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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

or

Commission file number: 1-11578

DISC, INC.

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

     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 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 number of shares outstanding of the registrant’s common stock as of April 30, 2003 was 4,827,867.

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PART I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

DISC, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements.

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DISC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements.

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DISC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements.

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DISC, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – The Company

     Basis of Presentation and Liquidity

          We have prepared the unaudited interim condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. We have condensed or omitted certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles pursuant to these rules and regulations. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the financial position, operating results and cash flows for the periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and accompanying notes for the years ended December 31, 2002 and 2001 included in our Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the fiscal year, which ends December 31, 2003, or for any other period.

          The unaudited condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern.

          The Company has incurred substantial losses from operations, negative cash flows from operations and has a working capital deficit. In addition, the Company anticipates that it will continue to incur net losses for the foreseeable future. These factors raise substantial doubt about the Company’s ability to continue as a going concern. In the past, the Company has obtained investor funding and credit facilities to maintain operations. In order for the Company to sustain its operations and meet its obligations going forward, it plans to seek additional financing from investors and to significantly increase sales. Subsequent to December 31, 2002 and through April 30, 2003, the Company has received funding of $860,000 in equity financing and $340,000 in debt financing from investors and generated cash from sales of its products. The ability to sustain its operations will depend on the Company’s ability to significantly increase sales or raise significant additional equity or debt financing. Additional financing may not be available on acceptable terms, if at all, and the inability to obtain that financing could adversely affect the continued operations of the Company’s business. The consolidated financial statements do not include any adjustment that might result should the Company be unable to continue as a going concern.

     Basis of Consolidation

          The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated.

     Foreign Currency Translation

          The functional currency of the Company’s foreign subsidiaries is the local currency. Accordingly, the assets and liabilities of the Company’s foreign subsidiaries are translated into U.S. Dollars using the exchange rates in effect at the balance sheet date. Income and expense items are translated at average exchange rates for the period. Foreign currency translation adjustments are included in accumulated other comprehensive loss as a separate component of stockholders’ equity. Foreign currency transaction gains or losses were not material in any of the periods presented.

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Note 2 – Balance Sheet Details

Note 3 – Related Party Transactions

          During the three months ended March 31, 2003, the Company sold and MK GVD Fund, the principal shareholder, purchased 114,589 shares of convertible preferred stock and warrants under a formula set out in a March 1996 agreement for aggregate proceeds of $860,000. The warrants allow the holder to purchase 286,473 shares of common stock for exercise prices ranging from $0.94-$0.96. 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

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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.

          The fair value of the warrants issued during the three months ended March 31, 2003, $230,000 was determined using a Black Scholes option pricing model with the following assumptions: volatility of 140.51%; risk free interest rates ranging from 2.58% to 3.12%; 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.

Note 4 – Debt

          In December 2002, the Company renewed its factoring agreement with Summit Financial Resources, L.P. (Summit) for an additional year. Receivables purchased under this agreement are limited to the lesser of $1,500,000 or 85% of eligible receivables and are collateralized by substantially all of the assets of the Company. Interest under the agreement is prime rate plus 4% and 0.0825% of the amount of receivables purchased, with a minimum charge of $7,500 per month. At March 31, 2003 borrowings were $252,000 under this agreement. At December 31, 2002, and March 31, 2003 the Company was not in compliance with the net tangible asset covenant of the agreement. The Company is having discussions with Summit regarding this non-compliance. Although the Company has not received a waiver, borrowings have continued under the agreement.

          In January 2003 we reached agreement with DISC GmbH’s German bank to restructure our long-term debt. The four outstanding term loans were consolidated into two loans. One of the loans is payable in monthly installments of 23,000 Euros at an interest rate of 4.85% per annum beginning in January 2003 and the other loan is payable in monthly installments of 27,000 Euros beginning in 2007, at an interest rate of 5.25% per annum.

          The loans are collateralized by substantially all the assets of DISC GmbH and a guaranty of its Parent (DISC, Inc.) Under the terms of the loans, if the bank believes that GmbH’s financial condition has materially deteriorated or is expected to materially deteriorate, the bank has the right to accelerate payment of the loans. See further discussion on the terms of the loans in Note 6 of our Financial Statements for the year ended December 31, 2002 and 2001 included in the Company’s Annual Report on Form 10-K.

Note 5 – Comprehensive Loss

          A summary of comprehensive loss for the periods presented is as follow:

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Note 6 – Recent Accounting Pronouncements

          In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities” (“SFAS 146”). SFAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The scope of SFAS 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. We adopted SFAS 146 during the third quarter of 2002. The provisions of EITF No. 94-3 shall continue to apply for an exit activity initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the adoption of SFAS 146. The effect on adoption of SFAS 146 will change on a prospective basis the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred.

          In November 2002, FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability for the fair value 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 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 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 has adopted the disclosure provisions of SFAS 148.

          In January 2003, the FASB issued 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

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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.

Note 7 – Operating Segments

          The Company operates in one industry segment.

          The following is a summary of the Company’s revenue attributed to the geographic regions:

Note 8 – Stock-Based Compensation

          Since all the Company’s stock options were granted at fair market value at the date of grant, no compensation cost has been recognized for its fixed stock option plans. Had compensation cost for the Company’s three stock-based compensation plans been determined consistent with SFAS 123, the Company’s net loss and net loss per share would have been increased to the pro forma amounts indicated below:

          The compensation cost calculated under SFAS 123 is based on options granted from 1996 through three months ended March 31, 2003, and because additional option grants are expected to be made each year, the above pro forma disclosures are not representative of the pro forma effects of option grants on reported net income for future years.

          The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected volatility of 120.75% for three months ended March 31, 2003, dividend yield of 0% for all years; risk-free interest rates for the last day of the month in which the options were granted; and expected lives of four years for the 1990 Plan and the 2001 Plan, and five years for the Non-Employee Option Plan.

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

          The following information should be read in conjunction with the Condensed Consolidated Financial Statements and notes thereto included in Item 1 of this Quarterly Report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and notes thereto contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 31, 2003.

     Results of Operations

          For the three months ended March 31, 2003, we had sales of $3,001,000, compared to sales of $2,653,000 for the three months ended March 31, 2002. The increase in sales for the three months ended March 31, 2003 from the same period in 2002 is primarily due to an increase in sales in Europe. This increase was partially offset by a decrease in net sales in North America due to the continued slow down by the Federal Government in information technology spending and continued weakness in the storage industry. 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. 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 for our products complicate forecasting for operational planning and may cause net sales and operating results to vary significantly from quarter to quarter.

          Cost of sales, as a percentage of sales, decreased to 79% for the three months ended March 31, 2003, as compared to 84% for the comparable 2002 period. The decrease for the three months ended March 31, 2003 from the same period in 2002 is primarily due to headcount reduction enacted after the first quarter of 2002 and a company wide 10% salary reduction enacted in January 2003. Our relatively low gross margins reflect our low levels of net sales, which have resulted in unabsorbed manufacturing costs and high costs of materials due to the inability to achieve purchasing economies of scale. We expect that, if product sales increase significantly, 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 sales increases, cost of sales per unit of product may not decrease significantly or at all because the magnitude of the sales increase may not be sufficient or because manufacturing, material and other costs may independently increase.

          For the three months ended March 31, 2003, research and development expenses were $548,000, compared to $610,000 for the comparable period of 2002. The decrease for the three month periods ended March 31, 2003 as compared to the comparable periods of 2002 was primarily due to a headcount reduction enacted after the first quarter of 2002 and a company wide salary reduction enacted in January 2003. We believe that research and development expenses will remain relatively constant in dollar amounts during the remainder of 2003.

          Marketing and sales expenses were $845,000 for the three months ended March 31, 2003 compared to $1,079,000 for the comparable period in 2002. The decrease for the three months ended March 31, 2003 from the same period in 2002 is primarily due to a decrease in headcount enacted after the first quarter of 2002 and a company wide 10% salary wide salary reduction enacted in January 2003. We believe that marketing and sales expenses will increase moderately in dollar amounts during the remainder of 2003 as we have added significant resources in marketing and business development to allow us to address new markets and expand our customer base, but decline as a percentage of sales in the long term.

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          General and administrative expenses were $370,000 for the three months ended March 31, 2003 compared to $387,000 for the comparable period in 2002. General and administrative expense remained relatively constant for the three months ended March 31, 2003 and 2002. We expect general and administrative expenses to remain relatively constant in dollar amounts during the remainder of 2003, although the Company is still assessing the costs associated with the implementation of the Sarbanes Oxley Act that will take effect in 2003.

          Intangible amortization of $190,000 for the three months ended March 31, 2003 consists of the amortization of acquired intangible assets. The July 2001 acquisition of DISC GmbH generated approximately $3,376,000 in identified intangibles, which are currently being amortized over periods ranging from four to six years. We expect amortization expense to be approximately $190,000 for each quarter during 2003. Amortization could be affected by other acquisitions or impairment of existing identified intangible assets in future periods.

          Interest expense was $70,000 for the three months ended March 31, 2003 as compared to interest expense of $63,000 for the comparable period in 2002. Interest expense remained relatively constant for the three months ended March 31, 2003 and 2002. Interest expense is expected to increase moderately due to an expected increase in borrowings from our factoring agreement during the remainder of 2003.

          Notwithstanding the foregoing, we may incur significant, unexpected expenses as a result of attempts to respond to technological advances, increased competition, new product announcements and releases by our competitors, changes in the data storage market, market opportunities and other factors discussed below in “Factors That May Affect Future Operating Results and the Market Price of Our Stock.”

     Liquidity and Capital Resources

          Net cash used in operating activities for the three month period ended March 31, 2003 was $683,000 compared to $891,000 used for the comparable period in 2002. Net cash used in operating activities in 2003 primarily reflects a loss of $1,402,000 partially offset by a decrease in accounts receivable of $385,000, a increase in inventory of $206,000, an increase in accounts payable of $158,000, and depreciation and amortization of $269,000. Net cash used in operating activities in 2002 primarily reflects a loss of $1,911,000 partially offset by a decrease in accounts receivable of $288,000, an increase in accounts payable of $673,000, a decrease in accrued expenses and other liabilities of $172,000, and depreciation and amortization of $294,000.

          Net cash used in investing activities was $57,000 for the three months ended March 31, 2003 compared to $22,000 for the three months ended March 31, 2002 and primarily consisted of purchases of hardware.

          Net cash provided by financing activities was $476,000 for the three months ended March 31, 2003 compared to $311,000, provided for the three months ended March 31, 2002. Net cash provided in 2003 consisted primarily of $860,000 of net proceeds from the issuance of preferred stock offset by the repayment of $390,000 of debt. Net cash provided in 2002 consisted primarily of $875,000 of net proceeds from the issuance of preferred stock offset by the repayment of $564,000 of debt.

          We have a factoring agreement that allows us to borrow the lesser of $1,500,000 or 85% of eligible receivables. At March 31, 2003, borrowings under the agreement totaled $252,000 and we were not in compliance with the tangible net assets covenant of the agreement. We are having discussions with Summit regarding this non-compliance. Although we have not received a waiver, borrowings have continued under the agreement.

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          We have incurred substantial losses from operations and have a working capital deficit. 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. 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. Subsequent to December 31, 2002 and through April 30, 2003, we have supported our operations with $860,000 in equity financing and $340,000 in debt financing 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 GmbH 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.

“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995

          This quarterly report on Form 10-Q 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 these forward-looking statements are subject to the safe harbors created by those provisions. These forward-looking statements include statements relating to:

	•		future research and development projects;
	•		increasing our sales efforts and possible increases in sales;
	•		potential future decreases in costs of sales per unit;
	•		expected research and development, marketing and sales and general and administrative expenditures;
	•		expected amortization expense for each quarter;
	•		expanding our sales channels;
	•		expected sales cycles;
	•		the need for, and availability of, additional financing; and
	•		actual and potential acquisitions and their effects on our financial position.

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.

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          The forward-looking statements included in this quarterly report on Form 10-Q 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, we cannot assure that the results contemplated in forward-looking statements will be realized. In addition, our business and operations are subject to substantial risks which increase the uncertainty inherent in such forward-looking statements (see “Risk Factors that May Affect Future Operating Results” starting on page 7 of our annual report on Form 10-K for the year ended December 31, 2002 and “Factors that May Affect Future Operating Results and the Market Price of our Stock” below). In light of the significant uncertainties inherent in the forward-looking information included in this quarterly report on Form 10-Q, 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.

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Factors That May Affect Future Operating Results and the Market Price of Our Stock

          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 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 our 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 March 31, 2003 had an accumulated deficit of $44,022,000. We expect to continue to incur net losses for the foreseeable future, and our ability to sustain our operations for a significant period after December 31, 2003 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 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 due to anticipated spending increases primarily on sales, marketing and research and development efforts. 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 to pursue 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;

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	•		timing of new product announcements and releases by us or our competitors;
	•		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 sales and operating expenses;
	•		gain or loss of significant customers or distributors;
	•		changes in economic conditions;
	•		personnel changes; and
	•		our ability to effectively integrate the products and operations of NSM GmbH with ours.

          Our quarterly revenue 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, or VARs, and small system integrators and from one to two years for original equipment manufacturers, or OEMs, 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 a much less reliable predicator 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 revenue in each quarter results from orders placed during that quarter. Because of the relatively large dollar size of orders from our distributors and OEMs, 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

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revenue. 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 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, VARs, OEMs 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.

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     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.

          We expect that international revenues 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:

	•		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

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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 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 and network attached storage 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.

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          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 propriety 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 United States 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. However, there can be no assurance that such claims will not be made 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 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 March 31, 2003, our executive officers, directors and principal shareholders beneficially owned, in the aggregate, approximately 91% of our outstanding common stock, preferred stock and warrants, on an as-if-converted basis. In particular, our largest investor beneficially owns approximately 90% of our outstanding common stock, preferred stock and warrants, on an as-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 disadvantage other shareholders with interests different from those of our officers, directors and principal shareholders. For example, our officers, directors and principal shareholders 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

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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 revenue.

          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.

     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 shareholder approval of new stock options 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 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,

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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 SmallCap Market is conditioned upon our meeting certain asset, revenues and stock price tests. If we fail any of these tests, our common stock may be delisted from trading on the Nasdaq system, which could materially adversely affect the trading market and prices for those securities. In addition, low price stocks are subject to additional risks including additional state regulatory requirements and the potential loss of effective trading markets.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

          We are not exposed to significant market risk related to fluctuations in interest rates related to interest income, because we have not, and are not expected to have significant investments 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 have historically typically been denominated in German Marks, and beginning January 1, 2002 are typically denominated in Euro. Our German subsidiary also incurs most of its expenses in the local currency, the Euro. Accordingly, our foreign subsidiary uses its local currency as its 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 United States 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 in Euro. We also plan to assess the need to periodically hedge anticipated transactions.

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Item 4. Controls and Procedures

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

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

          In the ordinary course of business, we may from time to time become involved in certain legal proceeding. As of the date of this quarterly report, we are not a party to any pending material legal proceedings.

Item 2. Changes in Securities and Use of Proceeds

          During the first quarter ended March 31, 2003, we sold and MK GVD Fund, our principal shareholder, purchased 114,589 shares of convertible preferred stock and warrants under a formula set out in a March 1996 agreement for aggregate proceeds of $860,000. The warrants allow the holder to purchase 286,473 shares of our common stock for exercise prices ranging form $0.94-$0.96. Pursuant to the 1996 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 our common stock for five trading days ended three days prior to the issuance date, but not to exceed $2.50 per share as converted into common stock. The shares of preferred stock are convertible into a total of 2,864,730 shares of our common stock. These securities were not registered under the Securities Act of 1933, as amended (the “Securities Act”) in reliance upon the exemption provided by Section 4(2) of the Securities Act.

          As more fully discussed in Note 3 to the Condensed Notes to the Condensed (consolidated Financial Statements, we have issued preferred stock during the first quarter ended March 31, 2003. The preferred stock has certain rights, privileges and preferences (including liquidation preferences) over our common stock.

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

          No matters were submitted to a vote of our security holders during the quarter ended March 31, 2003.

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits.

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	(b)		Reports on Form 8-K
			We did not file any reports on Form 8-K during the quarter ending March 31, 2003.

SIGNATURES

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

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I, Robert W. Riland III, certify that:

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I, Henry Madrid, certify that:

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INDEX TO EXHIBITS