<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

|X|   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 30, 2008

|_|   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934 For the transition period from ______ to _______

                        Commission File Number: 000-27267

                              I/OMAGIC CORPORATION
             (Exact name of registrant as specified in its charter)


            NEVADA                                               33-0773180
  (State or other jurisdiction                                (I.R.S. Employer
of incorporation or organization)                            Identification No.)


                       4 MARCONI, IRVINE, CALIFORNIA 92618
               (Address of principal executive offices) (Zip Code)


                                 (949) 707-4800
              (Registrant's telephone number, including area code)

                                 NOT APPLICABLE.
   (Former name, former address and former fiscal year, if changed since last
                                    report)

      Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |

      Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer"
and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer  |_|                      Accelerated filer          |_|
Non-accelerated filer    |_|                      Smaller reporting company  |X|
(Do not check if a smaller reporting company)

      Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes | | No |X|

      As of August 15, 2008, there were 4,540,292 shares of the issuer's
common stock issued and outstanding.

<PAGE>


                              CAUTIONARY STATEMENT

      All statements included or incorporated by reference in this Quarterly
Report on Form 10-Q, other than statements or characterizations of historical
fact, are "forward-looking statements." Examples of forward-looking statements
include, but are not limited to, statements concerning projected net sales,
costs and expenses and gross margins; our accounting estimates, assumptions and
judgments; the demand for our products; the competitive nature of and
anticipated growth in our industry; and our prospective needs for additional
capital. These forward-looking statements are based on our current expectations,
estimates, approximations and projections about our industry and business,
management's beliefs, and certain assumptions made by us, all of which are
subject to change. Forward-looking statements can often be identified by such
words as "anticipates," "expects," "intends," "plans," "predicts," "believes,"
"seeks," "estimates," "may," "will," "should," "would," "could," "potential,"
"continue," "ongoing," similar expressions and variations or negatives of these
words. These statements are not guarantees of future performance and are subject
to risks, uncertainties and assumptions that are difficult to predict.
Therefore, our actual results could differ materially and adversely from those
expressed in any forward-looking statements as a result of various factors, some
of which are set forth in the "Risk Factors" section of our Annual Report on
Form 10-K for the year ended December 31, 2007, which could cause our financial
results, including our net income or loss or growth in net income or loss to
differ materially from prior results, which in turn could, among other things,
cause the price of our common stock to fluctuate substantially. These
forward-looking statements speak only as of the date of this report. We
undertake no obligation to revise or update publicly any forward-looking
statement for any reason, except as otherwise required by law.






                                      i


<PAGE>

                                TABLE OF CONTENTS

                                     PART I
                              FINANCIAL INFORMATION

                                                                            PAGE
                                                                            ----

Item 1. Financial Statements...................................................1

     Condensed Consolidated Balance Sheets as of June 30, 2008 (unaudited)
        and December 31, 2007..................................................1

     Condensed Consolidated Statements of Operations for the Three and
        Six Months Ended June 30, 2008 and 2007 (unaudited)....................2

     Condensed Consolidated Statements of Cash Flows for the Six Months
        Ended June 30, 2008 and 2007 (unaudited)...............................3

     Notes to Condensed Consolidated Financial Statements......................4

Item 2. Management's Discussion and Analysis of Financial Condition
        and Results of Operations.............................................13

Item 3. Quantitative and Qualitative Disclosures About Market Risk ...........23

Item 4. Controls and Procedures ..............................................23

Item 4T. Controls and Procedures .............................................23

                                     PART II
                                OTHER INFORMATION

Item 1. Legal Proceedings ....................................................24

Item 1A. Risk Factors ........................................................24

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ..........24

Item 3. Defaults Upon Senior Securities ......................................24

Item 4. Submission of Matters to a Vote of Security Holders ..................24

Item 5. Other Information ....................................................24

Item 6. Exhibits .............................................................24

Signatures ...................................................................25

Exhibits Filed with this Report


                                      ii

<PAGE>

                         PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

<TABLE>
<S>       <C>
                                       I/OMAGIC CORPORATION AND SUBSIDIARY
                                      CONDENSED CONSOLIDATED BALANCE SHEETS


                                                                                                   DECEMBER 31,
                                                                                  JUNE 30, 2008        2007
                                                                                   ------------    ------------
                                                                                   (unaudited)
                                     ASSETS
CURRENT ASSETS
    Cash and cash equivalents                                                      $    645,771    $  1,463,122
    Restricted cash                                                                         502         341,899
    Accounts receivable, net                                                          1,100,450       6,941,856
    Inventory, net                                                                    2,959,646       5,492,846
    Prepaid expenses and other current assets                                           107,904         107,041
                                                                                   ------------    ------------
       Total current assets                                                           4,814,273      14,346,764
EQUIPMENT, net                                                                          215,606         247,551
TRADEMARKS, net                                                                         258,552         293,016
OTHER ASSETS                                                                             41,928          41,928
                                                                                   ------------    ------------
       TOTAL ASSETS                                                                $  5,330,359    $ 14,929,259
                                                                                   ============    ============

                 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
    Line of credit                                                                 $    359,240    $  3,864,942
    Accounts payable, accrued expenses and other                                        832,036       1,215,961
    Accounts payable - related parties                                                4,953,096       7,414,212
    Capital lease obligations - current portion                                          48,774          47,593
    Accrued mail-in rebates                                                             167,055         432,046
                                                                                   ------------    ------------
       Total current liabilities                                                      6,360,201      12,974,754
                                                                                   ------------    ------------
LONG-TERM LIABILITIES
    Capital lease obligations                                                            39,919          65,885
                                                                                   ------------    ------------
    Total long-term liabilities                                                          39,919          65,885
                                                                                   ------------    ------------
    Total liabilities                                                                 6,400,120      13,040,639
                                                                                   ------------    ------------
STOCKHOLDERS' EQUITY (DEFICIT)
    Preferred stock, $0.001 par value, 10,000,000 shares authorized
       Series A, 1,000,000 shares authorized, no shares issued and outstanding               --              --
       Series B, 1,000,000 shares authorized, no shares issued and outstanding               --              --
    Common stock, $0.001 par value, 100,000,000 shares authorized, 4,540,292 and
       4,540,292 shares issued and outstanding, respectively                              4,541           4,541
    Additional paid-in capital                                                       31,820,122      31,794,655
    Accumulated deficit                                                             (32,894,424)    (29,910,576)
                                                                                   ------------    ------------
    Total stockholders' equity (deficit)                                             (1,069,761)      1,888,620
                                                                                   ------------    ------------
       TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)                        $  5,330,359    $ 14,929,259
                                                                                   ============    ============

                   See accompanying notes to these condensed consolidated financial statements

                                                       1

<PAGE>

                                  I/OMAGIC CORPORATION AND SUBSIDIARY
                            CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                              (UNAUDITED)

                                               THREE MONTHS ENDED               SIX MONTHS ENDED
                                                     JUNE 30,                       JUNE 30,
                                              2008            2007            2008            2007
                                          ------------    ------------    ------------    ------------

NET SALES                                 $  2,205,033    $  6,487,868    $  7,736,966    $ 14,179,033
COST OF SALES                                3,211,707       5,984,302       8,376,345      12,779,406
                                          ------------    ------------    ------------    ------------
GROSS PROFIT (LOSS)                         (1,006,674)        503,566        (639,379)      1,399,627
                                          ------------    ------------    ------------    ------------
OPERATING EXPENSES
     Selling, marketing and advertising        351,135         264,343         697,697         607,784
     General and administrative                767,035         932,287       1,491,360       1,840,027
     Depreciation and amortization              32,537          35,393          66,409          69,600
                                          ------------    ------------    ------------    ------------
         Total operating expenses            1,150,707       1,232,023       2,255,466       2,517,411
                                          ------------    ------------    ------------    ------------
LOSS FROM OPERATIONS                        (2,157,381)       (728,457)     (2,894,845)     (1,117,784)
                                          ------------    ------------    ------------    ------------
OTHER INCOME (EXPENSE)
     Interest income                                --               1              --               5
     Interest expense                          (16,820)       (110,907)        (90,748)       (233,195)
     Currency transaction loss                     (84)           (853)           (446)            (11)
     Other income                                3,101             617           2,991           5,651
         Total other income (expense)          (13,803)       (111,142)        (88,203)       (227,550)
LOSS BEFORE PROVISION FOR INCOME TAXES      (2,171,184)       (839,599)     (2,983,048)     (1,345,334)
PROVISION FOR INCOME TAXES                          --              --             800             800
NET LOSS                                  $ (2,171,184)   $   (839,599)   $ (2,983,848)   $ (1,346,134)
                                          ============    ============    ============    ============
BASIC AND DILUTED LOSS PER SHARE          $      (0.48)   $      (0.18)   $      (0.66)   $      (0.30)
                                          ============    ============    ============    ============
BASIC AND DILUTED WEIGHTED-
   AVERAGE SHARES OUTSTANDING                4,540,292       4,540,292       4,540,292       4,540,292
                                          ============    ============    ============    ============


              See accompanying notes to these condensed consolidated financial statements

                                                   2

<PAGE>

                          I/OMAGIC CORPORATION AND SUBSIDIARY
                    CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                      (UNAUDITED)

                                                                 SIX MONTHS ENDED
                                                                     JUNE 30,
                                                               2008            2007
                                                            -----------    -----------

CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                                 $(2,983,848)   $(1,346,134)
   Adjustments to reconcile net loss to net cash provided
         by (used in) operating activities:
      Depreciation and amortization                              31,945         35,136
      Amortization of trademarks                                 34,464         34,464
      Allowance for doubtful accounts                          (136,128)          (133)
      Allowance for product returns                            (157,314)      (120,642)
      Reserves for sales incentives                              25,178       (573,959)
      Accrued point-of-sale rebates                             (70,732)            --
      Accrued market development funds, cooperative
         advertising costs and cross-dock fees                 (341,549)            --
      Allowance for obsolete inventory                           71,974       (289,709)
      Share-based compensation expense                           25,467         34,728
   Changes in assets and liabilities (net of dispositions
         and acquisitions)
      Accounts receivable                                     6,521,951      8,986,290
      Inventory                                               2,461,226       (218,424)
      Prepaid expenses and other current assets                    (863)      (106,964)
      Accounts payable, accrued expenses and other             (383,925)    (3,277,131)
      Accounts payable - related party                       (2,461,116)    (3,562,704)
      Capital leases                                            (24,785)            --
      Accrued mail-in rebates                                  (264,991)      (762,816)
                                                            -----------    -----------
Net cash provided by (used in) operating activities           2,346,954     (1,167,998)
                                                            -----------    -----------
CASH FLOWS FROM INVESTING ACTIVITIES
   Restricted cash                                              341,397        869,733
   Equipment additions                                               --       (123,553)
                                                            -----------    -----------
Net cash provided by investing activities                       341,397        746,180
                                                            -----------    -----------
CASH FLOWS FROM FINANCING ACTIVITIES
   Net payments on line of credit                            (3,505,702)      (595,415)
                                                            -----------    -----------
Net cash used in financing activities                        (3,505,702)      (595,415)
                                                            -----------    -----------
Net decrease in cash and cash equivalents                      (817,351)    (1,017,233)
Cash and cash equivalents at beginning of period              1,463,122      1,833,481
                                                            -----------    -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD                  $   645,771    $   816,248
                                                            ===========    ===========
   SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
      INTEREST PAID                                         $    90,748    $   233,195
                                                            ===========    ===========
      INCOME TAXES PAID                                     $       800    $       800
                                                            ===========    ===========


      See accompanying notes to these condensed consolidated financial statements

                                           3
</TABLE>

<PAGE>

                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 -- ORGANIZATION AND BUSINESS

Nature of Business
------------------

I/OMagic Corporation ("I/OMagic"), a Nevada corporation, and its subsidiary IOM
Holdings, Inc. (collectively, the "Company"), develops, manufactures through
subcontractors or obtains from suppliers, markets and sells electronic 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 retailers.

Liquidity and Going Concern
---------------------------

The Company experienced a net loss for the three and six month periods ended
June 30, 2008 of $2,171,184 and $2,983,848, respectively, and has experienced
losses for the years ended December 31, 2007, 2006, 2005 and 2004 of $4,708,617,
$309,172, $1,818,250 and $8,056,864, respectively. At June 30, 2008, the Company
had cash and cash equivalents of $645,771 and as of August 15, 2008, the Company
had only $225,677 of cash on hand. Also, at June 30, 2008, the Company had a
stockholders' deficit of $1,069,761. Accordingly, the Company is presently
experiencing a lack of liquidity and may have insufficient liquidity to fund its
operations for the next twelve months. The Company's consolidated financial
statements as of and for the year ended December 31, 2007 and the accompanying
condensed consolidated financial statements as of and for the three and six
months ended June 30, 2008 have been prepared on a going concern basis, which
contemplates the realization of assets and satisfaction of liabilities in the
normal course of business. As discussed in this report, the Company has incurred
significant recurring losses, has working capital and stockholders' deficits,
has serious liquidity concerns and may require additional financing in the
foreseeable future. These factors, among others, raise substantial doubt about
the Company's ability to continue as a going concern. The condensed consolidated
financial statements included in this document do not include any adjustments
that might result from the outcome of this uncertainty.

The Company's plans for correcting these deficiencies include ongoing efforts to
bring new products to market and exploring other products with its suppliers and
retailers to sell through its sales channels, negotiating suitable repayment
terms for outstanding obligations owed to the Company's related-party supplier,
seeking new equity capital and new vendor partnerships, timely collection of
existing accounts receivable, and sell-through of inventory currently in the
Company's sales channels. The Company also needs to restructure its operations
to reduce its operating costs. If the Company's capital requirements or cash
flow vary materially from its current projections, if the Company is unable to
successfully negotiate suitable repayment terms for outstanding obligations owed
to a related-party supplier, if the Company is unable to successfully
restructure its operations and lower its operating costs, if the Company is
unable to timely collect its accounts receivable or unable to sell-through
inventory currently in its sales channels as anticipated, or if unforeseen
circumstances occur, the Company may be unable to increase its liquidity and may
require additional financing. In addition, if the Company is unable to bring
successful new products to market soon, the Company may be forced to
substantially curtail its operations.

If the Company's net losses continue or increase, the Company could experience
significant additional shortages of liquidity and its ability to purchase
inventory and to operate its business may be significantly impaired, which could
lead to further declines in its results of operations and financial condition.

                                       4

<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 2 - BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of
I/OMagic Corporation have been prepared pursuant to the rules and regulations of
the Securities and Exchange Commission regarding interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for annual financial statements and
should be read in conjunction with the consolidated financial statements for the
year ended December 31, 2007, and notes thereto included in the Company's Annual
Report on Form 10-K, filed with the Securities and Exchange Commission on March
31, 2008. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments, consisting only of
adjustments of a normal recurring nature, necessary for a fair presentation of
the Company's financial position as of June 30, 2008, and its results of
operations for the periods presented. These unaudited condensed consolidated
financial statements are not necessarily indicative of the results to be
expected for the entire year.

The report of the Company's independent registered public accounting firm
contained in the Company's financial statements as of and for the year ended
December 31, 2007, dated March 31, 2008, includes a paragraph that explains that
the Company has incurred significant recurring losses, has serious liquidity
concerns and may require additional financing in the foreseeable future. The
report concludes that these matters, among others, raise substantial doubt about
the Company's ability to continue as a going concern. Reports of independent
auditors questioning a company's ability to continue as a going concern are
generally viewed unfavorably by analysts and investors. This report may make it
difficult for the Company to raise additional financing necessary to grow or
operate its business. The Company urges potential investors to review this
report before making a decision to invest in I/OMagic.

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 revenues and expenses during the
reporting period. Actual results could differ materially from those estimates
and assumptions.

The condensed consolidated financial statements include IOM Holdings, Inc.
Intercompany transactions and balances have been eliminated in consolidation.

Certain amounts from prior periods have been reclassified to conform with
current period presentation.

NOTE 3 - CONCENTRATION OF RISK

Retailers
---------

During the six months ended June 30, 2008, the Company's most significant
retailers were Staples, Target, Tech Data and Peytons. Collectively, these four
retailers accounted for 76.1% of the Company's net sales in the first six months
of 2008. During the six months ended June 30, 2007, the Company's most
significant retailers were Staples, Office Max, Office Depot and Circuit City.
Collectively, these four retailers accounted for 86.4% of the Company's net
sales in the first six months of 2007.

As of June 30, 2008, three of the Company's retailers represented 84.5% of total
accounts receivable. As a result of the substantial amount and concentration of
the Company's accounts receivable, if any of its major retailers fails to timely
pay the Company amounts owed, the Company could suffer a significant decline in
cash flow and liquidity which could adversely affect the Company's ability to
pay its liabilities and to purchase inventory to sustain its operations.


                                       5

<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Related Parties
---------------

During the six months ended June 30, 2008, the Company purchased inventory from
a related-party, BTC USA, an affiliate of Behavior Tech Computer Corp. ("BTC"),
in amounts totaling $723,600, which represented 17.4% of total inventory
purchases during the period. As of June 30, 2008, there were $4,953,096 in trade
payables outstanding to the related party.

NOTE 4 - ACCOUNTS RECEIVABLE

Accounts receivable as of June 30, 2008 and December 31, 2007 consisted of the
following:

                                                       JUNE 30,     DECEMBER 31,
                                                        2008            2007
                                                     -----------    -----------
Accounts receivable                                  $ 1,724,782    $ 8,246,733
Less: Allowance for doubtful accounts                    (10,000)      (146,128)
      Allowance for product returns                     (242,954)      (400,268)
      Reserve for sales incentives                       (66,166)       (40,988)
      Accrued point-of-sale rebates                     (189,797)      (260,529)
      Accrued market development funds, cooperative
         advertising costs and cross-dock fees          (115,415)      (456,964)
                                                     -----------    -----------
   TOTAL                                             $ 1,100,450    $ 6,941,856
                                                     ===========    ===========

NOTE 5 - INVENTORY

Inventory as of June 30, 2008 and December 31, 2007 consisted of the following:

                                                       JUNE 30,     DECEMBER 31,
                                                        2008            2007
                                                     -----------    -----------
Component parts                                      $   112,919    $   270,083
Finished goods--warehouse                              2,523,186      3,408,544
Finished goods--consigned                                835,515      2,254,219
                                                     -----------    -----------
                                                       3,471,620      5,932,846
Less: Allowance for obsolete and slow-moving
        inventory                                       (511,974)      (440,000)
                                                     -----------    -----------
         TOTAL                                       $ 2,959,646    $ 5,492,846
                                                     ===========    ===========

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

                                       6




<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 6 - EQUIPMENT

Equipment as of June 30, 2008 and December 31, 2007 consisted of the following:

                                                       JUNE 30,     DECEMBER 31,
                                                        2008            2007
                                                     -----------    -----------
Computer equipment and software                      $   975,523    $   975,523
Warehouse equipment                                      138,065        138,065
Office furniture and equipment                           281,155        281,155
Vehicles                                                  74,742         74,742
Leasehold improvements                                   106,633        106,633
                                                     -----------    -----------
                                                       1,576,118      1,576,118
Less: Accumulated depreciation                        (1,360,512)    (1,328,567)
                                                     -----------    -----------
  TOTAL                                              $   215,606    $   247,551
                                                     ===========    ===========

For the three and six months ended June 30, 2008 and 2007, depreciation and
amortization expense was $15,305 and $31,945 and $18,161 and $35,135,
respectively.

NOTE 7 - TRADEMARKS

Trademarks as of June 30, 2008 and December 31, 2007 consisted of the following:

                                                       JUNE 30,     DECEMBER 31,
                                                        2008           2007
                                                     -----------    -----------
         Trademarks                                  $   499,800    $   499,800
         Less:    Amortization                          (241,248)      (206,784)
                                                     -----------    -----------
             TOTAL                                   $   258,552    $   293,016
                                                     ===========    ===========

Amortization expense on these intangible assets for the three and six months
ended June 30, 2008 and 2007 was $17,232 and $34,464, respectively. Amortization
expense related to these intangible assets at June 30, 2008 in each of the next
five fiscal years and beyond is as follows:

         Remainder of 2008                             $     34,464
         2009                                                68,928
         2010                                                68,928
         2011                                                68,928
         2012                                                17,304
                                                       ------------
                                                       $    258,552
                                                       ============

NOTE 8 - LINE OF CREDIT AND SUBSEQUENT EVENT

On January 29, 2007, the Company entered into a Loan and Security Agreement with
Silicon Valley Bank which provided for a credit facility that was initially used
to pay off the Company's outstanding loan balance as of January 29, 2007 with
GMAC Commercial Finance, which balance was approximately $5.0 million, and was
also used to pay $62,000 of the Company's closing fees in connection with
securing the credit facility.

On April 18, 2008, the Company entered into a new Loan and Security Agreement
with Silicon Valley Bank which provided for a credit facility based on the
Company's accounts receivable. The Loan and Security Agreement served to amend
and restate the Company's prior Loan and Security Agreement dated January 29,
2007 with Silicon Valley Bank. On April 18, 2008, the Company also entered into
an Amendment to Loan Documents with Silicon Valley Bank, which provided that the
ancillary loan documents executed in connection with the Company's prior credit
facility with Silicon Valley Bank would apply to the new Loan and Security
Agreement.


                                       7

<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


The new credit facility allowed the Company to finance its accounts receivable
and borrow up to a maximum aggregate amount of $7.0 million; provided, that the
Company could only borrow up to a limit of 60% of each eligible account or such
other percentage as Silicon Valley Bank established. The credit facility was to
expire on January 29, 2009. Advances under the credit facility bore interest at
a floating rate equal to the prime rate published from time to time by Silicon
Valley Bank plus 2.5%. The credit facility required that the Company pay a
collateral handling fee of $2,000 per month and other customary fees and
expenses.

The Company's obligations under the Loan and Security Agreement were secured by
substantially all of its assets and were guaranteed by IOM Holdings, Inc. under
a Cross-Corporate Continuing Guaranty. The Company's obligations and the
guarantee obligations of IOM Holdings, Inc. were also secured under Intellectual
Property Security Agreements executed by the Company and IOM Holdings, Inc.

On July 31, 2008, the Company paid off its obligations owed under its Loan and
Security Agreement dated April 18, 2008 with Silicon Valley Bank and terminated
the Loan and Security Agreement.

NOTE 9 - TRADE CREDIT FACILITIES WITH RELATED PARTIES

On June 6, 2005, the Company entered into a trade credit facility with a related
party, Lung Hwa Electronics Co., Ltd., one of the Company's significant
stockholders, whereby the related party agreed to purchase and manufacture
inventory on behalf of the Company. The Company can purchase up to $15.0 million
of inventory either (i) through the related party as an international purchasing
office, or (ii) manufactured by the related party. For inventory purchased
through the related party, the terms are 120 days following the date of invoice
by the related party and the related party charges the Company a 5% handling fee
on a supplier's unit price. A 2% discount of the handling fee is applied if the
Company reaches an average running monthly purchasing volume of $750,000.
Returns made by the Company, which are agreed to by this supplier, result in a
credit to the Company for the handling charge. For inventory manufactured by the
related party, the payment terms are 90 days following the date of the invoice
by the related party. The Company is to pay the related party 10% of the
purchase price on any purchase orders issued to the related party, as a
down-payment for the order, within one week of the purchase order. The agreement
had an initial term of one year after which the agreement is to continue
indefinitely if not terminated at the end of the initial term. At the end of the
initial term and at any time thereafter, either party has the right to terminate
the facility upon 30 days' prior written notice to the other party. The
agreement containing the terms of the new trade credit facility was amended and
restated on July 21, 2005 to provide that the new facility would be retroactive
to April 29, 2005. During the six months ended June 30, 2008, the Company made
no purchases under this arrangement. As of June 30, 2008, there were no trade
payables outstanding under this arrangement.

In February 2003, the Company entered into an agreement with a related party,
BTC, one of the Company's significant stockholders, whereby the related party
and its affiliated companies agreed to supply the Company with up to $10.0
million of inventory. Mr. Steel Su, a director of the Company, is the Chief
Executive Officer of Behavior Tech Computer Corp. The agreement may be
terminated by either party upon 60 days' prior written notice. In addition, the
agreement provides for a trade line of credit of up to $10.0 million with
payment terms of net 60 days on a non-interest bearing basis. However, due to
substantial outstanding obligations owed to BTC, it is highly unlikely that the
Company would be able to obtain additional inventory supplies from BTC unless,
and at least until, the Company is able to negotiate repayment terms acceptable
to BTC. Even if the Company is able to negotiate repayment terms acceptable to
BTC, the Company may be unable to obtain additional inventory supplies from BTC
on the same terms as before, on satisfactory terms, or at all. During the six
months ended June 30, 2008, the Company purchased $723,600 of inventory under
this arrangement. As of June 30, 2008, there were $4,953,096 in trade payables
outstanding under this arrangement. As of August 15, 2008, the Company was out
of compliance with the payment terms of its agreement with BTC. The Company is
negotiating repayment terms for outstanding obligations owed to BTC.

                                       8

<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 10 - COMMITMENTS AND CONTINGENCIES

Legal Matters
-------------

On or about May 30, 2003, the Company and IOM Holdings, Inc. filed a complaint
for breach of contract and legal malpractice against Lawrence W. Horwitz,
Gregory B. Beam, Horwitz & Beam, Inc., Lawrence M. Cron, Horwitz & Cron, Kevin
J. Senn and Senn Palumbo Meulemans, LLP, the Company's former attorneys and
their respective law firms, in the Superior Court of the State of California for
the County of Orange. The complaint sought damages of $15.0 million arising out
of the defendants' representation of the Company and IOM Holdings, Inc. in an
acquisition transaction and in a separate arbitration matter. On or about
November 6, 2003, the Company filed its First Amended Complaint against all
defendants. Defendants responded to the First Amended Complaint denying the
Company's allegations. Defendants Lawrence W. Horwitz and Lawrence M. Cron also
filed a Cross-Complaint against I/OMagic for attorneys' fees in the approximate
amount of $79,000. The Company denied the allegations in the Cross-Complaint.
Trial began on February 6, 2006 and on March 10, 2006, the jury ruled in the
Company's favor against Lawrence W. Horwitz, Horwitz & Beam, Inc., Lawrence M.
Cron, Horwitz & Cron and Senn Palumbo Meulemans, LLP, and awarded the Company
$3.0 million in damages. Judgment was entered on or about April 5, 2006.
Thereafter, defendants filed a motion for new trial and a motion for judgment
notwithstanding the verdict. On May 31, 2006, the Court denied the motion for
new trial in its entirety, denied the motion for judgment notwithstanding the
verdict as to Lawrence W. Horwitz, Horwitz & Beam, Inc. and Lawrence M. Cron,
but granted the motion for judgment notwithstanding the verdict as to Horwitz &
Cron and Senn Palumbo Meulemans, LLP. An Amended Judgment Notwithstanding, the
Verdict based upon the Court's ruling on the motion for judgment notwithstanding
the verdict was entered on or about July 7, 2006. Thereafter, appeals were filed
as to both the original Judgment and the Amended Judgment. On March 27, 2008,
the Court of Appeal issued an opinion against the Company as to all defendants,
which reversed the Judgments in the Company's favor as to Lawrence W. Horwitz,
Horwitz & Beam, Inc. and Lawrence M. Cron. The Court of Appeal also ordered that
the Company is to pay defendants' costs on appeal, which the Company is unable
to estimate as of the filing of this report. The Company does not intend to
appeal the Court of Appeal's ruling.

In addition to the matter described above, the Company may be 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 effect on the Company's financial position, results of
operations or cash flows.

Other Contractual Obligations
-----------------------------

During its normal course of business, the Company has made commitments under
which it will or may be required to make payments in relation to certain
transactions. These include lease, service and retail agreements and employment
contracts. See "Note 11--Commitments and Contingencies" in the Company's Annual
Report on Form 10-K for the year ended December 31, 2007.

NOTE 11 - SHARE-BASED COMPENSATION

On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123 (revised 2004), SHARE-BASED PAYMENT, which requires
the measurement and recognition of compensation expense for all share-based
payment awards made to employees and directors based on estimated fair values.
SFAS No. 123(R) supersedes the Company's previous accounting under Accounting
Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. In
March 2005, the Securities and Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 107 relating to SFAS No. 123(R). The Company has also
applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).


                                       9

<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


The Company has a 2002 Stock Option Plan (the "2002 Plan") and a 2003 Stock
Option Plan (the "2003 Plan"). The 2002 Plan and 2003 Plan are collectively
referred to as the "Plans." The total number of shares of the Company's common
stock authorized for issuance under the 2002 Plan and the 2003 Plan are 133,334,
and 400,000, respectively. The Plans are more fully described in the Company's
Annual Report on Form 10-K for the year ended December 31, 2007.

As of June 30, 2008, there were options to acquire 353,775 shares of common
stock issued to employees and directors that were outstanding under the Plans.

The weighted-average exercise prices, remaining contractual lives and aggregate
intrinsic values for options and warrants granted, exercisable, and expected to
vest under the Plans as of June 30, 2008 were as follows:

                                              WEIGHTED-
                                  WEIGHTED-    AVERAGE
                                  AVERAGE      REMAINING
                      NUMBER OF   EXERCISE    CONTRACTUAL     INTRINSIC
OPTIONS                 SHARES     PRICE      LIFE (YEARS)     VALUE(1)
-------------------------------------------------------------------------
Outstanding            353,775    $  3.15        1.87        $ 1,114,391
Expected to vest       348,508    $  3.15        1.87        $ 1,097,800
Exercisable            314,431    $  3.14        1.77        $   973,829
----------
(1) Awards that are expected to vest take into consideration estimated
forfeitures for awards not yet vested.

There were no options granted during the six months ended June 30, 2008 and
2007. No cash was received from the exercise of stock options for the six months
ended June 30, 2008 and 2007. As of June 30, 2008, there was $64,870 of total
unrecognized compensation costs related to non-vested share-based compensation
arrangements. That cost is expected to be recognized over the weighted-average
period of 1.46 years.

Share-based compensation expense was $25,467 and $34,728 for the six months
ended June 30, 2008 and 2007, respectively. There was no tax deduction for
share-based compensation expense during those periods. When options are
exercised, the Company's policy is to issue new shares to satisfy share option
exercises.

The Company expenses share-based compensation in cost of goods sold or general
and administrative expenses depending on the job function of the employee.

NOTE 12 - INCOME TAXES

The Company is required to file federal and state income tax returns in the
United States. The preparation of these tax returns requires the Company to
interpret the applicable tax laws and regulations in effect in such
jurisdictions, which could affect the amount of tax paid by the Company. The
Company, in consultation with its tax advisors, bases its tax returns on
interpretations that are believed to be reasonable under the circumstances. The
tax returns, however, are subject to routine reviews by the various federal and
state taxing authorities in the jurisdictions in which the Company files its
returns. As part of these reviews, a taxing authority may disagree with respect
to the tax positions taken by the Company ("uncertain tax positions") and
therefore require the Company to pay additional taxes. The Company prepares an
accrual for uncertain tax positions as more definitive information becomes
available from taxing authorities, completion of tax audits, expiration of
statute of limitations, or upon occurrence of other events. With few exceptions,
the Company is no longer subject to United States federal, state or local, or
non-United States income tax examination by tax authorities for tax years before
2001.

                                       10

<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Prior to January 1, 2007, the Company analyzed and determined no accrual was
required for uncertain tax positions based upon SFAS No. 5, ACCOUNTING FOR
CONTINGENCIES, which requires the Company to accrue for the estimated additional
amount of taxes for the uncertain tax positions if it was probable the Company
would be required to pay such additional taxes. Effective January 1, 2007, the
Company adopted and implemented the provisions of FASB Interpretation No.
("FIN") 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES, which requires the
Company to accrue for the estimated additional amount of taxes for the uncertain
tax positions if it is more likely than not that the Company would be required
to pay such additional taxes. As a result of the implementation of FIN 48, the
Company recognized no charge for uncertain tax positions.

SFAS No. 109, ACCOUNTING FOR INCOME TAXES, requires that a valuation allowance
be established when it is more likely than not that its recorded net deferred
tax asset will not be realized. In determining whether a valuation allowance is
required, a company must take into account all positive and negative evidence
with regard to the utilization of a deferred tax asset. SFAS No. 109 further
states that it is difficult to conclude that a valuation allowance is not needed
when there is negative evidence such as cumulative losses in recent years. As of
June 30, 2008 and December 31, 2007 the valuation allowance for deferred tax
assets totaled $16,035,077 and $14,851,966, respectively. For the six month
periods ended June 30, 2008 and 2007, the net change in the valuation allowance
was $1,836,111 (increase) and $333,242 (increase), respectively.

The Company plans to continue to provide a full valuation allowance on future
tax benefits until it can sustain an appropriate level of profitability and
until such time, the Company would not expect to recognize any significant tax
benefits in its future results of operations.

As of June 30, 2008, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $36,523,000 and
$25,707,000, respectively, that expire through 2028 and 2018, 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.

FIN 48 not only impacts the amount of the Company's accrual for uncertain tax
positions but it also impacts the manner in which such accruals should be
classified in the Company's financial statements. In connection with the
implementation of FIN 48, and if an accrual is recorded, the Company will record
the aggregate accrual for uncertain tax positions as a component of current or
non-current income tax payable and the offsetting amounts as a component of the
Company's net deferred tax assets and liabilities.

The Company's continuing practice is to recognize interest and/or penalties
related to income tax matters in income tax expense. As of June 30, 2008 and
December 31, 2007, the Company had no accrual for the payment of interest and
penalties

NOTE 13 - LOSS PER SHARE

Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. Options with an exercise price in excess of the average
market value of the Company's common stock during the period have been excluded
from the calculation as their effect would be antidilutive. Additionally,
potentially dilutive securities are excluded from the computation of earnings
per share in periods in which a net loss is reported as their effect would be
antidilutive. Thus, both basic and diluted weighted-average shares outstanding
are the same in all periods presented.

                                       11

<PAGE>
                       I/OMAGIC CORPORATION AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 14 - SEGMENT INFORMATION

The Company currently operates in one business segment. All fixed assets are
located at the Company's headquarters in the United States. All sales for the
six months ended June 30, 2008 were in the United States.

NOTE 15 - RECENT ACCOUNTING PRONOUNCEMENTS

In March 2008, the FASB issued SFAS No. 161, DISCLOSURES ABOUT DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 161 is intended to improve
financial reporting about derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity's financial position, financial performance, and cash
flows. SFAS No. 161 is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008. The Company
believes that the adoption of SFAS No. 161 will not have a material impact on
its consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (R), BUSINESS COMBINATIONS. SFAS
No. 141(R) requires an entity to recognize the assets acquired, liabilities
assumed, contractual contingencies, and contingent consideration at their fair
value on the acquisition date. It also requires acquisition-related costs to be
expensed as incurred, restructuring costs to generally be expensed in periods
subsequent to the acquisition date, and changes in accounting for deferred tax
asset valuation allowances and acquired income tax uncertainties after the
measurement period impact income tax expense. The adoption of SFAS No. 141(R)
will change the Company's accounting treatment for business combinations on a
prospective basis beginning January 1, 2009.

In December 2007, the FASB issued SFAS No. 160, NONCONTROLLING INTERESTS IN
CONSOLIDATED FINANCIAL STATEMENTS. SFAS No. 160 changes the accounting and
reporting for minority interests, which will be characterized as non-controlling
interests and classified as a component of equity. SFAS No. 160 is effective for
the Company on a prospective basis in the first quarter of fiscal year 2009. The
Company has not yet determined the impact on its consolidated financial
statements of adopting SFAS No. 160.

In February 2007, the FASB issued SFAS No. 159, THE FAIR VALUE OPTION FOR
FINANCIAL ASSETS AND FINANCIAL LIABILITIES. SFAS No. 159 permits entities to
choose to measure, on an item-by-item basis, specified financial instruments and
certain other items at fair value. Unrealized gains and losses on items for
which the fair value option has been elected are required to be reported in
earnings at each reporting date. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007, the provisions of which are required to be
applied prospectively. The Company adopted SFAS No. 159 in the first quarter of
2008. The adoption of SFAS No. 159 did not have a material effect on the
Company's financial position, results of operations or cash flows for the second
quarter of 2008 and the Company has made no election under SFAS No. 159.

In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS, which
defines the fair value, establishes a framework for measuring fair value and
expands disclosures about fair value measurements. This statement is effective
for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. In February 2008, the FASB
issued FASB Staff Position 157-2, EFFECTIVE DATE OF FASB STATEMENT 157, which
deferred the effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008 for nonfinancial assets and nonfinancial liabilities. Early
adoption is encouraged, provided that the Company has not yet issued financial
statements for that fiscal year, including any financial statements for an
interim period within that fiscal year. The Company adopted SFAS No. 157
effective January 1, 2008. The adoption of SFAS No. 157 had no impact on the
Company's accounting or disclosure as to its assets and liabilities at June 30,
2008 and did not materially affect the Company's financial position, results of
operations or cash flows for the six months ended June 30, 2008. The Company
will continue to make an evaluation of the fair value of its assets and
liabilities as of the end of each future reporting period.


                                       12

<PAGE>


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

      THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30,
2008 AND THE RELATED NOTES AND THE OTHER FINANCIAL INFORMATION INCLUDED
ELSEWHERE IN THIS REPORT. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS
REGARDING THE DATA STORAGE AND DIGITAL ENTERTAINMENT INDUSTRIES AND OUR
EXPECTATIONS REGARDING OUR FUTURE PERFORMANCE, LIQUIDITY AND FINANCIAL
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 THE "RISK FACTORS" SECTION OF OUR ANNUAL REPORT ON FORM
10-K FOR THE YEAR ENDED DECEMBER 31, 2007 AND ELSEWHERE IN THIS REPORT.

OVERVIEW

      We sell data storage products, televisions, most of which are
high-definition televisions, or HDTVs, utilizing liquid crystal display, or LCD,
technology, and other consumer electronics products. Our data storage products
collectively accounted for approximately 81.2% of our net sales for the six
months of 2008, our HDTVs accounted for approximately 17.9% of our net sales for
the first six months of 2008 and our other consumer electronics products
collectively accounted for approximately 0.9% of our net sales in the first six
months of 2008.

      Our data storage products consist of a range of products that store
traditional personal computer data as well as movies, music, photos, video games
and other multi-media content. Our television products consist of a range of LCD
televisions of different sizes. Our other consumer electronics products consist
of a range of products that focus on digital movies, music and photos.

      We sell our products through computer, consumer electronics and office
supply superstores, wholesale clubs, distributors, and other major North
American retailers. Our network of retailers enables us to offer products to
consumers across North America, including in every major metropolitan market in
the United States. During the first six months of 2008, our most significant
retailers were Staples, Target, Tech Data and Peytons. Collectively, these four
retailers accounted for 76.1% of our net sales during that period. During the
first six months of 2007, our most significant retailers were Staples, Office
Max, Office Depot and Circuit City. Collectively, these four retailers accounted
for 86.4% of our net sales during that period.

      We market our products primarily under our I/OMagic(R) and Digital
Research Technologies(R) brand names, but from time to time, we also market
products under our Hi-Val(R) brand name. We sell our data storage products
primarily under our I/OMagic(R) brand name, bundling various hardware devices
with different software applications to meet a range of consumer needs. We
market our televisions under our Digital Research Technologies(R) brand name.

      We do not directly manufacture any of the components incorporated into
products that we sell. We subcontract the manufacturing of the majority of our
products or source our products from Asia, predominantly from Taiwan and China,
which allows us to offer products at highly competitive prices. Most of our
subcontract manufacturers and suppliers have substantial product development
resources and facilities, and are among the major component manufacturers and
suppliers in their product categories, which we believe affords us substantial
flexibility in offering new and enhanced products. Some of our largest
subcontract manufacturers and suppliers are also our stockholders, including
Behavior Tech Computer Corp. and its affiliated companies, or BTC, and Lung Hwa
Electronics Co., Ltd., or Lung Hwa. Both BTC and Lung Hwa have historically
provided us with significant trade lines of credit. Each of BTC and Lung Hwa
have historically provided us with significant benefits by allowing us to
purchase products on terms more advantageous than we believe are generally
available in our industry. These advantageous terms have historically included
generous trade lines of credit and extended payment terms. See "--Liquidity and
Capital Resources, Trade Credit Facilities" below. However, due to substantial
outstanding obligations owed to BTC, it is highly unlikely that we would be able
to obtain additional inventory supplies from BTC unless, and at least until, we
are able to negotiate repayment terms acceptable to BTC. Even if we are able to
negotiate repayment terms acceptable to BTC, we may be unable to obtain
additional inventory supplies from BTC on the same terms as before, on
satisfactory terms, or at all.

                                       13

<PAGE>

RECENT DEVELOPMENTS

      As of August 15, 2008, we had only $225,677 of cash on hand and we are
experiencing a lack of liquidity and may have insufficient liquidity to fund our
operations for the next twelve months. These factors, among others, raise
substantial doubt about our ability to continue as a going concern. See
"--Liquidity and Capital Resources, Overview" below.

      During the fourth quarter of 2007, we received notice from Office Depot
that it would not offer any of our products during at least the first quarter of
2008 and probably through the second quarter of 2008. In addition, during the
first quarter of 2008, we received notice from OfficeMax that it would not offer
any of our products during the first and second quarters of 2008. Our sales
through both Office Depot and OfficeMax are entirely on a consigned inventory
basis. Office Depot returned substantial inventory in the fourth quarter of 2007
and OfficeMax returned substantial inventory in the first quarter of 2008, each
in anticipation of discontinuing sales of our products. We intend to offer new
products to both Office Depot and OfficeMax for their consideration to include
in their product offerings during the second half of 2008. However, we cannot
provide any assurance that we will be able to sell any products through either
Office Depot or OfficeMax in the future.

      We continue to experience significant declines in sales of our data
storage products as we are experiencing intense price competition for magnetic
data storage products from major competitors such as Western Digital and Seagate
Technology/Maxtor who are original equipment manufacturers of hard disk drives,
which has significantly reduced selling prices and eroded our margins for
magnetic data storage products. Due to this intense price competition, we may
not be able to sell our inventory of magnetic data storage products at positive
gross margins. We are unable to predict whether the market for and selling
prices of magnetic data storage products will stabilize, increase or further
decline in the future. In response to these market conditions, and also as part
of its ongoing efforts to bring new products to market, management is currently
exploring other products with our suppliers and retailers to sell through our
sales channels.

      We are experiencing an inability to obtain supplies of our HDTVs due to
the substantial working capital requirements needed to sustain HDTV inventories.
If our inability to obtain supplies of HDTVs continues, we may not be able to
meet the demand of our retailers which may cause a decline in our net sales. We
do not believe that our existing subcontract manufacturers will be able to
independently provide adequate trade credit facilities to support our HDTV
sales, but we are attempting to negotiate new trade credit facilities with other
vendors to support future HDTV sales.

SEASONALITY

      Our sales have historically been seasonal. The seasonality of our sales is
in direct correlation to the seasonality experienced by our retailers and the
seasonality of the consumer electronics industry in general. After adjusting for
the addition of new retailers, our fourth quarter has historically generated the
strongest sales, which correlates to well-established consumer buying patterns
during the Thanksgiving through Christmas holiday season. Our first and third
quarters have historically shown some strength from time to time based on
post-holiday season sales in the first quarter and back-to-school sales in the
third quarter. Our second quarter has historically been our weakest quarter for
sales, again following well-established consumer buying patterns. The impact of
seasonality on our future results will be affected by our product mix, which
will vary from quarter to quarter.

                                       14

<PAGE>

CRITICAL ACCOUNTING POLICIES

      The preparation of our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America, requires us to make judgments and estimates that may have a significant
impact upon the portrayal of our financial condition and results of operations.
We believe that of our significant accounting policies, the following require
estimates and assumptions that require complex, subjective judgments by
management that can materially impact the portrayal of our financial condition
and results of operations: going concern assumption, revenue recognition; sales
incentives; market development funds and cooperative advertising costs, rebate
promotion costs and slotting fees; inventory obsolescence allowance;
lower-of-cost-or-market reserve; accounts receivable and allowance for doubtful
accounts; and product returns. These significant accounting principles are more
fully described in "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Critical Accounting Policies" in our Annual Report on
Form 10-K for the year ended December 31, 2007.

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:

      o     The first two data columns in each table show the dollar results for
            each period presented.

      o     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 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.

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


                                       15

<PAGE>
<TABLE>
<S>            <C>
THREE MONTHS ENDED JUNE 30, 2008 COMPARED TO THREE MONTHS ENDED JUNE 30, 2007

                                    Three Months Ended       Dollar      Percentage          Results as a
                                        June 30,            Variance      Variance           Percentage of
                               -------------------------    Favorable     Favorable            Net Sales
                                  2008          2007      (Unfavorable) (Unfavorable)     2008          2007
                               -----------   -----------   -----------   -----------   -----------   -----------
                                           (in thousands)

Net sales                      $     2,205   $     6,488   $    (4,283)      (66.0)%      100.0%        100.0%
Cost of sales                        3,212         5,984         2,772        46.3%       145.7%         92.2%
                               -----------   -----------   -----------   -----------   -----------   -----------
Gross profit (loss)                 (1,007)          504        (1,511)     (299.8)%      (45.7)%         7.8%
Selling, marketing and
   advertising expenses                351           264           (87)      (33.0)%       15.9%          4.1%
General and administrative
   expenses                            767           933           166        17.8%        34.8%         14.4%
Depreciation and amortization           32            35             3         8.6%         1.5%          0.5%
                               -----------   -----------   -----------   -----------   -----------   -----------
Operating loss                      (2,157)         (728)       (1,429)     (196.3)%      (97.8)%        19.0%
Net interest expense                   (17)         (111)           94        84.7%         0.8%          1.7%
Other income                             3            --             3      (100.0)%        0.1%           --%
                               -----------   -----------   -----------   -----------   -----------   -----------
Loss from operations before
   provision for income taxes       (2,171)         (839)       (1,332)     (158.8)%      (98.5)%       (12.9)%
Income tax provision                    --            --            --          --%          --%           --%
                               -----------   -----------   -----------   -----------   -----------   -----------
Net loss                       $    (2,171)  $      (839)  $    (1,332)     (158.8)%      (98.5)%       (12.9)%
                               ===========   ===========   ===========   ===========   ===========   ===========
</TABLE>

      NET SALES. Net sales decreased by $4,283,000, or 66%, to $2,205,000 in the
second quarter of 2008 as compared to $6,488,000 in the second quarter of 2007.
A combination of factors affected our net sales, including a $3.1 million, or
76%, decrease in sales of our magnetic data storage products. Sales of our
magnetic data storage products totaled $973,000, or 44% of net sales, for the
second quarter of 2008, as compared to $4.0 million, or 62% of net sales, for
the second quarter of 2007. Sales of our optical data storage products decreased
41% to $1.1 million, or 51% of net sales, for the second quarter of 2008, as
compared to $1.9 million, or 30% of net sales, for the second quarter of 2007.
These decreases were partially offset by $100,000 in sales of our HDTVs in the
second quarter of 2008. Our HDTV product line was introduced in the fourth
quarter of 2007. In addition, our overall product return rate was 15.3% in the
second quarter of 2008 compared to 14.3% in the second quarter of 2007. The
increase in our overall product return rate resulted from an sales of our HDTVs
in the fourth quarter of 2007 and the first quarter of 2008, which experienced a
high rate of return. Also, sales incentives, market development funds and
cooperative advertising costs, rebate promotion costs and slotting fees,
collectively as a percentage of gross sales, decreased to 11.8%, all of which
were offset against gross sales, in the second quarter of 2008, as compared to
18.4% in the second quarter of 2007. The decrease in our overall rate of sales
incentives, market development funds and cooperative advertising costs, rebate
promotion costs and slotting fees resulted primarily from a decrease in sales of
our magnetic data storage products in the second quarter of 2008 as compared to
the second quarter of 2007, partially offset by an increase in sales incentives
associated with our optical data storage products due to increased competitive
pressures for these products in the second quarter of 2008 as compared to the
second quarter of 2007.

                                       16

<PAGE>

      GROSS PROFIT. Gross profit declined by $1.5 million, or 299%, to a
negative gross margin of $1.0 million in the second quarter of 2008 as compared
to gross profit of $500,000 in the second quarter of 2007. The decline in gross
profit resulted primarily from a decrease in net sales and related competitive
pricing pressures causing substantially lower unit sales prices for our data
storage products and substantial increases in our inventory reserves for
obsolescence and lower of cost or market adjustments. Our gross profit margin as
a percentage of net sales decreased to a negative 46% in the second quarter of
2008 as compared to a positive gross margin of 8% in the second quarter of 2007.
The decline in our gross profit margin predominantly resulted from substantially
lower unit selling prices for both our magnet and optical data storage products
caused by competitive pricing pressures and substantial increases in our
inventory reserves for obsolescence and lower of cost or market adjustments.

      SELLING, MARKETING AND ADVERTISING EXPENSES. Selling, marketing and
advertising expenses increased by $87,000, or 33%, to $351,000 in the second
quarter of 2008 as compared to $264,000 in the second quarter of 2007. This
increase was primarily due to increases of $33,000 in shipping and handling
expenses, $20,000 in outside commissions, $19,000 in customer penalties, $18,000
in system support, $7,000 in salaries and benefits and $4,000 in sales expenses,
all of which were partially offset by deceases of $8,000 in vendor training
programs, $3,000 in travel and entertainment expenses, $2,000 in temporary help
and $1,000 in trade shows.

      GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased by $166,000, or 18%, to $767,000 in the second quarter of 2008 as
compared to $933,000 in the second quarter of 2007. This decrease is due
primarily to decreases of $75,000 in legal fees primarily related to prior-year
litigation expenses, $64,000 in outside services, $40,000 in financial relations
expenses, $25,000 in salaries and benefits, $22,000 in travel and entertainment
expenses, $12,000 in system support, $7,000 in insurance expenses, $5,000 in
building repairs and maintenance, $4,000 in bank and financing expenses, $3,000
in utilities and $1,000 in office supplies, all of which were partially offset
by increases of $60,000 in bad debt expense, $12,000 in temporary help, $10,000
in miscellaneous expenses, $7,000 in audit fees and $3,000 in property taxes.

      DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
decreased in the second quarter of 2008 as compared to the second quarter of
2007. This decrease primarily resulted from certain of our fixed assets becoming
fully depreciated since June 30, 2007.

      NET INTEREST EXPENSE. Net interest expense decreased by $94,000, or 85%,
to $17,000 in the second quarter of 2008 as compared to $111,000 in the second
quarter of 2007. This decrease primarily resulted from lower borrowings on our
line of credit in the second quarter of 2008 as compared to the second quarter
of 2007.

      OTHER INCOME. Other income increased by $3,000, or 100%, in the second
quarter of 2008 as compared to the second quarter of 2007 primarily as a result
of miscellaneous income.

                                       17


<PAGE>
<TABLE>
<S>       <C>
SIX MONTHS ENDED JUNE 30, 2008 COMPARED TO SIX MONTHS ENDED JUNE 30, 2007

                                    Six Months Ended         Dollar      Percentage          Results as a
                                        June 30,            Variance      Variance           Percentage of
                               -------------------------    Favorable     Favorable            Net Sales
                                  2008          2007      (Unfavorable) (Unfavorable)     2008          2007
                               -----------   -----------   -----------   -----------   -----------   -----------
                                           (in thousands)

Net sales                      $     7,737   $    14,179   $    (6,442)     (45.4)%        100.0%       100.0%
Cost of sales                        8,376        12,779         4,403       34.5%         108.3%        90.1%
                               -----------   -----------   -----------   -----------   -----------   -----------
Gross profit (loss)                   (639)        1,400        (2,039)     (33.8)%         (8.3)%        9.9%
Selling, marketing and
   advertising expenses                698           608           (90)     (14.8)%          9.0%         4.3%
General and administrative
   expenses                          1,492         1,840           348       18.9%          19.3%       13.09%
Depreciation and amortization           66            70             4        5.7%           0.9%         0.5%
                               -----------   -----------   -----------   -----------   -----------   -----------
Operating loss                      (2,895)       (1,118)       (1,777)    (158.9)%        (37.4)%       (9.1)%
Net interest expense                   (91)         (233)          142       60.9%           1.2%         1.6%
Other income                             3             6            (3)     (50.0)%           --%          --%
                               -----------   -----------   -----------   -----------   -----------   -----------
Loss from operations before
   provision for income taxes       (2,983)       (1,345)       (1,638)    (121.6%)        (38.6)%       (9.5)%
Income tax provision                     1             1            --         --%            --%          --%
                               -----------   -----------   -----------   -----------   -----------   -----------
Net loss                       $    (2,984)  $    (1,346)  $    (1,638)    (121.6)%        (38.6)%       (9.5)%
                               ===========   ===========   ===========   ===========   ===========   ===========
</TABLE>

      NET SALES. Net sales decreased by $6,442,000, or 45%, to $7,737,000 in the
six months ended June 30, 2008 as compared to $14,179,000 in the six months
ended June 30, 2007. A combination of factors affected our net sales, including
a $442,000 decrease in sales of our optical data storage products. Sales of our
optical data storage products decreased by 12% to $3.2 million, or 42% of our
net sales, in the six months ended June 30, 2008 as compared to $3.7 million, or
26% of our net sales, in the six months ended June 30, 2007. Sales of our CD-
and DVD-based products continued to decrease in the six months ended June 30,
2008 compared to the six months ended June 30, 2007 because they are generally
included as a standard component in most new computer systems. Also, sales of
our mobile data storage products decreased by $4.0 million, or 75%, to $1.3
million, or 17% of our net sales, in the six months ended June 30, 2008 as
compared to $5.3 million, or 38% of our net sales, in the six months ended June
30, 2007, and net sales of our desktop data storage products decreased by 62% to
$1.7 million, or $23% of our net sales in the six months ended June 30, 2008 as
compared to $4.7 million, or 33% of our net sales during the six months ended
June 30, 2007. Net sales for our HDTV products totaled $1.4 million in the six
months ended June 30, 2008, or 18% of our net sales for the period. Our HDTV
product line was introduced in the fourth quarter of 2007.

      In addition, our overall product return rate was 21.9% in the six months
ended June 30, 2008 compared to 10.7% in the six months ended June 30, 2007. The
increase in our overall product return rate resulted from an increase in returns
of all our product categories including our HDTV products which experienced a
return rate of 37%. Sales incentives, market development funds and cooperative
advertising costs, rebate promotion costs and slotting fees, collectively as a
percentage of gross sales, were 7.3%, all of which were offset against gross
sales, in the six months ended June 30, 2008 compared to 16.6% in the six months
ended June 30, 2007. The decrease in our overall rate of sales incentives,
market development funds and cooperative advertising costs, rebate promotion
costs and slotting fees resulted from a decrease in promotional support for our
magnetic data storage products, partially offset by an increase in the rate of
sales incentives, market development funds and cooperative advertising costs,
rebate promotion costs and slotting fees for our optical data storage products
which experience substantial market pressure for these incentives.

                                       18

<PAGE>

      GROSS PROFIT. Gross profit decreased by $2.0 million, to a gross loss of
$639,000 in the six months ended June 30, 2008 as compared to gross profit
$1,400,000 in the six months ended June 30, 2007. The decrease in gross profit
primarily resulted from a decrease in net sales, a substantial decrease in
average unit sales prices for our data storage products and increases in our
inventory reserves for obsolescence and lower of cost or market adjustments. Our
gross profit margin as a percentage of net sales decreased to a negative 8.3% in
the six months ended June 30, 2008 as compared to a gross profit margin of 9.9%
in the six months ended June 30, 2007. The decline in our gross profit margin
predominantly resulted from higher product costs and therefore higher cost of
sales which increased to 108% in the six months ended June 30, 2008 compared to
90% in the six months ended June 30, 2007 and lower unit selling prices for both
our optical and magnetic data storage products caused by competitive pricing
pressures.

      SELLING, MARKETING AND ADVERTISING EXPENSES. Selling, marketing and
advertising expenses increased by $90,000, or 15%, to $698,000 in the six months
ended June 30, 2008 as compared to $608,000 in the six months ended June 30,
2007. This increase was primarily due to decreases of $46,000 in trade show
expenses, $20,000 in system support, $20,000 in sales expenses, $18,000 in
customer penalties, $13,000 in outside sales commissions and $10,000 in salaries
and benefits, all of which were partially offset by decreases of $14,000 in
travel and entertainment expenses, $8,000 in vendor training programs, $8,000 in
shipping and handling expenses and $7,000 in temporary help.

      GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased by $348,000, or 19%, to $1,492,000 in the six months ended June 30,
2008 as compared to $1,840,000 in the six months ended June 30, 2007. This
decrease was primarily due to decreases of $121,000 in legal expenses primarily
related to litigation in the prior period, $97,000 in bank charges, $82,000 in
salaries and benefits, $80,000 in outside services, $43,000 in travel and
entertainment expenses, $33,000 in financial relations expenses, $13,000 in
office expenses, $9,000 in product design, $9,000 in repairs and maintenance,
$7,000 in utilities, $4,000 in audit expenses and $3,000 in outside services,
all of which were partially offset by increases of $60,000 in bad debts, $35,000
in insurance expense, $24,000 in temporary help, $13,000 in miscellaneous
expenses, $11,000 in finance charges, $5,000 in facility rent and $5,000 in
property taxes

      DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased by
$4,000, or 6%, to $66,000 in the six months ended June 30, 2008 as compared to
$70,000 in the six months ended June 30, 2007. This decrease primarily resulted
from certain of our fixed assets becoming fully depreciated since June 30, 2007.

      NET INTEREST EXPENSE. Net interest expense decreased by $142,000, or 61%,
to $91,000 in the six months ended June 30, 2008 as compared to $233,000 in the
six months ended June 30, 2007. This decrease primarily resulted from lower
borrowings on our line of credit in the six months ended June 30, 2008 as
compared to the six months ended June 30, 2007.

      OTHER INCOME. Other income decreased by $3,000, or 50%, in the second
quarter of 2008 as compared to the second quarter of 2007 primarily as a result
of lower miscellaneous income.

LIQUIDITY AND CAPITAL RESOURCES

     OVERVIEW

      Our principal sources of liquidity have been cash provided by operations
and borrowings under our bank and trade credit facilities. Our principal uses of
cash have been to provide working capital, finance capital expenditures and to
satisfy our debt service requirements. We anticipate that these sources and uses
will continue to be our principal sources and uses of cash in the foreseeable
future. As of June 30, 2008, we had a working capital deficit of $1.5 million,
an accumulated deficit of $32.9 million, $645,771 in cash and cash equivalents
and $1.1 million in net accounts receivable. This compares with working capital
of $1.4 million, an accumulated deficit of $29.9 million, $1.5 million in cash
and cash equivalents and $6.9 million in net accounts receivable as of December
31, 2007. For the six months ended June 30, 2008, our cash decreased $817,351,
or 56%, from $1.5 million to $645,771.

                                       19

<PAGE>

      As of August 15, 2008, we had only approximately $225,677 of cash on hand
and we are experiencing a lack of liquidity and may have insufficient liquidity
to fund our operations for the next twelve months. Our condensed consolidated
financial statements as of and for the three and six months ended June 30, 2008,
have been prepared on a going concern basis, which contemplates the realization
of assets and satisfaction of liabilities in the normal course of business. As
discussed in this report and in Note 1 to our condensed consolidated financial
statements included elsewhere in this report, we have incurred significant
recurring losses, have working capital and stockholders' deficits, have serious
liquidity concerns and may require additional financing in the foreseeable
future. These factors, among others, raise substantial doubt about our ability
to continue as a going concern. The condensed consolidated financial statements
included in this report do not include any adjustments that might result from
the outcome of this uncertainty.

      Our plans for correcting these deficiencies include ongoing efforts to
bring new products to market and exploring other products with our suppliers and
retailers to sell through our sales channels, negotiating suitable repayment
terms for outstanding obligations owed to a related-party supplier, seeking new
equity capital and new vendor partnerships, timely collection of existing
accounts receivable, and sell-through of inventory currently in our sales
channels. We also need to restructure our operations to reduce our operating
costs. If our capital requirements or cash flow vary materially from our current
projections, if we are unable to successfully negotiate suitable repayment terms
for outstanding obligations owed to a related-party supplier, if we are unable
to successfully restructure our operations and lower our operating costs, if we
are unable to timely collect our accounts receivable or unable to sell-through
inventory currently in our sales channels as anticipated, or if unforeseen
circumstances occur, we may be unable to increase our liquidity and may require
additional financing. In addition, if we are unable to bring successful new
products to market soon, we may be forced to substantially curtail our
operations.

      If our net losses continue or increase, we could experience significant
additional shortages of liquidity and our ability to purchase inventory and to
operate our business may be significantly impaired, which could lead to further
declines in our results of operations and financial condition.

     CASH FLOWS

      Cash provided by our operating activities totaled $2.3 million during the
six months ended June 30, 2008, as compared to cash used in our operating
activities of $1.2 million during the six months ended June 30, 2007, and
resulted primarily from the following combination of factors:

      o     a $6.5 million decrease in accounts receivable resulting from normal
            collections;
      o     a $2.5 million decrease in inventory;
      o     a $1.7 million increase in net loss;
      o     a $72,000 decrease in allowance for obsolete inventory; and
      o     a $25,000 decrease in our reserves for sales incentives.

         These increases in cash were partially offset by:

      o     a $2.5 million decrease in accounts payable - related parties,
            resulting from the payment of outstanding invoices;
      o     a $383,000 decrease in accounts payable ;
      o     a $341,000 decrease in accruals for market development funds,
            cooperative advertising costs and cross-dock fees;


                                       20

<PAGE>

      o     a $265,000 decrease in mail-in rebates accruals;
      o     a $157,000 decrease in our allowance for product returns;
      o     a $136,000 decrease in allowance for doubtful accounts;
      o     a $71,000 decrease in point-of-sale accruals;
      o     a $25,000 increase in our current portion of capital leases; and
      o     a $1,000 increase in prepaid expenses and other current assets.

      Cash provided by our investing activities totaled $341,000 during the six
months ended June 30, 2008 as compared to cash provided by our investing
activities of $746,000 during the six months ended June 30, 2007. Our investing
activities during the six months ended June 30, 2008 consisted of a $341,000
decrease in restricted cash related to our credit facility. Our investing
activities during the six months ended June 30, 2007 consisted of a $870,000
decrease in restricted cash related to our credit facility and $124,000 in
purchases of property and equipment.

      Cash used in our financing activities totaled $3.5 million during the six
months ended June 30, 2008 as compared to cash provided by financing activities
of $595,000 for the six months ended June 30, 2007. We made $3.5 million in net
payments on our line of credit in the six months ended June 30, 2008 compared to
net payments of $595,000 on our line of credit in the six months ended June 30,
2007.

     BANK CREDIT FACILITY

      On January 29, 2007, we entered into a Loan and Security Agreement with
Silicon Valley Bank which provided for a new credit facility. Our credit
facility with Silicon Valley Bank was initially used to pay off our outstanding
loan balance with GMAC Commercial Finance in the approximate amount of $5.0
million. On April 18, 2008, we entered into a new Loan and Security Agreement
with Silicon Valley Bank which provided for a credit facility based on our
accounts receivable. The Loan and Security Agreement amended and restated our
prior Loan and Security Agreement dated January 29, 2007 with Silicon Valley
Bank. On April 18, 2008, we also entered into an Amendment to Loan Documents
with Silicon Valley Bank, which provided that the ancillary loan documents
executed in connection with our prior credit facility with Silicon Valley Bank
would apply to the new Loan and Security Agreement.

      The new credit facility allowed us to finance our accounts receivable and
borrow up to a maximum aggregate amount of $7.0 million; provided, that we could
only borrow up to a limit of 60% of each eligible account or such other
percentage as Silicon Valley Bank established. The credit facility was to expire
on January 29, 2009. Advances under the credit facility bore interest at a
floating rate equal to the prime rate of interest published from time to time by
Silicon Valley Bank plus 2.5%. The credit facility required that we pay a
collateral handling fee of $2,000 per month and other customary fees and
expenses.

      Our obligations under the new Loan and Security Agreement were secured by
substantially all of our assets and were guaranteed by our subsidiary under a
Cross-Corporate Continuing Guaranty. Our obligations and the guarantee
obligations of our subsidiary were also secured under Intellectual Property
Security Agreements executed by us and our subsidiary.

      On July 31, 2008, we paid off our obligations under the Loan and Security
Agreement dated April 18, 2008 with Silicon Valley Bank and terminated the Loan
and Security Agreement.


                                       21

<PAGE>

     TRADE CREDIT FACILITIES

      On June 6, 2005, we entered into a trade credit facility with Lung Hwa,
one of our significant stockholders, under which Lung Hwa agreed to purchase and
manufacture inventory on our behalf. We are permitted to purchase up to $15.0
million of inventory either (i) through Lung Hwa as an international purchasing
office, or (ii) manufactured by Lung Hwa. For inventory purchased through Lung
Hwa, the terms are 120 days following the date of invoice by Lung Hwa and Lung
Hwa charges us a 5% handling fee on the 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 Lung Hwa, result
in a credit to us for the handling charge. For inventory manufactured by Lung
Hwa, the payment terms are 90 days following the date of the invoice by Lung
Hwa. We are to pay the related party 10% of the purchase price on any purchase
orders issued to Lung Hwa, as a down-payment for the order, within one week of
the purchase order. The agreement had an initial term of one year after which
the agreement is to continue indefinitely if not terminated at the end of the
initial term. At the end of the initial term and at any time thereafter, either
party has the right to terminate the facility upon 30 days' prior written notice
to the other party. The agreement was amended and restated on July 21, 2005 to
provide that the new facility would be retroactive to April 29, 2005. During the
six months ended June 30, 2008, we made no purchases under this arrangement. As
of June 30, 2008, there were no trade payables outstanding under this
arrangement.

      In February 2003, we entered into an agreement with BTC, one of our
significant stockholders, whereby BTC and its affiliated companies, agreed to
supply us with up to $10.0 million of inventory. Mr. Steel Su, one of our
directors, is the Chief Executive Officer of BTC. The agreement may be
terminated by either party upon 60 days' prior written notice. In addition, the
agreement provides for a trade line of credit of up to $10.0 million with
payment terms of net 60 days on a non-interest bearing basis. However, due to
substantial outstanding obligations owed to BTC, it is highly unlikely that we
would be able to obtain additional inventory supplies from BTC unless, and at
least until, we are able to negotiate repayment terms acceptable to BTC. Even if
we are able to negotiate repayment terms acceptable to BTC, we may be unable to
obtain additional inventory supplies from BTC on the same terms as before, on
satisfactory terms, or at all. During the six months ended June 30, 2008, we
purchased $723,600 of inventory under this arrangement. As of June 30, 2008,
there were $4,953,096 in trade payables outstanding under this arrangement. As
of August 15, 2008, we were out of compliance with the payment terms of our
agreement with BTC. We are negotiating repayment terms for outstanding
obligations owed to BTC.

      Lung Hwa and BTC have historically provided us with significantly
preferential trade credit terms. These terms have historically included extended
payment terms, substantial trade lines of credit and other preferential buying
arrangements. We believe that these terms are substantially better terms than we
could likely obtain from other subcontract manufacturers or suppliers. In fact,
we believe that our trade credit facility with Lung Hwa is likely unique and
could not be replaced through a relationship with an unrelated third party. If
either Lung Hwa or BTC does not continue to offer us substantially the same
preferential trade credit terms, our ability to finance inventory purchases
would be harmed, resulting in significantly reduced sales and profitability. In
addition, we would incur additional financing costs associated with shorter
payment terms which would also cause our profitability to decline or our losses
to increase.

                                       22

<PAGE>

     LIQUIDITY IMPACT OF CONSIGNMENT INVENTORY MODEL

      We retain most risks of ownership of our consignment inventory. These
products remain our inventory until their sale by our retailers. For example,
both Office Depot and OfficeMax returned substantial consigned inventory in the
fourth quarter of 2007 and the first quarter of 2008, respectively, each in
anticipation of discontinuing sales of our products. The return of this
inventory resulted in significant inventory valuation adjustments caused by the
declining value of the inventory, principally, our magnetic data storage
products. In addition, the turnover frequency of our inventory on consignment is
critical to generating regular cash flow in amounts necessary to keep financing
costs to targeted levels and to purchase additional inventory. If this inventory
turnover is not sufficiently frequent, our financing costs may exceed targeted
levels and we may be unable to generate regular cash flow in amounts necessary
to purchase additional inventory to meet the demand for other products. In
addition, as a result of our products' short life-cycles, which generate lower
average selling prices as the cycles mature, low inventory turnover levels may
force us to reduce prices and accept lower margins to sell consigned products.
If we fail to select high turnover products for our consignment inventory model,
our sales, profitability and financial resources will likely decline.

IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS

      The disclosure requirements and impacts of new accounting pronouncements
are described in "Note 15--Recent Accounting Pronouncements" of the notes to
condensed consolidated financial statements contained elsewhere in this report.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

         Not applicable.

ITEM 4T. CONTROLS AND PROCEDURES

     EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

      We conducted an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer of the effectiveness of the design and operation of our
disclosure controls and procedures. The term "disclosure controls and
procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
and Exchange Act of 1934, as amended ("Exchange Act"), means controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by the company in the reports it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures also include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by a
company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the company's management, including its
principal executive and principal financial officers, or persons performing
similar functions, as appropriate, to allow timely decisions regarding required
disclosure. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer concluded as of June 30, 2008 that our disclosure controls and
procedures were effective at the reasonable assurance level.

     CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

      There was no change during our most recently completed fiscal quarter that
has materially affected or is reasonably likely to materially affect, our
internal control over financial reporting, as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act.


                                       23

<PAGE>

                                    PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

      We are subject to legal proceedings, claims and litigation arising in the
ordinary course of business. While the amounts claimed may be substantial, the
ultimate liability cannot presently be determined because of considerable
uncertainties that exist. Therefore, it is possible that the outcome of those
legal proceedings, claims and litigation could adversely affect our quarterly or
annual operating results or cash flows when resolved in a future period.
However, based on facts currently available, management believes such matters
will not adversely affect our financial position, results of operations or cash
flows.

ITEM 1A. RISK FACTORS

      In addition to the other information set forth in this report, you should
carefully consider the factors discussed under "Risk Factors" in our Annual
Report on Form 10-K for the year ended December 31, 2007, which could materially
affect our business, financial condition and results of operations. The risks
described in our Annual Report on Form 10-K for the year ended December 31, 2007
are not the only risks we face. Additional risks and uncertainties not currently
known to us or that we currently deem to be immaterial also may materially
adversely affect our business, financial condition and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY 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

Exhibit
Number        Description
------        -----------

10.1          Loan and Security Agreement dated as of April 18, 2008 among
              I/OMagic Corporation, IOM Holdings, Inc. and Silicon Valley Bank
              (**)

10.2          Amendment to Loan Documents dated April 18, 2008 among I/OMagic
              Corporation, IOM Holdings, Inc. and Silicon Valley Bank (**)

31.1          Certification Required by Rule 13a-14(a) of the Securities
              Exchange Act of 1934, as amended, as Adopted Pursuant to Section
              302 of the Sarbanes-Oxley Act of 2002 (*)

31.2          Certification Required by Rule 13a-14(a) of the Securities
              Exchange Act of 1934, as amended, as Adopted Pursuant to Section
              302 of the Sarbanes-Oxley Act of 2002 (*)

32.1          Certification of President and Chief Financial Officer Pursuant to
              18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
              Sarbanes-Oxley Act of 2002 (*)
________________
(*)           Filed herewith.
(**)          Filed as an exhibit to the Registrant's Current Report on Form 8-K
              for April 18, 2008 filed with the Securities and Exchange
              Commission on April 22, 2008 and incorporated herein by reference.




                                       24

<PAGE>

                                   SIGNATURES

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

                                   I/OMAGIC CORPORATION


Dated:  August 19, 2008            By: /s/ THOMAS L. GRUBER
                                       -----------------------------------------
                                       Thomas L. Gruber, Chief Financial Officer
                                       (principal financial and accounting
                                       officer)





                                       25


<PAGE>


                         EXHIBITS FILED WITH THIS REPORT

Exhibit
Number            Description
------            -----------

31.1              Certification Required by Rule 13a-14(a) of the Securities
                  Exchange Act of 1934, as amended, as Adopted Pursuant to
                  Section 302 of the Sarbanes-Oxley Act of 2002

31.2              Certification Required by Rule 13a-14(a) of the Securities
                  Exchange Act of 1934, as amended, as Adopted Pursuant to
                  Section 302 of the Sarbanes-Oxley Act of 2002

32.1              Certification of President and Chief Financial Officer
                  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
                  Section 906 of the Sarbanes-Oxley Act of 2002