**SECURITIES AND EXCHANGE COMMISSION**

## **WASHINGTON, D.C. 20549**

----

 

### **FORM 10-Q**

 

 

ý    **QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended September 30, 2001**

 

o    **TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from________ to ________**

**Commissionfile number**

 

## **I/OMAGIC CORPORATION**

(Exact name of small business issuer as specified inits charter)

 

 

| **Nevada**                                                                                  |   | **88-0290623**                     |
|---------------------------------------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of                                                            |   | (IRS Employer  Identification No.) |
| incorporation or  organization)                                                             |   |                               |
|                                                                                        |   |                               |
| **1300 Wakeham, Santa Ana, CA   92705**
 (Address of principal executive offices) |
|                                                                                        |   |                               |

**(714) 953-3000**

(Issuer's telephone number)

 

 

(Former name, former address andformer fiscal year, if changed since last report)

 

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes ý                   No o

 

As of November 7, 2001,the number of shares of Common Stock issued and outstanding was 67,930,291.

 

TransitionalSmall Business Disclosure Format (check one):

Yes o                   No ý

 

 

**I/OMAGIC CORPORATION AND SUBSIDIARY**

**INDEX**

 

 

 

 
| PART I - FINANCIAL  INFORMATION |                                                                                                            |              |
|--------------------------------------|-----------------------------------------------------------------------------------------------------------------|-------------------|
|                                 |                                                                                                            |              |   |
|                                 | Item  1.  Financial Statements                                                                             |              |   |
|                                 |                                                                                                            |              |   |
|                                 | Balance Sheets –  December 31. 2000 and September 30, 2001 (unaudited)                                     |              |   |
|                                 |                                                                                                            |              |   |
|                                 | Statements of Operations - For  the three months and nine months ended September 30, 2000 and 2001  (unaudited) |              |   |
|                                 |                                                                                                            |              |   |
|                                 | Statements of Cash Flows  - For the  nine months ended September  30, 2000 and 2001 (unaudited)            |              |   |
|                                 |                                                                                                            |              |   |
|                                 | Notes to Financial  Statements                                                                                  |              |   |
|                                 |                                                                                                            |              |   |
|                                 | Item  2.   Management's Discussion and Analysis of Financial Conditions and  Results of Operations    |              |   |
|                                 |                                                                                                            |              |   |
|                                 |                                                                                                            |              |   |
| PART II – OTHER INFORMATION     |                                                                                                            |              |
|                                 |                                                                                                            |              |   |
|                                 | Item 1.                                                                                                         | Legal Proceedings |   |   |  
 

Item  2.

Changes  in Securities

 

 

 
 

Item 3.

Defaults Upon  Senior Securities

 

 

 
 

Item  4.

Submission  of Matters to a Vote of Security Holders

 

 

 
 

Item 5.

Other Information

 

 

 
 

Item 6.

Exhibits and  Reports on Form 8-K

 

 

 
 

 

 

 

SIGNATURES

 

 

 

 

**PART I – FINANCIAL INFORMATION**

 

**Item 1.     FinancialStatements**

 

 

 

 

FINANCIALINFORMATION

PART 1 - ITEM 1

 

I/OMAGIC CORPORATION

BALANCE SHEETS

DECEMBER31, 2000 AND SEPTEMBER 30, 2001 (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

**DECEMBER 31, 2000**

 

**SEPTEMBER 30, 2001**

 

CURRENT ASSETS

 

 

 

 

 

Cash

 

$

3,502,546

 

$

8,962,896

 

Accounts receivable, net of allowance   for doubtful accounts of $2,106,518 and $2,437,865

 

18,109,794

   

17,458,000

   

Accounts receivable from related parties

 

84,710

 

45,522

 

Inventory, net

 

6,783,715

 

9,967,046

 

Inventory in transit

 

13,011,000

 

-

 

Income tax receivable

 

34,311

 

34,311

 

Prepaid expenses and other current assets

 

184,523

 

1,352,128

 

Deferred tax provision

 

1,556,000

 

1,293,909

 

 

 

 

 

 

 

 

 

 

 

 

 

TOTAL CURRENT ASSETS

 

43,266,599

 

39,113,812

 

 

 

 

 

 

 

FURNITURE AND EQUIPMENT, NET

 

1,427,772

 

1,325,756

 

TRADEMARK, net of accumulated amortization of $1,446,852  and $2,893,696

 

8,198,827

   

6,751,983

   

DEFERRED INCOME TAXES, net of current portion

 

165,000

 

-

 

OTHER ASSETS

 

40,240

 

40,240

 

 

 

 

 

 

 

 

 

 

 

 

 

TOTAL ASSETS

 

$

53,098,438

 

$

47,231,791

 

 

 

 

 

 

 

 

The accompanying notesare an integral part of these financial statements

 

 

 

 

 

LIABILITIES AND  STOCKHOLDERS’ EQUITY

 

 

 

 

 

** **

 

**DECEMBER  31, 2000**

 

**SEPTEMBER  30, 2001**

 
**CURRENT  LIABILITIES**
 

 

 

 

 

Line of credit

 

$

6,996,969

 

$

6,695,941

 

Accounts payable and accrued expenses

 

12,171,712

 

8,566,514

 

Due to related parties

 

-

 

2,736,338

 

Current portion of capital lease obligation

 

27,121

 

16,337

 

Reserves for customer returns and allowances

 

2,232,087

 

3,144,759

 

 

 

 

 

 

 

TOTAL CURRENT LIABILITIES

 

21,427,889

 

21,159,889

 

 

 

 

 

 

 

 

 

 

 

 

 

CAPITAL LEASE OBLIGATIONS, net of current portion

 

10,978

 

1,790

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

21,438,867

 

21,161,679

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

 

 

 

 

REDEEMABLE CONVERTIBLE PREFERRED STOCK

 

 

 

 

 

 

 

 

 

 

 

10,000,000 shares authorized, $0.001 par value  Series A, 1,000,000 shares authorized     875,000 shares issued and  outstanding

 

875

 

875

 

Series B, 1,000,000 shares authorized   250,000 shares issued and outstanding

 

250

   

250

   

Additional paid-in capital

 

8,998,875

 

8,998,875

 

 

 

 

 

 

 

Total redeemable  convertible preferred stock

 

9,000,000

 

9,000,000

 

 

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

Class A common stock, $0.001 par value   100,000,000 shares authorized   67,917,791 and 67,930,291 (unaudited) shares   issued and outstanding

 

67,918

 

67,931

 

Additional paid in capital

 

31,493,345

 

31,493,958

 

Deferred compensation

 

(3,100

)

-

 

Accumulated deficit

 

(8,898,592

)

(14,491,777

)

 

 

 

 

 

 

TOTAL STOCKHOLDERS’ EQUITY

 

22,659,571

 

17,070,112

 

 

 

 

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

53,098,438

 

$

47,231,791

 

 

 

 

 

 

 

 

The accompanying notesare an integral part of these financial statements

 

 

STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS AND NINE MONTHS ENDED

SEPTEMBER 30, 2001  (UNAUDITED) AND 2000 (UNAUDITED)

 

 

 

 

 

**Nine Months Ended**

 

**Three  Months Ended**

 

 

 

**September 30,**

 

**September  30,**

 

 

 

 

 

 

 

 

 

 

 

 

 

**2001**

 

**2000**

 

**2001**

 

**2000**

 

 

 

 

 

 

 

 

 

 

 

Net  sales

 

$

45,858,482  

 

$

47,060,307

 

$

27,056,090

 

$

14,013,132

 

Cost of sales

 

39,548,635

 

38,755,182

 

19,215,140

 

11,449,256

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

6,309,847

 

8,305,125

 

7,840,950

 

2,563,876

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

Selling, marketing and advertising

 

5,241,471

 

2,579,902

 

3,663,657

 

1,003,536

 

General and administrative

 

4,258,517

 

4,491,154

 

1,503,716

 

1,924,753

 

Depreciation and amortization

 

1,672,260

 

1,114,581

 

559,427

 

549,138

 

 

 

 

 

 

 

 

 

 

 

Total operating expense

 

11,172,248

 

8,185,637

 

5,726,800

 

3,477,427

 

 

 

 

 

 

 

 

 

 

 

Income  (loss) from operations

 

(4,862,401

)

119,488

 

2,114,150

 

(913,551

)

 

 

 

 

 

 

 

 

 

 

Other  income (expense)

 

 

 

 

 

 

 

 

 

Interest income

 

34,953

 

42,718

 

1,000

 

19,286

 

Interest expense

 

(345,814

)

(920,887

)

(76,430

)

(456,639

)

Other income

 

10,170

 

20,163

 

-

 

100

 

 

 

 

 

 

 

 

 

 

 

Total  other income (expense)

 

(300,691

)

(858,006

)

(75,430

)

(437,253

)

 

 

 

 

 

 

 

 

 

 

Income  (loss) before provision for income taxes

 

(5,163,092

)

(738,518

) 

2,038,720

 

(1,350,804

) 

 

 

 

 

 

 

 

 

 

 

Provision for (benefit from) income taxes

 

430,091

 

10,864

 

600

 

(82,736

)

Net  income (loss)

 

$

(5,593,183  

)

$

(749,382

) 

$

2,038,120

 

$

(1,268,068

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

(0.08

)

$

(0.02

)

$

0.03

 

$

(0.03

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted  earnings (loss) per share

 

$

(0.08

)

$

(0.02

)

$

0.03

 

$

(0.03

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic weighted-average shares outstanding

 

67,923,148 

 

39,015,695

 

67,930,291

 

39,306,951

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted-average shares outstanding

 

67,923,148

 

39,015,695  

 

67,930,291

 

39,306,951

 

 

The accompanying notesare an integral part of these financial statements

 

 

STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED

SEPTEMBER 30, 2001 (UNAUDITED) AND 2000 (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Nine Months Ended**

 

 

 

**September 30,**

 

 

 

 

 

 

 

 

 

**2001**

 

**2000**

 

 

 

 

 

 

 

CASH  FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Loss from operations   Adjustments to reconcile net loss to net   cash provided by operating activities:

 

$

(5,593,183

)

$

(749,382

)

Depreciation and amortization

 

225,417

 

150,021

 

Amortization of trademark

 

1,446,844

 

964,560

 

Amortization of deferred compensation

 

3,100

 

9,300

 

Provision for allowance for doubtful  accounts

 

331,347

 

160,871

 

Reserve for obsolete inventory

 

36,260

 

74,263

 

Deferred income tax

 

427,091

 

(115,000

)

Reserve for customer returns and allowances

 

912,673

 

843,214

 

Tax effect of exercised options

 

-

 

52,000

 

Interest imputed on notes payable

 

-

 

318,120

 

(Increase) decrease in: 

 

 

 

 

 

Accounts receivable:

 

320,446

 

(9,820,305

)

Accounts receivable from related parties

 

39,189

 

7,040,717

 

Inventory

 

9,791,410

 

(345,861

)

Prepaid expenses and other current assets

 

(1,167,609

)

(47,599

)

Other assets

 

-

 

5,000

 

Increase (Decrease) in:

 

 

 

 

 

Accounts payable and accrued expenses

 

(3,605,197 

)

(2,359,659

)

Accounts payable to related parties

 

2,736,338

 

720,104

 

Income taxes payable

 

-

 

(61,858

)

 

 

 

 

 

 

Net cash provided by (used in) operating activities

 

5,904,126

 

(3,161,494

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Property additions

 

(123,401

)

(162,436

)

 

 

 

 

 

 

Net cash (used in) investing activities

 

(123,401

)

(162,436

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Net (payments) borrowings on line of credit

 

(301,028

)

2,111,532

 

Payments on capital lease obligations

 

(19,972

)

(11,609

)

Proceeds from exercise of warrants

 

625

 

53,058

 

Payments on notes payable – related party

 

-

 

(247,909

)

Proceeds from sale and issuance of common stock

 

-

 

2,000,000

 

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

(320,375

)

3,905,072

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

5,460,350

 

581,142

 

Cash and cash equivalents at beginning of period

 

3,502,546

 

1,943,522

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

8,962,896  

 

$

2,524,664

 

Supplemental cash flow information:

 

 

 

 

 

Interest paid

 

$

345,814

 

$

602,767

 

Income taxes paid

 

$

1,400

 

$

800

 

 

 

 

 

 

 

The accompanying notesare an integral part of these financial statements

 

SUPPLEMENTALSCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

 

During the ninemonths ended September 31, 2000, the Company entered into the

following non-cash transaction:

 

- Issued 6,250,000(unaudited) shares of common stock for $5,000,000

(unaudited) ininventory

- Issued 40,000(unaudited) shares of common stock for $60,000 (unaudited)

of legal services

 

 

NOTES TO FINANCIALSTATEMENTS

 

NOTE 1 -ORGANIZATION AND BUSINESS

 

I/OMagic Corporation (the "Company"), aNevada corporation, develops, manufactures through subcontractors, markets, anddistributes multimedia and communication card devices for portable and desktopcomputers. The Company sells its products in the United States to distributorsand retail customers.

 

In March 1996, I/O Magic Corporation, a Californiacorporation ("I/OMagic California"), originally incorporated onSeptember 30, 1993 entered into a Plan of Exchange and Acquisition Agreement(the "Acquisition Agreement") with Silvercrest International, Inc.("Silvercrest"), a Nevada corporation. Pursuant to the AcquisitionAgreement, Silvercrest acquired all of the outstanding stock of I/OMagicCalifornia totaling 6,570,583 shares in exchange for an aggregate 6,570,583shares of newly-issued common stock. In connection with the AcquisitionAgreement, the Company issued 624,704 shares of common stock. For accountingpurposes, the acquisition has been treated as a recapitalization of I/OMagicCalifornia, with I/OMagic California as the accounting acquirer (reverseacquisition). The reverse acquisition was recorded at the historical cost ofI/O Magic California. Prior to the execution of the Acquisition Agreement,Silvercrest was a public company listed on NASDAQ’s over-the-counter marketwith dormant operations and no assets or liabilities. Silvercrest subsequentlychanged its name to I/OMagic Corporation, a Nevada corporation.

 

 

NOTE 2 - SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

BASIS OF PRESENTATION

The accompanying unaudited condensed financialstatements have been prepared in accordance with the instructions to Form 10-Qand therefore, do not include all information and notes necessary for a fairpresentation of financial position, results of operations, and cash flows inconformity with generally accepted accounting principles.  The unaudited condensed financial statementsinclude the accounts of I/OMagic Corporation and subsidiary. The operatingresults for interim periods are unaudited and are not necessarily an indicationof the results to be expected for the full fiscal year. In the opinion ofmanagement, the results of operations as reported for the interim periodsreflect all adjustments which are necessary for a fair presentation ofoperating results.

 

USE OF ESTIMATES

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosures of contingent assets and liabilities at thedate of the financial statements, as well as the reported amounts of revenuesand expenses during the reporting period.

Significant estimates made by management include, butare not limited to, the provisions for allowance of doubtful accounts and priceprotection on accounts receivable, the net realizability of inventory, theevaluation of potential impairment of furniture and equipment, and theprovision for sales returns and warranties. Actual results could materiallydiffer from those estimates.

 

STOCK BASED COMPENSATION

SFAS No. 123, "Accounting for Stock-BasedCompensation," establishes and encourages the use of the fair value basedmethod of accounting for stock-based compensation arrangements under whichcompensation cost is determined using the fair value of stock-basedcompensation determined as of the date of grant and is recognized over theperiods in which the related services are rendered. The statement also permitscompanies to elect to continue using the current implicit value accountingmethod specified in Accounting Principles Bulletin ("APB") OpinionNo. 25, "Accounting for Stock Issued to Employees," to account forstock-based compensation issued to employees. The Company has elected to usethe implicit value based method and has disclosed the pro forma effect of usingthe fair value based method to account for its stock-based compensation. Forstock-based compensation issued to non-employees, the Company uses the fair valuemethod of accounting under the provisions of SFAS No. 123.

 

EARNINGS (LOSS) PER SHARE

The Company calculates earnings (loss) per share inaccordance with SFAS No. 128, "Earnings Per Share." SFAS No. 128replaced the presentation of primary and fully diluted earnings per share withthe presentation of basic and diluted earnings (loss) per share.  Basic earnings (loss) per share excludesdilution and is calculated by dividing income (loss) available to commonstockholders by the weighted-average number of common shares outstanding forthe period.  Diluted earnings (loss) pershare includes the potential dilutive effects that could occur if securities orother contracts to issue common stock were exercised or converted into commonstock ("potential common stock") that would then share in theearnings (loss) of the Company.

 

As of September 30, 2001 (unaudited) and 2000(unaudited), the Company had potential common stock as follows:

 

 

 

**2001**

 

**2000**

 

Weighted-average common  shares Outstanding during the period

 

67,923,148

 

39,015,695

 

Incremental shares assumed to be

outstanding since the beginning of the 

period related to stock options and warrants  outstanding (unaudited)

        

-

 

-

        

FULLY DILUTED WEIGHTED-AVERAGE COMMON SHARES AND  POTENTIAL COMMON STOCK   (UNAUDITED) 

 

67,923,148 

 

39,015,695

 

 

 

 

 

 

 

 

 

 

Since the Company had a net loss for the nine monthsended September 30, 2001 and September 30, 2000, basic and diluted shares arethe same.

 

NOTE 3 - ACCOUNTSPAYABLE AND ACCRUED EXPENSES

 

Accounts payableand accrued liabilities consisted of the following:

 

 

**September  30,**

 

 

 

**2001**

 

 

 

**(unaudited)**

 

 

 

 

 

Accounts payable

 

$

1,763,130

 

Accrued rebates and marketing

 

5,594,974

 

Accrued compensation and related benefits

 

465,305

 

Other

 

743,105

 

 

 

 

 

TOTAL

 

$

8,566,514

 

 

NOTE 4 - INVENTORY

 

Inventory consisted of the following

 

 

**September 30,**

 

 

 

**2001**

 

 

 

**(unaudited)**

 

 

 

 

 

Component parts

 

$

6,126,639

 

Finished goods

 

5,711,093

 

Reserves for inventory

 

(1,870,687

)

 

 

 

 

TOTAL

 

$

9,967,045

 

 

 

 

 

 

 

NOTE 5 – LINE OFCREDIT

 

On April 18, 2001 the credit facility which had beenassumed in the December 31, 2000 acquisition of IOM Holdings was paid off.  The payoff was by means of a new creditfacility with another institution and was for $5,285,621.  The new credit facility provides for arevolving line of credit allowing the Company to borrow the lesser of a)$8,000,000 or b) 65% of eligible receivables. Advances on the revolving line of credit bear interest at the base rate(6.75% as of September 30, 2001) plus 0.25%. As of September 30, 2001, the outstanding balance under the revolvingline of credit was $6,695,941.

 

 

NOTE 6 - CREDITLINES FROM RELATED PARTIES

 

In connection with a 1997 Strategic AllianceAgreement, the Company has available a trade line of credit through astockholder and supplier for purchases up to $2,000,000. Purchases arenon-interest bearing and are due 75 days from the date of receipt.  The credit agreement can be terminated orchanged at any time. As of December 31, 2000 and September 30, 2001(unaudited), there were $0 and $0, respectively, in trade payables outstandingunder this arrangement.

 

In connection with an April 1999 subscriptionagreement, the Company also has available an additional trade line of creditthrough a stockholder and vendor that provides a trade credit facility of up to$5,000,000 carrying net 75 day terms, as defined. As of December 31, 2000 andSeptember 30, 2001 (unaudited), there were $2,369,220 and $1,724,338,respectively, in trade payables outstanding under this arrangement.

 

In connection with a December 2000 subscriptionagreement, the Company also has available an additional trade line of creditthrough a stockholder and vendor that provides a trade credit facility of up to$3,000,000 carrying net 60 day terms, as defined. As of December 31, 2000 andSeptember 30, 2001 (unaudited), there were $0 and $1,012,000, respectively, intrade payables outstanding under this arrangement.

 

NOTE 7 -COMMITMENTS AND CONTINGENCIES

 

LEASES

 

The Company leases its facilities and certainequipment under non-cancelable, operating lease agreements, expiring throughMarch 2010.

 

Rent expense was $418,288 and $300,719 for the ninemonths ended September 30, 2001 and 2000, respectively, and is included ingeneral and administrative expenses in the accompanying statements of income.

 

 

 

EMPLOYMENTCONTRACT

The Company has entered into an employment contractwith one of its officers which expires upon written termination.  The agreement calls for a minimum basesalary and provides for certain expense allowances. In addition, the agreementprovides for a bonus based on the “net profits” of the Company, asdefined.  The bonus amount ranges from$20,000 to $70,000 for net profits up to $500,000.  For net profits in excess of $500,000, the bonus is 7% of suchexcess.  No bonuses were paid during thethree months ended September 30, 2001. As of September 30, 2001, there was $97,865 accrued under thisagreement.

 

RETAIL AGREEMENTS

In connection with certain retail agreements, theCompany has agreed to pay for certain marketing development and advertising onan ongoing basis. Marketing development and advertising costs are generallyagreed upon at the time of the event. The Company also records a liability forco-op marketing based on management’s evaluation of historical experience andcurrent industry and Company trends. During the three months ended September30, 2001 and 2000, the Company incurred $3,235,990 (unaudited) and $309,752(unaudited), respectively, related to these agreements.  Such is included in selling, marketing, andadvertising in the accompanying statements of income.

 

NOTE 8 - CAPITALTRANSACTIONS

 

COMMON STOCKISSUED FOR CASH

During the nine months ended September 30, 2000, theCompany issued an aggregate of 632,912 (unaudited) restricted shares of commonstock for cash totaling $2,000,000, or at a per share price of $3.16(unaudited).

 

COMMON STOCKISSUED IN CONNECTION WITH THE EXERCISE OF WARRANTS

During the nine months ended September 30, 2000, theCompany issued an aggregate of 105,578 (unaudited) restricted shares of commonstock in connection with the exercise of warrants for cash totaling $53,058(unaudited), or at a per share price ranging from $0.05 (unaudited) to $2.00(unaudited).

 

During the nine months ended September 30, 2001, theCompany issued an aggregate of 12,500 (unaudited) restricted shares of commonstock in connection with the exercise of warrants for cash totaling $625(unaudited), or at a per share price of $0.05 (unaudited).

 

COMMON STOCKISSUED FOR SERVICES

During the nine months ended September 30, 2000, theCompany issued an aggregate 40,000 (unaudited) unrestricted shares of commonstock, valued at $1.50 per share, for $60,000 of legal services, which representedthe fair market value of the services rendered.

 

COMMON STOCKISSUED FOR INVENTORY

During the nine months ended September 30, 2000, theCompany issued 6,250,000 (unaudited) shares of restricted common stock to astockholder and vendor, valued at $0.80 per share for $5,000,000 of inventory,as defined (valued at transferor’s cost basis).

 

STOCK OPTION PLANS

During the nine months ended September 30, 2000, theCompany granted non-qualified and incentive stock options to purchase a totalof 2,012,500 shares of common stock to officers and employees and certainconsultants under the Company’s stock option plans.  The stock options vest either immediately or ratably over fiveyears.  Exercise prices range from $2.00to $3.00 and the options expire five years from the date of grant.  No stock options were granted during thenine months ended September 30, 2001.

 

NOTE 9 - RELATEDPARTY TRANSACTIONS

 

During the nine months ended September 30, 2001 and2000, the Company had purchases from related parties totaling approximately$7,863,562 (unaudited) and $23,746,205 (unaudited), respectively.

 

King Eagle Enterprises, Inc., a related party, isinvolved in printing and packaging services to the Company.  King Eagle Enterprises, Inc. is currentlyseeking investments in and/or acquisitions of printing and packaging facilitiesto better accommodate cost/support to the Company.

 

NOTE 10 – RECENTLYISSUED ACCOUNTING PRONOUNCEMENTS

 

In July 2001, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 141, “Business Combinations.”  Management believes this statement will nothave a material impact on the Company’s financial statements.

 

In July 2001, the FASB issued SFAS No. 142, “Goodwilland Other Intangible Assets.” Management believes this statement will not have a material impact onthe Company’s financial statements.

 

In June 2001, the FASB issued SFAS No. 143,“Accounting for Asset Retirement Obligations.” This statement is not applicable to the Company.

 

In August 2001, the FASB issued SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets.”  Management believes this statement will not have a materialimpact, if any, on the Company’s financial statements.

 

NOTE 11 –SUBSEQUENT EVENTS

 

The Company is currently in the process of signing anew revolving line of credit with its current lending institution.  The proposed agreement will allow theCompany to borrow the lesser of a) $10,000,000 or b) 65% of eligiblereceivables. Advances will bear interest at the base rate (currently 6.75%) plus0.25%.  In addition, the Company willhave a line of $4,000,000 available for use by Letters of Credit for thepurchase of inventory.

 

 

**Item 2.  Management's Discussionand Analysis of Financial Condition and Results of Operations**

 

**                Three Months ended September30, 2001 and 2000**

 

                **Resultsof Operations**

 

 

Revenues for the period ended September 30, 2001("2001") were $27,056,090, compared to revenues for the period endedSeptember 30, 2000 ("2000") of $14,013,432. The increase in revenuesis primarily attributable to new agreements signed with two major customers atthe end of the second quarter. The Company had a sales backlog as of September30, 2001 of $5,522,984 and it had a sales backlog of $726,079 as of September30, 2000.

 

Cost of sales as a percentage of revenues decreasedfrom 81.70% ($11,449,256) in 2000 to 71.02% ($19,215,140) in 2001. This wasprimarily due to a change in the mix of goods sold to a mix in which the grossmargin of some items was greater than items sold the prior year.

 

Operating expenses as a percentage of revenuesdecreased from 24.82% ($3,477,427) in 2000 to 21.17% ($5,726,800) in 2001.

Selling, marketing and advertising as a percentage ofrevenues increased from 7.16% ($1,003,536) in 2000 to 13.54% ($3,663,657) in2001, primarily due to increased marketing in relation to a new sales agreementwith a major customer in the quarter.

 

General and administrative expenses as a percentage ofrevenues decreased from 13.74% ($1,924,753) in 2000 to 5.56% ($1,503,716) in2001. The decrease is primarily due to the increase in sales in 2001 versus2000, as most general and administrative expenses are fixed.  In addition, the Company reduced actualexpenses due to redundancy from the Company’s acquisition of IOM Holdings onDecember 31, 2000.  The Company began toreduce excess expenses in the second quarter of 2001 and expects such tocontinue throughout the year 2001.

 

Depreciation andamortization increased from $549,138 (3.92% of revenues) in 2000 to $559,427(2.07% of revenues) in 2001.  Thepercentage decrease is due to the increase in sales in 2001 versus 2000.

 

Other income (expense) decreased as a percentage ofsales from (3.12%) ($437,253 expense) to 0.28% ($75,430 expense).  This was primarily due to a decrease ininterest expense due to borrowings being lower in 2001.

 

Provision for income taxes for the period endedSeptember 30, 2000 represents Federal tax estimate and California statefranchise tax estimate.  Provision forincome taxes for the period ended September 30, 2001 represents minimumCalifornia state franchise tax.

 

Net losses decreased from $1,268,068 for the threemonths ended September 30, 2000 to net income of $2,038,120 for the threemonths ended September 30, 2001.

 

 

**Nine Months ended September  30,2001 and 2000**

 

                **Resultsof Operations**

 

 

Revenues for the period ended September 30, 2001("2001") were $45,858,482, compared to revenues for the period endedSeptember 30, 2000 ("2000") of $47,060,307. The slight decrease inrevenues is primarily attributable to the much lower sales in the first sixmonths ($18,802,392 in 2001 versus $33,047,175 in 2000), mostly offset by asignificant increase in sales in the three months ended September 30, 2001versus sales in the three months ended September 30, 2000, which is due to newagreements signed with two major customers at the end of the second quarter.The Company had a sales backlog as of September 30, 2001 of $5,522,984 and ithad a sales backlog of $726,079 as of September 30, 2000.

 

Cost of sales as a percentage of revenues increasedfrom 82.35% ($38,755,182) in 2000 to 86.24% ($39,548,635) in 2001.  This was primarily due to the write-down by$3,455,682 of obsolete and slow-moving inventory at June 30, 2001.  This was primarily inventory acquired in theacquisition of IOM Holdings on December 31, 2000.  In addition, the Company incurred much higher rebate costs in2001 than 2000 (the Company changed its policy to offset rebates againstrevenues). Cost of product as a percentage of revenues before rebates decreasedin 2001 from 2000 due to no OEM revenues in 2001, which have a lower margin.

 

Operating expenses as a percentage of revenuesincreased from 17.39% ($8,185,637) in 2000 to 24.36% ($11,172,248) in 2001.

 

Selling, marketing and advertising as a percentage ofrevenues increased from 5.48% ($2,579,902) in 2000 to 11.43% ($5,241,471) in2001.

General and administrative expenses as a percentage ofrevenues decreased from 9.54% ($4,491,154) in 2000 to 9.29% ($4,258,517) in2001.  The decrease is primarily due tothe reduction in actual expenses due to redundancy from the Company’sacquisition of IOM Holdings on December 31, 2000.  The Company began to reduce excess expenses in the second quarterof 2001 and expects such to continue throughout the year 2001.

 

Depreciation and amortization increased from$1,114,581 (2.37% of revenues) in 2000 to $1,672,260 (3.65% of revenues) in2001.  This is due to nine months ofamortization of the Hi-Val and Digital Research Technology trademarks in 2001versus six months in 2000.

 

Other income (expense) decreased as a percentage ofsales from (1.82%) ($858,006 expense) to 0.66% ($300,691 expense).  This was primarily due to a decrease ininterest expense due to borrowings being lower in 2001.

 

Provision for income taxes for the period endedSeptember 30, 2000 represents Federal tax estimate and California statefranchise tax estimate.  Provision forincome taxes for the period ended September 30, 2001 represents Federal taxesas a result of the Company’s estimated annualized taxable income being subjectto Alternative Minimum Taxes (AMT), California state franchise tax estimate,and the current period deferred benefit.

 

Net losses increased from $749,382 for the nine monthsended September 30, 2000 to a loss of $5,593,183 for the nine months endedSeptember 30, 2001.

 

 

**Liquidity and Capital Resources**

 

 

Since its inception, the Company has financed itsoperations and capital expenditures primarily with cash provided by operatingactivities, private securities issuances and securities issuances for product.The Company believes that working capital generated from operations issufficient to meet current activity. However, should the Company growsignificantly in size through additional large customers or acquisitions,securities issuances or other financing arrangements may be necessary. TheCompany currently has three lines of credit with its major suppliers: $5million with BTC, $3 million with Citrine and $2 million with Lung Hwa.Borrowings under those arrangements are provided to the Company interest freefor up to 60 days. The Company had trade accounts payable outstanding balanceson these lines of $1,724,338, $1,012,000 and $0, respectively, as of September30, 2001 and $5,572,276, $0 and $0, respectively, as of September 30, 2000.

 

In April 2000, the Company assumed a line of credit inthe acquisition of IOM Holdings (see NOTE 5). The Company believes that its current cash flow from operations, theamount available under the assumed line of credit and the amounts availableunder its existing vendor lines of credit are sufficient to meet its workingcapital and capital expenditure requirements at the current sales volume forthe next twelve months.

 

In addition, certain of the Company’s stockholders andvendors continue to provide inventory in exchange for common stock of theCompany.

 

For the nine months ended September 30, 2001 theCompany had a net increase in cash in the amount of $5,460,350. This was due tocash provided by operating activities of $5,904,126, cash used in investing activitiesof $123,401 and cash used in financing activities of $320,375. Cash from allaccounts receivable changes increased by $359,635 and cash from inventorychanges increased by $9,791,410. Cash used in investing activities was forleasehold improvements, furniture and computer equipment. Cash used infinancing activities was primarily for payments on the line of credit.

As the Company expands its distribution activities, itmay experience net negative cash flows from operations, pending an increase in grossmargins, and may be required to obtain additional financing to fund operationsthrough proceeds from offerings, to the extent available, or to obtainadditional financing to the extent necessary to augment its working capitalthrough public or private issuance of equity or debt securities.

 

The high technology requirements of the Internetincreasingly require that consumers upgrade their personal computers to takefull advantage of audio and video streaming capabilities. Further, there areincreasing Internet applications for digitally based graphics data, such aspictures taken by digital cameras. The Company believes that its currentdistribution channels currently fulfill and will continue to fulfill thesetrends in the computer peripherals marketplace. In the event the Companyresumes the revenue growth it experienced in 1999 and 2000, the Companybelieves that it will need additional capital. While there is no assurance thatit will be successful in raising additional capital, the Company is currentlyactively seeking both institutional debt, as well as private sources of equitycapital in order to assure that it will be capable of financing such growth.The Company is currently in the process of increasing its line of credit withits current lending institution.  In theevent the Company is unsuccessful in securing such financing, it may berequired to curtail its sales growth.

 

 
**Factors That May Affect Future Results**
 

 

The Company’s business, financial condition andresults of operations may be impacted by a number of factors including, withoutlimitation, those listed below.

 

SignificantCustomer Concentration

 

During the nine month period ended September 30, 2001the Company had three major customers which accounted for approximately 81% ofthe Company’s net sales.  The amountsdue from four major customers on September 30, 2001 amounted to approximately$15,368,431. The Company’s strategy is to constantly attempt to sign new majorretail customers in order to both increase the Company’s growth and to reducethe impact of any one customer.

 

The Company has no firm long-term sales commitmentsfrom any of its customers and enters into individual purchase orders with itscustomers. The Company has experienced cancellations of orders and fluctuationsin order levels from period to period and expects it will continue toexperience such cancellations and fluctuations in the future. In addition,customer purchase orders may be canceled and order volume levels can bechanged, canceled or delayed with limited or no penalties. The replacement ofcanceled, delayed or reduced purchase orders with new business cannot beassured. Moreover, the Company’s business, financial condition and results ofoperations will depend upon its ability to obtain orders from new customers, aswell as the financial condition and success of its customers, its customersproducts and the general economy. The factors affecting any of the Company’smajor customers or their customers could have a material adverse effect on theCompany’s business, financial condition and results of operations.

 

 

**Item 3.    Quantitative and Qualitative Disclosures About Market Risk.**

 

                                None.

 

 

 

**PART II – OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

InApril 1999, the Company filed an arbitration proceeding in Orange County,California against its former accountants and auditors, Ernst & Young, LLP,for failure to complete the 1997 audit. Ernst & Young, LLP counter-claimed to recover fees in connectionwith the audit.  In February 2001, thearbitrator ruled that there was potential liability for both parties.  The damage phase of the arbitration iscurrently ongoing.  Management expects afinal decision by the end of 2001.

 

AComplaint was filed on August 2, 2001 by Mark Vakili and Mitra Vakili(“Plaintiffs”) against I/OMagic Corporation, IOM Holdings, Inc., and others(collectively, the Defendants”), in Orange County Superior Court.  The dispute concerns the real property uponwhich I/OMagic Corporation’s offices are located. The real property is owned bya general partnership, Alex Properties, in which Plaintiffs and Tony Shahbazare general partners. The Plaintiffs’ claims against I/OMagic Corporation andIOM Holdings, Inc. relate to an accounting of rents and ejectment from theproperty.  The proceeding is in theearly stages, but the Defendants intend to vigorously defend the claims andpossibly file claims against the Plaintiffs if warranted.

 

**Item 2. Changes in Securities and Use of Proceeds**

 

                None.

 

**Item 3. Defaults Upon Senior Securities**

 

                None.

 

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

 

None.

 

**Item 5. Other Information**

 

None.

 

**Item 6. Exhibits and Reports on Form 8-K**

 

The following documents are filed as part of this report:

 

1.

 

Reports on Form 8-K filed:

 

None.

 

 

 

 

 

2.

 

Exhibits

 

None.

 

 

 

 

 

 

 

 

**Signatures**

 

Inaccordance with the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, duly authorized.

 

 

 

 

 

 

 

 

 

 

I/OMAGIC CORPORATION

 

 

 

 

 

 

 

 

DATED:

November 14,  2001

 

 

 

 

 

By:

/s/ Tony Shahbaz

 

 

 

 

 

 

 

Tony Shahbaz, President and Chief Executive

 

 

 

 

 

 

 

Officer, Chief Financial Officer

 

 

 

 

 

 

 

 

 

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