock is traded on the NASDAQ Small Cap Market under the symbol DCSR. The high and low sales prices set forth below are as reported by the NASDAQ Small Cap Market System.

     The closing price of our common stock on March 14, 2003, as reported by the NASDAQ Small Cap Market System was $1.03. As of March 17, 2003, according to the records of our transfer agent, we had approximately 40 shareholders of record. Because many of our shares are held by brokers and other institutions on behalf of stockholders, the number of record holders is not necessarily indicative of the total number of stockholders. As of October 16, 2002 (the record date for our 2002 annual meeting), we had over 800 shareholders, and we believe that we presently have over 800 shareholders. We have never paid cash dividends and have no present plans to pay dividends. Please see “Liquidity and Capital Resources” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 7 of the Notes to Financial Statements regarding dividend requirements on the Convertible Preferred Stock.

Recent Sales of Unregistered Securities

     See “Item 13. Certain Relationships and Related Transactions” for a description of equity securities we sold during the last fiscal year that were not registered under the Securities Act. The sales of preferred stock during the last fiscal year were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act, or Regulation D promulgated thereunder, as transactions by an issuer not involving a public offering. The recipients of securities in each such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and other instruments issued in such transaction.

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Item 6. Selected and Supplementary Financial Data.

     The following selected financial information has been derived from our audited financial statements. The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes to the financial statements included in Item 8 of this Form 10-K in order to fully understand factors that may affect the comparability of the information presented below.

     (1) We acquired NSM GmbH Storage on July 30, 2001 in a transaction accounted for as a purchase. The Consolidated Statement of Operations and Consolidated Balance Sheet data includes the operations of NSM GmbH Storage subsequent to July 29, 2001.

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SUPPLEMENTARY QUARTERLY FINANCIAL DATA

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

     This section and other parts of this Annual Report on Form 10-K contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and we intend that such forward-looking statements are subject to the safe harbors created by those provisions. These forward-looking statements include our estimates, plans and beliefs that (i) costs of sales per product unit will decrease; (ii) research and development expenses will remain relatively constant; (iii) sales and marketing expenses will increase; (iv) general and administrative expenses will remain relatively constant; (v) we will seek additional financing from investors; (vi) we will significantly increase sales; (vii) we will continue to incur net losses; (viii) our selling efforts to large system integrators and OEMs will increase; and (ix) we will expand our current network of resellers. For this purpose, any statements contained in this Annual Report on Form 10-K except for historical information may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as “may”, “will”, “expect”, “believe”, “anticipate”, “intend”, “could”, “estimate” or “continue”, or the negative or other variations those terms, or comparable terminology are intended to identify forward-looking statements.

     The forward-looking statements included in this Annual Report on Form 10-K are based on current expectations that involve a number of risks and uncertainties. These forward-looking statements are based on assumptions, regarding our business, which involve judgments with respect to, among other things, future economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated in forward-looking statements will be realized. In addition, our business and operations are subject to substantial risks that increase the uncertainty inherent in the forward-looking statements (see “Risk Factors that May Affect Future Operating Results” in Item 1. and “Item 7. In light of the significant uncertainties inherent in the forward-looking information included in this Annual Report on Form 10-K, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that expectations will be realized.

     The following commentary should be read in conjunction with the consolidated financial statements and related footnotes that appear beginning on page 36.

Overview

     We develop and market a family of computer nearline storage systems that use 5.25 inch rewritable, magneto optical disks, DVD and CD-ROM disks.

     In July 2001, we acquired NSM Storage GmbH for 965,210 shares of common stock and $10,000 in cash. We also agreed to severance payments of $75,000 to each of the two Managing Directors and principal shareholders of NSM and had acquisition related costs of approximately $408,000. The acquisition was accounted for under the purchase method of accounting, and as a result our historical results of operations do not include the results of operations of NSM prior to July 30, 2001. The excess amount of the purchase price over the fair market value of the identified nets assets acquired was accounted for as goodwill. Goodwill is not amortized but is tested for impairment annually.

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     As a result of the acquisition of NSM, at December 31, 2002, we have goodwill and intangible assets of $4,591,000, net of associated amortization of $1,079,000. Goodwill is not being amortized. Other intangible assets are being amortized on a straight-line basis over their estimated useful lives of a four to six year period. Such intangible assets are evaluated for impairment when events or circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows resulting from the use of the assets. At December 31, 2002, we do not consider goodwill and other intangible assets to be impaired.

     The purchase price was allocated as set forth in Note 4 to the consolidated financial statements. The “Income Approach,” which includes an analysis of the markets, cash flows and risks associated with achieving such cash flows, was the primary method used in valuing the identified intangibles acquired. Expected cash flows were discounted at the Company’s weighted average cost of capital adjusted upward to reflect additional inherent risks. Because the in-process research and development had not reached the stage of technological feasibility at the acquisition date and had no alternative future use, the amount allocated of $ 242,000 was immediately charged to operations. The amounts allocated to core technology, developed technology, trade name and patents are being amortized over an estimated useful life of four to six years.

     Because of the significance of the acquisition of NSM, we do not believe the analysis of our historical financial conditions and results of operations set forth below are indicative, nor should they be relied upon as an indicator, of our future performance.

Results of Operations

     Net Sales. We had net sales of $12,938,000 in 2002, $12,150,000 in 2001 and $6,821,000 in 2000. The increase in sales in 2002 as compared to 2001 is primarily due to the increased sales from our acquisition of NSM in July 2001 and an increase in service revenue. This increase was offset by a slow down by the Federal Government in information technology spending and the overall weakness in the storage industry. Approximately 45% of the increase in 2001 as compared to 2000 was due to our acquisition of NSM. In addition in 2001 as compared to 2000, we had higher unit sales and a higher sales price per unit which resulted from sales of units with a larger number of media slots. These increases resulted in increases in media sales and service revenue. The general sales cycles for distribution of our products are similar to those of most businesses selling products designed for use as part of large systems, and range from three to six months for Value Added Resellers (VAR) and small System Integrators and from one to two years for Original Equipment Manufacturers (OEM), Product Integrators and large System Integrators. Because our products are part of large systems, the sales cycles for our products vary significantly and are difficult to predict for any particular transaction. The long and often unpredictable sales cycles of our products complicate forecasting for operational planning and may cause net sales and operating results to vary significantly.

     Cost of Sales. Cost of sales, as a percentage of sales, was approximately 81% in 2002, 79% in 2001 and 85% in 2000. The slight increase in cost of sales as a percentage of sales in 2002 as compared to 2001 is primarily due to product mix as service revenue which has a lower margin then our other products has increased as a percentage of net sales. The decrease in cost of sales as a percentage of sales in 2001 is primarily due to the increase in revenue as manufacturing costs are relatively fixed. Our relatively low gross margins reflect our low sales volumes, which have resulted in unabsorbed manufacturing costs and high costs of materials due to the inability to achieve purchasing economies of scale due to low sales volume. If we are able to increase sales, then we expect costs of sales per unit of product will decrease because fixed manufacturing costs will be distributed over the larger sales volume, and material costs will decrease as the result of volume purchases. However, even with product sale increases, cost of sales per unit of product may

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not decrease significantly or at all because the magnitude of the sales increase was not sufficient or because manufacturing, materials or other costs may increase independently.

     Research and Development Expenses. Research and development expenses consist primarily of personnel and related costs. Research and development expenses were $2,447,000 in 2002, $2,001,000 in 2001 and $1,158,000 in 2000. Expenses increased in 2002 as compared to 2001 primarily due to a full year’s cost of personnel added as a result of our acquisition in July 2001. The increase in expenses in 2001 as compared to 2000 is primarily due to an increase in headcount due to our acquisition of NSM. We believe that research and development expenses will remain relatively constant in dollar amounts during 2003 as compared to 2002.

     Marketing and Sales Expenses. Marketing and sales expenses consist primarily of salaries and related costs for sales and marketing personnel, sales commissions, trade shows and other marketing activities. Marketing and sales expenses were $4,189,000 in 2002, $3,745,000 in 2001 and $2,665,000 in 2000. Expenses increased in 2002 as compared to 2001 primarily due to the cost of personnel added as a result of our acquisition in July 2001. The increase in 2001 was primarily due to the full year’s expense of headcount hired throughout fiscal 2000 and the increase in headcount as a result of the acquisition of NSM. We believe that marketing and sales expenses will increase moderately in dollar amounts in 2003 as compared to 2002 due to increased sales commissions from the anticipated increase in sales.

     General and Administrative Expenses. General and administrative expenses consist primarily of personnel and related costs and legal and accounting services. General and administrative expenses were $1,731,000 in 2002, $1,422,000 in 2001 and $1,048,000 in 2000. General and administrative expenses were increased moderately during 2002 due to the increase in headcount as a result of our acquisition in July 2001. The increase in 2001 was primarily due to an increase in headcount as a result of the acquisition of NSM and an increase in professional fees. We believe that general and administrative expenses will remain relatively constant in dollar amounts during 2003 as compared to 2002, although the Company is still in the process of assessing the costs associating with the implementation of the requirements of the Sarbanes-Oxley Act that will take effect in 2003.

     Amortization. Amortization consists of the amortization of acquired intangible assets. In 2001, the acquisition of NSM generated approximately $3,376,000 in identified intangibles, which is currently being amortized over periods ranging from four to six years (see Note 4 of Notes to Consolidated Financial Statements). Amortization expense was $762,000 in 2002 and $317,000 in 2001. We expect amortization expense to be approximately $760,000 in 2003. Amortization could be affected by other acquisitions or impairment of existing identified intangible assets in future periods.

     Interest expense. Interest expense was $291,000, $198,000 and $113,000 in 2002, 2001 and 2000, respectively. The increase in 2002 is primarily due to a full year’s interest expense on the debt assumed upon the acquisition of NSM in July 2001. The increase in 2001 is primarily due to the interest on the debt assumed from our acquisition of NSM. Interest expense in 2003 is expected to increase moderately due to an expected increase in borrowings from our factoring agreement.

     Other income and expense. Other income and expense was $341,000 in 2002 and is primarily comprised of a gain of $300,000 related debt extinguishments as discussed in Note 6 of Notes to Consolidated Financial Statements.

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Liquidity and Capital Resources

     Net cash used in operating activities was $4,760,000 in 2002, compared to $3,830,000 used in 2001. Net cash used by operating activities in 2002 and 2001 primarily reflects a loss of $6,366,000 and $5,298,000 respectively, partially offset by depreciation and amortization of $1,127,000 in 2002 and $971,000 in 2001.

     Net cash used in investing activities was $106,000 during 2002, compared to $889,000 in 2001. Net cash used in 2002 consisted primarily of purchases of hardware and office furniture. Net cash in 2001 consisted primarily of purchases of hardware, office furniture and leasehold improvements and the direct costs of the acquisition of NSM Storage.

     Net cash provided by financing activities was $4,398,000 in 2002, compared to $5,481,000 provided in 2001. Net cash provided in 2002 consisted primarily of $5,375,000 of net proceeds from the issuance of preferred stock offset by the repayment of $977,000 of bank debt. Net cash provided in 2001 consisted primarily of $5,150,000 of net proceeds from the issuance of preferred stock.

     We have a factoring agreement that allows us to borrow the lesser of $1,500,000 or 85% of eligible receivables. At December 31, 2002, we were not in compliance with the tangible net assets covenant of the agreement. We have requested a waiver of the non-compliance and although a written waiver has not been received, borrowings have continued under the agreement. In addition, at December 31, 2002, DISC GmbH has revolving lines of credit totaling $242,000 and terms loans totaling $1,723,000. In January 2003, we reached agreement with the bank whereby the terms loans for DISC GmbH were restructured and the loans will be repaid as described in the table below.

     We have incurred substantial losses from operations, negative cash flow from operating activities and have a working capital deficit. In the past, we have obtained investor funding and credit facilities to maintain operations. In order for us to sustain operations and meet our obligations going forward, we plan to seek additional financing from investors and to significantly increase sales. We anticipate that we will continue to incur net losses for the foreseeable future. These factors raise substantial doubt about our ability to continue as a going concern. Subsequent to December 31, 2002 and through March 28, 2003, we have supported our operations with $860,000 in funding from investors and cash generated from sales of our products. The ability to sustain our operations will depend on our ability to significantly increase sales or raise significant additional equity or debt financing on terms acceptable to us. There is no assurance that any of these conditions will be achieved. In particular, we expect to require increasing amounts of cash to finance our efforts to increase sales, which we plan to achieve by increasing selling efforts to large system integrators and OEMs, by hiring additional sales and sales support staff and by making evaluation units available. In addition, we intend to expand our current network of resellers. We may require cash to finance purchases of inventory to satisfy anticipated increased sales as our products achieve market acceptance. In addition, we expect that the continued integration of our acquisition of NSM and the support of its operations will require cash as well. If we incur greater expenditures than we anticipate in these or other matters, and we cannot raise funds at acceptable terms or at all, we may not be able to develop or enhance our products, take advantage of other opportunities or respond to competitive pressures or unanticipated requirements.

     We have operating lease commitments for our facilities in Milpitas, (California) Bingen, (Germany) and various sales offices as described in the table below. In addition, although we have not committed to make any material capital expenditures as of December 31, 2002, our budget for capital equipment expenditures for 2003 is approximately $826,000. The majority of these purchases are expected to be in the areas of process and molding tooling to reduce cost and improve producibility of our products. We also have

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principal and interest payments due related to the debt assumed in our acquisition of NSM Storage GmbH as described in the table below.

     Details of our contractual obligations and commitments as of December 31, 2002, are as follows:

     The terms of the Series C Preferred Stock and outstanding warrants may limit the availability of financing for us, particularly equity financing, because of the superior preferences of the Series C Preferred Stock and the potential dilutive effect of the outstanding warrants. Holders of Series C Preferred Stock are entitled to receive cumulative dividends in the amount of approximately $112,000 per year when and if declared. We have never paid cash dividends and have no present plans to pay dividends.

Critical Accounting Policies

     We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are the most critical to aid in understanding our financial results include the following:

     Revenue Recognition

     We generally recognize revenue upon the shipment of our product to the customer provided that we have received a signed purchase order, the price is fixed, title has passed to the customer and collection of the resulting receivable is probable. We enter into contracts to sell our products and services, and, while the majority of our sales agreements contain standard terms, there are agreements that contain multiple elements or non-standard terms and conditions. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting, including how the price should be allocated among the deliverable elements if there are multiple deliverables, whether undelivered elements are essential to the functionality of delivered elements, and when to recognize revenue. We recognize revenue for delivered elements only when the following criteria is satisfied: undelivered elements are not essential to the functionality of delivered elements, uncertainties regarding customer acceptance are resolved, no significant obligations remain, other then the normal warranty obligation, and the fair value of each undelivered element is known. Changes in the allocation of the sales price between deliverables might impact the timing of revenue recognition, but would not change the total revenue recognized on the contract. Provisions for returns, allowances and warranty are recorded at the time revenue is recognized based on the Company’s historical experience. Service revenue is recognized ratably over the length of the service contract.

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     Accounts Receivable

     We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Since our accounts receivable are concentrated in a relatively small number of customers, a significant change in the financial position of one of these customers could have a material adverse effect on the collectability of our accounts receivable and our future operating results.

     Inventories

     We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory or the estimated net realizable value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our historical usage for the preceding twenty-four months and estimated forecast requirements for the next twelve months. Our industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if our inventory were determined to be overvalued, we would be required to recognize such costs in our cost of sales at the time of such determination. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory.

     Warranty

     Our warranty reserve is established based on our best estimate of our obligation for anticipated claims, based on historical experience, of the amounts necessary to repair or replace our product during the warranty period, which is generally one year, except for products sold in Europe where the statutory requirement is two years. While we believe that our warranty reserve is adequate and the judgment applied is appropriate, such amounts estimated to repair of replace our product could differ materially from what will actually transpire in the future and this would adversely affect our gross margins.

     Determining functional currencies for the purpose of consolidation.

     In preparing our consolidated financial statements, we are required to translate the financial statements of our foreign subsidiary from the currency in which they keep their accounting records, the German Mark for fiscal 2001 and the Euro for periods subsequent to December 31, 2001, into United States dollars. This process results in exchange gains or losses which, under the relevant accounting guidance are either included within the statement of operations or as a separate part of our shareholder’s equity under the caption “ accumulated other comprehensive loss”.

     Under the relevant accounting guidance the treatment of these translation gains or losses is dependent upon management’s determination of the functional currency of our subsidiary. The functional currency is based on management judgment and involves consideration of all economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts the majority of its transactions would be considered the functional currency.

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     If the subsidiary’s functional currency is deemed to be the local currency, then any gain or loss associated with the translation of the subsidiary’s financial statements is included in accumulated other comprehensive income or loss on the balance sheet.

     Based on our assessment of the factors discussed above, we determined that the subsidiary’s local currency to be the functional currency. Accordingly, we had accumulated other comprehensive loss of $295,000 which is included within our balance sheet at December 31, 2002. To the extent that DISC GmbH has assets or liabilities denominated in currencies other than the Euro, its functional currency, foreign exchange gains and losses are recognized in the income statement.

     The magnitude of these gains or losses is dependent upon movements in the exchange rate of the Euro against the United States dollar. Any future translation gains or losses could be significantly higher than those noted in 2002.

     Income Taxes

     As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

     Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance of $16.2 million as of December 31, 2002, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward and tax credits, before they expire. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods we may need to establish an additional valuation allowance which could materially impact our financial position and results of operations.

     Recent Accounting Pronouncements

     In June 2001, the Financial Accounting Standards Board (“FASB”) issued statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We do not expect that the adoption of SFAS 143 will have a significant effect on our financial position or results of operations.

     In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity

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has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company believes that the adoption of this standard will have no material impact on its financial statements.

     In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company believes that the adoption of this standard will have no material impact on its financial statements.

     In December 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods beginning after December 15, 2002. The Company believes that the adoption of this standard will have no material impact on its financial statements.

     In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2000. The Company believes that the adoption of this standard will have no material impact on its financial statements.

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

     We are not exposed to significant market risk related to fluctuations in interest rates because we are not expected to have a significant investment portfolio in fiscal 2003. In addition, we do not use derivative financial instruments of any kind.

     We are exposed to short-term fluctuations in interest rates as our borrowings on our lines of credit have variable interest rates. A sharp increase in interest rates would have an adverse impact on our interest expense.

     International sales are made mostly from our German subsidiary and are typically denominated in the Euro. Our German subsidiary also incurs most of its expenses in the local currency. Accordingly, our foreign subsidiary uses their local currency as their functional currency.

     Our international business is subject to risks typical of an international business including, but not limited to differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors. We are also exposed to foreign exchange rate fluctuations as the financial results of our foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected performance.

     We plan to assess the need to enter into foreign currency exchange forward contracts to offset the impact of currency fluctuations on certain nonfunctional currency assets and liabilities, primarily denominated Euro. We also plan to assess the need to periodically hedge anticipated transactions.

Item 8. Financial Statements and Supplementary Data.

     The financial statements required by this item are submitted as a separate section of this Form 10-K. See Item 15(a)(1) for a listing of financial statements provided in the section titled “Financial Statements.”

Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

     None.

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PART III

Item 10. Directors and Executive Officers of the Registrant.

     Robert W. Riland III, 39, became our President and Chief Executive Officer in March 2002. Mr. Riland was appointed to the Board of Directors and named Chairman of the Board of Directors in September 2002. Mr. Riland joined us in March 2000 as Vice President of Marketing and was promoted to Vice President of Sales and Marketing in July 2000. From July 1997 to February 2000, Mr. Riland served as Vice President of Sales at Maxoptix Corporation, a manufacturer of high capacity magneto-optical drives and library systems.

     Frank T. Connors, 68, has been our Secretary since May 1990, a member of our Board of Directors since June 1988 and was Chairman of the Board of Directors from June 1988 to August 1996 and our Chief Executive Officer from May 1990 to December 1994. Mr. Connors is Chairman of the Board of Directors of STM Wireless, Inc., a publicly held manufacturer of satellite communication networks.

     Michael D. Kaufman, 61, became a member of our Board of Directors in December 1988. Since October 1987, he has been the Managing General Partner of MK Global Ventures, MK Global Ventures II and MK GVD Fund, in Palo Alto, California, venture capital firms specializing in early-stage and start-up financing of high technology companies. Mr. Kaufman also serves on the Boards of Directors of Concerto Software, Inc., a telecommunications company, Syntellect Inc., a telecommunications company, Asante Technologies Inc., a networking company, and Human Pheromones Sciences, Inc., a company that develops and markets consumer products containing human pheromones.

     F. Rigdon Currie, 72, became member of our Board of Directors in December 1988. From February 1988 until he retired in 1998, Mr. Currie was a Limited Partner of MK Global Ventures II and MK GVD FUND. Mr. Currie still has a financial interest in MK Global II and MK GVD FUND. Mr. Currie serves on the Board of Directors of Acacia Research, Inc. a company that provides products for the media technology and life science sectors.

     Arch J. Mcgill, 70, became member of our Board of Directors in August 1993. Since October 1985, he has been President of Chardonnay, Inc., a venture capital investment and executive business advisory services company. Mr. McGill serves on the Board of Directors of CIBER, Inc., a provider of system integration services.

     Michael A. McManus, Jr., 59, became a member of our Board of Directors in August 1993. He is presently the President and Chief Executive Officer of Misonix Inc., a medical device company. From November 1991 to March 1998, he was President and Chief Executive Officer of New York Bancorp, Inc., the holding company for Home Federal Savings Bank. Mr. McManus also serves on the Boards of Directors of National Wireless Holdings Inc., a communications company, Novavax, Inc., a biopharmaceutical company, and the United States Olympic Committee.

     Henry Madrid, 46, is our Vice President, Finance and Chief Financial Officer. Mr. Madrid, a certified public accountant, joined us as Vice President of Finance and Chief Financial Officer in January 1990.

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     Robert Cellucci, 60, joined us in February 1998 as our Vice President, Operations. From September 1997 to January 1998 he served as Manufacturing and Materials consultant for Cyberdent, a dental equipment start-up and from 1994 to August 1997, Mr. Cellucci served as the Vice President of Operations at Ion Systems, a manufacturer of static control equipment and systems.

     Wilfried Beckmann, 42, joined the Company as the Managing Director of DISC GmbH upon our acquisition of NSM Storage GmbH in July 2001. From 1993 to 1998 Mr. Beckmann was the Chief Financial Officer of NSM Storage and became the Managing Director of NSM Storage in 1999.

     Horst Schellong, 52, joined the Company as the Vice President of Engineering of DISC GmbH upon our acquisition of NSM Storage GmbH in July 2001. In March 2002, he became Vice President of Engineering of world wide engineering operations. From 1995 to June 2001 Mr. Schellong was Vice President of Engineering of NSM Storage GmbH.

     Each of our directors is elected at the annual meeting of shareholders and holds office until the next annual meeting. Our executive officers are appointed by our board of directors or our president and serve at the discretion of our board of directors. There are no family relationships between any director, executive officer or person nominated or chosen by us to become a director or executive officer.

Section 16(a) Beneficial Ownership Reporting Compliance

     Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers and directors, and persons who own more than ten percent of a registered class of our equity securities, to file reports of securities ownership and changes in such ownership with the Securities and Exchange Commission. Officers, directors and greater than ten percent shareholders also are required by rules promulgated by the Securities and Exchange Commission to furnish us with copies of all Section 16(a) forms they file.

     Based solely upon a review of the copies of such forms furnished to us, the absence of a Form 3 or Form 5 or written representations that no Forms 5 were required, we believe that, during fiscal year 2002, our officers, directors and greater than ten percent beneficial owners complied with all applicable Section 16(a) filing requirements, except for the Forms 5 required for the Stock Option Grant for our Vice President of Operations, Robert Cellucci and certain purchases of preferred stock as described further in item 13 on page 33.

Item 11. Executive Compensation.

Summary Compensation Table

     The following Summary Compensation Table shows compensation paid by us for services rendered during fiscal years 2002, 2001 and 2000 to the person who was our Chief Executive Officer and the other executive officers who received salary and bonus compensation which exceeded $100,000 in fiscal year 2002.

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Option Grants in Last Fiscal Year

     The following table sets forth certain information with respect to stock options granted to our Chief Executive Officer and our four other most highly compensated executive officers during the fiscal year ended December 31, 2002. We have never granted any stock appreciation rights. All options grants were made under the 2001 stock plan.

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values

     The following table provides information on the value of options exercised in fiscal 2002 and the value of unexercised in-the-money options held by the named executive officers as December 31, 2002.

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Equity Compensation Plan Information

     The following chart gives aggregate information regarding grants under all of our equity compensation plans as of December 31, 2002.

Compensation of Directors

     Pursuant to our 1995 Stock Option Plan for Non-Employee Directors, each non-employee director receives an initial grant of options to purchase 25,000 shares of our common stock upon commencement of service as a director. In addition to such initial grant of 25,000 options, each non-employee director is granted an option to purchase 5,000 shares of our Common Stock during each year of service as a director commencing with fiscal year 1995.

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Compensation Committee Interlocks and Insider Participation

     Frank T. Connors, Michael A. McManus, Jr. and F. Rigdon Currie comprised the Board’s Compensation Committee during fiscal 2002. Mr. Connors has been our Secretary since May 1990 and was our Chief Executive Officer from May 1990 to December 1994. Neither Mr. McManus nor Mr. Currie has been an officer or employee of our company. Please see “Item 13. Certain Relationships and Related Transactions” for a discussion of certain relationships and transactions between Mr. Currie and DISC. During fiscal year 2002, none of our executive officers (i) served as a member of the Compensation Committee (or other board committee performing equivalent functions or, in the absence of any such committee, the board of directors) of another entity, one of whose executive officers served on our Compensation Committee, (ii) served as a director of another entity, one of whose executive officers served on our Compensation Committee, or (iii) served as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the board of directors) of another entity, one of whose executive officers served as a member of our Board of Directors.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

     The following table sets forth certain information regarding the beneficial ownership of our common stock as of December 31, 2002, as to (i) all directors, (ii) the named executive officers identified in the Summary Compensation Table located in Item 11, (iii) all directors and executive officers as a group, and (iv) each person known to us to be the beneficial owner of more than 5% of any class of our voting securities.

     Each share of our Series C, Series D, Series E and Series I through Series O Preferred Stock is convertible into one share of common stock and is entitled to one vote per share. Each share of our Series F Preferred Stock is convertible into two shares of common stock and is entitled to two votes per share. Each share of Series G, Series H and Series P through Series WW Preferred Stock is convertible into ten shares of common stock and is entitled to ten votes per share. Because our outstanding Preferred Stock votes together with and has the same rights to cumulative voting as the common stock, the number of shares held by each beneficial owner includes all shares of common stock and Preferred Stock on an as-if-converted basis, and “Percentage of Class” represents the total of our common and Preferred Stock, on an as-if-converted basis, issued and outstanding as of December 31, 2002. Except as otherwise indicated, we believe, based on information furnished by these owners, that the beneficial owners of the common stock and Preferred Stock have sole investment and voting power with respect to such shares, subject to applicable community property laws.

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Item 13. Certain Relationships and Related Transactions.

     During the twelve months ended December 31, 2002, the Company sold and MK GVD Fund, the principal shareholder, purchased 637,452 shares of convertible preferred stock and warrants under a formula set out in a March 1996 agreement for aggregate proceeds of $5,375,000. The warrants allow the holder to purchase 1,593,611 shares of common stock for exercise prices ranging from $0.80-$2.03. Under the agreement the number of shares of preferred stock was determined based on the lower of 85% of the closing bid price or the average closing price of the Company’s Common Stock for the five trading days ended three days prior to the issuance date, but not to exceed $2.50 per share as converted into common stock.

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     The fair value of the warrants issued during the twelve months ended December 31, 2002, $1,553,000 was determined using a Black Scholes option pricing model with the following assumptions: volatility of ranging from 142%-145%; risk free interest rates ranging from 2.50% to 4.94%; expected life of five years and no dividend yield. The fair value of the warrants is recorded in shareholders equity.

     A beneficial conversion feature is computed as the intrinsic value of the spread between the quoted market price of common stock and the conversion price multiplied by the number of common shares into which the preferred stock converts. This beneficial conversion feature is accounted for as a deemed dividend to the preferred stockholders and increases the net loss attributable to common shareholders. Our Board of Directors approved the above transactions. Michael D. Kaufman, a member of our Board of Directors, is the managing general partner of MK GVD Fund, MK Global Ventures and MK Global Ventures II. F. Rigdon Currie, a member of our Board of Directors, was, and continues to be, Special Limited Partner of MK GVD Fund and MK Global Ventures II. However, we believe that the terms and provisions of the above transactions were as fair to us as they could have been if made with unaffiliated third parties.

Item 14. Controls and Procedures.

     Within the 90 days prior to the date of this annual report on Form 10-K, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer along with our Vice President of Finance and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our President and Chief Executive Officer along with the our Vice President of Finance and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us (including its consolidated subsidiaries) required to be included in our periodic SEC filings. There have been no significant changes in our internal controls or in other factors which could significantly affect internal controls subsequent to the date we carried out our evaluation.

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PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a)  The following documents are filed as part of this Form 10-K:

     1.     Financial Statements.

     Our consolidated financial statements as set forth under Item 8 of this Annual Report on Form 10-K are presented herein at the pages noted.

     2.     Financial Statement Schedules.

     Financial statement schedules have been omitted as the information required to be set forth therein is not applicable or is readily available in the consolidated financial statements or notes to the consolidated financial statements.

     3.     Exhibits.

     The exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this Form 10-K.

(b)  Reports on Form 8-K:

     On March 12, 2002, we filed a report on Form 8-K announcing the appointment of Robert W. Riland, III to the position of President and CEO.

     On September 17, 2002, we filed Report on Form 8-K announcing the appointment of Robert W. Riland III to succeed J. Richard Ellis as a member of Board of Directors and Chairman.

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CONSOLIDATED FINANCIAL STATEMENTS

DISC, INC.
CONSOLIDATED BALANCE SHEETS