I/OMagic (IOMG) S-1 IPO registration

As filed with the Securities and Exchange Commission on May 6, 2004

Registration No. 333-                

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM S-1

REGISTRATION STATEMENT

Under

THE SECURITIES ACT OF 1933

I/OMAGIC CORPORATION

(Exact name of registrant as specified in its charter)

Nevada	3572	88-0290623
(State or Other Jurisdiction of Incorporation or Organization)	(Primary Standard Industrial Classification Code Number)	(I.R.S. Employer Identification No.)

4 Marconi

Irvine, California 92618

(949) 707-4800

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

Tony Shahbaz

Chief Executive Officer

I/OMagic Corporation

4 Marconi

Irvine, California 92618

(949) 707-4800

(949) 707-4850 (fax)

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

Copies of all correspondence to:

Larry A. Cerutti, Esq. John T. Bradley, Esq. Rutan & Tucker, LLP 611 Anton Boulevard, 14th Floor Costa Mesa, California 92626 (714) 641-5100 (714) 546-9035 (fax) William Mark Levinson, Esq. S. Elizabeth Foster, Esq. Luce, Forward, Hamilton & Scripps LLP 777 South Figueroa, Suite 3600 Los Angeles, California 90017 (213) 892-4992 (213) 892-7731 (fax)

Approximate date of commencement of proposed sale to the public:    As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.     ¨

CALCULATION OF REGISTRATION FEE

Title of each Class of Securities to be Registered	Amount to be Registered (1)	Proposed Maximum Offering Price Per Share (2)		Proposed Maximum Aggregate Offering Price (2)		Amount of Registration Fee
Common stock, $.001 par value	1,725,000	$	4.00	$	6,900,000	$	874.23

(1) Includes 225,000 shares of common stock issuable upon exercise of the underwriter’s over-allotment option. In the event of a stock split, stock dividend, anti-dilution adjustment or similar transaction involving common stock of the registrant, in order to prevent dilution, the number of shares registered shall be automatically increased to cover the additional shares in accordance with Rule 416(a) under the Securities Act.

(2) The proposed maximum offering price per share has been estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(c) of the Securities Act of 1933 and is based upon the average of the closing bid and asked prices of the Registrant’s common stock on the OTC Bulletin Board on May 3, 2004.

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell securities, and we are not soliciting offers to buy these securities, in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED MAY 6, 2004

PROSPECTUS

1,500,000 Shares

Common Stock

This a public offering of 1,500,000 shares of our common stock. We are offering 1,000,000 shares and the selling stockholders are offering 500,000 shares. We will not receive any of the proceeds from the sale of shares by the selling stockholders.

Our common stock is quoted on the OTC Bulletin Board under the symbol, “IOMG.” On May 3, 2004, the last reported sale price of our common stock on the OTC Bulletin Board was $4.25 per share. We have submitted an application for listing on the Nasdaq SmallCap Market under the symbol “IOMC.” This offering is intended primarily to allow us to satisfy the requirement for listing on the Nasdaq SmallCap Market that we have 300 round lot holders of our common stock. A qualifying round lot holder is a stockholder who owns at least 100 shares of our common stock. There can be no assurance that we will satisfy any of the requirements for listing on the Nasdaq SmallCap Market or that our shares will be listed on the Nasdaq SmallCap Market upon consummation of this offering or ever. See “Risk Factors” beginning on page 6.

Investing in our shares involves risks. See “Risk Factors” beginning on page 6 for some of the factors you should consider before buying shares of our common stock.

	Per Share	Total
Price to public	$	$
Underwriting discounts and commissions (1)	$	$
Proceeds to us, before expenses	$	$
Proceeds to selling stockholders	$	$

(1) We have agreed to pay Wedbush Morgan Securities Inc. additional compensation described in “Underwriting.”

We and the selling stockholders have granted the underwriter a 45-day option to purchase up to an additional 225,000 shares of our common stock on the same terms and conditions as set forth above solely to cover over-allotments, if any.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense.

Wedbush Morgan Securities Inc.

The date of this prospectus is                         , 2004.

TABLE OF CONTENTS

	Page
Prospectus Summary	1
Risk Factors	6
Special Note Regarding Forward-Looking Statements	16
Use of Proceeds	17
Dividend Policy	17
Price Range of Common Stock	18
Capitalization	19
Dilution	20
Selected Consolidated Historical Financial Data	21
Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Business	32
Management	49
Certain Relationships and Related Transactions	57
Principal and Selling Stockholders	58
Description of Capital Stock	59
Shares Eligible For Future Sale	61
Underwriting	63
Legal Matters	66
Experts	66
Where You Can Find More Information	66
Index to Consolidated Financial Statements	F-1

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information that is different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus, regardless of the time of delivery of this prospectus, or any sale of our common stock, is accurate only on the date of this prospectus.

Through and including                    , 2004 (the 25th day after the date of this prospectus), all dealers effecting transactions in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This requirement is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to its unsold allotment or subscription.

Certain persons participating in this offering may engage in transactions that stabilize, maintain or otherwise affect the price of our common stock. Specifically, the underwriter may over-allot in connection with the offering and may bid for, and purchase, shares of our common stock in the open market. For a description of these activities, see “Underwriting.”

In connection with this offering, the underwriter and its affiliates may engage in passive market-making transactions in our common stock in accordance with Rule 103 of Regulation M. See “Underwriting.”

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ABOUT THIS PROSPECTUS

This prospectus includes statistical data regarding our company and the markets in which we compete. We derived this data from our records or from information published or prepared by The NPD Group. Although we believe this information is reliable, we have not independently verified it.

Unless otherwise indicated, the information in this prospectus assumes that:

• Wedbush Morgan Securities does not exercise its over-allotment option; and

• the public offering price of our common stock will be $4.25 per share, which is the last sale price of our common stock on the OTC Bulletin Board on May 3, 2004.

To the best of our knowledge, we own or have rights to use all of the product names, brand names and trademarks that we use in conjunction with the sale of our products, including our I/OMagic^®, Digital Research Technologies^® and Hi-Val^® brand names and related logos, and our “MediaStation,” “DataStation,” Digital Photo Library^™, EasyPrint^™ and Sound Assault^™ product names. In addition, this prospectus refers to other product names, trade names and trademarks that are the property of their respective owners.

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PROSPECTUS SUMMARY

To fully understand this offering and its consequences to you, you should read the following summary along with the more detailed information and our consolidated financial statements and the notes to those statements appearing elsewhere in this prospectus.

I/OMagic Corporation

We operate in the data storage and digital entertainment industries. We sell data storage and digital entertainment products primarily in the United States and to a lesser extent in Canada, together known as the North American marketplace. Our data storage product offerings are predominantly focused on optical data storage media and include recordable compact disc, or CD, drives and recordable digital video or versatile disc, or DVD, drives predominantly for personal computers, or PCs. Our digital entertainment product offerings are predominantly focused on products that complement our line of data storage products and include MP3 players, digital audio headphones and palm-sized 20 gigabyte hard disk drives that we call our Digital Photo Library^™ system. Our data storage products accounted for approximately 94% of our net sales during the year ended December 31, 2003, and our digital entertainment products accounted for approximately 6% of our net sales for that period.

For the years ended December 31, 2003 and 2002, according to The NPD Group, a provider of sales tracking services for, among others, the consumer electronics and information technology industries, we achieved the number one market share in both unit and dollar sales of “after-market” compact disc rewritable, or CD-RW, drives in North America. “After-market” products are products not built into a PC at the time of its initial purchase. We launched our dual-format recordable DVD drives in July 2003. According to The NPD Group in its Retail Hardware Report, we were able to achieve the number four market share in both unit and dollar sales of after-market recordable DVD drives in North America during 2003, with only six months of sales during that year. We believe that the market for DVD-based data storage products will experience significant growth over the next few years and that we are in a position to benefit from this growth in terms of sales and market share.

We sell our products through computer, consumer electronics and office supply superstores and other major North American retailers, including Best Buy, Best Buy Canada, CompUSA, Circuit City, Fred Meyer Stores, Microcenter, Office Depot, OfficeMax, RadioShack, Staples, and Target. Our retailers collectively operate retail locations throughout North America. We also have relationships with other retailers, catalog companies and Internet retailers such as Buy.com, PC Mall, Tiger Direct and Dell.

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We market our products under three brand names. Our three brand names are I/OMagic^®, Digital Research Technologies^® and Hi-Val^®. We sell our data storage products under each of these brand names, bundling various hardware devices with different software applications to meet different consumer needs. Our digital entertainment products are currently sold under our I/OMagic^® and Digital Research Technologies^® brand names.

Market Opportunity

Storing, managing, protecting, retrieving and transferring data has become critical to individuals and businesses due to their increasing dependence on and participation in data-intensive activities. The data storage industry is growing in response to the needs of individuals and businesses to store, manage, protect, retrieve and transfer increasing amounts of data resulting from:

• the growth in the number of PCs, and the number, size and complexity of computer networks and software programs;

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• the emergence and development of new data-intensive activities, such as e-mail, e-commerce, and the increasing availability of products and services over the Internet, together with the rise in bandwidth available to access and download data from over the Internet; and

• the existence and availability of increasing amounts of digital entertainment data, such as music, movie, photographic, video gaming and other multi-media data.

We believe that the following key factors, among others, are driving and will continue to drive growth in the data storage and digital entertainment industries:

• Increased use of the Internet. As individuals and businesses increase their data-intensive use of the Internet for communications, commerce and data retrieval, the corresponding need to utilize data storage devices for the storage, management, protection, retrieval and transfer of data, especially high-capacity, cost-effective data storage devices, will continue to grow. In addition, increasing bandwidth allowing higher data transfer rates is making use of the Internet for data-intensive activities more convenient and cost-effective.

• Growth in new types of data. The growth in new types of data such as music, photographic, movie, and video gaming data, including high-resolution audio and video data, requires far greater storage capacity than traditional PC data. We believe that individual consumers and businesses increasingly depend on their abilities to store, manage, protect, retrieve and transfer these types of data using data storage devices.

• Growth in the critical importance of data. Business databases contain information about customers, suppliers, competitors and industry trends that may be analyzed and transformed into a valuable asset and a competitive advantage. Efficiently storing, managing, protecting, retrieving and transferring this information has become increasingly important to the success of many businesses.

• Decrease in the cost of storing data. The cost of data storage on magnetic, optical and solid state media continues to decrease with advances in technology and improved manufacturing processes. This decrease in cost encourages and enables individual consumers and businesses to purchase more data storage media and devices.

We believe that the factors listed above are driving growth in the major product categories of the data storage and digital entertainment industries, which include data storage devices for traditional PC data and digital entertainment data, digital photography products and digital audio products.

Our Strategy

Our primary goal is to remain a leading provider of data storage products and to expand our market share in the data storage industry. Our secondary goal is to expand our digital entertainment product line to offer additional products that complement our data storage products. Our business strategy to achieve these goals includes the following elements:

• Continue to develop and solidify our North American retail network. We have developed, and plan to continue to develop and solidify, close working relationships with leading North American retailers. These retailers carry many of the products we sell, and as we offer both new and enhanced data storage and digital entertainment products, we intend to take advantage of our existing relationships with these retailers to offer these products to consumers.

• Continue to develop and expand strategic relationships. We have developed, and plan to continue to develop and expand upon, our strategic relationships with our subcontract manufacturers, such as Behavior Tech Computer Corp. and Lung Hwa Electronics Co., Ltd. in Asia, in order to enhance our product development efforts and benefit from their knowledge of data storage and digital entertainment

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products. Some of these relationships are particularly strong because some of our important subcontract manufacturers are also our stockholders. By continuing to subcontract manufacture our products, we intend to continue to increase our operating leverage by delivering products incorporating new technology without the substantial investment and fixed costs associated with product development and manufacturing in an industry characterized by rapid product innovation and obsolescence.

• Continue to develop and offer high value products. We intend to continue to work in conjunction with our retailers and subcontract manufacturers to enhance existing products and develop new products to satisfy consumer demands and preferences. We believe that our core competencies such as our efficient management of product development and management of our product supply chain will enable us to enhance our products and develop new products in a cost-effective and timely manner. We believe that our target consumers seek high value products that combine performance, functionality and reliability at prices competitive with other leading products offered in the marketplace. We intend to continue to focus on high value product offerings by promoting and offering our products as affordable alternatives to higher-priced products offered by our competitors.

• Increase market share using our three-brand and “good, better, best” approaches. As a result of our close relationships with leading North American retailers and our three-brand and “good, better, best” marketing strategies, we have become a leading provider of data storage products. We plan to continue to focus on increasing our market share for our data storage products and on developing and building market share for our digital entertainment products. As funds become available, we intend to invest in a comprehensive targeted, brand- and product-specific marketing program to further establish awareness of our three brands and our products, and to solidify the confidence of existing users, and attract new purchasers, of our products. We also intend to further expand our “good, better, best” approach throughout our data storage product lines and into our digital entertainment product lines to sell products to consumers with varying needs, preferences and budgets.

• Expand into new sales channels. We plan to expand our market penetration beyond our existing retailers to including corporate and government procurers, value-added resellers and value-added distributors. Our company websites are located athttp://www.iomagic.com,http://www.dr-tech.com andhttp://www.hival.com. On these websites, we plan to continue to offer select products for direct purchase by consumers, conduct special promotions, and offer downloads and upgrades to existing and potential purchasers of our products.

• Market products to our existing consumer base. We intend to market new, enhanced and current products to existing purchasers of our products. We believe that we can increase sales of our digital entertainment products by marketing them to existing purchasers of our data storage products, and vice versa, so that purchasers of products of one of our two principal product categories buy products from our other principal product category. In addition, we believe that existing users of our products can be an important source of referrals for potential new purchasers of our products.

Corporate Information

Our principal executive offices are located at 4 Marconi, Irvine, California 92618. Our telephone number is (949) 707-4800. Our Internet addresses arehttp://www.iomagic.com,http://www.dr-tech.com andhttp://www.hival.com. Information contained on our websites or that is accessible through our websites should not be considered to be part of this prospectus.

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The Offering

Common stock offered by us	1,000,000 shares
Common stock offered by the selling stockholders	500,000 shares
Total	1,500,000 shares
Common stock to be outstanding after this offering	5,529,672 shares
Use of proceeds	We intend to use the net cash proceeds that we will receive from this offering for general corporate purposes, including working capital. See “Use of Proceeds.”
OTC Bulletin Board symbol	IOMG
Proposed Nasdaq SmallCap Market symbol	IOMC

The number of shares of common stock that will be outstanding after this offering is based on the 4,529,672 shares outstanding as of May 3, 2004, and excludes the following:

• 126,375 shares of common stock issuable upon exercise of outstanding options issued by us under our 2002 Stock Option Plan, at a weighted average exercise price of $3.67;

• 406,958 additional shares of common stock reserved for future issuance under our 2002 and 2003 Stock Option Plans;

• 126,167 shares of common stock issuable upon exercise of outstanding options, other than outstanding options issued under our 2002 Stock Option Plan, at a weighted average exercise price of $31.54;

• 40,004 shares of common stock issuable upon exercise of outstanding warrants at a weighted average exercise price of $9.78; and

• 172,500 shares reserved for future issuance under the underwriter’s warrant.

You should read the discussion under “Management — Stock Option Plans” for additional information about our 2002 and 2003 stock option plans.

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Summary Consolidated Historical Financial Information

The following consolidated historical financial information should be read in conjunction with the consolidated audited financial statements and the notes to those statements and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The consolidated statements of operations and comprehensive income data with respect to the years ended December 31, 2003, 2002 and 2001 and the consolidated balance sheet data at December 31, 2003 and 2002 are derived from, and are qualified by reference to, the consolidated audited financial statements included elsewhere in this prospectus. The historical results are not necessarily indicative of results to be expected for any future periods.

	Fiscal Years Ended December 31,
	2003			2002			2001			2000			1999
Consolidated Statements of Operations and Comprehensive Income Data:
Net sales	$	62,222,513		$	83,529,708		$	67,788,959		$	60,805,437		$	36,661,092
Cost of sales		53,083,729			74,665,823			62,776,334			53,126,489			31,419,757
Gross profit		9,138,784			8,863,885			5,012,625			7,678,948			5,241,335
Operating expenses		9,236,912			10,022,445			10,180,839			10,126,111			3,837,293
Income (loss) from operations		(98,128	)		(1,158,560	)		(5,168,214	)		(2,447,163	)		1,404,042
Total other income (expense)		(194,337	)		(5,525,033	)		(376,431	)		(4,963,286	)		30,256
Income (loss) from operations before income taxes		(292,465	)		(6,683,593	)		(5,544,645	)		(7,410,449	)		1,434,298
Income tax (benefit) expense		(27,148	)		1,663,638			3,000			(999,600	)		(428,500	)
Net income (loss)	$	(265,317	)	$	(8,347,231	)	$	(5,547,645	)	$	(6,410,849	)	$	1,862,798
Basic and diluted earnings (loss) per share	$	(0.06	)	$	(1.84	)	$	(1.23	)	$	(2.44	)	$	0.86
Weighted average shares outstanding, basic and diluted		4,529,672			4,528,894			4,528,341			2,629,894			2,153,954
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	6,091,369		$	7,320,143		$	4,423,623		$	3,502,546		$	1,943,522
Working capital		10,910,155			11,288,330			18,374,492			21,838,710			7,598,786
Total assets		40,112,792			41,757,969			55,903,767			53,098,438			22,916,329
Stockholders’ equity		16,377,717			16,726,720			17,115,651			22,659,571			7,875,963
Redeemable convertible preferred stock	$	—		$	—		$	9,000,000		$	9,000,000		$	—

No cash dividends on our common stock were declared during any of the periods presented above.

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RISK FACTORS

The following discussion summarizes material risks which you should carefully consider before you decide to buy our common stock in this offering. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business, financial condition and results of operations. Any of the following risks, if they actually occur, would likely harm our business, financial condition and results of operations. As a result, the trading price of our common stock could decline, and you could lose all or part of the money you paid to buy our common stock.

Risks Related to Our Business

We have incurred significant losses in the past, and we may continue to incur significant losses in the future. If we continue to incur losses, our business will be adversely affected.

We have incurred net losses in each year since the year ended December 31, 1999. As of December 31, 2003, we had an accumulated deficit of approximately $15,000,000. During the years ended December 31, 2003, 2002 and 2001, we incurred net losses in the amounts of approximately $265,000, $8,350,000, and $5,550,000, respectively. Historically, we have relied upon cash from operations and financing activities to fund all of the cash requirements of our business. An extended period of net losses would result in negative cash flow and may prevent us from operating or expanding our business. We cannot assure you that we will be able to attain, sustain or increase profitability on a quarterly or annual basis in the future. If we are not able to achieve, sustain or increase profitability, our business will be adversely affected and our stock price may decline.

We currently depend on a small number of major retailers for the vast majority of our net sales. A reduction in business from any of these retailers, or the failure by any of these retailers to timely pay amounts owed to us, could adversely affect our net sales and could seriously harm our business and financial condition.

During the year ended December 31, 2003, net sales to our two largest retailers represented approximately 28% and 13%, respectively, of our total net sales, and net sales to our next four largest retailers represented approximately 10%, 10%, 9% and 8%, respectively, of our total net sales. During the year ended December 31, 2003, aggregate net sales to these six retailers represented approximately 78% of our total net sales. We expect that we will continue to be dependent upon these retailers for a significant majority of our revenues for the foreseeable future.

Our agreements with these retailers do not require them to purchase any specified number of products or dollar amount of sales. Therefore, we cannot assure you that our net sales generated from these retailers, individually or in the aggregate, will reach or exceed historical levels in any future period. A cessation or reduction of business from, or a decrease in prices of products sold to, any of these retailers has significantly reduced our net sales for one or more reporting periods in the past and could, in the future, harm our business and financial condition. We cannot assure you that, if sales to any of these retailers cease or decline, we will be able to replace these sales with sales to either existing or new retailers in a timely manner, or at all. If we could not replace these sales, our business and financial condition would be adversely affected. Further, should one or more of these retailers fail to pay us amounts owed in a timely manner, we could suffer a substantial decline in our profitability, which would have a material adverse affect on our business, financial condition and results of operations.

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If we are unable to renew or replace our business loan agreement with United National Bank prior to its September 1, 2004 expiration date, our ability to purchase additional inventory and to expand or sustain our current sales volume would be adversely affected. In addition, we may be unable to fund our day-to-day operations.

Our business loan agreement with United National Bank expires on September 1, 2004. This agreement provides that if United National Bank calls the loan because of a default under the terms of the agreement, other than a payment default, we can repay the loan in six equal monthly installments unless we obtain a replacement credit facility, in which case all amounts would be due and payable. If we are unable to renew or replace this agreement, or if United National Bank calls the loan due in advance of its expiration as a result of a default by us, we may lack the funds to acquire sufficient amounts of inventory and our ability to expand or sustain our current sales volume will be adversely affected. In addition, we may be unable to fund our day-to-day operations.

One or more of our retailers may directly import or private label products that are identical, or very similar, to our products. This could cause a decline in our sales and could have an adverse impact on our business, financial condition and results of operations.

Optical data storage products and digital entertainment products are widely available from manufacturers and other suppliers around the world. Our major retailers include Best Buy, Circuit City, CompUSA, Staples, Office Depot and OfficeMax. Collectively, these six retailers accounted for 78% of our net sales for the year ended December 31, 2003. Each of these retailers has substantially greater resources than we do, and has the ability to directly import or private label, data storage and digital entertainment products from manufacturers and other suppliers around the world, including from some of our own subcontract manufacturers. Our retailers may believe that higher profit margins can be achieved if they implement a direct import or private label program, excluding us from the sales channel. Accordingly, one or more of our retailers may stop buying products from us in favor of a direct import or private label program. As a consequence, our sales and profitability would be adversely affected, which could have an adverse impact on our business, financial condition and results of operations.

We rely heavily on our Chief Executive Officer, and the loss of his services could adversely affect our business, financial condition and results of operations.

Our success depends, to a significant extent, upon the continued services of Tony Shahbaz, who is our Chairman of the Board, President, Chief Executive Officer and Secretary. For example, Mr. Shahbaz has developed key personal relationships with our suppliers and retail customers, including with our subcontract manufacturers, upon which we greatly rely in connection with our operations and the execution of our business strategies. Although we have entered into an employment agreement with Mr. Shahbaz, that agreement is of limited duration and is subject to early termination by Mr. Shahbaz under certain circumstances. In addition, we do not maintain “key person” life insurance covering Mr. Shahbaz or any other executive officer. The loss of Mr. Shahbaz could significantly delay or prevent the achievement of our business objectives. Consequently, the loss of Mr. Shahbaz could adversely affect our business, financial condition and results of operations.

The high concentration of our sales within the data storage industry could have a material adverse affect on our business, financial condition and results of operations if demand for those products declines or if competition within the industry intensifies.

Sales of our data storage products for the year ended December 31, 2003 accounted for approximately 94% of our net sales. Except for our digital entertainment products, which accounted for only approximately 6% of our net sales in the year ended December 31, 2003, we have not diversified our product categories, and all of these product categories are within the data storage industry. We expect data storage products to continue to account for the vast majority of our sales for the foreseeable future. As a result, our business, financial condition and results of operations would be significantly and adversely impacted by a downturn in the market for data storage products.

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If we fail to accurately forecast the costs of our product rebate or other promotional programs, our brand image, and our business, financial condition and results of operations may be adversely affected.

We rely heavily on product rebates and other promotional programs to maintain and increase sales of our products. If we fail to accurately forecast the costs of these rebate or other promotional programs, we may fail to allocate sufficient resources to these programs. For example, we may fail to keep sufficient funds available for mail-in product rebates. If we are unable to satisfy our promotional obligations, such as providing cash rebates to consumers, our brand image and goodwill with those consumers and our retailers would be harmed, which may adversely affect our business, financial condition and results of operations.

Competition within the data storage and digital entertainment industries is intense. All of our significant competitors have greater resources than we do and could use these resources to gain market share and cause us to lose sales and market share.

The data storage and digital entertainment industries are extremely competitive. All of our significant competitors have substantially greater production, financial, research and development, and marketing resources than we do. As a result, these companies may be able to compete more aggressively over a longer period of time than we can. In addition, our lack of resources relative to all of our significant competitors may cause us to fail to anticipate or respond adequately to technological developments and changing consumer demands and preferences, or may cause us to experience significant delays in developing or introducing new or enhanced products. These failures or delays could reduce our competitiveness and cause a decline in our market share and sales.

Data storage and digital entertainment products are subject to rapid technological changes. If we fail to accurately anticipate and adapt to these rapid technological changes, the products we sell will become obsolete, and our business, sales, financial condition and results of operations will be adversely affected.

The data storage and digital entertainment industries are extremely competitive and subject to rapid technological changes which cause product obsolescence. Companies within the data storage and digital entertainment industries are continuously developing new products with heightened performance and functionality. This puts pricing pressure on, and constantly threatens the obsolescence of, existing products. Our typical product life cycle is extremely short and ranges from only three to twelve months, generating lower average selling prices as the cycle matures. If we fail to accurately anticipate the introduction of new technologies, we may end up holding significant amounts of obsolete inventory that can only be sold at substantially lower prices and profit margins than we expected. In addition, if we fail to accurately anticipate the introduction of new technologies, we may be unable to compete effectively due to our failure to offer products most demanded by the marketplace. If any of these failures occur, our business, sales, financial condition and results of operations will be adversely affected.

Our indemnification obligations to our retailers for product defects could require us to pay substantial damages, resulting in an adverse affect on our business, financial condition and results of operations.

A number of our agreements with our retailers provide that we will defend, indemnify and hold them, and their customers, harmless from damages and costs that arise from product warranty claims or from claims for injury or damage resulting from defects in our products. If such claims are asserted against us, our insurance coverage may not be adequate to cover the costs associated with our defense of those claims or the cost of any resulting liability we would incur if those claims are successful. A successful claim brought against us for product defects that is in excess of, or excluded from, our insurance coverage could have an adverse affect on our business, financial condition and results of operations.

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If we are subjected to one or more intellectual property infringement claims, our business, financial condition and results of operations may be adversely affected.

Our products rely on intellectual property developed, owned or licensed by third parties. From time to time in the past, intellectual property infringement claims have been asserted against us. We expect to continue to be subjected to such claims in the future. Intellectual property infringement claims may also be asserted against our retailers as a result of selling our products. As a consequence, our retailers could assert indemnification claims against us. If any third party is successful in asserting an infringement claim against us, we could be required to acquire licenses, which may not be available on commercially reasonable terms, if at all, to discontinue selling certain products to pay substantial monetary damages or to develop non-infringing technologies, none of which may be feasible. Both infringement and indemnification claims could be time-consuming and costly to defend or settle and would divert management’s attention and our resources away from our business. Because we are a small company and may not have sufficient litigation defense resources, any one of these developments could place substantial financial and administrative burdens on us and our business, financial condition and results of operations could be adversely affected.

We are subject to penalties for both early and late product deliveries, which may adversely affect our business, financial condition and results of operations.

Our future operating results are dependent upon our ability to deliver products to our retailers in a timely manner. Often, the purchase orders placed by our retailers require us to deliver products on a specific date. Many of our retailers impose penalties for both early and late product deliveries, which could result in significant additional costs to us. Our failure to timely deliver products to our retailers could result in significant losses which would adversely affect our business, financial condition and results of operations.

Our failure to successfully manage our planned product expansion and our planned expansion into new sales channels could have a material adverse affect on our business, financial condition and results of operations.

We plan to offer new data storage and digital entertainment products in the future. In particular, we plan to offer additional DVD-based products, including DVRs, and to offer products with heightened performance and added functionality. We also plan to offer a next-generation DVD-based product, such as Blu-ray^® DVD or HD-DVD, depending on which of these competing formats we believe is most likely to prevail in the marketplace. These planned product offerings will require significant investments of capital and management’s close attention. In offering new digital entertainment products, our resources and personnel are likely to be strained because we have little experience in the digital entertainment industry.

We also plan to expand our sales of new and existing products into additional sales channels, such as corporate and government procurers, value-added resellers and value-added distributors. In addition, we plan to further develop our product offerings over the Internet at our company websites located athttp://www.iomagic.com,http://www.dr-tech.com andhttp://www.hival.com. These planned expansions will require significant resources, including for improvement of our information systems and accounting controls, management of product data, expansion of the capabilities of our administrative and operational personnel, and attracting, training, managing and retaining additional qualified personnel.

Our failure to successfully manage any of the above tasks associated with our planned product expansion and our expansion into new sales channels could have a material adverse affect on our business, financial condition and results of operations.

A significant product defect or product recall could have a material adverse affect on our brand image and our business, financial condition and results of operations.

A significant product defect could materially harm our brand image and could force us to conduct a product recall. This could result in damage to our relationships with our retailers and loss of consumer loyalty. Because

9

we are a small company, a product recall would be particularly harmful to us because we have limited financial and administrative resources to effectively manage a product recall and it would detract management’s attention from implementing our core business strategies. As a result, a significant product defect or product recall could materially and adversely affect our brand image and our business, financial condition and results of operations.

If our products are not among the first-to-market, or if consumers do not respond favorably to either our new or enhanced products, our sales and profits would decline and our business, financial condition and results of operations could be adversely affected.

One of our core strategies is to be among the first-to-market with new and enhanced product offerings based on established technologies. We believe that our I/OMagic^®, Digital Research Technologies^® and Hi-Val^® brands are perceived by the retailers and end-users of our products as among the leaders in the data storage industry. We also believe that the retailers and end-users of our products view products offered under our brands as embodying newly established technologies or technological enhancements. For instance, in introducing new and enhanced optical data storage products, we seek to be among the first-to-market, offering heightened product performance such as faster data recordation and access speeds. If our products are not among the first-to-market, our competitors may be able to bring products to market more rapidly than we do and therefore may gain market share at our expense, harming our sales and profits.

As a consequence of this core strategy, we are exposed to consumer rejection of our new and enhanced product offerings to a greater degree than if we offered products later in their industry life cycle. For example, our anticipated future sales are largely dependent on future consumer demand for DVD-based products displacing current consumer demand for CD-based products. Accordingly, future sales and any future profits from DVD-based products are substantially dependent upon widespread consumer acceptance of DVD-based products. If this widespread consumer acceptance of DVD-based products does not occur, or is delayed, our business, financial condition and results of operations will be adversely affected.

Failure to adequately protect our trademark rights could harm our business and cause us to lose market share and sales.

We sell our products under three brand names, I/OMagic^®, Digital Research Technologies^® and Hi-Val^®. Each of these trademarks has been registered by us with the United States Patent & Trademark Office. We also sell products under various product names such as “MediaStation,” “DataStation,” Digital Photo Library^™, EasyPrint^™ and Sound Assault^™. One of our key business strategies is to use our brand names and product names to successfully compete in the data storage and digital entertainment industries. We have expended significant resources promoting our brand names and our product names. We cannot assure you that the registration of our brand name trademarks, or our other actions to protect our non-registered product names, will deter or prevent their unauthorized use by others. We also cannot assure you that other companies, including our competitors, will not use our product names. If other companies, including our competitors, use our brand names or product names, consumer confusion could result, meaning that consumers may not recognize us as the source of our products. This would reduce the value of goodwill associated with these trademarks. This consumer confusion and the resulting reduction in goodwill could cause us to lose market share and cause our sales to decline.

Our use of a consignment sales model is increasing, which requires us to carry and finance greater amounts of inventory. If we are unable to carry and finance greater amounts of inventory, sales of our products will be reduced.

We are increasingly using a consignment sales model, which requires us to carry and finance greater amounts of inventory. Our existing financing sources may be inadequate to fund inventory levels required by our increasing use of a consignment sales model. If we are unable to obtain additional financing, we may be unable to finance sufficient inventory levels and we may be unable to fill orders in a timely manner, or at all, which would cause reduced sales of our products and would adversely affect our business, financial condition and results of operations.

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Consumer acceptance of alternative sales channels may increase. If we are unable to adapt to these alternative sales channels, this may result in reduced sales of our products.

We are accustomed to conducting business through traditional retail sales channels. Consumers purchase our products predominantly through six retailers, who collectively accounted for approximately 78% of our net sales for the year ended December 31, 2003. We currently generate a small number of direct sales of our products over the Internet, through our websites. We believe that many of our target consumers are knowledgeable about technology and comfortable with the use of the Internet for product purchases. Consumers may increasingly prefer alternative sales channels, such as direct mail order or direct purchase from manufacturers. In addition, Internet commerce, or direct purchase via the Internet, is becoming increasingly accepted by consumers as a convenient, secure and cost-effective method of purchasing data storage and digital entertainment products. The migration of consumer purchasing habits from traditional retailers to Internet retailers could have a significant impact on our ability to sell our products. We cannot assure you that we will be able to predict and respond to increasing consumer preference of alternative sales channels such as Internet commerce.

If our products fail to comply with existing and evolving government regulations and industry standards, we may have difficulty selling our products and could be subjected to liability for selling products that do not comply with applicable regulations.

Our products are designed to comply with industry standards and government regulations, some of which are evolving as new technologies are deployed. In the United States, our products must comply with regulations imposed by the United States Federal Communications Commission, or FCC, and Underwriters Laboratories, as well as numerous industry standards such as technological standards related to CD- or DVD-based products. We also must comply with numerous import/export regulations. In particular, our data communications devices in our data storage and digital entertainment product categories are subject to numerous FCC regulations. The failure of our products to comply, or delays in compliance, with the various existing and evolving regulations or standards could negatively impact our ability to sell our products and could result in liability on our part for selling products that fail to comply with applicable regulations.

A labor strike at a shipping port at which our products are shipped or received would prevent us from taking timely delivery of inventory, which would cause our sales to decline and could harm our business, financial condition and results of operations.

From time to time, shipping ports experience labor strikes or work stoppages which prevent the delivery of products shipped internationally via ocean freight. The shipping port located in Long Beach, California, through which we receive most of our products shipped by our subcontract manufacturers in Asia, experienced a labor strike in September 2002 which lasted for nearly two weeks. As a result, there was a significant disruption in our ability to deliver products to our retailers, which caused our sales to decline. Any future labor strike or work stoppage at a shipping port at which our products are received would prevent us from taking timely delivery of inventory and cause our sales to decline. In addition, many of our retailers impose penalties for both early and late product deliveries, which could result in significant additional costs to us. To meet our obligations to our retailers, we may be required to arrange for alternative means of product shipment, such as air freight, which could add significantly to our product costs. We would typically be unable to pass these extra costs along to either our retailers or to consumers. Also, because the average selling prices of our products decline during their short product life cycle, delayed delivery of products could yield significantly less sales or profits than planned, adversely affecting our business, financial condition and results of operations.

Our lack of long-term purchase orders and commitments may adversely affect our business, financial condition and results of operations.

All of our significant retailers issue purchase orders solely in their own discretion, often only one to two weeks before the requested date of shipment. Our retailers are generally able to cancel orders or delay the

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delivery of products on short notice. Accordingly, we cannot assure you that any of these retailers will continue to purchase our products in the future. In addition, we cannot rely on long-term purchase orders or commitments to protect us from the negative financial effects of a decline in demand for our products. The limited certainty of product orders can make it difficult for us to forecast our sales and allocate our resources accordingly. Moreover, our expense levels are based in part on our expectations of future sales and, should our expectations regarding future product orders and sales be inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls. As a result, our lack of long-term purchase orders and purchase commitments may adversely affect our business, financial condition and results of operations.

Our operations are vulnerable because we have limited redundancy and backup systems.

Our internal order and product data management system is an electronic system through which our retailers place orders for our products and through which we manage product pricing, shipment, return and other matters. This system’s continued and uninterrupted performance is critical to our daily business operations. Despite precautions that we have taken, unanticipated interruptions in our computer and telecommunications systems have, in the past, caused problems or stoppages in this electronic system. These interruptions could occur in the future. We have limited ability and personnel to process purchase orders and manage product pricing and other matters in any manner other than through this electronic system. Our business, financial condition and results of operations could be adversely affected by any damage or failure that interrupts or delays this electronic system.

Risks Related to this Offering

Our stock price is highly volatile, which could result in substantial losses for investors purchasing shares of our common stock and in litigation against us.

The market price of our common stock has fluctuated significantly in the past and may continue to fluctuate significantly in the future. During the year ended December 31, 2003, the high and low closing bid prices of a share of our common stock were $8.50 and $3.50, respectively. The market price of our common stock may continue to fluctuate in response to one or more of the following factors, many of which are beyond our control:

• changes in market valuations of similar companies;

• stock market price and volume fluctuations generally;

• economic conditions specific to the data storage and digital entertainment products industries;

• announcements by us or our competitors of new or enhanced products or technologies or of significant contracts, acquisitions, strategic relationships, joint ventures or capital commitments;

• the loss of one or more of our top six retailers or the cancellation or postponement of orders from any of those retailers;

• delays or problems in our introduction of new products or technological innovations;

• disputes or litigation concerning our rights to use third parties’ intellectual property;

• changes in our pricing policies or the pricing policies of our competitors;

• changes in foreign currency exchange rates affecting our product costs and pricing;

• regulatory developments or enforcement;

• fluctuations in our quarterly or annual operating results;

• additions or departures of key personnel; and

• future sales of our common stock or other securities.

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The price at which you purchase shares of our common stock in this offering may not be indicative of the price that will prevail in the trading market. You may be unable to sell your shares of common stock at or above your purchase price, which may result in substantial losses to you. Moreover, in the past, securities class action litigation has often been brought against a company following periods of stock price volatility. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and our resources from our business. Any of the risks described above could have an adverse effect on our business, financial condition and results of operations.

Our common stock has an extremely small public float and shares of our common stock eligible for public sale after this offering could cause the market price of our stock to drop, even if our business is doing well.

As of May 3, 2004, there were approximately 4.5 million shares of our common stock outstanding. As a group, our executive officers, directors and 10% shareholders beneficially own approximately 3.5 million of these shares. Accordingly, our common stock has a public float of approximately 1 million shares held by a relatively small number of public investors. After this offering, we will have approximately 5.5 million shares of common stock outstanding. Of these shares, approximately 2.5 million shares will be freely tradable without restriction or further registration under federal or state securities laws, including the 1,500,000 shares sold in this offering, unless purchased by our affiliates. In addition, we have a registration statement on Form S-8 in effect covering 133,333 shares of common stock issuable upon exercise of options under our 2002 Stock Option Plan and we intend to file a registration statement on Form S-8 covering 400,000 shares of common stock issuable upon exercise of options under our 2003 Stock Option Plan. Currently, options covering 126,375 shares of common stock are outstanding under our 2002 Stock Option Plan. The shares of common stock issued upon exercise of these options will be freely tradable without restriction or further registration, except to the extent purchased by one of our affiliates.

We cannot predict the effect, if any, that future sales of shares of our common stock into the public market will have on the market price of our common stock. However, sales of substantial amounts of common stock, including shares issued upon the exercise of stock options or warrants, or an anticipation that such sales could occur, may materially and adversely affect prevailing market prices for our common stock.

Our management will have broad discretion to use the proceeds from this offering, including the ability to apply the proceeds to uses that do not increase our operating results, sales, revenues or market value.

Our management will have considerable discretion in the application of the net proceeds of this offering. You will not have the opportunity, as part of your investment decision, to assess whether the net proceeds are being used appropriately. The net proceeds may be used for corporate purposes that do not increase our results of operations, sales, revenues or market value. Prior to being used in our business, the net proceeds of this offering may be placed in investments that do not produce income or that lose value. The failure to apply these funds effectively could impair our business, financial condition and results of operations, and could decrease the market value of our common stock.

We cannot assure you that our application to list our common stock on the Nasdaq SmallCap Market will be approved.

We have submitted an application to list our common stock on the Nasdaq SmallCap Market under the symbol “IOMC.” Even if we meet the Nasdaq requirement for 300 round lot holders of our common stock upon consummation of this offering, we will still need to meet the remaining Nasdaq SmallCap Market listing requirements, including our common stock having a minimum bid price of $4.00 per share. There can be no assurance that our shares will be listed on the Nasdaq SmallCap Market upon consummation of this offering, or ever. In the event our shares are not listed on the Nasdaq SmallCap Market, our shares will continue to trade on the OTC Bulletin Board.

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If the ownership of our common stock continues to be highly concentrated, it may prevent you and other stockholders from influencing significant corporate decisions and may result in conflicts of interest that could cause our stock price to decline.

As a group, our executive officers, directors, 10% stockholders beneficially own or control approximately 80% of our outstanding shares of common stock (after giving effect to the exercise of all outstanding vested options exercisable within 60 days from May 3, 2004). As a result, our executive officers, directors, and 10% stockholders, acting as a group, have substantial control over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets, or any other significant corporate transaction. Some of these controlling stockholders may have interests different than yours. For example, these stockholders may delay or prevent a change of control of I/OMagic, even one that would benefit our stockholders, or pursue strategies that are different from the wishes of other investors. The significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise.

Our amended and restated articles of incorporation, amended and restated bylaws and Nevada law contain provisions that could discourage transactions resulting in a change in control of I/OMagic, which may negatively affect the market price of our common stock.

Our articles of incorporation and our bylaws contain provisions that may enable our management or our board of directors to discourage, delay or prevent a change in the ownership of I/OMagic or in our management. In addition, these provisions could limit the price that investors would be willing to pay in the future for shares of our common stock. These provisions include the following:

• our board of directors is authorized, without prior stockholder approval, to create and issue preferred stock, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock;

• stockholders are permitted to remove members of our board of directors only upon the vote of at least two-thirds of the outstanding shares of stock entitled to vote at a meeting called for such purpose or by written consent; and

• our board of directors are expressly authorized to make, alter or repeal our bylaws.

We may be subject to the restrictions contained in Sections 78.378 through 78.3793 of the Nevada Revised Statutes which provide, subject to certain exceptions and conditions, that if a person acquires a “controlling interest,” which is equal to one-fifth, one-third, or one-half or more of the voting power of a corporation, that person is an “interested stockholder” and may not vote that person’s shares. The effect of these restrictions may be to discourage, delay or prevent a change in control of I/OMagic.

We cannot assure you that an active market for our shares of common stock will develop or, if it does develop, will be maintained in the future.

On March 25, 1996, our common stock commenced trading on the OTC Bulletin Board. Since that time, there has been limited trading in our shares, at widely varying prices, and the trading to date has not created an active market for our shares. We cannot assure you that an active market for our shares will be established or maintained in the future. If an active market is not established or maintained, you may not be able to readily sell your shares of our common stock.

Because we are subject to “penny stock” rules, the level of trading activity in our common stock may be reduced.

Broker-dealer practices in connection with transactions in “penny stocks” are regulated by penny stock rules adopted by the Securities and Exchange Commission. Penny stocks, are, generally, equity securities with a price

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of less than $5.00 (other than securities registered on some national securities exchanges or quoted on Nasdaq). The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the nature and level of risks in investing in the penny stock market. The broker-dealer also must provide the prospective investor with current bid and offer quotations for the stock and the compensation to be paid to the broker-dealer and its salespeople in the transaction. Furthermore, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer’s presumed control over the market, and must provide each holder of penny stock with a monthly account statement showing the market value of each penny stock held in the customer’s account. In addition, broker-dealers who sell penny stocks to persons other than established customers and “accredited investors” must make a special written determination that the penny stock is a suitable investment for the prospective investor and receive the purchaser’s written agreement to the transaction. These requirements may have the effect of reducing the level of trading activity in a penny stock, such as our common stock, and investors in our common stock may find it difficult to sell their shares.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements, including statements concerning future conditions in the data storage and digital entertainment industries, and concerning our future business, financial condition, operating strategies, and operational and legal risks. We use words like “believe,” “expect,” “may,” “will,” “could,” “seek,” “estimate,” “continue,” “anticipate,” “intend,” “future,” “plan” or variations of those terms and other similar expressions, including their use in the negative, to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as to our expectations as of the date of this prospectus. These forward-looking statements are subject to a number of risks and uncertainties, including those identified under “Risk Factors” and elsewhere in this prospectus. Although we believe that the expectations reflected in these forward-looking statements are reasonable, actual conditions in the data storage and digital entertainment industries, and actual conditions and results in our business, could differ materially from those expressed in these forward-looking statements. In addition, none of the events anticipated in the forward-looking statements may actually occur. Any of these different outcomes could cause the price of our common stock to decline substantially. Except as required by law, we undertake no duty to update any forward-looking statement after the date of this prospectus, either to conform any statement to reflect actual results or to reflect the occurrence of unanticipated events.

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USE OF PROCEEDS

We estimate the net proceeds from the sale of shares of common stock in this offering to be approximately $3.4 million, or approximately $4.0 million if the underwriter exercises its over-allotment option in full, based on an assumed offering price of $4.25 per share and after deducting the underwriting discounts and commissions and estimated offering expenses described in “Underwriting — Commissions and Expenses.” We will not receive any of the proceeds from the sale of shares of our common stock by the selling stockholders.

We intend to use the net proceeds from this offering for general corporate purposes, including working capital. Management will have broad discretion in the allocation of the net proceeds among working capital and other general corporate purposes. If suitable opportunities are available, we may use a portion of the net proceeds currently intended for working capital for the acquisition of, or investment in, other companies or other assets that are complementary to our business. As of the date of this prospectus, we have no understandings, commitments or agreements relating to any potential business acquisitions or investments.

Pending these uses, we intend to invest the net proceeds of this offering in short-term, high-grade interest-bearing securities, certificates of deposit, or direct or guaranteed U.S. government obligations.

DIVIDEND POLICY

We have not declared or paid any cash dividends on our capital stock in the past, and we do not anticipate declaring or paying cash dividends on our common stock in the foreseeable future. In addition, our business loan agreement with United National Bank, described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”, restricts the payment of dividends without the bank’s consent.

We will pay dividends on our common stock only if and when declared by our board of directors. The board of director’s ability to declare a dividend is subject to restrictions imposed by Nevada law. In determining whether to declare dividends, the board of directors will consider these restrictions as well as our financial condition, results of operations, working capital requirements, future prospects and other factors it considers relevant.

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PRICE RANGE OF COMMON STOCK

Our common stock has been traded on the OTC Bulletin Board under the symbol “IOMG” since December 20, 2002. From March 25, 1996 until December 19, 2002, our common stock traded on the OTC Bulletin Board under the symbol “IOMC.” The table below shows, for each fiscal quarter indicated, the high and low closing bid prices for shares of our common stock. This information has been obtained from the OTC Bulletin Board. The prices shown reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. The prices listed below and elsewhere within this prospectus reflect the one-for-fifteen reverse split of our common stock effected December 20, 2002.

	Low		High
Year Ended December 31, 2002
First Quarter (January 1—March 31)	$	8.40	$	16.05
Second Quarter (April 1—June 30)		5.25		13.95
Third Quarter (July 1—September 30)		6.15		9.90
Fourth Quarter (October 1—December 31)		3.75		9.00
Year Ended December 31, 2003
First Quarter	$	3.50	$	8.50
Second Quarter		3.50		8.00
Third Quarter		5.00		6.50
Fourth Quarter		3.80		6.25

As of May 3, 2004, we had 4,529,672 shares of common stock outstanding held of record by approximately 72 stockholders. Within the holders of record of our common stock are depositories that hold shares of stock for brokerage firms which, in turn, hold shares of stock for beneficial owners. On May 3, 2004, the last reported sale price of our common stock on the OTC Bulletin Board was $4.25 per share.

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2003 and as adjusted to reflect the sale by us of 1,000,000 shares of common stock in this offering and the application of the estimated net proceeds assuming an offering price of $4.25 per share, which was the last reported sale price of our common stock on the OTC Bulletin Board on May 3, 2004, after deducting underwriting discounts and commissions and estimated offering expenses. The information in the table below is qualified by, and should be read in conjunction with, our consolidated audited financial statements and related notes appearing elsewhere in this prospectus. The following table assumes that the underwriter does not exercise its over-allotment option and excludes the following shares:

• 126,375 shares of common stock issuable upon exercise of outstanding options issued by us under our 2002 Stock Option Plan at a weighted average exercise price of $3.67;

• 406,958 additional shares of common stock reserved for future issuance under our 2002 and 2003 Stock Option Plans;

• 126,167 shares of common stock issuable upon exercise of outstanding options, other than outstanding options issued under our 2002 Stock Option Plan, at a weighted average exercise price of $31.54;

• 40,004 shares of common stock issuable upon exercise of outstanding warrants at a weighted average exercise price of $9.78; and

• 172,500 shares reserved for future issuance under the underwriter’s warrant.

	December 31, 2003
	Actual			As Adjusted
Cash and cash equivalents	$	6,091,369		$	9,490,119
Long-term debt and capital lease obligations, less current portion	$	—		$	—
Stockholders’ equity:
Preferred stock, $.001 par value per share, 10,000,000 shares authorized; no shares issued and outstanding, actual; and no shares issued and outstanding, as adjusted		—			—
Common stock, $.001 par value per share, 100,000,000 shares authorized; 4,529,672 shares issued and outstanding, actual; and 5,529,672 shares issued and outstanding, as adjusted		4,530			5,530
Additional paid-in capital		31,557,988			34,955,738
Treasury stock, 13,493 shares, at cost		(126,014	)		(126,014	)
Accumulated deficit		(15,058,787	)		(15,058,787	)
Total stockholders’ equity		16,377,717			19,776,467
Total capitalization	$	16,377,717		$	19,776,467

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DILUTION

Purchasers of our common stock offered by this prospectus will suffer immediate and substantial dilution in net tangible book value per share. Net tangible book value per share represents the amount of total tangible assets less total liabilities, divided by the number of shares of our common stock outstanding as of December 31, 2003. Dilution in net tangible book value per share represents the difference between the amount per share paid by purchasers of our common stock in this offering and the net tangible book value per share of our common stock immediately after this offering.

Our net tangible book value as of December 31, 2003 was approximately $11.6 million, or approximately $2.56 per share of common stock. After giving effect to the sale by us of 1,000,000 shares of common stock in this offering at an assumed offering price of $4.25 per share, the last reported sale price of our common stock on the OTC Bulletin Board on May 3, 2004, and after deduction of the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our net tangible book value as of December 31, 2003 would have been approximately $15.0 million, or $2.71 per share. This represents an immediate increase in net tangible book value of $0.15 per share of common stock to existing stockholders and an immediate dilution of $1.54 per share to purchasers of common stock in this offering.

Assumed public offering price per share			$	4.25
Net tangible book value per share as of December 31, 2003	$	2.56
Increase in net tangible book value per share attributable to new investors		.15
Pro Forma Net tangible book value per share as of December 31, 2003, after giving effect to this offering				2.71
Dilution in net tangible book value per share to new investors			$	1.54

The above information does not take into account further dilution to new investors that could occur upon the issuance of additional shares of our common stock. It also excludes shares of our common stock issuable upon exercise of outstanding stock options and warrants, as well as shares of our common stock reserved for future issuance under our stock option plans.

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SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA

The following selected consolidated historical financial data should be read in conjunction with the consolidated audited financial statements and the notes to those statements and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The consolidated statements of operations and comprehensive income data with respect to the years ended December 31, 2003, 2002 and 2001 and the consolidated balance sheet data at December 31, 2003 and 2002 are derived from, and are qualified by reference to, the consolidated audited financial statements included elsewhere in this prospectus. The historical results reflected below, and elsewhere in this prospectus, are not necessarily indicative of results to be expected for any future periods.

	Fiscal Years Ended December 31,
	2003			2002			2001			2000			1999
Consolidated Statements of Operations and Comprehensive Income Data:
Net sales	$	62,222,513		$	83,529,708		$	67,788,959		$	60,805,437		$	36,661,092
Cost of sales		53,083,729			74,665,823			62,776,334			53,126,489			31,419,757
Gross profit		9,138,784			8,863,885			5,012,625			7,678,948			5,241,335
Operating expenses		9,236,912			10,022,445			10,180,839			10,126,111			3,837,293
Income (loss) from operations		(98,128	)		(1,158,560	)		(5,168,214	)		(2,447,163	)		1,404,042
Total other income (expense)		(194,337	)		(5,525,033	)		(376,431	)		(4,963,286	)		30,256
Income (loss) from operations before income taxes		(292,465	)		(6,683,593	)		(5,544,645	)		(7,410,449	)		1,434,298
Income tax (benefit) expense		(27,148	)		1,663,638			3,000			(999,600	)		(428,500	)
Net income (loss)	$	(265,317	)	$	(8,347,231	)	$	(5,547,645	)	$	(6,410,849	)	$	1,862,798
Basic and diluted earnings (loss) per share	$	(0.06	)	$	(1.84	)	$	(1.23	)	$	(2.44	)	$	0.86
Weighted average shares outstanding, basic and diluted		4,529,672			4,528,894			4,528,341			2,629,894			2,153,954
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	6,091,369		$	7,320,143		$	4,423,623		$	3,502,546		$	1,943,522
Working capital		10,910,155			11,288,330			18,374,492			21,838,710			7,598,786
Total assets		40,112,792			41,757,969			55,903,767			53,098,438			22,916,329
Stockholders’ equity		16,377,717			16,726,720			17,115,651			22,659,571			7,875,963
Redeemable convertible preferred stock	$	—		$	—		$	9,000,000		$	9,000,000		$	—

No cash dividends on our common stock were declared during any of the periods presented above.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated audited financial statements and the related notes and the other financial information included elsewhere in this prospectus. This discussion contains forward-looking statements regarding the data storage and digital entertainment industries and our expectations regarding our future performance, liquidity and capital resources. Our actual results could differ materially from those expressed in these forward-looking statements as a result of any number of factors, including those set forth under “Risk Factors” and under other captions contained elsewhere in this prospectus.

Overview

We are a leading provider of optical data storage products. We also sell digital entertainment products. Our data storage products consist of a range of products that store traditional PC data as well as music, photos, movies, games and other multi-media content. These products are designed principally for general data storage purposes. Our digital entertainment products consist of a range of products that focus on digital music, photos and movies. These products are designed principally for entertainment purposes.

We sell our products through computer, consumer electronics and office supply superstores and other retailers who collectively operate retail locations throughout North America. Our network of retailers enables us to offer products to consumers across North America, including every major metropolitan market in the United States. Our largest retailers include Best Buy, Circuit City, CompUSA, Staples, Office Depot and OfficeMax. We employ a three-brand approach to achieve our goal of product differentiation among various sales channels and price points. Our three brands are I/OMagic^®, Digital Research Technologies^® and Hi-Val^®.

Prior to 2003, we also emphasized the sale of other PC-related and consumer electronics products including, media, keyboards, mice, cameras, audio and graphic cards and flat panel television monitors. During the latter part of 2002 and the early part of 2003, we made a strategic decision to de-emphasize these additional product offerings in order to focus our management and financial resources on the manufacture and sale of our data storage and digital entertainment products, especially the manufacture and sale of dual-format DVD recordable devices that we introduced in July 2003. Because of our planned introduction of these devices in the third quarter of 2003, we reduced our promotional activities, such as rebates and point-of-sale discounts, for our CD-based products. This reduction in promotional activities, combined with our transition out of certain product offerings and other factors discussed below, resulted in a 25.5% decline in net sales for 2003 as compared to 2002.

Despite this significant reduction in net sales for 2003, we reduced our net loss from $8.3 million in 2002 to $265,000 for 2003. We believe that this significant improvement in our operating results is due, in large part, to the following factors:

• Settlement of significant litigation. During 2003, we settled a significant litigation matter. This settlement required us to record a $5.2 million expense in 2002, which contributed significantly to our net loss in 2002.

• Focus on smaller number of product offerings. Our decision to reduce the number of product offerings in order to focus our attention on our data storage and digital entertainment products has had the benefit of eliminating or reducing product offerings that were not very profitable.

• More efficient management reporting. We expanded our review and management of operating expenses in order to reduce costs. In doing so, we instituted improved financial controls and procedures to better monitor personnel, legal and accounting costs. We spent more time and effort tracking consigned inventory that resides at our retailers. In doing so, we believe that we can better control overstocking of our products, which in turn allows us to better control price reductions and marketing programs in our efforts to sell inventory. We also spent additional time and effort in managing the

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shipment of products to our retailers to ensure that deliveries to these retailers were made on time in order to avoid penalties which many retailers assess on late shipments.

Retailers

Historically, a limited number of retailers have accounted for a significant percentage of our net sales. For the years ended December 31, 2001, 2002 and 2003, our six largest retailers accounted for approximately 92%, 88% and 78% of our net sales, respectively. We expect that sales of our products to a limited number of retailers will continue to account for a majority of our sales in the foreseeable future. We do not have long-term purchase agreements with any of our retailers. If we were to lose any of our major retailers or experience any material reduction in orders from any of them, it could have a material adverse effect on our business and results of operations.

Seasonality

Our data storage and digital entertainment products have historically been affected by seasonal purchasing patterns. Our products tend to have higher unit sales in the fourth quarter. These sales generally follow seasonal purchasing patterns of our end-user customers who purchase most of our products through retailers. Generally, our second quarter is the weakest. The impact of seasonality on our future results will be affected by our product mix, which will vary from quarter to quarter.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of net sales and expenses for each period. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue Recognition

Currently, the majority of our net sales are non-consignment and are recognized upon shipment to retailers. A growing percentage of our net sales are consignment sales. Consignment sales are recognized when our retailers sell our products to the consumers. All of our sales include limited rights to return unsold inventory. We provide for estimated future returns of inventory based on historical experience. However, if certain returns in excess of our estimates occur, those amounts are accrued at the time we become aware of them, which may not be in the same period in which we book the initial sale. In addition, some retailers have limited price protection rights for inventories of our products held by them. If we reduce the list price of these previously purchased products, these retailers may be entitled to receive credits from us. We accrue for estimated cost for these limited price protection arrangements when the customer is authorized to make the price change. We also offer to both consumers and retailers certain rebate arrangements. We accrue for the estimated cost of these rebate arrangements using actual sell-through data supplied by our retailers and historical redemption percentages. Our net sales are defined as our gross sales less these estimated future returns, limited price protection arrangements, rebate arrangements and marketing development fund/cooperative arrangements.

Advertising and Market Development Costs

Advertising and market development costs are charged to operations or offset against gross sales in accordance with Emerging Issues Task Force Issue No. 01-9. For the year ended December 31, 2003, our

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advertising and market development costs were $8.5 million, of which $8.4 million was offset against gross sales. For the year ended December 31, 2002, our advertising and market development costs were $9.3 million, all of which was offset against gross sales. For the year ended December 31, 2001, our advertising and market development costs were $13.3 million, of which $13.2 million was offset against gross sales.

Consideration generally given by us to a retailer is presumed to be a reduction of selling price, and therefore, a reduction of gross sales. However, if we receive an identifiable benefit that is sufficiently separable from our sales to that retailer, such that we could have paid an independent company to receive that benefit and we can reasonably estimate the fair value of that benefit, then the consideration is characterized as an expense. We estimate the fair value of the benefits we receive by tracking the advertising done by our retailers on our behalf and calculating the value of that advertising using a comparable rate for similar publications.

Inventory Obsolescence Allowance

We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. These write-downs result in a charge to cost of sales. These write-downs relate directly to the amount of slow-moving or obsolete inventory which we have in our warehouse. This inventory usually is the result of returns by retailers at the end of a product’s life cycle. We plan to make a concerted effort in 2004 to sell this inventory more quickly than in prior years and thus reduce our write-downs.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our retailers to make required payments. Our current retailers consist of either large national or regional retailers with good payment histories with us. Since we have not experienced any previous payment defaults with any of our current retailers, our allowance for doubtful accounts is minimal. We perform periodic credit evaluations of our retailers. If the financial condition of our retailers were to deteriorate, resulting in the impairment of their ability to make payments, additional allowances may be required. New retailers are evaluated through Dunn & Bradstreet before terms are established. Although we expect to collect all amounts due, actual collections may differ.

Product Returns

Our policy is to allow return of product from consumers upon proper request by them and authorization by us. We have no time limit on product returns from consumers; however, our retailers generally have terms with their customers which range from fourteen to thirty days from date of purchase. This time period will generally flow through to us. We also include estimated time of product on the shelf and time to return product to us. Actual returns are recorded as reductions to gross sales for the period in which they are received. In addition, we maintain an allowance for sales returns for estimated future returns for products currently or previously sold for which we estimate we have not yet received. We use historical data and estimates based on observations to determine the allowance for each period. We estimate that sales for two months, the current and the prior, will be returned in future months. We use the actual return rate of the prior year to estimate what percent of the two months will be returned. Sales are adjusted by the estimated returns, while cost of sales are adjusted by the estimated cost of sales and the allowance is adjusted for the estimated gross margin. In periods in which sales are higher, such as normally our fourth quarter, the allowance is increased as we expect more returns. In periods in which sales are lower, such as normally our second quarter, the allowance is decreased as we expect less returns than we have already reserved for.

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Results of Operations

The tables presented below, which compare our results of operations from one period to another, present the results for each period, the change in those results from one period to another in both dollars and percentage change and the results for each period as a percentage of net sales. The columns present the following:

• The first two data columns in each table show the absolute results for each period presented.

• The columns entitled “Dollar Variance” and “Percentage Variance” show the change in results, both in dollars and percentages. These two columns show favorable changes as a positive and unfavorable changes as negative. For example, when our net sales increase from one period to the next, that change is shown as a positive number in both columns. Conversely, when expenses increase from one period to the next, that change is shown as a negative in both columns.

• The last two columns in each table show the results for each period as a percentage of net sales.

Fiscal Year Ended December 31, 2003 Compared to Fiscal Year Ended December 31, 2002

	Year Ended December 31,						Dollar Variance			Percentage Variance		Results as a Percentage of Net Sales for the Year Ended December 31,
	2003			2002			Favorable (Unfavorable)			Favorable (Unfavorable)		2003		2002
	(in thousands)
Net sales	$	62,223		$	83,530		$	(21,307	)	(25.5	%)	100.0	%	100.0	%
Cost of sales		53,084			74,666			21,582		28.9		85.3		89.4
Gross profit		9,139			8,864			275		3.1		14.7		10.6
Selling, marketing and advertising expenses		1,507			1,438			(69	)	(4.8	)	2.5		1.7
General and administrative expenses		6,462			7,361			899		12.2		10.4		8.8
Depreciation and amortization		1,268			1,224			(44	)	(3.6	)	2.0		1.5
Operating loss		(98	)		(1,159	)		1,061		91.5		(0.2	)	(1.4	)
Net interest expense		(248	)		(384	)		136		35.4		(0.4	)	(0.4	)
Settlement expense and related legal costs		0			(5,178	)		5,178		100.0		—		(6.2	)
Other income		54			37			17		45.9		0.1		—
Loss from operations before provision for income taxes		(292	)		(6,684	)		6,392		95.6		(0.5	)	(8.0	)
Income tax provision		(27	)		1,663			1,690		101.6		0.1		2.0
Net loss	$	(265	)	$	(8,347	)	$	8,082		96.8	%	(0.4	)%	(10.0	)%

Net Sales. The significant decrease in net sales for 2003 is primarily due to our strategic decision to de-emphasize the sale of certain products, coupled with reduced sales of our CD-based products. The principal reason for the reduction in CD-based product sales was reduced promotional activities, such as rebates and point-of-sale discounts, for these products because of our concentration in the production and sale of our new dual-format DVD recordable devices which we introduced in July 2003. Also contributing to the overall decline in net sales for 2003 was a $14.4 million, or 70.2%, decrease in net sales to OfficeMax as compared to 2002. This decline was primarily the result of our mutual agreement with OfficeMax to discontinue sales from April 2003 through October 2003. During this period of time, we negotiated more favorable promotional programs with OfficeMax and, as a result, we began selling our dual-format DVD recordable drives to them beginning in November 2003.

Gross Profit. The increase in gross profit, both in dollar terms and as a percentage of net sales, is primarily due to a reduction in freight costs from $4.5 million in 2002 to $2.1 million in 2003. We were able to reduce these costs because throughout most of 2003 we were able to obtain products from our Asian subcontract

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manufacturers using normal freight methods, that is, ocean vessels rather than via airfreight which we were required to do during portions of 2002 due to west coast port strikes during that year.

Another contributing factor to our improvement in gross profit is a reduction in our inventory obsolescence charges from $2.1 million (2.5% of net sales) for 2002 to $0.1 million (0.2% of net sales) for 2003. During 2002, we wrote down to lower of cost or market a significant amount of slow-moving inventory. Due to the short life cycle of many of our products, we expect to continue to experience inventory obsolescence charges in the future. However, we can not predict with any certainty the future level of these write-downs.

Selling, Marketing and Advertising Expenses.Selling, marketing and advertising expenses increased slightly in 2003. This increase was primarily due to an increase in slotting fees of $190,000 for new retailers, an increase in advertising costs of $157,000 and an increase in new store allowance for retailers of $57,000. Commissions were lower due to reduced sales volume.

General and Administrative Expenses.The decrease in general and administrative expenses is primarily due to a reduction in legal expenses of $411,000 as a result of the settlement of several litigation matters, a $223,000 reduction in payroll and related expenses due to our planned reduced headcount in 2003 for our U.S. operations, a $152,000 reduction in insurance expenses, and a $202,000 reduction in warehouse supplies and outside assembly of product due to lower sales in 2003. These reductions were partially offset by a $179,000 increase in bad debt expenses ($1.5 million in 2003 as compared to $1.3 million in 2002) and a $72,000 increase in product design expenses.

Depreciation and Amortization Expenses.The increase in depreciation and amortization expenses is primarily due to accelerated amortization on our prior Santa Ana facility which was originally to be leased through 2010. At the beginning of 2003, we decided to move to a larger facility by the end of September 2003 and thus, we accelerated our amortization by $389,000 in 2003. Amortization of our Hi-Val^® and Digital Research Technologies^® trademarks was reduced by $338,000 during 2003 because of our decision in 2002 to increase the useful lives of the trademarks by an additional ten years. As a result, during the second quarter of 2002, we decreased the amount of annual amortization of these trademarks, which was originally based on useful lives of five years.

Other Income (Expense).Other income (expense) decreased by $5.3 million as compared to 2002. This significant decrease is primarily due to a $5.2 million expense we recorded in 2002 relating to settlement costs and related legal expenses in connection with a significant litigation matter. During 2003, interest expense decreased by $136,000 to $248,000 due to reduced borrowings under our line of credit.

Income Tax Expense (Benefit). Income taxes provision decreased by $1.69 million in 2003 to a $27,000 benefit as compared to an expense of $1.68 million in 2002. In 2003, our income taxes represented primarily refunds we received. In 2002, our income tax provision represented the write-off of deferred tax assets.

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Fiscal Year Ended December 31, 2002 compared to Fiscal Year Ended December 31, 2001

	Year Ended December 31,						Dollar Variance			Percentage Variance		Results as a Percentage of Net Sales for the Year Ended December 31,
	2002			2001			Favorable (Unfavorable)			Favorable (Unfavorable)		2002		2001
	(in thousands)
Net sales	$	83,530		$	67,789		$	15,741		23.2	%	100.0	%	100.0	%
Cost of sales		74,666			62,776			(11,890	)	(18.9	)	89.4		92.6
Gross profit		8,864			5,013			3,851		76.8		10.6		7.4
Selling, marketing and advertising expenses		1,438			1,488			50		3.4		1.7		2.2
General and administrative expenses		7,361			6,461			(900	)	(13.9	)	8.8		9.5
Depreciation and amortization		1,224			2,232			1,008		45.2		1.5		3.3
Operating loss		(1,159	)		(5,168	)		4,009		77.6		(1.4	)	(7.6	)
Net interest expense		(384	)		(387	)		3		0.8		(0.4	)	(0.6	)
Settlement expense and related legal costs		(5,178	)		—			(5,178	)	—		(6.2	)	—
Other income		37			10			27		270.0		—		—
Loss from operations before provision for income taxes		(6,684	)		(5,545	)		(1,139	)	(20.5	)	(8.0	)	(8.2	)
Income tax provision		1,663			3			(1,660	)	(553.3	)	2.0		—
Net loss	$	(8,347	)	$	(5,548	)	$	(2,799	)	(50.5	%)	(10.0	)%	(8.2	)%

Net sales. The increase in net sales for 2002 is primarily due to increased sales to our existing consignment retailers, sales to new retailers, and a $4.2 million increase in net sales resulting from a recalculation of our reserve for future returned products. The increase in net sales due to a change in our reserves for future returns on sales was based on a monthly calculation we make to adjust sales for estimated future product returns based on historical data. Two factors resulted in this increase. First, the overall increase in sales volume in 2002 as compared to 2001 resulted in $3.2 million of the increase. Second, the percentage of estimated returns was reduced in early 2002 based on actual returns showing that the return rate previously used should have been reduced. This resulted in a $975,000 increase in net sales. We believe that better installation manuals and improved technical support during 2001 resulted in a lower product return rate.

Gross Profit. The increase in gross profit, both in dollar terms and as a percentage of net sales, is primarily due to a reduction in inventory adjustments from $3.6 million for 2001 to $602,000 for 2002. This was offset by an increase in our inventory obsolescence charges from $410,000 for 2001 to $2.1 million for 2002.

Selling, Marketing and Advertising Expenses. Selling, marketing and advertising expenses decreased slightly in 2002. The slight reduction in these expenses was primarily due to a direct advertising expense of $121,000 in 2001 that we did not experience in 2002, $56,000 less retailer product evaluation expenses and $47,000 less payroll in 2002, offset by $136,000 higher commission expense during 2002 due to the increase in sales.

General and Administrative Expenses. The increase in general and administrative expenses is primarily due to a $449,000 increase in bad debt expense as compared to 2001 ($1.3 million in 2002 as compared to $851,000 in 2001), a $198,000 increase in payroll expenses, a $149,000 increase in insurance expenses, a $125,000 increase in warehouse supplies, a $117,000 increase in financial relations expenses, and a $98,000 increase in subcontracting of product assembly. These increases in expenses were offset by a $153,000 decrease in rent expense in connection with our move from a second facility at the end of April 2002 and a $151,000 decrease in expenses for consultants.

Depreciation and Amortization Expenses.The decrease in depreciation and amortization expenses is primarily due to a reduction in the amount of amortization of our trademarks. During 2002, we engaged an

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outside valuation service to review the value of our trademarks and their useful lives. Based upon this valuation, we determined that the useful lives of our trademarks should be increased by ten years. As a result, the amount of annual amortization was decreased beginning in 2002.

Other Income (Expenses). Other income (expenses) increased to $5.5 million as compared to $376,000 in 2001. This increase was primarily due to $5.2 million of settlement costs and related legal expenses in connection with a significant litigation matter. We also recorded a small gain of $39,000 on the disposal of property and equipment which we sold in connection with vacating our second facility at the end of April 2002.

Income Tax Expense (Benefit). The income taxes provision for 2002 consisted of a $1.8 million write-off of deferred tax assets, offset by $92,000 of net income tax refund.

Liquidity and Capital Resources

Our principal sources of liquidity have been cash provided by operations and borrowings under our bank credit facility and trade credit facilities. Our principal uses of cash have been to finance working capital, capital expenditures and debt service requirements. We anticipate these uses will continue to be our principal uses of cash in the future. As of December 31, 2003, we had working capital of $11.0 million, an accumulated deficit of $15.1 million, $6.2 million in cash and cash equivalents and $18.4 million in net accounts receivable.

Cash provided by our operating activities totaled $3.6 million during 2003 as compared to $3.3 million for 2002. This increase in cash provided by operations during 2003 primarily resulted from a $7.8 million increase in cash from the use of our trade credit facilities from related parties, an $816,000 increase in accounts payable, a $689,000 increase provided by the depreciation and amortization of fixed assets, and an increase of $579,000 provided by the amortization of our trademarks. These increases were offset by a $3.0 million legal settlement payment, a $265,000 net loss from operations, the use of $542,000 in cash for reserves for obsolete inventory, a $378,000 increase in prepaid expenses, and a $2.6 million reduction in accrued expenses. Our accrued expenses had decreased to $2.6 million primarily due to a $1.7 million reduction in accrued promotions and marketing expenses due to fewer sales in 2003 than 2002 and a $705,000 reduction in accrued legal fees.

Cash used in our investing activities totaled $170,000 during 2003 as compared to $62,000 for 2002. Our investing activities in 2003 consisted of leasehold improvements, furniture and computer equipment.

Cash used in our financing activities totaled $4.5 million during 2003 as compared to $302,000 for 2002. Our financing activities in 2003 consisted of a $4.4 million payoff on the line of credit with our prior lender and $83,000 in the repurchase of shares of our common stock.

Effective January 1, 2002, we obtained a $9.0 million asset-based line of credit (with a sub-limit of $8.0 million) with ChinaTrust Bank (USA) that was to expire December 15, 2003. The credit facility contained a number of restrictive financial covenants. On each of December 31, 2002, March 31, 2003, and June 30, 2003, we were not in compliance with certain of those financial covenants. However, we subsequently obtained waivers with respect to our noncompliance with these financial covenants from the lender which, among other things, on December 31, 2002 modified the original expiration date of the line of credit from December 15, 2003 to October 15, 2003.

On August 15, 2003, we entered into an asset-based business loan agreement with United National Bank. The credit facility with United National Bank provides for a revolving loan of up to $6,000,000 secured by substantially all of our assets and expires September 1, 2004. Advances up to 65% of eligible accounts receivable bear interest at the floating interest rate equal to the prime rate of interest as reported in theWall Street Journalplus 0.75%. As of December 31, 2003, the interest rate was 4.75%. The business loan agreement provides that if United National Bank calls the loan because of a default under the terms of the loan agreement, other than a payment default, we can repay the loan in six equal monthly installments unless we obtain a replacement credit

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facility in which case, all amounts would be due and payable. The business loan agreement also contains a number of restrictive financial covenants. We were in compliance with these covenants at December 31, 2003.

Effective September 2, 2003, we borrowed $3.4 million under the United National Bank credit facility to pay off the outstanding balance on our ChinaTrust Bank (USA) credit facility. As of December 31, 2003, the outstanding balance with United National Bank was $5.9 million and we had available to us $61,000 of additional borrowings. Our credit facility with United National Bank expires on September 1, 2004.

In January 2003, we entered into a trade credit facility with Lung Hwa Electronics. Lung Hwa Electronics is a stockholder and subcontract manufacturer of I/OMagic. Under the terms of the facility, Lung Hwa Electronics has agreed to purchase inventory on our behalf. We can purchase up to $10,000,000 of inventory, with payment terms of 120 days following the date of invoice by Lung Hwa Electronics. Lung Hwa Electronics charges us a 5% handling fee on a supplier’s unit price. A 2% discount of the handling fee is applied if we reach an average running monthly purchasing volume of $750,000. Returns made by us, which are agreed to by a supplier, result in a credit to us for the handling charge. As security for the trade credit facility, we paid Lung Hwa Electronics a $1.5 million security deposit during 2003. As of December 31, 2003, $750,000 of this deposit had been applied against outstanding trade payables as the agreement allowed us to apply the security deposit against our outstanding trade payables. This trade credit facility is for an indefinite term, however, either party has the right to terminate the facility upon 30 days’ written notice to the other party. As of December 31, 2003, we owed Lung Hwa Electronics $2.0 million in trade payables net of the remaining $750,000 deposit.

In February 2003, we entered into a Warehouse Services and Bailment Agreement with Behavior Tech Computer (USA) Corp., or BTC USA. Under the terms of the agreement, BTC USA has agreed to supply and store at our warehouse up to $10,000,000 of inventory on a consignment basis. We are responsible for insuring the consigned inventory, storing the consigned inventory for no charge; and furnishing BTC USA with weekly statements indicating all products received and sold and the current level of consigned inventory. The agreement also provides us with a trade line of credit of up to $10,000,000 with payment terms of net 60 days, without interest. The agreement may be terminated by either party upon 60 days’ prior written notice to the other party. As of December 31, 2003, we owed BTC USA $8.3 million under this arrangement. BTC USA is a subsidiary of Behavior Tech Computer Corp., one of our significant stockholders. Mr. Steel Su, a director of I/OMagic, is the Chief Executive Officer of Behavior Tech Computer Corp. See “Certain Relationships and Related Transactions.”

We believe current and future available capital resources, revenues generated from operations, and other existing sources of liquidity, including our trade credit facilities with Lung Hwa Electronics and BTC USA and our credit facility with United National Bank which we believe will be renewed, will be sufficient to fund our anticipated working capital and capital expenditure requirements for at least the next twelve months. If, however, our capital requirements or cash flow vary materially from our current projections or if unforeseen circumstances occur, we may require additional financing. For example, if the level of consignment sales to our retailers were to increase substantially from current levels, our current credit facility with United National Bank, which is a receivables-based line of credit, may not meet all of our financing needs since the length of time between delivery of product and the creation of an account receivable that may be financed is longer for consignment sales as compared to non-consignment sales. Accordingly, we would need to obtain other financing, including possibly an inventory-based line of credit, to meet all of our liquidity needs. Our failure to raise capital, if needed, could restrict our growth, limit our development of new products or hinder our ability to compete.

Backlog

Our backlog at December 31, 2003 was $5.3 million as compared to a backlog at December 31, 2002 of $12.4 million. Based on historical trends, we anticipate that our December 31, 2003 backlog may be reduced by approximately 10%, or $500,000, to a net amount of $4.8 million as a result of returns and reclassification of certain expenses as reductions to net sales. Our backlog may not be indicative of our actual sales beyond a

29

rotating six-week cycle. The amount of backlog orders represents revenue that we anticipate recognizing in the future, as evidenced by purchase orders and other purchase commitments received from retailers. The shipment of these orders for non-consigned retailers or the sell-through of our products by consigned retailers causes recognition of the purchase commitments as revenue. However, there can be no assurance that we will be successful in fulfilling such orders and commitments in a timely manner, that retailers will not cancel purchase orders, or that we will ultimately recognize as revenue the amounts reflected as backlog based upon industry trends, historical sales information, returns and price protections.

Contractual Obligations

The following table outlines payments due under our significant contractual obligations over the next five years, exclusive of interest:

	Payments Due by Period
Contractual Obligations At December 31, 2003	Total		Less than 1 Year		1-3 Years		4-5 Years		After 5 Years
Long Term Debt	$	—	$	—	$	—	$	—	$	—
Capital Lease Obligations		—		—		—		—		—
Operating Leases		925,328		359,667		565,691		—		—
Unconditional Purchase Obligations		—		—		—		—		—
Total Contractual Cash Obligations	$	925,328	$	359,667	$	565,691	$	—	$	—

The above table outlines our obligations as of December 31, 2003 and does not reflect the changes in our obligations that occurred after that date.

Impacts of New Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities” which addresses the consolidation of business enterprises (variable interest entities) to which the usual condition (ownership of a majority voting interest) of consolidation does not apply. The interpretation focuses on financial interests that indicate control. It concludes that in the absence of clear control through voting interests, a company’s exposure (variable interest) to the economic risks and potential rewards from the variable interest entity’s assets and activities are the best evidence of control. Variable interests are rights and obligations that convey economic gains or losses from changes in the values of the variable interest entity’s assets and liabilities. Variable interests may arise from financial instruments, service contracts, nonvoting ownership interests and other arrangements. If an enterprise holds a majority of the variable interests of an entity, it would be considered the primary beneficiary. The primary beneficiary would be required to include the assets, liabilities and the results of operations of the variable interest entity in its financial statements. In December 2003, the FASB issued a revision to FIN 46 to address certain implementation issues. This statement is not applicable to us.

In April 2003, FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting and reporting for derivative instruments and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for derivative instruments and hedging activities entered into or modified after September 30, 2003, except for certain forward purchase and sale securities. For these forward purchase and sale securities, SFAS No. 149 is effective for both new and existing securities after September 30, 2003. This statement is not applicable to us.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies

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and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 will be effective for financial instruments entered into or modified after May 31, 2003 and otherwise will be effective at the beginning of the first interim period beginning after June 15, 2003. This statement is not applicable to us.

Quantitative And Qualitative Disclosures About Market Risk

Our operations were not subject to commodity price risk during 2003. Our sales to a foreign country (Canada) were less than 1.5% of our total sales, and thus we experienced negligible foreign currency exchange rate risk. We do not hedge against this risk.

We currently have a business loan agreement with United National Bank in an amount of up to $6 million. The line of credit provides for an interest rate equal to the prime lending rate as reported in theWall Street Journal plus three-quarters of one percent. This interest rate is adjustable upon each movement in the prime lending rate. If the prime lending rate increases, our interest rate expense will increase on an annualized basis by the amount of the increase multiplied by the principal amount outstanding under the United National Bank business loan agreement.

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BUSINESS

Company Overview

We operate in the data storage and digital entertainment industries. We sell data storage and digital entertainment products primarily in the United States and to a lesser extent in Canada, together known as the North American marketplace. For the year ended December 31, 2003, sales generated within the United States accounted for approximately 98% of our net sales and sales generated within Canada accounted for approximately 2% of our net sales. Our data storage product offerings are predominantly focused on optical data storage drives and include recordable compact disc, or CD, drives and recordable digital video or versatile disc, or DVD, drives predominantly for personal computers, or PCs. Although we have sold various media in the past, such as floppy disks, CDs and DVDs, we do not currently sell media products. Our digital entertainment product offerings are predominantly focused on products that complement our line of data storage products and include MP3 players, digital audio headphones and palm-sized 20 gigabyte hard disk drives that we call our Digital Photo Library^™ system. Our data storage products accounted for approximately 94% of our net sales during the year ended December 31, 2003, and our digital entertainment products accounted for approximately 6% of our net sales for that period.

For the years ended December 31, 2003 and 2002, according to The NPD Group, a provider of sales tracking services for, among others, the consumer electronics and information technology industries, we achieved the number one market share in both unit and dollar sales of “after-market” compact disc rewritable, or CD-RW, drives in North America. “After-market” products are products not built into a PC at the time of its initial purchase. We launched our dual-format recordable DVD drives in July 2003. According to The NPD Group in its Retail Hardware Report, we were able to achieve the number four market share in both unit and dollar sales of after-market recordable DVD drives in North America during 2003, with only six months of sales during that year. We believe that the market for DVD-based data storage products will experience significant growth over the next few years and that we are in a position to benefit from this growth in terms of sales and market share.

We sell our products through computer, consumer electronics and office supply superstores and other major North American retailers, including Best Buy,Best Buy Canada, CompUSA, Circuit City, Fred Meyer Stores, Microcenter, Office Depot, OfficeMax, RadioShack, Staples, and Target. Our retailers collectively operate retail locations throughout North America. We also have relationships with other retailers, catalog companies and Internet retailers such as Buy.com, PC Mall, Tiger Direct and Dell. Our most significant retailers are Best Buy, Circuit City, CompUSA, Staples, Office Depot and OfficeMax. Collectively, these six retailers accounted for 78% of our net sales for the year ended December 31, 2003.

We market our products under three brand names. Our three brand names are I/OMagic^®, Digital Research Technologies^® and Hi-Val^®. We sell our data storage products under each of these brand names, bundling various hardware devices with different software applications to meet different consumer needs. Our digital entertainment products are currently sold under our I/OMagic^® and Digital Research Technologies^® brand names.

We employ a “good, better, best” marketing strategy, offering a range of products within some of our product categories. We believe that this strategy enables us to address different segments of the market for data storage and digital entertainment products by offering varying products with different levels of performance and functionality at multiple price points designed to satisfy the diverse needs and budgets of consumers.

We do not directly manufacture any of the products that we sell. We subcontract manufacture our products in Asia, predominantly in Taiwan and China, which allows us to offer products at highly competitive prices. Most of our subcontract manufacturers have substantial product development resources and facilities, and are among the major component manufacturers in their product categories, which we believe affords us substantial

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flexibility in offering new and enhanced products. Some of our largest subcontract manufacturers are also our stockholders, including Behavior Tech Computer Corp. and its affiliated companies, or BTC, and Lung Hwa Electronics Co., Ltd. BTC and Lung Hwa Electronics also provide us with significant trade lines of credit. According to industry sources, BTC is among the largest optical storage drive manufacturers in the world and Lung Hwa Electronics is a major manufacturer of digital entertainment products. See “Management,” “Principal and Selling Stockholders” and “Certain Relationships and Related Transactions.”

I/OMagic Corporation was incorporated under the laws of the State of Nevada in October 1992. We have two subsidiaries, I/OMagic Corporation, a California corporation, and IOM Holdings, Inc., a Nevada corporation. Our principal executive offices are located in Irvine, California and our main telephone number is (949) 707-4800.

Industry Overview

Storing, managing, protecting, retrieving and transferring data has become critical to individuals and businesses due to their increasing dependence on and participation in data-intensive activities. The data storage industry is growing in response to the needs of individuals and businesses to store, manage, protect, retrieve and transfer increasing amounts of data resulting from:

• the growth in the number of PCs, and the number, size and complexity of computer networks and software programs;

• the emergence and development of new data-intensive activities, such as e-mail, e-commerce, and the increasing availability of products and services over the Internet, together with the rise in bandwidth available to access and download data from over the Internet; and

• the existence and availability of increasing amounts of digital entertainment data, such as music, movie, photographic, video game and other multi-media data.

Traditional PC data generally includes document, e-mail, financial and historical, software program and other data. The data storage industry has grown significantly over the last two decades as the PC has become a virtually indispensable tool in the home and office, resulting in increasing amounts of traditional PC data. As a result of these and other developments, traditional PC data storage requirements have correspondingly increased.

Digital entertainment data generally includes music, photographic, movie and video game data. For nearly two decades, music has been offered on CDs as the prevailing standard. In the mid-to-late 1990s, the ability to copy CDs, and to download, remix, and copy or “burn” music to a personalized CD began to gain popularity and made the recordable CD drive, or “CD burner,” a desirable component of the PC. With the growth and acceptance of the Internet and the advent of on-line music availability, the demand for on-line music has increased and as a result, the demand for faster and easier data storage and retrieval has grown.

We believe that the increasing amount of traditional PC and digital entertainment data that is being generated and used is stimulating increased demand for products offering data storage, management, protection, retrieval and transfer. We also believe that those products that offer flexibility and high-capacity storage in a cost-effective, user-friendly manner are in highest demand.

According to The NPD Group in its Retail Hardware Report for 2003, the North American data storage industry, including all media (for example, floppy disks, CDs and DVDs) and drives, grew to approximately $2.2 billion in 2003, representing a 10% increase from approximately $2.0 billion in 2002.

Key Factors Driving Growth in the Data Storage and Digital Entertainment Industries

We believe that the following key factors, among others, are driving and will continue to drive growth in the data storage and digital entertainment industries:

• Increased use of the Internet. As individuals and businesses increase their data-intensive use of the Internet for communications, commerce and data retrieval, the corresponding need to utilize data storage

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devices for the storage, management, protection, retrieval and transfer of data, especially high-capacity, cost-effective data storage devices, will continue to grow. In addition, bandwidth is increasing and is expected to continue to increase. Increasing bandwidth allows higher data transfer rates over the Internet and makes use of the Internet for data-intensive activities more convenient and cost-effective.

• Growth in new types of data. The growth in new types of data such as music, photographic, movie, and video game data, including high-resolution audio and video data, requires far greater storage capacity than traditional PC data. We believe that individual consumers and businesses increasingly depend on their abilities to store, manage, protect, retrieve and transfer these types of data using data storage devices.

• Growth in the critical importance of data. Business databases contain information about customers, suppliers, competitors and industry trends that may be analyzed and potentially transformed into a valuable asset and a competitive advantage. Efficiently storing, managing, protecting, retrieving and transferring this information has become increasingly important to many businesses.

• Decrease in the cost of storing data. The cost of data storage continues to decrease with advances in technology and improved manufacturing processes. This decrease in cost encourages and enables individual consumers and businesses to purchase more data storage media and devices.

• Convergence of technologies. Product offerings are beginning to embody the convergence of data storage and digital entertainment playback technologies. For instance, a digital video recorder, or DVR, can operate as the primary tool for storage, management, protection, retrieval and transfer of traditional PC data as well as digital entertainment data such as music, photos, movies, video games and other multi-media.

Types of Data Storage Media

The following types of data storage media are the principal means through which traditional PC data as well as digital entertainment data can be stored, managed, protected, retrieved and transferred:

• Magnetic. Magnetic data storage drives store digital data by magnetically altering minutely small areas of a magnetic media surface so that specific areas represent either a “1” or a “0.” Indeed, all digital data is comprised of different combinations of “1s” and “0s” regardless of the media on which the data is stored. Examples of magnetic data storage media include floppy disks, Zip^® disks, hard disks and magnetic tape.

• Optical. Optical data storage drives store digital data by using lasers to alter minutely small areas of an optical media surface. Examples of optical data storage media include CDs and DVDs.

• Solid State. Solid state storage devices store digital data by applying electronic charges to alter minutely small areas of a memory chip or card. Examples of solid state media include flash memory chips, flash memory cards and thumbdrives. Thumbdrives are more commonly known as universal serial bus, or USB, drives which are small, portable flash memory devices that plug into any standard USB drive. Solid state media is typically used for digital data storage in digital cameras, personal digital assistants, or PDAs, cellular phones and MP3 players.

Relative Advantages and Disadvantages of Types of Data Storage Media

Each of the principal types of data storage media generally available to consumers has certain advantages and disadvantages. These include:

Magnetic Media

• Floppy disks. Floppy disks are removable media allowing physical transport of data. External floppy disk drives allow portability of the drive itself. Floppy disks benefit from being “legacy” products with a

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large existing user base and a low cost per unit for a floppy disk. Relative to other available media, floppy disks have extremely low capacity, holding up to approximately 1.44 megabytes per disk depending on the user’s operating system and other factors, and represent a very high cost per megabyte. In addition, floppy disks typically employ older, less efficient storage, management, protection, retrieval and transfer technology, and offer moderate data access times and data transfer rates, moderate reliability and a tendency towards degradation over time which risks the loss of data stored on the disk.

• Zip^® disks. Zip^® disks are removable media allowing physical transport of data. External Zip^® disk drives allow portability of the drive itself. Relative to other available media, Zip^® disks have moderate capacity, holding up to approximately 200 megabytes per disk depending on the user’s operating system and other factors, and represent a moderate cost per megabyte. Zip^® disks themselves have a moderate cost per unit and offer moderate data access times and data transfer rates. A special Zip^® drive is required to utilize Zip^® disk technology and media.

• Magnetic tape. Magnetic tape is removable media allowing physical transport of data. Magnetic tape drives are typically larger than other storage drives, making them comparatively less portable. Relative to other available media, magnetic tape has moderate to high capacity, holding up to approximately 80 gigabytes, or 80,000 megabytes, depending on the user’s operating system and other factors, and represents a moderate cost per megabyte. While magnetic tape itself is not expensive, magnetic tape drives have a high cost per unit. Magnetic tape media typically employs older, less efficient storage, management, protection, retrieval and transfer technology, and offers slow data access times but fast data transfer rates, moderate reliability and a tendency towards degradation over time which risks the loss of data stored on the tape.

• Hard disks. Hard disks are fixed media and typically are not removable, thus prohibiting the physical transport of data and portability of the drive itself. Relative to other available media, hard disks have high capacity, holding up to approximately 500 gigabytes, or 500,000 megabytes, depending on the user’s operating system and other factors, and offer a low cost per megabyte. Hard disks have a fixed storage capacity and are not scalable. Hard disks offer fast data access times and data transfer rates and generally good reliability, but data protection and retrieval is dependent on drive reliability. Hard disks require another device or medium for data back-up purposes or for data transportability.

Optical Media

• Compact discs. CDs are removable media allowing physical transport of data. External CD drives allow portability of the drive itself. Relative to other available media, CDs have moderate capacity, holding up to approximately 600 megabytes, depending on the user’s operating system and other factors, and offer virtually unlimited storage capacity with the use of additional low cost CDs. CDs offer only moderate data access times and data transfer rates as compared to hard disk technologies; however, new technology continues to improve data access times for this media. CDs are also compatible with numerous devices ranging from PCs to CD and DVD players typically found in the home and office. Unlike hard disks, the integrity of data protection and retrieval is not drive-dependent, since a reliability problem with an optical drive will not affect digital data already stored on a CD, and ease of transport allows access to data using another drive if a problem exists with a user’s primary drive unit. In addition, unlike magnetic media, use of CDs results in limited or no degradation of the CD itself.

• Digital video or digital versatile discs. The relative advantages and disadvantages of DVD drives and media are generally the same as for CD drives and media. However, as compared to other available media, DVDs are moderate to high capacity, holding up to approximately 4.3 gigabytes, or 4,300 megabytes, depending on the user’s operating system and other factors.

Solid State Media

• Flash memory chips. Flash memory chips are generally not removable media. Typically, flash memory chips are used in portable devices such as digital cameras, PDAs and cellular phones. Relative to other

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available media, flash memory chips have moderate capacity, holding up to approximately 1 gigabyte, or 1,000 megabytes, depending on the user’s operating system and other factors, and offer very high cost per megabyte and high cost per unit. Flash memory chips are highly reliable, consume very little power and offer very fast data access times and data transfer rates, but require another device or medium for data back-up purposes.

• Flash memory cards. The relative advantages and disadvantages of flash memory cards are generally the same as for flash memory chips. However, flash memory cards are removable media allowing physical transport of data.

Industry Challenges and Trends

We believe that the challenges currently facing the data storage and digital entertainment industries include:

• Need for transition to high-capacity, cost-effective and flexible media and related storage devices. We believe that, as a result of the rapid growth in data and in new applications requiring or using high data-content movies, photos, music and games and other multi-media content, the data storage industry needs to offer higher capacity, more cost-effective and flexible media and storage devices. To meet this need, the data storage industry is shifting its product offerings from CD- to DVD-based technologies.

• Need for broad-based product offerings to stimulate further growth. The demand for data storage and digital entertainment products is expanding and market opportunities are therefore available to sell these products to a wide range of consumers seeking products ranging from entry-level to state-of-the-art. Most companies in these industries offer a limited range of products in each product category. By offering various products combining different levels of performance and functionality at multiple price points to a wide range of consumers, we believe that the industry can further stimulate sales of data storage and digital entertainment products.

• Need to identify and satisfy consumer demands and preferences. The data storage and digital entertainment industries are characterized in part by rapidly changing consumer demands and preferences for higher levels of product performance and functionality. We believe that, to be successful, companies in these industries must closely identify changes in consumer demands and preferences and introduce both new and enhanced data storage and digital entertainment products to provide higher levels of performance and functionality than existing products.

Trends in the data storage and digital entertainment industries include the trend toward higher capacity optical storage media and related drives, including the trend away from CD-based media and devices and towards DVD-based media and devices. According to The NPD Group in its Retail Hardware Report for 2003, unit sales of recordable CD drives in the North American marketplace declined 14% in 2003 as compared to 2002, while unit sales of recordable DVD drives increased by 447% in 2003 as compared to 2002. We believe that this illustrates the transition from CD-based data storage products to DVD-based devices and we believe that this trend will continue into the future.

Developing trends in the data storage and digital entertainment industries include the early adoption of super-high-capacity optical data storage devices using technology such as Blu-ray^™ DVD or High-definition DVD. Blu-ray^™ DVD technology is expected to expand DVD capacity up to tenfold and is expected to allow, for the first time in a device widely available to consumers, the storage and retrieval of high definition videos and images for playback on high-definition DVD players and compatible televisions and monitors. A competing new technology also exists called High-definition DVD, or HD-DVD. The storage capacity of HD-DVD is limited to approximately 60% of a Blu-ray^™ DVD. Proponents of HD-DVD technology contend, however, that it has less compatibility problems with existing DVD technology as compared to Blu-ray^™ DVD technology and that data compression software reduces the importance of the greater storage capacity offered by Blu-ray^™ DVD technology.

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It is not yet clear whether Blu-ray^™ DVD or HD-DVD will become the dominant technology, if they will coexist, or if a new technology will emerge. Nonetheless, we believe that the increased performance offered by these technologies will likely result in increased consumer demand for optical data storage devices. Furthermore, we believe that regardless of which technology becomes the dominant technology, we will be able to incorporate either technology into our product offerings in much the same way as we do today with the large number of format types ranging from recordable and rewritable CD-based products to DVD-based products.

The I/OMagic Solution

We sell data storage and digital entertainment products to the North American marketplace. We believe that we possess a combination of core competencies that provide us with a competitive advantage, including the ability to successfully identify consumer needs and preferences, use our sales and distribution channels to sell new and enhanced products, efficiently manage product development cycles, efficiently manage our product supply chain, and use our brands and merchandising efforts to market and sell data storage and digital entertainment products.

Successfully executing our core competencies yields substantial benefits including the ability to:

• rapidly bring both new and enhanced products to market in a cost-effective manner;

• offer high-value products which combine performance, functionality and reliability at competitive prices; and

• establish and maintain a large market presence for our core data storage product offerings resulting in significant market share.

We work closely with our retailers to promote our products, monitor consumer demands and preferences and stay at the forefront of the market for data storage and digital entertainment products. We also work closely with our subcontract manufacturers and benefit from their substantial research and development resources and economies of scale. As a result of working with our retailers and subcontract manufacturers, we are able to rapidly bring new and enhanced data storage and digital entertainment products to market in a cost-effective manner.

The market intelligence we gain through consultation with our retailers and subcontract manufacturers enables us to deliver products that combine performance and functionality demanded by the marketplace. Obtaining these products through our subcontract manufacturers, along with efficient management of our supply chain, allows us to offer these products at competitive prices.

We sell our products through computer, consumer electronics and office supply superstores and other retailers who collectively operate retail locations throughout North America. Our network of retailers enables us to offer products to consumers across North America, including nearly every major metropolitan market in the United States. Our largest retailers include Best Buy, Circuit City, CompUSA, Staples, Office Depot and OfficeMax.

We employ a three-brand strategy to sell some of the same or similar products through different retailers and to maintain consumer loyalty to at least one of our brands. Our three-brand marketing strategy enables us to provide each of our most significant industry retailers with their own distinct brand. We believe that this approach reduces price competition among our most significant retailers as a result of brand differentiation and benefits us by making our products more attractive to those retailers. We also employ a “good, better, best” marketing strategy offering consumers a broad line of data storage products ranging from entry-level to state-of-the-art. Our “good, better, best” lines of products combine different levels of performance and functionality at various price points. We believe that our “good, better, best” strategy allows us to sell to consumers who seek a more attractive combination of performance and functionality at lower prices than other leading data storage products. We intend to adopt this strategy in expanding our digital entertainment product offerings.

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As a result of our access to a large retail network and our three-brand and “good, better, best” marketing strategies, we believe that we have established and will maintain a large market presence for our core data storage product offerings, resulting in significant market share. According to The NPD Group in its Retail Hardware Reports, we achieved the number one market share in both unit and dollar sales of CD-RW drives in North America in 2002 and 2003. We believe that the data storage industry is shifting from CD-based products to DVD-based products. As a result, we launched our dual-format recordable DVD drives in July 2003. According to The NPD Group in its Retail Hardware Report, we achieved the number four market share in both unit and dollar sales of recordable DVD drives in North America during 2003, with only six months of sales during that year. By using the same strategies in offering our digital entertainment products, we believe that we will be able to establish a large market presence resulting in significant market share for those products as well.

Our Data Storage Solution

We focus on optical data storage products to respond to the demands and preferences of the data storage marketplace. We believe that the market for data storage products, especially “after-market” devices that can be purchased separately from and easily used in conjunction with a standard PC, has shifted its demand largely to optical media and drives. We believe that optical media and drives represent the optimal combination of high-capacity storage capability, cost-effectiveness and flexibility. Magnetic hard-disk and drive technology is the closest competitor to optical media in the contexts of storage capacity, cost-effectiveness and flexibility. However, while the storage capacity of any given hard disk is fixed, optical media has virtually unlimited storage capacity through the addition of low-cost CDs or DVDs. Moreover, optical media has far more flexibility than hard disk media, allowing users to store music, photos and movies utilizing a stand-alone recorder or a desktop or laptop PC and then play them back on standalone CD or DVD players. In addition, hard disk media is usually built into a PC, lacking effective portability and ease of physical transport of data.

We believe that our focus on optical data storage products is also consistent with the proliferation of digital entertainment devices. Digital cameras, MP3 players and other digital entertainment devices are well-complemented by the use of optical media for data back-up and high-capacity storage purposes. Existing solid state media, while convenient in many respects, offers relatively low storage capacity and relatively poor cost effectiveness. Accordingly, optical media, with its high storage capacity, cost effectiveness and convenience, together with a related drive unit, is a complementary product for consumers who desire to store, manage, protect, retrieve and transfer digital data used in conjunction with their digital entertainment devices.

Our Digital Entertainment Solution

The acceptance of relatively new technologies such as data compression technologies like MP3, and the widespread availability of digital entertainment media such as music, photos, movies and games are stimulating the proliferation of digital entertainment products. We offer digital entertainment products incorporating these technologies to capitalize on the widespread availability of digital entertainment media. We seek to provide users of our digital entertainment products with enjoyable, user-friendly experiences from products that combine high levels of performance, functionality and reliability at competitive prices.

Some of the data storage products that we offer and plan to offer, such as CD and DVD duplicators and DVRs, can operate as both data storage and digital entertainment products. Due to their versatility, we believe that products that combine data storage and digital entertainment functionality are more attractive to many consumers. Accordingly, we believe that further convergence of data storage and digital entertainment products will offer additional opportunities to satisfy consumer demands and preferences.

To assist us in increasing sales of our digital entertainment products, we intend to emulate many of the methods employed in our data storage business, including our three-brand and “good, better, best” marketing strategies. We also intend to work closely with our retailers and subcontract manufacturers in developing and offering our digital entertainment products for sale.

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Our Strategy

Our primary goal is to remain a leading provider of optical data storage products and to expand our market share in the data storage industry. Our secondary goal is to expand our digital entertainment product line to offer additional products that complement our data storage products. Our business strategy to achieve these goals includes the following elements:

• Continue to develop and solidify our North American retail network. We sell data storage and digital entertainment products primarily in the United States and to a lesser extent in Canada. We have developed, and plan to continue to develop and solidify, close working relationships with leading North American computer, consumer electronic and office supply superstores and other retailers. Our retailers carry many of the products we sell, and as we offer both new and enhanced data storage and digital entertainment products, we intend to take advantage of our existing relationships with these retailers to offer our products to consumers.

• Continue to develop and expand strategic relationships. We have developed, and plan to continue to develop and expand, our strategic relationships with our subcontract manufacturers in order to augment our new and enhanced product offerings and benefit from their knowledge of data storage and digital entertainment products. Some of these relationships are particularly strong because some of our significant subcontract manufacturers are also our stockholders. We plan to continue to develop and explore other subcontract manufacturer relationships as well. By continuing to subcontract manufacture our products, we intend to continue to increase our operating leverage by delivering products incorporating new technology without the substantial investment and fixed costs associated with product development and manufacturing in an industry characterized by rapid product innovation and obsolescence.

• Continue to develop and offer high value products. We intend to continue to work in conjunction with our retailers and subcontract manufacturers to enhance existing products and develop new products to satisfy consumer demands and preferences. We believe that our core competencies such as our efficient management of product development and management of our product supply chain will enable us to enhance our products and offer new products in a cost-effective and timely manner. We believe that our target consumers seek high value products that combine performance, functionality and reliability at prices competitive with other leading products offered in the marketplace. We intend to continue to focus on high value product offerings by promoting and offering our products as affordable alternatives to higher-priced products offered by our competitors.

• Increase market share using our three-brand and “good, better, best” approaches. As a result of our close working relationships with leading North American retailers and our three-brand and “good, better, best” marketing strategies, we have become a leading provider of data storage products. We plan to continue to focus on increasing our market share for our data storage products and on developing and building market share for our digital entertainment products. As funds become available, we intend to invest in a comprehensive targeted, brand- and product-specific marketing program to further establish awareness of our three brands and our products, and to solidify the confidence of existing users, and attract new purchasers, of our products. We also intend to further expand our “good, better, best” approach throughout our data storage product lines and into our digital entertainment product lines to sell products to consumers with varying needs, preferences and budgets.

• Expand into new sales channels. We plan to expand our market penetration beyond our existing retailers to including corporate and government procurers, value-added resellers and value-added distributors. Our company websites are located athttp://www.iomagic.com,http://www.dr-tech.com andhttp://www.hival.com. On these websites, we plan to continue to offer select products for direct purchase by consumers, conduct special promotions, and offer downloads and upgrades to existing and potential purchasers of our products.

• Market products to our existing consumer base. We intend to market new, enhanced and current products to existing purchasers of our products. We believe that we can increase sales of our digital

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entertainment products by marketing them to existing purchasers of our data storage products, and vice versa, so that purchasers of products of one of our two principal product categories buy products from our other principal product category. In addition, we believe that existing users of our products can be an important source of referrals for potential new purchasers of our products.

Our Products

We have two product categories: our data storage product category and our digital entertainment product category. Our data storage products consist of a range of products that store traditional PC data as well as music, photos, movies, games and other multi-media. These products are designed principally for general data storage purposes. Our digital entertainment products consist of a range of products that focus on digital music, movies and photos. These products are designed principally for entertainment purposes.

Our Data Storage Products

Our data storage products are based on one or more of the following technology formats which allow the storage, management, protection, retrieval and transfer of data:

Technology	Meaning	Data Storage and Retrieval Capability (1)
CD-ROM	Compact Disc-Read Only Memory	Retrieval only
CD-R	Compact Disc-Recordable	Retrieval and single-session storage
CD-RW	Compact Disc-Rewritable	Retrieval and multi-session storage
DVD-ROM	Digital Video Disc-Read Only Memory	Retrieval only
DVD-R or DVD+R	Digital Video Disc-Recordable	Retrieval and single-session storage
DVD-RW or DVD+RW	Digital Video Disc-Rewritable	Retrieval and multi-session storage and backward compatibility with CDs
DVD+/-RW+/-R	Dual Format Digital Video Disc-Rewritable and Recordable	Retrieval and multi-session storage and backward compatibility with CDs and DVD-Rs
CD-RW+DVD	Compact Disc-Rewritable DVD	Retrieval and multi-session storage and backward compatibility with CDs and DVD-ROMs
DVR	Digital Video Recorder	Retrieval and multi-session storage and backward compatibility with CDs and DVDs

(1) Single-session storage media and devices allow storage on a disc only a single time, whereas multi-session storage media and devices allow repeated storage, erasure and re-storage of data. Backward compatible devices permit the use of media based on older technology in devices employing newer technology, such as DVD-based devices which permit the use of CD media.

Many of the technologies identified in the table above are competing formats. We seek to deliver data storage products that enable the storage, management, protection, retrieval and transfer of data to and from all major formats to satisfy the needs of consumers regardless of their choice of format. Because certain formats ultimately may be rejected or disfavored by the marketplace, we do not base our products on a single format or on a small number of formats. We seek to offer products that are cross-compatible over numerous formats to offer the most comprehensive solution available to the broadest range of consumers.

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Our data storage products currently include:

• Internal and external optical data storage drives based on the following technologies: CD-ROM, CD-RW, DVD-ROM, DVD+R, DVD+RW, DVD+/-RW+/-R or CD-RW+DVD;

• External CD-RW and DVD+RW drives that integrate a recordable drive and a built-in seven-in-one, or 7-n-1, digital media card reader with a proprietary external casing that features a three-way adjustable lighting system allowing the user to adjust the lighting to blue, red or purple, which we call our MediaStation devices; our 7-n-1 digital media card reader supports seven different types of solid state memory devices: CompactFlash, IBM Micro Drive, Multimedia Card, Secure Digital, Memory Stick, Memory Stick Pro and SmartMedia;

• Internal dual format DVD recordable drives that integrate a recordable drive and a built-in 7-n-1 digital media card reader;

• Disc duplicator systems that are stand-alone units that do not require a computer connection and that copy information from a source disc, such as a CD or DVD, to a compatible target disc;

• External floppy disk drives that integrate a floppy disk drive and a built-in 7-n-1, digital media card reader with a proprietary external casing that features a three-way adjustable lighting system allowing the user to adjust the lighting to blue, red or purple, which we call our DataStation devices; and

• Case enclosures for external or portable data storage drives.

We plan to offer data storage products that use dual-layer DVD technology which is expected to double DVD capacity to approximately 8.5 gigabytes, or 8,500 megabytes, depending on the user’s operating system and other factors. We plan to continue our efforts to enhance our data storage products by increasing performance and functionality as well as reducing the size of their drive units and enclosures to increase portability and ergonomics.

According to The NPD Group in its Retail Hardware Report, sales of recordable CD drives in the North American marketplace declined to approximately $300 million in 2003, representing a 37% decrease from approximately $475 million in 2002. However, this was offset by substantial growth in recordable DVD drives, which we believe illustrates the transition from CD-based data storage products to DVD-based devices. According to The NPD Group in its Retail Hardware Report, sales of recordable DVD drives in the North American marketplace increased to approximately $225 million in 2003, representing a 234% increase from approximately $67 million in 2002. Unit sales of DVD recordable drives increased to approximately 1 million units in 2003, representing a 447% increase from approximately 187,000 units in 2002.

We believe that the market for data storage products is undergoing a transition from CD- to DVD-based data storage products. Compared to the CD format, the DVD format enables users to store substantially more data. We intend to continue to closely monitor the data storage market and, if the market continues its shift from CD-based data storage products to DVD-based data storage products, we expect to continue to shift our focus predominately to DVD products.

Our Digital Entertainment Products

Our existing and planned digital entertainment products include:

• MP3 digital audio players;

• 20 gigabyte palm-sized portable external hard drives with built-in 7-n-1 media card readers that facilitate the convenient storage of high-resolution digital music, photos and movies and other data files, enabling the transfer of these files from a flash memory card to a hard drive and eliminating the need for purchasing multiple, less cost-effective flash memory cards; we refer to this system as our Digital Photo Library^™ system;

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• Six channel digital audio headphones with WinDVD^™ software, which is a software-only DVD decoder and application for the PC that allows users to playback DVD movies, MPEG video content, video CDs, and audio CDs on PCs that are equipped with a DVD drive without the need for a hardware decoder card; the headphones and WinDVD^™ software support Dolby Digital^®/AC-3 surround sound and include a built-in amplifier that allows a user to connect a PC, DVD drive and home theater system into one centralized unit; we refer to these headphones as our Sound Assault^™ headphones;

• Do-it-yourself digital photo accessories such as our line of EasyPrint^™ products that allow users to create personalized photo frames, key chains, magnets and pocket-sized photo albums from their own digital photos using our proprietary photo-enhancing and printing software; and

• DVRs, which are stand-alone DVD-based video and audio storage and playback devices; DVRs allow users to record movies and other television or video content as well as audio content directly onto DVDs and play that content back over a user’s television or other video monitor and sound system.

We plan to expand our line of digital audio headphones. In addition, we are working with our subcontract manufacturers to develop new MP3 audio players and MP4 video players with embedded MP3 technology for audio playback.

We believe that the market for digital entertainment products is expanding. We intend to continue to monitor the digital entertainment market and develop products to meet changing demands of the marketplace. Currently, our digital entertainment products represent a relatively new product category. These products accounted for approximately 6% of our net sales during 2003. We expect to continue to allocate resources to this product category to attempt to increase net sales. We believe that our strategic relationships with our retailers and our subcontract manufacturers will further our ability to achieve these goals.

Product Warranties

Each of our products sold to consumers is subject to a minimum warranty of one year. These warranties cover only repair or replacement of the product.

Product Development

Our product offerings are directed toward satisfying the demands of the North American marketplace for data storage and digital entertainment products. We operate in industries that are subject to rapid technological change, product obsolescence and rapid changes in consumer demands and preferences. We attempt to anticipate and respond to these changes by focusing on the following primary objectives:

• Enhancement of existing products. We seek to offer products with increased performance and expanded functionality to satisfy existing and emerging consumer demands and preferences. Our enhanced product offerings are directed toward, among other things, offering increased data storage and retrieval speeds, and enhanced user-friendliness and ease of product installation. These product offerings are also focused on products with reduced manufacturing costs to enable us to maintain and improve gross margins while continuing to offer high-value products to consumers.

• Development of new products. We seek to offer new products that, among other things, use existing technology and adopt new technology to satisfy existing and emerging consumer demands and preferences. Our new product offerings typically focus on the implementation of existing technology to offer products that are compatible with a wide range of formats. These offerings also typically include implementation of new technology to offer products that deliver better solutions to the core needs of the data storage and digital entertainment marketplaces such as high-capacity, cost-effective, flexible and portable data storage, management, protection, retrieval and transfer.

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Our retailers and our subcontract manufacturers play an important role in the enhancement of our existing products and the development of new products. We work closely with our retailers and our subcontract manufacturers to identify existing market trends, predict future market trends and monitor the sales performance of our products.

Many of our retailers are among the largest computer, consumer electronics and office supply retailers in North America such as Best Buy, Circuit City, CompUSA, Staples, Office Depot and OfficeMax. Through their close contact with the marketplace for data storage and digital entertainment products, our retailers are able to provide us with important information about consumer demands and preferences.

Many of our subcontract manufacturers have substantial product development resources and facilities in Asia, and are among the major component manufacturers in their product categories. Some of our largest subcontract manufacturers are also our stockholders, including BTC and Lung Hwa Electronics. According to industry sources, BTC is among the largest optical storage drive manufacturers in the world and Lung Hwa Electronics is a major manufacturer of digital entertainment products. These subcontract manufacturers expend substantial resources on research, development and design of new technologies and efficient manufacturing processes.

Our Irvine, California headquarters houses a product development team that coordinates and manages the subcontract logistics and product development efforts of our subcontract manufacturers in Asia. At our Irvine facility, we also develop user manuals, product packaging and marketing literature as well as installation guides and supplemental materials, including software and hardware designed to permit user-friendly product installation.

Operations

We do not directly manufacture any of the products that we sell. We subcontract manufacture our data storage and digital entertainment products. We believe that by outsourcing the manufacturing of our products to our subcontract manufacturers, we benefit from:

• Lower overhead costs. By subcontract manufacturing our products we believe that we benefit from lower overhead costs resulting from the elimination of capital expenditures related to owning and operating manufacturing facilities, such as expenditures related to acquiring a manufacturing plant, property and equipment, and staffing, as well as the ongoing cash requirements to fund such an operation.

• Economies of scale. By subcontract manufacturing our products with some of the largest production facilities available in the industry, we believe that we benefit from our subcontract manufacturers’ economies of scale, which enable us to keep unit production costs low, our supply chain management efficient and our expansion or contraction of product orders flexible in response to changing consumer demands and preferences.

• Engineering and manufacturing resources. By subcontract manufacturing our products we believe that we benefit from our subcontract manufacturers’ substantial engineering and manufacturing resources, which aid us in offering new and enhanced products and enable us to rapidly bring them to market in a cost-effective manner.

• Diversification of manufacturing risks. By subcontract manufacturing our products to a group of manufacturers we believe that we are able to diversify the risks associated with employing a single manufacturer. We also believe that we are potentially able to expand our opportunities with respect to new products as they arise by virtue of the varying expertise of those manufacturers.

• Reduction of potential liabilities. By subcontract manufacturing our products we believe that we reduce potential significant liabilities associated with direct product manufacturing, including environmental

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liabilities and liabilities resulting from warranty claims. We believe that the reduction in potential liabilities decreases our business risks and results in tangible economic benefits such as cost savings related to insurance and the operation of compliance programs.

We believe that the relatively low overhead costs resulting from subcontract manufacturing the products we offer for sale, the economies of scale of our subcontract manufacturers, and the engineering and manufacturing resources of our subcontract manufacturers enable us to offer products combining high levels of performance, functionality and reliability at prices competitive with other leading products offered in the marketplace.

We utilize a subcontract logistics and product development consultant located in Taipei, Taiwan. Our consultant assists us in identifying new products, qualifying prospective manufacturing facilities and coordinating product purchases and shipments from some of our subcontract manufacturers. The majority of our products are shipped directly by our subcontract manufacturers to our packaging, storage and distribution facility in Irvine. These products are then packaged and shipped by us either directly to retail locations across North America or to a centralized distribution center. Product shipments are primarily made through major commercial carriers.

Quality Control

Our primary subcontract manufacturers are among the major computer and electronic component manufacturers in Asia who we believe have rigorous quality control and shipping guidelines. We regularly inspect and test product samples, periodically tour our subcontract manufacturing facilities, monitor defective product returns and test defective products.

Sales and Marketing

Three-Brand Marketing Strategy

We employ a three-brand approach to achieve our goal of product differentiation among various sales channels and price points. Our three brands are I/OMagic^®, Digital Research Technologies^® and Hi-Val^®. We sell our data storage products under each of these brands, bundling various hardware devices with different software applications to meet different consumer needs. Currently, our digital entertainment products are sold under our I/OMagic^® and Digital Research Technologies^® brands. This three-brand approach enables us to provide each of our major industry retailers with their own distinct brand, to differentiate products sold through different channels, and to stimulate competition among those channels. This enables us to capture market share and limit some of the negative effects of third-party competition.

“Good, Better, Best” Marketing Strategy

We utilize a “good, better, best” marketing strategy. We believe that this strategy helps us satisfy the demands and preferences of a diverse consumer base by offering a variety of products within some of our product lines. We offer “good” products that provide basic performance, functionality and value. We also offer “better” products that include higher performance and functionality than our “good” products, but at a higher price point. In addition, we offer “best” products that include greater performance and functionality than our “good” and “better” products, often incorporating sophisticated proprietary technology in addition to basic performance, functionality and value. Often our “best” products are among the first-to-market with new features and technology to be made widely available to consumers. Our “best” products are at the highest price points within each of our product lines, but we believe that these products still represent good values for consumers.

We believe that our “good, better, best” marketing strategy enables us to sell our three brands through multiple national retail sales channels, maintain high-value products and successfully coordinate a high frequency of sales promotions. We believe that this strategy also enables us to address different segments of the

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market for data storage and digital entertainment products by offering varying products with different levels of performance and functionality at multiple price points designed to satisfy the diverse needs and budgets of consumers.

Sales Channels

According to The NPD Group in its Retail Hardware Reports for 2002 and 2003, during each of those years we ranked as the leader in unit and dollar sales of CD-RW drives in the North American marketplace, competing against companies such as Sony, TDK and Memorex. Our goal is to maintain this ranking for our CD-RW drives and to achieve and maintain a similar ranking for our DVD-based products. We believe that our ongoing transition from CD-based products to DVD-based products is consistent with the shift in market demand and will enable us to maintain or even increase our leadership position in the North American marketplace.

We primarily sell our products through retailers who collectively operate locations throughout North America. These include nationally-recognized computer, consumer electronics and office supply superstores. In addition, we sell our products through Internet retailers and mail order catalogs.

Our North American retailers include Best Buy, Best Buy Canada, CompUSA, Circuit City, Fred Meyer Stores, Microcenter, Office Depot, OfficeMax, RadioShack, Staples, and Target. We also have relationships with other retailers and with catalog companies and Internet retailers such as Buy.com, PC Mall, Tiger Direct and Dell.

We cooperate with our retailers to promote our products and brand names. We participate in co-sponsored events with our retailers and industry trade shows such as COMDEX^®, CES^® and RetailVision^®. We participate in these events and trade shows in order to develop new relationships with potential retailers and maintain close relationships with our existing retailers. We also fund co-operative advertising campaigns, develop custom product features and promotions, provide direct personal contact with our sales representatives, develop and procure certain products as requested by our retailers, and use our three-brand marketing strategy to provide each of our major industry retailers with their own distinct brand. We cooperate with our retailers to use point-of-sale and mail-in rebate promotions to increase sales of our products. We also utilize sales circulars and our close working relationships with our significant retailers to obtain national exposure for our products and our brands. We believe that these marketing efforts help generate additional shelf-space for our products with our major retailers, promote retail traffic and sales of our products, and enhance our goodwill with these retailers.

We maintain a large database containing information regarding many end-users of our products. Through a targeted, direct marketing strategy, we intend to offer these end-users other products to establish repeat end-user customers, increase our product sales and promote brand loyalty. We also intend to communicate trends in the data storage and digital entertainment industries to these end-users, highlight new and existing products and direct existing and potential end-user customers to our retail websites.

We plan to expand our market penetration beyond traditional and Internet retailers to include corporate and government procurers, value-added resellers and value-added distributors. We currently sell and plan to continue to sell products, conduct special promotions, and offer downloads and upgrades on our company websites to existing and potential end-user customers. Our websites are located athttp://www.iomagic.com,http://www.dr-tech.com andhttp://www.hival.com.

Competition

We operate in the highly competitive data storage and digital entertainment industries. We believe that our data storage products compete with other types of data storage devices such as internal and external hard drives, magnetic tape drives, floppy disk drives and flash memory devices, as well as internal and external optical data storage products offered by other companies.

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Companies that offer products similar to our data storage products include Sony, Hewlett-Packard, TDK, Memorex, Philips Electronics, Samsung Electronics and Toshiba. We also indirectly compete against original equipment manufacturers such as Dell and Hewlett-Packard to the extent that they manufacture their own computer peripheral products or incorporate the functionalities offered by our products directly into PCs. Companies that offer products similar to our digital entertainment products include Sony, Apple Computer, Bose, Rio Audio and Creative Technology.

We believe that our ability to compete in the data storage and digital entertainment industries depends on many factors, including the following:

• Product value. The performance, functionality, reliability and price of our products are critical elements of our ability to compete. We believe that we offer, and that our target consumers seek, products that combine higher levels of performance, functionality and reliability at lower prices than other leading products offered in the marketplace. We focus on offering these high value products by positioning them as affordable alternatives to products offered by leading brands such as Sony, Hewlett-Packard, TDK and Memorex.

• Market penetration. Market penetration and brand recognition are critical elements of our ability to compete. Most consumers purchase products similar to ours from off-the-shelf retailers such as large computer, consumer electronics and office supply superstores. Market penetration in the industries in which we compete is typically based on the number of retailers who offer a company’s products and the amount of shelf-space allocated to those products. We believe that our broad-based, high value product offerings, our retailer support, our consumer support and our cooperative marketing and other promotional efforts promote close working relationships with our retailers and improve our ability to obtain critical shelf-space which enables us to establish, maintain and increase market penetration.

• Product enhancement and development and time-to-market. Enhancement of our existing products, development of new products and rapid time-to-market to satisfy evolving consumer demands and preferences are key elements of our ability to compete. Consumers continuously demand higher levels of performance and functionality in data storage and digital entertainment products. We attempt to compete successfully by bringing products with higher levels of performance and functionality rapidly to market to satisfy changing consumer demands and preferences. We believe that the research and development efforts and economies of scale of our major subcontract manufacturers enable us to rapidly introduce enhanced products and new products offering higher levels of performance and functionality. Our products are often among the first-to-market with new features and technology to be made widely available to consumers.

Intellectual Property

We currently rely on a combination of contractual rights, copyrights, trademarks and trade secrets to protect our proprietary rights. I/OMagic^®, Hi-Val^® and Digital Research Technologies^® are our registered trademarks. We also sell products under various product names such as MediaStation, DataStation, Digital Photo Library^™, EasyPrint^™ and Sound Assault^™. As we develop new products, we may file federal trademark applications covering the trademarks under which we sell those products. There can be no assurance that we will eventually secure a registered trademark covering these products. We currently do not have any issued or pending patents.

We own, license or have otherwise obtained the right to use certain technologies incorporated in our products. We may receive infringement claims from third parties relating to our products and technologies. In those cases, we intend to investigate the validity of the claims and, if we believe the claims have merit, to respond through licensing or other appropriate actions. To the extent claims relate to technology included in components purchased from third-party vendors for incorporation into our products, we would forward those claims to the appropriate vendor. If we or our product manufacturers are unable to license or otherwise provide any necessary technology on a cost-effective basis, we could be prohibited from marketing products containing

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that technology, incur substantial costs in redesigning products incorporating that technology, or incur substantial costs defending any legal action taken against us.

We have been, and may in the future be, notified of claims asserting that we may be infringing certain patents, trademarks and other intellectual property rights of third parties. We cannot predict the outcome of such claims and there can be no assurance that such claims will be resolved in our favor. An unfavorable resolution of such claims may have a material adverse effect on our business, prospects, financial condition and results of operations. The data storage industry, has been characterized by significant litigation relating to infringement of patents and other intellectual property rights. We have in the past been engaged in infringement litigation, both as plaintiff and defendant. There can be no assurance that future intellectual property claims will not result in litigation. If infringement is established, we may be required to pay substantial damages or we may be enjoined from manufacturing and selling an infringing product. In addition, the costs of engaging in the prosecution or defense of intellectual property claims may be substantial regardless of the outcome.

A number of our agreements with our retailers provide that we will defend, indemnify and hold harmless our retailers from damages and costs that arise from product warranty claims or claims for injury or damage resulting from defects in our products. If such claims are asserted against us, our insurance coverage may not be adequate to cover the costs associated with our defense of those claims or any resulting liability we would incur if those claims are successful. A successful claim brought against us for product defects that is in excess of, or excluded from, our insurance coverage could have a material adverse affect on our business and results of operations.

Government Regulation

Our products are designed by our subcontract manufacturers to comply with a significant number of regulations and industry standards, some of which are evolving as new technologies are deployed. In the United States, our products must comply with various regulations defined by the United States Federal Communications Commission, or FCC, and Underwriters Laboratories, or other nationally recognized test laboratories. We also must comply with numerous import/export regulations. The regulatory process in the United States can be time-consuming and can require the expenditure of substantial resources. We cannot assure that the FCC will grant the requisite approvals for any of our products on a timely basis, or at all. The failure of our products to comply, or delays in compliance, with the various existing and evolving standards could negatively impact our ability to sell our products. United States regulations regarding the manufacture and sale of data communications devices are subject to future change. We cannot predict what impact, if any, such changes may have upon our business.

Employees

As of May 3, 2004, we had approximately 74 full-time permanent employees and one full-time temporary employee. We have no collective bargaining agreements with our employees. We believe that our relationship with our employees is good.

Properties

Our corporate headquarters is located in Irvine, California in a leased facility of approximately 55,000 square feet. This facility contains all of our operations, including sales, marketing, finance, administration, production, shipping and receiving. The lease term began on September 1, 2003 and expires on August 31, 2006, with an option to extend the lease for another three year term upon providing notice 60 days prior to expiration of the current lease term. Our monthly lease payments are $25,480, $26,244, and $27,032 during the first, second, and third years of the lease, respectively. Under the option to extend the lease, monthly lease payments would be determined according to the then prevailing market price for the first year, and an increase of 3% per annum for years two and three. We believe this facility is adequate for our anticipated business purposes for the foreseeable future. We have no other leased or owned real property.

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Legal Proceedings

Hi-Val, Inc.

On August 2, 2001, Mark and Mitra Vakili filed a complaint in the Superior Court of the State of California for the County of Orange against Tony Shahbaz, our Chairman, President, Chief Executive Officer and Secretary. This complaint was later amended to add Alex Properties and Hi-Val, Inc. as plaintiffs, and I/OMagic, IOM Holdings, Inc., Steel Su, a director of I/OMagic, and Meilin Hsu, an officer of Behavior Tech. Computer Corp., as defendants. On or about March 28, 2003, all parties to the action entered into a Settlement Agreement and Release which settled this action. As part of the Settlement Agreement and Release, we entered into a new written lease agreement with Alex Properties relating to the real property in Santa Ana, California, which we physically occupied. On September 30, 2003, pursuant to the terms of the lease agreement, we vacated this real property. During the latter part of 2003 and continuing into the first quarter of 2004, counsel for Mark and Mitra Vakili and Alex Properties alleged, on their behalf, that we had improperly caused damage to the Santa Ana facility. On or about February 15, 2004, all parties to the original Settlement Agreement and Release executed a First Amendment to Settlement Agreement and Release, releasing all defendants from all of these new claims conditioned upon the making of the final $1,000,000 payment under the Settlement Agreement and Release by February 17, 2004, rather than on the original due date of March 15, 2004. We made this payment, and a dismissal of the case was filed with the court on March 8, 2004.

Horwitz and Beam

On May 30, 2003, I/OMagic and IOM Holdings, Inc. filed a complaint for breach of contract and legal malpractice against our former attorneys and their respective law firms in the Superior Court of the State of California for the County of Orange. The complaint seeks damages of $15 million arising out of the defendants’ representation of I/OMagic and IOM Holdings, Inc. in an acquisition transaction and in a separate arbitration matter. On November 6, 2003, we filed our First Amended Complaint against all defendants. Defendants have responded to our First Amended Complaint denying our allegations. Defendants Lawrence W. Horwitz and Lawrence M. Cron have also filed a Cross-Complaint against us for attorneys’ fees in the approximate amount of $79,000. We have denied their allegations in the Cross-Complaint. As of the date of this prospectus, discovery has commenced. The outcome of this action is presently uncertain. However, we believe that all of our claims are meritorious.

Magnequench International, Inc.

On March 15, 2004, Magnequench International, Inc., or plaintiff, filed an Amended Complaint for Patent Infringement in the United States District Court of the District of Delaware against, among others, I/OMagic, Sony Corp., Acer Inc., Asustek Computer, Inc., Iomega Corporation, LG Electronics, Inc., Lite-On Technology Corporation and Memorex Products, Inc., or defendants. The complaint seeks to permanently enjoin defendants from, among other things, selling products that allegedly infringe one or more claims of plaintiff’s patents. The complaint also seeks damages of an unspecified amount, and treble damages based on defendants’ alleged willful infringement. In addition, the complaint seeks reimbursement of plaintiff’s costs as well as reasonable attorney’s fees, and a recall of all existing products of defendants that infringe one or more claims of plaintiff’s patents that are within the control of defendants or their wholesalers and retailers. Finally, the complaint seeks destruction (or reconfiguration to non-infringing embodiments) of all existing products in the possession of defendants that infringe one or more claims of plaintiff’s patents. We are presently evaluating the merits of this complaint and, as of the date of this prospectus, have not yet responded to the allegations in the complaint. The outcome of this action is presently uncertain. However, at this time, we do not expect the defense or outcome of this action to have a material adverse affect on our business, financial condition or results of operations.

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MANAGEMENT

Directors and Executive Officers

The names, ages and positions held by our directors and executive officers as of May 3, 2004 and their business experience are as follows:

Name	Age	Titles
Tony Shahbaz	42	Chairman of the Board, President, Chief Executive Officer, Secretary, Director
Steve Gillings	54	Chief Financial Officer
Anthony Andrews	41	Vice President of Product Development and Engineering, Director
Steel Su	52	Director
Daniel Hou (1)	55	Director
Daniel Yao (1)	47	Director
Young-Hyun Shin	51	Director

(1) Member of the Audit Committee, Compensation Committee and Nominating Committee.

Tony Shahbaz is a founder of I/OMagic and has served as our Chairman of the Board, President, Chief Executive Officer, Secretary and as a director since September 1993, and as our Chief Financial Officer from September 1993 to October 2002. Prior to founding I/OMagic, Mr. Shahbaz was employed by Western Digital Corporation from September 1986 to March 1993. During his tenure at Western Digital Corporation, Mr. Shahbaz held several positions including Vice President of Worldwide Sales for Western Digital Paradise, and Regional Director of Asia Pacific Sales and Marketing Operations.

Steve Gillings has served as our Chief Financial Officer since October 2002. Prior to that, Mr. Gillings served as our Vice President of Finance from October 2000 to October 2002 and as our Controller from November 1997 to October 2000. Mr. Gillings received a B.S. degree in Accounting from the University of California at Berkeley in 1971 and an M.B.A. degree in Finance from California State University Fullerton in 1992.

Anthony Andrews has served as our Vice President of Product Development and Engineering since he joined I/OMagic in March 1994 and has served as a director since October 1995. From 1988 to 1994, Mr. Andrews was a principal engineer at Western Digital Corporation, where he was involved in product and software design and played a key role in the development of portable notebook power management software. Prior to that, Mr. Andrews was a staff engineer with Rockwell International from 1985 to 1988. Mr. Andrews received a B.S. degree in Math and Computer Science from the University of California at Los Angeles in 1985.

Steel Su has served as a director of I/OMagic since September 2000 and is a founder of Behavior Tech Computer Corp. and has served as its Chairman since 1980. Mr. Su has served and continues to serve as a director or chairman of the following affiliates of Behavior Tech Computer Corp.: Behavior Design Corporation (chairman), Behavior Tech Computer (USA) Corp. (chairman), Behavior Tech Computer Affiliates, N.V. (chairman) and BTC Korea Co., Ltd. (director). Mr. Su has served as chairman of Gennet Technology Corp., Emprex Technologies Corp., MaxD Technology Inc. and Maritek Inc. since 1992, 1998, 2000 and 1999, respectively. Mr. Su has also served as a director of Aurora Systems Corp. and Wearnes Peripherals International (PTE) Limited since 1998 and 2000, respectively. Mr. Su received a B.S. degree in Electronic Engineering from Ching Yuan Christian University in 1974 and an M.B.A. degree from National Taiwan University in 2001.

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Daniel Hou has served as a director of I/OMagic since January 1998. Since 1986, Mr. Hou has served as the President of Hou Electronics, Inc., a computer peripheral supplier that he founded. Mr. Hou is a prior President of the Southern California Chinese Computer Association and is an active member of the American Chemistry Society. Mr. Hou received a B.A. degree in Chemistry from National Chung-Hsing University, Taiwan in 1973 and a Masters degree in Material Science from the University of Utah in 1978.

Daniel Yao has served as a director of I/OMagic since February 2001 and has been a Chief Strategy Officer for Ritek Corporation since July 2000. Prior to joining Ritek, Mr. Yao served as the Senior Investment Consultant for Core Pacific Securities Capital from July 1998 to July 2000. Prior to that, Mr. Yao was an Executive Vice President for ABN Amro Bank in Taiwan from July 1996 to July 1998. Mr. Yao received a B.A. degree in Business Management from National Taiwan University in 1978 and a M.B.A. degree from the University of Rochester in New York.

Young-Hyun Shin has served as a director of I/OMagic since September 2000. Mr. Shin was the former President and Chief Executive Officer of BTC Korea Co., Ltd. from March 1988 through October 2003. Mr. Shin has served and continues to serve as a director of BTC Korea Co., Ltd. since March 1988. Mr. Shin received a B.S. degree in Electronics from Yonsei University in 1979.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers, directors and persons who beneficially own more than 10% of a registered class of our equity securities (“reporting persons”) to file initial reports of ownership and reports of changes in ownership of our common stock and other equity securities with the Securities and Exchange Commission. The reporting persons are required by the Securities and Exchange Commission regulations to furnish us with copies of all reports that they file.

Based solely upon a review of copies of the reports furnished to us during our fiscal year ended December 31, 2003 and thereafter, or any written representations received by us from reporting persons that no other reports were required, we believe that all Section 16(a) filing requirements applicable to our reporting persons during our fiscal year ended December 31, 2003 were met, except that Mr. Young-Huyn Shin filed a late Form 4 to report one transaction.

Based solely upon a review of copies of the reports furnished to us prior to January 1, 2003, or written representations received by us from current reporting persons that no other reports were required, we believe that all Section 16(a) filing requirements applicable to our current reporting persons prior to January 1, 2003 were met, except as described below:

The following individuals did not timely file the following numbers of Forms 3, 4 or 5 to report the following numbers of transactions: Mr. Tony Shahbaz — 9 reports, 17 transactions; Mr. Steel Su — 6 reports, 8 transactions; Mr. Daniel Yao — 2 reports, 2 transactions; Mr. Daniel Hou — 2 reports, 2 transactions; Mr. Anthony Andrews — 3 reports, 7 transactions; and Mr. Young-Hyun Shin — 5 reports, 5 transactions. These individuals are in the process of preparing all required Forms 3, 4 or 5 to report these transactions.

Code of Ethics

Our board of directors has adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees and an additional Code of Business Ethics that applies to our Chief Executive Officer and Senior Financial Officers.

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We intend to satisfy the disclosure requirement under Item 10 of Form 8-K relating to amendments to or waivers from provision of these codes that relate to one or more of the items set forth in Item 406(b) of Regulation S-K, by describing on our Internet website, within five business days following the date of a waiver or a substantive amendment, the date of the waiver or amendment, the nature of the amendment or waiver, and the name of the person to whom the waiver was granted.

Information on our Internet website is not, and shall not be deemed to be, a part of this prospectus or incorporated into any other filings we make with the Securities and Exchange Commission.

Compensation of Executive Officers

The following table provides information concerning the annual and long-term compensation for the years ended December 31, 2003, 2002 and 2001 earned for services in all capacities as an employee by our Chief Executive Officer and each of our other executive officers who received an annual salary and bonus of more than $100,000 for services rendered to us during 2003 (collectively, the “named executive officers”):

Summary Compensation Table

Name and Principal Position	Year	Annual Compensation
		Salary			Bonus
Tony Shahbaz	2003	$	198,500		$	28,259
Chairman, President, Chief	2002	$	202,259		$	89,067
Executive Officer and Secretary	2001	$	180,857	(1)		—
Steve Gillings	2003	$	95,000		$	5,000
Chief Financial Officer	2002		—			—
	2001		—			—

(1) Includes $40,853 of salary earned by Mr. Shahbaz as an employee of IOM Holdings, Inc.

Option Grants in Last Fiscal Year

We did not grant any stock options or stock appreciation rights to Mr. Shahbaz or Mr. Gillings during 2003.

Aggregated Option Exercises and Fiscal Year-End Values

The following table provides information regarding the value of unexercised options held by Mr. Shahbaz and Mr. Gillings as of December 31, 2003. Mr. Shahbaz and Mr. Gillings did not acquire shares through the exercise of any options during the year ended December 31, 2003.

	Number of Securities Underlying Unexercised Options at December 31, 2003				Value ($) of Unexercised In-The-Money Options at December 31, 2003 (3)
Name	Exercisable		Unexercisable		Exercisable		Unexercisable
Tony Shahbaz	59,585	(1)	14,416	(2)	$	0	$	0
Steve Gillings	5,367		1,299		$	0	$	0

(1) Includes 551 shares of common stock underlying options held by Mr. Shahbaz’s wife, Fedra Shahbaz.

(2) Includes 116 shares of common stock underlying options held by Mr. Shahbaz’s wife, Fedra Shahbaz.

(3) Based upon the last reported sale price of our common stock of $3.90 per share on December 31, 2003 (the last trading day during 2003) as reported on the OTC Bulletin Board, less the exercise price of the options.

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Employment Contracts and Termination of Employment and Change-in-Control Arrangements

On October 15, 2002, we entered into an employment agreement with Tony Shahbaz for Mr. Shahbaz to serve as our President and Chief Executive Officer. Under the terms of the employment agreement, which are effective as of January 1, 2002, Mr. Shahbaz is entitled to receive an initial annual salary of $198,500 and is eligible to receive quarterly bonuses equal to 7% of our quarterly net income. Mr. Shahbaz is also entitled to a monthly car allowance equal to $1,200. The employment agreement terminates on October 15, 2007; however, it is subject to automatic renewal. Under the terms of the employment agreement, if Mr. Shahbaz is terminated for cause, Mr. Shahbaz is entitled to receive four times his annual salary and any and all warrants and options granted to him shall be extended an additional seven years from date of termination. Under the employment agreement, upon termination without cause, Mr. Shahbaz shall be paid his remaining salary amount for the remaining outstanding term of the agreement. Mr. Shahbaz’s employment agreement further provides that the agreement shall not be terminated without the prior written consent of Mr. Shahbaz in the event of a merger, transfer of assets, or dissolution of I/OMagic, and that the rights, benefits, and obligations under the agreement shall be assigned to the surviving or resulting corporation or the transferee of I/OMagic’s assets.

We are presently in the process of negotiating a revised employment agreement with Mr. Shahbaz.

Board Committees

Our board of directors currently has an Audit Committee, a Compensation Committee and a Nominating Committee.

The Audit Committee selects our independent auditors, reviews the results and scope of the audit and other services provided by our independent auditors and reviews our financial statements for each interim period and for our year end. Since November 2002, this committee has consisted of Mr. Daniel Hou and Mr. Daniel Yao. Our board of directors has determined that Mr. Yao is an Audit Committee financial expert.Our board of directors has also determined that Mr. Hou and Mr. Yao are “independent” as defined in NASD Marketplace Rule 4200(a)(15).

The Compensation Committee is responsible for establishing and administering our policies involving the compensation of all of our executive officers and establishing and recommending to our board of directors the terms and conditions of all employee and consultant compensation and benefit plans. Since April 2004, this committee has consisted of Mr. Hou and Mr. Yao.

The Nominating Committee selects nominees for the board of directors. Beginning in and since April 2004, the Nominating Committee has consisted of Mr. Hou and Mr. Yao. The Nominating Committee utilizes a variety of methods for identifying and evaluating nominees for director, including candidates that may be referred by stockholders. Stockholders that desire to recommend candidates for the board for evaluation may do so by contacting I/OMagic in writing, identifying the potential candidate and providing background information. Candidates may also come to the attention of the Nominating Committee through current board members, professional search firms and other persons. In evaluating potential candidates, the Nominating Committee will take into account a number of factors, including, among others, the following:

• independence from management;

• whether the candidate has relevant business experience;

• judgment, skill, integrity and reputation;

• existing commitments to other businesses;

• corporate governance background;

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• financial and accounting background, to enable the nominating committee to determine whether the candidate would be suitable for Audit Committee membership; and

• the size and composition of the board.

Compensation Committee Interlocks and Insider Participation

No member of our board of directors has a relationship that would constitute an interlocking relationship with executive officers and directors of another entity. During 2003, Mr. Shahbaz, our Chief Executive Officer, President and Secretary, was a member of the Compensation Committee. While a member of that committee, during 2003 he did not make any salary recommendations to our Compensation Committee or our board of directors regarding salary increases for key executives.

Compensation of Directors

Our directors do not receive any compensation for their services, however each director is entitled to reimbursement of his reasonable expenses incurred in attending meetings of our board of directors.

Equity Compensation Plan Information

The following table provides information about our common stock that may be issued upon the exercise of options, warrants, and rights under all of our existing equity compensation plans as of December 31, 2003.

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)	(b)		(c)
Equity compensation plans approved by security holders	—	$	—	533,333
Equity compensation plans not approved by security holders	126,167	$	31.58	—
Warrants issued for services	40,008	$	8.49	—
Total	166,175	$	27.77	533,333

Stock Option Plans

We currently have two stock option plans: our 2002 Stock Option Plan and our 2003 Stock Option Plan. Our 2002 Stock Option Plan was adopted by our board of directors in September 2002 and approved by our stockholders on November 4, 2002. Our 2003 Stock Option Plan was adopted by our board of directors in November 2003 and approved by our stockholders on December 18, 2003. The 2002 and 2003 Stock Option Plans authorize the issuance of incentive stock options, commonly known as ISOs, and non-qualified stock options, commonly known as NQOs, to our officers, directors or key employees, or consultants that do business with I/OMagic.

As of May 3, 2004, we had approximately 80 employees, officers and directors eligible to receive options under the 2002 and 2003 Stock Option Plans. As of May 3, 2004 options to purchase 126,375 shares of our common stock were issued and outstanding under the 2002 Stock Option Plan and no options had been issued under the 2003 Stock Option Plan. The following is a description of some of the key terms of the 2002 and 2003 Stock Option Plans.

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Shares Subject to the 2002 and 2003 Stock Option Plans

A total of 133,333 shares of common stock are authorized for issuance under the 2002 Stock Option Plan. A total of 400,000 shares of common stock are authorized for issuance under the 2003 Stock Option Plan. Any shares of common stock that are subject to an award but are not used because the terms and conditions of the award are not met may again be used for awards under the 2002 and 2003 Stock Option Plans.

Administration

The 2002 and 2003 Stock Option Plans are administered by a committee of not less than two nor more than five persons appointed by our board of directors, each of whom must be a director of I/OMagic. Our board of directors also may act as the committee at any time or from time to time. It is the intent of the 2002 and 2003 Stock Option Plans that they be administered in a manner such that option grants and exercises would be “exempt” under Rule 16b-3 of the Securities Exchange Act of 1934, or the Exchange Act.

The committee is empowered to select those eligible persons to whom options shall be granted under the 2002 and 2003 Stock Option Plans, to determine the time or times at which each option shall be granted, whether options will be ISOs or NQOs, and the number of shares to be subject to each option, and to fix the time and manner in which each such option may be exercised, including the exercise price and option period, and other terms and conditions of such options, all subject to the terms and conditions of the 2002 and 2003 Stock Option Plans. The committee has sole discretion to interpret and administer the 2002 and 2003 Stock Option Plans, and its decisions regarding the 2002 and 2003 Stock Option Plans are final.

The 2002 and 2003 Stock Option Plans may be wholly or partially amended or otherwise modified, suspended or terminated at any time and from time to time by our board of directors. Our board of directors may not materially impair any outstanding options without the express consent of the optionee or increase the number of shares subject to the 2002 or 2003 Stock Option Plan, materially increase the benefits to optionees under the 2002 or 2003 Stock Option Plan, materially modify the requirements as to eligibility to participate in the 2002 or 2003 Stock Option Plan or alter the method of determining the option exercise price without stockholder approval. No option may be granted under the 2002 Stock Option Plan after September 24, 2012 and no option may be granted under the 2003 Stock Option Plan after November 16, 2013.

Option Terms

ISOs granted under the 2002 or 2003 Stock Option Plan must have an exercise price of not less than 100% of the fair market value of the common stock on the date the ISO is granted and must be exercised, if at all, within ten years from the date of grant. In the case of an ISO granted to an optionee who owns more than 10% of the total voting securities of I/OMagic on the date of grant, such exercise price shall be not less than 110% of the fair market value on the date of grant, and the option period may not exceed five years. NQOs granted under the 2002 or 2003 Stock Option Plan must have an exercise price of not less than 85% of the fair market value of the common stock on the date the NQO is granted.

Options may be exercised during a period of time fixed by the committee, except that no option may be exercised more than ten years after the date of grant and no option shall vest at less than 20% per year over a consecutive five-year period. In the discretion of the committee, payment of the purchase price for the shares of stock acquired through the exercise of an option may be made in cash, shares of I/OMagic common stock or a combination of cash and shares of I/OMagic common stock.

Federal Income Tax Consequences

NQOs

Holders of NQOs do not realize income as a result of a grant of the option, but normally realize compensation income upon exercise of an NQO to the extent that the fair market value of the shares of common

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stock on the date of exercise of the NQO exceeds the exercise price paid. I/OMagic will be required to withhold taxes on ordinary income realized by an optionee upon the exercise of a NQO.

In the case of an optionee subject to the “short-swing” profit recapture provisions of Section 16(b) of the Exchange Act, the optionee realizes income only upon the lapse of the six-month period under Section 16(b), unless the optionee elects to recognize income immediately upon exercise of his or her option.

ISOs

Holders of ISOs will not be considered to have received taxable income upon either the grant of the option or its exercise. Upon the sale or other taxable disposition of the shares, long-term capital gain will normally be recognized on the full amount of the difference between the amount realized and the option exercise price paid if no disposition of the shares has taken place within either two years from the date of grant of the option or one year from the date of exercise. If the shares are sold or otherwise disposed of before the end of the one-year or two-year periods, the holder of the ISO must include the gain realized as ordinary income to the extent of the lesser of the fair market value of the option stock minus the option price, or the amount realized minus the option price. Any gain in excess of these amounts, presumably, will be treated as capital gain. I/OMagic will be entitled to a tax deduction in regard to an ISO only to the extent the optionee has ordinary income upon the sale or other disposition of the option shares.

Upon the exercise of an ISO, the amount by which the fair market value of the purchased shares at the time of exercise exceeds the option price will be an “item of tax preference” for purposes of computing the optionee’s alternative minimum tax for the year of exercise. If the shares so acquired are disposed of prior to the expiration of the one-year and two-year periods described above, there should be no “item of tax preference” arising from the option exercise.

Possible Anti-Takeover Effects

Although not intended as an anti-takeover measure by our board of directors, one of the possible effects of the 2002 and 2003 Stock Option Plans could be to place additional shares, and to increase the percentage of the total number of shares outstanding, in the hands of the directors and officers of I/OMagic. Such persons may be viewed as part of, or friendly to, incumbent management and may, therefore, under certain circumstances be expected to make investment and voting decisions in response to a hostile takeover attempt that may serve to discourage or render more difficult the accomplishment of such attempt.

In addition, options may, in the discretion of the committee, contain a provision providing for the acceleration of the exercisability of outstanding, but unexercisable, installments upon the first public announcement of a tender offer, merger, consolidation, sale of all or substantially all of the assets of I/OMagic, or other attempted changes in the control of I/OMagic. In the opinion of our board of directors, such an acceleration provision merely ensures that optionees under the 2002 and 2003 Stock Option Plans will be able to exercise their options as intended by the board of directors and stockholders of I/OMagic prior to any such extraordinary corporate transaction which might serve to limit or restrict such right. Our board of directors is, however, presently unaware of any threat of hostile takeover involving I/OMagic.

Indemnification of Directors and Officers

The underwriting agreement between us and Wedbush Morgan Securities provides for indemnification by Wedbush Morgan Securities of our company and our officers and directors, and by us of Wedbush Morgan Securities for certain liabilities arising under the Securities Act or otherwise.

Our amended and restated articles of incorporation and amended and restated bylaws provide that we shall, to the fullest extent permitted by Nevada Revised Statutes section 78.751, indemnify all persons that we have

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power to indemnify under that section against all expenses, liabilities or other matters covered by that section, and that this indemnification is not exclusive of any other indemnification rights to which those persons may be entitled. Indemnification under this provision is as to action both in an official capacity and in another capacity while holding office. Indemnification continues as to a person who has ceased to be a director, officer, employee or agent and extends to the benefit of the heirs, executors and administrators of such a person. Section 78.751 of the Nevada Revised Statutes provides that the expenses of our officers and directors incurred in defending a civil or criminal action, suit or proceeding must be paid by us as they are incurred and in advance of the final disposition of the action, suit or proceeding, upon receipt of an undertaking by or on behalf of the director or officer to repay the amount if it is ultimately determined by a court of competent jurisdiction that he is not entitled to indemnification.

Our amended and restated articles of incorporation also provide that a director of I/OMagic shall not be liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director, except to the extent exemption from limitation or liability is not permitted under the Nevada Revised Statutes. Any amendment, modification or repeal of this provision by our stockholders would not adversely affect any right or protection of a director of I/OMagic in respect of any act or omission occurring prior to the time of such amendment, modification or repeal. Our amended and restated articles of incorporation do not, however, eliminate or limit a director’s liability for any act or omission involving intentional misconduct, fraud or a knowing violation of law, or the payment of unlawful distributions to stockholders. Furthermore, they do not limit liability for claims against a director arising out of the director’s responsibilities under the federal securities laws or any other law. However, we have purchased directors and officers liability insurance to protect our directors and executive officers against liability under circumstances specified in the policy.

Section 2115 of the California General Corporation Law, or the California Code, provides that corporations such as I/OMagic that are incorporated in jurisdictions other than California and that meet various tests are subject to several provisions of the California Code, to the exclusion of the law of the jurisdiction in which the corporation is incorporated. We believe that as of December 31, 2003, we met the tests contained in Section 2115. Consequently, we are subject to, among other provisions of the California Code, Section 317 which governs indemnification of directors, officers and others. Section 317 generally eliminates the personal liability of a director for monetary damages in an action brought by or in the right of I/OMagic for breach of a director’s duties to I/OMagic or our stockholders except for liability:

• for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law;

• for acts or omissions that a director believes to be contrary to the best interests of I/OMagic or our stockholders or that involve the absence of good faith on the part of the director;

• for any transaction for which a director derived an improper personal benefit;

• for acts or omissions that show a reckless disregard for the director’s duty to I/OMagic or our stockholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director’s duties, of a risk of serious injury to I/OMagic or our stockholders;

• for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director’s duty to I/OMagic or our stockholders; and

• for engaging in transactions described in the California Code or California case law which result in liability, or approving the same kinds of transactions.

To the extent indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of I/OMagic under the foregoing provisions, or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless

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in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.

The inclusion of the above provisions in our amended and restated articles of incorporation and amended and restated bylaws may have the effect of reducing the likelihood of derivative litigation against our directors and may discourage or deter stockholders or management from bringing a lawsuit against our directors for breach of their duty of care, even though such an action, if successful, might otherwise have benefited us and our stockholders. At present, there is no litigation or proceeding pending involving a director of ours as to which indemnification is being sought, nor are we aware of any threatened litigation that may result in claims for indemnification by any of our directors.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In January 2003, we entered into a trade credit facility with Lung Hwa Electronics. Lung Hwa Electronics is a stockholder and subcontract manufacturer of I/OMagic. Under the terms of the facility, Lung Hwa Electronics has agreed to purchase inventory on our behalf. We can purchase up to $10,000,000 of this inventory from Lung Hwa Electronics, with payment terms of 120 days following the date of invoice by Lung Hwa Electronics. Lung Hwa Electronics charges us a 5% handling fee on a supplier’s unit price. A 2% discount of the handling fee is applied if we reach an average running monthly purchasing volume of $750,000. Returns made by us, which are agreed to by a supplier, result in a credit to us for the handling charge. As security for the trade credit facility, we paid Lung Hwa Electronics a $1.5 million security deposit during 2003. As of December 31, 2003, $750,000 of this deposit had been applied against outstanding trade payables as the agreement allowed us to apply the security deposit against our outstanding trade payables. The $750,000 balance of the deposit can currently be applied against our outstanding trade payables, but is expected to remain on deposit with Lung Hwa Electronics until the end of the term of the trade credit facility, at which time any balance will be offset against our outstanding trade payables and any remaining balance will be refunded. This trade credit facility is for an indefinite term, however, either party has the right to terminate the facility upon 30 days’ written notice to the other party. As of December 31, 2003, we owed Lung Hwa Electronics $2.0 million in trade payables net of the remaining $750,000 deposit.

In February 2003, we entered into a Warehouse Services and Bailment Agreement with BTC USA. Under the terms of the agreement, BTC USA has agreed to supply and store at our warehouse up to $10,000,000 of inventory on a consignment basis. We are responsible for insuring the consigned inventory, storing the consigned inventory for no charge; and furnishing BTC USA with weekly statements indicating all products received and sold and the current level of consigned inventory. The agreement also provides us with a trade line of credit of up to $10,000,000 with payment terms of net 60 days, without interest. The agreement may be terminated by either party upon 60 days’ prior written notice to the other party. As of December 31, 2003, we owed BTC USA $8.3 million under this arrangement. BTC USA is a subsidiary of BTC, one of our significant stockholders. Mr. Steel Su, a director of I/OMagic, is the Chief Executive Officer of BTC. BTC USA, its affiliates and Mr. Su also have beneficial ownership in certain other entities that are also our stockholders. Tony Shahbaz, our Chief Executive Officer, President, Secretary and a Director, also has beneficial ownership in these entities. See “Principal and Selling Stockholders.”

In 2003, we leased our Santa Ana facility from January 2003 through September 2003 from Alex Properties. Alex Properties was owned through late March 2003 by Mr. Tony Shahbaz, our Chief Executive Officer, President, Secretary and Director, and Mr. Steel Su, a director of I/OMagic. In late March 2003, Alex Properties was turned over to Mark Vakili as part of the settlement of a lawsuit. In 2003, we paid $86,016 to Alex Properties for rent while it was owned by Mr. Shahbaz and Mr. Su.

We are a party to an employment agreement with Tony Shahbaz, our Chief Executive Officer, President, Secretary and a Director, as more particularly described above under the heading “Management — Employment Contracts and Termination of Employment and Change-in-Control Arrangements.”

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PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth information with respect to the beneficial ownership of our common stock as of May 3, 2004, and as adjusted to reflect the sale of common stock offered in this offering, by:

• each person known by us to beneficially own more than 5% of the outstanding shares of our common stock;

• each of our directors;

• each of the executive officers named in the summary compensation table contained on page 58 of this prospectus;

• each selling stockholder; and

• all of our directors and executive officers as a group.

The percentage of share ownership indicated below is based on 4,529,672 shares of common stock outstanding as of May 3, 2004, and on 5,529,672 of common stock outstanding after this offering, assuming that the underwriter’s over-allotment option is not exercised.

The beneficial ownership numbers and percentages indicated below are calculated based on requirements of the Securities and Exchange Commission. All shares of our common stock subject to options currently exercisable either currently or within 60 days after May 3, 2004 are deemed to be outstanding for the purpose of computing the percentage of ownership of the person holding the options, but are not deemed to be outstanding for computing the percentage of ownership of any other person.

Unless otherwise indicated below, each stockholder named in the following table has sole voting and investment power with respect to all shares beneficially owned, subject to applicable community property laws. The address of each of the following stockholders, unless otherwise indicated below, is c/o I/OMagic Corporation, 4 Marconi, Irvine, California 92618.

	Shares Beneficially Owned Prior to Offering			Maximum Number of Shares Being Offered	Shares Beneficially Owned After Offering
Name of Beneficial Owner (1)	Number	Percent			Number	Percent
Tony Shahbaz (2)	2,502,002	55.2	%			%
Steel Su (3)	640,123	14.1	%			%
Sung Ki Kim (4)	375,529	8.3	%			%
Daniel Yao (5)	342,218	7.6	%			%
Daniel Hou (6)	136,851	3.0	%			%
Anthony Andrews (7)	20,932	*		—	20,932	*
Young-Hyun Shin (8)	1,400	*		—	1,400	*
Steve Gillings (9)	12,033	*		—	12,033	*
All directors and executive officers as a group (7 persons) (10)	3,655,559	80.7	%	500,000		%

* Less than 1.00% of our outstanding common stock.

(1) Unless otherwise indicated, the address of each person in this table is c/o I/OMagic Corporation, 4 Marconi, Irvine, CA 92618. Messrs. Shahbaz and Gillings are executive officers of I/OMagic Corporation. Messrs. Shahbaz, Andrews, Su, Hou, Shin, and Yao are directors.

(2) Consists of: (i) 594,668 shares of common stock and 93,166 shares of common stock underlying options held individually by Mr. Shahbaz; (ii) 604 shares of common stock underlying options held individually by Mr. Shahbaz’s wife, Fedra Shahbaz; (iii) 1,223,757 shares of common stock held by Susha, LLC, a California limited liability company, or Susha California; (iv) 550,001 shares of common stock held by

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Susha, LLC, a Nevada limited liability company, or Susha Nevada; and (v) 39,806 shares of common stock held by King Eagle Enterprises, Inc., a California corporation. Also includes up to 126,667 shares of common stock that may be transferrable by Mr. Shahbaz to a third party. Mr. Shahbaz has sole voting and sole investment power over the shares held by Susha California, Susha Nevada and King Eagle Enterprises, Inc.

(3) Consists of 457,334 shares of common stock and 16,122 shares of common stock underlying options held individually by Mr. Su, and 166,667 shares of common stock held by Behavior Tech Computer Corp. Also includes up to 126,667 shares of common stock that may be transferrable by Mr. Su to a third party. Mr. Su is the Chief Executive Officer of BTC and has sole voting and sole investment power over the shares held by Behavior Tech Computer Corp.

(4) Represents 375,529 shares of common stock held by BTC Korea Co., Ltd., or BTC Korea. Since October 22, 2003, Mr. Kim serves as Chief Executive Officer and President of BTC Korea and has sole voting and sole investment power over the shares held by BTC Korea. The address for Mr. Kim is c/o BTC Korea Co., Ltd., 160-5, Kajwa-Dong Seo-Ku, Incheon City, Korea.

(5) Consists of 1,400 shares of common stock underlying options held individually by Mr. Yao and 340,818 shares of common stock held by Citrine Group Limited, a wholly owned subsidiary of Ritek Corporation. Mr. Yao currently serves as the Chief Strategy Officer of Ritek Corporation. Mr. Yao has sole voting and sole investment power over the shares held by Citrine Group Limited. The address for Mr. Yao is c/o Citrine Group Limited, No. 42, Kuanfu N. Road, 30316 R.O.C., HsinChu Industrial Park, Taiwan.

(6) Consists of 3,515 shares of common stock underlying options held individually by Mr. Hou, and 133,336 shares of common stock held by Hou Electronics. Mr. Hou has sole voting and sole investment power over the shares held by Hou Electronics.

(7) Consists of 2,491 shares of common stock and 17,999 shares of common stock underlying options held individually by Mr. Andrews, and 442 shares of common stock underlying options held individually by Mr. Andrews’ wife, Nancy Andrews.

(8) Consists of 1,400 shares of common stock underlying options held individually by Mr. Shin.

(9) Consists of 12,033 shares of common stock underlying options held individually by Mr. Gillings.

(10) Includes 146,681 shares of common stock underlying options.

DESCRIPTION OF CAPITAL STOCK

Our authorized capital stock consists of 100,000,000 shares of common stock, $.001 par value per share, and 10,000,000 shares of preferred stock, $.001 par value per share. The following description of our capital stock does not purport to be complete and is subject to and qualified in its entirety by our amended and restated articles of incorporation, our amended and restated bylaws and the applicable provisions of Nevada law.

Common Stock

The holders of outstanding shares of our common stock are entitled to receive dividends, out of assets legally available for payment of dividends, at the times and in the amounts as the board of directors may, from time to time, determine, subordinate to any preferences that may be granted to the holders of preferred stock and subject to the restrictions on the payment of dividends contained in our business loan agreement with United National Bank.

The holders of our common stock are entitled to one vote per share on all matters on which the holders of common stock are entitled to vote and are entitled to cumulative voting rights with respect to the election of directors.

Holders of our common stock are not entitled to preemptive rights and our common stock may not be redeemed or converted, except as may be provided by future agreements between us and the holders of our common stock. Upon the liquidation, dissolution or winding-up of I/OMagic, any assets legally available for

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distribution to our stockholders would be divided among the holders of our common stock in proportion to the number of shares of common stock held by each of them, after the payment of all of our debts and liabilities and the satisfaction of the rights of any outstanding class or series of preferred stock having a superior right to assets available for distribution.

All outstanding shares of our common stock are, and the shares of common stock to be issued in this offering will be, when issued and delivered, validly issued, fully paid and nonassessable. We do not currently have any shares of preferred stock issued or outstanding. However, the rights, preferences and privileges of holders of common stock would be subordinate to any series of preferred stock that we may issue in the future.

As of May 3, 2004, we had 4,529,672 shares of common stock outstanding. As of May 3, 2004, there were approximately 72 holders of record of our common stock. We believe that the number of beneficial owners on that date was substantially higher. Upon completion of this offering, there will be 5,529,672 shares of our common stock outstanding. There are 533,333 shares of common stock currently reserved for issuance under our 2002 and 2003 Stock Option Plans, of which 126,375 shares are issuable upon exercise of outstanding options and another 126,167 shares are reserved for issuance upon exercise of options issued outside of our 2002 and 2003 Stock Option Plans. Also, 172,500 shares of common stock are issuable upon exercise of the underwriter’s warrant in addition to 40,004 shares of common stock issuable upon exercise of other outstanding warrants.

Preferred Stock

We may issue preferred stock, from time to time, in one or more series. Our board of directors, without the approval of the holders of our common stock, may fix or alter the voting rights, redemption provisions, dividend rights, dividend rates, claims to our assets, conversion rights and any other rights, preferences, privileges and restrictions of any wholly-unissued series of preferred stock. The issuance of shares of preferred stock with any of these rights could adversely affect the voting power or other rights of the holders of our common stock. The issuance of shares of preferred stock could have the effect of making it more difficult for a third party to acquire, or could discourage or delay a third party from acquiring, a majority of our outstanding stock. As of the date of this prospectus, we have no shares of preferred stock outstanding.

Certain Provisions of Our Articles of Incorporation and Bylaws

Below is a summary of certain provisions of our amended and restated articles of incorporation, or our Articles, and our amended and restated bylaws, or our Bylaws, that could be deemed to have an anti-takeover effect. These provisions are intended to enhance the likelihood of continuity and stability in the composition of our board of directors and in the policies it formulates and to discourage an unsolicited takeover of I/OMagic if our board of directors determines that the takeover may not be in the best interests of I/OMagic and our stockholders. However, these provisions could also have the effect of discouraging certain attempts to acquire I/OMagic or remove incumbent management even if some or a majority of our stockholders deemed such an attempt to be in their best interests.

Our Bylaws establish an advance notice procedure forstockholder proposals to be considered at annual meetings of our stockholders. In general, a stockholder’s notice must be delivered to our secretary not later than the close of business on the 120th day prior to the first anniversary of the date of our proxy statement was released to stockholders in connection with the preceding year’s annual stockholder meeting. If, however, the date of the annual meeting is more than 30 days before or more than 30 days after the anniversary date, any stockholder proposal must be delivered a reasonable time before we begin to print and mail our proxy materials in order to be considered timely. Our Bylaws provide that special meetings of our stockholders may be called only by our President, by our board of directors or at the written request of stockholders owning a majority of our issued and outstanding capital stock and entitled to vote at the meeting. These provisions make it more difficult for stockholders to take any action opposed by our board of directors.

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Our Bylaws may be amended, altered or repealed by our board of directors or by the vote of holders of a majority of our outstanding shares.

Transfer Agent and Registrar

The stock transfer agent and registrar for our common stock is Transfer Online, Inc. Its telephone number is (503) 227-2950 and its Internet website address ishttp://www.transferonline.com.

SHARES ELIGIBLE FOR FUTURE SALE

The sale of a substantial amount of our common stock in the public market after this offering, including shares issued upon exercise of outstanding common stock options or warrants, could adversely affect the prevailing market price of our common stock.

As of May 3, 2004, we had 4,529,672 shares of common stock outstanding. Upon completion of this offering, we will have 5,529,672 shares of common stock outstanding. All of the shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act of 1933, or Securities Act, unless held by an “affiliate” of I/OMagic, as defined in Rule 144 of Regulation D under the Securities Act, or Rule 144. Sales by any affiliate would be limited by the resale limitations of Rule 144. In connection with this offering, our executive officers, directors and certain other stockholders who will hold in the aggregate              outstanding shares upon completion of this offering have agreed not to sell or transfer any common stock for 180 days after the date of this prospectus without first obtaining the written consent of Wedbush Morgan Securities.

The shares of our outstanding common stock that are not registered in this offering will be “restricted securities,” as defined in Rule 144, and may not be sold in the absence of registration under the Securities Act unless an exemption from registration is available, including an exemption contained in Rule 144. In general, under Rule 144 as currently in effect, any person who has “beneficially owned” restricted securities, as is defined in Rule 144, for at least one year is entitled to sell, within any three-month period, a number of shares that does not exceed the greater of 1% of the total number of shares of common stock outstanding on the sale date, provided that public information about us, as required by Rule 144, is then available and the seller complies with the other requirements under Rule 144 including the method of sale and the giving of notice. In general, under Rule 144 as currently in effect, a person who is not an “affiliate” and has not been an “affiliate” within three months prior to the sale and has, held the shares proposed to be sold for at least two yeas prior to the sale is entitled to sell those shares under Rule 144(k) without regard to any volume limitations.

On June 24, 2003, we filed a registration statement on Form S-8 with the Securities and Exchange Commission to register the issuance of 133,333 shares of our common stock issuable upon exercise of options granted under our 2002 Stock Option Plan. We intend to file a registration statement on Form S-8 with the Securities and Exchange Commission to register the issuance of 400,000 shares of our common stock issuable upon exercise of options that may be granted under our 2003 Stock Option Plan. Upon registration and issuance, all of these shares issuable under our 2002 and 2003 Stock Option Plans will be freely tradable without restriction or further registration under the Securities Act, except to the extent purchased by one of our affiliates, in which case the Rule 144 requirements described above would apply.

We also have options outstanding outside of a formal stock option plan to purchase up to 126,167 shares of our common stock. In addition, holders of warrants to purchase an aggregate 40,004 shares of our common stock have registration rights that are exercisable upon the occurrence of certain events, including the listing of our common stock on Nasdaq or the American Stock Exchange and meeting a minimum specified market capitalization threshold. Also, holders of                  shares of our common stock have registration rights that are exercisable upon the occurrence of certain events, including the filing of this registration statement and the

61

making of this offering. If the shares of common stock issuable upon exercise of these options or warrants are registered with the Securities and Exchange Commission, upon their issuance, all of these shares will be freely tradable without restriction or further registration under the Securities Act, except to the extent purchased by one of our affiliates, in which case the Rule 144 requirements described above would apply.

No predictions can be made as to the effect, if any, that future sales of shares of our common stock, or future grants of options and warrants to acquire shares of our common stock, or the availability of shares of our common stock for future sale, will have on the market price of our common stock prevailing from time to time. Sales of substantial amounts of common stock in the public market, or the perception that these sales could occur, whether they actually occur or not, could adversely affect the prevailing market prices of our common stock. See “Principal and Selling Stockholders,” “Description of Capital Stock” and “Underwriting.”

62

UNDERWRITING

Under the terms of an underwriting agreement with us and the selling stockholders, Wedbush Morgan Securities has agreed to purchase, from us and the selling stockholders, all shares of common stock being offered under this prospectus at the public offering price less the underwriting discounts and commissions set forth on the cover page of this prospectus. Other than the shares covered by the over-allotment option, Wedbush Morgan Securities is obligated to purchase and accept delivery of all of the shares of common stock if any are purchased.

We have been advised by Wedbush Morgan Securities that it proposes initially to offer the shares of common stock in part directly to the public at the public offering price shown on the cover page of this prospectus and in part to dealers at this price of $             per share. After this offering, the public offering price, concession and reallowance to dealers may be reduced by Wedbush Morgan Securities. This reduction will not change the amount of proceeds to be received by us and the selling stockholders as set forth on the cover page of this prospectus. The common stock is offered by Wedbush Morgan Securities as stated in this prospectus, subject to receipt and acceptance by Wedbush Morgan Securities of all shares of common stock being sold, and subject to its right to reject any order to purchase shares in whole or in part.

Over-Allotment Option

We and certain of the selling stockholders have granted Wedbush Morgan Securities an option, exercisable within 45 days after the date of this prospectus, to purchase up to 225,000 additional shares of common stock at the public offering price less the underwriting discounts and commissions. Wedbush Morgan Securities may exercise this option solely to cover over-allotments, if any, made in this offering. If purchased, these additional shares will be sold by Wedbush Morgan Securities on the same terms as the rest of the shares offered in this prospectus are being sold. We and certain of the selling stockholders will be obligated to sell shares to Wedbush Morgan Securities to the extent the over-allotment option is exercised.

Commissions and Expenses

The following table shows the underwriting discounts and commissions to be paid to Wedbush Morgan Securities by us and the selling stockholders in connection with this offering:

	Per Share	Total
		With Overallotment	Without Overallotment
Underwriting discounts and commissions payable by us
Underwriting discounts and commissions payable by the selling stockholders

We estimate that expenses payable by us in connection with this offering, other than the underwriting discounts and commissions referred to above, will be approximately $405,000.

Expenses

We have committed to reimburse Wedbush Morgan Securities for its reasonable out-of-pocket expenses.

Underwriter’s Warrant

On completion of this offering, we will issue to Wedbush Morgan Securities, a warrant to purchase up to 172,500 shares of our common stock at an exercise price equal to 110% of the public offering price. This warrant will be exercisable for five years from the date of this prospectus.

The warrant will not entitle its holder to any voting, dividend or other stockholder rights. Any profit realized on the sale of the shares issuable upon exercise of the warrant may be deemed to be additional underwriting

63

compensation. During the term of the warrant, the holder will have the opportunity to profit from a rise in the market price of our common stock without assuming the risk of the ownership of the underlying shares of common stock. The holder will be most likely to exercise the warrant when the exercise price is less than the market price for our common stock. However, we offer no assurance as to when or whether the warrant will be exercised.

Lock-Up Agreements

In connection with this offering, our executive officers, directors and certain other stockholders, have informed us that they plan to enter into an agreement with Wedbush Morgan Securities under which they would agree not to sell or transfer any common stock for 180 days after the date of this prospectus without first obtaining the written consent of Wedbush Morgan Securities. The persons who we believe will be entering into this agreement will beneficially own, in the aggregate, approximately                      shares of our common stock upon completion of this offering. Wedbush Morgan Securities may shorten or waive this lock-up restriction in its sole discretion.

Indemnity

In the underwriting agreement, we and the selling stockholders have agreed to indemnify Wedbush Morgan Securities, and its legal counsel, against certain liabilities, including liabilities under the Securities Act, and to contribute to any payments that Wedbush Morgan Securities may be required to make for these liabilities.

Stabilization and Short Sales

In connection with this offering, Wedbush Morgan Securities may purchase and sell shares of our common stock in the open market in connection with transactions intended to stabilize the price of our common stock. These transactions may include short sales, stabilizing transactions, and purchases of our shares in the open market to cover positions created by short sales in accordance with Regulation M under the Securities and Exchange Act of 1934.

Short sales involve the sale by Wedbush Morgan Securities of a greater number of shares than they are required to purchase in the offering. Stabilizing transactions consist of certain bids or purchases made for the purpose of preventing or slowing a decline in the market price of our common stock while the offering is in progress. “Covered” short sales are sales made in an amount not greater than the over-allotment option to purchase additional shares in this offering. Wedbush Morgan Securities may close out any covered short position by either exercising the over-allotment option or purchasing shares in the open market. In determining the source of shares to close out the covered short position, Wedbush Morgan Securities will consider, among other things, the price of shares available for purchase in the open market compared to the price at which Wedbush Morgan Securities may purchase shares through the over-allotment option. “Naked” short sales are sales in excess of the over-allotment option. Any naked short position is closed out by purchasing shares in the open market. A naked short position is more likely to be created if Wedbush Morgan Securities is concerned that there may be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase shares in the offering.

64

The activities of Wedbush Morgan Securities described above may stabilize, maintain or otherwise affect the market price of our common stock. As a result, the price of our common stock may be higher than the price that otherwise might exist in the open market. These transactions may be effected on the Nasdaq SmallCap Market, if our common stock is listed on that market, the OTC Bulletin Board or otherwise and, if commenced, may be discontinued at any time.

No representation or prediction is made by us or the selling stockholders or Wedbush Morgan Securities as to the direction or magnitude of any effect that the transactions described above, if they occur, may have on the price of our common stock. Wedbush Morgan Securities is not required to engage in any of these activities.

Offers Outside of the United States

Neither we nor Wedbush Morgan Securities have taken any action that would permit a public offering of the shares of common stock offered by this prospectus in any jurisdiction other than the United States where action for that purpose is required. The shares of common stock offered by this prospectus may not be offered or sold, directly or indirectly, and this prospectus or the offering material or advertisements related to the offer and sale of these shares of common stock may not be distributed or published, in any jurisdiction other than the United States, and within the United States only in those states, and except under circumstances that will result in compliance with the applicable rules and regulations of each state in which the offer or sale is made. This prospectus is not an offer to sell or a solicitation of an offer to buy any shares of common stock offered hereby in any jurisdiction in which such an offer or solicitation is unlawful.

Electronic Distribution

A prospectus in electronic format may be made available on the Internet websites or through other online services maintained by Wedbush Morgan Securities or by its affiliates. In those cases, prospective investors may view offering terms online and prospective investors may be allowed to place orders online. Wedbush Morgan Securities may agree with us to allocate a specific number of shares for sale to online brokerage account holders. Any such allocation for online distribution will be made on the same basis as other allocations. Persons making such distributions will be required to comply with the rules of the National Association of Securities Dealers.

Other than the prospectus in electronic format as described above, none of the information on Wedbush Morgan Securities’ or any selling stockholder’s website, and none of the information contained in any other website maintained by Wedbush Morgan Securities or any selling stockholder, is part of this prospectus or the registration statement of which this prospectus forms a part. None of this information has been approved or endorsed by us, by Wedbush Morgan Securities or by any selling stockholder, and should not be relied upon by investors or prospective investors in the offering.

Passive Market Making

In connection with this offering and before the commencement of offers or sales of the common stock, Wedbush Morgan Securities, who is a qualified market maker on the Nasdaq SmallCap Market, assuming that we are successful in listing our shares on the Nasdaq SmallCap Market, may engage in passive market making transactions in our common stock on the Nasdaq SmallCap Market immediately prior to the commencement of sales in this offering in accordance with Rule 103 of Regulation M under the Exchange Act. A passive market maker must comply with applicable volume and price limitations and must be identified as such. In general, a passive market maker must display its bid at a price not in excess of the highest independent bid. If all independent bids are lowered below the passive market maker’s bid, however, the bid must then be lowered when certain purchase limits are exceeded.

65

LEGAL MATTERS

The validity of the shares of common stock offered by us in this offering, along with certain other matters in connection with this offering, will be passed upon for us by Rutan & Tucker, LLP, Costa Mesa, California which has acted as our counsel in connection with this offering. Certain matters in connection with this offering will be passed upon for Wedbush Morgan Securities by Luce, Forward, Hamilton & Scripps LLP, Los Angeles, California, which has acted as the underwriter’s counsel in connection with this offering.

EXPERTS

The consolidated balance sheets of I/OMagic Corporation and subsidiaries as of December 31, 2002 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003, have been included in this prospectus and in the registration statement of which this prospectus forms a part in reliance upon the report of Singer Lewak Greenbaum & Goldstein LLP, independent certified public accountants, appearing elsewhere in this prospectus, and upon the authority of that firm as experts in accounting and auditing.

WHERE YOU CAN FIND MORE INFORMATION

We have filed a registration statement on Form S-1 with respect to the common stock offered in this prospectus with the Securities and Exchange Commission, or SEC, in compliance with the Securities Act, and the rules and regulations enacted under its authority. This prospectus, which constitutes a part of the registration statement, does not contain all of the information included in the registration statement and its exhibits and schedules. Statements contained in this prospectus regarding the contents of any document referred to in this prospectus are not necessarily complete, and in each instance, we refer you to the full text of the document which is filed as an exhibit to the registration statement. Each statement concerning a document which is filed as an exhibit should be read along with the entire document. For further information regarding us and the common stock offered in this prospectus, we refer you to this registration statement and its exhibits and schedules. The registration statement, including its exhibits and schedules, may be inspected without charge at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room.

The SEC also maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, such as us, that file electronically with the SEC. The SEC’s website address ishttp://www.sec.gov.

66

I/OMAGIC CORPORATION

AND SUBSIDIARY

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

AND SUPPLEMENTAL INFORMATION

December 31, 2003

	Page
INDEPENDENT AUDITOR’S REPORT	F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets	F-3
Consolidated Statements of Operations	F-5
Consolidated Statements of Stockholders’ Equity	F-6
Consolidated Statements of Cash Flows	F-7
Notes to Consolidated Financial Statements	F-10
SUPPLEMENTAL INFORMATION
Independent Auditor’s Report on Financial Statement Schedule	F-31
Valuation and Qualifying Accounts—Schedule II	F-32

F-1

INDEPENDENT AUDITOR’S REPORT

To the Board of Directors

I/OMagic Corporation and subsidiaries

Irvine, California

We have audited the accompanying consolidated balance sheets of I/OMagic Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of I/OMagic Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.

/s/    SINGER LEWAK GREENBAUM & GOLDSTEIN LLP

Los Angeles, California

March 4, 2004, except for the first paragraph of Note 18,

as to which the date is March 9, 2004, the second paragraph

of Note 18 as to which the date is March 15, 2004

and for the first and second paragraphs

of Note 10, as to which the date is

March 31, 2004

F-2

I/OMAGIC CORPORATION

AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31,

ASSETS

	2003		2002
Current assets
Cash and cash equivalents	$	6,091,369	$	7,320,143
Accounts receivable, net of allowance for doubtful accounts of $20,553 and $2,135,660		18,439,893		19,055,201
Inventory, net of allowance for obsolete inventory of $505,029 and $1,046,812		9,706,708		8,240,280
Inventory in transit		—		675,000
Prepaid expenses and other current assets		407,260		28,955
Total current assets		34,645,230		35,319,579
Property and equipment, net		539,943		1,059,067
Trademarks, net of accumulated amortization of $4,871,044 and $4,292,308		4,774,635		5,353,371
Restricted cash		100,000		—
Other assets		52,984		25,952
Total assets	$	40,112,792	$	41,757,969

The accompanying Notes are an integral part of these financial statements.

F-3

I/OMAGIC CORPORATION

AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31,

LIABILITIES AND STOCKHOLDERS’ EQUITY

	2003			2002
Current liabilities
Line of credit	$	5,938,705		$	10,372,827
Accounts payable and accrued expenses		5,572,878			7,285,246
Accounts payable - related parties		10,370,119			2,607,278
Reserves for customer returns and price protection		853,373			765,898
Current portion of settlement payable		1,000,000			3,000,000
Total current liabilities		23,735,075			24,031,249
Settlements payable, net of current portion		—			1,000,000
Total liabilities		23,735,075			25,031,249
Commitments and contingencies
Stockholders’ equity
Preferred stock, $0.001 par value 10,000,000 shares authorized
Series A, 1,000,000 shares authorized, 0 and 0 shares issued and outstanding		—			—
Series B, 1,000,000 shares authorized, 0 and 0 shares issued and outstanding		—			—
Common stock, $0.001 par value 100,000,000 shares authorized 4,529,672 and 4,529,672 shares issued and outstanding		4,530			4,530
Additional paid-in capital		31,557,988			31,557,988
Treasury stock, 13,493 and 4,226 shares, at cost		(126,014	)		(42,330	)
Accumulated deficit		(15,058,787	)		(14,793,468	)
Total stockholders’ equity		16,377,717			16,726,720
Total liabilities and stockholders’ equity	$	40,112,792		$	41,757,969

The accompanying Notes are an integral part of these financial statements.

F-4

I/OMAGIC CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Years Ended December 31,

	2003			2002			2001
Net sales	$	62,222,513		$	83,529,708		$	67,788,959
Cost of sales		53,083,729			74,665,823			62,776,334
Gross profit		9,138,784			8,863,885			5,012,625
Operating expenses
Selling, marketing, and advertising		1,507,222			1,437,704			1,487,828
General and administrative		6,461,613			7,360,904			6,461,112
Depreciation and amortization		1,268,077			1,223,837			2,231,899
Total operating expenses		9,236,912			10,022,445			10,180,839
Loss from operations		(98,128	)		(1,158,560	)		(5,168,214	)
Other income (expense)
Interest income		378			2,047			31,780
Interest expense		(248,754	)		(385,948	)		(418,381	)
Currency transaction gain (loss)		55,693			(1,717	)		—
Settlement expense and related legal costs		—			(5,178,174	)		—
Gain (loss) on disposal of property and equipment		(61	)		38,759			—
Other income (expense)		(1,593	)		—			10,170
Total other income (expense)		(194,337	)		(5,525,033	)		(376,431	)
Loss before provision for (benefit from) income taxes		(292,465	)		(6,683,593	)		(5,544,645	)
Provision for (benefit from) income taxes		(27,148	)		1,663,638			3,000
Net loss	$	(265,317	)	$	(8,347,231	)	$	(5,547,645	)
Basic and diluted loss per share	$	(0.06	)	$	(1.84	)	$	(1.23	)
Basic and diluted weighted-average shares outstanding		4,529,672			4,528,894			4,528,341

The accompanying Notes are an integral part of these financial statements.

F-5

I/OMAGIC CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Years Ended December 31,

	Preferred Stock																			Additional Paid-In Capital		Deferred Compen- sation			Treasury Stock			Accumulated Deficit			Total
	Series A								Series B
	Shares		Amount			Additional Paid-In Capital			Shares		Amount			Additional Paid-In Capital			Common Stock
																	Shares	Amount
Balance, December 31, 2000	875,000		$	875		$	6,999,125		250,000		$	250		$	1,999,750		4,528,006	$	4,528	$	31,556,735	$	(3,100	)	$	—		$	(8,898,592	)	$	31,659,571
Issuance of common stock in connection with the exercise of warrants	—			—			—		—			—			—		833		1		624		—			—			—			625
Amortization of deferred compensation	—			—			—		—			—			—		—		—		—		3,100			—			—			3,100
Net loss	—			—			—		—			—			—		—		—		—		—			—			(5,547,645	)		(5,547,645	)
Balance, December 31, 2001	875,000			875			6,999,125		250,000		$	250			1,999,750		4,528,839		4,529		31,557,359		—			—			(14,446,237	)		26,115,651
Purchase of treasury stock	—			—			—										—		—		—		—			(42,330	)		—			(42,330	)
Repurchase of Series A – redeemable convertible preferred stock	(875,000	)		(875	)		(6,999,125	)	—			—			—		—		—		—		—			—			6,222,222			(777,778	)
Repurchase of Series B – redeemable convertible preferred stock	—			—			—		(250,000	)		(250	)		(1,999,750	)	—		—		—		—			—			1,777,778			(222,222	)
Issuance of common stock in connection with the exercise of warrants	—			—			—		—			—			—		833		1		629		—			—			—			630
Net loss	—			—			—		—			—			—		—		—		—		—			—			(8,347,231	)		(8,347,231	)
Balance, December 31, 2002	—			—			—		—			—			—		4,529,672	$	4,530	$	31,557,988	$	—		$	(42,330	)	$	(14,793,468	)	$	16,726,720
Purchase of treasury stock	—			—			—		—			—			—		—		—		—		—			(83,684	)		—			(83,684	)
Net loss	—			—			—		—			—			—		—		—		—		—			—			(265,319	)		(265,319	)
Balance, December 31, 2003	—			—			—		—			—			—		4,529,672	$	4,530	$	31,557,988	$	—		$	(126,014	)	$	(15,058,787	)	$	16,377,717

The accompanying Notes are an integral part of these financial statements.

F-6

I/OMAGIC CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31,

	2003			2002			2001
Cash flows from operating activities
Net loss	$	(265,317	)	$	(8,347,231	)	$	(5,547,645	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities
Depreciation and amortization		689,341			307,505			302,775
(Gain) loss on disposal of property and equipment		61			(38,759	)		—
Amortization of trademarks		578,736			916,332			1,929,124
Amortization of deferred compensation		—			—			3,100
Allowance for doubtful accounts		1,478,089			1,300,000			850,937
Reserves for customer returns and allowances		87,475			(1,839,781	)		373,592
Reserves for obsolete inventory		125,000			2,070,200			410,000
Impairment of deferred income taxes		—			1,755,311			—
(Increase) decrease in
Accounts receivable		(862,783	)		7,489,342			(10,585,686	)
Accounts receivable—related parties		—			—			84,710
Inventory		(916,430	)		1,026,227			7,373,008
Prepaid expenses and other current assets		(378,304	)		2,263,469			(2,107,901	)
Other assets		(27,032	)		14,288			—
Increase (decrease) in
Accounts payable and accrued expenses		(1,712,369	)		(4,690,892	)		6,442,547
Accounts payable—related parties		7,762,841			(2,965,802	)		(1,065,041	)
Settlement payable		(3,000,000	)		4,000,000			—
Net cash provided by (used in) operating activities		3,559,308			3,260,209			(1,536,480	)

The accompanying Notes are an integral part of these financial statements.

F-7

I/OMAGIC CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31,

	2003			2002			2001
Cash flows from investing activities
Proceeds from disposal of property and equipment	$	500		$	74,000		$	—
Restricted cash		(100,000	)		—			—
Purchase of property and equipment		(170,776	)		(135,597	)		(141,219	)
Net cash used in investing activities		(270,276	)		(61,597	)		(141,219	)
Cash flows from financing activities
Net borrowings (payments) on line of credit		(4,434,122	)		750,586			2,625,272
Payments on capital lease obligations		—			(10,978	)		(27,121	)
Purchase of treasury stock		(83,684	)		(42,330	)		—
Payments on repurchase of redeemable convertible preferred stock		—			(1,000,000	)		—
Proceeds from exercise of warrants		—			630			625
Net cash provided by (used in) financing activities		(4,517,806	)		(302,092	)		2,598,776
Net increase (decrease) in cash and cash equivalents		(1,128,774	)		2,896,520			921,077
Cash and cash equivalents, beginning of year		7,320,143			4,423,623			3,502,546
Cash and cash equivalents, end of year	$	6,091,369		$	7,320,143		$	4,423,623
Supplemental disclosures of cash flow information
Interest paid	$	229,379		$	363,171		$	396,868
Income taxes paid (refunded)	$	(3,083	)	$	(91,055	)	$	3,000

The accompanying Notes are an integral part of these financial statements.

F-8

I/OMAGIC CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31,

Supplemental schedule of non-cash investing and financing activities

The Company did not have any non-cash transactions during the year ended December 31, 2003.

During the year ended December 31, 2002, the Company entered into the following non-cash transactions:

• Paid $1,000,000 to repurchase 875,000 shares of Series A redeemable convertible preferred stock and 250,000 shares of Series B redeemable convertible preferred stock, valued at $7,000,000 and $2,000,000, respectively. The gain on repurchase of $8,000,000 was netted against accumulated deficit in the consolidated balance sheet.

The Company did not have any non-cash transactions during the year ended December 31, 2001.

The accompanying Notes are an integral part of these financial statements.

F-9

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 1 - ORGANIZATION AND BUSINESS

I/OMagic Corporation (“I/OMagic”), a Nevada corporation, and its subsidiaries (collectively, the “Company”) develop, manufacture through subcontractors, market, and distribute data storage and digital entertainment products for the consumer electronics market. The Company sells its products in the United States and Canada to distributors and retail customers.

Acquisitions

Hi-Val, Inc.

On March 29, 2000, one of I/OMagic’s subsidiaries, IOM Holdings, Inc. (“IOMH”), acquired certain assets of Hi-Val, Inc. (“Hi-Val”) from Development Specialists, Inc., the assignee of Hi-Val’s assets pursuant to a general assignment executed by Hi-Val pursuant to Section 493.010 of the California Code of Civil Procedure. The stated purchase price for the assets was $15,878,335; however, total consideration was adjusted to $15,401,154, based on imputed interest. The purchase price was paid by IOMH as follows: (i) $6,878,335 in cash, (ii) $7,000,000 in the form of a promissory note at 0% interest (imputed to $6,522,819 based on 9.5% interest), and (iii) $2,000,000 in the form of a promissory note at prime (9.5% as of December 31, 2000). In connection with the transaction, IOMH paid $712,681 to its lender, Finova Capital Corporation. IOMH recorded $9,645,679 in excess of cost over fair value of net assets acquired, identified as the trademarks, which were being amortized on a straight-line basis over five years. During the year ended December 31, 2002, the term was extended by 10 years. The acquisition was accounted for by the purchase method.

For financial statement purposes, the acquisition occurred on April 1, 2000. The assets acquired were as follows:

Accounts receivable	$	2,987,637
Inventory		1,890,818
Due from related party		563,689
Property and equipment		1,173,654
Liabilities assumed		(860,323	)
Trademark		9,645,679
Total	$	15,401,154

IOM Holdings, Inc.

On December 31, 2000, I/OMagic acquired 100% of the issued and outstanding shares of IOM Holdings, Inc., a Nevada corporation, for 1,600,000 restricted shares of common stock. The entities were under common control; therefore, the acquisition has been accounted for in a manner similar to a pooling-of-interests.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of I/OMagic and its subsidiaries, IOM Holdings and I/OMagic Corporation, a California corporation. All material intercompany accounts and transactions have been eliminated.

F-10

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Split

On December 6, 2002, the Company amended its Articles of Incorporation to effect a 1-for-15 reverse stock split as of December 20, 2002. All share and per share data have been retroactively restated to reflect this reverse stock split.

Revenue Recognition

For transactions satisfying the conditions for revenue recognition under Statement of Financial Accounting Standards (“SFAS”) No. 48, “Revenue Recognition when Right of Return Exists,” product revenue is recorded at the time of shipment, net of estimated allowances and returns. For transactions not satisfying the conditions for revenue recognition under SFAS No. 48, product revenue is deferred until the conditions are met, net of an estimate for cost of sales. Consignment sales are recognized when our customers sell our products to the consumers.

Comprehensive Income

The Company utilizes SFAS No. 130, “Reporting Comprehensive Income.” This statement establishes standards for reporting comprehensive income and its components in a financial statement. Comprehensive income as defined includes all changes in equity (net assets) during a period from non-owner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities.For the years ended December 31, 2003, 2002, and 2001, comprehensive income is not presented in the Company’s financial statements since the Company did not have any of the items of comprehensive income in any period presented.

Foreign Currency

Gains and losses from foreign currency transactions, such as those resulting from the settlement of foreign receivables, are included in the consolidated statement of operations.

Cash and Cash Equivalents

For purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.

Restricted Cash

Cash which is used to back a Letter of Credit with a customer is considered restricted.

F-11

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Inventory

Inventory is stated at the lower of cost, using the weighted-average method, which approximates the first-in, first-out method or market.

Property and Equipment

Property and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over estimated useful lives as follows:

Computer equipment and software	5 years
Warehouse equipment	7 years
Office furniture and equipment	5 to 7 years
Equipment under capital leases	5 years
Vehicles	5 years
Leasehold improvements	Estimated useful life or lease term whichever is shorter

Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation expense on assets acquired under capital leases is included with depreciation expense on owned assets.

Trademarks

The trademarks acquired in April 2000 were originally being amortized over a 5-year period. A valuation by an independent third party in early 2002 established that the trademarks had an additional 10-year life. Therefore, effective with the second quarter 2002, the Company extended the amortization period by ten years. The Company continually evaluates whether events or circumstances have occurred that indicate the remaining estimated value of the trademarks may not be recoverable. When factors indicate that the value of the trademarks may be impaired, the Company estimates the remaining value and reduces the trademarks to that amount.

Accounting for the Impairment of Long-Lived Assets

The Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. Management determined that there was no impairment of long-lived assets during the years ended December 31, 2003, 2002, and 2001.

Fair Value of Financial Instruments

For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, line of credit, accounts payable and accrued expenses, accounts payable—related parties, reserve for customer returns and allowances, and settlement payable, the carrying amounts approximate fair value due to their short maturities.

F-12

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock-Based Compensation

SFAS No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” establishes and encourages the use of the fair value based method of accounting for stock-based compensation arrangements under which compensation cost is determined using the fair value of stock-based compensation determined as of the date of grant and is recognized over the periods in which the related services are rendered. The statement also permits companies to elect to continue using the current intrinsic value accounting method specified in Accounting Principles Bulletin (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for stock-based compensation issued to employees. The Company has elected to use the intrinsic value based method and has disclosed the pro forma effect of using the fair value based method to account for its stock-based compensation. For stock-based compensation issued to non-employees, the Company uses the fair value method of accounting under the provisions of SFAS No. 123.

Advertising Costs

The Company expenses advertising costs as incurred. For the years ended December 31, 2003, 2002, and 2001, advertising costs were $160,000, $3,500, and $120,577, respectively.

Income Taxes

Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each period end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period, if any, and the change during the period in deferred tax assets and liabilities.

Loss Per Share

The Company calculates loss per share in accordance with SFAS No. 128, “Earnings Per Share.” Basic loss per share is computed by dividing the net loss available to common stockholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.

The following potential common shares have been excluded from the computations of diluted net loss per share for the years ended December 31, 2003, 2002, and 2001 because the effect would have been anti-dilutive:

	2003	2002	2001
Stock options outstanding	126,167	146,167	166,500
Warrants outstanding	40,008	—	8,000
Redeemable convertible preferred Stock	—	—	240,000
Total	166,175	146,167	414,500

F-13

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Price Protection Reserve

The Company has agreements with certain customers which, in the event of a price decrease, allow those customers (subject to limitations) a credit equal to the difference between the price originally paid and the new lower price on units in the customers’ inventories or in transit to the customers on the date of the price decrease. When a specific price decrease is agreed upon with a customer, the Company reduces sales by the estimated amount to be deducted by the customer on a future payment with a corresponding increase in reserves for price protection.

Rebate Promotions Accruals

The Company periodically offers rebate promotions to customers which are provided to their end-user customers. During the period of the rebate promotion, the Company reduces sales by the estimated amount of the rebate promotion with a corresponding accrual for the estimated liability. Estimates for rebate promotions are based on a number of variable factors that depend on the specific program or product. These variables include the length of the rebate promotion, the estimated sales during the promotion, and the anticipated redemption rate of the program based on historical experience.

MDF/COOP Marketing Promotions Accruals

The Company has agreements with certain customers in which the customer is allowed to use a set percentage of its purchases of the Company’s products for various marketing purposes. The purpose of these agreements is to encourage advertising and promotional events to promote the sale of the Company’s products. Each period the Company reduces sales by the estimated amounts to be deducted by the customers on future payments with a corresponding increase in the accrual for the estimated liability.

Product Returns

The Company’s policy is to allow return of product from its retail customers upon proper request by them and authorization by the Company. The Company has no time limit on product returns from its retail customers; however, its customers generally have terms with their end-user customers which range from fourteen to thirty days from date of purchase. This time period will generally flow through to the Company. The Company also includes estimated time of product on the shelf and time to return product to it. Actual returns are recorded as reductions to gross sales for the period in which they are received. In addition, the Company maintains an allowance for sales returns for estimated future returns for products currently or previously sold for which it estimates it has not yet received. The Company uses historical data and estimates based on observations to determine the allowance for each period. For the years ended December 31, 2003, 2002, and 2001, the Company had reserves for sales returns totaling $475,026, $367,626, and $861,831, respectively.

F-14

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Inventory Obsolescence Allowance

The Company writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. These write-downs result in a charge to cost of sales.

Allowance for Doubtful Accounts

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in the impairment of their ability to make payments, additional allowances may be required. Since the Company’s current customers are national retailers with a good payment history with the Company, its allowance for doubtful accounts is minimal.

The Company performs periodic credit evaluations of its customers and maintains allowances for potential credit losses based on management’s evaluation of historical experience and current industry trends. Although the Company expects to collect amounts due, actual collections may differ.

Recently Issued Accounting Pronouncements

In April 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting and reporting for derivative instruments and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for derivative instruments and hedging activities entered into or modified after September 30, 2003, except for certain forward purchase and sale securities. For these forward purchase and sale securities, SFAS No. 149 is effective for both new and existing securities after September 30, 2003. This statement is not applicable to the Company. In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 will be effective for financial instruments entered into or modified after May 31, 2003 and otherwise will be effective at the beginning of the first interim period beginning after June 15, 2003. This statement is not applicable to the Company.

In January 2003, the FASB issued FIN 46,Consolidation of Variable Interest Entities, which addresses the consolidation of business enterprises (variable interest entities) to which the usual condition (ownership of a majority voting interest) of consolidation does not apply. The interpretation focuses on financial interests that indicate control. It concludes that in the absence of clear control through voting interests, a company’s exposure (variable interest) to the economic risks and potential rewards from the variable interest entity’s assets and activities are the best evidence of control. Variable interests are rights and obligations that convey economic gains or losses from changes in the values of the variable interest entity’s assets and liabilities. Variable interests may arise from financial instruments, service contracts, nonvoting ownership interests and other arrangements. If an enterprise holds a majority of the variable interests of an entity, it would be

F-15

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recently Issued Accounting Pronouncements (continued)

considered the primary beneficiary. The primary beneficiary would be required to include the assets, liabilities and the results of operations of the variable interest entity in its financial statements. In December 2003, the FASB issued a revision to FIN 46 to address certain implementation issues. This statement is not applicable to the Company.

Reclassifications

Certain amounts included in the prior years’ financial statements have been reclassified to conform with the current year presentation. Such reclassifications did not have any effect on reported net loss.

NOTE 3 - RISKS AND UNCERTAINTIES

Technological Obsolescence

The data storage and digital entertainment industries are characterized by rapid technological advancement and change. Should demand for the Company’s products prove to be significantly less than anticipated, the ultimate realizable value of such products could be substantially less than the amounts reflected in the accompanying balance sheets.

Reliance on Independent and Related Party Manufacturers/Subcontractors

The Company does not maintain its own manufacturing or production facilities and does not intend to do so in the foreseeable future. The Company anticipates that its products will be manufactured, and independent companies, some of which are stockholders of the Company, will supply its raw materials and components. Many of these independent and related party manufacturers/subcontractors may manufacture and supply products for the Company’s existing and potential competitors. As is customary in the manufacturing industry, the Company does not have any material ongoing licensing or other supply agreements with its manufacturers and suppliers. Typically, the purchase order is the Company’s “agreement” with the manufacturer. Therefore, any of these companies could terminate their relationships with the Company at any time. In the event the Company was to have difficulties with its present manufacturers and suppliers, the Company could experience delays in supplying products to its customers.

Reliance on Retail Distributors

The Company’s success will depend to a significant extent upon the ability to develop and maintain a multi-channel distribution system with retail distributors to sell the Company’s products in the marketplace. There cannot be any assurance that the Company will be successful in obtaining and retaining the retail distributors it requires to continue to grow and expand its marketing and sales efforts.

NOTE 4 - CONCENTRATIONS OF RISK

Cash and Cash Equivalents

The Company maintains its cash and cash equivalent balances in several banks located in Southern California and a financial institution that from time to time exceed amounts insured by the Federal Deposit

F-16

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 4 - CONCENTRATIONS OF RISK (Continued)

Cash and Cash Equivalents (continued)

Insurance Corporation up to $100,000 per bank and by the Securities Investor Protection Corporation up to $500,000 per financial institution. As of December 31, 2003 and 2002, balances totaling $6,375,233 and $7,453,045, respectively, were uninsured. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash.

Customers

During the year ended December 31, 2003, the Company had net sales to two major customers that represented 28% and 13% of net sales. As of December 31, 2003, accounts receivable from these two customers were 13% and 4% of accounts receivable, respectively.

During the year ended December 31, 2002, the Company had net sales to four major customers that represented 27%, 26%, 15%, and 14% of net sales. As of December 31, 2002, the Company had four customers that accounted for 28%, 25%, 17%, and 16% of accounts receivable.

During the year ended December 31, 2001, the Company had net sales to four major customers that represented 36%, 20%, 15%, and 14% of net sales. As of December 31, 2001, the Company had four customers that accounted for 25%, 23%, 18%, and 15% of accounts receivable.

Suppliers

During the year ended December 31, 2003, the Company purchased inventory from two related party vendors that represented 45% and 26% of purchases. In addition, the Company purchased inventory from a third vendor that represented 13% of purchases. As of December 31, 2003, there were two suppliers that represented 69% and 17% of accounts payable – related parties.

During the year ended December 31, 2002, the Company purchased inventory from two related party vendors that represented 47% and 18% of purchases. As of December 31, 2002, there were two suppliers that represented 60% and 12% of accounts payable and accounts payable—related parties.

During the year ended December 31, 2001, the Company purchased inventory from two related party vendors that represented 26% and 14% of purchases. As of December 31, 2001, there were two suppliers that represented 51% and 42% of accounts payable and accounts payable—related parties.

NOTE 5 - INVENTORY

Inventory as of December 31, 2003 and 2002 consisted of the following:

	2003			2002
Component parts	$	3,658,140		$	3,098,085
Finished goods—warehouse		2,317,765			2,223,579
Finished goods—consigned		4,235,832			3,965,428
Reserves for inventory		(505,029	)		(1,046,812	)
Total	$	9,706,708		$	8,240,280

F-17

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 5 - INVENTORY (Continued)

Consigned inventory is located at the stores and distribution centers of certain customers with which the Company has consignment agreements. The inventory is owned by the Company until sold by the customers.

NOTE 6 - PROPERTY AND EQUIPMENT

Property and equipment as of December 31, 2003 and 2002 consisted of the following:

		2003		2002
Computer equipment and software		$	1,041,979	$	988,666
Warehouse equipment			55,238		58,570
Office furniture and equipment			264,629		241,557
Vehicles			91,304		91,304
Leasehold improvements			88,020		631,129
			1,541,170		2,011,226
Less accumulated depreciation and amortization			1,001,227		952,159
Total	��	$	539,943	$	1,059,067

For the years ended December 31, 2003, 2002, and 2001, depreciation and amortization expense was $689,341, $307,505, and $302,775, respectively.

NOTE 7 - TRADEMARKS

Trademarks as of December 31, 2003 and 2002 consisted of the following:

	2003		2002
Trademarks	$	9,645,679	$	9,645,679
Less accumulated amortization		4,871,044		4,292,308
Total	$	4,774,635	$	5,353,371

For the years ended December 31, 2003, 2002, and 2001, amortization expense was $578,736, $916,332, and $1,929,124, respectively. Amortization expense for the trademarks will be $578,736 for each of the next five years.

NOTE 8 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses as of December 31, 2003 and 2002 consisted of the following:

	2003		2002
Accounts payable	$	2,525,508	$	1,709,736
Accrued rebates and marketing		2,369,544		4,041,126
Accrued compensation and related benefits		192,002		301,851
Other		485,824		1,232,533
Total	$	5,572,878	$	7,285,246

F-18

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 9 - LINE OF CREDIT

On January 1, 2002, the Company obtained a $9.0 million asset-based line of credit (with a sub-limit of $8.0 million) with ChinaTrust Bank (USA) that was to expire December 15, 2003. The credit facility contained a number of restrictive financial covenants. On each of December 31, 2002, March 31, 2003, and June 30, 2003, the Company was not in compliance with certain of those financial covenants. However, the Company subsequently obtained waivers of these violations from the lender. The waiver relating to the December 31, 2002 covenant violation also modified the original expiration date of December 15, 2003 to October 15, 2003. Subsequently, the Company replaced this line of credit with a line of credit from United National Bank.

On August 15, 2003, the Company entered into an agreement for an asset-based line of credit with United National Bank, effective August 18, 2003. The line allows the Company to borrow up to a maximum of $6,000,000. The line of credit expires September 1, 2004 and is secured by a UCC filing on substantially all of the Company’s assets. Advances on the line bear interest at the floating commercial loan rate equal to the prime rate as reported in theWall Street Journal plus 0.75%. As of December 31, 2003, the interest rate was 4.75%. The agreement also calls for the Company to be in compliance with certain financial covenants which the Company was in compliance with at December 31, 2003.

The new line of credit was initially used to pay off the outstanding balance with ChinaTrust Bank (USA) as of September 2, 2003, which was $3,379,827. The outstanding balance with United National Bank as of December 31, 2003 was $5,938,705. The amount available to the Company for borrowing as of December 31, 2003 was $61,295.

NOTE 10 - CREDIT FACILITIES FROM RELATED PARTY

In connection with a 1997 Strategic Alliance Agreement, the Company has available a trade line of credit through a related party for purchases up to $2,000,000. Purchases are non-interest bearing and are due 75 days from the date of receipt. The credit agreement can be terminated or changed at any time. As of December 31, 2002 and December 31, 2003, there were $0 and $0, respectively, in trade payables outstanding under this arrangement. This trade line of credit was terminated on March 31, 2004.

Pursuant to an oral agreement, the Company also has available an additional trade line of credit through a related party that provides a trade credit facility of up to $3,000,000 carrying net 60 day terms, as defined. As of December 31, 2002 and December 31, 2003, there were $0 and $0, respectively, in trade payables outstanding under this arrangement. This trade line of credit was terminated on March 31, 2004.

In January 2003, the Company entered into a trade credit facility with a related party, whereby the related party has agreed to purchase inventory on behalf of the Company. The agreement allows the Company to purchase up to $10,000,000, with payment terms of 120 days following the date of invoice. The third party will charge the Company a 5% handling charge on the supplier’s unit price. A 2% discount to the handling fee will be applied if the Company reaches an average running monthly purchasing volume of $750,000. Returns made by the Company, which are agreed by the supplier, will result in a credit to the Company for the handling charge.

F-19

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 10 - CREDIT FACILITIES FROM RELATED PARTY (Continued)

As security for the trade facility, the Company paid the related party a security deposit of $1,500,000, of which $750,000 may be applied against outstanding accounts payable to the related party after six months. As of December 31, 2003, $750,000 had been applied against outstanding accounts payable to the related party. The remaining $750,000 deposit has been offset against Accounts Payable—Related Parties in the accompanying financial statements. The agreement is for 12 months. At the end of the 12-month period, either party may terminate the agreement upon 30 days’ written notice. Otherwise, the agreement will remain continuously valid without effecting a newly signed agreement. Both parties have the right to terminate the agreement one year following the inception date by giving the other party 30 days’ written notice of termination. As of December 31, 2003, there were $2,047,173 in trade payables net of the deposit still outstanding ($750,000) under this arrangement.

In February 2003, the Company entered into an agreement with a related party, whereby the related party will supply and store at the Company’s warehouse up to $10,000,000 of inventory on a consignment basis. Under the agreement, the Company will insure the consignment inventory, store the consignment inventory for no charge, and furnish the related party with weekly statements indicating all products received and sold and the current consignment inventory level. The agreement may be terminated by either party with 60 days written notice. In addition, this agreement provides for a trade line of credit of up to $10,000,000 with payment terms of net 60 days, non-interest bearing. As of December 31, 2003, there were $8,322,946 in trade payables outstanding under this arrangement. As of December 31, 2002, there were $2,607,278 in trade payables outstanding under a prior arrangement with this related party.

NOTE 11 - COMMITMENTS AND CONTINGENCIES

Leases

The Company leases its facilities and certain equipment under non-cancelable, operating lease agreements, expiring through August 2006.

The Company previously leased its facilities from a related party that was, through March 2003, under the control of an officer of the Company. In March 2003, in connection with the settlement of the Vakili lawsuit (see Litigation), an officer of the Company relinquished control, to the Vakilis, of the entity that owned the warehouse and office space that was being leased by the Company. Under the terms of the settlement agreement, the lease dated April 1, 2000, as amended on June 1, 2000 and which originally expired in March 2010, was terminated and replaced with a new lease. The new lease required monthly payments of $28,687 and expired on September 30, 2003. The Company moved to its current facilities in September 2003.

F-20

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 11 - COMMITMENTS AND CONTINGENCIES (Continued)

Future minimum lease payments under these non-cancelable operating lease obligations at December 31, 2003 were as follows:

Year Ending December 31,
2004	$	359,667
2005		350,631
2006		215,060
Total	$	925,358

Service Agreements

Periodically, the Company enters into various agreements for services including, but not limited to, public relations, financial consulting, and manufacturing consulting. The agreements generally are ongoing until such time they are terminated, as defined. Compensation for services is paid either on a fixed monthly rate or based on a percentage, as specified, and may be payable in shares of the Company’s common stock. During the years ended December 31, 2003, 2002, and 2001, the Company incurred expenses of $333,982, $349,056, and $383,395, respectively, in connection with such arrangements. These expenses are included in general and administrative expenses in the accompanying statements of operations.

Employment Contract

The Company entered into an employment agreement with one of its officers on October 15, 2002, which expires on October 15, 2007. The agreement, which is effective as of January 1, 2002, calls for an initial salary of $198,500, and provides for certain expense allowances. In addition, the agreement provides for a quarterly bonus equal to 7% of the Company’s quarterly net income. For the years ended December 31, 2003, 2002, and 2001, bonuses totaling $28,259, $89,067 and $0, respectively, were paid under the terms of this agreement. As of December 31, 2003 and 2002, the accrued bonuses were $0 and $0, respectively.

The Company and the officer are presently in the process of negotiating a revised employment agreement.

Retail Agreements

In connection with certain retail agreements, the Company has agreed to pay for certain marketing development and advertising on an ongoing basis. Marketing development and advertising costs are generally agreed upon at the time of the event. The Company also records a liability for co-op marketing based on management’s evaluation of historical experience and current industry and Company trends.

In May 2001, the Company entered into an agreement to provide marketing and promotional funds to a customer of up to 10% of the net sales to this customer for a 24-month period, which was temporarily adjusted to 17% for a period during the year ended December 31, 2001. During the year ended December 31, 2001, the Company paid $6,068,479, of which $2,193,535 and $3,874,944 was expensed during the years ended December 31, 2002 and 2001, respectively.

For the years ended December 31, 2003, 2002, and 2001, the Company incurred $2,893,200, $3,388,570, and $2,890,502, respectively, related to its retail agreements with its customers. These amounts are netted against revenue in the accompanying statements of operations.

F-21

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 11 - COMMITMENTS AND CONTINGENCIES (Continued)

Litigation

Effective on or about March 28, 2003, the Company, among others, entered into a Settlement Agreement and Release with Mark Vakili, Mitra Vakili, Hi-Val, and others, in connection with a complaint filed in the Superior Court of the State of California for the County of Orange (Case No. 01CC09894). Under the terms of that agreement, (i) the Company paid the plaintiffs an aggregate of $3,000,000 on March 31, 2003, (ii) the Company agreed to pay to the plaintiffs an aggregate of $1,000,000 on March 15, 2004, (iii) Mr. Shahbaz and Mr. Su, each a director of the Company, relinquished any claims held by either of them to any interest in Alex Properties, (iv) the Company entered into a new written lease agreement with Alex Properties relating to the real property in Santa Ana, California, which the Company had already physically occupied, and (v) Mr. Shahbaz and Mr. Su transferred, to parties designated by Mark Vakili and Mitra Vakili, an aggregate of 13,333 post-split shares of the Company’s common stock from the aggregate 66,667 post-split shares of the Company’s common stock being returned by Mark Vakili and Mitra Vakili to Mr. Shahbaz and Mr. Su. Mr. Shahbaz and Mr. Su had previously transferred the 66,667 post-split shares to Mark Vakili and Mitra Vakili. On September 30, 2003, pursuant to the terms of the lease agreement, the Company vacated the real property in Santa Ana.

Thereafter, Mark Vakili, Mitra Vakili and Alex Properties alleged claims that the Company had improperly caused damage to the Santa Ana facility (the “New Lease Claims”). The Company denied, and continues to deny all of the New Lease Claims, and denied, and continues to deny that any such New Lease Claims have any merit. In early February 2004, all parties to the original Settlement Agreement and Release executed a First Amendment to Settlement Agreement and Release, releasing all defendants from all of the New Lease Claims in the event the Company paid the above-mentioned $1,000,000 by February 17, 2004 (rather than March 15, 2004). The Company paid the $1,000,000 on February 17, 2004, thereby effectuating the release of all of the New Lease Claims on such date, and directly causing the filing of a dismissal of the Vakili action with the court on March 8, 2004.

On May 30, 2003, an action for breach of contract and legal malpractice,IOM Holdings, Inc. and I/OMagic Corporation v. Lawrence W. Horwitz, Gregory B. Beam, Horwitz & Beam, Lawrence M. Cron, Horwitz & Cron, Kevin J. Senn, and Senn Palumbo Meulemans, LLP, was filed by the Company and IOM Holdings against its former attorneys and their law firms in the Superior Court of the State of California for the County of Orange (Case no. 03CC07383). The claims alleged arose out of the defendants’ representation of the Company and its subsidiaries. A claim of $15 million in damages has been alleged against the defendants. On November 6, 2003, the Company filed its First Amended Complaint against all defendants. Defendants have responded to the Company’s First Amended Complaint denying its allegations. Defendants Horwitz and Cron have also filed a Cross-Complaint against the Company for attorneys’ fees in the amount of $78,971.15 that they claim are owed to them for their work done in the matter in which the Company is suing them. The Company has denied their allegations in the Cross-Complaint based on the fact that Defendants are not entitled to such fees. As of the date of this report, discovery on all parties has commenced and responses are now being prepared. The outcome of this action is presently uncertain.

In addition, the Company is involved in certain legal proceedings and claims which arise in the normal course of business. Management does not believe that the outcome of these matters will have a material affect on the Company’s financial position or results of operations.

F-22

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 12 - REDEEMABLE CONVERTIBLE PREFERRED STOCK

During December 2000, the Company amended its Articles of Incorporation to authorize 10,000,000 shares of preferred stock, of which 1,000,000 shares are designated as Series A preferred stock. Preferred stockholders of the Series A preferred stock do not have voting powers and are entitled to receive dividends on an equal basis with the holders of common stock of the Company.

In addition, the Company designated 1,000,000 shares as Series B preferred stock. The Series B stockholder has the same rights as the Series A holders, except the Company will be obligated to redeem any issued shares which have been outstanding for two years.

On January 22, 2001, the Company issued 875,000 shares of Series A preferred stock to its financial institution in satisfaction of $7,000,000 owed under long-term debt. As of December 31, 2000, the shares were presented as outstanding on the balance sheet, and the related debt was eliminated.

On January 22, 2001, the Company issued 250,000 shares of Series B preferred stock to its financial institution in satisfaction of $2,000,000 owed under long-term debt. As of December 31, 2000, the shares were presented as outstanding on the balance sheet, and the related debt was eliminated.

On October 25, 2002, the Company repurchased all of the issued Series A and Series B redeemable convertible preferred stock totaling 875,000 and 250,000 shares, respectively, for a payment of $1,000,000. The gain on repurchase of $8,000,000 was netted against accumulated deficit in the accompanying consolidated balance sheet.

NOTE 13 - COMMON STOCK

Amendment to Articles of Incorporation

On January 12, 2001, the Company amended its Articles of Incorporation to increase the number of authorized common shares from 50,000,000 to 100,000,000. On December 6, 2002, the Company amended its Articles of Incorporation to effect a 1-for-15 reverse stock split as of December 20, 2002.

Common Stock Issued in Connection with the Exercise of Warrants

During the year ended December 31, 2002, the Company issued an aggregate of 833 shares of common stock in connection with the exercise of A Warrants in the year ended December 31, 2001 for cash of $630 or at a per share price of $0.75.

During the year ended December 31, 2001, the Company issued an aggregate of 833 shares of common stock in connection with the exercise of A Warrants in the year ended December 31, 2000 for cash of $625, or at a per share price of $0.75.

Treasury Stock

On February 12, 2002, the Company announced the approval by the Board of Directors of the Company to redeem its own stock in open market transactions of up to $500,000. During the year ended December 31, 2003, the Company purchased 9,267 shares of common stock for $83,684 on the open market. It is the Company’s intention to cancel these shares.

F-23

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 14 - WARRANTS AND STOCK OPTIONS

Warrants

In connection with an October 1995 private placement of notes payable and warrants, the Company issued 53,667 A Warrants to purchase common stock for $0.75 per share, exercisable for five years from the date of issuance, and 53,667 B Warrants to purchase common stock for $14.25 per share, exercisable for five years from the date of issuance. For every 30 days the B Warrants were outstanding, commencing six months from the date of issuance, the B Warrant holders were entitled to a $0.60 discount on the exercise price per month to a minimum exercise price of $7.50 per share.

Interest expense ascribed to the warrants was deemed to be insignificant and recording such was not deemed appropriate by management as the value of the Company was nominal prior to the effective date of the Acquisition Agreement, the consummation of which was not assured. During the years ended December 31, 2001 and 2000, A Warrants of 833 and 833, respectively, were exercised. Through December 31, 2001, A Warrants aggregating 53,534 have been exercised. As of December 31, 2001, the remaining 133 outstanding A warrants expired. Through December 31, 2001, B warrants aggregating 1,667 have been exercised. As of December 31, 2001, the remaining 52,000 outstanding B warrants expired.

Through December 31, 1996, the Company issued an aggregate 6,667 warrants to purchase restricted shares of common stock for $24.75 per share, exercisable five years from the date of grant, to a consultant for services provided. Compensation expense related to these warrants, as determined by management to be the fair value of services received had the Company paid cash, was insignificant. As of December 31, 2001, none of the warrants had been exercised, and such warrants expired.

During the years ended December 31, 2001 and 2000, the Company issued warrants to purchase 8,000 and 2,667 shares, respectively, of restricted common stock to the Company’s prior law firm and a consultant, respectively. The warrants were exercisable at prices ranging from $4.50 to $30.00 (fair market value or higher) per share for one year. Management of the Company determined that no additional amounts would have been paid to such law firm for services as invoiced services were paid in cash. Accordingly, the Company did not record legal or consulting expense. During the years ended December 31, 2001 and 2000, 0 and 2,667 warrants, respectively, were exercised. As of December 31, 2003, none of the remaining warrants were exercised, and such warrants expired.

During the year ended December 31, 2000, the Company issued warrants to purchase 10,000 shares of common stock to a public relations firm. The warrants were exercisable at prices ranging from $30.00 to $60.00 (fair market value or higher), 4,000 of the shares to be issued were restricted. The warrants expired between six and 12 months from the date of grant. During the years ended December 31, 2001 and 2000, 4,000, and 6,000 warrants, respectively, expired.

During the year ended December 31, 2003, the Company issued warrants to purchase 20,004 shares of common stock to an investor relations firm. The warrants are exercisable at $7.19 per share and vest over six months from grant date. These warrants expire in March 2004. The value of the warrants was not material.

During the year ended December 31, 2003, the Company issued warrants to purchase 20,004 shares of common stock to a financial advisory firm. The warrants are exercisable at $9.78 per share and vest over six months from grant date. These warrants expire in July 2004. The value of the warrants was not material.

F-24

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 14 - WARRANTS AND STOCK OPTIONS (Continued)

Stock Option Plans

The Company has the following two stock option plans:

• 2002 Stock Option Plan (the “2002 Plan”)

• 2003 Stock Option Plan (the “2003 Plan”)

The total number of shares of the Company’s common stock authorized for issuance under the 2002 Plan and the 2003 Plan are 133,333, and 400,000, respectively.

Under the 2002 Plan and the 2003 Plan (collectively, the “Company Plans”) options granted may be either “incentive stock options,” within the meaning of Section 422 of the Internal Revenue Code, or “nonqualified options.” Incentive options granted under the Company Plans must have an exercise price of not less than the fair market value of a share of common stock on the date of grant unless the optionee owns more than 10% of the total voting securities of the Company. In this case, the exercise price will not be less than 110% of the fair market value of a share of common stock on the date of grant. Incentive stock options may not be granted to an optionee under any of the Company Plans if the aggregate fair market value, as determined on the date of grant, of the stock with respect to which incentive stock options are exercisable by such optionee in any calendar year under the Company Plans, exceeds $100,000. Nonqualified options granted under the Company Plans must have an exercise price of not less than the fair market value of a share of common stock on the date of grant. Nonqualified options granted under the Company Plans must have an exercise price of not less than 85% of the fair market value of a share of common stock on the date of grant.

Under the Company Plans, options may be exercised during a period of time fixed by the committee administering the Company Plans (which could include the entire Board of Directors). Options granted under the Company Plans must vest at a rate not less than 20% per year over a consecutive five-year period. No option granted under any of the Company Plans may be exercised more than 10 years after the date of grant. Incentive stock options granted to an optionee who owns more than 10% of the voting securities of the Company may not be exercised more than five years after the date of grant.

In April 1996, the Company issued options to purchase restricted shares of common stock at $0.15 per share, which was below market, to two employees, resulting in the Company recording deferred compensation of $124,000, which was being amortized over five years, the vesting period of the options. During the year ended December 31, 1997, one of the employees left the Company and forfeited his options. Accordingly, the Company reversed the deferred compensation relating to this employee. During the year ended December 31, 2001, 3,333 of these options were exercised.

F-25

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 14 - WARRANTS AND STOCK OPTIONS (Continued)

Stock Option Plans (Continued)

As of December 31, 2003, 2002, and 2001, the balance of deferred compensation totaled $0, $0, and $0, respectively.

The following summarizes options and warrants granted and outstanding through December 31, 2003:

	Number of Shares				Total		Weighted- Average Exercise Price
	Employee		Non- Employee
Outstanding, December 31, 2000	149,833		29,167		179,000		$	30.55
Exercised	—		(833	)	(833	)	$	0.75
Expired, cancelled	(7,667	)	(4,000	)	(11,667	)	$	45.96
Outstanding, December 31, 2001	142,166		24,334		166,500		$	29.62
Expired, cancelled	(20,333	)	—		(20,333	)	$	27.59
Outstanding, December 31, 2002	121,833		24,334		146,167		$	29.90
Granted	—		40,008		40,008		$	8.49
Expired, cancelled	(20,000	)	—		(20,000	)	$	16.95
Outstanding, December 31, 2003	101,833		64,342		166,175		$	26.30
Exercisable, December 31, 2003	80,491		58,866		139,357		$	24.96

The following table is a summary of the stock options and warrants as of December 31, 2003:

Range of Exercise Prices	Stock Options and Warrants Outstanding	Stock Options and Warrants Exercisable	Weighted- Average Remaining Contractual Life	Weighted- Average Exercise Price of Options and Warrants Outstanding		Weighted- Average Exercise Price of Options and Warrants Exercisable
$  7.00 - 29.99	40,008	40,008	4.41 years	$	8.49	$	8.49
$30.00 - 44.99	116,500	91,487	1.37 years	$	30.40	$	30.40
$45.00 - 52.50	9,667	7,862	1.37 years	$	45.39	$	45.39
	166,175	139,357

Pro forma information regarding net loss and loss per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. For the years ended December 31, 2003, 2002 and 2001, options were not granted.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

F-26

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 14 - WARRANTS AND STOCK OPTIONS (Continued)

Stock Option Plans (Continued)

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. Adjustments are made for options forfeited prior to vesting. The effect on net loss and basic and diluted loss per share had compensation costs for the Company’s stock option plans been determined based on a fair value at the date of grant consistent with the provisions of SFAS No. 123 for the years ended December 31, 2003, 2002, and 2001 is as follows:

	2003			2002			2001
Net loss
As reported	$	(265,317	)	$	(8,347,231	)	$	(5,547,645	)
Add stock based compensation expense included in net loss, net of tax		—			—			—
Deduct total stock based employee compensation expense determined under fair value method for all awards, net of tax		(309,252	)		(309,636	)		(241,672	)
Pro forma	$	(574,569	)	$	(8,656,867	)	$	(5,789,317	)
Earnings per common share
Basic - as reported	$	(0.06	)	$	(1.84	)	$	(1.23	)
Basic - pro forma	$	(0.13	)	$	(1.91	)	$	(1.28	)
Diluted - as reported	$	(0.06	)	$	(1.84	)	$	(1.23	)
Diluted - pro forma	$	(0.13	)	$	(1.91	)	$	(1.28	)

F-27

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 15 - INCOME TAXES

The components of the income tax provision (benefit) for the years ended December 31, 2003, 2002, and 2001 were as follows:

	2003			2002			2001
Current	$	(27,148	)	$	(57,362	)	$	3,000
Deferred		—			1,721,000			—
Total	$	(27,148	)	$	1,663,638		$	3,000

Income tax expense (benefit) for the years ended December 31, 2003, 2002, and 2001 differed from the amounts computed applying the federal statutory rate of 34% to pre-tax income as a result of:

	2003			2002			2001
Computed “expected” tax benefit	$	(144,000	)	$	(2,272,000	)	$	(1,885,000	)
Income in income taxes resulting from expenses not deductible for tax purposes		8,100			12,000			18,000
Change in beginning of the year balance of the valuation allowance for deferred tax assets allocated to income tax expense		40,200			4,261,000			2,090,000
State and local income taxes, net of tax benefit		98,100			(277,000	)		(220,000	)
Other		(29,548	)		(60,362	)		—
Total	$	(27,148	)	$	1,663,638		$	3,000

Significant components of the Company’s deferred tax assets and liabilities for federal income taxes at December 31, 2003 and 2002 consisted of the following:

	2003			2002
Deferred tax assets
Net operating loss carryforward	$	7,420,800		$	5,271,000
Allowance for doubtful accounts		8,800			134,000
Allowances for sales returns		216,300			157,000
Allowances for price protection		162,100			171,000
Accrued compensation		66,900			86,000
Amortization of trademarks		1,053,700			1,081,000
Settlement payable and related accrued legal expenses		428,400			1,971,000
Inventory		371,000			576,000
Other		7,300			10,000
Valuation allowance		(9,269,600	)		(8,947,000	)
Total deferred tax assets		465,700			510,000

F-28

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 15 - INCOME TAXES (Continued)

	2003		2002
Deferred tax liabilities
State tax	$	465,700	$	495,000
Other		—		15,000
Total deferred tax liabilities		465,700		510,000
		—		—
Less current portion		—		—
Long-term portion	$	—	$	—

As of December 31, 2003 and 2002, the valuation allowance for deferred tax assets, totaled approximately $9,269,600 and $8,947,000, respectively. For the years ended December 31, 2003, 2002, and 2001, the net change in the valuation allowance was $322,600 (increase), $4,238,000 (increase), and $2,129,000 (increase), respectively.

As of December 31, 2003, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $19,202,000 and $10,092,000, respectively, that expire through 2023 and 2013, respectively. The utilization of net operating loss carryforwards may be limited under the provisions of Internal Revenue Code Section 382 and similar state provisions due to the change in ownership.

NOTE 16 - RELATED PARTY TRANSACTIONS

During the years ended December 31, 2003, 2002, and 2001, the Company made purchases from related parties totaling $32,754,145, $12,705,232, and $22,031,190, respectively.

Until March 28, 2003, the Company leased its warehouse and office space from a related party under the control of an officer of the Company. During the years ended December 31, 2003, 2002, and 2001, the Company made rental payments totaling $86,018, $344,070, and $344,070, respectively, to this related party.

NOTE 17 – SELECTED QUARTERLY FINANCIAL DATA-UNAUDITED

The following table is a summary of the unaudited quarterly financial information for the years ended December 31, 2003 and 2002.

Year Ended December 31, 2003	First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Total Year
	(In thousands, except per share data)
Net sales	$	17,064		$	12,793		$	13,505		$	18,861		$	62,223
Gross profit		2,436			1,910			2,062			2,731			9,139
Operating expenses		2,150			3,162			1,826			2,099			9,237
Operating income (loss)		286			(1,252	)		236			632			(98	)
Other income (expense)		(80	)		(26	)		(44	)		(44	)		(194	)
Pre-tax income (loss)		206			(1,278	)		192			588			(292	)
Income tax provision (benefit)		(3	)		1			(2	)		(23	)		(27	)
Net income (loss)		209			(1,279	)		194			611			(265	)
Net income (loss) per common share diluted	$	0.05		$	(0.28	)	$	0.04		$	0.13		$	(0.06	)

F-29

I/OMAGIC CORPORATION

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003

NOTE 17 – SELECTED QUARTERLY FINANCIAL DATA-UNAUDITED (Continued)

Year Ended December 31, 2002	First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Total Year
	(In thousands, except per share data)
Net sales	$	26,720		$	14,086		$	20,393		$	22,331		$	83,530
Gross profit		4,045			849			1,555			2,415			8,864
Operating expenses		2,955			2,633			2,338			2,097			10,023
Operating income (loss)		1,090			(1,784	)		(783	)		318			(1,159	)
Other income (expense)		(75	)		(181	)		(259	)		(5,010	)		(5,525	)
Pre-tax income (loss)		1,015			(1,965	)		(1,042	)		(4,692	)		(6,684	)
Income tax provision (benefit)		—			500			499			664			1,663
Net income (loss)		1,015			(2,465	)		(1,541	)		(5,356	)		(8,347	)
Net income (loss) per common share diluted	$	0.21		$	(0.54	)	$	(0.34	)	$	(1.18	)	$	(1.84	)

NOTE 18 - SUBSEQUENT EVENTS

Consulting Agreement

On March 9, 2004, the Company entered into a consulting agreement for public investor relations services. The agreement is on a month-to-month basis at $2,500 per month. In addition, the consultant will be issued warrants to purchase 20,000 shares of common stock, consisting of 10,000 warrants with an exercise price of $4.00 and 10,000 warrants with an exercise price of $6.00. The warrants vest immediately and expire eighteen months from issuance.

Litigation

On March 15, 2004, Magnequench International, Inc., or plaintiff, filed an Amended Complaint for Patent Infringement in the United States District Court of the District of Delaware (Civil Action No. 04-135 (GMS)) against, among others, the Company, Sony Corp., Acer Inc., Asustek Computer, Inc., Iomega Corporation, LG Electronics, Inc., Lite-On Technology Corporation and Memorex Products, Inc., or defendants. The complaint seeks to permanently enjoin defendants from, among other things, selling products that allegedly infringe one or more claims of plaintiff’s patents. The complaint also seeks damages of an unspecified amount, and treble damages based on defendants’ alleged willful infringement. In addition, the complaint seeks reimbursement of plaintiff’s costs as well as reasonable attorney’s fees, and a recall of all existing products of defendants that infringe one or more claims of plaintiff’s patents that are within the control of defendants or their wholesalers and retailers. Finally, the complaint seeks destruction (or reconfiguration to non-infringing embodiments) of all existing products in the possession of defendants that infringe one or more claims of plaintiff’s patents. The Company is presently evaluating the merits of this complaint and, as of the date of this report, has not yet responded to the allegations in the complaint. The outcome of this action is presently uncertain. However, at this time, the Company does not expect the defense or outcome of this action to have a material adverse affect on its business, financial condition or results of operations.

F-30

INDEPENDENT AUDITOR’S REPORT ON FINANCIAL STATEMENT SCHEDULE

To the Board of Directors

I/OMagic Corporation and subsidiaries

Irvine, California

Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The consolidated supplemental schedule II is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not a part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.

/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP

Los Angeles, California

March 4, 2004, except for

the first paragraph of

Note 18, as to which the date

is March 9, 2004, the second

paragraph of Note 18 as to

which the date is March 15,

2004 and for the first and

second paragraphs of

Note 10, as to which the

date is March 31, 2004

F-31

I/OMAGIC CORPORATION

AND SUBSIDIARIES

December 31, 2003

	Balance, Beginning of Year		Additions Charged to Operations		Additions (Deductions) from Reserve			Balance, End of Year
Allowance for doubtful accounts
December 31, 2003	$	2,135,660	$	1,478,089	$	(3,593,196	)	$	20,553
December 31, 2002	$	2,679,118	$	1,300,000	$	(1,843,458	)	$	2,135,660
December 31, 2001	$	2,106,518	$	850,937	$	(278,337	)	$	2,679,118
Reserves for obsolete inventory
December 31, 2003	$	1,046,812	$	125,000	$	(666,783	)	$	505,029
December 31, 2002	$	558,703	$	2,070,200	$	(1,582,091	)	$	1,046,812
December 31, 2001	$	1,834,427	$	410,000	$	(1,685,724	)	$	558,703

F-32

PROSPECTUS

Wedbush Morgan Securities Inc.

                    , 2004

PART II: INFORMATION NOT REQUIRED IN PROSPECTUS

Item 13.Other Expenses of Issuance and Distribution

The following table sets forth an estimate of the costs and expenses, other than the underwriting discounts and commissions, payable by us in connection with the issuance and distribution of the common stock being registered. All amounts except the SEC registration fee are estimated.

SEC registration fee	$	874.23
NASD filing fee	$	*
Nasdaq SmallCap listing fee	$	*
Legal fees and expenses	$	*
Accountants’ fees and expenses	$	*
Printing expenses	$	*
Blue sky fees and expenses	$	*
Transfer agent and registrar fees and expenses	$	*
Miscellaneous	$	*
Total	$	*

* To be filed by amendment

Item 14.Indemnification of Directors and Officers

The underwriting agreement between us and Wedbush Morgan Securities provides for indemnification by Wedbush Morgan Securities of our Company and our officers and directors, and by us of Wedbush Morgan Securities for certain liabilities arising under the Securities Act of 1933 (“Securities Act”) or otherwise.

Our amended and restated articles of incorporation and amended and restated bylaws provide that we shall, to the fullest extent permitted by Nevada Revised Statutes section 78.751, indemnify all persons that we have power to indemnify under that section against all expenses, liabilities or other matters covered by that section, and that this indemnification is not exclusive of any other indemnification rights to which those persons may be entitled. Indemnification under this provision is as to action both in an official capacity and in another capacity while holding office. Indemnification continues as to a person who has ceased to be a director, officer, employee or agent and extends to the benefit of the heirs, executors and administrators of such a person. Section 78.751 of the Nevada Revised Statutes provides that the expenses of our officers and directors incurred in defending a civil or criminal action, suit or proceeding must be paid by us as they are incurred and in advance of the final disposition of the action, suit or proceeding, upon receipt of an undertaking by or on behalf of the director or officer to repay the amount if it is ultimately determined by a court of competent jurisdiction that the director or officer is not entitled to indemnification.

Our amended and restated articles of incorporation also provide that our directors shall not be liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director, except to the extent required under the Nevada Revised Statutes. Any amendment, modification or repeal of this provision by our stockholders would not adversely affect any right or protection of any director in respect of any act or omission occurring prior to the time of such amendment, modification or repeal. Our amended and restated articles of incorporation do not, however, eliminate or limit a director’s liability for any act or omission involving intentional misconduct, fraud or a knowing violation of law, or the payment of unlawful distributions to stockholders. Furthermore, they do not limit liability for claims against a director arising out of the director’s responsibilities under the federal securities laws or any other law. However, we have purchased directors’ and officers’ liability insurance to protect our directors and executive officers against liability under circumstances specified in the policy.

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Section 2115 of the California General Corporation Law, or the California Code, provides that corporations such as us that are incorporated in jurisdictions other than California (in our case, Nevada) and that meet various tests are subject to several provisions of the California Code, to the exclusion of the law of the jurisdiction in which the corporation is incorporated. We believe that as of December 31, 2003, we met the tests contained in Section 2115. Consequently, we are subject to, among other provisions of the California Code, Section 317 which governs indemnification of directors, officers and others. Section 317 generally eliminates the personal liability of a director for monetary damages in an action brought by or in the right of the company for breach of a director’s duties to the company or our stockholders except for liability:

• for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law;

• for acts or omissions that a director believes to be contrary to the best interests of the company or our stockholders or that involve the absence of good faith on the part of the director;

• for any transaction for which a director derived an improper personal benefit;

• for acts or omissions that show a reckless disregard for the director’s duty to the company or our stockholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director’s duties, of a risk of serious injury to the company or our stockholders;

• for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director’s duty to the company or our stockholders; and

• for engaging in or approving transactions described in the California Code or California case law which result in liability.

To the extent indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of I/OMagic under the foregoing provisions, or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.

The inclusion of the above provisions in our amended and restated articles of incorporation and amended and restated bylaws may have the effect of reducing the likelihood of derivative litigation against our directors and may discourage or deter stockholders or management from bringing a lawsuit against our directors for breach of their duty of care, even though such an action, if successful, might otherwise have benefited us and our stockholders. At present, there is no litigation or proceeding pending involving a director of ours as to which indemnification is being sought, nor are we aware of any threatened litigation that may result in claims for indemnification by any of our directors.

Item 15.Recent Sales of Unregistered Securities

In October 2003, we issued warrants to purchase 20,004 shares of common stock at an exercise price of $7.19 per share. The warrants expired on March 31, 2004.

In October 2003, we issued warrants to purchase 20,004 shares of common stock at an exercise price of $9.78 per share. The warrants expire on July 9, 2004.

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In March 2004, we issued warrants to purchase 10,000 shares of common stock at an exercise price of $4.00 per share. The warrants expire on September 9, 2005.

In March 2004, we issued warrants to purchase 10,000 shares of common stock at an exercise price of $6.00 per share. The warrants expire on September 9, 2005.

In March 2004, we issued options to purchase an aggregate of 64,375 shares of common stock under our 2002 Stock Option Plan at an exercise price of $3.50 per share. The options expire on March 9, 2014.

In March 2004, we issued options to purchase an aggregate of 62,000 shares of common stock under our 2002 Stock Option Plan at an exercise price of $3.85 per share. The options expire on March 9, 2009.

The issuances of our securities described above were made in reliance upon the exemption from registration available under Section 4(2) of the Securities Act of 1933, as amended, as transactions not involving a public offering. This exemption was claimed on the basis that these transactions did not involve any public offering and the purchasers in each offering were sophisticated and had sufficient access to the kind of information registration would provide.

Item 16.Exhibits and Financial Statement Schedules

Exhibit Number	Description
1.1	Form of Underwriting Agreement**
3.1	Amended and Restated Articles of Incorporation of I/OMagic Corporation filed with the Secretary of State of Nevada on December 6, 2002 (7)
3.2	Amended and Restated Bylaws of I/OMagic Corporation dated July 25, 2002 (1)
4.1	Specimen stock certificate representing the Registrant’s common stock, $.001 par value**
5.1	Opinion of Rutan & Tucker, LLP**
10.2	Employment Agreement dated October 15, 2002 between I/OMagic Corporation and Tony Shahbaz (#) (2)
10.3	Business Loan Agreement dated December 31, 2002 between I/OMagic Corporation and ChinaTrust Bank (USA) (4)
10.4	Rider to Business Loan Agreement dated December 31, 2002 between I/OMagic Corporation and ChinaTrust Bank (USA) (4)
10.5	Change in Terms Agreement dated December 31, 2002 between I/OMagic Corporation and ChinaTrust Bank (USA) (4)
10.6	I/OMagic Corporation 2002 Stock Option Plan (#) (3)
10.7	Agreement dated January 23, 2003 between I/OMagic Corporation and Lung Hwa Electronics Co., Ltd. (4)
10.8	Warehouse Services and Bailment Agreement dated February 3, 2003 between I/OMagic Corporation and Behavior Tech Computer (USA) Corp. (4)
10.9	I/OMagic Corporation 2003 Stock Option Plan (#) (6)

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Exhibit Number	Description
10.10	Forbearance Agreement and Release entered into as of June 16, 2003 by ChinaTrust Bank (USA) and I/OMagic Corporation (5)
10.11	Standard Industrial/Commercial Single-Tenant Lease-Net dated July 1, 2003 between Laro Properties, L.P. and I/OMagic Corporation (5)
10.12	Business Loan Agreement (Asset Based) dated August 15, 2003 between United National Bank and I/OMagic Corporation (5)
10.13	Promissory Note dated August 15, 2003 between United National Bank and I/OMagic Corporation (5)
10.14	Commercial Security Agreement dated August 15, 2003 between United National Bank and I/OMagic Corporation (5)
10.15	Letter Agreement dated March 18, 2004 between United National Bank and I/OMagic Corporation (7)
14.1	I/OMagic Corporation Code of Business Conduct and Ethics dated March 15, 2004 (7)
14.2	I/OMagic Corporation Code of Business Ethics for CEO and Senior Financial Officers dated March 15, 2004 (7)
14.3	Charter of the Audit Committee of the Board of Directors of I/OMagic Corporation dated March 15, 2004 (7)
21.1	Subsidiaries of the Registrant (7)
23.1	Consent of Independent Auditors*

* Filed herewith.

** To be filed by amendment.

(#) Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit.

(1) Incorporated by reference to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2002 (File No. 000-27267).

(2) Incorporated by reference to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended September 30, 2002 (File No. 000-27267).

(3) Incorporated by reference to Registrant’s definitive proxy statement for the annual meeting of stockholders held November 4, 2002.

(4) Incorporated by reference to the Registrant’s annual report on Form 10-K for the year ended December 31, 2002 (File No. 000-27267).

(5) Incorporated by reference to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2003 (File No. 000-27267).

(6) Incorporated by reference to the Registrant’s definitive proxy statement for the annual meeting of stockholders held December 18, 2003.

(7) Incorporated by reference to the Registrant’s annual report on Form 10-K for the year ended December 31, 2003 (File No. 000-27267).

Item 17.Undertakings

The undersigned registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4)

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or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.

(2) For purposes of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described in Item 14 hereof, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.

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SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on May 5, 2004.

I/OMAGIC CORPORATION
By:	/s/    TONY SHAHBAZ
	Tony Shahbaz, Chief Executive Officer

Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the capacities and on the dates indicated.

Name	Title	Date
/s/    TONY SHAHBAZ         Tony Shahbaz	Chief Executive Officer, President, Secretary and Director (Principal Executive Officer)	May 5, 2004
/s/    STEVE GILLINGS         Steve Gillings	Chief Financial Officer (Principal Accounting and Financial Officer)	May 5, 2004
/s/    ANTHONY ANDREWS         Anthony Andrews	Director	May 5, 2004
/s/    DANIEL HOU         Daniel Hou	Director	May 5, 2004
/s/    DANIEL YAO         Daniel Yao	Director	May 5, 2004
/s/    STEEL SU         Steel Su	Director	May 5, 2004
Young-Hyun Shin	Director	May 5, 2004

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EXHIBIT INDEX

Exhibit Number	Description
23.1	Consent of Independent Auditors