10-Q 1 f76935e10-q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 1-11578 (Commission file number) DISC, INC. (Exact name of registrant as specified in its charter) California 77-0129625 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 372 Turquoise Street 95035 Milpitas, California (Zip Code) (Address of principal executive offices) 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 [ ] The number of shares outstanding of the registrant's common stock as of October 31, 2001 was 4,814,013. PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS DISC, INC. CONSOLIDATED BALANCE SHEET

See the accompanying condensed notes to these consolidated financial statements. DISC, INC. CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements. DISC, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

See the accompanying condensed notes to these consolidated financial statements. DISC, INC. CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- THE COMPANY BASIS OF PRESENTATION We have prepared the unaudited interim 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 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 consolidated financial statements should be read in conjunction with the financial statements and accompanying notes for the years ended December 31, 2000 and 1999 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, 2001, or for any other period. During the first nine months of 2001, we received $4,650,000 of equity financing from our largest investor. Our investor also agreed to provide up to an additional $300,000 of equity financing to us, if needed. We believe that this committed investment, together with current cash reserves, cash to be generated from operations and borrowings from our factoring agreement with a financial institution, which allows us to sell the lesser of $1,500,000 or 85% of eligible accounts receivable, will be sufficient to meet our operating requirements at least through the end of 2001, although we anticipate that we will continue to incur net losses for the foreseeable future. The ability to sustain our operations for a significant period after December 31, 2001 will depend on our ability to significantly increase sales or raise significant additional equity or debt financing. BASIS OF CONSOLIDATION The 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. Dollar using 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 other comprehensive income as a separate component of stockholders' equity. Foreign currency transaction gains or losses are recorded in operating expenses and were not significant for the nine months ended September 30, 2001. NOTE 2 -- INVENTORIES The components of inventory were as follows:

NOTE 3 -- ACQUISITION OF NSM STORAGE GmbH AND SUBSIDIARIES On July 30, 2001, we acquired all of the outstanding shares of NSM Storage GmbH, a German limited liability company, which was subsequently renamed to DISC GmbH. We acquired DISC GmbH to expand our product offerings and increase our customer base in Europe. As consideration for the acquired business, we issued 965,210 shares of our common stock and paid $10,000 in cash. This transaction has been accounted for under the purchase method of accounting pursuant to the recently issued Financial Accounting Standard ("FAS") No. 141. Following is a table of total consideration paid and the preliminary allocation of consideration paid. Consideration paid:

Consideration paid allocation:

The Company's allocation of the aggregate consideration paid is based on management's preliminary analysis and estimates of the fair values of the tangible assets and intangible assets. The book values of tangible assets and liabilities acquired are assumed to approximate fair values. The allocation of the purchase price has not yet been finalized. Our quarterly results include the operations of DISC GmbH for the two months beginning August 1, 2001. Had the acquisition of DISC GmbH occurred on January 1, 2001, pro forma combined revenues would have been $4,372,000 and $10,168,000 for the three and nine months ended September 30, 2001. Pro forma net loss attributable to common shareholders would have been $1,666,000 or ($0.37) per share and $5,940,000 or ($1.46) per share for the three and nine months ended September 30, 2001. NOTE 4 -- RESTATEMENT Under EITF Nos. 98-5 and 00-27 and related standards, if a company issues convertible preferred stock with a beneficial conversion feature, then the value of the beneficial conversion feature is accounted for as a deemed dividend. 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. As described in Note 5, the Company has funded its operations through the sales, in private placements, of preferred stock and warrants to its principal investor. Management believes that these equity transactions were made in the best interests of the Company. In determining whether there was a beneficial conversion feature, management utilized an estimated fair value of common stock which was lower than its quoted market price. Management believed that the negotiated price of the stock was representative of the market price of the stock in a private placement of that size. Management concluded that there was no beneficial conversion feature associated with the issuance of convertible preferred stock and warrants, and the Company did not record a deemed dividend. Recently, the Company became aware that the SEC has insisted that the quoted market price be used in calculating a beneficial conversion feature. As the result of the SEC's position, the Company has restated its financial statements to reflect a deemed dividend as a charge to accumulated deficit and earnings per share. The restatement did not affect the Company's assets, liabilities, revenues or expenses as originally reported. In the restatement, the deemed dividend is added to net loss to determine net loss attributable to common shareholders. In addition to the restatement to use the quoted market price to measure the beneficial conversion feature, the Company restated to report a cumulative effect of accounting change as of October 1, 2000, representing the effect of the change in accounting method from use of the stated conversion price to use of the accounting conversion price in applying the intrinsic value method for determining the beneficial conversion feature for all convertible preferred stock issuances as required by EITF 00-27. The EITF required that the effect of adopting the accounting conversion price be recorded in the fourth quarter of 2000. Refer to our Form 10K/A for the year ended December 31, 2000, Form 10Q/A for the three month period ended March 31, 2001 and Form 10Q/A for the three month and six month periods ended June 30, 2001, for a further discussion of the impact of the restatement. NOTE 5 -- RELATED PARTY TRANSACTIONS During the nine months ended September 30, 2001, the Company sold and MK GVD Fund, the principal shareholder, purchased 71,038, 70,988 and 90,090 shares of convertible preferred stock, Series BB, CC and EE, respectively, and warrants under a formula set out in a March 1996 agreement for aggregate proceeds of $1,300,000, $1,150,000 and $1,000,000, respectively. The warrants allow the holder to purchase 177,595, 117,469 and 225,225 shares of common stock for an exercise price of $2.29, $2.03 and $1.39 per share, respectively. Under the agreement the number of shares of preferred stock was determined based on 85% of 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. The fair value of the warrants was determined using a Black Scholes option pricing model with the following assumptions: volatility of 142%; risk free interest rate of 5.08%; expected life: 5 years and no dividend yield. The fair value of the warrants is recorded in shareholders equity. In addition, in August 2001, we received $1,200,000 from MK GVD Fund in exchange for 60,000 shares of our Series DD preferred stock and warrants to purchase 150,000 shares of our common stock at an exercise price of $2.50 per share. The sales of the convertible debentures, preferred stock and warrants were deemed to be exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4 (2) of the Securities Act, as transactions by an issuer not involving a public offering. MK GVD Fund has also agreed to provide up to an additional $300,000 to us, if needed. NOTE 6 -- COMPREHENSIVE INCOME (LOSS) A summary of comprehensive loss for the periods presented is as follow:

NOTE 7 -- RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and requires recognition of all derivatives as assets or liabilities in the balance sheet and measurement of those instruments at fair value. We adopted SFAS 133 as of January 1, 2001 and it did not have a material effect on our financial condition or results of operations. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business Combinations." This standard eliminates the pooling-of-interests method of accounting for business combinations, except for qualifying business combinations that were initiated prior to July 1, 2001, and applies to all business combinations accounted for under the purchase method that are completed after June 30, 2001. We have adopted SFAS 141 as of July 1, 2001. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets." This standard eliminates the amortization of goodwill, and requires goodwill to be reviewed at least annually for impairment, the useful lives of previously recognized intangible assets to be reassessed and the remaining amortization periods to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001. The implementation of this standard is not expected to have a significant impact on the Company's financial condition or results of operations in the current fiscal year. NOTE 8 -- OPERATING SEGMENTS For purposes of segments reporting in accordance with SFAS No. 131, the Company has determined that it operates in one industry segment. The following is a summary of the Company's revenue attributed to the geographic regions:

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS For the three and nine months ended September 30, 2001, the company had sales of $3,739,000 and $7,813,000, respectively, compared to sales of $1,838,000 and $4,910,000 for the three and nine months ended September 30, 2000. These increases were primarily related to an increase in unit sales and our acquisition of DISC GmbH and were aided by an increase in the sale of media and service contracts. 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 75% and 81% for the three and nine months ended September 30, 2001, as compared to 79% and 84% for the comparable 2000 periods, primarily due to the increase in net sales. 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 was not sufficient or because manufacturing, material and other costs may independently increase. For the three and nine months ended September 30, 2001, research and development expenses were $551,000 and $1,339,000, respectively, compared to $280,000 and $838,000 for the comparable period of 2000. The increase for the three month period ended September 30, 2001 as compared to the comparable period of 2000, was primarily due to an increase in headcount in connection with the acquisition of DISC GmbH. In addition to the increase in headcount related to NSM, the increase for the nine month period ended September 30, 2001 as compared to the comparable period of 2000, was also due to an increase in headcount in connection with our network attach storage program. We believe that research and development expenses will continue to increase moderately during the remainder of 2001 due to new projects currently under development. Marketing and sales expenses were $1,008,000 and $2,588,000 for the three and nine months ended September 30, 2001 compared to $726,000 and $1,919,000 for the comparable periods in 2000. The increase for the three months ended September 30, 2001 as compared to the comparable period in 2000, is primarily due to an increase in headcount and related marketing and sales expenses related to the acquisition of DISC GmbH. In addition to the acquisition of DISC GmbH, the increase in expenses for the nine month period ended September 30, 2001, as compared to the comparable period of 2000, is primarily due to an increase in our sales and marketing headcount. We believe that marketing and sales expenses will increase during the remainder of 2001 as we have added significant resources in marketing and business development to allow us to address new markets and expand our customer base. General and administrative expenses were $392,000 and $982,000 for the three and nine months ended September 30, 2001, compared to $250,000 and $772,000 for the comparable periods in 2000. For the three month period ended September 30, 2001, the increase is primarily due to the acquisition of DISC GmbH, and the increase for the nine month period ended September 30, 2001, was also due to an increase in headcount and an increase in professional fees. General and administrative expenses are expected to remain relatively constant during the remainder of 2001. 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 During the nine month period ended September 30, 2001, we used $4,171,000 of cash in operations, primarily to fund operating losses. During the first nine months of 2001, we received $4,650,000 of equity financing from our largest investor (see Note 5 Related Party Transactions in Condensed Notes to Financial Statements). Our largest investor also agreed to provide up to an additional $300,000 of equity financing to us, if needed. We believe that this committed investment together with borrowing from our factoring agreement with a financial institution, which allows us to sell the lesser of $1,500,000 or 85% of eligible accounts receivable, current cash reserves and cash to be generated from operations will be sufficient to meet our operating requirements at least through the end of 2001, although we anticipate that we will continue to incur net losses for the foreseeable future. We also expect to require increasing amounts to increase sales as we approach large system integrators and OEMs with additional sales and sales support staff and evaluation units. In addition, we plan to expand our current network of resellers. We also expect that it will require cash to finance purchases of inventory in anticipation of possible increases in sales. In addition, we expect that the integration of our recent acquisition of DISC GmbH and the support of its operations will require cash as well. If we incur greater expenditures than we currently anticipate in connection with these or other matters, and if we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. The ability to sustain our operations for a significant period after December 31, 2001 will depend on our ability to significantly increase sales or raise significant additional equity or debt financing. We may not be able to increase sales or raise significant additional equity or debt financing, from our largest investor or otherwise, on a timely basis or at all. In particular, while we have relied upon regular investments by our largest investor to sustain our operations, our largest investor has no commitment to continue its investments, other than with respect to the additional $300,000 of equity financing mentioned above. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and requires recognition of all derivatives as assets or liabilities in the balance sheet and measurement of those instruments at fair value. We adopted SFAS 133 as of January 1, 2001 and it did not have a material effect on our financial condition or results of operations. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business Combinations." This standard eliminates the pooling-of-interests method of accounting for business combinations, except for qualifying business combinations that were initiated prior to July 1, 2001, and applies to all business combinations accounted for under the purchase method that are completed after June 30, 2001. We have adopted SFAS 141 as of July 1, 2001. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets." This standard eliminates the amortization of goodwill, and requires goodwill to be reviewed at least annually for impairment, the useful lives of previously recognized intangible assets to be reassessed and the remaining amortization periods to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001. The implementation of this standard is not expected to have a significant impact on the Company's financial condition or results of operations. "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; - 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. 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, 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 which increase the uncertainty inherent in such forward-looking statements (see "Additional Factors that May Affect Future Operating Results and the Market Price of our Stock" starting on page 5 of our annual report on Form 10-K for the year ended December 31, 2000 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. 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: 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; - 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 Storage 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 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 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. 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 DISC, 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. 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 System 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. 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, 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. 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 September 30, 2001 had an accumulated deficit of $34,491,000. 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, 2001 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. 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. ANY INABILITY TO MEET OUR FUTURE CAPITAL REQUIREMENTS WOULD LIMIT OUR ABILITY TO GROW. We will likely need to seek additional funding in the future. In the event we need to raise additional funds, we may not be able to do so on favorable terms, if at all. We have a commitment from our largest investor to invest up to $300,000 during the remainder of 2001, if needed, to help fund our capital requirements. However there can be no assurance that this investor, or any of our other investors, will be willing to make similar commitments in the future. 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. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. CONCENTRATION OF OWNERSHIP AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL SHAREHOLDERS MAY PREVENT OTHER INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS. As of October 31, 2001, our executive officers, directors and principal shareholders beneficially owned, in the aggregate, approximately 88% of our outstanding common stock, preferred stock and warrants, on an as-if-converted basis. In particular, our largest investor beneficially owns approximately 87% 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. WE ACQUIRED DISC GmbH. IF WE ARE NOT SUCCESSFUL IN INTEGRATING THEIR PRODUCTS AND OPERATIONS WITH OURS, OUR REVENUE AND OPERATING RESULTS COULD DECLINE. We recently acquired DISC GmbH, formerly NSM Storage GmbH. If we are not successful in integrating its products, services, technology and operations with ours, including coordinating our research development and sales and marketing efforts, the net sales and operating results of the combined company could decline. During the integration of DISC GmbH, our financial performance will be subject to risks commonly associated with an acquisition, including the financial impact of expenses necessary to realize benefits from the acquisition and the potential for disruption of operations, including the diversion of management's attention. We will face difficulties integrating personnel with disparate backgrounds and combining corporate cultures, and we may lose key employees. We may also lose customers and potential customers of DISC GmbH in connection with the transition of ownership or otherwise. We may not be able to accurately predict the impairment of the goodwill resulting form the acquisition. Further, we may not be able to accurately forecast the effect on future operating results from amortization of identifiable intangible assets. 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 original equipment manufacturers, or 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 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, value-added resellers, or VARs, original equipment manufacturers, or OEMs, and systems integrators, or SIs. 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. 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. WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES. California is in the midst of an energy crisis that could disrupt our operations and increase our expenses. In the event of an acute power shortage, that is, when power reserves for the state of California fall below certain critical levels, California has on some occasions implemented, and may in the future continue to implement, rolling blackouts throughout California. We currently do not have backup generators or alternate sources of power in the event of a blackout, and our current insurance does not provide coverage for any damages we or our customers may suffer as a result of any interruption in our power supply. If blackouts interrupt our power supply, we would be temporarily unable to continue operations at our California facilities. Any such interruption in our ability to continue operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations. Furthermore, the deregulation of the energy industry instituted in 1996 by the California government has caused power prices to increase. Under deregulation, utilities were encouraged to sell their plants, which traditionally had produced most of California's power, to independent energy companies that were expected to compete aggressively on price. Instead, due in part to a shortage of supply, wholesale prices have skyrocketed over the past year. If wholesale prices continue to increase, the operating expenses associated with our facilities are located in California will likely increase which would harm our results of operations. 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. 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. In addition, the terrorist acts of September 11, 2001 and subsequent terrorist activities have created an uncertain economic environment and we cannot predict the impact of these events, or of any related military action, on our customers or business. We believer that, in light of these events, some businesses may curtail or eliminate capital spending on information technology. If capital spending in our markets declines, it may be necessary for us to gain significant market share from our competitors in order to achieve our financial goals and achieve profitability. 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. We do not have any employment agreements with our employees. 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are not exposed to significant market risk related to fluctuations in interest rates, as we are not expected to have a significant amount of interest income in fiscal 2001. In addition, we do not use derivative financial instruments of any kind and all of our transactions are in U.S. currency. As a result of our recent acquisition of NSM Storage GmbH, we will experience an increased exposure to the change in foreign currency exchange rates or weak economic conditions in foreign markets. We plan to assess the need to enter into foreign exchange forward contracts to offset the impact of currency fluctuations on certain nonfunctional currency assets and liabilities, primarily denominated in German Marks. We also plan to assess the need to periodically hedge anticipated transactions with currency options. PART II -- OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS As more fully discussed in Note 5 to the Condensed Notes to Financial Statements, we have issued 71,038 shares of our Series BB preferred stock, 70,988 shares of our Series CC preferred stock, 60,000 shares of our Series DD preferred stock and 90,090 shares of our Series EE preferred stock. The preferred stock have certain rights, privileges and preferences (including liquidation preferences) over our common stock. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. We held our Annual Meeting of Shareholders on September 20, 2001. 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 1990 Stock Plan to 2,800,000. ABSTENTIONS AND FOR AGAINST SHARES NOT VOTED ---------- ---------- ---------------- 16,717,172 14,576 2,674,535 3. To approve the adoption of our 2001 Stock Plan. ABSTENTIONS AND FOR AGAINST SHARES NOT VOTED ---------- ---------- ---------------- 16,706,392 23,356 2,674,535 4. To appoint Pricewaterhouse Coopers LLP as independent auditors for the fiscal year ending December 31, 2001. ABSTENTIONS AND FOR AGAINST SHARES NOT VOTED ---------- ---------- ---------------- 18,162,286 9,550 1,234,447 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits.

(b) Reports on Form 8-K Current Report on Form 8-K filed on August 14, 2001 relating to the acquisition of NSM Storage GmbH. 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. DISC, INC. Dated November 14, 2001 By: /s/ J. Richard Ellis ------------------------------------ J. Richard Ellis President and Chief Executive Officer (Principal Executive Officer) Dated November 14, 2001 By: /s/ Henry Madrid ------------------------------------- Henry Madrid Vice President of Finance and Chief Financial Officer (Principal Financial and Accounting Officer) INDEX TO EXHIBITS

DISC INC/CA 10-Q