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

                                    FORM 10-Q
(Mark One)
[ X ]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

                For the quarterly period ended September 30, 2005

                                       OR

[   ] 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 of             (I.R.S. Employer Identification No.)
Incorporation or Organization)

         4 Marconi, Irvine, CA                             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 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 whether the registrant is an accelerated filer (as defined in
Rule  12b-2  of  the  Exchange  Act).   Yes  [   ]    No  [  X  ]

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  November  11,  2005,  there were 4,531,572 shares of the issuer's common
stock  issued  and  outstanding.


<PAGE>


                      I/OMAGIC CORPORATION AND SUBSIDIARY

                                TABLE OF CONTENTS

                                                                           Page
                                                                          Number
                                                                          ------

PART  I  -  FINANCIAL  INFORMATION

Item  1.    Financial  Statements

            Consolidated  Balance  Sheets - September 30, 2005 (unaudited)
            and December 31,  2004                                           3

            Consolidated  Statements  of  Income  - For the three and
            nine months ended September  30,  2005  and  2004 (unaudited)    5

            Consolidated  Statements  of  Cash  Flows  -  For  the  nine
            months ended September  30,  2005  and  2004  (unaudited)        6

            Notes  to  Consolidated  Financial  Statements                   7

Item  2.    Management's Discussion and Analysis of Financial Condition
            and  Results  of  Operations                                    15

Item  3.    Quantitative and Qualitative Disclosures About Market Risk      46

Item  4.    Controls  and  Procedures                                       46


PART  II  -  OTHER  INFORMATION

Item  1.     Legal  Proceedings                                             49

Item  2.     Unregistered  Sale  of Equity Securities and Use of Proceeds   50

Item  3.     Defaults  Upon  Senior  Securities                             50

Item  4.     Submission  of  Matters  to  a  Vote  of  Security  Holders    50

Item  5.     Other  Information                                             50

Item  6.     Exhibits                                                       50

SIGNATURES                                                                  51

EXHIBITS  FILED  WITH  THIS  REPORT                                         52

<PAGE>

                         PART I - FINANCIAL INFORMATION


ITEM 1.     FINANCIAL STATEMENTS


                              I/OMAGIC CORPORATION
                                 AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS
              SEPTEMBER 30, 2005  (UNAUDITED) AND DECEMBER 31, 2004


                                     ASSETS

<TABLE>
<CAPTION>
                                                                SEPTEMBER 30,    DECEMBER 31,
                                                                    2005            2004
                                                               ---------------  -------------
                                                                 (unaudited)
<S>                                                            <C>              <C>
CURRENT ASSETS
Cash and cash equivalents                                      $     2,781,920  $   3,587,807
Restricted cash                                                         38,295      1,044,339
Accounts receivable, net of allowance for doubtful
     accounts of $123,222 (unaudited) and $24,946                   12,090,212     14,598,422
Inventory, net of allowance for obsolete inventory of $34,709
     (unaudited) and $1,463,214                                      7,179,842      6,146,766
Inventory in transit                                                    78,607        513,672
Prepaid expenses and other current assets                            1,524,627        741,244
                                                               ---------------  -------------
     Total current assets                                           23,693,503     26,632,250
PROPERTY AND EQUIPMENT, net of accumulated depreciation of
       $1,392,789 (unaudited) and $1,256,036                           195,100        307,661
TRADEMARK, net of accumulated amortization
       of $5,501,476 (unaudited) and $5,449,780                        448,104        499,800
OTHER ASSETS                                                            27,032         27,032
                                                               ---------------  -------------
     TOTAL ASSETS                                              $    24,363,739  $  27,466,743
                                                               ===============  =============
</TABLE>

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


                                        3
<PAGE>

                              I/OMAGIC CORPORATION
                                 AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS
              SEPTEMBER 30, 2005 (UNAUDITED) AND DECEMBER 31, 2004

                      LIABILITIES AND STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>


                                                                         SEPTEMBER 30,    DECEMBER 31,
                                                                             2005             2004
                                                                        ---------------  --------------
                                                                          (unaudited)
                                                                        ---------------
<S>                                                                     <C>              <C>
CURRENT LIABILITIES
Line of credit                                                          $    5,509,304   $   5,962,891
 Accounts payable and accrued expenses                                       5,510,742       5,221,719
 Accounts payable - related parties                                          5,617,227       7,346,596
 Reserves for customer returns and price protection                            500,643         573,570
                                                                        ---------------  --------------
   Total current liabilities                                                17,137,916      19,104,776
                                                                        ---------------  --------------
COMMITMENTS AND CONTINGENCIES                                                        -               -
STOCKHOLDERS' EQUITY
Preferred Stock
   10,000,000 shares authorized, $0.001 par value                                    -               -
       Series A, 1,000,000 shares authorized, 0 and 0 shares
       Issued and outstanding                                                        -               -
       Series B, 1,000,000 shares authorized, 0 and 0 shares
       Issued and outstanding                                                        -               -
 Common stock, $0.001 par value
      100,000,000 shares authorized
     4,531,572 (unaudited) and 4,529,672 shares issued and outstanding           4,532           4,530
Additional paid-in capital                                                  31,564,636      31,557,988
Treasury stock, 13,493 (unaudited) and 13,493 shares, at cost                 (126,014)       (126,014)
Accumulated deficit                                                        (24,217,331)    (23,074,537)
                                                                        ---------------  --------------
   Total stockholders' equity                                                7,225,823       8,361,967
                                                                        ---------------  --------------
     TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                         $   24,363,739   $  27,466,743
                                                                        ===============  ==============
</TABLE>

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

                                        4
<PAGE>

                              I/OMAGIC CORPORATION
                                 AND SUBSIDIARY
                        CONSOLIDATED STATEMENTS OF INCOME
         FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
                                   (UNAUDITED)


<TABLE>
<CAPTION>


                                                    THREE MONTHS ENDED                     NINE MONTHS ENDED
                                                     SEPTEMBER 30,                           SEPTEMBER 30,
                                               2005            2004 (RESTATED)        2005      2004 (RESTATED)
                                       -------------------------------------------------------------------------
                                           (unaudited)           (unaudited)      (unaudited)     (unaudited)

<S>                                    <C>                   <C>                  <C>           <C>
NET SALES                              $         8,423,756   $        9,946,733   $27,018,179   $    32,910,080
COST OF SALES                                    7,074,310            9,391,995    23,569,496        29,662,573
                                       --------------------  -------------------  ------------  ----------------
GROSS PROFIT                                     1,349,446              554,738     3,448,683         3,247,507
                                       --------------------  -------------------  ------------  ----------------
OPERATING EXPENSES
Selling, marketing, and advertising                182,265              195,756       479,690           846,767
General and administrative                       1,254,080            1,293,576     3,713,921         4,113,347
Depreciation and amortization                       49,148              208,265       188,449           626,505
                                       --------------------  -------------------  ------------  ----------------
   Total operating expenses                      1,485,493            1,697,597     4,382,060         5,586,619
                                       --------------------  -------------------  ------------  ----------------
LOSS FROM OPERATIONS                              (136,047)          (1,142,859)     (933,377)       (2,339,112)
                                       --------------------  -------------------  ------------  ----------------
OTHER INCOME (EXPENSE)
Interest income                                         64                   62           346               314
Interest expense                                   (76,543)             (38,090)     (218,694)         (122,137)
Other income (expense)                                  52               11,675        11,332            (8,746)
                                       --------------------  -------------------  ------------  ----------------
          Total other income (expense)             (76,427)             (26,353)     (207,016)         (130,569)
                                       --------------------  -------------------  ------------  ----------------

LOSS BEFORE INCOME TAXES                          (212,474)          (1,169,212)   (1,140,393)       (2,469,681)

PROVISION FOR INCOME TAXES                               -                  336         2,400             2,532
                                       --------------------  -------------------  ------------  ----------------
NET LOSS                               $          (212,474)  $       (1,169,548)  $(1,142,793)  $    (2,472,213)
                                       ====================  ===================  ============  ================
BASIC AND DILUTED LOSS PER SHARE       $             (0.05)  $            (0.26)  $     (0.25)  $         (0.55)
                                       ====================  ===================  ============  ================
BASIC AND DILUTED WEIGHTED-AVERAGE
SHARES OUTSTANDING                               4,530,581            4,529,672     4,529,978         4,529,672
                                       ====================  ===================  ============  ================
</TABLE>


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


                                        5
<PAGE>


                              I/OMAGIC CORPORATION
                                 AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
                                   (UNAUDITED)


<TABLE>
<CAPTION>



                                                              NINE MONTHS ENDED SEPTEMBER 30,
                                                                 2005                     2004
                                                                                      (RESTATED)
                                                   ---------------------------------  ------------
                                                              (unaudited)             (unaudited)

<S>                                                <C>                                <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss                                           $                     (1,142,793)  $(2,472,213)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation and amortization                                               136,753       192,453
Amortization of trademarks                                                   51,696       434,052
Allowance for doubtful accounts                                             179,183       180,000
Reserve for customer returns and allowances                                 (72,929)     (541,787)
Reserve for obsolete inventory                                              705,426       843,596
(Increase) decrease in
Accounts receivable                                                       2,329,027     6,271,047
Inventory                                                                (1,738,502)    2,857,058
Inventory in transit                                                        435,066      (910,919)
Prepaid expenses and other current assets                                  (783,383)     (231,600)
Other assets                                                                      -        25,952
Decrease in
Accounts payable and accrued expenses                                       289,024      (854,451)
Accounts payable - related parties                                       (1,729,369)   (7,740,066)
Settlement payable                                                                -    (1,000,000)
                                                   ---------------------------------  ------------
Net cash used in operating activities                                    (1,340,801)   (2,946,878)
                                                   ---------------------------------  ------------

CASH FLOWS FROM INVESTING ACTIVITIES
   Purchase of property and equipment                                       (24,193)      (22,758)
   Restricted cash                                                        1,006,044     1,788,360
                                                   ---------------------------------  ------------

   Net cash provided by investing activities                                981,851     1,765,602
                                                   ---------------------------------  ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of warrants                                            6,650             -
Net payments on line of credit                                             (453,587)      (16,030)
                                                   ---------------------------------  ------------
Net cash used in financing activities                                     ( 446,937)      (16,030)
                                                   ---------------------------------  ------------
Net decrease in cash and cash equivalents                                  (805,887)   (1,197,306)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                            3,587,807     4,005,705
                                                   ---------------------------------  ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD           $                      2,571,920   $ 2,808,399
                                                   =================================  ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 INTEREST PAID                                     $                        211,658   $   114,495
                                                   =================================  ============
 INCOME TAXES PAID                                 $                          2,400   $     2,532
                                                   =================================  ============
</TABLE>

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


                                        6
<PAGE>
                              I/OMAGIC CORPORATION
                                 AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - ORGANIZATION AND BUSINESS

I/OMagic  Corporation  ("I/OMagic"),  a  Nevada  corporation, and its subsidiary
(collectively,  the  "Company")  develop,  manufacture  through  subcontractors,
market,  and  distribute  data storage and digital entertainment products to the
consumer  electronics  marketplace.


NOTE  2  -  RESTATEMENT  OF  2004  FINANCIAL  STATEMENTS

The  Company  previously  accounted  for  its sales incentives by reducing gross
sales  at  the time sales incentives were offered to its retailers. Upon further
examination  of  its  accounting  methodology  for  sales  incentives,  and  a
quantitative analysis of its historical sales incentives, the Company determined
that  it  made an error in its application of the relevant accounting principles
under SFAS 48, as interpreted under Topic 13, and determined that it should have
estimated  and  recorded  sales  incentives  at the time its products were sold.
Under  SFAS  48, as interpreted under Topic 13, the eventual sales price must be
fixed  or  determinable before revenue can be recognized.  Due to the nature and
extent  of  the  Company's sales incentive history, the Company should have been
assessing  its  revenue recognition criteria to determine whether it was able to
effectively  estimate  or  determine  its eventual sales price.  The Company has
determined  the  effect  of  the  correction  on its previously issued financial
statements  and  has  restated  the  accompanying  financial  statements and the
financial  information  below  for the three and nine months ended September 30,
2004.

The Company previously accounted for product returns using a method that did not
take  into account the different return characteristics of categories of similar
products and also did not adequately take into account the variability over time
of  product  return rates.  The Company conducted a quantitative analysis of its
historical  product  return  data to determine moving averages of product return
rates  by  groupings of similar products. Following completion of this analysis,
the Company determined that it made an error in its method of estimating product
returns.  The  Company  has  determined  the  effect  of  the  correction on its
previously  issued  financial  statements  and  has  restated  the  accompanying
financial  statements and the financial information below for the three and nine
months  ended  September  30,  2004.

The  effects  of  the restatement on net sales, cost of sales, gross profit, net
income,  basic and diluted income per common share, reserves for product returns
and  sales  incentives,  and stockholders' equity as of and for the three months
ended  September  30,  2004  are  as  follows:


<TABLE>
<CAPTION>

                                                     AS ORIGINALLY    RESTATEMENT
                                                       REPORTED       ADJUSTMENTS    AS RESTATED
                                                    ---------------  -------------  -------------
<S>                                                 <C>              <C>            <C>
Net sales                                           $    8,302,490   $  1,644,243   $  9,946,733
Cost of sales                                            8,654,753        737,242      9,391,995
Gross profit                                              (352,263)       907,001        554,738
Net income (loss)                                   $   (2,076,549)  $    907,001   $ (1,169,548)

PROFIT (LOSS) PER COMMON SHARE:
   Basic                                            $        (0.46)  $       0.20   $      (0.26)
   Diluted                                          $        (0.46)  $       0.20   $      (0.26)
Reserves for product returns and sales incentives   $    1,292,426   $ (1,021,955)  $    270,471
Stockholders' equity                                $   12,924,663   $  1,021,955   $ 13,946,618
</TABLE>

The effects of the restatement on net sales, cost of sales, gross profit, net
income, basic and diluted income per common share, reserves for product returns
and sales incentives, and stockholders' equity as of and for the nine months
ended


                                        7
<PAGE>

September  30,  2004  are  as  follows:

<TABLE>
<CAPTION>
                                                     AS ORIGINALLY    RESTATEMENT
                                                       REPORTED       ADJUSTMENTS    AS RESTATED
                                                    ---------------  -------------  -------------
<S>                                                 <C>              <C>            <C>
Net sales                                           $   30,854,250   $  2,055,830   $ 32,910,080
Cost of sales                                           28,587,583      1,074,990     29,662,573
Gross profit                                             2,266,667        980,840      3,247,507
Net income (loss)                                   $   (3,453,053)  $    980,840   $ (2,472,213)

PROFIT (LOSS) PER COMMON SHARE:
   Basic                                            $        (0.76)  $       0.21   $      (0.55)
   Diluted                                          $        (0.76)  $       0.21   $      (0.55)
Reserves for product returns and sales incentives   $    1,292,426   $ (1,021,955)  $    270,471
Stockholders' equity                                $   12,924,663   $  1,021,955   $ 13,946,618
</TABLE>


NOTE  3  -  SUMMARY  OF  SIGNIFICANT  ACCOUNTING  POLICIES

BASIS  OF  PRESENTATION

The  accompanying unaudited consolidated financial statements have been prepared
in  accordance  with  the  rules  and regulations of the Securities and Exchange
Commission  and,  therefore,  do not include all information and notes necessary
for  a  fair presentation of financial position, results of operations, and cash
flows  in  conformity  with  generally  accepted  accounting  principles.  The
unaudited consolidated financial statements include the accounts of I/OMagic and
its  subsidiary. The operating results for interim periods are unaudited and are
not  necessarily an indication of the results to be expected for the full fiscal
year.  In  the  opinion of management, the results of operations as reported for
the  interim  periods  reflect  all  adjustments  which are necessary for a fair
presentation of operating results.  These financial statements should be read in
conjunction  with  the Company's Form 10-K for the year ended December 31, 2004.

USE  OF  ESTIMATES

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

RECENT ACCOUNTING PRONOUNCEMENTS

In  May 2005, the Financial Accounting Standards Board ("FASB") issued Statement
of  Accounting  Standards  (SFAS)  No.  154,  "Accounting  Changes  and  Error
Corrections"  an  amendment  to Accounting Principles Bulletin (APB) Opinion No.
20,  "Accounting  Changes",  and  SFAS  No.  3, "Reporting Accounting Changes in
Interim  Financial  Statements" though SFAS No. 154 carries forward the guidance
in  APB  No.  20  and  SFAS  No.  3  with  respect  to accounting for changes in
estimates,  changes  in  reporting  entity,  and  the  correction  of  errors.

SFAS  No.  154 establishes new standards on accounting for changes in accounting
principles,  whereby  all  such  changes  must be accounted for by retrospective
application  to  the  financial  statements  of  prior  periods  unless  it  is
impracticable  to  do  so.  SFAS No. 154 is effective for accounting changes and
error  corrections  made in fiscal years beginning after December 15, 2005, with
early  adoption  permitted  for  changes and corrections made in years beginning
after  May 2005.   Management does not expect adoption of SFAS No. 154 to have a
material  impact  on  the  Company's  financial  statements.

In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47, "Accounting
for Conditional Asset Retirement Obligations". FIN No. 47 clarifies that the
term conditional asset retirement obligation as used in FASB Statement No. 143,
"Accounting for Asset Retirement Obligations," refers to a legal obligation to
perform an asset retirement activity in which the timing and (or) method of
settlement are conditional on a future event that may or may not be within the



                                        8
<PAGE>

control  of the entity.  The obligation to perform the asset retirement activity
is unconditional even though uncertainty exists about the timing and (or) method
of  settlement.  Uncertainty  about  the timing and/or method of settlement of a
conditional  asset retirement obligation should be factored into the measurement
of  the  liability when sufficient information exists.  This interpretation also
clarifies  when  an  entity  would  have  sufficient  information  to reasonably
estimate  the  fair  value  of  an  asset  retirement  obligation. FIN No. 47 is
effective  no  later than the end of fiscal years ending after December 15, 2005
(which  would  be  December 31, 2005 for calendar-year companies). Retrospective
application  of  interim financial information is permitted but is not required.
Management  does  not expect adoption of FIN No. 47 to have a material impact on
the  Company's  financial  statements.

STOCK-BASED  COMPENSATION

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

Pro  forma information regarding net loss and loss per share is required by SFAS
No. 123 and has been determined as if the Company had accounted for its employee
stock  options  under the fair value method of SFAS No. 123. For the nine months
ended September 30, 2005, 370,000 options to purchase common stock were granted.
For the nine months ended September 30, 2004, 126,375 options to purchase common
stock  were  granted.

For  purposes  of pro forma disclosures, the estimated fair value of the options
is  amortized to expense over the options' vesting periods. Adjustments are made
for  options  forfeited  prior  to vesting. The effect on net loss and basic and
diluted  loss  per  share  had compensation costs for the Company's stock option
plans been determined based on a fair value at the date of grant consistent with
the  provisions  of  SFAS  No.  123  for  the three months and nine months ended
September  30,  2005  (unaudited)  and  2004  (unaudited)  is  as  follows:

<TABLE>
<CAPTION>




                                                        THREE MONTHS ENDED                   NINE MONTHS ENDED
                                                       --------------------                 -------------------
                                                           SEPTEMBER 30,                        SEPTEMBER 30,
                                                       --------------------                 -------------------
                                                           (unaudited)                          (unaudited)
<S>                                              <C>                   <C>           <C>                  <C>
                                                                            2004                               2004
                                                                2005     (RESTATED)                2005     (RESTATED)
                                                 --------------------  ------------  -------------------  ------------
Net loss
 As reported                                     $          (212,474)  $(1,169,548)  $       (1,142,793)  $(2,472,213)

 Add stock based compensation expense
    included in net income, net of tax                             -             -                    -             -
 Deduct total stock based employee
   compensation expense determined under
   fair value method for all awards, net of tax             (388,555)      (22,610)            (432,708)      (52,878)
                                                 --------------------  ------------  -------------------  ------------

 PRO FORMA                                       $          (601,029)  $(1,192,158)  $       (1,575,501)  $(2,525,091)
                                                 ====================  ============  ===================  ============
Loss per common share
 Basic - as reported                             $             (0.05)  $     (0.26)  $            (0.25)  $     (0.55)
 Basic - pro forma                               $             (0.13)  $     (0.26)  $            (0.35)  $     (0.56)
 Diluted - as reported                           $             (0.05)  $     (0.26)  $            (0.25)  $     (0.55)
 Diluted - pro forma                             $             (0.13)  $     (0.26)  $            (0.35)  $     (0.56)
</TABLE>


                                        9
<PAGE>


EARNINGS  (LOSS)  PER  SHARE

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

As  of  September  30,  2005  (unaudited) and September 30, 2004 (unaudited) the
Company  had  potential  common  stock  as  follows:


<TABLE>
<CAPTION>

                                                                THREE MONTHS ENDED           NINE MONTHS ENDED
                                                                --------------------        -------------------
                                                                   SEPTEMBER 30,               SEPTEMBER 30,
                                                                --------------------        -------------------
                                                                    (unaudited)                 (unaudited)
<S>                                                     <C>                  <C>        <C>                 <C>
                                                                       2005       2004                2005       2004
                                                        -------------------  ---------  ------------------  ---------
Weighted average common shares
 outstanding during the period                                    4,530,581  4,529,978           4,529,672  4,529,672
Incremental shares assumed to be outstanding
 since the beginning of the period related
 to stock options and warrants outstanding (unaudited)                    -          -                   -          -
                                                        -------------------  ---------  ------------------  ---------
Fully diluted weighted average common shares and
 potential common stock                                           4,530,581  4,529,978           4,529,672  4,529,672
                                                        ===================  =========  ==================  =========
</TABLE>

The following potential common shares have been excluded from the computation of
diluted  earnings  per  share  for  the  three  months  ended September 30, 2005
(unaudited)  and  September  30,  2004  (unaudited)  and  the  nine months ended
September  30,  2005  (unaudited) and September 30, 2004 (unaudited) since their
effect  would  have  been  anti-dilutive.

<TABLE>
<CAPTION>


                           September 30,
                           --------------
                            (unaudited)
<S>                        <C>             <C>

                                     2005     2004
                           --------------  -------
Stock options outstanding         478,950  126,150
Warrants outstanding              150,000   20,000
                           --------------  -------
TOTAL                             628,950  146,150
                           ==============  =======

</TABLE>

NOTE  4  -  INVENTORY
Inventory  consisted  of  the  following:

<TABLE>
<CAPTION>


                                                  September 30,    December 31,
                                                      2005             2004
                                                 ---------------  --------------
                                                   (unaudited)
<S>                                              <C>              <C>
Component parts                                  $    1,520,661   $   2,123,173
Finished goods - warehouse                            1,904,071       2,614,202
Finished goods - consigned                            3,789,819       2,872,605
Reserves for obsolete and slow moving inventory         (34,709)     (1,463,214)
                                                 ---------------  --------------
TOTAL                                            $    7,179,842   $   6,146,766
                                                 ===============  ==============
</TABLE>

                                       10
<PAGE>
For the nine months ended September 30, 2005, $2,133,932 (unaudited) in obsolete
inventory  was  written  off  against  the  reserve.


NOTE  5  -  PROPERTY  AND  EQUIPMENT

Property  and  equipment  as  of September 30, 2005 (unaudited) and December 31,
2004  consisted  of  the  following:

<TABLE>
<CAPTION>

                                                 September 30,    December 31,
                                                      2005             2004
                                                ---------------  -------------
                                                  (unaudited)
<S>                                             <C>              <C>
Computer equipment and software                 $     1,052,740  $   1,051,485
Warehouse equipment                                      55,238         55,238
Office furniture and equipment                          281,974        266,889
Vehicles                                                 91,304         91,304
Leasehold improvements                                  106,633         98,780
                                                ---------------  -------------
                                                      1,587,889      1,563,696
Less accumulated depreciation and amortization        1,392,789      1,256,035
                                                ---------------  -------------
TOTAL                                           $       195,100  $     307,661
                                                ===============  =============
</TABLE>



For  the  nine  months  ended  September  30,  2005  and  2004, depreciation and
amortization  expense  was  $136,753  (unaudited)  and  $192,453  (unaudited),
respectively.


NOTE  6  -  ACCOUNTS  PAYABLE  AND  ACCRUED  EXPENSES

Accounts  payable  and  accrued  expenses  consisted  of  the  following:

<TABLE>
<CAPTION>
                                            September 30,    December 31,
                                                2005            2004
                                            -------------   -------------
                                             (unaudited)
<S>                                        <C>              <C>
Accounts payable                           $       750,228  $   1,282,082
Accrued rebates and marketing                    4,132,947      3,231,655
Accrued compensation and related benefits          188,895        158,896
Other                                              438,672        549,086
                                           ---------------  -------------
TOTAL                                      $     5,510,742  $   5,221,719
                                           ===============  =============
</TABLE>


NOTE  7  -  LINE  OF  CREDIT

On  August  15,  2003,  the Company entered into an agreement for an asset-based
line  of  credit  with United National Bank, effective August 18, 2003. The line
allowed  the  Company  to  borrow  up  to a maximum of $6.0 million. The line of
credit  was  initially  used  to pay off the outstanding balance with ChinaTrust
Bank  (USA) as of September 2, 2003, which was $3,379,827.  On March 9, 2005 the
line  of  credit with United National Bank was replaced by a line of credit from
GMAC  Commercial Finance.  On March 9, 2005, the Company entered into a Loan and
Security  Agreement  ("Loan  Agreement")  for an asset-based line of credit with
GMAC  Commercial  Finance LLC ("GMAC"). The line of credit allows the Company to
borrow  up to a maximum of $10.0 million. The line of credit expires on March 9,
2008  and  is  secured by substantially all of the Company's assets. The line of
credit  allows for a sublimit of $2.0 million for outstanding letters of credit.
Advances  on  the  line  of credit bear interest at the floating commercial loan
rate  initially  equal  to  the  prime  rate  plus  0.75%.  The prime rate as of
September  30, 2005 was 6.75%. The Company also has the option to use the 30-day
LIBOR  rate  (as  determined by the London Interbank Market), which was 3.86% at
September  30,  2005,  plus  an  initial  amount  of  3.50%.

These rates are applicable if the average amount available for borrowing for the
prior  six month period is between $1.0 million and $3.5 million. If the average
amount  available  for  borrowing  is  less  than  $1.0  million, then the rates
applicable  to  all  amounts  borrowed  increase  by 0.5%. If the average amount
available  for borrowing is greater than $3.5 million, then the rates applicable
to  all  amounts borrowed decrease by 0.25%. For the unused portion of the line,
the Company is


                                       11
<PAGE>

to pay on a monthly basis, an unused line fee in the amount of 0.25% of the
average  unused  portion  of  the  line  for  the  preceding  month.

The  Loan Agreement contains one financial covenant-that the Company maintain at
the  end  of each measurement period through and including September 30, 2005, a
fixed  charge  coverage  ratio  (the ratio of (a) EBITDA minus internally funded
Capital  Expenditures  to  (b)  the  sum of any scheduled principal and interest
payments on all funded debt and income taxes paid or payable) of at least 1.2 to
1.0 and a fixed charge coverage ratio of at least 1.5 to 1.0 for all measurement
periods  thereafter.  A  measurement  period is defined in the Loan Agreement as
the  three  month period ending March 31, 2005, the six month period ending June
30,  2005,  the  nine  month  period ending September 30, 2005, the twelve month
period  ending  December 31, 2005, and thereafter the twelve month period ending
on March 31, June 30, September 30, and December 31 of each year during the term
of  the  credit facility.  As of March 31 2005, the Company was in breach of the
financial  covenant.

On  May  23,  2005,  the  Company  entered  into  a  Letter  Agreement  ("Letter
Agreement")  with  GMAC  with  respect to a certain financial covenant under the
Loan  Agreement  with GMAC dated March 9, 2005. The Letter Agreement amended the
Loan  Agreement  to  exclude  the  required  fixed charge coverage ratio for the
measurement  period  ending  March  31,  2005.  The Letter Agreement amended the
financial  covenant to provide that the Company maintain a fixed charge coverage
ratio  of at least 1.0 to 1.0 for the months of April 2005 and May 2005, a fixed
charge coverage ratio of at least 1.2 to 1.0 for the three months ended June 30,
2005  and  the  six months ended September 30, 2005, and a fixed charge coverage
ratio of at least 1.5 to 1.0 for the nine months ended December 31, 2005 and for
each  twelve  month period thereafter ending on March 31, June 30, September 30,
and December 31 during the term of the credit facility.

On  June  30,  2005,  the  Company  entered  into  a First Amendment to Loan and
Security  Agreement  ("First Amendment") with GMAC with respect to the foregoing
financial  covenant. The First Amendment amended the Letter Agreement to exclude
the  required  fixed  charge  coverage  ratio for the measurement periods ending
April  30,  2005 and May 31, 2005. The fixed charge coverage ratio as it applies
to  future  measurement periods remained the same. The Company was in compliance
with this covenant for the nine months ended September 30, 2005.

The  obligations  of  the  Company  under  the  Loan  Agreement  are  secured by
substantially  all  of  the  Company's  assets  and  guaranteed by the Company's
wholly-owned  subsidiary, IOM Holdings, Inc. (the "Subsidiary"). The obligations
of  the  Company  and  the  guarantee  obligations of its Subsidiary are secured
pursuant  to  a  Pledge  and  Security  Agreement  executed  by  the  Company, a
Collateral  Assignment  Agreement  executed by the Company, a Guaranty Agreement
executed  by  its  Subsidiary,  a  General  Security  Agreement  executed by its
Subsidiary,  an  Intellectual  Property  Security  Agreement  and  Collateral
Assignment  executed  by  the  Company,  and  an  Intellectual Property Security
Agreement  and  Collateral  Assignment  executed  by  its  Subsidiary.

The  new credit facility was initially used to pay off the Company's outstanding
balance  with  United  National  Bank  as  of  March 10, 2005, which balance was
$3,809,320  (unaudited),  and  was  also  used  to  pay $25,000 of the Company's
closing  fees  for  the GMAC line of credit. The line of credit will be used for
general  operations.  The outstanding balance with GMAC as of September 30, 2005
was  $5,509,304  (unaudited).  The  Company  was  in an overdraft position as of
September  30, 2005 in the amount of $1,060,298 after its ineligible assets were
recalculated  in early October 2005.  As of the date of this report, the Company
is  no  longer  in  an  overdraft  position.

NOTE  8  -  TRADE  CREDIT  FACILITIES  WITH  RELATED  PARTIES

In  February  2003,  the  Company entered into an agreement with a related party
whereby  the related party agreed to supply and store at the Company's warehouse
up  to  $10.0  million of inventory on a consignment basis. Under the agreement,
the  Company  is  to  insure  the  consignment  inventory, store the consignment
inventory  for  no  charge, and furnish the related party with weekly statements
indicating  all products received and sold and the current consignment inventory
level.  The  agreement  may  be  terminated  by  either party with 60 days prior
written  notice. In addition, this agreement provides for a trade line of credit
of  up to $10.0 million with payment terms of net 60 days, non-interest bearing.
During  the  nine  months  ended  September  30,  2005,  the  Company  purchased
approximately $14.0 million (unaudited) of inventory under this arrangement.  As
of  September  30,  2005,  there  were  $4,413,513 (unaudited) in trade payables
outstanding  under  this  arrangement.


                                       12
<PAGE>

Effective  as of June 6, 2005, the Company entered into an agreement for a trade
credit  facility  with  a  related party whereby the related party has agreed to
purchase  and  manufacture  inventory  on the Company's behalf.  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 payment terms are
120  days  following  the  date  of  invoice  by the related party for which 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 a 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.  Upon
effectiveness  of  the  Agreement,  the  Company was required to pay the related
party  $1.5 million as an early payment for all invoices coming due for payment.
Of this amount, $1.0 million was paid on April 28, 2005 and $500,000 was paid on
April  29,  2005.  Any early payment funds remaining three months after the date
of  the  Agreement are to be refunded to the Company immediately.  Once the $1.5
million  has  been exhausted, or three months from the date of the Agreement has
expired, whichever is sooner, the Company is to pay the related party 10% of the
purchase  price  on  any  purchase  order  issued  to  the  related  party, as a
down-payment  for  the  order,  within  one  week  of  the  purchase order.  The
Agreement  has  an  initial  term  of  one  year  after which the Agreement will
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.

On  July  21,  2005,  the Company entered into an Amended and Restated Agreement
(the  "Amendment")  with  this  related  party  with respect to its trade credit
facility  that  amended  certain  terms  of  the  aforementioned  June  6,  2005
agreement. The Amendment resulted in material amendments to the agreement to (i)
apply  the  terms  of  the  agreement  retroactively  so  that  the agreement is
effective  as  of  April 29, 2005; (ii) change the payment terms of the 10% down
payment  for  products  ordered  from  payment  within one week of the Company's
purchase  order  to payment within ten days of the related party's invoice date;
(iii)  define  the  related party's invoice date as no earlier than the shipment
date  of  products  to  the  Company;  and (iv) designate all purchase orders as
F.O.B.  the  Company's  warehouse in Irvine, California, unless otherwise agreed
upon  in  writing  by  both  parties. During the nine months ended September 30,
2005,  the  Company  purchased  $1.4  million (unaudited) of inventory under the
prior  agreement  and  $2.7  million  (unaudited)  under this arrangement. As of
September  30,  2005,  there were $1,203,714 (unaudited) in trade payables under
this arrangement.

NOTE  9  -  COMMITMENTS  AND  CONTINGENCIES

LEASES

The  Company  leases  its  facilities and certain equipment under non-cancelable
operating lease agreements that expire through December 2008.  The Company moved
to  its  current  facilities  in  September  2003.

Rent  expense  was  $282,486  (unaudited)  and $274,725 (unaudited) for the nine
months  ended  September  30,  2005  and  2004, respectively, and is included in
general  and  administrative  expenses in the accompanying statements of income.

LITIGATION

On May 30, 2003, I/OMagic and IOM Holdings, Inc. filed a complaint for breach of
contract  and  legal  malpractice  against Lawrence W. Horwitz, Gregory B. Beam,
Horwitz & Beam, Lawrence M. Cron, Horwitz & Cron, Kevin J. Senn and Senn Palumbo
Mealemans,  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  seeks  damages  of  $15.0  million  arising  out  of  the defendants'
representation  of I/OMagic and IOM Holdings, Inc. in an acquisition transaction
and in a separate arbitration matter. On November 6, 2003, the Company filed its
First Amended Complaint against all defendants. Defendants have responded to the
Company's  First Amended Complaint denying the Company's allegations. Defendants
Lawrence  W.  Horwitz  and  Lawrence  M.  Cron have also filed a Cross-Complaint
against  the  Company  for attorneys' fees in the approximate amount of $79,000.
The  Company has denied their allegations in the Cross-Complaint. As of the date
of this report, discovery has commenced and a trial date in this action has been
set  for  February  6,  2006. The outcome of this action is presently uncertain.
However,  the  Company  believes  that  all  of  its  claims  and  defenses  are
meritorious.


                                       13
<PAGE>

On  May  6, 2005, OfficeMax North America, Inc., or plaintiff, filed a Complaint
for  Declaratory  Judgment  in  the United States District Court of the Northern
District  of  Ohio  against  the Company. The complaint seeks declaratory relief
regarding  whether  plaintiff  is  still  obligated to the Company under certain
previous  agreements  between  the parties. The complaint also seeks plaintiff's
costs  as  well  as  reasonable attorneys' fees. The complaint arises out of the
Company's  contentions that plaintiff is still obligated to the Company under an
agreement  entered  into in May 2001 and plaintiff's contention that it has been
released  from  such  obligation. As of the date of this report, the Company has
filed  a  motion  to  dismiss,  or  in  the  alternative,  a  motion to stay the
plaintiff's action against the Company.  The outcome of this action is presently
uncertain.  However,  at  this  time, the Company does not expect the defense or
outcome  of  this  action  to  have  a  material adverse affect on its business,
financial  condition  or  results  of  operations.

On May 20, 2005, the Company filed a complaint for breach of contract, breach of
implied  covenant  of  good  faith  and  fair dealing, and common counts against
OfficeMax  North America, Inc., or defendant, in the Superior Court of the State
of California for the County of Orange, Case No. 05CC06433.  The complaint seeks
damages  of  in  excess  of $22 million arising out of the defendants' breach of
contract under an agreement entered into in May 2001. On or about June 20, 2005,
OfficeMax removed the case against OfficeMax to the United States District Court
for  the  Central  District of California, Case No. SA CV05-0592 DOC(MLGx)  (the
"California Case"). On or about June 28, 2005, the Company and OfficeMax jointly
filed  a  stipulation  in  requesting  that  the United States District Court in
California  temporarily  stay  the  California  Case  pending the outcome of the
Motion in Ohio.  On July 6, 2005, the United States District Court in California
denied  the parties joint stipulation request to temporarily stay the California
Case  and instead ordered that OfficeMax answer the complaint by August 1, 2005.
On  August  1,  2005,  OfficeMax  filed its Answer and Counter-Claim against the
Company.  The  Counter-Claim  against  the Company alleges four causes of action
against  the  Company:  breach of contract, unjust enrichment, quantum valebant,
and  an  action  for declaratory relief.  The Counter-Claim alleges, among other
things,  that  the  Company is liable to OfficeMax in the amount of no less than
$138,000  under the terms of a vendor agreement executed between the Company and
OfficeMax  in  connection with the return of computer peripheral products to the
Company  for  which  OfficeMax  allegedly  has  never  been  reimbursed.  The
Counter-Claim  seeks,  among  other  things, at least $138,000 from the Company,
along  with  pre-judgment  interest,  attorneys'  fees and costs of suit.    The
Company  filed a response denying all of the affirmative claims set forth in the
Counter-Claim,  denying  any  wrongdoing or liability, denying that OfficeMax is
entitled  to  obtain  any  relief,  and  plans  to  vigorously  contest  the
Counter-Claim.   As  of  the  date of this report, discovery has commenced and a
trial  date  in  this  action has been set for October 17, 2006.  The outcome of
this  action  is presently uncertain.  However, the Company believes that all of
its  claims  and  defenses  are  meritorious.

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

NOTE  10  -  RELATED  PARTY  TRANSACTIONS

During  the  nine  months  ended  September  30, 2005 and 2004, the Company made
purchases  from  related  parties totaling approximately $18,073,816 (unaudited)
and  $13,436,147  (unaudited),  respectively.

During  the nine months ended September 30, 2005 and 2004, the Company had trade
payables  to  related  parties totaling approximately $5,617,227 (unaudited) and
$2,630,053  (unaudited),  respectively.


NOTE  11  -  SUBSEQUENT  EVENTS

The  Company  entered  into a consulting agreement for public investor relations
services  effective as of November 14, 2005.  The agreement is for six months at
$9,000  per  month.  In addition, the consultant was issued warrants to purchase
up  to  30,000  shares  of  common  stock, consisting of 15,000 warrants with an
exercise  price  of  $8.00 and 15,000 warrants with an exercise price of $10.00.
The  warrants  vested  immediately  and  expire  twelve  months  from  issuance.


                                       14
<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
consolidated audited financial statements and the related notes and the other
financial information in our most recent annual report on Form 10-K and our
consolidated unaudited financial statements and the related notes and other
financial information included elsewhere in this report. This discussion
contains forward-looking statements regarding the data storage industry and our
expectations regarding our future performance, liquidity and capital resources.
Our actual results could differ materially from those expressed in these
forward-looking statements as a result of any number of factors, including those
set forth under "Risk Factors" and under other captions contained elsewhere in
this report.

OVERVIEW

     We are a leading provider of optical data storage products and also sell a
range of portable magnetic data storage products that we call our GigaBank
products. In addition, and to a much lesser extent, we sell digital
entertainment and other products. Our data storage products collectively
accounted for approximately 99% of our net sales in 2004 and in the first nine
months of 2005, and our digital entertainment and other products collectively
accounted for only approximately 1% of our net sales in 2004 and in the first
nine months of 2005.

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

     We sell our products through computer, consumer electronics and office
supply superstores and other retailers in over 10,000 retail locations
throughout North America. Our network of retailers enables us to offer products
to consumers across North America, including every major metropolitan market in
the United States. In the past three years, our retailers have included Best
Buy, Circuit City, CompUSA, Office Depot, OfficeMax and Staples. Our principle
brand is I/OMagic , however, from time to time, we also sell products under our
Hi-Val  and Digital Research Technologies  brand names.

     Our net sales declined by $5.9 million, or 17.9%, to $27.0 million in the
first nine months of 2005 from $32.9 million in the first nine months of 2004.
Our net loss decreased by $1.3 million, or 52%, to $1.2 million in the first
nine months of 2005 from a net loss of $2.5 million in the first nine months of
2004. We believe that this change in our operating results is due, in large
part, to the following factors:

  -  Decreased  sales.  As  discussed  further  below,  we  believe  that  our
substantial decline in net sales in the first nine months of 2005 as compared to
the  first  nine  months  of  2004  is  primarily  due to the following factors:

     -the  rapid  and  continued  decline  in  sales  of  our CD-based products;

     -lower  average  selling  prices  of  our  DVD-based  products;

     -the  decline  in sales of our DVD-based products to Circuit City, CompUSA,
      RadioShack  and  Micro  Center  that  were  not  offset by sales of our
      GigaBank products  to  these  retailers;  and

     -a decrease  in  net  sales  to  Best Buy due to its expanded operation of
      private  label  programs  in  2005;



                                       15
<PAGE>

  all of which was partially offset by an increase in net sales to Staples
  and Office Depot, which expanded their product offerings to include
  our GigaBank line of products during our initial launch in 2004 and have
  further expanded these offerings by introducing higher capacities and
  newer models.

  -  Increased gross profit. Our gross profit increased to $3.4 million for the
     first nine months of 2005 from $3.2 million for the first nine months of
     2004. Net sales decreased 17.9% for the first nine months of 2005 to $27.0
     million from $32.9 million for the first nine months of 2004.  This
     decrease was offset by a decrease of 20.5% in cost of sales for the first
     nine months of 2005 to $23.6 million, or 87.4% of net sales, from $29.7
     million, or 90.3% of net sales, for the first nine months of 2004.  The
     percentage decrease in net sales was not as large as the percentage
     decrease in cost of sales because of large decreases in sales incentives
     and slotting fees, which are dilutive factors to sales and contributed to
     net sales for the First nine months of 2005 as compared to the first nine
     months of 2004.  For the first nine months of 2005, slotting fees were
     none as compared to $855,000 for the first nine months of 2004.  For the
     first nine months of 2005, sales incentives declined by $578,000 as
     compared to the first nine months of 2004.

     We believe that the significant decline in our net sales during the first
nine months of 2005 as compared to the first nine months of 2004 resulted in
part from the rapid and continued decline in sales of our CD-based products. We
elected to de-emphasize CD-based products because we believe that they are
included as a standard component in most new computer systems and because
DVD-based products are backward-compatible with CDs. Predominantly based on
market forces, but also partly as a result of our decision to de-emphasize
CD-based products, our sales of recordable CD-based products declined by 74.7%
to $2.2 million in the first nine months of 2005 from $8.7 million in the first
nine months of 2004.

     In addition, we also believe that part of the significant decline in our
net sales during the first nine months of 2005 as compared to the first nine
months of 2004 resulted in part from the decline in sales of our DVD-based
products.  For the first nine months of 2005, sales of our recordable DVD-based
products decreased to $14.4 million, or 36.0%, as compared to $22.5 million in
sales for the same period in 2004.  We experienced a 28.4% decrease in our
average selling price of DVD-based products for the first nine months of 2005 as
compared to the first nine months of 2004, similar to the decrease of
approximately 22.0% in the average selling prices of recordable DVD drives in
the North American retail marketplace in the first nine months of 2005 as
compared to the first nine months of 2004.  We believe that this decrease is an
industry-wide effect and that these lower average selling prices were primarily
the result of a slower than anticipated growth in DVD-compatible applications
and infrastructure, which resulted in lower demand for DVD-based products.  We
believe that, based on industry forecasts that predicted significant sales
growth of DVD-based data storage products, suppliers produced quantities of
these products that were substantial and excessive relative to the ultimate
demand for those products. As a result of these relatively substantial and
excessive quantities, the market for DVD-based data storage products experienced
intense competition and downward pricing pressures resulting in lower than
expected overall dollar sales.

     In addition to the other factors described above, we believe that USB
portable data storage devices, which are an alternative to optical data storage
products, have caused a decline in the relative market share of CD- and
DVD-based optical data storage products and likewise caused a decline in our
sales of CD- and DVD-based products in the first nine months of 2005.  Our
business focus in 2004 was predominantly on DVD-based optical data storage
products.  Our business focus in 2005 has been predominantly on DVD-based
optical data storage products and our line of GigaBank  products, which are
compact and portable

                                       16
<PAGE>

hard disk drives with a built-in USB connector. We expect to broaden our range
of data storage products by expanding our GigaBank product line and we
anticipate that sales of these devices will increase as a percentage of our
total net sales over the next twelve months. In the third quarter of 2004, we
began selling our GigaBank products. Sales of our GigaBank products increased
1,003.1% to $9.2 million in the first nine months of 2005 as compared to
$834,000 in the first nine months of 2004. Sales of our GigaBank products
represented 34.3% of our total net sales in the first nine months of 2005. Our
net sales to some of our retailers, including Staples and Office Depot, have
increased during the first nine months of 2005 as compared to 2004 due to their
expanded offerings of our GigaBank line of products. Other retailers, however,
including Circuit City, CompUSA, RadioShack and Micro Center did not begin or
expand sales of our GigaBank products as rapidly as Staples and Office Depot and
thus the general decline in sales of our DVD-based products to these retailers
was not offset by sales of our GigaBank products to these retailers. As of the
date of this report, we have begun shipping our line of GigaBank products to
additional retailers, including RadioShack and CompUSA, for the initial launch
of these portable storage devices in their retail outlets. Another factor
contributing significantly to the decline in our net sales during the first nine
months of 2005 as compared to the same period in 2004 was the continued and
expanded operation of private label programs by Best Buy. We had only $62,000 in
sales to Best Buy in the first nine months of 2005, representing a decrease of
nearly 100% from $5.2 million in sales to Best Buy in the same period in 2004.
We believe that this decrease reflects, at least in part, Best Buy's increased
sales of private label products that compete with products that we sell.

     One of our core strategies is to be among the first-to-market with new and
enhanced product offerings based on established technologies. We expect to apply
this strategy, as we have done in the contexts of CD- and DVD-based technologies
and for our GigaBank  products, to next-generation super-high capacity optical
data storage devices, such as Blu-ray DVD or HD-DVD drives. This strategy
extends not only to new products, but also to enhancements of existing products.
We believe that by employing this strategy, we will be able to maintain
relatively high average selling prices and margins and avoid relying on the
highly competitive market of last-generation and older devices.  In addition,
the Company has also concentrated its efforts and resources on developing new
product categories to be released in the upcoming year to supplement our current
data storage product offerings.

Operating  Performance  and  Financial  Condition

     We focus on numerous factors in evaluating our operating performance and
our financial condition. In particular, in evaluating our operating performance,
we focus primarily on net sales, net product margins, net retailer margins,
rebates and sales incentives, and inventory turnover as well as operating
expenses and net income.

     NET SALES. Net sales is a key indicator of our operating performance. We
closely monitor overall net sales, as well as net sales to individual retailers,
and seek to increase net sales by expanding sales to additional retailers and
expanding sales to existing retailers both by increasing sales of existing
products and introducing new products. Management monitors net sales on a weekly
basis, but also considers sales seasonality, promotional programs and product
life-cycles in evaluating weekly sales performance. As net sales increase or
decrease from period to period, it is critical for management to understand and
react to the various causes of these fluctuations, such as successes or failures
of particular products, promotional programs, product pricing, retailer
decisions, seasonality and other causes. Where possible, management attempts to
anticipate potential changes in net sales and seeks to prevent adverse changes
and stimulate positive changes by addressing the expected causes of adverse and
positive changes. We believe that our good working relationships with our
retailers enable us to monitor closely consumer acceptance of particular
products and promotional programs which in turn enable us to better anticipate
changes in market conditions.

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<PAGE>

     NET PRODUCT MARGINS. Net product margins, from product-to-product and
across all of our products as a whole, is an important measurement of our
operating performance. We monitor margins on a product-by-product basis to
ascertain whether particular products are profitable or should be phased out as
unprofitable products. In evaluating particular levels of product margins on a
product-by-product basis, we focus on attaining a level of net product margin
sufficient to contribute to normal operating expenses and to provide a profit.
The level of acceptable net product margin for a particular product depends on
our expected product sales mix. However, we occasionally sell products for
certain strategic reasons to, for example, complete a product line or for
promotional purposes, without a rigid focus on historical product margins or
contribution to operating expenses or profitability.

     NET RETAILER MARGINS. We seek to manage profitability on a retailer level,
not solely on a product level. Although we focus on net product margins on a
product-by-product basis and across all of our products as a whole, our primary
focus is on attaining and building profitability on a retailer-by-retailer
level. For this reason, our mix of products is likely to differ among our
various retailers. These differences result from a number of factors, including
retailer-to-retailer differences, products offered for sale and promotional
programs.

     REBATES AND SALES INCENTIVES. Rebates and sales incentives offered to
customers and retailers are an important aspect of our business and are
instrumental in obtaining and maintaining market leadership through competitive
pricing in generating sales on a regular basis as well as stimulating sales of
slow-moving products. We focus on rebates and sales incentives costs as a
proportion of our total net sales to ensure that we meet our expectations of the
costs of these programs and to understand how these programs contribute to our
profitability or result in unexpected losses.

     INVENTORY TURNOVER. Our products' life-cycles typically range from 3-12
months, generating lower average selling prices as the cycles mature. We attempt
to keep our inventory levels at amounts adequate to meet our retailers' needs
while minimizing the danger of rapidly declining average selling prices and
inventory financing costs. By focusing on inventory turnover levels, we seek to
identify slow-moving products and take appropriate actions such as
implementation of rebates and sales incentives to increase inventory turnover.

     Our use of a consignment sales model with certain retailers results in
increased amounts of inventory that we must carry and finance.  Although our use
of a consignment sales model results in greater exposure to the danger of
declining average selling prices, it allows us to more quickly and efficiently
implement promotional programs and pricing adjustments to sell off slow-moving
inventory and prevent further price erosion.

     Our targeted inventory turnover levels for our combined sales models is 6
to 8 weeks of inventory, which equates to an annual inventory turnover level of
approximately 6.5 to 8.5. For the first nine months of 2005, our annualized
inventory turnover level was 5.0 as compared to 6.3 for the first nine months of
2004, representing a period-to-period decrease of 21% as a result of an 18%
decrease in net sales and a 105% increase in consigned inventory at our
retailers' warehouses or retail locations which was partially offset by an 32%
decrease in on-hand and in-transit inventory. The increase in consigned
inventory results directly from our introduction of our GigaBank  products.  The
decrease in our on-hand and in-transit inventory results from efforts to more
efficiently use our capital resources by not purchasing and maintaining excess
inventory.  The decline in inventory turnover for the first nine months of 2005
included $705,000 in additional reserves for slow-moving and obsolete inventory
as compared to $844,000 in additional reserves for slow-moving and obsolete
inventory in the first nine months of 2004.  For the year 2004, our annualized
inventory turnover level was 7.2 as compared to 6.6 in 2003, representing a
period-to-period increase of 9% primarily as a result of a 37% decline in
inventory offset by a 30% decrease in net


                                       18
<PAGE>

sales. The decline in inventory in 2004 included $2.0 million in additional
reserves for slow-moving and obsolete inventory.

     OPERATING EXPENSES. We focus on operating expenses to keep these expenses
within budgeted amounts in order to achieve or exceed our targeted
profitability. We budget certain of our operating expenses in proportion to our
projected net sales, including operating expenses relating to production,
shipping, technical support, and inside and outside commissions and bonuses.
However, most of our expenses relating to general and administrative costs,
product design and sales personnel are essentially fixed over large sales
ranges. Deviations that result in operating expenses in greater proportion than
budgeted signal to management that it must ascertain the reasons for the
unexpected increase and take appropriate action to bring operating expenses back
into the budgeted proportion.

     NET INCOME. Net income is the ultimate goal of our business. By managing
the above factors, among others, and monitoring our actual results of
operations, our goal is to generate net income at levels that meet or exceed our
targets.

     In evaluating our financial condition, we focus primarily on cash on hand,
available trade lines of credit, available bank line of credit, anticipated
near-term cash receipts, and accounts receivable as compared to accounts
payable. Cash on hand, together with our other sources of liquidity, is critical
to funding our day-to-day operations. Funds available under our line of credit
with GMAC Commercial Finance are also an important source of liquidity and a
measure of our financial condition. We use our line of credit on a regular basis
as a standard cash management procedure to purchase inventory and to fund our
day-to-day operations without interruption during periods of slow collection of
accounts receivable. Anticipated near-term cash receipts are also regarded as a
short-term source of liquidity, but are not regarded as immediately available
for use until receipt of funds actually occurs.

     The proportion of our accounts receivable to our accounts payable and the
expected maturity of these balance sheet items is an important measure of our
financial condition. We attempt to manage our accounts receivable and accounts
payable to focus on cash flows in order to generate cash sufficient to fund our
day-to-day operations and satisfy our liabilities. Typically, we prefer that
accounts receivable are matched in duration to, or collected earlier than,
accounts payable. If accounts payable are either out of proportion to, or due
far in advance of, the expected collection of accounts receivable, we will
likely have to use our cash on hand or our line of credit to satisfy our
accounts payable obligations, without relying on additional cash receipts, which
will reduce our ability to purchase and sell inventory and may impact our
ability, at least in the short-term, to fund other parts of our business.

     SALES MODELS

     We employ three primary sales models:  a standard terms sales model, a
consignment sales model and a special terms sales model. We generally use one of
these three primary sales models, or some combination of these sales models,
with each of our retailers.

     Standard Terms

     Currently, the majority of our net sales are on a terms basis. Under our
standard terms sales model, a retailer is obligated to pay us for products sold
to it within a specified number of days from the date of sale of products to the
retailer.  Our standard terms are typically net 60 days. We typically collect
payment from a retailer within 60 to 75 days following the sale of products to a
retailer.


                                       19
<PAGE>

     Consignment

     Under our consignment sales model, a retailer is obligated to pay us for
products sold to it within a specified number of days following our notification
by the retailer of the resale of those products. Retailers notify us of their
resale of consigned products by delivering weekly or monthly sell-through
reports. A sell-through report discloses sales of products sold in the prior
period covered by the report - that is, a weekly or monthly sell-through report
covers sales of consigned products in the prior week or month, respectively. The
period for payment to us by retailers relating to their sale of consigned
products corresponding to these sell-through reports varies from retailer to
retailer. For sell-through reports generated weekly, we typically collect
payment from a retailer within 30 days of the receipt of those reports. For
sell-through reports generated monthly, we typically collect payment from a
retailer within 15 days of the receipt of those reports. Products held by a
retailer under our consignment sales model are recorded as our inventory at
offsite locations until their resale by the retailer.

     Consignment sales represented a growing percentage of our net sales from
2001 through 2003. However, during 2004, our consignment sales model accounted
for 32% of our total net sales as compared to 37% of our total net sales in
2003, primarily as a result of consigning fewer products to Best Buy, which was
our largest consignment retailer, which was partially offset by an increase in
consigning more products to Staples. During the first nine months of 2005 our
consignment sales model accounted for 35% of our total net sales as compared to
31% of our total net sales in the first nine months of 2004, primarily as a
result of consigning our new GigaBank  products to Staples and Office Depot.
Although consignment sales declined as a percentage of our net sales in 2004,
and increased as a percentage of our net sales in the first nine months of 2005
as compared to the same period in 2004, it is not yet clear whether consignment
sales as a percentage of our total net sales will decline or grow on an annual
basis.

     Our consignment sales model is based in part on the preferences of some of
our retailers. Our retailers often prefer the benefits resulting from our
consignment sales model over our standard terms sales model. These benefits
include payment by a retailer only in the event of resale of a consigned
product, resulting in less risk borne by the retailer of price erosion due to
competition and technological obsolescence. Deferring payment until following
the sale of a consigned product also enables a retailer to avoid having to
finance the purchase of that product by using cash on hand or by borrowing funds
and incurring borrowing costs. In addition, retailers also often operate under
budgetary constraints on purchases of certain products or product categories. As
a result of these budgetary constraints, the purchase by a retailer of certain
products typically will cause reduced purchasing power for other products.
Products consigned to a retailer ordinarily fall outside of these budgetary
constraints and do not cause reduced purchasing power for other products. As a
result of these benefits, we believe that we are able to sell more products by
using our consignment sales model than by using only our standard terms sales
model.

     Managing an appropriate level of consignment sales is an important
challenge. As noted above, the payment period for products sold on consignment
is based on the day consigned products are resold by a retailer, and the payment
period for products sold on a standard terms basis is based on the day the
product is sold initially to the retailer, independent of the date of resale of
the product. Accordingly, we generally prefer that higher-turnover inventory is
sold on a consignment basis while lower-turnover inventory is sold on a
traditional terms basis. Management focuses closely on consignment sales to
manage our cash flow to maximize liquidity as well as net sales. Close attention
is directed toward our inventory turnover levels to ensure that they are
sufficiently frequent to maintain appropriate liquidity. Our consignment sales
model enables us to have more pricing control over inventory sold through our
retailers as compared to our standard terms sales model. If we identify a
decline in inventory turnover levels for products in our consignment sales
channels, we can implement price modifications more quickly and efficiently as
compared to the implementation of sales incentives in connection with our
standard terms sales model. This affords us more flexibility to take action to
attain our targeted inventory turnover levels.


                                       20
<PAGE>

     We retain most risks of ownership of products in our consignment sales
channels. These products remain as our inventory until their resale by our
retailers.  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 sales channels, our sales,
profitability and financial resources may decline.

     Special Terms

     We occasionally employ a special terms sales model.  Under our special
terms sales model, the payment terms for the purchase of our products are
negotiated on a case-by-case basis and typically cover a specified quantity of a
particular product. We ordinarily do not offer any rights of return or rebates
for products sold under our special terms sales model. Our payment terms are
ordinarily shorter under our special terms sales model than under our standard
terms or consignment sales models and we typically require payment in advance,
at the time of sale, or shortly following the sale of products to a retailer.

RETAILERS

     Historically, a limited number of retailers have accounted for a
significant percentage of our net sales. During the first nine months of 2005
and during the years 2004 and 2003, our six largest retailers accounted for
approximately 96%, 78% and 88%, respectively, of our total net sales. We expect
that sales of our products to a limited number of retailers will continue to
account for a majority of our sales in the foreseeable future. We do not have
long-term purchase agreements with any of our retailers. If we were to lose any
of our major retailers or experience any material reduction in orders from any
of them, and were unable to replace our sales to those retailers, it could have
a material adverse effect on our business and results of operations.

SEASONALITY

     Our data storage products have historically been affected by seasonal
purchasing patterns. The seasonality of our sales is in direct correlation to
the seasonality experienced by our retailers and the seasonality of the consumer
electronics industry. 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.

     PRICING PRESSURES

     We face downward pricing pressures within our industry that arise from a
number of factors. The products we sell are subject to rapid technological
change and obsolescence. Companies within the data storage industry are
continuously developing new products with heightened performance and
functionality. This puts downward pricing pressures on existing products and
constantly threatens to make them, or causes them to be, obsolete. Our typical
product life-cycle is extremely short and ranges from only three to twelve
months, generating lower average selling prices as the cycle matures.


                                       21
<PAGE>

     In addition, the data storage industry is extremely competitive. Numerous
large competitors such as BenQ, Hewlett-Packard, Sony, TDK and other competitors
such as Lite-On, Memorex, Philips Electronics and Samsung Electronics compete
with us in the optical data storage industry. Numerous large competitors such as
PNY Technologies, Sony, Seagate Technology and Western Digital offer products
similar to our GigaBank  products. Intense competition within our industry
exerts downward pricing pressures on products that we offer. Also, one of our
core strategies is to offer our products as affordable alternatives to
higher-priced products offered by our larger competitors. The effective
execution of this business strategy results in downward pricing pressure on
products that we offer because our products must appeal to consumers partially
based on their attractive prices relative to products offered by our large
competitors. As a result, we are unable to rely as heavily on other non-price
factors such as brand recognition and must consistently maintain lower prices.

     Finally, the actions of our retailers often exert downward pricing
pressures on products that we offer. Our retailers pressure us to offer products
to them at attractive prices. In doing this, we do not believe that the overall
goal of our retailers is to increase their margins on these products. Instead,
we believe that our retailers pressure us to offer products to them at
attractive prices in order to increase sales volume and consumer traffic, as
well as to compete more effectively with other retailers of similar products.
Additional downward pricing pressure also results from the continuing threat
that our retailers may begin to directly import or private-label products that
are identical or very similar to our products. Our pricing decisions with regard
to certain products are influenced by the ability of retailers to directly
import or private-label identical or similar products. Therefore, we constantly
seek to maintain prices that are highly attractive to our retailers and that
offer less incentive to our retailers to commence or maintain direct import or
private-label programs.

CRITICAL  ACCOUNTING  POLICIES  AND  ESTIMATES

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

     Revenue Recognition

     We recognize revenue under three primary sales models:  a standard terms
sales model, a consignment sales model and a special terms sales model.  We
generally use one of these three primary sales models, or some combination of
these sales models, with each of our retailers.

     Standard Terms

     Under our standard terms sales model, a retailer is obligated to pay us for
products sold to it within a specified number of days from the date that title
to the products is transferred to the retailer.  Our standard terms are
typically net 60 days from the transfer of title to the products to a retailer.
We typically collect payment from a retailer within 60 to 75 days from the
transfer of title to the products to a retailer. Transfer of title occurs and
risk of ownership passes to a retailer at the time of shipment or delivery,
depending on the terms of our agreement with a particular retailer. The sale
price of our products is substantially fixed or determinable at the date of sale
based on purchase orders generated by a retailer and


                                       22
<PAGE>

accepted by us. A retailer's obligation to pay us for products sold to it under
our standard terms sales model is not contingent upon the resale of those
products. We recognize revenue for standard terms sales at the time title to
products is transferred to a retailer.

     Consignment

     Under our consignment sales model, a retailer is obligated to pay us for
products sold to it within a specified number of days following our notification
by the retailer of the resale of those products. Retailers notify us of their
resale of consigned products by delivering weekly or monthly sell-through
reports. A sell-through report discloses sales of products sold in the prior
period covered by the report - that is, a weekly or monthly sell-through report
covers sales of consigned products in the prior week or month, respectively. The
period for payment to us by retailers relating to their resale of consigned
products corresponding to these sell-through reports varies from retailer to
retailer. For sell-through reports generated weekly, we typically collect
payment from a retailer within 30 days of the receipt of those reports. For
sell-through reports generated monthly, we typically collect payment from a
retailer within 15 days of the receipt of those reports. At the time of a
retailer's resale of a product, title is transferred directly to the consumer.
Risk of theft or damage of a product, however, passes to a retailer upon
delivery of that product to the retailer. The sale price of our products is
substantially fixed or determinable at the date of sale based on a product
sell-through report generated by a retailer and delivered to us.  Except in the
case of theft or damage, a retailer's obligation to pay us for products
transferred under our consignment sales model is entirely contingent upon the
resale of those products. Products held by a retailer under our consignment
sales model are recorded as our inventory at offsite locations until their
resale by the retailer. Because we retain title to products in our consignment
sales channels until their resale by a retailer, revenue is not recognized until
the time of resale. Accordingly, price modifications to inventory maintained in
our consignment sales channels do not have an effect on the timing of revenue
recognition. We recognize revenue for consignment sales in the period during
which resale occurs.

     Special Terms

     Under our special terms sales model, the payment terms for the purchase of
our products are negotiated on a case-by-case basis and typically cover a
specified quantity of a particular product. The result of our negotiations is a
special agreement with a retailer that defines how and when transfer of title
occurs and risk of ownership shifts to the retailer. We ordinarily do not offer
any rights of return or rebates for products sold under our special terms sales
model.  A retailer is obligated to pay us for products sold to it within a
specified number of days from the date that title to the products is transferred
to the retailer, or as otherwise agreed to by us.  Our payment terms are
ordinarily shorter under our special terms sales model than under our standard
terms or consignment sales models and we typically require payment in advance,
at the time of transfer of title to the products or shortly following the
transfer of title to the products to a retailer.  Transfer of title occurs and
risk of ownership passes to a retailer at the time of shipment, delivery,
receipt of payment or the date of invoice, depending on the terms of our
agreement with the retailer. The sale price of our products is substantially
fixed or determinable at the date of sale based on our agreement with a
retailer.  A retailer's obligation to pay us for products sold to it under our
special terms sales model is not contingent upon the resale of those products.
We recognize revenue for special terms sales at the time title to products is
transferred to a retailer.

     Sales Incentives

     From time to time, we enter into agreements with certain retailers
regarding price decreases that are determined by us in our sole discretion.
These agreements allow those retailers (subject to limitations) a credit equal
to the difference between our current price and our new reduced price on units
in the retailers' inventories or in transit to the retailers on the date of the
price decrease.


                                       23
<PAGE>

     We record an estimate of sales incentives based on our actual sales
incentive rates over a trailing twelve-month period, adjusted for any known
variations, which are charged to operations and offset against gross sales at
the time products are sold with a corresponding accrual for our estimated sales
incentive liability. This accrual-our sales incentive reserve-is reduced by
deductions on future payments taken by our retailers relating to actual sales
incentives.

     At the end of each quarterly period, we analyze our existing sales
incentive reserve and apply any necessary adjustments based upon actual or
expected deviations in sales incentive rates from our applicable historical
sales incentive rates. The amount of any necessary adjustment is based upon the
amount of our remaining field inventory, which is calculated by reference to our
actual field inventory last conducted, plus inventory-in-transit and less
estimated product sell-through.  The amount of our sales incentive liability for
each product is equal to the amount of remaining field inventory for that
product multiplied by the difference between our current price and our new
reduced price to our retailers for that product. This data, together with all
data relating to all sales incentives granted on products in the applicable
period, is used to adjust our sales incentive reserve established for the
applicable period.

     In the first nine months of 2005, our sales incentives were $1.1 million,
or 2.8% of gross sales, as compared to $1.6 million, or 3.8% of gross sales, in
the first nine months of 2004, all of which was offset against gross sales.  In
2004, our sales incentives were $2.5 million, or 4.2% of gross sales, all of
which was offset against gross sales.  In 2003, our sales incentives were $2.9
million, or 3.5% of gross sales, all of which was offset against gross sales.

Market  Development  Fund  and  Cooperative  Advertising Costs, Rebate Promotion
Costs  and  Slotting  Fees

     Market development fund and cooperative advertising costs, rebate promotion
costs and slotting fees are charged to operations and offset against gross sales
in accordance with Emerging Issues Task Force Issue No. 01-9. Market development
fund and cooperative advertising costs and rebate promotion costs are each
promotional costs. Slotting fees are fees paid directly to retailers for
allocation of shelf-space in retail locations. In the first nine months of 2005,
our market development fund and cooperative advertising costs, rebate promotion
costs and slotting fees were $4.5 million, or 12.1% of gross sales, all of which
was offset against gross sales, as compared to market development fund and
cooperative advertising costs, rebate promotion costs and slotting fees of $5.1
million, or 11.8% of gross sales, in the first nine months of 2004, all of which
was offset against gross sales.  These costs and fees increased as a percentage
of our net gross sales in the first nine months of 2005, primarily as a result
of instituting sales incentives and marketing promotions to promote our double
layer recordable DVD drives and to further launch our GigaBank  product line.
In 2004, our market development fund and cooperative advertising costs, rebate
promotion costs and slotting fees were $7.8 million, or 13.0% of gross sales,
all of which was offset against gross sales.  In 2003, our market development
fund and cooperative advertising costs, rebate promotion costs and slotting fees
were $8.4 million, or 10.3% of gross sales, all of which was offset against
gross sales.

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


                                       24
<PAGE>

Inventory  Obsolescence  Allowance

     Our warehouse supervisor, production supervisor and production manager
physically review our warehouse inventory for slow-moving and obsolete products.
All products of a material amount are reviewed quarterly and all products of an
immaterial amount are reviewed annually. We consider products that have not been
sold within six months to be slow-moving. Products that are no longer compatible
with current hardware or software are considered obsolete. The potential for
re-sale of slow-moving and obsolete inventories is considered through market
research, analysis of our retailers' current needs, and assumptions about future
demand and market conditions. The recorded cost of both slow-moving and obsolete
inventories is then reduced to its estimated market value based on current
market pricing for similar products. We utilize the Internet to provide
indications of market value from competitors' pricing, third party inventory
liquidators and auction websites. The recorded costs of our slow-moving and
obsolete products are reduced to current market prices when the recorded costs
exceed those market prices. For the first nine months of 2005 we increased our
inventory reserve and recorded a corresponding increase in cost of goods sold of
$705,000 for inventory for which recorded cost exceeded the current market price
of this inventory on hand. For the first nine months of 2004, we increased our
inventory reserve and recorded a corresponding increase in cost of goods sold of
$844,000. All adjustments establish a new cost basis for inventory as we believe
such reductions are permanent declines in the market price of our products.
Generally, obsolete inventory is sold to companies that specialize in the
liquidation of these items while we continue to market slow-moving inventories
until they are sold or become obsolete.  For the first nine months of 2005 and
2004, gains recorded as a result of sales of obsolete inventory above the
reserved amount were not significant to our results of operations and accounted
for less than 1% of our total net sales. Although we have no specific
statistical data on this matter, we believe that our practices are reasonable
and consistent with those of our industry.

Inventory  Adjustments

     Our warehouse supervisor, production supervisor and production manager
physically review our warehouse inventory for obsolete or damaged
inventory-related items on a monthly basis. Inventory-related items (such as
sleeves, manuals or broken products no longer under warranty from our
subcontract manufacturers) which are considered obsolete or damaged are reviewed
by these personnel together with our Controller or Chief Financial Officer. At
the discretion of our Controller or Chief Financial Officer, these items are
physically disposed of and we make corresponding accounting adjustments
resulting in inventory adjustments. In addition, on a monthly basis, our detail
inventory report and our general ledger are reconciled by our Controller and any
variances result in a corresponding inventory adjustment. Although we have no
specific statistical data on this matter, we believe that our practices are
reasonable and consistent with those of our industry.

Allowance  for  Doubtful  Accounts

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


                                       25
<PAGE>

Product  Returns

     We have a limited 90-day to one year time period for product returns from
end-users; however, our retailers generally have return policies that allow
their customers to return products within only fourteen to thirty days after
purchase. We allow our retailers to return damaged or defective products to us
following a customary return merchandise authorization process. We have no
informal return policies. We utilize actual historical return rates to determine
our allowance for returns in each period. Gross sales is reduced by estimated
returns and cost of sales is reduced by the estimated cost of those sales. We
record a corresponding accrual for the estimated liability associated with the
estimated returns. This estimated liability is based on the gross margin of the
products corresponding to the estimated returns. This accrual is offset each
period by actual product returns.

     Our current estimated weighted average future product return rate is
approximately 13.9%. As noted above, our return rate is based upon our past
history of actual returns and we estimate amounts for product returns for a
given period by applying this historical return rate and reducing actual gross
sales for that period by a corresponding amount. Our historical return rate for
a particular product is the life-to-date return rate of similar products. This
life-to-date return rate is updated monthly. We also compare this life-to-date
return rate to our trailing 18-month return rate to determine whether any
material changes in our return rate have occurred that may not be reflected in
the life-to-date return rate. We believe that using a trailing 18-month return
rate takes two key factors into consideration, specifically, an 18-month return
rate provides us with a sufficient period of time to establish recent historical
trends in product returns for each product category, and provides us with a
period of time that is short enough to account for recent technological shifts
in our product offerings in each product category. If an unusual circumstance
exists, such as a product category that has begun to show materially different
actual return rates as compared to life-to-date return rates, we will make
appropriate adjustments to our estimated return rates. Factors that could cause
materially different actual return rates as compared to life-to-date return
rates include product modifications that simplify installation, a new product
line, within a product category, that needs time to better reflect its return
performance and other factors.

     Although we have no specific statistical data on this matter, we believe
that our practices are reasonable and consistent with those of our industry.

     Our warranty terms under our arrangements with our suppliers are that any
product that is returned by a retailer or retail customer as defective can be
returned by us to the supplier for full credit against the original purchase
price. We incur only minimal shipping costs to our suppliers in connection with
the satisfaction of our warranty obligations.

RESULTS  OF  OPERATIONS

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

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

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


                                       26
<PAGE>

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

THREE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED) COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2004 (UNAUDITED)

<TABLE>
<CAPTION>

                                                                                                          RESULTS AS A PERCENTAGE
                                                                             DOLLAR       PERCENTAGE        OF NET SALES FOR THE
                                                  THREE MONTHS ENDED        VARIANCE       VARIANCE          THREE MONTHS ENDED
                                                      SEPTEMBER 30,         --------       --------              SEPTEMBER 30,
                                                  --------------------      FAVORABLE      FAVORABLE        --------------------
                                                               2004                                                      2004
                                                               ----                                                      ----
                                                  2005      (RESTATED)    (UNFAVORABLE)  (UNFAVORABLE)      2005      (RESTATED)
                                                  ----      ----------    -------------  -------------      ----      ----------
                                                          (in thousands)
<S>                                    <C>                   <C>          <C>             <C>               <C>      <C>

Net sales                              $             8,424   $    9,947   $      (1,523)            (15.3)%  100.0%      100.0%
Cost of sales                                        7,074        9,392           2,318              24.7     84.0        94.4
                                       --------------------  -----------  --------------  -----------------  ------  ----------
Gross profit                                         1,350          555             795             143.2     16.0         5.6
Selling, marketing and advertising
   expenses                                            183          196              13               6.6      2.1         2.0
General and administrative expenses                  1,254        1,293              39               3.0     14.9        13.0
Depreciation and amortization                           50          209             159              76.1      0.6         2.1
                                       --------------------  -----------  --------------  -----------------  ------  ----------
Operating loss                                        (137)      (1,143)          1,006              88.0     (1.6)      (11.5)
Net interest expense                                   (76)         (38)            (38)           (100.0)    (0.9)       (0.4)
Other income                                             -           12             (12)           (100.0)       -         0.1
                                       --------------------  -----------  --------------  -----------------  ------  ----------
Loss from operations before
   provision for income taxes                         (213)      (1,169)            956              81.8     (2.5)      (11.8)
Income tax provision (benefit)                           -            1               1             100.0        -           -
                                       --------------------  -----------  --------------  -----------------  ------  ----------
Net loss                               $              (213)  $   (1,170)  $         957              81.8%    (2.5)%     (11.8)%
                                       ====================  ===========  ==============  =================  ======  ==========
</TABLE>


     NET SALES. We believe that the decrease in the amount of $1.5 million in
net sales from $9.9 million in net sales for the three months ended September
30, 2004 to $8.4 million in net sales for the three months ended September 30,
2005 is primarily due to a substantial decrease in sales of our CD- and
DVD-based products. This decrease was partially offset by an increase in sales
of our GigaBank  products.  Our sales to Staples and Office Depot increased
significantly but were offset by significant decreases in sales to Circuit City,
CompUSA, RadioShack and Micro Center.  Circuit City, CompUSA, RadioShack and
Micro Center did not begin or expand sales of our GigaBank  products as rapidly
as Staples and Office Depot and thus the general decline in sales of our
DVD-based products to these retailers was not offset by sales of our GigaBank
products to these retailers.  As of the date of this report, we have begun
shipping our line of GigaBank  products to additional retailers, including
RadioShack and CompUSA, for the initial launch of these portable storage devices
in their retail outlets.

     Sales of our GigaBank  products represented 36.6% of our total net sales in
the third quarter of 2005.  Sales of our GigaBank  products increased to $3.2
million, or by 283.7%, in the third quarter of 2005 from $834,000 in the third
quarter of 2004.  Our sales of DVD-based products decreased to $4.6 million, or
by 37.8%, in the third quarter of 2005 from $7.4 million in the third quarter of
2004, as a result of the transition in the data storage category from DVD-based
products to GigaBank  USB portable storage devices.  In addition, predominantly
based on market forces, but also partly as a result of our decision to
de-emphasize CD-based products, our sales of recordable CD-based products
declined to $359,000, or 81.1%, in the third quarter of 2005 from $1.9 million
in the third quarter of 2004.

     We believe that USB portable data storage devices, which are an alternative
to optical data storage products, have caused a decline in the relative market
share of CD- and DVD-based optical data storage products and likewise caused a
decline in our sales of CD- and DVD-based products in the third quarter of 2005.
Our business focus is predominantly on DVD-based optical data storage products
but we also focus on and sell our GigaBank  products.  We expect to broaden our
range of data storage products by expanding our GigaBank  product line and we
anticipate that sales of these devices will increase as a


                                       27
<PAGE>

percentage of our total net sales over the next twelve months. A change
in the allowance for product returns also resulted in an adjustment of $253,000
causing a decrease in net sales in the third quarter of 2005 as compared to an
adjustment of $530,000 that resulted in an increase in net sales in the third
quarter of 2004.

     The decrease in net sales for the third quarter of 2005 was comprised of a
$2.3 million decrease in net sales resulting from a decrease in the volume of
products sold.  We also had a decrease of $219,000 resulting from a change in
our reserves for future returns on sales.  These decreases were partially offset
by a $1.0 million increase in net sales resulting from higher average product
sales prices.    We had a decrease of $1.9 million in net sales for the third
quarter of 2005 for our CD-based products resulting from a decrease of $276,000
due to lower average product sales prices and a decrease of $1.7 million
resulting from a decrease in the volume of products sold.  We had a decrease of
$2.8 million in net sales for the third quarter of 2005 for our DVD-based
products resulting from a decrease of $1.5 million due to lower average product
sales prices and a decrease of $1.3 million resulting from a decrease in the
volume of products sold.  A $2.3 million increase in net sales for the third
quarter of 2005 for our GigaBank  products resulted from an increase of $2.8
million due to an increase in the volume of products sold, offset by a decrease
of $459,000 resulting from a decrease in lower average product sales prices.

     GROSS PROFIT. The increase in gross profit to $1.3 million, or by 134.2%,
in the third quarter of 2005 from $555,000 in the third quarter of 2004 is
primarily due to a decrease in market development fund and cooperative
advertising costs, rebate promotion costs and slotting fees, a greater decrease
in our direct product costs  relative to the decrease in our gross sales net of
returns, and a decrease in our reserve for slow-moving inventory. The increase
in gross profit as a percentage of our net sales was primarily due to a decrease
in market development fund and cooperative advertising costs, rebate promotion
costs and slotting fees to 8.6% of gross sales during the third quarter of 2005
from 13.4% of gross sales during the third quarter of 2004.  Our direct product
costs, inventory shrinkage and related freight costs decreased to 84.0% of net
sales for the third quarter of 2005 from 94.4% of net sales for the third
quarter of 2004, primarily due to the decrease in market development fund and
cooperative advertising costs, rebate promotion costs and slotting fees in
addition to the decrease in direct product costs.

     Our inventory reserve increased by $169,000 in the third quarter of 2005 as
compared to $475,000 in the third quarter of 2004 due to our adjustment of the
value of our slow-moving and obsolete inventory.  As a result of the short life
cycles of many of our products resulting from, in part, the effects of rapid
technological change, we expect to experience additional slow-moving and
obsolete inventory charges in the future. However, we cannot predict with any
certainty the future level of these charges.

     SELLING, MARKETING, AND ADVERTISING EXPENSES. Selling, marketing and
advertising expenses decreased by $13,000 in the third quarter of 2005 as
compared to the third quarter of 2004. This decrease was primarily due to a
$19,000 reduction in commissions as a result of reduced sales volume offset by
an $11,000 increase in payroll and related expenses due to increased personnel.

     GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased by $39,000 in the third quarter of 2005 as compared to the third
quarter of 2004.  This decrease was primarily due to a $69,000 decrease in
payroll and related expenses, offset by small increases in other expenses.

     DEPRECIATION AND AMORTIZATION EXPENSES. The $159,000 decrease in
depreciation and amortization expenses is primarily due to decreased
amortization of our trademarks resulting from an impairment in the value of our
Hi-Val  and Digital Research Technologies  trademarks in the aggregate amount of
$3.7 million recorded as of December 31, 2004.  In addition, some of our fixed
assets became fully depreciated during the third quarter of 2005.


                                       28
<PAGE>

     OTHER INCOME (EXPENSE). Other income (expense) increased by $51,000 in the
third quarter of 2005 as compared to the third quarter of 2004.  Net interest
expense increased by $38,000 due to both greater borrowings under our lines of
credit and higher interest rates in the third quarter of 2005 as compared to the
third quarter of 2004.  In addition, we had no gains related to foreign currency
transactions in connection with our sales in Canada in the third quarter of 2005
as compared to $13,000 in gains in the third quarter of 2004.

NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED) COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2004 (UNAUDITED)

<TABLE>
<CAPTION>

                                                                                                          RESULTS AS A PERCENTAGE
                                                                             DOLLAR       PERCENTAGE        OF NET SALES FOR THE
                                                  NINE MONTHS ENDED        VARIANCE       VARIANCE           NINE MONTHS ENDED
                                                      SEPTEMBER 30,         --------       --------              SEPTEMBER 30,
                                                  --------------------      FAVORABLE      FAVORABLE        --------------------
                                                               2004                                                      2004
                                                               ----                                                      ----
                                                  2005      (RESTATED)    (UNFAVORABLE)  (UNFAVORABLE)      2005      (RESTATED)
                                                  ----      ----------    -------------  -------------      ----      ----------
                                                          (in thousands)

<S>                                   <C>                  <C>          <C>             <C>                <C>       <C>
Net sales                             $           27,018   $   32,910   $      (5,892)           (17.9)%    100.0%       100.0%
Cost of sales                                     23,569       29,662           6,093             20.5       87.2         90.1
                                      -------------------  -----------  --------------  ----------------    ------   ----------
Gross profit                                       3,449        3,248             201              6.2       12.8          9.9
Selling, marketing and advertising
   expenses                                          480          847             367             43.3        1.8          2.6
General and administrative expenses                3,714        4,113             399              9.7       13.7         12.5
Depreciation and amortization                        189          627             438             69.9        0.7          1.9
                                      -------------------  -----------  --------------  ----------------    ------   ----------
Operating loss                                      (934)      (2,339)          1,405             60.1       (3.4)        (7.1)
Net interest expense                                (218)        (122)            (96)           (78.7)      (0.8)        (0.4)
Other income (expense)                                11           (8)             19            237.5          -            -
                                      -------------------  -----------  --------------  ----------------    ------   ----------
Loss from operations before
   provision for income taxes                     (1,141)      (2,469)          1,328             53.8       (4.2)        (7.5)
Income tax provision                                   2            3               1             33.3          -            -
                                      -------------------  -----------  --------------  ----------------    ------   ----------
Net Loss                              $           (1,143)  $   (2,472)  $       1,329             53.8%      (4.2)%       (7.5)%
                                      ===================  ===========  ==============  ================    ======   ==========
</TABLE>

     NET SALES. As discussed above, we believe that the significant decrease in
the amount of $5.9 million in net sales from $32.9 million for the nine months
ended September 30, 2004 to $27.0 million for the nine months ended September
30, 2005 is primarily due to the following factors: the continued decline in
sales of our CD-based products; lower average selling prices of DVD-based
products; slower than anticipated growth of DVD-compatible applications; the
decrease in sales of our DVD-based products; and the continued operation of
private label programs by Best Buy.  The decline in net sales caused by these
factors was partially offset by a substantial increase in the sale of our
GigaBank  products.

     We believe that the significant decline in our net sales during the first
nine months of 2005 as compared to the first nine months of 2004 resulted in
part from the rapid and continued decline in sales of our CD-based products.
Predominantly based on market forces, but also partly as a result of our
decision to de-emphasize CD-based products, our sales of recordable CD-based
products declined by 74.7% to $2.2 million in the first nine months of 2005 from
$8.7 million in the first nine months of 2004.

     In addition, we also believe that part of the significant decline in our
net sales during the first nine months of 2005 as compared to the first nine
months of 2004 resulted in part from the decline in sales of our DVD-based
products.  For the first nine months of 2005, sales of our recordable DVD-based
products decreased to $14.4 million, or 36.0%, as compared to $22.5 million in
sales for the same period in 2004.  We experienced a 28.4% decrease in our
average selling price of DVD-based products for the first nine months of 2005 as
compared to the first nine months of 2004, similar to the decrease of
approximately 22.0% in the average selling prices of recordable DVD drives in
the North American retail marketplace in the first nine months of 2005 as
compared to the first nine months of 2004.  We believe that this decrease is an
industry-wide effect and that these lower average selling prices were primarily
the result of a slower than anticipated growth in DVD-compatible applications
and infrastructure, which resulted in lower


                                       29
<PAGE>

demand for DVD-based products. We believe that, based on industry forecasts that
predicted significant sales growth of DVD-based data storage products, suppliers
produced quantities of these products that were substantial and excessive
relative to the ultimate demand for those products. As a result of these
relatively substantial and excessive quantities, the market for DVD-based data
storage products experienced intense competition and downward pricing pressures
resulting in lower than expected overall dollar sales.

     In addition to the other factors described above, we believe that USB
portable data storage devices, which are an alternative to optical data storage
products, have caused a decline in the relative market share of CD- and
DVD-based optical data storage products and likewise caused a decline in our
sales of CD- and DVD-based products in the first nine months of 2005.  Our
business focus in 2004 was predominantly on DVD-based optical data storage
products.  Our business focus in 2005 has been predominantly on DVD-based
optical data storage products and our line of GigaBank  products, which are
compact and portable hard disk drives with a built-in USB connector.  We expect
to broaden our range of data storage products by expanding our GigaBank  product
line and we anticipate that sales of these devices will increase as a percentage
of our total net sales over the next twelve months.  In the third quarter of
2004, we began selling our GigaBank  products.  Sales of our GigaBank  products
increased 1,003.1% to $9.2 million in the first nine months of 2005 as compared
to $834,000 in the first nine months of 2004.  Sales of our GigaBank  products
represented 34.3% of our total net sales in the first nine months of 2005.  Our
net sales to some of our retailers, including Staples and Office Depot, have
increased during the first nine months of 2005 as compared to 2004 due to their
expanded offerings of our GigaBank  line of products.  Other retailers, however,
including Circuit City, CompUSA, RadioShack and Micro Center did not begin or
expand sales of our GigaBank  products as rapidly as Staples and Office Depot
and thus the general decline in sales of our DVD-based products to these
retailers was not offset by sales of our GigaBank  products to these retailers.
As of the date of this report, we have begun shipping our line of GigaBank
products to additional retailers, including RadioShack and CompUSA, for the
initial launch of these portable storage devices in their retail outlets.

     Another factor contributing significantly to the decline in our net sales
during the first nine months of 2005 as compared to the same period in 2004 was
the continued and expanded operation of private label programs by Best Buy. We
had only $62,000 in sales to Best Buy in the first nine months of 2005,
representing a decrease of nearly 100% from $5.2 million in sales to Best Buy in
the same period in 2004. We believe that this decrease reflects, at least in
part, Best Buy's increased sales of private label products that compete with
products that we sell.

     A change in the allowance for product returns also resulted in an
adjustment of $116,000 causing a decrease in sales in the first nine months of
2005 as compared to an adjustment of $1.7 million that resulted in an increase
in sales in the first nine months of 2004.

     The overall decrease in net sales for the first nine months of 2005 was
comprised of a $7.9 million decrease in net sales resulting from a decrease in
the volume of products sold and a decrease of $556,000 resulting from a change
in our reserves for future returns on sales.  This decrease was partially offset
by a $2.6 million increase from higher average product sales prices.  We had a
decrease of $6.5 million in net sales for the first nine months of 2005 for our
CD-based products resulting from a decrease of $832,000 due to lower average
product sales prices and a decrease of $5.6 million resulting from a decrease in
the volume of products sold.  We had a decrease of $8.1 million in net sales for
the first nine months of 2005 for our DVD-based products resulting from a
decrease of $5.8 million due to lower average product sales prices and a
decrease of $2.3 million due to an increase in the volume of products sold.
The $8.4 million increase in net sales for the first nine months of 2005 for our
GigaBank  products resulted from an increase of $10.5 million due to an increase
in the volume of products sold, offset by a decrease of $2.1 million due to
lower average product sales prices.


                                       30
<PAGE>

     GROSS PROFIT. Gross profit increased to $3.4 million for the first nine
months of 2005 from $3.2 million for the first nine months of 2004.  Net sales
decreased 17.9% for the first nine months of 2005 to $27.0 million from $32.9
million for the first nine months of 2004.  This decrease was offset by a
decrease of 20.5% in cost of sales for the first nine months of 2005 to $23.6
million, or 87.4% of net sales, from $29.7 million, or 90.3% of net sales, for
the first nine months of 2004.  The percentage decrease in net sales was not as
large as the percentage decrease in cost of sales because of large decreases in
sales incentives and slotting fees, which are dilutive factors to sales and
contributed to net sales for the first nine months of 2005 as compared to the
first nine months of 2004.  For the first nine months of 2005, slotting fees
were none as compared to $855,000 for the first nine months of 2004.  For the
first nine months of 2005, sales incentives declined by $578,000 as compared to
the first nine months of 2004.

     Our inventory reserve increased by $705,000 in the first nine months of
2005 as compared to $844,000 in the first nine months of 2004 due to our
adjustment of the value of our slow-moving and obsolete inventory.  As a result
of the short life cycles of many of our products resulting from, in part, the
effects of rapid technological change, we expect to experience additional
slow-moving and obsolete inventory charges in the future. However, we cannot
predict with any certainty the future level of these charges.

     SELLING, MARKETING, AND ADVERTISING EXPENSES. Selling, marketing and
advertising expenses decreased by $367,000 in the first nine months of 2005 as
compared to the first nine months of 2004. This decrease was primarily due to no
advertising expenses incurred in the first nine months of 2005 as compared to
advertising expenses of $263,000 incurred in the first nine months of 2004.  In
addition, this decrease partially resulted from lower commissions as a result of
reduced sales volume and reduced payroll and related expenses due to fewer
personnel and lower retailer performance charges.

     GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased by $399,000 in the first nine months of 2005 as compared to the first
nine months of 2004.  This decrease was primarily due to a $325,000 decrease in
payroll and related expenses and a $122,000 decrease in financial relations
expenses, offset by a $52,000 increase in legal expenses.

     DEPRECIATION AND AMORTIZATION EXPENSES. The $438,000 decrease in
depreciation and amortization expenses is primarily due to decreased
amortization of our trademarks resulting from an impairment in the value of our
Hi-Val  and Digital Research Technologies  trademarks in the aggregate amount of
$3.7 million recorded as of December 31, 2004.  In addition, some of our fixed
assets became fully depreciated during 2005.

     OTHER INCOME (EXPENSE). Other income (expense) increased by $77,000 in the
first nine months of 2005 as compared to the first nine months of 2004.  Net
interest expense increased by $96,000 due to both greater borrowings under our
lines of credit and higher interest rates in the first nine months of 2005 as
compared to the first nine months of 2004.  This was partially offset by an
increase in income in the amount of $19,000 related to foreign currency
transactions in connection with our sales in Canada.

LIQUIDITY  AND  CAPITAL  RESOURCES

     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 finance working capital, capital expenditures and debt service
requirements. We anticipate that these sources and uses will continue to be our
principal sources and uses of cash in the future. As of September 30, 2005, we
had working capital of $6.6 million, an accumulated deficit of $24.2 million,
$2.8 million in cash and cash equivalents and $12.1 million in net accounts
receivable. This compares with working capital of $7.5 million, an accumulated


                                       31
<PAGE>

deficit of $23.1 million, $3.6 million in cash and cash equivalents and $14.6
million in net accounts receivable as of December 31, 2004.

     Our cash decreased to $2.8 million, or by 22.4%, from $3.6 million in the
first nine months of 2005 as compared to a decrease to $2.8 million, or by
30.0%, from $4.0 million in the first nine months of 2004.

     Cash used in our operating activities totaled $1,341,000 during the nine
months ended September 30, 2005 as compared to cash used in our operating
activities of $2,947,000 during the nine months ended September 30, 2004. This
$1.6 million decrease in cash used in our operating activities primarily
resulted from a decrease of $1.3 million in net loss in the first nine months of
2005 as compared to the first nine months of 2004.  The decrease in cash used in
our operating activities also resulted from a $1.1 million increase in accounts
payable and accrued expenses, a $6.0 million increase in the use of our trade
credit facilities with related parties, a decrease in legal settlements payable
of $1.0 million as we made the final payment in the first quarter of 2004 on the
settlement of a litigation matter, and a $469,000 increase in reserves for
product returns and allowances.  These increases in cash were partially offset
by decreases in cash resulting from a decrease in our reserve for obsolete
inventory of $138,000 and an increase in our prepaid expenses of $552,000. Net
sales decreased $5.9 million which resulted in a $3.9 million decrease in cash
resulting from an increase in accounts receivable and a $3.2 million decrease in
cash from a net increase in our inventory and inventory in-transit

     Cash provided by our investing activities totaled $982,000 during the first
nine months of 2005 as compared to cash provided by our investing activities of
$1.8 million the first nine months of 2004. Our investing activities consisted
of restricted cash related to our United National Bank loan and purchases of
property and equipment.

     Cash used in our financing activities totaled $447,000 during the first
nine months of 2005 as compared to cash used in our financing activities of
$16,000 for the first nine months of 2004. We paid down $2.2 million of our
United National Bank loan through funds generated by our operations during the
first quarter of 2005.  We paid down the balance of $3.8 million of our United
National Bank loan through our new line of credit with GMAC Commercial Finance
and we borrowed an additional $1.7 million on our GMAC Commercial Finance line
of credit during the first nine months of 2005.

     Our net loss decreased to $1.1 million, or by 56.0%, for the first nine
months of 2005 from $2.5 million for the first nine months of 2004, primarily
resulting from a 20.5% decrease in cost of sales to $23.6 million in the first
nine months of 2005 from $29.7 million in the first nine months of 2004 and a
decrease in operating expenses to $4.4 million in the first nine months of 2005
from $5.6 million in the first nine months of 2004, offset by a decrease in our
net sales to $27.0 million, or by 17.9%, in the first nine months of 2005 from
$32.9 million in the first nine months of 2004.  If either the absolute level or
the downward trend of our net loss or net sales continues or increases, we could
experience significant 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 operating performance and financial condition.

     On August 15, 2003, we entered into an asset-based business loan agreement
with United National Bank. The agreement provided for a revolving loan of up to
$6.0 million secured by substantially all of our assets and initially was to
expire on September 1, 2004 and which, on numerous occasions in 2004 and 2005,
was extended to its final expiration date on March 11, 2005.  Advances of up to
65% of eligible accounts receivable bore interest at a floating interest rate
equal to the prime rate of interest as reported in The Wall Street Journal plus
0.75%.  On March 9, 2005, we replaced our asset-based line of credit with United
National Bank with an asset-based line of credit with GMAC Commercial Finance.


                                       32
<PAGE>

     Our asset-based line of credit with GMAC Commercial Finance expires on
March 9, 2008 and allows us to borrow up to $10.0 million.  The line of credit
bears interest at a floating interest rate equal to the prime rate of interest
plus 0.75%.  This interest rate is adjustable upon each movement in the prime
lending rate.  If the prime lending rate increases, our interest rate expense
will increase on an annualized basis by the amount of the increase multiplied by
the principal amount outstanding under our credit facility.  We also have the
option to use the 30-day LIBOR rate (as determined by the London Interbank
Market) plus an initial amount of 3.50%. Our obligations under our loan
agreement with GMAC Commercial Finance are secured by substantially all of our
assets and guaranteed by our wholly-owned subsidiary, IOM Holdings, Inc.  The
loan agreement contains one financial covenant which requires that we maintain a
certain fixed charge coverage ratio.  The covenant was modified by a May 23,
2005 Letter Agreement with GMAC and again by a June 30, 2005 First Amendment To
Loan And Security Agreement ("First Amendment").  The First Amendment requires
that we maintain a fixed charge coverage ratio of at least 1.2 to 1.0 for the
three months ended June 30, 2005 and the six months ended September 30, 2005.
The ratio becomes 1.5 to 1.0 for the nine months ended December 31, 2005 and for
the twelve months in all subsequent quarters.  Our new credit facility was
initially used to pay off our outstanding loan balance as of March 10, 2005 with
United National Bank, which balance was approximately $3.8 million, and was also
used to pay $25,000 of our closing fees in connection with securing the credit
facility.  As of September 30, 2005, we owed GMAC Commercial Finance
approximately $5.5 million.  We were in an overdraft position as of September
30, 2005 in the amount of $1.1 million after our ineligible assets were
recalculated in early October 2005.  As of the date of this report, the Company
is no longer in an overdraft position.

     In January 2003, we entered into a trade credit facility with Lung Hwa
Electronics. Lung Hwa Electronics is a stockholder and subcontract manufacturer
and supplier of I/OMagic. Under the terms of the facility, Lung Hwa Electronics
has agreed to purchase inventory on our behalf. We can purchase up to $10.0
million of inventory, with payment terms of 120 days following the date of
invoice by Lung Hwa Electronics. Lung Hwa Electronics charges us a 5% handling
fee on a supplier's unit price. A 2% discount of the handling fee is applied if
we reach an average running monthly purchasing volume of $750,000. Returns made
by us, which are agreed to by a supplier, result in a credit to us for the
handling charge. As security for the trade credit facility, we paid Lung Hwa
Electronics a $1.5 million security deposit during 2003. As of September 30,
2005, all of this deposit had been applied against outstanding trade payables as
the agreement allowed us to apply the security deposit against our outstanding
trade payables. This trade credit facility is for an indefinite term; however,
either party has the right to terminate the facility upon 30 days' prior written
notice to the other party.

     In July 2005, we entered into an amended and restated trade credit facility
agreement with Lung Hwa Electronics, with the terms retroactive to April 29,
2005.  Under the terms of the amended and restated trade credit facility, we can
purchase up to $15.0 million of inventory, with payment terms of 120 days
following the date of invoice by Lung Hwa Electronics for inventory purchased
directly from Lung Hwa Electronics and 90 days following the date of invoice by
Lung Hwa Electronics for inventory purchased from a third party through Lung Hwa
Electronics on our behalf.  A 10% deposit is required to be made by us to Lung
Hwa Electronics within 10 days of Lung Hwa Electronics' invoice date.  Lung Hwa
Electronics charges us a 5% handling fee on a supplier's unit price. A 2%
discount of the handling fee is applied if we reach an average running monthly
purchasing volume of $750,000. Returns made by us, which are agreed to by a
supplier, result in a credit to us for the handling charge.  As of September 30,
2005, we owed Lung Hwa Electronics $1.2 million in trade payables under this
agreement.

     In February 2003, we entered into a Warehouse Services and Bailment
Agreement with Behavior Tech Computer (USA) Corp., or BTC USA. Under the terms
of the agreement, BTC USA has agreed to supply and store at our warehouse up to
$10.0 million of inventory on a consignment basis. We are responsible for
insuring the consigned inventory, storing the consigned inventory for no charge,


                                       33
<PAGE>

and furnishing BTC USA with weekly statements indicating all products received
and sold and the current level of consigned inventory. The agreement also
provides us with a trade line of credit of up to $10.0 million with payment
terms of net 60 days, without interest. The agreement may be terminated by
either party upon 60 days' prior written notice to the other party. As of
September 30, 2005, we owed BTC USA $4.4 million under this arrangement. BTC USA
is a subsidiary of Behavior Tech Computer Corp., one of our significant
stockholders. Mr. Steel Su, a director of I/OMagic, is the Chief Executive
Officer of Behavior Tech Computer Corp.

     Lung Hwa Electronics and BTC USA provide us with significantly preferential
trade credit terms. These terms include 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 Electronics is likely unique and could not be
replaced through a relationship with an unrelated third party. If either of Lung
Hwa Electronics or BTC USA 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.

     We retain most risks of ownership of products in our consignment sales
channels. These products remain our inventory until their resale by our
retailers.  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 sales channels, our sales,
profitability and financial resources may decline.

     If, like Best Buy, any other of our major retailers, or a significant
number of our smaller retailers, implement or expand private label programs
covering products that compete with our products, our net sales will likely
continue to decline and our net losses are likely to increase, which in turn
could have a material and adverse impact on our liquidity, financial condition
and capital resources. We expect the decline in our sales to Best Buy to
continue in subsequent reporting periods as a result of continued private label
programs.

     We believe that the significant decline in our net sales during the first
nine months of 2005, as compared to the same period in 2004, resulted in part
from a continued decline in sales of our CD-based products, lower average
selling prices of DVD-based products, a greater and more rapid decline in sales
of our DVD-based products greater than the increase in the sales of our GigaBank
products due to the slow transition of certain of our retailers data storage
product offerings from DVD-based optical storage products to our GigaBank
products, and the continued operation of private label programs by Best Buy.

     Despite the decline in our results of operations during the first nine
months of 2005, we believe that current and future available capital resources,
revenues generated from operations, and other existing sources of liquidity,
including our trade credit facilities with Lung Hwa Electronics and BTC USA and
our credit facility with GMAC Commercial Finance will be sufficient to fund our
anticipated working capital and capital expenditure requirements for at least
the next twelve months. If, however, our capital requirements or cash flow vary
materially from our current projections or if unforeseen circumstances occur, we
may require additional financing. Our failure to raise capital, if needed, could
restrict our growth, limit our development of new products or hinder our ability
to compete.


                                       34
<PAGE>

BACKLOG

     Our backlog at September 30, 2005 was $4.4 million as compared to a backlog
at September 30, 2004 of $5.0 million. Based on historical trends, we anticipate
that our September 30, 2005 backlog may be reduced by approximately 13.9%, or
$608,000, to a net amount of $3.8 million as a result of returns and
reclassification of certain expenses as reductions to net sales.

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

IMPACT  OF  NEW  ACCOUNTING  PRONOUNCEMENTS

     In May 2005, the Financial Accounting Standards Board ("FASB") issued
Statement of Accounting Standards (SFAS) No. 154, "Accounting Changes and Error
Corrections" an amendment to Accounting Principles Bulletin (APB) Opinion No.
20, "Accounting Changes", and SFAS No. 3, "Reporting Accounting Changes in
Interim Financial Statements" though SFAS No. 154 carries forward the guidance
in APB No. 20 and SFAS No. 3 with respect to accounting for changes in
estimates, changes in reporting entity, and the correction of errors.

     SFAS No. 154 establishes new standards on accounting for changes in
accounting principles, whereby all such changes must be accounted for by
retrospective application to the financial statements of prior periods unless it
is impracticable to do so.  SFAS No. 154 is effective for accounting changes and
error corrections made in fiscal years beginning after December 15, 2005, with
early adoption permitted for changes and corrections made in years beginning
after May 2005.   We do not expect adoption of SFAS No. 154 to have a material
impact on our financial statements.

     In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47,
"Accounting for Conditional Asset Retirement Obligations". FIN No. 47 clarifies
that the term conditional asset retirement obligation as used in FASB Statement
No. 143, "Accounting for Asset Retirement Obligations," refers to a legal
obligation to perform an asset retirement activity in which the timing and (or)
method of settlement are conditional on a future event that may or may not be
within the control of the entity.  The obligation to perform the asset
retirement activity is unconditional even though uncertainty exists about the
timing and (or) method of settlement.  Uncertainty about the timing and/or
method of settlement of a conditional asset retirement obligation should be
factored into the measurement of the liability when sufficient information
exists.  This interpretation also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. FIN No. 47 is effective no later than the end of fiscal years ending
after December 15, 2005 (which would be December 31, 2005 for calendar-year
companies). Retrospective application of interim financial information is
permitted but is not required.  We do not expect adoption of FIN No. 47 to have
a material impact on our financial statements.


                                       35
<PAGE>

                                  RISK FACTORS

     An investment in our common stock involves a high degree of risk. In
addition to the other information in this Quarterly Report and in our other
filings with the Securities and Exchange Commission, including our subsequent
reports on Forms 10-Q, 10-K and 8-K , you should carefully consider the
following discussion, which summarizes material risks, before deciding to invest
in shares of our common stock or to maintain or increase your investment in
shares of our common stock. Any of the following risks, if they actually occur,
would likely harm our business, financial condition and results of operations.
As a result, the trading price of our common stock could decline, and you could
lose all or part of the money you paid to buy our common stock.

IF WE CONTINUE TO SUSTAIN LOSSES, WE WILL BE IN VIOLATION OF THE GMAC COMMERCIAL
FINANCE COVENANT AND WE MAY BE UNABLE TO BORROW FUNDS TO PURCHASE INVENTORY, TO
SUSTAIN OR EXPAND OUR CURRENT SALES VOLUME AND TO FUND OUR DAY-TO-DAY
OPERATIONS.

     Our credit facility with GMAC Commercial Finance has one financial covenant
which requires us to have a fixed charge coverage ratio of at least 1.2 to 1.0
for the six months ended September 30, 2005.  The ratio becomes 1.5 to 1.0 for
the nine months ended December 31, 2005 and for each twelve month period
thereafter.  If we are unable to attain those ratios, then GMAC Commercial
Finance has the option to immediately terminate the line of credit and the
unpaid principal balance and all accrued interest on the unpaid balance will
then be immediately due and payable.  If the loan were to be called and we were
unable to obtain alternative financing, we would lack adequate funds to acquire
inventory in amounts sufficient to sustain or expand our current sales
operation.  In addition, we would be unable to fund our day-to-day operations.

WE HAVE INCURRED SIGNIFICANT LOSSES IN THE PAST, AND WE MAY CONTINUE TO INCUR
SIGNIFICANT LOSSES IN THE FUTURE. IF WE CONTINUE TO INCUR LOSSES, WE WILL
EXPERIENCE NEGATIVE CASH FLOW WHICH MAY HAMPER CURRENT OPERATIONS AND MAY
PREVENT US FROM EXPANDING OUR BUSINESS.

     We have incurred net losses in each of the last five years and for the nine
months ended September 30, 2005. As of September 30, 2005, we had an accumulated
deficit of approximately $24.2 million. During 2004, 2003, 2002, 2001, 2000 and
the nine months ended September 30, 2005, we incurred net losses in the amounts
of approximately $8.1 million, $460,000, $8.8 million, $5.4 million, $6.2
million and $1.1 million, respectively. Historically, we have relied upon cash
from operations and financing activities to fund all of the cash requirements of
our business. If our extended period of net losses continues, this will result
in negative cash flow and may hamper current operations and may prevent us from
expanding our business. We cannot assure you that we will attain, sustain or
increase profitability on a quarterly or annual basis in the future. If we do
not achieve, sustain or increase profitability, our business will be adversely
affected and our stock price may decline.

WE DEPEND ON A SMALL NUMBER OF RETAILERS FOR THE VAST MAJORITY OF OUR SALES. A
REDUCTION IN BUSINESS FROM ANY OF THESE RETAILERS COULD CAUSE A SIGNIFICANT
DECLINE IN OUR SALES AND PROFITABILITY.

     The vast majority of our sales are generated from a small number of
retailers. During the first nine months of 2005, net sales to our three largest
retailers, Staples, Office Depot and CompUSA represented approximately 43%, 19%
and 14%, respectively, or an aggregate of approximately 76%, of our total net
sales. During 2004, net sales to our five largest retailers, Staples, Circuit
City, Best Buy, Office Depot and CompUSA represented approximately 32%, 17%,
11%, 10% and 10%, respectively, or an aggregate of approximately 80%, of our
total net sales. We expect that we will continue to depend upon a small number
of retailers for a significant majority of our sales for the foreseeable future.


                                       36
<PAGE>

     Our agreements with these retailers do not require them to purchase any
specified number of products or dollar amount of sales or to make any purchases
whatsoever. Therefore, we cannot assure you that, in any future period, our
sales generated from these retailers, individually or in the aggregate, will
equal or exceed historical levels. We also cannot assure you that, if sales to
any of these retailers cease or decline, we will be able to replace these sales
with sales to either existing or new retailers in a timely manner, or at all. A
cessation or reduction of sales, or a decrease in the prices of products sold to
one or more of these retailers has significantly reduced our net sales for one
or more reporting periods in the past and could, in the future, cause a
significant decline in our net sales and profitability.

OUR LACK OF LONG-TERM PURCHASE ORDERS AND COMMITMENTS COULD LEAD TO A RAPID
DECLINE IN OUR SALES AND PROFITABILITY.

     All of our significant retailers issue purchase orders solely in their own
discretion, often only one to two weeks before the requested date of shipment.
Our retailers are generally able to cancel orders or delay the delivery of
products on short notice. In addition, our retailers may decide not to purchase
products from us for any reason. Accordingly, we cannot assure you that any of
our current retailers will continue to purchase our products in the future. As a
result, our sales volume and profitability could decline rapidly with little or
no warning whatsoever. For example, our sales to Best Buy decreased 99% from
$5.2 million in the first nine months of 2004 to only $62,000 for the first nine
months of 2005.  In addition, our sales to Radio Shack USA decreased 100% from
$1.8 million in the first nine months of 2004 to no sales in the first nine
months of 2005.

     We cannot rely on long-term purchase orders or commitments to protect us
from the negative financial effects of a decline in demand for our products. The
limited certainty of product orders can make it difficult for us to forecast our
sales and allocate our resources in a manner consistent with our actual sales.
Moreover, our expense levels are based in part on our expectations of future
sales and, if our expectations regarding future sales are inaccurate, we may be
unable to reduce costs in a timely manner to adjust for sales shortfalls.
Furthermore, because we depend on a small number of retailers for the vast
majority of our sales, the magnitude of the ramifications of these risks, is
greater than if our sales were less concentrated within a small number of
retailers. As a result of our lack of long-term purchase orders and purchase
commitments we may experience a rapid decline in our sales and profitability.

ONE OR MORE OF OUR LARGEST RETAILERS MAY DIRECTLY IMPORT OR PRIVATE LABEL
PRODUCTS THAT ARE IDENTICAL OR VERY SIMILAR TO OUR PRODUCTS. THIS COULD CAUSE A
SIGNIFICANT DECLINE IN OUR SALES AND PROFITABILITY.

     Optical data storage products and digital entertainment products are widely
available from manufacturers and other suppliers around the world. Our retailers
have included Best Buy, Circuit City, CompUSA, Office Depot, Radio Shack and
Staples. Sales to these six retailers collectively accounted for 84% of our net
sales for 2004 and 85% of our net sales for the first nine months of 2005. Each
of these retailers has substantially greater resources than we do, and has the
ability to directly import or private-label data storage and digital
entertainment products from manufacturers and other suppliers around the world,
including from some of our own subcontract manufacturers and suppliers. For
example, Best Buy, our largest retailer, already has a private label program and
sells certain products that compete with some of our products. We had only
$62,000 in sales to Best Buy in the first nine months of 2005, representing a
decrease of nearly 100% from $5.2 million in the first nine months of 2004. We
believe that this decrease reflects, at least in part, Best Buy's increased
sales of private label products that compete with products that we sell. Our
retailers may believe that higher profit margins can be achieved if they
implement a direct import or private-label program, excluding us from the sales
channel. Accordingly, one or more of our

                                       37
<PAGE>

largest retailers may stop buying products from us in favor of a direct import
or private-label program. As a consequence, our sales and profitability could
decline significantly.

HISTORICALLY, A SUBSTANTIAL PORTION OF OUR ASSETS HAVE BEEN COMPRISED OF
ACCOUNTS RECEIVABLE REPRESENTING AMOUNTS OWED BY A SMALL NUMBER OF RETAILERS. WE
EXPECT THIS TO CONTINUE IN THE FUTURE. IF ANY OF THESE RETAILERS FAILS TO TIMELY
PAY US AMOUNTS OWED, WE COULD SUFFER A SIGNIFICANT DECLINE IN CASH FLOW AND
LIQUIDITY WHICH, IN TURN, COULD CAUSE US TO BE UNABLE PAY OUR LIABILITIES AND
PURCHASE AN ADEQUATE AMOUNT OF INVENTORY TO SUSTAIN OR EXPAND OUR CURRENT SALES
VOLUME.

     Our accounts receivable represented 50%, 53% and 46% of our total assets as
of September 30, 2005, December 31, 2004 and December 31, 2003, respectively.
As of September 30, 2005, 85% of our accounts receivable represented amounts
owed by three retailers, each of whom represented over 10% of the total amount
of our accounts receivable.  Similarly, as of December 31, 2004, 73% of our
accounts receivable represented amounts owed by two retailers, each of whom
represented over 10% of the total amount of our accounts receivable. As a result
of the substantial amount and concentration of our accounts receivable, if any
of our major retailers fails to timely pay us amounts owed, we could suffer a
significant decline in cash flow and liquidity which would negatively affect our
ability to make payments under our line of credit with GMAC Commercial Finance
and which, in turn, could adversely affect our ability to borrow funds to
purchase inventory to sustain or expand our current sales volume. Accordingly,
if any of our major retailers fails to timely pay us amounts owed, our sales and
profitability may decline.

WE RELY HEAVILY ON OUR CHIEF EXECUTIVE OFFICER, TONY SHAHBAZ. THE LOSS OF HIS
SERVICES COULD ADVERSELY AFFECT OUR ABILITY TO SOURCE PRODUCTS FROM OUR KEY
SUPPLIERS AND OUR ABILITY TO SELL OUR PRODUCTS TO OUR RETAILERS.

     Our success depends, to a significant extent, upon the continued services
of Tony Shahbaz, who is our Chairman of the Board, President, Chief Executive
Officer and Secretary. For example, Mr. Shahbaz has developed key personal
relationships with our suppliers and retailers, including with our subcontract
manufacturers. We greatly rely on these relationships in the conduct of our
operations and the execution of our business strategies. Mr. Shahbaz and some of
these subcontract manufacturers and suppliers have acquired interests in
business entities that own shares of our common stock. Further, some of these
manufacturers also directly hold shares of our common stock. The loss of Mr.
Shahbaz could, therefore, result in the loss of our favorable relationships with
one or more of our subcontract manufacturers or suppliers. Although we have
entered into an employment agreement with Mr. Shahbaz, that agreement is of
limited duration and is subject to early termination by Mr. Shahbaz under
certain circumstances. In addition, we do not maintain "key person" life
insurance covering Mr. Shahbaz or any other executive officer. The loss of Mr.
Shahbaz could significantly delay or prevent the achievement of our business
objectives. Consequently, the loss of Mr. Shahbaz could adversely affect our
business, financial condition and results of operations.

THE HIGH CONCENTRATION OF OUR SALES WITHIN THE DATA STORAGE INDUSTRY COULD
RESULT IN A SIGNIFICANT REDUCTION IN NET SALES AND NEGATIVELY AFFECT OUR
EARNINGS IF DEMAND FOR THOSE PRODUCTS DECLINES.

     Sales of our data storage products accounted for over 99% of our net sales
in the first nine months of 2005 and approximately 99% in the year 2004. Except
for our digital entertainment and other products, which accounted for less than
1% of our net sales in the first nine months of 2005 and in the year 2004, we
have not diversified our product categories outside of the data storage
industry. We expect data storage products to continue to account for the vast
majority of our net sales for the foreseeable future. As a result, our net sales
and profitability would be significantly and adversely impacted by a downturn in
the demand for data storage products.


                                       38
<PAGE>

IF WE FAIL TO ACCURATELY FORECAST THE COSTS OF OUR PRODUCT REBATE OR OTHER
PROMOTIONAL PROGRAMS, WE MAY EXPERIENCE A SIGNIFICANT DECLINE IN CASH FLOW AND
OUR BRAND IMAGE MAY BE ADVERSELY AFFECTED RESULTING IN REDUCED SALES AND
PROFITABILITY.

     We rely heavily on product rebates and other promotional programs to
establish, maintain and increase sales of our products. If we fail to accurately
forecast the costs of these programs, we may fail to allocate sufficient
resources to these programs. For example, we may fail to have sufficient funds
available to satisfy mail-in product rebates. If we are unable to satisfy our
promotional obligations, such as providing cash rebates to consumers, our brand
image and goodwill with consumers and retailers would be harmed, which may
result in reduced sales and profitability. In addition, our failure to
adequately forecast the costs of these programs may result in unexpected
liabilities causing a significant decline in cash flow and capital resources
with which to operate our business.

OUR TWO PRINCIPAL SUBCONTRACT MANUFACTURERS PROVIDE US WITH SIGNIFICANTLY
PREFERENTIAL TRADE CREDIT TERMS. IF EITHER OF THESE MANUFACTURERS DOES NOT
CONTINUE TO OFFER US SUBSTANTIALLY THE SAME PREFERENTIAL CREDIT TERMS, OUR SALES
AND PROFITABILITY WOULD DECLINE SIGNIFICANTLY.

     Lung Hwa Electronics and Behavior Tech Computer Corp., our two principal
subcontract manufacturers and suppliers, provide us with significantly
preferential trade credit terms. These terms include 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 Electronics is likely unique and
could not be replaced through a relationship with an unrelated third party. If
either of these subcontract manufacturers and suppliers 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.

THE DATA STORAGE INDUSTRY IS EXTREMELY COMPETITIVE. ALL OF OUR SIGNIFICANT
COMPETITORS HAVE GREATER FINANCIAL AND OTHER RESOURCES THAN WE DO, AND ONE OR
MORE OF THESE COMPETITORS COULD USE THEIR GREATER RESOURCES TO GAIN MARKET SHARE
AT OUR EXPENSE.

     The data storage industry is extremely competitive. All of our significant
competitors in the data storage industry, including BenQ, Hewlett-Packard,
Lite-On, Memorex, Philips Electronics, Samsung Electronics, Sony and TDK have
substantially greater production, financial, research and development,
intellectual property, personnel and marketing resources than we do. As a
result, each of these companies could compete more aggressively and sustain that
competition over a longer period of time than we could. Our lack of resources
relative to all of our significant competitors may cause us to fail to
anticipate or respond adequately to technological developments and changing
consumer demands and preferences, or may cause us to experience significant
delays in obtaining or introducing new or enhanced products. These failures or
delays could reduce our competitiveness and cause a decline in our market share
and sales.

DATA STORAGE PRODUCTS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGES. IF WE FAIL TO
ACCURATELY ANTICIPATE AND ADAPT TO THESE CHANGES, THE PRODUCTS WE SELL WILL
BECOME OBSOLETE, CAUSING A DECLINE IN OUR SALES AND PROFITABILITY.

     Data storage products are subject to rapid technological changes which
often cause product obsolescence. Companies within the data storage industry are
continuously developing new products with heightened performance and
functionality. This puts pricing pressure on existing products and constantly
threatens to make them, or causes them to be, obsolete. Our typical product life
cycle is extremely short and ranges from only three to twelve months, generating
lower average selling prices as the cycle matures.


                                       39
<PAGE>

If we fail to accurately anticipate the introduction of new technologies, we may
possess significant amounts of obsolete inventory that can only be sold at
substantially lower prices and profit margins than we anticipated. In addition,
if we fail to accurately anticipate the introduction of new technologies, we may
be unable to compete effectively due to our failure to offer products most
demanded by the marketplace. If any of these failures occur, our sales, profit
margins and profitability will be adversely affected.

IF WE FAIL TO SELECT HIGH TURNOVER PRODUCTS FOR OUR CONSIGNMENT SALES CHANNELS,
OUR FINANCING COSTS MAY EXCEED TARGETED LEVELS, WE MAY BE UNABLE TO FUND
ADDITIONAL PURCHASES OF INVENTORY AND WE MAY BE FORCED TO REDUCE PRICES AND
ACCEPT LOWER MARGINS TO SELL CONSIGNED PRODUCTS, WHICH WOULD CAUSE OUR SALES,
PROFITABILITY AND FINANCIAL RESOURCES TO DECLINE.

     We retain most risks of ownership of products in our consignment sales
channels. These products remain our inventory until their resale by our
retailers.  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. As of
September 30, 2005 and December 31, 2004, we carried and financed inventory
valued at approximately $3.8 million and $2.9 million, respectively, in our
consignment sales channels. Sales generated through consignment sales were
approximately 35% and 32%, respectively, of our total net sales for the nine
months ended September 30, 2005 and for the year ended December 31, 2004. If we
fail to select high turnover products for our consignment sales channels, our
sales, profitability and financial resources may decline.

OUR INDEMNIFICATION OBLIGATIONS TO OUR RETAILERS FOR PRODUCT DEFECTS COULD
REQUIRE US TO PAY SUBSTANTIAL DAMAGES, WHICH COULD HAVE A SIGNIFICANT NEGATIVE
IMPACT ON OUR PROFITABILITY AND FINANCIAL RESOURCES.

     A number of our agreements with our retailers provide that we will defend,
indemnify and hold them, and their customers, harmless from damages and costs
that arise from product warranty claims or from claims for injury or damage
resulting from defects in our products. If such claims are asserted against us,
our insurance coverage may not be adequate to cover the costs associated with
our defense of those claims or the cost of any resulting liability we incur if
those claims are successful. A successful claim brought against us for product
defects that is in excess of, or excluded from, our insurance coverage could
adversely affect our profitability and financial resources and could make it
difficult or impossible for us to adequately fund our day-to-day operations.

IF WE ARE SUBJECTED TO ONE OR MORE INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS,
OUR SALES, EARNINGS AND FINANCIAL RESOURCES MAY BE ADVERSELY AFFECTED.

     Our products rely on intellectual property developed, owned or licensed by
third parties. From time to time, intellectual property infringement claims have
been asserted against us. We expect to continue to be subjected to such claims
in the future. Intellectual property infringement claims may also be asserted
against our retailers as a result of selling our products. As a consequence, our
retailers could assert indemnification claims against us. If any third party is
successful in asserting an infringement claim against us, we could be required
to acquire licenses, which may not be available on commercially reasonable
terms, if at all, to discontinue selling certain products to pay substantial
monetary damages or to develop non-infringing technologies, none of which may be
feasible. Both infringement and indemnification claims could be time-consuming
and costly to defend or settle and would divert management's attention and our


                                       40
<PAGE>

resources away from our business. In addition, we may lack sufficient litigation
defense resources, therefore any one of these developments could place
substantial financial and administrative burdens on us and our sales and
earnings may be adversely affected.

IF WE FAIL TO SUCCESSFULLY MANAGE THE EXPANSION OF OUR BUSINESS, OUR SALES MAY
NOT INCREASE COMMENSURATELY WITH OUR CAPITAL INVESTMENTS, WHICH WOULD CAUSE OUR
PROFITABILITY TO DECLINE.

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

     Our failure to successfully manage our planned product expansion could
result in our sales not increasing commensurately with our capital investments,
causing a decline in our profitability.

A SIGNIFICANT PRODUCT DEFECT OR PRODUCT RECALL COULD MATERIALLY AND ADVERSELY
AFFECT OUR BRAND IMAGE, CAUSING A DECLINE IN OUR SALES, AND COULD REDUCE OR
DEPLETE OUR FINANCIAL RESOURCES.

     A significant product defect could materially harm our brand image and
could force us to conduct a product recall. This could result in damage to our
relationships with our retailers and loss of consumer loyalty. Because we are a
small company, a product recall would be particularly harmful to us because we
have limited financial and administrative resources to effectively manage a
product recall and it would detract management's attention from implementing our
core business strategies. As a result, a significant product defect or product
recall could materially and adversely affect our brand image, causing a decline
in our sales, and could reduce or deplete our financial resources.

IF OUR PRODUCTS ARE NOT AMONG THE FIRST-TO-MARKET, OR IF CONSUMERS DO NOT
RESPOND FAVORABLY TO EITHER OUR NEW OR ENHANCED PRODUCTS, OUR SALES AND EARNINGS
WILL DECLINE.

     One of our core business strategies is to be among the first-to-market with
new and enhanced products based on established technologies. We believe that our
I/OMagic  brand is perceived by the retailers and end-users of our products as
among the leaders in the data storage industry. We also believe that these
retailers and end-users view products offered under our I/OMagic  brand as
embodying newly established technologies or technological enhancements. For
instance, in introducing new and enhanced optical data storage products and
portable magnetic data storage devices such as our GigaBank  products, we seek
to be among the first-to-market, offering heightened product performance such as
faster data recordation and access speeds. If our products are not among the
first-to-market, our competitors may gain market share at our expense, which
would decrease our net sales and earnings.

     As a consequence of this core strategy, we are exposed to consumer
rejection of our new and enhanced products to a greater degree than if we
offered products later in their industry life cycle. For example, our
anticipated future sales are largely dependent on future consumer demand for
DVD-based products displacing current consumer demand for CD-based products as
well as increasing demand for portable magnetic data storage devices such as our
GigaBank  products. Accordingly, future sales and any future profits from
DVD-based products and our GigaBank  line of products are substantially
dependent upon widespread consumer acceptance of DVD-based products and portable
data storage

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<PAGE>

devices. If this widespread consumer acceptance of DVD-based products and our
GigaBank products does not occur, or is delayed, our sales and earnings will be
adversely affected.

A LABOR STRIKE OR CONGESTION AT A SHIPPING PORT AT WHICH OUR PRODUCTS ARE
SHIPPED OR RECEIVED COULD PREVENT US FROM TAKING TIMELY DELIVERY OF INVENTORY,
WHICH COULD CAUSE OUR SALES AND PROFITABILITY TO DECLINE.

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

FAILURE TO ADEQUATELY PROTECT OUR TRADEMARK RIGHTS COULD CAUSE US TO LOSE MARKET
SHARE AND CAUSE OUR SALES TO DECLINE.

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

CONSUMER ACCEPTANCE OF ALTERNATIVE SALES CHANNELS MAY INCREASE. IF WE ARE UNABLE
TO ADAPT TO THESE ALTERNATIVE SALES CHANNELS, SALES OF OUR PRODUCTS MAY DECLINE.

     We are accustomed to conducting business through traditional retail sales
channels. Consumers purchase our products predominantly through a small number
of retailers. For example, during the first nine months of 2005, five of our
retailers accounted for 92% of our total net sales. Similarly, during 2004, five
of our retailers accounted for 80% of our total net sales. We currently generate
only a small number of direct sales of our products through our Internet
websites. We believe that many of our target consumers are knowledgeable about
technology and comfortable with the use of the Internet for product purchases.
Consumers may increasingly prefer alternative sales channels, such as direct
mail order or direct purchase from manufacturers. In addition, Internet commerce
is becoming increasingly accepted by consumers as a


                                       42
<PAGE>

convenient, secure and cost-effective method of purchasing data storage and
digital entertainment products. The migration of consumer purchasing habits from
traditional retailers to Internet retailers could have a significant impact on
our ability to sell our products. We cannot assure you that we will be able to
predict and respond to increasing consumer preference of alternative sales
channels. If we are unable to adapt to alternative sales channels, sales of our
products may decline.

OUR OPERATIONS ARE VULNERABLE BECAUSE WE HAVE LIMITED REDUNDANCY AND BACKUP
SYSTEMS.

     Our internal order, inventory and product data management system is an
electronic system through which our retailers place orders for our products and
through which we manage product pricing, shipment, returns and other matters.
This system's continued and uninterrupted performance is critical to our
day-to-day business operations. Despite our precautions, unanticipated
interruptions in our computer and telecommunications systems have, in the past,
caused problems or stoppages in this electronic system. These interruptions, and
resulting problems, could occur in the future. We have extremely limited ability
and personnel to process purchase orders and manage product pricing and other
matters in any manner other than through this electronic system. Any
interruption or delay in the operation of this electronic system could cause a
significant decline in our sales and profitability.

OUR STOCK PRICE IS HIGHLY VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR
INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND IN LITIGATION AGAINST US.

     The market price of our common stock has fluctuated significantly in the
past and may continue to fluctuate significantly in the future. During the first
nine months of 2005, the high and low closing bid prices of a share of our
common stock were $6.50 and $0.75, respectively. During 2004, the high and low
closing bid prices of a share of our common stock were $4.50 and $3.00,
respectively. The market price of our common stock may continue to fluctuate in
response to one or more of the following factors, many of which are beyond our
control:

-     changes in market valuations of similar companies;

-     stock market price and volume fluctuations generally;

-     economic conditions specific to the data storage or digital entertainment
      products industries;

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

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

-     delays in our introduction of new products or technological innovations or
      problems in the functioning of these new products or innovations;

-     disputes or litigation concerning our rights to use third parties'
      intellectual property or third parties' infringement of our intellectual
      property;

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

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


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<PAGE>

-     regulatory developments or increased enforcement;

-     fluctuations in our quarterly or annual operating results;

-     additions or departures of key personnel; and

-     future sales of our common stock or other securities.

     The price at which you purchase shares of our common stock may not be
indicative of the price that will prevail in the trading market. You may be
unable to sell your shares of common stock at or above your purchase price,
which may result in substantial losses to you.

     In the past, securities class action litigation has often been brought
against a company following periods of stock price volatility. We may be the
target of similar litigation in the future. Securities litigation could result
in substantial costs and divert management's attention and our resources from
our business. Any of the risks described above could have an adverse effect on
our business, financial condition and results of operations and therefore on the
price of our common stock.

OUR COMMON STOCK HAS A SMALL PUBLIC FLOAT AND SHARES OF OUR COMMON STOCK
ELIGIBLE FOR PUBLIC SALE COULD CAUSE THE MARKET PRICE OF OUR STOCK TO DROP, EVEN
IF OUR BUSINESS IS DOING WELL.

     As of November 11, 2005, there were approximately 4.5 million shares of our
common stock outstanding. As a group, our executive officers, directors and 10%
shareholders beneficially own approximately 3.5 million of these shares.
Accordingly, our common stock has a public float of approximately 1.0 million
shares held by a relatively small number of public investors. In addition, we
have a registration statement on Form S-8 in effect covering 133,334 shares of
common stock issuable upon exercise of options under our 2002 Stock Option Plan
and a registration statement on Form S-8 in effect covering 400,000 shares of
common stock issuable upon exercise of options under our 2003 Stock Option Plan.
Currently, options covering 108,950 shares of common stock are outstanding under
our 2002 Stock Option Plan and options covering 370,000 shares of common stock
were issued July 14, 2005 under our 2003 Stock Option Plan. The shares of common
stock issued upon exercise of these options will be freely tradable without
restriction or further registration, except to the extent purchased by one of
our affiliates.

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

IF THE OWNERSHIP OF OUR COMMON STOCK CONTINUES TO BE HIGHLY CONCENTRATED, IT MAY
PREVENT YOU AND OTHER STOCKHOLDERS FROM INFLUENCING SIGNIFICANT CORPORATE
DECISIONS AND MAY RESULT IN CONFLICTS OF INTEREST THAT COULD CAUSE OUR STOCK
PRICE TO DECLINE.

     As a group, our executive officers, directors, and 10% stockholders
beneficially own or control approximately 75% of our outstanding shares of
common stock (after giving effect to the exercise of all outstanding vested
options exercisable within 60 days from November 11, 2005). As a result, our
executive officers, directors, and 10% stockholders, acting as a group, have
substantial control over the outcome of corporate actions requiring stockholder
approval, including the election of directors, any merger, consolidation or sale
of all or substantially all of our assets, or any other significant corporate
transaction. Some of these controlling stockholders may have interests different
than yours. For example,


                                       44
<PAGE>

these stockholders may delay or prevent a change in control of I/OMagic, even
one that would benefit our stockholders, or pursue strategies that are different
from the wishes of other investors. The significant concentration of stock
ownership may adversely affect the trading price of our common stock due to
investors' perception that conflicts of interest may exist or arise.

OUR ARTICLES OF INCORPORATION, OUR BYLAWS AND NEVADA LAW EACH CONTAIN PROVISIONS
THAT COULD DISCOURAGE TRANSACTIONS RESULTING IN A CHANGE IN CONTROL OF I/OMAGIC,
WHICH MAY NEGATIVELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.

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

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

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

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

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

WE CANNOT ASSURE YOU THAT AN ACTIVE MARKET FOR OUR SHARES OF COMMON STOCK WILL
DEVELOP OR, IF IT DOES DEVELOP, WILL BE MAINTAINED IN THE FUTURE. IF AN ACTIVE
MARKET DOES NOT DEVELOP, YOU MAY NOT BE ABLE TO READILY SELL YOUR SHARES OF OUR
COMMON STOCK.

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


IF OUR STOCK BECOMES SUBJECT TO "PENNY STOCK" RULES, THE LEVEL OF TRADING
ACTIVITY IN OUR COMMON STOCK MAY BE REDUCED.  IF THE LEVEL OF TRADING ACTIVITY
IS REDUCED, YOU MAY NOT BE ABLE TO READILY SELL YOUR SHARES OF OUR COMMON STOCK.

     Broker-dealer practices in connection with transactions in "penny stocks"
are regulated by penny stock rules adopted by the Securities and Exchange
Commission. Penny stocks are, generally, equity securities with a price of less
than $5.00 per share that trade on the OTC Bulletin Board or the Pink Sheets.
The penny stock rules require a broker-dealer, prior to a transaction in a penny
stock not otherwise exempt from the rules, to deliver a standardized risk
disclosure document that provides information about penny


                                       45
<PAGE>

Stocks and the nature and level of risks in investing in the penny stock market.
The broker-dealer also must provide the prospective investor with current bid
and offer quotations for the penny stock and the amount of compensation to be
paid to the broker-dealer and its salespeople in the transaction. Furthermore,
if the broker-dealer is the sole market maker, the broker-dealer must disclose
this fact and the broker-dealer's presumed control over the market, and must
provide each holder of penny stock with a monthly account statement showing the
market value of each penny stock held in the customer's account. In addition,
broker-dealers who sell penny stocks to persons other than established customers
and "accredited investors" must make a special written determination that the
penny stock is a suitable investment for the prospective investor and receive
the purchaser's written agreement to the transaction. These requirements may
have the effect of reducing the level of trading activity in a penny stock, such
as our common stock, and investors in our common stock may find it difficult to
sell their shares.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Our operations were not subject to commodity price risk during the first
nine months of 2005. Our sales to a foreign country (Canada) were approximately
0.8% of our total sales for the first nine months of 2005, and thus we
experienced negligible foreign currency exchange rate risk. We do not hedge
against this risk.

     We currently have an asset-based business loan agreement with GMAC
Commercial Finance in the amount of up to $10.0 million. The line of credit
provides for an interest rate equal to the prime lending rate as reported in The
Wall Street Journal plus 0.75%. This interest rate is adjustable upon each
movement in the prime lending rate. If the prime lending rate increases, our
interest rate expense will increase on an annualized basis by the amount of the
increase multiplied by the principal amount outstanding under the GMAC
Commercial Finance business loan agreement.

ITEM 4.  CONTROLS AND PROCEDURES

     Evaluation of Disclosure Controls and Procedures

     We conducted an evaluation, with the participation of our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,
or the Exchange Act, as of September 30, 2005, to ensure that information
required to be disclosed by us in the reports filed or submitted by us under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities Exchange Commission's rules and forms,
including to ensure that information required to be disclosed by us in the
reports filed or submitted by us under the Exchange Act is accumulated and
communicated to our management, including our principal executive and principal
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure.  Based on that evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that as
of September 30, 2005, our disclosure controls and procedures were not effective
at the reasonable assurance level due to the material weaknesses described
below.

     A material weakness is a control deficiency (within the meaning of the
Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. Management has identified the
following material weaknesses which have caused management to conclude that, as
of September 30, 2005, our disclosure controls and procedures were not effective
at the reasonable assurance level:


                                       46
<PAGE>

     1.  As a result of our restatement of prior periods' financial statements
as of and for the years ended December 31, 2003 and 2002 and for each of the
quarterly periods in the years ended December 31, 2003 and 2002, and through the
nine months ended September 30, 2004, we were unable to meet our requirements to
timely file our Form 10-K for the year ended December 31, 2004 and our Form 10-Q
for the quarter ended March 31, 2005. Although we were able to timely file our
Forms 10-Q for the quarters ended June 30, 2005 and September 30, 2005,
management evaluated, in the fourth quarter of 2005 and as of September 30,
2005, the impact of our inability to timely file periodic reports with the
Securities and Exchange Commission on our assessment of our disclosure controls
and procedures and concluded, in the fourth quarter of 2005 and as of September
30, 2005, that the control deficiency that resulted in the inability to timely
make these filings represented a material weakness.

     2.  We did not maintain a sufficient complement of finance and accounting
personnel to handle the matters necessary to timely file our Form 10-K for the
year ended December 31, 2004 and our Form 10-Q for the quarter ended March 31,
2005. Although we were able to timely file our Form 10-Q for the quarter ended
June 30, 2005, management evaluated, in the fourth quarter of 2005 and as of
September 30, 2005, the impact of our lack of sufficient finance and accounting
personnel on our assessment of our disclosure controls and procedures and
concluded, in the fourth quarter of 2005 and as of September 30, 2005, that the
control deficiency that resulted in our lack of sufficient personnel represented
a material weakness.

     Remediation of Material Weaknesses

     To remediate the material weaknesses in our disclosure controls and
procedures identified above, we have done the following, in the periods
specified below, which correspond to the material weaknesses identified above:

     1.  In connection with making the changes discussed above to our disclosure
controls and procedures, in addition to working with our independent auditors,
in the fourth quarter of 2004, we retained a third-party consultant, who is an
experienced partner of a registered public accounting firm specializing in
public company financial reporting, to advise us and our Audit Committee
regarding our financial reporting processes.  We also engaged, in the fourth
quarter of 2004, another third-party accounting firm, other than our independent
auditors, to assist us with our financial reporting processes.  These
third-parties have assisted us in altering our financial reporting processes,
which we expect will better enable us to timely file our periodic reports.
Additionally, in the third quarter of 2005, we created a new position-Corporate
Compliance Manager-to further assist us in timely making required filings with
the Securities and Exchange Commission and ensuring the accuracy of our
financial reporting and the effectiveness of our disclosure controls and
procedures.  We have employed the services of professional placement agencies
and are currently in the process of filling this position with an appropriate
candidate.  In the third quarter of 2005, we further improved our ability to
timely make required filings by implementing additional automated reporting
procedures with respect to product returns and sales incentives through
enhancements to our MIS financial reporting system that expedite our internal
reporting processes as well as periodic reviews by our independent auditors.  In
addition, we allocated and continue to allocate part of the time of certain
company personnel with accounting experience to assist us in generating reports
and schedules necessary to timely file our periodic reports.  Prior to this
time, these personnel focused their time on other matters. We also intend, in
2005, to continue to implement enhancements to our financial reporting
processes, including increased training of our finance and accounting staff
regarding financial reporting requirements and the evaluation and further
implementation of automated procedures within our MIS financial reporting
system.

     Management expects that the remediation described in item 1 immediately
above will remediate the corresponding material weakness also described above by
December 31, 2005. Management estimates that it has paid the third-party
consultant approximately $37,000 in connection with his services and


                                       47
<PAGE>

estimates that it has paid the third-party accounting firm approximately $63,000
in connection with its services. Management believes that a suitable candidate
for its new position-Corporate Compliance Manager-will have an annual salary of
at least $75,000, not including benefits and other costs of employment.
Management is unable, however, to estimate our capital or other expenditures
associated with the allocation of time of certain company personnel to assist us
in generating reports and schedules necessary to timely file our periodic
reports, our enhancements to our MIS financial reporting system or our
additional capital or other expenditures related to higher fees paid to our
independent auditors in connection with their review of this remediation.

     2.  Management believes that the procedures we implemented in connection
with the restatement of our financial statements, and the circumstances
surrounding the restatement, have led to a greater depth of understanding by
management of revenue recognition principles. Management also believes that
these procedures, and the circumstances surrounding the restatement, have led to
improved and expedited financial reporting processes as a result of more
detailed and accurate recording of sales incentives and product returns as they
relate to revenue recognition. In addition, management believes that these
procedures, and the circumstances surrounding the restatement, have led to
improved and expedited financial reporting processes as a result of more
detailed and accurate recording of charges to our inventory reserve. Management
further believes that the involvement of the third-party consultant and the
third-party accounting firm, as discussed above, has led to improved procedures
and controls with respect to these matters. We also believe that the new
position of Corporate Compliance Manager, once it is filled with a suitable
candidate, will contribute additional expertise to our team of finance and
accounting personnel. In addition, as noted above, we allocated and continue to
allocate part of the time of certain company personnel with accounting
experience to assist us in generating reports and schedules necessary to timely
file our periodic reports and we believe that this has assisted us, and will
continue to assist us, in timely filing our periodic reports.

     Management expects that the remediation described in item 2 immediately
above will remediate the corresponding material weakness also described above by
December 31, 2005. As noted above, management estimates that it has paid the
third-party consultant approximately $37,000 in connection with his services and
estimates that it has paid the third-party accounting firm approximately $63,000
in connection with its services. As also noted above, management believes that a
suitable candidate for its new position-Corporate Compliance Manager-will have
an annual salary of at least $75,000, not including benefits and other costs of
employment. Management is unable, however, to estimate our capital or other
expenditures associated with the allocation of time of certain company personnel
to assist us in generating reports and schedules necessary to timely file our
periodic reports or our additional capital or other expenditures related to
higher fees paid to our independent auditors in connection with their review of
this remediation.

     Changes in Internal Control over Financial Reporting

     The changes noted above, specifically, the changes relating to our creation
of the new position of Corporate Compliance Manager, and our efforts to fill
that position with a suitable candidate, and enhancements to our MIS financial
reporting system, are the only changes during our most recently completed fiscal
quarter that have materially affected or are 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.


                                       48
<PAGE>
                           PART II - OTHER INFORMATION

ITEM  1.  LEGAL  PROCEEDINGS

     Horwitz and Beam

     On May 30, 2003, I/OMagic and IOM Holdings, Inc. filed a complaint for
breach of contract and legal malpractice against Lawrence W. Horwitz, Gregory B.
Beam, Horwitz & Beam, Lawrence M. Cron, Horwitz & Cron, Kevin J. Senn and Senn
Palumbo Meulemans, LLP, our former attorneys and their respective law firms, in
the Superior Court of the State of California for the County of Orange. The
complaint seeks damages of $15 million arising out of the defendants'
representation of I/OMagic and IOM Holdings, Inc. in an acquisition transaction
and in a separate arbitration matter. On November 6, 2003, we filed our First
Amended Complaint against all defendants. Defendants have responded to our First
Amended Complaint denying our allegations. Defendants Lawrence W. Horwitz and
Lawrence M. Cron have also filed a Cross-Complaint against us for attorneys'
fees in the approximate amount of $79,000. We have denied their allegations in
the Cross-Complaint. As of the date of this report, discovery has commenced and
a trial date in this action has been set for February 6, 2006. The outcome of
this action is presently uncertain. However, we believe that all of our claims
are meritorious.

     OfficeMax North America, Inc.

     On May 6, 2005, OfficeMax North America, Inc., or plaintiff, filed a
Complaint for Declaratory Judgment in the United States District Court of the
Northern District of Ohio against I/OMagic. The complaint seeks declaratory
relief regarding whether plaintiff is still obligated to us under certain
previous agreements between the parties. The complaint also seeks plaintiff's
costs as well as reasonable attorneys' fees. The complaint arises out of our
contentions that plaintiff is still obligated to us under an agreement entered
into in May 2001 and plaintiff's contention that it has been released from such
obligation. As of the date of this report, we have filed a motion to dismiss, or
in the alternative, a motion to stay the plaintiff's action against us.  The
outcome of this action is presently uncertain. However, at this time, we do not
expect the defense or outcome of this action to have a material adverse affect
on our business, financial condition or results of operations.

     On May 20, 2005, we filed a complaint for breach of contract, breach of
implied covenant of good faith and fair dealing, and common counts against
OfficeMax North America, Inc., or defendant, in the Superior Court of the State
of California for the County of Orange, Case No. 05CC06433.  The complaint seeks
damages of in excess of $22 million arising out of the defendants' breach of
contract under an agreement entered into in May 2001. On or about June 20, 2005,
OfficeMax removed the case against OfficeMax to the United States District Court
for the Central District of California, Case No. SA CV05-0592 DOC(MLGx)  (the
"California Case"). On or about June 28, 2005, I/OMagic and OfficeMax jointly
filed a stipulation in requesting that the United States District Court in
California temporarily stay the California Case pending the outcome of the
Motion in Ohio.  On July 6, 2005, the United States District Court in California
denied the parties joint stipulation request and instead ordered that OfficeMax
answer the complaint by August 1, 2005.  On August 1, 2005, OfficeMax filed its
Answer and Counter-Claim against us.  The Counter-Claim against us alleges four
causes of action:  breach of contract, unjust enrichment, quantum valebant, and
an action for declaratory relief.  The Counter-Claim alleges, among other
things, that we are liable to OfficeMax in the amount of no less than $138,000
under the terms of a vendor agreement between the two parties and the return of
computer peripheral products to us by OfficeMax.  The Counter-Claim seeks, among
other things, at least $138,000 from us, along with pre-judgment interest,
attorneys' fees and costs of suit.  We filed a response denying all of the
affirmative claims set forth in the Counter-Claim, denying any wrongdoing or
liability, denying that OfficeMax is


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<PAGE>

entitled to obtain any relief, and plan to vigorously contest the Counter-Claim.
As of the date of this report, discovery has commenced and a trial date in this
action has been set for October 17, 2006. The outcome of this action is
presently uncertain. However, we believe that all of our claims and defenses are
meritorious.

     In addition, we are 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 our financial position
or results of operations.


ITEM 2.  UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS

     On July 14 2005, we issued options to purchase an aggregate of 240,000
shares of common stock under our 2002 Stock Option Plan at an exercise price of
$2.50 per share to a total of 12 officers, directors and employees. The options
expire on July 14, 2010.

     On July 14, 2005, we issued options to purchase an aggregate of 130,000
shares of common stock under our 2002 Stock Option Plan at an exercise price of
$2.75 per share to a total of 2 officers, directors and employees. The options
expire on July 14, 2010.

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            Amended and Restated Agreement between Lung Hwa
                          Electronics Co. Ltd., and I/OMagic Corporation, dated
                          July 21, 2005 (1)

            31            Certifications 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            Certifications of Chief Executive Officer 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.
(1)     Filed with the Securities and Exchange Commission on July 27, 2005 as an
exhibit to I/OMagic Corporation's Report on Form 8-K and incorporated  herein
by  reference.


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<PAGE>

                                   SIGNATURES

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

                                   I/OMAGIC  CORPORATION


Dated:  November  11,  2005        By:     /s/  Tony  Shahbaz
                                           ------------------
                                           Tony Shahbaz, President and Chief
                                           Executive Officer
                                           (principal executive officer)

Dated:  November  11,  2005        By:     /s/  Steve  Gillings
                                           ---------------------
                                           Steve Gillings, Chief Financial
                                           Officer
                                           (principal financial and
                                           accounting officer)




                                       51
<PAGE>

EXHIBITS  FILED  WITH  THIS  REPORT

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


31          Certifications 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          Certifications of Chief Executive Officer 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


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