----

----

**SECURITIES AND EXCHANGECOMMISSION****WASHINGTON, D.C. 20549**

----

**FORM 10-Q**

 

| ý                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **For the quarterly period ended June 30, 2001**                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| o                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **For the transition period from                                        to                                   ** |

**Commissionfile number 000-27267**

| **I/OMAGIC  CORPORATION**                                          |
|--------------------------------------------------------------------|
|                                                                    |
| (Exact  name of small business issuer as specified in its charter) |

 

| **Nevada**                                                       |   | **88-0290623**                     |
|------------------------------------------------------------------|--------|------------------------------------|
| ****                                                             |   | ****                               |
| (State or other  jurisdiction of  incorporation or organization) |   | (IRS  Employer Identification No.) |

 

| **1300 Wakeham, Santa Ana, CA  92705** |
|---------------------------------------------|
| ****                                        |
| (Address  of principal executive offices)   |

 

| **(714) 953-3000**           |
|------------------------------|
| ****                         |
| (Issuer's  telephone number) |

 

| **6 Autry, Irvine, CA   92618**                                                |
|-------------------------------------------------------------------------------------|
| ****                                                                                |
| (Former  name, former address and former fiscal year, if changed since last report) |

 

Checkwhether the issuer (1) filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.Yes       ý         No        o

Asof August 20, 2001, the number of shares of Common Stock issued and outstandingwas 67,930,291.

Transitional Small Business Disclosure Format(check one):Yes       o         No        ý

----

----

 

**I/OMAGIC CORPORATION AND SUBSIDIARY**

**INDEX**

| PART I - FINANCIAL  INFORMATION |                                                                                                      |                                                                                    |
|--------------------------------------|-----------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------|
|                                 |                                                                                                      |                                                                                    |   |
|                                 | Item 1.                                                                                                   | Financial  Statements                                                                   |   |
|                                 |                                                                                                      |                                                                                    |
|                                 | Balance  Sheets – December 31. 2000 and June 30, 2001 (unaudited)                                    |                                                                                    |
|                                 |                                                                                                      |                                                                                    |
|                                 | Statements  of Operations - For the three months and six months ended June 30, 2000 and  2001 (unaudited) |                                                                                    |
|                                 |                                                                                                      |                                                                                    |
|                                 | Statements  of Cash Flows - For the  six months  ended June 30, 2000 and 2001 (unaudited)            |                                                                                    |
|                                 |                                                                                                      |                                                                                    |
|                                 | Notes to Financial Statements                                                                             |                                                                                    |
|                                 |                                                                                                      |                                                                                    |
|                                 | Item  2.                                                                                                  | Management's  Discussion and Analysis of Financial Conditions and Results of Operations |   |
|                                 |                                                                                                      |                                                                                    |
| PART II – OTHER INFORMATION     |                                                                                                      |                                                                                    |
|                                 |                                                                                                      |                                                                                    |   |
|                                 | Item 1.                                                                                                   | Legal Proceedings                                                                       |   |
|                                 | Item  2.                                                                                                  | Changes  in Securities                                                                  |   |
|                                 | Item 3.                                                                                                   | Defaults Upon  Senior Securities                                                        |   |
|                                 | Item  4.                                                                                                  | Submission  of Matters to a Vote of Security Holders                                    |   |
|                                 | Item 5.                                                                                                   | Other Information                                                                       |   |
|                                 | Item 6.                                                                                                   | Exhibits and  Reports on Form 8-K                                                       |   |
|                                 |                                                                                                      |
| SIGNATURES                           |                                                                                                      |
|                                      |                                                                                                           |                                                                                         |  |  |  |  |  |  |

 

** **

**PART I – FINANCIALINFORMATION**

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

 

 

| FINANCIAL INFORMATION                            |
|--------------------------------------------------|
| PART 1 - ITEM 1                                  |
|                                             |
| I/OMAGIC  CORPORATION                            |
| BALANCE SHEETS                                   |
| DECEMBER  31, 2000 AND JUNE 30, 2001 (UNAUDITED) |
|                                             |
| ASSETS                                           |

 

|                                                                     | DECEMBER  31, 2000                                                                        |       | JUNE  30, 2001 |       |
|--------------------------------------------------------------------------|-------------------------------------------------------------------------------------------|------------|----------------|------------|
|                                                                     |                                                                                           |       |                |       |
|                                                                     |                                                                                      |       | (Unaudited)    |       |
| CURRENT ASSETS                                                           |                                                                                      |       |           |       |
|                                                                     | Cash                                                                                      | $          | 3,502,546      |       | $ | 718,772 |   |
|                                                                     | Accounts receivable,  net of allowance for doubtful accounts of $2,106,518 and $2,451,401 | 18,109,794 |           | 14,705,882 |   |
|                                                                     | Accounts receivable  from related parties                                                 | 84,710     |           | 135,751    |   |
|                                                                     | Inventory, net                                                                            | 6,783,715  |           | 7,058,386  |   |
|                                                                     | Inventory in transit                                                                      | 13,011,000 |           | 3,605,550  |   |
|                                                                     | Income tax receivable                                                                     | 34,311     |           | 34,311     |   |
|                                                                     | Prepaid expenses and  other current assets                                                | 184,523    |           | 1,232,415  |   |
|                                                                     | Current portion of  deferred income taxes                                                 | 1,556,000  |           | 1,293,909  |   |
|                                                                     |                                                                                           |       |                |       |
|                                                                     | TOTAL CURRENT ASSETS                                                                      | 43,266,599 |           | 28,784,976 |   |
|                                                                     |                                                                                      |       |           |       |
| FURNITURE AND  EQUIPMENT, NET                                            | 1,427,772                                                                                 |       | 1,388,479      |       |
| TRADEMARK, net of  accumulated amortization of $1,446,852 and $2,411,416 | 8,198,827                                                                                 |       | 7,234,263      |       |
| DEFERRED INCOME TAXES,  net of current portion                           | 165,000                                                                                   |       | -              |       |
| OTHER ASSETS                                                             | 40,240                                                                                    |       | 40,240         |       |
|                                                                     |                                                                                           |       |                |       |
| TOTAL ASSETS                                                             | $                                                                                         | 53,098,438 |           | $          | 37,447,959 |   |
|                                                                     |                                                                                           |       |                |       |
|                                                                          |                                                                                           |            |                |            |  |  |  |  |

 

The accompanying notes are an integralpart of these financial statements

 

| I/OMAGIC  CORPORATION                            |
|--------------------------------------------------|
| BALANCE  SHEETS                                  |
| DECEMBER 31, 2000 AND  JUNE 30, 2001 (UNAUDITED) |
|                                             |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY       |

 

|                                               |                                                                                                                                       | DECEMBER  31, 2000 |       | JUNE  30,2001 |        |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------|--------------------|------------|---------------|-------------|
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               |                                                                                                                                       |               |       | (Unaudited)   |        |
| CURRENT LIABILITIES                                |                                                                                                                                       |               |       |          |        |
|                                               | Line of credit                                                                                                                             |               | $          | 6,996,969     |        | $ | 3,896,011 |   |
|                                               | Accounts payable and  accrued expenses                                                                                                     |               | 12,171,712 |          | 4,683,724   |   |
|                                               | Due to related parties                                                                                                                     |               | -          |          | 2,753,097   |   |
|                                               | Current portion of  capital lease obligation                                                                                               |               | 27,121     |          | 20,629      |   |
|                                               | Reserves for customer  returns and allowances                                                                                              |               | 2,232,087  |          | 2,058,110   |   |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               | TOTAL CURRENT  LIABILITIES                                                                                                                 |               | 21,427,889 |          | 13,411,571  |   |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               |                                                                                                                                       |               |       |          |        |
| CAPITAL LEASE  OBLIGATIONS, net of current portion |                                                                                                                                       | 10,978             |       | 4,396         |        |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               | Total liabilities                                                                                                                          |               | 21,438,867 |          | 13,415,967  |   |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               |                                                                                                                                       |               |       |          |        |
| COMMITMENTS AND  CONTINGENCIES                     |                                                                                                                                       |               |       |          |        |
|                                               |                                                                                                                                       |               |       |          |        |
| REDEEMABLE CONVERTIBLE  PREFERRED STOCK            |                                                                                                                                       |               |       |          |        |
|                                               | 10,000,000 shares  authorized, $0.001 par value                                                                                            |               |       |          |        |   |
|                                               | Series A, 1,000,000  shares authorized 875,000 shares issued and outstanding                                                               |               | 875        |          | 875         |   |
|                                               | Series B, 1,000,000  shares authorized 250,000 shares issued and outstanding                                                               |               | 250        |          | 250         |   |
|                                               | Additional paid-in  capital                                                                                                                |               | 8,998,875  |          | 8,998,875   |   |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               | Total redeemable  convertible preferred stock                                                                                              |               | 9,000,000  |          | 9,000,000   |   |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               |                                                                                                                                       |               |       |          |        |
| STOCKHOLDERS’ EQUITY                          |                                                                                                                                       |               |       |          |        |
|                                               | Class A common stock,  $0.001 par value 100,000,000 shares authorized 67,917,791 and 67,930,291  (unaudited shares) issued and outstanding |               | 67,918     |          | 67,931      |   |
|                                               | Additional paid in  capital                                                                                                                |               | 31,493,345 |          | 31,493,958  |   |
|                                               | Deferred compensation                                                                                                                      |               | (3,100     | )             | -           |   |
|                                               | Accumulated deficit                                                                                                                        |               | (8,898,592 | )             | (16,529,897 | ) |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               | TOTAL STOCKHOLDERS’  EQUITY                                                                                                           |               | 22,659,571 |          | 15,031,992  |   |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                               | TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                            |               | $          | 53,098,438    |        | $ | 37,447,959 |   |
|                                               |                                                                                                                                       |                    |       |               |        |
|                                                    |                                                                                                                                            |                    |            |               |             |  |  |  |  |  |

The accompanying notes are an integralpart of these financial statements

 

| I/OMAGIC  CORPORATION                           |
|-------------------------------------------------|
| STATEMENTS OF  OPERATIONS                       |
| FOR  THE THREE MONTHS AND SIX MONTHS ENDED      |
| JUNE  30, 2001 (UNAUDITED) AND 2000 (UNAUDITED) |

 

|                                             | Six  Months Ended  June 30,  (Unaudited) |       | Three  Months Ended  June 30,  (Unaudited) |      |
|--------------------------------------------------|------------------------------------------|------------|--------------------------------------------|-----------|
|                                             |                                          |       |                                            |      |
|                                             | 2001                                     |       | 2000                                       |      | 2001 |   | 2000 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Net sales                                        | $                                        | 18,802,392 |                                       | $         | 33,047,175 |   | $ | 8,587,241 |   | $ | 17,097,395 |   |
| Cost of sales                                    | 20,333,495                               |       | 27,305,926                                 |      | 11,196,218 |   | 14,067,192 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Gross profit (loss)                              | (1,531,103                               | )          | 5,741,249                                  |      | (2,608,977 | ) | 3,030,203 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Operating expenses                               |                                     |       |                                       |      |   |   |   |   |
|                                             | Selling, marketing and  advertising      | 1,577,814  |                                       | 1,576,366 |   | 1,028,653 |   | 703,377 |   |
|                                             | General and  administrative              | 2,754,801  |                                       | 2,566,401 |   | 1,328,967 |   | 1,586,220 |   |
|                                             | Depreciation and  amortization           | 1,112,833  |                                       | 565,443   |   | 557,922 |   | 547,850 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
|                                             | Total operating  expense                 | 5,445,448  |                                       | 4,708,210 |   | 2,915,542 |   | 2,837,447 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Income (loss) from  operations                   | (6,976,551                               | )          | 1,033,039                                  |      | (5,524,519 | ) | 192,756 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Other income (expense)                           |                                     |       |                                       |      |   |   |   |   |
|                                             | Interest income                          | 33,953     |                                       | 23,432    |   | 4,848 |   | 20,432 |   |
|                                             | Interest expense                         | (269,384   | )                                          | (464,248  | ) | (80,392 | ) | (463,471 | ) |
|                                             | Other income                             | 10,170     |                                       | 20,063    |   | - |   | 20,063 |   |
|                                             | Other expense                            | -          |                                       | -         |   | 48,116 |   | - |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Total other income  (expense)                    | (225,261                                 | )          | (420,753                                   | )         | (27,428 | ) | (422,976 | ) |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Income  (loss) before provision for income taxes | (7,201,812                               | )          | 612,286                                    |      | (5,551,947 | ) | (230,220 | ) |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Provision for income  taxes                      | 429,491                                  |       | 93,600                                     |      | 2,400 |   | 226,600 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Net income (loss)                                | $                                        | (7,631,303 | )                                          | $         | 518,686 |   | $ | (5,554,347 | ) | $ | (456,820 | ) |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Basic earnings (loss)  per share                 | $                                        | (0.11      | )                                          | $         | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Diluted earnings  (loss) per share               | $                                        | (0.11      | )                                          | $         | 0.01 |   | $ | (0.08 | ) | $ | (0.01 | ) |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Basic weighted-average  shares outstanding       | 67,919,851                               |       | 38,906,793                                 |      | 67,921,225 |   | 39,268,673 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |
| Diluted  weighted-average shares outstanding     | 67,919,851                               |       | 39,135,433                                 |      | 67,921,225 |   | 39,268,673 |   |
|                                             |                                          |       |                                            |      |  |   |  |   |

 

The accompanying notesare an integral part of these financial statements

 

| I/OMAGIC  CORPORATION                           |
|-------------------------------------------------|
| STATEMENTS OF CASH  FLOWS                       |
| FOR  THE SIX MONTHS ENDED                       |
| JUNE  30, 2001 (UNAUDITED) AND 2000 (UNAUDITED) |

 

|                                        | Six  Months Ended  June 30,  (Unaudited)                                                  |       |
|---------------------------------------------|-------------------------------------------------------------------------------------------|------------|
|                                        |                                                                                           |       |
|                                        | 2001                                                                                      |       | 2000 |   |
|                                        |                                                                                           |       |  |   |
|                                        |                                                                                      |       |   |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:      |                                                                                      |       |   |   |
|                                        | Income (loss) from  operations                                                            | $          | (7,631,303 | ) | $ | 518,686 |   |
|                                        | Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |   |   |   |
|                                        | Depreciation and  amortization                                                            | 148,271    |   | 83,163 |   |
|                                        | Amortization of  trademark                                                                | 964,564    |   | 482,280 |   |
|                                        | Amortization of  deferred compensation                                                    | 3,100      |   | 6,200 |   |
|                                        | Interest Imputed on  notes payable                                                        | -          |   | 318,121 |   |
|                                        | Tax effect of  exercised options                                                          | -          |   | 24,000 |   |
|                                        | Provision for  allowance for doubtful accounts                                            | 344,883    |   | 78,642 |   |
|                                        | Reserve for obsolete  inventory                                                           | (138,881   | ) | (24,087 | ) |
|                                        | Deferred income tax                                                                       | 427,091    |   | (75,800 | ) |
|                                        | Reserve for customer  returns and allowances                                              | (173,976   | ) | 669,264 |   |
|                                        | (Increase) decrease  in:                                                                  |       |   |   |   |
|                                        | Accounts receivable                                                                       | 3,059,028  |   | (10,930,149 | ) |
|                                        | Accounts receivable  from related parties                                                 | (51,041    | ) | 6,931,427 |   |
|                                        | Inventory                                                                                 | 9,269,660  |   | (762,313 | ) |
|                                        | Prepaid expenses and  other current assets                                                | (1,047,894 | ) | (60,750 | ) |
|                                        | Other assets                                                                              | -          |   | 5,000 |   |
|                                        | Increase (Decrease)  in:                                                                  |       |   |   |   |
|                                        | Accounts payable and  accrued expenses                                                    | (7,487,988 | ) | 773,440 |   |
|                                        | Accounts payable to  related parties                                                      | 2,753,097  |   | 268,971 |   |
|                                        | Income taxes payable                                                                      | -          |   | 20,500 |   |
|                                        |                                                                                           |       |  |   |
|                                        | Net cash provided by  (used in) operating activities                                      | 438,611    |   | (1,673,405 | ) |
|                                        |                                                                                           |       |  |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:      |                                                                                      |       |   |   |
|                                        | Property additions                                                                        | (108,978   | ) | (81,350 | ) |
|                                        |                                                                                           |       |  |   |
|                                        | Net cash used in  investing activities                                                    | (108,978   | ) | (81,350 | ) |
|                                        |                                                                                           |       |  |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:      |                                                                                      |       |   |   |
|                                        |                                                                                      |       |   |   |
|                                        | Net (payments)  borrowings on line of credit                                              | (3,100,958 | ) | 2,673,804 |   |
|                                        | Payments on capital  lease obligations                                                    | (13,074    | ) | (6,930 | ) |
|                                        | Proceeds from exercise  of warrants                                                       | 625        |   | 50,625 |   |
|                                        | Payments on notes  payable – related party                                           | -          |   | (247,909 | ) |
|                                        | Proceeds from sale and  issuance of common stock                                          | -          |   | 2,000,000 |   |
|                                        |                                                                                           |       |  |   |
|                                        | Net cash provided by  (used in) financing activities                                      | (3,113,407 | ) | 4,469,589 |   |
|                                        |                                                                                      |            |   |  |   |
|                                        | Net increase (decrease)  in cash and cash equivalents                                     | (2,783,774 | ) | 2,714,834 |   |
|                                        | Cash and cash  equivalents at beginning of period                                         | 3,502,546  |   | 1,943,522 |   |
|                                        |                                                                                           |       |  |   |
| Cash and cash  equivalents at end of period | $                                                                                         | 718,772    |   | $ | 4,658,356 |   |
|                                        |                                                                                           |       |  |   |
| Supplemental cash flow  information:        |                                                                                      |       |   |   |
|                                        | Interest paid                                                                             | $          | 269,384 |   | $ | 146,127 |   |
|                                        | Income taxes paid                                                                         | $          | 800 |   | $ | 800 |   |
|                                             |                                                                                           |            |  |  |  |  |  |  |  |

 

The accompanying notes are an integralpart of these financial statements

 

SUPPLEMENTALSCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

Duringthe six months ended June 30, 2000, the Company entered into the followingnon-cash transaction:

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

-Converted accounts payable of $60,000 (unaudited) for 40,000 (unaudited) sharesof common stock.

 

NOTESTO FINANCIAL STATEMENTS

NOTE1 - ORGANIZATION AND BUSINESS

I/OMagicCorporation (the "Company"), a Nevada corporation, markets anddistributes computer peripheral products and digital entertainmentproducts.  The Company sells its productsin the United States through distribution and national retail chains.  The Company sells its products under thebrand names of I/O Magic, Hi-Val, and Digital Research Technologies.

## Acquisitions

*Hi-Val,Inc.*

On March 29, 2000, IOM Holdings, Inc. (“IOMH”) acquiredcertain assets of Hi-Val, Inc. (“Hi-Val”) for the benefit of Hi-Val’s creditors pursuant to Section493.010 of the California Code of Civil Procedures.  The purchase price for the assets was $15,878,335; however, totalconsideration was adjusted to $15,401,154, based on imputed interest.  The purchase price was paid as follows: (i)$6,878,335 through the revolving line of credit, (ii) $7,000,000 notes payableat 0% interest (imputed to $6,522,819 based on 9.5% interest), and (iii)$2,000,000 notes payable at prime (9.5% as of December 31, 2000), plus 0.5%issued to IOMH’s lending institution. IOMH recorded $9,645,679 in excess of cost over fair value of net assetsacquired, identified as a trademark, which is being amortized on a straight-linebasis over five years.  The acquisitionwas accounted for by the purchase method. 

 

*IOMHoldings, Inc.*

On December 31, 2000, I/O Magic acquired 100% of theissued and outstanding shares of IOM Holdings, Inc., a Nevada corporation, for24,000,000 restricted shares of common stock. The entities were under common control; therefore, the acquisition hasbeen accounted for in a manner similar to a pooling-of-interests.  

NOTE2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASISOF PRESENTATIONThe accompanying unaudited condensed financial statements have been prepared inaccordance with the instructions to Form 10-Q and therefore, do not include allinformation and notes necessary for a fair presentation of financial position,results of operations, and cash flows in conformity with generally acceptedaccounting principles.  The unauditedcondensed financial statements include the accounts of I/OMagic Corporation.The operating results for interim periods are unaudited and are not necessarilyan indication of the results to be expected for the full fiscal year. In theopinion of management, the results of operations as reported for the interimperiods reflect all adjustments which are necessary for a fair presentation ofoperating results.

USEOF ESTIMATESThe preparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and the disclosuresof contingent assets and liabilities at the date of the financial statements,as well as the reported amounts of revenues and expenses during the reportingperiod. Significant estimates made by management include, but are not limitedto, the provisions for allowance of doubtful accounts and price protection onaccounts receivable, the net realizability of inventory, the evaluation ofpotential impairment of furniture and equipment, and the provision for salesreturns and warranties. Actual results could materially differ from those estimates.

STOCKBASED COMPENSATIONSFAS No. 123, "Accounting for Stock-Based Compensation," establishesand encourages the use of the fair value based method of accounting forstock-based compensation arrangements under which compensation cost is determinedusing the fair value of stock-based compensation determined as of the date ofgrant and is recognized over the periods in which the related services arerendered. The statement also permits companies to elect to continue using thecurrent implicit value accounting method specified in Accounting PrinciplesBulletin ("APB") Opinion No. 25, "Accounting for Stock Issued toEmployees," to account for stock-based compensation issued to employees.The Company has elected to use the implicit value based method and hasdisclosed the pro forma effect of using the fair value based method to accountfor its stock-based compensation. For stock-based compensation issued tonon-employees, the Company uses the fair value method of accounting under theprovisions of SFAS No. 123.

EARNINGSPER SHAREThe Company calculates earnings per share in accordance with SFAS No. 128,"Earnings Per Share." SFAS No. 128 replaced the presentation ofprimary and fully diluted earnings per share with the presentation of basic anddiluted earnings (loss) per share. Basic earnings (loss) per share excludes dilution and is calculated bydividing income (loss) available to common stockholders by the weighted-averagenumber of common shares outstanding for the period.  Diluted earnings (loss) per share includes the potential dilutiveeffects that could occur if securities or other contracts to issue common stockwere exercised or converted into common stock ("potential commonstock") that would then share in the earnings (loss) of the Company.

Asof June 30, 2001 (unaudited) and 2000 (unaudited), the Company had potentialcommon stock as follows:

|                                                                                                                                           | 2001                           |       | 2000       |       |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------|------------|------------|------------|
|                                                                                                                                           |                                |       |            |       |
| Weighted-average  common shares                                                                                                                |                           |       |       |       |
|                                                                                                                                           | Outstanding during the  period | 67,919,851 |       | 38,906,793 |   |
|                                                                                                                                           |                           |       |       |       |   |
| Incremental shares  assumed to be outstanding since the beginning of the period related to stock  options and warrants outstanding (unaudited) | -                              |       | 228,640    |       |
|                                                                                                                                           |                                |       |            |       |
| FULLY DILUTED  WEIGHTED-AVERAGE COMMON SHARES AND POTENTIAL COMMON STOCK (UNAUDITED)                                                           | 67,919,851                     |       | 39,135,433 |       |
|                                                                                                                                           |                                |       |            |       |

Sincethe Company had a net loss for the six months ended June 30, 2001, basic anddiluted shares are the same.

NOTE3 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accountspayable and accrued liabilities consisted of the following:

|                                       | June  30,  2001 |
|--------------------------------------------|-----------------|
|                                       |                 |
|                                       | (unaudited)     |
|                                       |            |
| Accounts payable                           | $               | 1,220,990 |
| Accrued rebates and  marketing             | 2,515,848       |
| Accrued compensation  and related benefits | 477,818         |
| Other                                      | 469,068         |
|                                       |                 |
| TOTAL                                      | $               | 4,683,724 |
|                                       |                 |

NOTE4 - INVENTORY

Inventoryconsisted of the following:

|                   | June  30,  2001 |      |
|------------------------|-----------------|-----------|
|                   |                 |      |
|                   | (unaudited)     |      |
|                   |            |      |
| Component parts        | $               | 5,067,517 |   |
| Finished goods         | 3,686,415       |      |
| Reserves for inventory | (1,695,546      | )         |
|                   |                 |      |
| TOTAL                  | $               | 7,058,386 |   |
|                   |                 |      |

NOTE5 – LINE OF CREDIT

OnApril 18, 2001 the credit facility which had been assumed in the December 31,2000 acquisition of IOM Holdings was paid off. The payoff was by means of a new credit facility with anotherinstitution and was for $5,285,621.  Thenew credit facility provides for a revolving line of credit allowing theCompany to borrow the lesser of a) $8,000,000 or b) 65% of eligiblereceivables.  Advances on the revolvingline of credit bear interest at the base rate (6.75% as of June 30, 2001) plus0.25%.  As of June 30, 2001, theoutstanding balance under the revolving line of credit was $3,896,011.

NOTE6 - CREDIT LINES FROM RELATED PARTIES

The company has available three lines of credit from related partiesfor a total of $9.0 million as follows:

In connection with a1997 Strategic Alliance Agreement, the Company has available a trade line ofcredit through a stockholder and supplier for purchases up to $2,000,000.Purchases are non-interest bearing and are due 75 days from the date ofreceipt.  The credit agreement can beterminated or changed at any time. As of December 31, 2000 and June 30, 2001(unaudited), there were $0 and $0, respectively, in trade payables outstandingunder this arrangement.

Inconnection with an April 1999 subscription agreement, the Company also hasavailable an additional trade line of credit through a stockholder and vendor thatprovides a trade credit facility of up to $5,000,000 carrying net 75 day terms,as defined. As of December 31, 2000 and June 30, 2001 (unaudited), there were$2,369,220 and $1,402,326, respectively, in trade payables outstanding underthis arrangement.

Furthermore,the Company has a $2.0 million trade line of credit with Citrine/Ritek. 

NOTE7 - COMMITMENTS AND CONTINGENCIES

LEASES

TheCompany leases its facilities and certain equipment under non-cancelable,operating lease agreements, expiring through March 2010.

Rentexpense was $271,891 and $138,752 for the six months ended June 30, 2001 and2000, respectively, and is included in general and administrative expenses inthe accompanying statements of operations.

EMPLOYMENTCONTRACTThe Company has entered into an employment contract with one of its officerswhich expires upon written termination. The agreement calls for a minimum base salary and provides for certainexpense allowances. In addition, the agreement provides for a bonus based onthe “net profits” of the Company, as defined. The bonus amount ranges from $20,000 to $70,000 for net profits up to$500,000.  For net profits in excess of$500,000, the bonus is 7% of such excess. Bonuses of $216,467 for the year ended December 31, 1999 were paid duringthe six months ended June 30, 2000.  Nobonuses were paid during the three months ended June 30, 2001.  As of June 30, 2001, there was $97,865accrued under this agreement.

RETAILAGREEMENTSIn connection with certain retail agreements, the Company has agreed to pay forcertain marketing development and advertising on an ongoing basis. Marketingdevelopment and advertising costs are generally agreed upon at the time of theevent. The Company also records a liability for co-op marketing based on management’sevaluation of historical experience and current industry and Company trends.During the three months ended June 30, 2001 and 2000, the Company incurred$879,858 (unaudited) and $621,834 (unaudited), respectively, related to theseagreements.  Such is included inselling, marketing, and advertising in the accompanying statements ofoperations.

NOTE8 - CAPITAL TRANSACTIONS

COMMONSTOCK ISSUED FOR CASHDuring the six months ended June 30, 2000, the Company issued an aggregate of632,912 (unaudited) restricted shares of common stock for cash totaling$2,000,000, or at a per share price of $3.16 (unaudited).

COMMONSTOCK ISSUED IN CONNECTION WITH THE EXERCISE OF WARRANTSDuring the six months ended June 30, 2000, the Company issued an aggregate of52,500 (unaudited) restricted shares of common stock in connection with theexercise of warrants for cash totaling $50,624 (unaudited), or at a per shareprice ranging from $0.05 (unaudited) to $2.00 (unaudited).

Duringthe six months ended June 30, 2001, the Company issued 12,500 (unaudited)shares of common stock in connection with the exercise of warrants for cash of$625, or at a price per share of $0.05.

COMMONSTOCK ISSUED FOR INVENTORYDuring the six months ended June 30, 2000, the Company issued 6,250,000(unaudited) shares of restricted common stock to a stockholder and vendor,valued at $0.80 per share for $5,000,000 of inventory, as defined (valued attransferor’s cost basis).

STOCKOPTION PLANSDuring the six months ended June 30, 2000, the Company granted non-qualifiedand incentive stock options to purchase a total of 2,012,500 shares of commonstock to officers and employees and certain consultants under the Company’sstock option plans.  The stock optionsvest either immediately or ratably over five years.  Exercise prices range from $2.00 to $3.00 and the options expirefive years from the date of grant.  Nostock options were granted during the six months ended June 30, 2001.

NOTE9 - RELATED PARTY TRANSACTIONS

Duringthe six months ended June 30, 2001 and 2000, the Company had purchases fromrelated parties totaling approximately $1,935,900 (unaudited)and $18,782,800(unaudited), respectively.

KingEagle Enterprises, Inc., a related party, is involved in printing and packagingservices to the Company.  King EagleEnterprises, Inc. is currently seeking investments in and/or acquisitions ofprinting and packaging facilities to better accommodate cost/support to theCompany.

TheCompany leases its corporate office from its major shareholder.  During the six months ended June 30, 2001,the Company paid $172,032 for rent expense.

NOTE10 – SUBSEQUENT EVENTS

TheCompany is currently in the process of signing a new revolving line of creditwith its current lending institution. The proposed agreement will allow the Company to borrow the lesser of a)$11,000,000 or b) 65% of eligible receivables. Advances will bear interest atthe base rate (currently 6.75%) plus 0.25%.

**Item 2. Management's Discussion and Analysis of Financial Condition and Resultsof Operations**

                   **Three Monthsended June 30, 2001 and 2000**

                   **Resultsof Operations**

Revenuesfor the period ended June 30, 2001 ("2001") were $8,587,241, comparedto revenues for the period ended June 30, 2000 ("2000") of$17,097,395. The decrease in revenues is primarily attributable to the slowdownin the national economy, which has affected the Company’s customers and thusthe Company.  The Company signed newagreements with two major customers at the end of the second quarter, and theCompany believes that these agreements will enable the Company to increase itssales in the third quarter. The Company had a sales backlog as of June 30, 2001of $18,404,895 and it had a sales backlog of $1,951,665 as of June 30, 2000.

Costof sales as a percentage of revenues increased from 82.28% ($14,067,192) in2000 to 130.38% ($11,196,218) in 2001. This was primarily due to the write-downby $3,455,682 of obsolete and slow-moving inventory.  This was primarily Hi-Val inventory acquired in the IOM Holdingsacquisition on December 31, 2000.  Inaddition, the Company incurred much higher rebate costs in 2001 than 2000 (theCompany changed its policy to offset rebates against revenues). Cost of productas a percentage of revenues before rebates decreased in 2001 from 2000 due tono OEM revenues in 2001, which have a lower margin.

Operatingexpenses as a percentage of revenues increased from 16.60% ($2,837,447) in 2000to 33.95% ($2,915,542) in 2001.

Selling,marketing and advertising as a percentage of revenues increased from 4.11% ($703,377)in 2000 to 11.98% ($1,028,653) in 2001, primarily due to increased marketing inrelation to the new sales agreement with a major customer in the quarter.

Generaland administrative expenses as a percentage of revenues increased from 9.28%($1,586,220) in 2000 to 15.48% ($1,328,967) in 2001. The increase is primarilydue to the decrease in sales in 2001 versus 2000, as most general andadministrative expenses are fixed.  Inaddition, the Company had some redundant expenses resulting from the Company’sacquisition of IOM Holdings on December 31, 2000.  The Company began to reduce excess expenses in the second quarterof 2001 and expects such to continue throughout the year 2001.

Depreciationand amortization increased from $547,850 (3.20% of revenues) in 2000 to$557,922 (6.50% of revenues) in 2001. The percentage increase is due to the reduction in sales in 2001 versus2000.

Otherincome (expense) decreased as a percentage of sales from (2.47%) ($422,976expense) to 0.32% ($27,428 expense). This was primarily due to a decrease in interest expense due toborrowings being lower in 2001.

Provisionfor income taxes for the period ended June 30, 2000 represents Federal taxestimate and California state franchise tax estimate.  Provision for income taxes for the period ended June 30, 2001represents Federal taxes as a result of the Company’s estimated annualizedtaxable income being subject to Alternative Minimum Taxes (AMT), Californiastate franchise tax estimate, and the current period deferred benefit.

Netlosses decreased from $456,820 for the three months ended June 30, 2000 to aloss of $5,554,347 for the three months ended June 30, 2001.

 

**Six Months ended June 30, 2001 and 2000**

                   **Resultsof Operations**

Revenuesfor the period ended June 30, 2001 ("2001") were $18,802,392,compared to revenues for the period ended June 30, 2000 ("2000") of$33,047,175. The decrease in revenues is primarily attributable to the slowdownin the national economy, which has affected the Company’s customers and thusthe Company.  The Company signed newagreements with two major customers at the end of the second quarter, and theCompany believes that these agreements will enable the Company to increase itssales in the third quarter. The Company had a sales backlog as of June 30, 2001of $18,404,895 and it had a sales backlog of $1,951,665 as of June 30, 2000.

Costof sales as a percentage of revenues increased from 82.63% ($27,305,926) n 2000to 108.14% ($20,333,495) in 2001.  Thiswas primarily due to the write-down by $3,455,682 of obsolete and slow-movinginventory.  This was primarily inventoryacquired in the acquisition of IOM Holdings on December 31, 2000.In addition,the Company incurred much higher rebate costs in 2001 than 2000 (the Companychanged its policy to offset rebates against revenues). Cost of product as apercentage of revenues before rebates decreased in 2001 from 2000 due to no OEMrevenues in 2001, which have a lower margin.

Operatingexpenses as a percentage of revenues increased from 14.25% ($4,708,210) in 2000to 28.96% ($5,445,448) in 2001.

Selling,marketing and advertising as a percentage of revenues increased from 4.77%($1,576,366) in 2000 to 8.39% ($1,577,814) in 2001.

Generaland administrative expenses as a percentage of revenues increased from 7.77%($2,566,401) in 2000 to 14.65% ($2,754,801) in 2001.  The increase is primarily due to the decrease in sales in 2001versus 2000, as most general and administrative expenses are fixed.  In addition, the Company had some redundantexpenses resulting from the Company’s acquisition of IOM Holdings on December31, 2000.  The Company began to reduceexcess expenses in the second quarter of 2001 and expects such to continuethroughout the year 2001.

Depreciationand amortization increased from $565,443 (1.71% of revenues) in 2000 to$1,112,833 (5.92% of revenues) in 2001. This is due to six months or amortization of the Hi-Val and DigitalResearch Technology trademarks in 2001 versus three months in 2000.  In addition, part of the percentage increaseis due to the reduction in sales in 2001 versus 2000.

Otherincome (expense) decreased as a percentage of sales from (1.27%) ($420,753expense) to 1.20% ($225,261 expense). This was primarily due to a decrease in interest expense due toborrowings being lower in 2001.

Provisionfor income taxes for the period ended June 30, 2000 represents Federal taxestimate and California state franchise tax estimate.  Provision for income taxes for the period ended June 30, 2001represents Federal taxes as a result of the Company’s estimated annualizedtaxable income being subject to Alternative Minimum Taxes (AMT), Californiastate franchise tax estimate, and the current period deferred benefit

Netprofits decreased from $518,686 income for the six months ended June 30, 2000 toa loss of $7,631,303 for the six months ended June 30, 2001.

 

**Liquidity and Capital Resources**

Sinceits inception, the Company has financed its operations and capital expendituresprimarily with cash provided by operating activities, private securities issuancesand securities issuances for product. The Company believes that working capitalgenerated from operations is sufficient to meet current activity. However,should the Company grow significantly in size through additional largecustomers or acquisitions, securities issuances or other financing arrangementsmay be necessary. The Company currently has two lines of credit with its majorsuppliers: $5 million with BTC and $2 million with Lung Hwa. Borrowings underthose arrangements is provided to the Company interest free for up to 60 days.The Company had trade accounts payable outstanding balances on these lines of$2,053,625 and $5,167,919, respectively, as of June 30, 2001 and 2000.

In April 2000, the Company assumed a lineof credit in the acquisition of IOM Holdings (see NOTE 5).  The Company believes that its current cashflow from operations, the amount available under the assumed line of credit andthe amounts available under its existing vendor lines of credit are sufficientto meet its working capital and capital expenditure requirements at the currentsales volume for the next twelve months.

Inaddition, certain of the Company’s stockholders and vendors continue to provideinventory in exchange for common stock of the Company.

Forthe six months ended June 30, 2001 the Company had a net decrease in cash inthe amount of $2,783,774. This was due to cash provided by operating activitiesof $438,610, cash used in investing activities of $108,978 and cash used infinancing activities of $3,113,407. Cash from all accounts receivable changesincreased by $3,007,988 and cash from inventory changes increased by$9,269,660. Cash used in investing activities was for leasehold improvements,furniture and computer equipment. Cash used in financing activities wasprimarily for payments on the line of credit.

Asthe Company expands its distribution activities, it may experience net negativecash flows from operations, pending an increase in gross margins, and may berequired to obtain additional financing to fund operations through proceedsfrom offerings, to the extent available, or to obtain additional financing tothe extent necessary to augment its working capital through public or privateissuance of equity or debt securities.

Thehigh technology requirements of the Internet increasingly require thatconsumers upgrade their personal computers to take full advantage of audio andvideo streaming capabilities. Further, there are increasing Internetapplications for digitally based graphics data, such as pictures taken bydigital cameras. The Company believes that its current distribution channelscurrently fulfill and will continue to fulfill these trends in the computerperipherals marketplace. In the event the Company resumes the revenue growth itexperienced in 1999 and 2000, the Company believes that it will need additionalcapital. While there is no assurance that it will be successful in raisingadditional capital, the Company is currently actively seeking bothinstitutional debt, as well as private sources of equity capital in order toassure that it will be capable of financing such growth. The Company iscurrently in the process of increasing its line of credit with its currentlending institution.  In the event theCompany is unsuccessful in securing such financing, it may be required tocurtail its sales growth.

**Factors That May Affect Future Results**

TheCompany’s business, financial condition and results of operations may beimpacted by a number of factors including, without limitation, those listed below.

SignificantCustomer Concentration

Duringthe six month period ended June 30, 2001 the Company had three major customerswhich accounted for approximately 79% of the Company’s net sales and four majorcustomers who accounted for $12,810,582 of accounts receivable. The Company’sstrategy is to engage only with the largest retail customers in order toincrease the Company’s growth and to expand its product offering.

TheCompany has no firm long-term sales commitments from any of its customers andenters into individual purchase orders with its customers. The Company hasexperienced cancellations of orders and fluctuations in order levels fromperiod to period and expects it will continue to experience such cancellationsand fluctuations in the future. In addition, customer purchase orders may becanceled and order volume levels can be changed, canceled or delayed withlimited or no penalties. The replacement of canceled, delayed or reducedpurchase orders with new business cannot be assured. Moreover, the Company’sbusiness, financial condition and results of operations will depend upon itsability to obtain orders from new customers, as well as the financial conditionand success of its customers, its customers products and the general economy.The factors affecting any of the Company’s major customers or their customerscould have a material adverse effect on the Company’s business, financialcondition and results of operations.

**PART II – OTHERINFORMATION**

**Item 1.  Legal Proceedings**

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

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

                   Incorporatedby reference from Registrant's Report on Form 10-K filed with the Securitiesand Exchange Commission on June 30, 2001 (see Management's Discussion andAnalysis and ­Liquidity and Capital Resources).  See Financial Statement ­Supplemental Schedule of Non-CashInvesting and Financing Activities and Note 6.

**Item 3. Defaults Upon Senior Securities**

                   None

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

                   None.

**Item 5.  Other Information**

                   None.

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

                   Thefollowing documents are filed as part of this report:

                                        1.  Reports on Form 8-K filed:  None

 

**Signatures**

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

|   |            | I/OMAGIC CORPORATION                         |
|--------|-----------------|----------------------------------------------|
|   |            |                                         |
| DATED: | August 18, 2001 |                                         | By:  | /s/ Tony Shahbaz |
|   |            |                                         |   |  |
|   |            | Tony  Shahbaz, President and Chief Executive |
|   |            | Officer,  Chief Financial Officer            |
|        |                 |                                              |  |  |  |