FORM 10-KU.S. SECURITIES AND EXCHANGE
COMMISSIONWASHINGTON,
DC 20549

x
ANNUAL REPORT UNDER SECTION 13 OR 15(D)
OF THE
SECURITIES EXCHANGE ACT OF 1934FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2005

OR

oTRANSITION REPORT PURSUANT TO SECTION
13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NO. 0-20728

RIMAGE CORPORATION(Exact name of registrant as specified in its charter)

|                                                                                                 |  |                                       
|------------------------------------------------------------------------------------------------ |  | --------------------------------------
|Minnesota                                                                                        |  | 41-1577970                            
|State or other
  jurisdiction of
  incorporation or organization                                 |  | (I.R.S. Employer
  Identification No.)
|                                                                                                 |  |                                       
|7725 Washington Avenue South,
  Minneapolis, Minnesota(Address of principal
  executive offices) |  | 55439(Zip Code)                       
|                                                                                                 |  |                                       
|Registrants telephone
  number:                                                                 |  | (952) 944 - 8144                      

|                                                              |                                                              
|------------------------------------------------------------- | -------------------------------------------------------------
|Securities registered pursuant to Section 12(b) of
  the Act: | None                                                         
|                                                              |                                                              
|Securities registered pursuant to Section 12(g) of
  the Act: | Common
  Stock, $.01 par valuePreferred Stock Purchase Rights

Indicate by check mark if the registrant is a well-known seasoned issuer,
 as defined in Rule 405 of the Securities Act.  Yes o No
x

Indicate by check mark if the registrant is not required to file reports
 pursuant to Section 13 or Section 15(d) of the Act.  Yes o No
x

Indicate by checkmark 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
o

Indicate by checkmark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.o

Indicate by checkmark whether the registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large
Accelerated Filer o Accelerated
Filer x Non-Accelerated Filer
o

Indicate by checkmark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act): Yes o No
x

The aggregate market value of common stock held by
non-affiliates of the registrant, computed by reference to the last quoted
price at which such stock was sold on such date as reported by the Nasdaq Stock
Market as of the last business day of the registrants most recently completed
second fiscal quarter was approximately $201,800,000.

As of February 28, 2006, 9,650,233 shares of the
registrants common stock were outstanding.

DOCUMENTS
INCORPORATED BY REFERENCE

Portions of the registrants definitive proxy
statement for its 2006 Annual Meeting of Shareholders, to be filed within 120
days after the end of the fiscal year covered by this report, are incorporated
by reference into Part III hereof.

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TABLE
OF CONTENTS

|           |                                                                                                   |     
|---------- | ------------------------------------------------------------------------------------------------- | ----
|           |                                                                                                   | Page
|           |                                                                                                   |     
|           |                                                                                                   |     
|PART I     |                                                                                                   | 3   
|           |                                                                                                   |     
|Item 1.    | Business                                                                                          | 3   
|           |                                                                                                   |     
|           | General                                                                                           | 3   
|           | Products                                                                                          | 3   
|           | Marketing and Distribution                                                                        | 4   
|           | Competition                                                                                       | 5   
|           | Manufacturing                                                                                     | 5   
|           | Research and Development                                                                          | 5   
|           | Patents and Government Regulation                                                                 | 5   
|           | Employees                                                                                         | 6   
|           | Cautionary Note Regarding
  Forward-Looking Statements                                            | 6   
|Item 1A.   | Risk Factors                                                                                      | 6   
|Item 1B.   | Unresolved Staff Comments                                                                         | 12  
|Item 2.    | Properties                                                                                        | 12  
|Item 3.    | Legal Proceedings                                                                                 | 12  
|Item 4.    | Submission of Matters to a Vote of
  Security Holders                                             | 12  
|           |                                                                                                   |     
|PART II    |                                                                                                   | 13  
|           |                                                                                                   |     
|Item 5.    | Market for Common Equity, Related
  Stockholder Matters and Issuer Purchases of Equity Securities | 13  
|           | Shareholders                                                                                      | 13  
|           | Dividends                                                                                         | 13  
|           |                                                                                                   |     
|Item 6.    | Selected Financial Data                                                                           | 14  
|Item 7.    | Managements Discussion and Analysis
  of Financial Condition and Results of Operations           | 15  
|           | Overview                                                                                          | 15  
|           | Results of Operations                                                                             | 15  
|           | Liquidity and Capital Resources                                                                   | 17  
|           | Critical Accounting Policies                                                                      | 18  
|           | New Accounting Pronouncements                                                                     | 19  
|           | Available Information                                                                             | 20  
|Item 7A.   | Quantitative and Qualitative
  Disclosures About Market Risk                                      | 20  
|Item 8.    | Financial Statements and
  Supplementary Data                                                     | 22  
|Item 9.    | Changes in and Disagreements with
  Accountants on Accounting and Financial Disclosure            | 43  
|Item 9A.   | Controls and Procedures                                                                           | 43  
|Item
  9B. | Other Information                                                                                 | 44  
|           |                                                                                                   |     
|PART III   |                                                                                                   | 44  
|           |                                                                                                   |     
|Item 10.   | Directors and Executive Officers of
  the Registrant                                              | 44  
|Item 11.   | Executive Compensation                                                                            | 44  
|Item 12.   | Security Ownership of Certain
  Beneficial Owners and Management and Related Stockholder Matters  | 44  
|Item 13.   | Certain Relationships and Related
  Transactions                                                  | 44  
|Item 14.   | Principal Accountant Fees and
  Services                                                          | 44  
|           |                                                                                                   |     
|PART IV    |                                                                                                   | 45  
|           |                                                                                                   |     
|Item 15.   | Exhibits and Financial Statement
  Schedules                                                      | 45  
|           |                                                                                                   |     
|SIGNATURES | 47                                                                                               

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General
Information

PART I

ITEM 1.BUSINESS

General

Rimage Corporation (Rimage) is a leading provider of
CD recordable (CD-R) and DVD recordable (DVD-R) publishing systems required
for producing discs with customized digital content on an on-demand basis.
Rimages publishing systems, which include equipment to handle a full range of
low-to-high production volumes, incorporate robotics, software and custom
printing technology for disc labeling. Rimage focuses its CD-R and DVD-R
publishing solutions on a set of vertical markets with special needs for
customized, on-demand digital information, including digital photography,
medical imaging, banking and finance, government, and business offices.

Incorporated as IXI, Inc. in Minnesota in February
1987, Rimage has focused on digital storage production equipment since its
inception. From 1987 until the introduction of its first CD-R production
equipment in 1995, most of Rimages products consisted of diskette and tape
duplication equipment. Rimage also generated a significant portion of its
revenue from CD-ROM and diskette duplication and production services from 1993
until 1999. From 1994 to 1997, Rimage also engaged in other lines of business,
including development of browser and archiving software and distribution of
CD-ROM stamping presses.

Since 1995, Rimage has focused its business on
development and sale of its CD-R publishing systems, and since 2000, its DVD-R
publishing systems. In 1997, Rimage ceased distribution activities for CD-ROM
stamping presses and terminated browser and archiving software development.
During the third quarter of 1998, Rimage ceased operations of its Minnesota
services business and sold the equipment and inventory associated with that
business. On June 30, 1999, Rimage ceased operations of its Colorado services
business and sold all the assets associated with that business. The resources
previously applied to these businesses were instead applied to development and
sales of CD-R and DVD-R products for commercial applications.

On March 1, 2000, Rimage acquired Cedar Technologies,
Inc. (Cedar) and issued 497,496 shares of its common stock for all of the
outstanding shares of Cedar. Cedar had developed and manufactured CD-R publishing
and duplication equipment for desktop applications that sold at a lower price
point than the higher volume systems sold by Rimage. Cedar products formed the
basis for the introduction of Rimages desktop line of products.

Products

Rimages products are designed to enable the
automation of data distribution and archiving processes. In some cases this
results in a reduction of labor and training costs for users of the products,
in other cases it enables totally new and innovative applications. Rimage products
provide compelling solutions for distribution and archiving of information on
CDs and DVDs for just-in-time, on-demand and mass customization applications.

The principal benefits to users of Rimages products
include unattended operation, reduced labor costs, higher throughput than
alternative systems and higher quality. One of the essential elements of
Rimages marketing and development is to provide users with a path for future
product upgrades for improved products or products with additional capabilities,
such as drives with faster recording speeds. Rimage has made a long-term
commitment to its customers by providing maintenance service contracts,
replacement parts and repair service to customers for current, as well as past
products.

Sales of CD-R/DVD-R production equipment comprised 62%
of Rimages revenue from operations during both 2005 and 2004, and 70% in 2003.
Rimages other major sources of revenue are recurring in nature and consist of
consumables (ribbons, ink cartridges and Rimage-branded blank CD-R and DVD-R
media), parts and maintenance contract sales.

Since the acquisition of Cedar, Rimages CD-R and
DVD-R hardware products have been divided into two primary product lines: the
Producer line of equipment for higher volume CD-R and DVD-R production
requirements, and the Desktop line of lower-cost products for office and other
desktop applications. The Producer line of products continues to generate the
majority of Rimages revenue, comprising 51% of total revenues in both 2005 and
2004, at $48,428,000 and $36,186,000, respectively. The Desktop line
contributed 11% to total revenues each year, at $10,692,000 in 2005 and
$7,887,000 in 2004. The balance of revenue in each year was generated through
sale of

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Rimage-branded blank CD-R/DVD-R media, ribbons, ink
cartridges, parts, repair services and maintenance contracts. Such recurring
revenues comprised 38% of total revenue in both 2005 and 2004, at $36,290,000
and $26,775,000, respectively. The growth in recurring revenues has been spurred
by the expansion of the Companys worldwide installed base of CD-R/DVD-R
publishing systems as well as the Companys introduction in 2004 of its new
consumable supplies strategy involving media kits. Through this strategy, the
Company assembles Rimage-branded blank CD-R and DVD-R discs with replacement
printer ribbons and cartridges into kits to simplify the customers purchase
and use of these consumable products in the production process.

The Producer II Series.The Producer
II Series of CD-R/DVD-R publishing systems represents the current generation of
the Producer line and consists of a family of products that cover a broad range
of applications for the publishing and duplication of CD-Rs and DVD-Rs. Each
Producer II product incorporates CD-R or DVD-R recorders, or both, with
customized robotics, a thermal or thermal re-transfer printer for on-disc color
printing, software, and computer hardware components.

Rimage offers its Producer II line of products in four
basic configurations to meet the varying needs of its commercial customers. The
Autostar II provides industry leading speed and throughput for on-demand
CD-R/DVD-R production, utilizing up to four simultaneous data streams. The
Autostar II can contain any combination of CD-R/DVD-R recorders and provides
for a capacity of 300 discs. The Protégé II system comes standard with two CD-R
recorders that may be interchanged with DVD-R recorders and the Amigo II comes
with one recorder. The Autostar II, Protégé II and Amigo II are all available
with either Rimages Everest or Prism printers. The DiscLab system was
introduced in 2004, replacing its predecessor, the Endeavor. Designed as a
network attached publishing system, the DiscLab features an embedded host PC,
two CD-R or DVD-R recorders, an Everest printer and a small product size and
footprint. The markets served by Rimages Producer line of products include the
digital photography, medical, banking and government industries. Prices of the
Producer II line of products range from $10,000 to $30,000.

The Everest printer was developed to meet the need of
customers for an on-demand surface printer able to produce color and monochrome
labels with quality similar to offset and silkscreen printing systems. Everest
produces images on CD-R and DVD-R media that are indelible and cover the full
surface of the media. Rimages Prism Printer provides high-speed, laser quality
monochrome and spot color printing on standard CD-R/DVD-R media for in-house,
customized printing. The Producer line also includes Autoprinters that
incorporate either an Everest or Prism printer.

The Desktop Series. Originally
established through the acquisition of Cedar Technologies, Inc., Rimages
Desktop Series of CD-R/DVD-R products features economical pricing, a compact
desktop design, software, network compatibility and stand-alone,
plug-and-play technology ideal for office environments. The Desktop line of
products offers a two-drive recorder unit. In June 2004, the Company introduced
the Rimage 2000i Desktop publishing system and Rimage 480i thermal inkjet
printer. Co-developed by the Company and Hewlett-Packard, the Rimage 480i
inkjet printer features 4800 dpi resolution for high clarity color printing on
CD-R/DVD-R discs. In April 2005, the Company introduced its lowest cost Desktop
product, the Rimage 360i, which also uses the Companys proprietary thermal
inkjet printing technology.

Marketing
and Distribution

Rimage currently utilizes the following principal
means of distributing its products: Direct sales using its own sales force, primarily
in Europe; a two tier distribution system of distributors to value added
resellers in Europe, the U.S. and Latin America; and a distributor to end-user
system in Asia Pacific and in some areas in Europe. Rimages channel partners,
primarily consisting of distributors, value added resellers and other strategic
partners, currently generate the majority of the Companys sales.

Rimage has historically focused its sales and
marketing efforts on high-volume CD-R and DVD-R publishing solutions for its
Producer product line in such areas as banking and finance and wholesale photo
processing labs. Rimage plans to continue to expand its position in many of its
traditional markets. Additionally, Rimage is focusing on new applications with
high-growth potential in retail photography, medical imaging and business
services. This has led to the expansion of the Companys sales and marketing
organization to help penetrate these targeted markets and strengthen marketing
support for new products.

During 2005 and 2004, Rimage derived 12% and 13% of
its respective revenues from one of its distributors, and 11% and 12% of its
respective revenues from a strategic partner. Two distributors generated more
than 10% of revenues in 2003, at 16% and 12% of revenues, respectively.

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Rimage conducts foreign sales through its U.S.
operation and its subsidiaries in Germany and Japan, Rimage Europe GmbH, and
Rimage Japan, respectively.  Foreign
sales constituted approximately 34%, 38% and 42% of Rimages revenue for the
years ended December 31, 2005, 2004, and 2003, respectively.

Competition

Rimage competes with a number of manufacturers of
CD-R/DVD-R production equipment and related products. Primary competitors of
the Company currently include Primera Technology, Inc., Microtech Systems, Inc.
and LSK Data Systems GmbH. Rimage is able to compete effectively in the sale of
CD-R/DVD-R production equipment because of technological leadership in
automated solutions and its early start within the CD-R/DVD-R production
equipment industry. Rimage believes that its quality printing capabilities for
CD-R/DVD-R, its transporter mechanisms and its software differentiate its
products from those of competitors. Rimage also competes with alternative
technologies in the storage media industry such as high capacity hard drives,
flash memory, new CD-R/DVD-R technologies, file servers accessible through
computer networks and the Internet, and additional media is under development.
Rimage believes its technology has advantages over these alternative technologies
in terms of reliability, performance, cost and ease of use.

Manufacturing

Rimages manufacturing operations consist primarily of
the assembly of products from components purchased from third parties. Some
parts are standard components and others are manufactured to Rimages
specifications. Rimages employees at its facility in Edina, Minnesota conduct
assembly and testing operations. Components include CD-R/DVD-R drives, circuit
boards, electric motors, machined and molded parts, precision sheet metal
assemblies, and other mechanical parts.

Although Rimage believes it has identified alternative
assembly contractors for most of its subassemblies, an actual change in such
contractors would likely require a period of training and testing. Accordingly,
a sudden interruption in a supply relationship or the production capacity of
one or more of such contractors could result in Rimages inability to deliver
one or more products for a period of several months.

Research
and Development

At December 31, 2005, 35 employees were involved in
research and development at Rimage. This staff, with software, electrical,
mechanical and drafting capabilities, engages in research and development of
new products, and development of enhancements to existing products.

The industries served by Rimage are subject to rapid
technological changes. Alternate data storage media exist or are under
development, including high capacity hard drives, new CD-R/DVD-R technologies,
file servers accessible through computer networks, and the Internet. All these
forces may affect the usage of CD-R and DVD-R media. Rimage believes that it
must continue to innovate and anticipate advances in the storage media industry
in order to remain competitive.

Rimages expenditures for research and development
were $5,512,000 $4,530,000 and $3,765,000 in 2005, 2004 and 2003, representing
5.8%, 6.4% and 7% of revenues, respectively. Rimage anticipates its
expenditures in research and development will approximate 7% to 8% of revenues
during 2006.

Patents
and Government Regulation

Rimage currently maintains eleven U.S. and foreign patents
and has a total of nineteen U.S. and foreign patents pending. In addition,
Rimage protects the proprietary nature of its software primarily through
copyright and license agreements and through close integration with its
hardware offerings. It is Rimages policy to protect the proprietary nature of
its new product developments whenever they are likely to become significant
sources of revenue. No guarantee can be given that Rimage will be able to
obtain patent or other protection for its products.

As the number of Rimages products increase and the
functionality of those products expands, Rimage believes that it may become
increasingly subject to attempts by others to duplicate its proprietary
technology and to the possibility of infringement of Rimage patents. In
addition,although Rimage does not believe that any of its products infringe
the rights of others, third parties have claimed, and may in the future claim,
Rimages products infringe on their rights and these third parties may assert
infringement claims against Rimage in the future. Rimage may litigate such
infringement claims or settle such claims through license or other royalty
arrangements.

Rimage is currently working to move its product
portfolio into full compliance with the European Union Restriction of Hazardous
Substances Directive, which restricts the use of certain hazardous substances
in electrical and

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electronic equipment. Rimage has retained an external
consulting firm to guide its efforts in this compliance project. Rimage expects
that its products will be in full compliance with this directive by July 1,
2006, the beginning of compliance enforcement.

The FCC requires some of Rimages equipment meet radio
frequency emission standards. Rimage takes steps to ensure proper compliance of
all products.

Employees

At December 31, 2005, Rimage had 208 full-time
employees, of which 35 were involved in research and development, 93 in
assembly, testing, repair and customer service, and 80 in sales, marketing,
administration and management. None of Rimages employees are represented by a
labor union or covered by a collective bargaining agreement.

Cautionary
Note Regarding Forward-Looking Statements

We make written and oral statements from time to time
regarding our business and prospects, such as projections of future
performance, statements of managements plans and objectives, forecasts of
market trends, and other matters that are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. Statements containing the words or
phrases will likely result, are expected to, will continue, is
anticipated, estimates, projects, believes, expects,
anticipates,
intends, target, goal, plans, objective,
should or similar
expressions identify forward-looking statements, which may appear in documents,
reports, filings with the Securities and Exchange Commission, news releases,
written or oral presentations made by our authorized officers or other
representatives. For such statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.

Our future results, including results related to
forward-looking statements, involve a number of risks and uncertainties. No
assurance can be given that the results reflected in any forward-looking
statements will be achieved. Any forward-looking statement made by or on behalf
of us speaks only as of the date on which such statement is made. We do not
undertake any obligation to update or keep current any forward-looking
statement to reflect events or circumstances arising after the date of such
statement.

In addition to other matters identified or described
by us from time to time in filings with the SEC, there are several important
factors that could cause our future results to differ materially from
historical results or trends, results anticipated or planned by us, or results
that are reflected from time to time in any forward-looking statement that may
be made by or on behalf of us. These important factors are described below
under Item 1A. Risk Factors.

ITEM 1A.     RISK FACTORS

If any of the following risks actually occur, our
results of operations, cash flows and the market price of our common stock
could be negatively impacted. Although we believe that we have identified and
discussed below the key risk factors affecting our business, there may be additional
risks and uncertainties that are not presently known or that are not currently
believed to be significant that may adversely affect our performance or
financial condition.

Technology in our industry evolves rapidly, potentially
causing our products to become obsolete, and we must continue to enhance
existing systems and develop new systems or we will lose sales.

Rapid technological advances, rapidly changing
customer requirements and fluctuations in demand characterize the current
market for our products. Further, there are alternative data storage media and
additional media is under development, including high capacity hard drives,
flash memory, new CD-R/DVD-R technologies, file servers accessible through
computer networks and the Internet. Our existing and development-stage products
may become obsolete if our competitors introduce newer or more appealing
technologies. If these technologies are patented or proprietary to our
competitors, we may not be able to access these technologies. We believe that
we must continue to innovate and anticipate advances in the storage media
industry in order to remain competitive. If we fail to anticipate or respond to
technological developments or customer requirements, or if we are significantly
delayed in developing and introducing products, our business will suffer lost
sales.

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Our market is becoming more competitive. Competition may
result in price reductions, lower gross profits and loss of market share.

The storage media industry is becoming more competitive
and we face the potential for increased competition in developing and selling
our CD-R and DVD-R publishing systems in both the U.S. and in foreign markets.
Our competitors may have or could develop or acquire significant marketing,
financial, development and personnel resources. Our current primary competitors
include Primera Technology, Inc., Microtech Systems, Inc. and LSK Data Systems
GmbH. To remain competitive, we believe that we must continue to provide:

| |   |                                                                          
| | - | -------------------------------------------------------------------------
| | § | technologically advanced systems that satisfy the
  demands of end-users;
| | § | continuing advancements in our CD-R and DVD-R
  products;                
| | § | a dependable and efficient distribution and reseller
  network;          
| | § | superior customer service; and                                           
| | § | high levels of quality and reliability.                                  

We cannot assure you that we will be able to compete
successfully against our current or future competitors. The storage media
industry has increased visibility, which may lead to large, well-known,
well-financed companies entering into this market. Increased competition from
manufacturers of systems or consumable supplies may result in price reductions,
lower gross profit margins, increased discounts to distribution and loss of
market share and could require increased spending by us on research and
development, sales and marketing and customer support.

If our products fail to compete successfully with other
existing publishing systems or newly-developed products for the storage media
industry, our business will suffer.

The success of our products depends upon our end users
choosing our CD-R and DVD-R technology for their storage media needs. However,
alternative data storage media exist, such as high capacity hard drives, flash
memory, new CD-R/DVD-R technologies, file servers accessible through computer
networks and the Internet, and additional media is under development. If end
users perceive any technology that is competing with ours as more reliable,
higher performing, less expensive or having other advantages over our technology,
the demand for our CD-R and DVD-R products could decrease. Further, some of our
competitors may make strategic acquisitions or establish cooperative
relationships with suppliers or companies that produce complementary products
such as cameras, computer equipment, software or biometric applications.
Competition from other publishing systems or other storage media is likely to
increase. If our products do not compete successfully with existing or new
competitive products, our business will suffer.

We sell a significant portion of our products
internationally, which exposes us to risks associated with foreign operations.

We sell a significant amount of our products to
customers outside the United States, particularly in Europe, Asia and Latin
America. International sales accounted for 34%, 38% and 42% of our revenue for
the years ended December 31, 2005, 2004 and 2003, respectively. We expect that
shipments to international customers, including customers in Europe, Asia and
Latin America, will continue to account for a significant portion of our net
sales. Sales outside the United States involve the following risks, among
others:

| |   |                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | § | foreign governments may impose tariffs, quotas and
  taxes;                                                                                                                             
| | § | the demand for our products will depend, in part, on
  local economic health;                                                                                                           
| | § | political and economic instability may reduce demand
  for our products;                                                                                                                
| | § | restrictions on the export or import of technology
  may reduce or eliminate our ability to sell in certain markets;                                                                    
| | § | potentially limited intellectual property protection
  in certain countries may limit our recourse against infringing products or
  cause us to refrain from selling in certain markets;
| | § | we may face difficulties in managing our
  international operations;                                                                                                                    
| | § | the burden and cost of complying with a variety of
  foreign laws;                                                                                                                      
| | § | we may decide to price our products in foreign
  currency denominations;                                                                                                                
| | § | our contracts with foreign distributors and
  resellers cannot fully protect us against political and economic instability;                                                             
| | § | we may face difficulties in collecting receivables;
  and                                                                                                                               
| | § | we may not be able to control our international
  distributors efforts on our behalf.                                                                                                  

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The financial results of our German and Japanese
subsidiaries are translated into U.S. dollars for consolidation with our
overall financial results. Additionally, we hedge against currency fluctuations
associated with foreign currency denominated transactions (principally European
Euro) with Rimage Europe. Despite our hedging activity, currency translations
and fluctuations may adversely affect the financial performance of our
consolidated operations. Currency fluctuations also may increase the relative
price of our product in foreign markets and thereby could also cause our
products to become less affordable or less price competitive than those of
foreign manufacturers. These risks associated with foreign operations may have
a material adverse effect on our revenue from or costs associated with
international sales.

If our
domestic or international intellectual property rights are not adequately
protected, others may offer products similar to ours which could depress our
product selling prices and gross profit margins or result in loss of market
share.

We believe that protecting our proprietary technology
is important to our success and competitive positioning. In addition to common
law intellectual property rights, we rely on patents, trade secrets,
trademarks, copyrights, know-how, license agreements and contractual provisions
to establish and protect our intellectual property rights. However, these legal
means afford us only limited protection and may not adequately protect our
rights or remedies to gain or keep any advantages we may have over our
competitors.

We cannot assure you that others may not independently
develop the same or similar technologies or otherwise obtain access to our
technology and trade secrets. Our competitors, who may have or could develop or
acquire significant resources, may make substantial investments in competing
technologies, may apply for and obtain patents that will prevent, limit, or
interfere with our ability to manufacture or market our products. Further,
although we do not believe that any of our products infringe the rights of
others, third parties have claimed, and may in the future claim, our products
infringe on their rights and these third parties may assert infringement claims
against us in the future.

Costly litigation may be necessary to enforce patents
issued to us, to protect trade secrets or know-how we own, to defend us
against claimed infringement of the rights of others or to determine the
ownership, scope, or validity of our proprietary rights and the rights of others.
Any claim of infringement against us may involve significant liabilities to
third parties, could require us to seek licenses from third parties, and could
prevent us from manufacturing, selling, or using our products. The occurrence
of this litigation, or the effect of an adverse determination in any of this
type of litigation, could have a material adverse effect on our business,
financial condition and results of operations. Further, the laws of some of the
countries in which our systems are or may be sold may not protect our systems
and intellectual property to the same extent as the United States or at all.
Our failure to protect or enforce our intellectual property rights could have a
material adverse effect on our business, results of operations and financial
condition.

Our sales will decline and our business will be materially
harmed if our key channel partners do not effectively market or sell our
products or if there is a significant reduction, delay or cancellation of
orders from such channel partners or our direct OEM customers.

We distribute our products to end users through our
own sales force, through distributors and through a two-tier system of
distributors and resellers. Although certain distributors and resellers have
made certain contractual commitments to us, they are independent businesses
that we do not control. We cannot be certain that our distribution channel will
continue to market or sell our systems effectively. Our agreements with
distributors and resellers do not contain requirements that a certain
percentage of such parties sales are of our products nor do the agreements
restrict their ability to choose alternative sources for CD-R or DVD-R
publishing systems.

During 2005 and 2004, we derived approximately 12% and
13% of our respective revenues from a single distributor, and 11% and 12% of
respective revenues from a strategic partner. Two of our distributors generated
more than 10% of revenues in 2003, at 16% and 12% of revenues, respectively. A
significant reduction, delay or cancellation of orders from our key channel
partners or our direct OEM customers, or the loss of any of them, could have a
negative impact upon our operating results. Further, some of our channel
partners are small organizations with limited capital and our success in
distributing our products to end-users will depend upon the continued viability
and financial stability of these entities. These channel partners may choose to
devote their efforts to other products in different markets or reduce or fail
to devote the necessary resources to provide effective sales and marketing
support of our product. We believe that our future growth and success will
continue to depend in large part upon the success of our channel partners in
operating their businesses and our relationships with our direct OEM customers.

8

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If we do not maintain adequate inventories of component parts
or finished goods or if we fail to adequately forecast demand, the likely
resulting delays in producing our publishing systems products would damage our
business.

Because most of our systems are built upon order, we
do not maintain a significant inventory of completed systems. We assemble the
Producer II Series and Desktop Series systems as they are ordered, which causes
us to forecast production based on past sales and our estimates of future
demand. In the event that we significantly underestimate our needs or encounter
an unexpectedly high level of demand for our systems or our suppliers are
unable to deliver our orders of components in a timely manner, we may be unable
to fill our product orders on time which could harm our reputation and result
in reduced sales.

We rely on single-source suppliers, which could cause delays,
increases in costs or prevent us from completing customer orders, all of which
could materially harm our business.

We assemble our Producer II Series and Desktop Series
products using materials and components supplied by various subcontractors and
suppliers. We purchase critical components for our systems, including
CD-R/DVD-R drives, circuit boards, electric motors, machined and molded parts,
precision sheet metal assemblies and mechanical parts, from third parties, some
of whom are single-source suppliers of these components. If any of our
suppliers is unable to ship critical components, we would be unable to
manufacture and ship products to our end-users, distributors or resellers. If
the price of these components increases for any reason, or if these suppliers
are unable or unwilling to deliver, we may have to find another source, which
could result in interruptions, increased costs, delays, loss of sales and
quality control problems.

The termination or interruption of any of these
relationships, or the failure of these manufacturers or suppliers to supply
products or components to us on a timely basis or in sufficient quantities,
likely would cause us to be unable to meet orders for our products and harm our
reputation and our business. Identifying and qualifying alternative suppliers
of components would take time, involve significant additional costs and may
delay the production of our products. Further, if we obtain a new supplier for
a component or assemble our product using an alternative component, we may need
to conduct additional testing of our products to ensure the product meets our
quality and performance standards. Any delays in delivery of our product to
end-users, distributors or resellers could be extended and our costs associated
with the change in product manufacturing could increase.

The failure of our third-party manufacturers to
manufacture the products for us, and the failure of our components suppliers to
supply us with the components, consistent with our requirements as to quality,
quantity and timeliness could materially harm our business by causing delays,
loss of sales, increases in costs and lower gross profit margins.

Our products
must be compatible with products designed and manufactured by others and, in
the event of design changes or the introduction of new products by them or us,
our products must continue to be compatible with products of others.

Our Producer II Series and Desktop Series of our
CD-R/DVD-R publishing systems incorporate computer and related computer
equipment, hardware and software manufactured by others. Our products are
designed to provide end users with a fully-integrated publishing system and
therefore, our products must operate with the computer and related equipment of
others to function properly for end users. Problems with the products of others
may adversely affect the performance and reliability of our publishing system
products and damage our reputation with end users. Further, if there are
changes in our products, changes in the computer or computer related equipment
integrated into our products or if we offer new products, we must maintain
compatibility and interoperability of our products with the products of others.
We cannot assure you that we will be able to adapt our products to be
compatible with any newly designed product of another party. We would likely
incur substantial costs to test and de-bug any newly designed product that we
integrate into our products. Further, our new product development efforts may
be hampered by our need to maintain compatibility with the products of others
and we may incur additional expense designing for compatibility.

9

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Our publishing systems may have manufacturing or design
defects that we discover after shipment, which could negatively affect our
revenues, increase our costs and harm our reputation.

Our publishing systems are complex and may contain
undetected and unexpected defects, errors or failures. If these product defects
are substantial, the result could be product recalls, an increased amount of
product returns, loss of market acceptance and damage to our reputation, all of
which could increase our costs and cause us to lose sales. We carry general
commercial liability insurance covering our products with policy limits per
occurrence and in the aggregate that we have deemed to be sufficient. We cannot
predict, however, whether this insurance is sufficient, or if not, whether we
will be able to obtain sufficient insurance to cover the risks associated with
our business or whether such insurance will be available at premiums that are
commercially reasonable. In addition, these insurance policies must be renewed
annually. Although we have been able to obtain liability insurance, such
insurance may not be available in the future on acceptable terms, if at all. A
successful claim against us or settlement by us in excess of our insurance
coverage or our inability to maintain insurance in the future could have a
material adverse effect on our business, results of operations, liquidity and
financial condition.

If our systems fail to comply with domestic and international
government regulations, or if these regulations result in a barrier to our
business, we could lose sales.

Our systems must comply with various domestic and
international laws, regulations and standards. Additionally, new regulations
enacted in various countries provide standards on waste management and recovery
(the European Union Waste, Electrical and Electronic Equipment Directive) and
the reduction of hazardous substances in electrical and electronic equipment
(the European Union Restriction of Hazardous Substances Directive). In the
event that we are unable or unwilling to comply with any such laws, regulations
or standards, we may decide not to conduct business in certain markets.
Particularly in international markets, we may experience difficulty in securing
required licenses or permits on commercially reasonable terms, or at all.
Failure to comply with existing or evolving laws or regulations, including
export and import restrictions and barriers, or to obtain timely domestic or
foreign regulatory approvals or certificates could result in lost sales.

Fluctuations in our future operating results may negatively
affect the market price of our common stock.

We have experienced fluctuations in our quarterly
operating results and we expect those fluctuations to continue due to a variety
of factors. Some of the factors that influence our quarterly operating results
include:

| |   |                                                                           
| | - | --------------------------------------------------------------------------
| | § | the number and mix of products sold in the quarter;                       
| | § | the timing of major projects;                                             
| | § | the availability and cost of components and
  materials;                  
| | § | timing, costs and benefits of new product
  introductions;                
| | § | customer order size and shipment timing;                                  
| | § | seasonal factors affecting timing of purchase
  orders;                   
| | § | promotions by ourselves or competitors, and the
  timing of the promotion;
| | § | the impact to the marketplace of competitive
  products and pricing; and  
| | § | the timing and level of operating expenses.                               

Because of these factors, our quarterly operating
results are difficult to predict and are likely to vary in the future. If our
operating results are below financial analysts or investors expectations, the
market price of our common stock may fall abruptly and significantly.

If we fail to retain and attract highly skilled managerial
and technical personnel, we may fail to remain competitive.

Our future success depends, in significant part, upon
the continued service and performance of our senior management and other key
personnel. The loss of the services of our management team, some of whom have
significant experience in our industry and other key personnel, could impair
our ability to effectively manage our company and to carry out our business
plan. We do not carry key person life insurance on any of our executive
officers. In addition, competition for skilled employees in our industry is
intense. Our future success also depends on our continuing ability to attract,
retain and motivate highly qualified managerial, technical and sales personnel.
Our inability to retain or attract qualified personnel could have a significant
negative effect and thereby materially harm our business and financial
condition.

10

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Our stock price may be volatile and a shareholders
investment could decline in value.

Our stock price has fluctuated in the past and may
continue to fluctuate significantly, making it difficult for an investor to
resell shares or to resell shares at an attractive price. The market prices for
securities of emerging companies have historically been highly volatile. Future
events concerning us or our competitors could cause such volatility, including:

| |   |                                                                                                 
| | - | ------------------------------------------------------------------------------------------------
| | § | actual or anticipated variations in our operating
  results,                                    
| | § | investments required in infrastructure and/or
  personnel to meet long-term strategic objectives
| | § | technological innovations or new commercial products
  introduced by us or our competitors,     
| | § | developments concerning proprietary rights,                                                     
| | § | changes in senior management,                                                                   
| | § | investor perception of us and our industry,                                                     
| | § | general economic and market conditions including
  market uncertainty                           
| | § | national or global political events, and                                                        
| | § | public confidence in the securities markets and
  regulation by or of the securities markets.   

In addition, the stock market is subject to price and
volume fluctuations that affect the market prices for companies in general, and
small-capitalization, high-technology companies in particular, which are often
unrelated to the operating performance of these companies. Any failure by us to
meet or exceed estimates of financial analysts is likely to cause a decline in
our common stock price.

Future sales of shares of our common stock in the public
market may negatively affect our stock price.

Future sales of our common stock, or the perception
that these sales could occur, could have a significant negative effect on the
market price of our common stock. In addition, upon exercise of outstanding
options and warrants, the number of shares outstanding of our common stock
could increase substantially. This increase, in turn, could dilute future
earnings per share, if any, and could depress the market value of our common
stock. Dilution and potential dilution, the availability of a large amount of
shares for sale, and the possibility of additional issuances and sales of our
common stock may negatively affect both the trading price of our common stock
and the liquidity of our common stock. These sales also might make it more
difficult for us to sell equity securities or equity-related securities in the
future at a time and price that we would deem appropriate.

Provisions of Minnesota law, our bylaws and
other agreements may deter a change of control of our company and may have a
possible negative effect on our stock price.

Certain provisions of our Minnesota law, our bylaws
and other agreements may make it more difficult for a third party to acquire,
or discourage a third party from attempting to acquire, control of our company,
including:

| |   |                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | § | the provisions of Minnesota law relating to business
  combinations and control share acquisitions;                                                                                                       
| | § | the provisions of our bylaws regarding the business
  properly brought before shareholders;                                                                                                               
| | § | the right of our board of directors to establish
  more than one class or series of shares and to fix the relative rights and
  preferences of any such different classes or series;                      
| | § | our shareholder rights plan, which would cause
  substantial dilution to any person or group attempting to acquire our company
  on terms not approved in advance by our board of directors; and          
| | § | the provisions of our stock option plans allowing
  for the acceleration of vesting or payments of awards granted under the plans
  in the event of specified events that result in a change in control.

These measures could discourage or prevent a takeover
of our company or changes in our management, even if an acquisition or such
changes would be beneficial to our shareholders. This may have a negative
effect on the price of our common stock.

11

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Compliance with changing regulation of corporate governance
and public disclosure may result in additional expenses.

Keeping abreast of, and in compliance with, changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002 and in particular Section
404 of that act relating to management certification of internal controls, the
regulations of the Securities and Exchange Commission and the rules of the
Nasdaq Stock Market, have required an increased amount of management attention
and external resources. We intend to invest all reasonably necessary resources
to comply with evolving corporate governance and public disclosure standards,
and this investment may result in increased general and administrative expenses
and a diversion of management time and attention from revenue-generating
activities to compliance activities.

ITEM
1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.     PROPERTIES

Rimage headquarters are located in a leased facility of
58,500 square feet at 7725 Washington Avenue South, Edina, Minnesota 55439. The
Company rents this facility under a noncancellable 48-month lease initiated
August 1, 2004. Monthly base rent was $33,394 for the first year, with 2%
inflationary increases each subsequent year of the lease. This facility is used
for manufacturing, engineering, service, sales, marketing and administration.
Rimage also leases a facility of approximately 2,400 square feet in
Dietzenbach, Germany used for service, sales and light assembly. The current
term of the lease in Germany expires in December 2006. Additionally, the
Company leases a facility of approximately 1,075 square feet in Tokyo, Japan,
used for sales and service. The current term of the lease in Japan expires on March
31, 2007.  Rimage believes its current
facilities will accommodate operations through 2006, and continues to assess
options to meet its future space requirements.

ITEM 3.     LEGAL PROCEEDINGS

Rimage may become involved in various legal actions in
the ordinary course of its business. Although the outcome of any such legal
actions cannot be predicted, management believes that there are no pending
legal proceedings against or involving Rimage for which the outcome is likely
to have a material adverse effect upon its financial position or results of
operations.

ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Rimage did not submit any matters to a vote of security holders during
the last quarter of the fiscal year covered by this report.

12

---



PART II

|        |                                                                                                  
|------- | -------------------------------------------------------------------------------------------------
|ITEM 5. | MARKET FOR COMMON EQUITY, RELATED
  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Rimages common stock is
traded on the Nasdaq Global Market under the symbol RIMG. The following table
sets forth, for the periods indicated, the range of low and high prices for
Rimages common stock as reported on The Nasdaq Stock Market.

|                    |  |     |       |      |  |       | 
|------------------- |  | --- | ----- | ---- |  | ----- | 
|                    |  | Low |       | High | 
|                    |  |     |       |      | 
|                    |  |     |       |      | 
|Calendar Year 2004: |  |     |       |      | 
|1st Quarter         |  |     | 13.56 |      |  | 17.50 | 
|2nd Quarter         |  |     | 13.11 |      |  | 17.40 | 
|3rd Quarter         |  |     | 12.02 |      |  | 15.21 | 
|4th Quarter         |  |     | 13.06 |      |  | 16.29 | 
|Calendar Year 2005: |  |     |       |      |  |       | 
|1st Quarter         |  |     | 15.43 |      |  | 21.40 | 
|2nd Quarter         |  |     | 18.59 |      |  | 22.50 | 
|3rd Quarter         |  |     | 20.11 |      |  | 27.03 | 
|4th Quarter         |  |     | 23.90 |      |  | 32.41 | 

Shareholders

As of February 22, 2006,
there were 75 shareholders of record of Rimages common stock.

Dividends

To date, Rimage has not paid
or declared any cash dividends on its common stock. The payment by Rimage of
dividends, if any, on its common stock in the future is subject to the
discretion of the Board of Directors and will depend on Rimages continued
earnings, financial condition, capital requirements and other relevant factors.

13

---



ITEM
6.     SELECTED FINANCIAL DATA

The selected consolidated
financial data below should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations in
Item 7 below and the Consolidated Financial Statements and the Notes thereto
included in Item 8 below. (In thousands, except per share data).

Consolidated Statements of Income Information:

|                                       |  |                          |        |      |   |        |  |      |        |      |   |        |  |   |        | 
|-------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------ | 
|                                       |  | Year ended
  December 31 |       
|                                       |  |                          |       
|                                       |  | 2005                     |        | 2004 |   | 2003   |  | 2002 |        | 2001 |  
|                                       |  |                          |        |      |   |        |  |      |        |      |  
|Revenues                               |  | $                        | 95,410 |      | $ | 70,848 |  | $    | 53,797 |      | $ | 46,581 |  | $ | 38,894 | 
|Cost of revenues                       |  |                          | 51,957 |      |   | 38,027 |  |      | 27,399 |      |   | 23,986 |  |   | 19,669 | 
|Gross profit                           |  |                          | 43,453 |      |   | 32,821 |  |      | 26,398 |      |   | 22,595 |  |   | 19,225 | 
|Operating expenses                     |  |                          | 26,829 |      |   | 19,386 |  |      | 14,841 |      |   | 13,176 |  |   | 12,760 | 
|Operating income                       |  |                          | 16,624 |      |   | 13,435 |  |      | 11,557 |      |   | 9,419  |  |   | 6,465  | 
|Other income, net                      |  |                          | 1,419  |      |   | 608    |  |      | 515    |      |   | 760    |  |   | 972    | 
|Income tax expense                     |  |                          | 6,675  |      |   | 4,971  |  |      | 4,406  |      |   | 3,715  |  |   | 2,628  | 
|Net income                             |  |                          | 11,368 |      |   | 9,072  |  |      | 7,666  |      |   | 6,464  |  |   | 4,809  | 
|                                       |  |                          |        |      |   |        |  |      |        |      |   |        |  |   |        | 
|Basic net income per share             |  | $                        | 1.19   |      | $ | 0.98   |  | $    | 0.86   |      | $ | 0.74   |  | $ | 0.55   | 
|Diluted net income per
  share         |  | $                        | 1.10   |      | $ | 0.91   |  | $    | 0.79   |      | $ | 0.68   |  | $ | 3.51   | 
|Weighted average shares
  outstanding: |  |                          |        |      |   |        |  |      |        |      |   |        |  |   |        | 
|Basic                                  |  |                          | 9,530  |      |   | 9,290  |  |      | 8,931  |      |   | 8,703  |  |   | 8,701  | 
|Diluted                                |  |                          | 10,312 |      |   | 9,932  |  |      | 9,743  |      |   | 9,497  |  |   | 9,509  | 

Consolidated
Balance Sheet Information:

|                                 |  |                            |        |      |   |        |  |      |        |      |   |        |  |   |        | 
|-------------------------------- |  | -------------------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------ | 
|                                 |  | Balances as of December 31 |       
|                                 |  |                            |       
|                                 |  | 2005                       |        | 2004 |   | 2003   |  | 2002 |        | 2001 |  
|                                 |  |                            |        |      |   |        |  |      |        |      |  
|Cash and cash equivalents        |  | $                          | 18,489 |      | $ | 13,320 |  | $    | 26,742 |      | $ | 17,339 |  | $ | 14,767 | 
|Marketable securities            |  |                            | 45,982 |      |   | 39,175 |  |      | 21,855 |      |   | 18,998 |  |   | 13,343 | 
|Trade accounts receivable,
  net |  |                            | 12,689 |      |   | 10,184 |  |      | 6,243  |      |   | 6,644  |  |   | 5,008  | 
|Inventories                      |  |                            | 6,621  |      |   | 7,396  |  |      | 3,334  |      |   | 3,042  |  |   | 3,625  | 
|Current assets                   |  |                            | 86,444 |      |   | 71,665 |  |      | 59,849 |      |   | 47,337 |  |   | 38,783 | 
|Property and equipment, net      |  |                            | 2,525  |      |   | 2,386  |  |      | 1,137  |      |   | 1,314  |  |   | 1,608  | 
|Total assets                     |  |                            | 89,009 |      |   | 74,138 |  |      | 61,024 |      |   | 48,709 |  |   | 40,454 | 
|Current liabilities              |  |                            | 12,467 |      |   | 11,277 |  |      | 9,013  |      |   | 6,552  |  |   | 5,151  | 
|Long-term liabilities            |  |                            | 13     |      |   | 139    |  |      |       |      |   |       |  |   | 68     | 
|Stockholders equity             |  |                            | 76,529 |      |   | 62,722 |  |      | 52,011 |      |   | 42,157 |  |   | 35,235 | 

14

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|        |                                                                                        
|------- | ---------------------------------------------------------------------------------------
|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF
  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The percentage relationships
to revenues of certain income and expense items for the three years ended
December 31, 2005 and the percentage changes in these income and expense items
between years are contained in the following table:

|                                    |  |                              |       |                                                     |  |       |   |                 |       |                 |  |       |  |  |      | 
|----------------------------------- |  | ---------------------------- | ----- | --------------------------------------------------- |  | ----- | - | --------------- | ----- | --------------- |  | ----- |  |  | ---- | 
|                                    |  | Percentage
  (%) of Revenues |       | Percent (%)
  Increase (Decrease)
  Between Periods | 
|                                    |  |                              |       |                                                     | 
|                                    |  | 2005                         |       | 2004                                                |  | 2003  |   | 2005
  vs. 2004 |       | 2004
  vs. 2003 | 
|                                    |  |                              |       |                                                     |  |       |   |                 |       |                 | 
|Revenues                            |  |                              | 100.0 |                                                     |  | 100.0 |   |                 | 100.0 |                 |  | 34.7  |  |  | 31.7 | 
|Cost of revenues                    |  |                              | (54.5 | )                                                   |  | (53.7 | ) |                 | (50.9 | )               |  | 36.6  |  |  | 38.8 | 
|                                    |  |                              |       |                                                     |  |       |   |                 |       |                 |  |       |  |  |      | 
|Gross profit                        |  |                              | 45.5  |                                                     |  | 46.3  |   |                 | 49.1  |                 |  | 32.4  |  |  | 24.3 | 
|Operating expenses:                 |  |                              |       |                                                     |  |       |   |                 |       |                 |  |       |  |  |      | 
|Research and
development            |  |                              | (5.8  | )                                                   |  | (6.4  | ) |                 | (7.0  | )               |  | 21.7  |  |  | 20.3 | 
|Selling,
general and administrative |  |                              | (22.3 | )                                                   |  | (20.9 | ) |                 | (20.6 | )               |  | 43.5  |  |  | 34.1 | 
|                                    |  |                              |       |                                                     |  |       |   |                 |       |                 |  |       |  |  |      | 
|Operating income                    |  |                              | 17.4  |                                                     |  | 19.0  |   |                 | 21.5  |                 |  | 23.7  |  |  | 16.2 | 
|Other income, net                   |  |                              | 1.5   |                                                     |  | 0.8   |   |                 | 0.9   |                 |  | 133.3 |  |  | 18.1 | 
|                                    |  |                              |       |                                                     |  |       |   |                 |       |                 |  |       |  |  |      | 
|Income before income
taxes          |  |                              | 18.9  |                                                     |  | 19.8  |   |                 | 22.4  |                 |  | 28.5  |  |  | 16.3 | 
|Income tax expense                  |  |                              | (7.0  | )                                                   |  | (7.0  | ) |                 | (8.2  | )               |  | 34.3  |  |  | 12.8 | 
|                                    |  |                              |       |                                                     |  |       |   |                 |       |                 |  |       |  |  |      | 
|Net income                          |  |                              | 11.9  |                                                     |  | 12.8  |   |                 | 14.2  |                 |  | 25.3  |  |  | 18.3 | 
|                                    |  |                              |       |                                                     |  |       |   |                 |       |                 |  |       |  |  |      | 

Overview

Rimage develops,
manufactures and distributes CD-Recordable (CD-R) and DVD-Recordable (DVD-R)
publishing and duplication systems from its operations in the United States and
Germany, and effective June 2005, in Japan. These systems allow customers to
benefit from cost savings by eliminating their manual labor efforts in
industries such as photography, medical, banking and government. Rimage
anticipates increased sales and marketing expenditures as a result of increased
resources focused on developing these markets. As Rimages sales within North
America and Europe have averaged 94% of total sales over the past three years,
the strength of the economies in these regions plays an important role in
determining the success of Rimage.

Rimage earns revenues
through the sale of equipment, consumables (ribbons, ink cartridges and
Rimage-branded blank CD-R and DVD-R media), maintenance contracts, parts and
repair services. Rimages recurring revenues (consumables, maintenance
contracts, parts and service) comprised approximately 38% of its consolidated
revenues in both 2005 and 2004. Rimage has no long-term debt and does not
require significant capital investment as all fabrication of its products is
outsourced to vendors.

Results of Operations

Revenues. Revenues were $95.4 million, $70.8 million and $53.8 million
for 2005,
2004 and 2003, respectively, reflecting increases of 35%, 32% and 16%, respectively,
over the prior years.

The growth in revenues from
2004 to 2005 was impacted by an increased volume of sales in all product line
categories, with Producer product line equipment contributing the largest
growth among all products at $12.2 million. Producer product line sales in 2005
include the shipment of approximately $9.0 million in equipment related to the
Companys product rollout into the U.S. retail market. Recurring revenues,
including sales of CD-R and DVD-R media, printer ribbons and ink cartridges,
parts and maintenance contracts, also contributed significantly to sales
growth, with an increase of $9.5 million in 2005. The strong growth in
recurring revenues is primarily due to the continued expansion of the Companys
worldwide installed base of CD-R and DVD-R publishing systems and increased
emphasis on sales of consumables and maintenance contracts. Sales of desktop
product line equipment increased $2.8 million from 2004 to 2005.

International sales rose 20%
in 2005 and comprised 34% of total sales, compared to 38% in 2004 and 42% in
2003. The European market continued to generate the majority of international
sales, and contributed most of the increase in 2005. Sales in Asian markets
also increased, reflecting increased sales efforts in this region with the
establishment of a subsidiary operation in Japan in 2005. Currency fluctuations
primarily affecting the Companys European operations decreased reported 2005
consolidated revenues by less than 1% relative to 2004.

15

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The growth in revenues from
2003 to 2004 was primarily impacted by an increase of 65% or $10.5 million in
the volume of recurring revenues. The strong growth in recurring revenues was
particularly impacted by $6.5 million in sales of Rimage-branded media kits,
which the Company began to sell in 2004, and the continued expansion of the
Companys worldwide installed base of CD-R and DVD-R publishing systems. Also
contributing to 2004 revenue growth was an increase in the volume of Producer
product line equipment sales of $4.8 million, largely impacted by the
introduction of the DiscLab system in 2004. The impact of currency fluctuations
on the Companys European operations increased reported 2004 revenues by
approximately $2.1 million, or 3% of consolidated revenues.

The Company expects to
achieve continued revenue growth in 2006, the rate at which will be dependent
upon many factors, including the effectiveness of the Companys channel
partners, the timing of new product introductions, the rate of adoption of new
applications for the Companys products in its targeted markets and the impact
of foreign currency exchange rate fluctuations.

Gross Profit. Gross profit as a percentage of revenues was 45.5% for the
year ended
December 31, 2005, compared to 46.3% and 49.1% for the years ended December 31,
2004, and 2003, respectively.

The small decline in gross
profit as a percentage of revenues from 2004 to 2005 was primarily due to
increased costs for service and manufacturing labor and overhead stemming from
increased investments in these areas to support an expected continued growth in
total sales.

The decline in gross profit
as a percentage of revenues from 2003 to 2004 primarily reflects increased
sales of, as well as a higher concentration of, consumable products, particularly
CD-R and DVD-R media, which generally carry lower margins than equipment sales.
Sales of CD-R and DVD-R media and related media kits increased to approximately
15% of total revenues in 2004, compared to 6% in 2003. Additionally, Producer
equipment sales, which generally carry the highest margins among all product
offerings, declined to 51% of total revenues from 58% in the prior year. The
decline was also impacted by additional manufacturing costs associated with the
Companys introduction of its new Desktop product line, and inventory costs
associated with the discontinuation of the previous Desktop product line.

Rimage anticipates that its
gross profit percentage in 2006 will be in the low to mid-40% range. Actual
margins will continue to be affected by many factors, including product mix,
the timing of new product introductions, manufacturing volume, the rate of
growth of service related revenues relative to associated service support
costs, foreign currency exchange rate fluctuations and levels of sales returns.

Operating Expenses. Research and development expenses were $5.5 million,
$4.5 million and
$3.8 million for the years ended December 31, 2005, 2004 and 2003,
respectively, representing 5.8%, 6.4% and 7.0% of revenues, respectively.

The dollar increase in
research and development expenses from 2004 to 2005 reflects continued
development of next generation products, materials and resources required to
complete development work on the Rimage 360i desktop product released in the
second quarter of 2005 and a 21% increase in average headcount to support
continued development of new products and enhancements to existing products.

The dollar increase in
spending in 2004 relative to 2003 was due to increased costs for materials and
resources to support a high level of new product development related to the
Companys Desktop and Producer product lines. Such development activities led
to the Companys introduction during 2004 of the Rimage 2000i, part of its
next-generation Desktop Series, and the DiscLab system, an addition to its
Producer Series of products. Additionally, expenses include development costs
associated with the Rimage 360i desktop product, released in 2005.

Rimage anticipates its
research and development expenditures to be within the range of 7% to 8% of
revenues during 2006. These expenditures will be made to support new product
development initiatives and improve existing products.

Selling, general and
administrative expenses for the years ended December 31, 2005, 2004 and 2003
were $21.3 million, $14.9 million and $11.1 million, respectively, representing
22.3%, 20.9% and 20.6% of revenues, respectively.

The dollar growth in
selling, general and administrative expenses in 2005 relative to 2004 reflects
an increase in sales and marketing costs of $2.3 million and an increase in
general and administrative expenses of $4.1 million. The growth in sales and
marketing expenses is the result of the implementation of programs to support
the second quarter launch of the Rimage 360i desktop product and other
marketing initiatives and promotional activities, as

16

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well as a 14% increase in
average sales and marketing headcount relative to the prior year. The increase
in general and administrative expenses in 2005 was impacted largely by $2.3
million of consulting expenses incurred in the last half of the year for a
strategic analysis of the Companys operations and potential new applications
for its products. Also contributing to the expense growth in 2005 were
increased costs associated with a 20% increase in average headcount and
increased management compensation costs.

The dollar growth in
expenses from 2003 to 2004 primarily reflects the implementation of sales and
marketing initiatives to support new product introductions and expansion of the
Companys sales and marketing organization. Sales and marketing expenses grew
$2.7 million in 2004, affected by a 21% increase in average headcount between
periods, increased travel related costs and increased costs associated with
product marketing and promotion, including expenses associated with the
Companys co-op marketing program. General and administrative expenses
contributed the remaining $1.1 million of growth in expenses, impacted
primarily by incremental expenses associated with Sarbanes-Oxley related
compliance, an increase in management compensation and increased costs for
expanded coverage under the Companys Directors and Officers liability
insurance.

Selling, general and
administrative expenses are projected to approximate 22% to 23% of revenues
during 2006. Expenses in 2006 are expected to include costs to support
continued global expansion of the Companys sales and marketing organization,
more than $2 million of expenses associated with the planned implementation of
an enterprise resource planning system and $1.2 million of expenses to conclude
the strategic consulting analysis initiated in the last half of 2005.

Other Income, Net. The Company recognized interest income on cash
investments of
$1,544,000, $657,000, and $519,000 in 2005, 2004 and 2003, respectively. The
year-over-year increases in interest income were driven by a $7.8 million and
$8.5 million respective increase in average cash equivalent and marketable
securities balances and a small increase in average effective yields. See
Liquidity and Capital Resources below for a discussion of changes in cash
levels. Other income in each year was impacted by gains or losses on foreign
currency transactions, with a net loss of $134,000 in 2005 and net gains of
$18,000 and $30,000 in 2004 and 2003, respectively.

Income Taxes. The provision for income taxes represents federal, state,
and foreign
income taxes on income. For the years ended December 31, 2005, 2004 and 2003,
income tax expense amounted to $6.7 million, $5.0 million and $4.4 million,
respectively, representing 37.0%, 35.4% and 36.5% of income before income
taxes, respectively. The increase in the effective tax rate in 2005 relative to
2004 primarily reflects the impact of higher taxable income, a portion of which
was subject to a tax surcharge, an increase in state income taxes and a reduced
benefit for the research tax credit. The lower effective tax rate in 2004
relative to 2003 reflects the impact of adjustments to the tax provision made
as a result of a reassessment of the Companys tax exposures. The Company
anticipates its effective tax rate will range between 35% and 37% for the full
year 2006.

Net Income / Net Income Per Share. Resulting net income for the years
ended
December 31, 2005, 2004 and 2003 amounted to $11.4 million, $9.1 million and
$7.7 million, representing 11.9%, 12.8% and 14.2% of revenues, respectively.
Related net income per diluted share amounts were $1.10 in 2005, $0.91 in 2004
and $0.79 in 2003.

Liquidity and Capital Resources

The Company expects it will
be able to maintain current operations, including anticipated capital
expenditure requirements, through its internally generated funds and, if
required, from Rimages existing credit agreement. This agreement allows for
advances under an unsecured revolving loan up to a maximum advance of $10
million. At December 31, 2005, no amounts were outstanding under the credit
agreement.

At December 31, 2005, the
Company had working capital of approximately $74 million, an increase of $14
million from working capital reported at December 31, 2004. The increase was
primarily impacted by 2005 net income of $11.4 million and proceeds from stock
option exercises of $1.8 million, partially offset by $1.3 million of capital
expenditures. The Company intends on utilizing its current assets primarily for
its continued organic growth. To help strengthen the Companys ability to mange
anticipated future growth, the Company expects to invest more than $4 million
in 2006 for the implementation of an enterprise resource planning system, of
which approximately $2 million is expected to be capitalized. Additionally, the
Company may use its available cash for potential future strategic initiatives
or alliances.

Net cash provided by
operating activities totaled $11.7 million, $5.1 million and $11.9 million for
the years ended December 31, 2005, 2004 and 2003, respectively. The $6.6
million increase in cash provided by operating activities in 2005 relative to
2004 was impacted by a $2.3 million increase in net income and a $4.7 million
smaller use of cash from changes in operating assets and liabilities. Primarily
contributing to the change in operating assets and liabilities was a $3.2
million smaller net change in inventories and accounts payable between years,
resulting from a

17

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reduction in inventories
($775,000) and an increase in accounts payable ($696,000) in 2005, compared to
an increase in inventories ($4.1 million) and an increase in accounts payable
($2.4 million) in 2004. The increase in 2004 inventories was due to a build-up
of inventory for long lead-time parts as well as a need to stock additional
inventory of CD-R and DVD-R media, printer ribbons and cartridges as a result
of expected growth in consumable product sales. Inventory levels at December
31, 2005 decreased 10% from December 31, 2004, due primarily to increased sales
and improved inventory management. Also favorably impacting the change in
operating assets and liabilities in 2005 was a $1.4 million smaller increase in
accounts receivable, due primarily to the timing of sales and a small
improvement in days sales outstanding.

Net cash used in investing
activities amounted to $8.1 million, $19.7 million and $3.6 million for the
years ended December 31, 2005, 2004 and 2003, respectively. Cash used in investing
activities for each year primarily reflects purchases of marketable securities,
net of maturities of marketable securities. Investing activities also include
purchases of property and equipment of $1.3 million in 2005, $2.2 million in
2004 and $0.8 million in 2003. Purchases in 2005 consisted primarily of tooling
for the Companys Desktop Series of products, computer related equipment and
leasehold improvements. In 2006, the Company expects total capital expenditures
to range between $2.5 million and $3.5 million, primarily reflecting
investments to support the Companys information technology requirements and
the production and product development processes.

Net cash provided by
financing activities totaled $1.8 million in 2005 and $1.0 million in both 2004
and 2003. Amounts in each year primarily reflect proceeds from stock option
exercises.

A summary of Rimages
contractual obligations for minimum lease payments under non-cancelable
operating or capital leases and other non-cancelable obligations at December
31, 2005 is as follows (in thousands):

|                                     |  |                          |        |      |  |        |  |      |     |  |      |     |      |  |    |  |  |   | 
|------------------------------------ |  | ------------------------ | ------ | ---- |  | ------ |  | ---- | --- |  | ---- | --- | ---- |  | -- |  |  | - | 
|                                     |  | Payments
  due by period |       
|                                     |  |                          |       
|Contractual Obligations              |  | Total                    |        | 2006 |  | 2007   |  | 2008 |     |  | 2009 |     | 2010
|                                     |  |                          |        |      |  |        |  |      |     |  |      |     |     
|Operating leases                     |  | $                        | 1,713  |      |  | 769    |  |      | 551 |  |      | 339 |      |  | 50 |  |  | 4 | 
|                                     |  |                          |        |      |  |        |  |      |     |  |      |     |     
|Capital leases (1)                   |  |                          | 27     |      |  | 13     |  |      | 13  |  |      | 1   |      |  |   |  |  |  | 
|                                     |  |                          |        |      |  |        |  |      |     |  |      |     |     
|Inventory purchase
  obligations (2) |  |                          | 9,922  |      |  | 9,922  |  |      |    |  |      |    |      |  |   |  |  |  | 
|                                     |  |                          |        |      |  |        |  |      |     |  |      |     |     
|Total contractual cash
obligations   |  | $                        | 11,662 |      |  | 10,704 |  |      | 564 |  |      | 340 |      |  | 50 |  |  | 4 | 
|                                     |  |                          |        |      |  |        |  |      |     |  |      |     |     

| |     |                                                                                                                             
| | --- | ----------------------------------------------------------------------------------------------------------------------------
| | (1) | Amounts include principal
  and interest.                                                                                   
| | (2) | Represents non-cancelable
  purchase order commitments to a supplier of the Company for delivery of
  inventory during 2006.

Critical Accounting Policies

Management utilizes its
technical knowledge, cumulative business experience, judgment and other factors
in the selection and application of the Companys accounting policies. The
following accounting policies are considered by management to be the most
critical to the presentation of the consolidated financial statements because
they require the most difficult, subjective and complex judgments:

Revenue
Recognition. Revenue
for product sales (including hardware and consumables), which do not include
any requirement for installation or training, is recognized on shipment, at
which point the following criteria of SAB Topic 13(A)(1) have been satisfied:

| |   |                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Persuasive evidence of an
  arrangement exists. Orders are received for all sales and sales invoices are
  mailed on shipment.                                                                                                                            
| |  | Delivery has occurred.
  Product has been transferred to the customer or the customers designated
  delivery agent, at which time title and risk of loss transfers.                                                                                      
| |  | The vendors price is
  fixed or determinable. All sales prices are fixed at the time of the sale
  (shipment).                                                                                                                                           
| |  | Collectibility is
  probable. All sales are made on the basis that collection is expected in line
  with the Companys standard payment terms, which are consistent with industry
  practice in the geographies in which the Company markets its products.

A standard product sale by
the Company does not require a commitment on the Companys part to provide
installation, set-up or training. When such services are requested, value-added
resellers generally arrange and perform the service directly with the customer,
with no financial interest or obligation on the part of the Company. In the
limited situations in which the Company does provide installation or training
services for customers, the

18

---



Company
charges separately for the service based upon its published list prices, and
recognizes the associated service revenue upon the successful completion of the
service.

The Company
records a reserve for sales returns from its customers. The amount of the
reserve is based upon historical trends, timing of new product introductions
and other factors. A return policy is in place with the Companys distributors
to restrict the volume of returned products, and the Company reviews the
distributors inventory to insure compliance with the return policy.

Revenue for
maintenance agreements is recognized on a straight-line basis over the life of
the contracts (commencing once the period covered by standard warranty
expires).

Emerging
Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables provides revenue recognition guidance for arrangements with
multiple deliverables, and the criteria to determine if items in a multiple
deliverable agreement should be accounted for separately. The elements of the
Companys sales transactions are clearly and separately stated and sufficient
evidence of their fair value exists to separately account for the elements.

Allowance For Doubtful Accounts And Sales
Returns. The Company records a reserve for accounts
receivable that are potentially uncollectible. The reserve is established based
on a specific assessment of accounts with known collection exposure, based upon
a review of the age of the receivable, the customers payment history, the customers
financial condition and industry and general economic conditions, as well as a
general assessment of collection exposure in the remaining receivable
population based upon bad debt history. Actual bad debt exposure could differ
significantly from managements estimates if economic conditions worsened for
the Companys customers. As described above under Revenue Recognition, the
Company also records a reserve for sales returns from its customers. The amount
of the reserve is based upon historical trends, timing of new product
introductions and other factors.

Inventory Reserves.
The Company records reserves for inventory shrinkage and for potentially
excess, obsolete and slow moving inventory. The amounts of these reserves are
based upon historical loss trends, inventory levels, expected product lives and
forecasted sales demand. Results could be materially different if demand for
the Companys products decreased because of economic or competitive conditions,
or if products became obsolete because of technical advancements in the
industry or by the Company.

Deferred Tax Assets.
The Company recognizes deferred tax assets for the expected future tax impact
of temporary differences between book and taxable income. A valuation allowance
and income tax charge are recorded when, in managements judgment, realization
of a specific deferred tax asset is uncertain. Income tax expense could be
materially different from actual results because of changes in managements
expectations regarding future taxable income, the relationship between book and
taxable income and tax planning strategies employed by the Company.

Warranty Reserves.
The Companys non-consumable products are warranted to the end-user to ensure
end-user confidence in design, workmanship and overall quality. Warranty
lengths vary by product type, ranging from periods of six to twelve months.
Warranty covers parts, labor and other associated expenses. The Company
performs the majority of warranty work, while authorized distributors and
dealers also perform some warranty work. The Company records a liability for
warranty claims at the time of sale. The amount of the liability is based on an
analysis of historical claims experience, which includes labor, parts and
freight costs and consideration of the proportion of parts that can be re-used.
Also considered are the anticipated impact of product improvements, releases of
new products and other factors. Claims experience could be materially different
from actual results because of the introduction of new, more complex products;
a change in the Companys warranty policy in response to industry trends,
competition or other external forces; or manufacturing changes that could
impact product quality.

In applying
the critical accounting policies described above, management reassesses its
estimates each reporting period based on available information. Changes in such
estimates did not have a significant impact on earnings for the year ended
December 31, 2005.

New Accounting Pronouncements

In December 2004, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS)
No. 123 (Revised 2004), Share-Based Payment. SFAS No 123R is a revision of
SFAS No. 123, Accounting for Stock-Based Compensation and supersedes
Accounting Principles
Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees and its related implementation
guidance. SFAS No. 123R focuses primarily on accounting for transactions in
which an entity obtains employee services through share-based payment
transactions. SFAS No 123R requires a public entity to measure the cost of
employee services received in exchange

19

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for the award of equity instruments based on
the fair value of the award at the date of grant. The cost will be recognized
over the period during which an employee is required to provide services in
exchange for the award. This Statement also amends SFAS No. 95, Statement of
Cash Flows, to require that excess tax benefits be reflected as financing cash
inflows rather than operating cash inflows. The Company will adopt the
provisions of SFAS No. 123R effective with the first quarter of 2006 using the
modified prospective method. While the Company cannot precisely determine the
impact on net earnings that may result from the adoption of SFAS No 123R,
estimated compensation expense related to the years ended December 31, 2005,
2004 and 2003 can be found in the notes to the Consolidated Financial
Statements included in this Form 10-K. The ultimate amount of future
compensation expense will be dependent on the number of option shares granted
during each year, their timing and vesting period and the volatility of the
Companys common stock, among other factors. The Company has not completed its
evaluation of the impact of adopting SFAS No. 123R, but expects the adoption to
have an adverse impact on net earnings and net income per share.

FASB Interpretation No. 47, Accounting for
Conditional Asset Retirement Obligations, was issued in March 2005, and
provides clarification on certain provisions of SFAS No. 143, Accounting for
Asset Retirement Obligations. Under Interpretation No. 47, an entity is
required to recognize a liability for the fair value of a conditional asset
retirement obligation if the fair value of the liability can be reasonably estimated.
The fair value of a liability for a conditional asset retirement obligation
should be recognized when incurred, generally upon acquisition, construction,
development or through the normal operation of the asset. This Interpretation
also clarifies when an entity would have sufficient information to reasonably
estimate the fair value of an asset retirement obligation. Interpretation No.
47 was effective for the Company in fiscal year 2005, and did not have an
impact on the Companys consolidated financial statements.

In November 2004, the FASB issued SFAS No.
151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS No. 151
amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify
the accounting for abnormal amounts of idle facility expense, freight, handling
charges and spoilage. This Statement requires that those items be recognized as
current period charges regardless of whether they meet the criterion of so
abnormal which was the criterion specified in ARB No. 43. In addition, this
Statement requires that allocation of fixed production overheads to the cost of
production be based on normal capacity of the production facilities. The
provisions under SFAS No. 151 are effective for the Company beginning January
1, 2006, and shall be applied prospectively. The Company does not expect that
the adoption of this pronouncement will have a significant impact on its
consolidated financial statements.

In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections. SFAS No. 154 replaces APB No. 20,
Accounting Changes, and SFAS No. 3, Reporting Changes in Interim Financial
Statements. SFAS No. 154 requires retrospective application to prior periods
financial statements of voluntary changes in accounting principle unless it is
impracticable to do so. Retrospective application refers to the application of
a different accounting principle to previously issued financial statements as
if that principle had always been used. Statement No. 154s retrospective-application
requirement replaces APB 20s requirement to recognize most voluntary changes
in accounting principle by including in net income of the period of the change
the cumulative effect of changing to the new accounting principle. This
Statement is effective for the Company for accounting changes and corrections
of errors made beginning January 1, 2006. The Company does not currently expect
the adoption of this pronouncement to have a significant impact on its
consolidated financial statements.

Available Information

Rimage
maintains a website at www.rimage.com. Its annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are
available on its website, as soon as reasonably practicable after these
documents are filed with the SEC. To obtain copies of these reports, go to
www.rimage.com and click on Investor Relations, then click on EDGAR
Filings. A copy of any report filed by the Company with the SEC will also be
furnished without charge to any shareholder who requests it in writing to:
Secretary, Rimage Corporation 7725 Washington Avenue South, Minneapolis,
Minnesota 55439.

ITEM 7A.   QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

Foreign Currency Translation. The Company is exposed to market risk from
foreign exchange rate fluctuations of the European Euro and Japanese Yen to the
U.S. dollar as the financial position and operating results of the Companys
German and Japanese subsidiaries, Rimage Europe and Rimage Japan, respectively,
are translated into U.S. dollars for consolidation. Resulting translation
adjustments are recorded as a separate component of stockholders equity.

20

---



Derivative financial instruments. The Company
enters into forward exchange contracts principally to hedge inter-company
receivables denominated in Euros arising from sales to its subsidiary in
Germany. Gains or losses on
forward exchange contracts are calculated at each period end and are recognized
in net income in the period in which they arose. The Company records the fair
value of its open forward foreign exchange contracts in other current assets or
other current liabilities depending on whether the net amount is a gain or a
loss. The Company does not utilize financial instruments for trading or other
speculative purposes.

Exchange Rate
Sensitivity.The table below summarizes information on
foreign currency forward exchange agreements that are sensitive to foreign
currency exchange rates. For these foreign currency forward exchange
agreements, the table presents the notional amounts and weighted average
exchange rates by expected (contractual) maturity dates. These notional amounts
generally are used to calculate the contractual payments to be exchanged under
the contract.

|                                                   |  |                                         |       |      |  |      |  |      |   |        |  |       |  |       |   |  |   |       |  |   |    | 
|-------------------------------------------------- |  | --------------------------------------- | ----- | ---- |  | ---- |  | ---- | - | ------ |  | ----- |  | ----- | - |  | - | ----- |  | - | -- | 
|                                                   |  | Expected
  Maturity or Transaction Date |      
|                                                   |  |                                         |      
|                                                   |  |                                         |       |      |  |      |  |      |   | There- |  |       |  | Fair  |  
|                                                   |  | 2006                                    |       | 2007 |  | 2008 |  | 2009 |   | after  |  | Total |  | Value |  
|                                                   |  |                                         |       |      |  |      |  |      |   |        |  |       |  |       |  
|                                                   |  | (US$ Equivalent in Thousands)           |      
|                                                   |  |                                         |      
|Anticipated
  Transactions and Related Derivatives |  |                                         |      
|                                                  
|Forward
Exchange Agreements                        |  |                                         |      
|(Receive
$US/Pay )                                |  |                                         |       |      |  |      |  |      |   |        |  |       |  |       |   |  |   |       |  |   |    | 
|Contract
Amount                                    |  | $                                       | 4,578 |      |  |     |  |      |  |        |  |      |  |       |  |  | $ | 4,578 |  | $ | 25 | 
|Average
Contractual                                |  |                                         |       |      |  |      |  |      |   |        |  |       |  |       |   |  |   |       |  |   |    | 
|Exchange
Rate                                      |  |                                         | 1.195 |      |  |     |  |      |  |        |  |      |  |       |  |  |   | 1.195 |  |   |    | 

21

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ITEM 8.
     FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA

Financial Statements

|                                                                                                                                   |                                                                    | 
|---------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------ | 
|                                                                                                                                   | Page in Annual
Report on Form 10-K
For Year EndedDecember 31, 2005
|Managements
  Report on Internal Control over Financial Reporting                                                                 | 23                                                                 | 
|                                                                                                                                   |                                                                    | 
|Reports of Independent Registered
  Public Accounting Firm                                                                         | 24-25                                                              | 
|                                                                                                                                   |                                                                    | 
|Consolidated Balance Sheets, as of
  December 31, 2005 and 2004                                                                    | 26                                                                 | 
|                                                                                                                                   |                                                                    | 
|Consolidated Statements of Income,
  for the years ended December 31, 2005, 2004 and 2003                                          | 27                                                                 | 
|                                                                                                                                   |                                                                    | 
|Consolidated Statements of
  Stockholders Equity and Comprehensive Income, for the years ended December
  31, 2005, 2004 and 2003 | 28                                                                 | 
|                                                                                                                                   |                                                                    | 
|Consolidated Statements of Cash
  Flows, for the years ended December 31, 2005, 2004 and 2003                                      | 29                                                                 | 
|                                                                                                                                   |                                                                    | 
|Notes to Consolidated Financial
  Statements                                                                                       | 30-43                                                              | 

22

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Managements Report
on Internal Control over Financial
Reporting

The Board of Directors and Stockholders
Rimage Corporation:

Management is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules
13a15-(f) and 15d-15(f) under the Securities Exchange Act of 1934. The
Companys internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A companys internal control
over financial reporting includes those policies and procedures that:

| |       |                                                                                                                                                                                                                                                                                                                                                    
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i)   | pertain to the maintenance of records that, in
  reasonable detail, accurately and fairly reflect the transactions and
  dispositions of the assets of the Company;                                                                                                                                                                                
| |       |                                                                                                                                                                                                                                                                                                                                                    
| | (ii)  | provide reasonable assurance that transactions are
  recorded as necessary to permit preparation of financial statements in
  accordance with generally accepted accounting principles, and that receipts
  and expenditures of the Company are being made only in accordance with
  authorizations of management and directors of the Company; and
| |       |                                                                                                                                                                                                                                                                                                                                                    
| | (iii) | provide reasonable assurance regarding prevention or
  timely detection of unauthorized acquisition, use or disposition of the
  Companys assets that could have a material effect on the financial
  statements.                                                                                                                                 

Because of its inherent limitations, internal control
over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.

Under the supervision of our chief executive officer
and our chief financial officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting based on the
framework in Internal Control  Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on our assessment and those criteria,
management believes that the Company maintained effective internal control over
financial reporting as of December 31, 2005.

KPMG LLP, the independent registered public accounting
firm that audited our consolidated financial statements in this Form 10-K, has
issued an attestation report on managements assessment of the effectiveness of
the Companys internal control over financial reporting, which report is
included in this Form 10-K.

23

---



Report
of Independent Registered Public Accounting Firm on Consolidated Financial
Statements

The
Board of Directors and Stockholders
Rimage Corporation:

We
have audited the accompanying consolidated balance sheets of Rimage Corporation
and subsidiaries as of December 31, 2005 and 2004, and the related consolidated
statements of income, stockholders equity and comprehensive income, and cash
flows for each of the years in the three-year period ended December 31, 2005.
These consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

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

In
our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Rimage Corporation
and subsidiaries as of December 31, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles.

We
also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Rimage
Corporations internal control over financial reporting as of December 31,
2005, based on criteria established in  Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO), and our report dated March 15, 2006 expressed an unqualified opinion on
managements assessment of, and the effective operation of, internal control
over financial reporting.

/s/
KPMG LLP

Minneapolis, MinnesotaMarch 15,
2006

24

---



Report of Independent Registered
Public Accounting Firm on Internal Control Over Financial Reporting

The Board of Directors and Stockholders
Rimage Corporation:

We have audited managements assessment, included in
the accompanying Managements Report on Internal Control Over Financial
Reporting,that Rimage
Corporation maintained effective internal control over financial reporting as
of December 31, 2005, based on criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).The Companys management
is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on managements
assessment and an opinion on the effectiveness of the Companys internal
control over financial reporting based on our audit.

We conducted our audit in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.

A companys internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the companys assets that could have a material effect
on the financial statements.

Because of its inherent limitations, internal control
over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.

In our opinion, managements assessment that Rimage
Corporation maintained effective internal control over financial reporting as
of December 31, 2005, is fairly stated, in all material respects, based on
criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).Also, in our opinion,
Rimage Corporation maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2005, based on criteria established in Internal
ControlIntegrated Framework
issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards
of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Rimage Corporation and subsidiaries as of
December 31, 2005 and 2004, and the related consolidated statements of income,
stockholders equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 2005, and our report dated
March 15, 2006 expressed an
unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Minneapolis, Minnesota
March 15, 2006

25

---



RIMAGE
CORPORATION AND SUBSIDIARIESConsolidated Balance Sheets
December 31, 2005 and 2004(In
thousands, except share data)

|                                                                                                                               |  |                |        |                |   |        | 
|------------------------------------------------------------------------------------------------------------------------------ |  | -------------- | ------ | -------------- | - | ------ | 
|                                                                                                                               |  | December
  31, |        | December
  31, |  
|                                                                                                                               |  | 2005           |        | 2004           |  
|                                                                                                                               |  |                |        |                |  
|Assets                                                                                                                         |  |                |        |                |   |        | 
|                                                                                                                               |  |                |        |                |   |        | 
|Current assets:                                                                                                                |  |                |        |                |   |        | 
|Cash and cash
  equivalents                                                                                                    |  | $              | 18,489 |                | $ | 13,320 | 
|Marketable
  securities                                                                                                        |  |                | 45,982 |                |   | 39,175 | 
|Trade accounts
  receivable, net of allowance for doubtful accounts and sales returns of
  $854,000 and $600,000, respectively |  |                | 12,689 |                |   | 10,184 | 
|Inventories                                                                                                                    |  |                | 6,621  |                |   | 7,396  | 
|Prepaid expenses
  and other current assets                                                                                    |  |                | 1,284  |                |   | 462    | 
|Deferred income
  taxes - current                                                                                              |  |                | 1,379  |                |   | 1,128  | 
|                                                                                                                               |  |                |        |                |   |        | 
|Total current
  assets                                                                                                         |  |                | 86,444 |                |   | 71,665 | 
|                                                                                                                               |  |                |        |                |   |        | 
|Property and
  equipment, net                                                                                                  |  |                | 2,525  |                |   | 2,386  | 
|Deferred income
  taxes - non-current                                                                                          |  |                | 18     |                |   |       | 
|Other
  non-current assets                                                                                                     |  |                | 22     |                |   | 87     | 
|                                                                                                                               |  |                |        |                |   |        | 
|Total assets                                                                                                                   |  | $              | 89,009 |                | $ | 74,138 | 
|                                                                                                                               |  |                |        |                |   |        | 
|                                                                                                                               |  |                |        |                |   |        | 
|Liabilities and Stockholders Equity                                                                                           |  |                |        |                |   |        | 
|                                                                                                                               |  |                |        |                |   |        | 
|Current
  liabilities:                                                                                                         |  |                |        |                |   |        | 
|Trade accounts
  payable                                                                                                       |  | $              | 5,413  |                | $ | 4,717  | 
|Accrued
  compensation                                                                                                         |  |                | 2,896  |                |   | 2,300  | 
|Other accrued
  expenses                                                                                                       |  |                | 1,332  |                |   | 1,121  | 
|Income taxes
  payable                                                                                                         |  |                | 283    |                |   | 1,100  | 
|Deferred income
  and customer deposits                                                                                        |  |                | 2,531  |                |   | 1,821  | 
|Other current
  liabilities                                                                                                    |  |                | 12     |                |   | 218    | 
|                                                                                                                               |  |                |        |                |   |        | 
|Total current
  liabilities                                                                                                    |  |                | 12,467 |                |   | 11,277 | 
|                                                                                                                               |  |                |        |                |   |        | 
|Long-term
  liabilities:                                                                                                       |  |                |        |                |   |        | 
|Deferred income
  taxes                                                                                                        |  |                |       |                |   | 123    | 
|Other
  non-current liabilities                                                                                                |  |                | 13     |                |   | 16     | 
|                                                                                                                               |  |                |        |                |   |        | 
|Total long-term
  liabilities                                                                                                  |  |                | 13     |                |   | 139    | 
|                                                                                                                               |  |                |        |                |   |        | 
|Total
  liabilities                                                                                                            |  |                | 12,480 |                |   | 11,416 | 
|                                                                                                                               |  |                |        |                |   |        | 
|Stockholders
  equity:                                                                                                        |  |                |        |                |   |        | 
|Preferred stock,
  $.01 par value, authorized 250,000 shares, no shares issued and outstanding                                 |  |                |       |                |   |       | 
|Common stock,
  $.01 par value, authorized 29,750,000 shares, issued and outstanding
  9,630,324 and 9,365,479 respectively    |  |                | 96     |                |   | 94     | 
|Additional
  paid-in capital                                                                                                   |  |                | 22,389 |                |   | 19,678 | 
|Retained
  earnings                                                                                                            |  |                | 54,240 |                |   | 42,872 | 
|Accumulated
  other comprehensive income (loss)                                                                                |  |                | (196   | )              |   | 78     | 
|                                                                                                                               |  |                |        |                |   |        | 
|Total
  stockholders equity                                                                                                   |  |                | 76,529 |                |   | 62,722 | 
|                                                                                                                               |  |                |        |                |   |        | 
|                                                                                                                               |  |                |        |                |   |        | 
|Commitments and
  contingencies (notes 9 and 13)                                                                               |  |                |        |                |   |        | 
|Total liabilities and
  stockholders equity                                                                                   |  | $              | 89,009 |                | $ | 74,138 | 
|                                                                                                                               |  |                |        |                |   |        | 

See accompanying notes to consolidated financial
statements

26

---



RIMAGE
CORPORATION AND SUBSIDIARIESConsolidated Statements of Income
Years Ended December 31, 2005, 2004 and 2003(In
thousands, except per share data)

|                                              |  |      |        |      |   |        |   |   |        |  
|--------------------------------------------- |  | ---- | ------ | ---- | - | ------ | - | - | ------ | -
|                                              |  | 2005 |        | 2004 |   | 2003   |  
|                                              |  |      |        |      |   |        |  
|Revenues                                      |  | $    | 95,410 |      | $ | 70,848 |   | $ | 53,797 |  
|Cost of revenues                              |  |      | 51,957 |      |   | 38,027 |   |   | 27,399 |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Gross profit                                  |  |      | 43,453 |      |   | 32,821 |   |   | 26,398 |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Operating
  expenses:                         |  |      |        |      |   |        |   |   |        |  
|Research and
  development                    |  |      | 5,512  |      |   | 4,530  |   |   | 3,765  |  
|Selling, general
  and administrative         |  |      | 21,317 |      |   | 14,856 |   |   | 11,076 |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Total operating expenses                      |  |      | 26,829 |      |   | 19,386 |   |   | 14,841 |  
|                                              |  |      |        |      |   |        |   |   |        |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Operating income                              |  |      | 16,624 |      |   | 13,435 |   |   | 11,557 |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Other income
  (expense):                     |  |      |        |      |   |        |   |   |        |  
|Interest, net                                 |  |      | 1,544  |      |   | 657    |   |   | 519    |  
|Gain (loss) on
  currency exchange            |  |      | (134   | )    |   | 18     |   |   | 30     |  
|Other, net                                    |  |      | 9      |      |   | (67    | ) |   | (34    | )
|                                              |  |      |        |      |   |        |   |   |        |  
|Total other income, net                       |  |      | 1,419  |      |   | 608    |   |   | 515    |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Income before
  income taxes                  |  |      | 18,043 |      |   | 14,043 |   |   | 12,072 |  
|Income tax
  expense                          |  |      | 6,675  |      |   | 4,971  |   |   | 4,406  |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Net income                                    |  | $    | 11,368 |      | $ | 9,072  |   | $ | 7,666  |  
|                                              |  |      |        |      |   |        |   |   |        |  
|                                              |  |      |        |      |   |        |   |   |        |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Net income per basic
  share                  |  | $    | 1.19   |      | $ | 0.98   |   | $ | 0.86   |  
|                                              |  |      |        |      |   |        |   |   |        |  
|                                             
|                                              |  |      |        |      |   |        |   |   |        |  
|Net income per diluted
  share                |  | $    | 1.10   |      | $ | 0.91   |   | $ | 0.79   |  
|                                              |  |      |        |      |   |        |   |   |        |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Basic weighted
  average shares outstanding   |  |      | 9,530  |      |   | 9,290  |   |   | 8,931  |  
|                                              |  |      |        |      |   |        |   |   |        |  
|                                              |  |      |        |      |   |        |   |   |        |  
|Diluted weighted
  average shares outstanding |  |      | 10,312 |      |   | 9,932  |   |   | 9,743  |  
|                                              |  |      |        |      |   |        |   |   |        |  

See accompanying notes to consolidated financial
statements

27

---



RIMAGE CORPORATION AND SUBSIDIARIESConsolidated
Statements of Stockholders Equity and Comprehensive Income
Years Ended December 31, 2005, 2004, and 2003
(In thousands)

|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|----------------------------------------------------------- | ------ | -------------- | ----- | ------------------------------ | - | ------------------- |  | --------------------------------------------------- | ------ | ----- | - | ------ |  | - | ---- | - | - | ------ | -
|                                                            |        | Common
  Stock |       | Additional
  paid-in
  capital |   | Retained
  earnings |  | Accumulated
  other
  comprehensive
  income (loss) |        | Total |  
|                                                           
|Shares                                                      | Amount
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Balance at December 31, 2002                                |        |                | 8,719 |                                | $ | 87                  |  | $                                                   | 16,157 |       | $ | 26,134 |  | $ | (221 | ) | $ | 42,157 |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Stock issued in warrant and stock option exercises          |        |                | 391   |                                |   | 4                   |  |                                                     | 948    |       |   |       |  |   |     |   |   | 952    |  
|Income tax reductions relating to exercise of stock options |        |                |      |                                |   |                    |  |                                                     | 1,052  |       |   |       |  |   |     |   |   | 1,052  |  
|Comprehensive income:                                       |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Net income                                                  |        |                |      |                                |   |                    |  |                                                     |       |       |   | 7,666  |  |   |     |   |   | 7,666  |  
|Translation adjustment                                      |        |                |      |                                |   |                    |  |                                                     |       |       |   |       |  |   | 178  |   |   | 178    |  
|Unrealized gain from available-for-sale securities          |        |                |      |                                |   |                    |  |                                                     |       |       |   |       |  |   | 7    |   |   | 7      |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Total comprehensive income                                  |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   | 7,851  |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Balance at December 31, 2003                                |        |                | 9,110 |                                |   | 91                  |  |                                                     | 18,157 |       |   | 33,800 |  |   | (36  | ) |   | 52,012 |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Stock issued in stock option exercises                      |        |                | 255   |                                |   | 3                   |  |                                                     | 991    |       |   |       |  |   |     |   |   | 994    |  
|Income tax reductions relating to exercise of stock options |        |                |      |                                |   |                    |  |                                                     | 522    |       |   |       |  |   |     |   |   | 522    |  
|Accelerated vesting of stock options                        |        |                |      |                                |   |                    |  |                                                     | 8      |       |   |       |  |   |     |   |   | 8      |  
|Comprehensive income:                                       |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Net income                                                  |        |                |      |                                |   |                    |  |                                                     |       |       |   | 9,072  |  |   |     |   |   | 9,072  |  
|Translation adjustment                                      |        |                |      |                                |   |                    |  |                                                     |       |       |   |       |  |   | 170  |   |   | 170    |  
|Unrealized loss from available- for-sale securities         |        |                |      |                                |   |                    |  |                                                     |       |       |   |       |  |   | (56  | ) |   | (56    | )
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Total comprehensive income                                  |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   | 9,186  |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Balance at December 31, 2004                                |        |                | 9,365 |                                | $ | 94                  |  | $                                                   | 19,678 |       | $ | 42,872 |  | $ | 78   |   | $ | 62,722 |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Stock issued in stock option exercises                      |        |                | 265   |                                |   | 2                   |  |                                                     | 1,843  |       |   |       |  |   |     |   |   | 1,845  |  
|Income tax reductions relating to exercise of stock options |        |                |      |                                |   |                    |  |                                                     | 868    |       |   |       |  |   |     |   |   | 868    |  
|Comprehensive income:                                       |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Net income                                                  |        |                |      |                                |   |                    |  |                                                     |       |       |   | 11,368 |  |   |     |   |   | 11,368 |  
|Translation adjustment                                      |        |                |      |                                |   |                    |  |                                                     |       |       |   |       |  |   | (314 | ) |   | (314   | )
|Unrealized gain from available-for-sale securities          |        |                |      |                                |   |                    |  |                                                     |       |       |   |       |  |   | 40   |   |   | 40     |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Total comprehensive income                                  |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   | 11,094 |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  
|Balance at December 31, 2005                                |        |                | 9,630 |                                | $ | 96                  |  | $                                                   | 22,389 |       | $ | 54,240 |  | $ | (196 | ) | $ | 76,529 |  
|                                                            |        |                |       |                                |   |                     |  |                                                     |        |       |   |        |  |   |      |   |   |        |  

See accompanying notes to consolidated financial statements.

28

---



RIMAGE
CORPORATION AND SUBSIDIARIESConsolidated Statements of Cash Flows
Years ended December 31, 2005, 2004, and 2003(in thousands)

|                                                                                    |  |      |          |      |   |          |   |   |         |  
|----------------------------------------------------------------------------------- |  | ---- | -------- | ---- | - | -------- | - | - | ------- | -
|                                                                                    |  | 2005 |          | 2004 |   | 2003     |  
|                                                                                    |  |      |          |      |   |          |  
|Cash flows from operating activities:                                               |  |      |          |      |   |          |   |   |         |  
|Net income                                                                          |  | $    | 11,368   |      | $ | 9,072    |   | $ | 7,666   |  
|Adjustments to reconcile net income to net cash provided by operating
  activities: |  |      |          |      |   |          |   |   |         |  
|Depreciation and amortization                                                       |  |      | 1,228    |      |   | 919      |   |   | 930     |  
|Deferred income tax expense (benefit)                                               |  |      | (392     | )    |   | 234      |   |   | (254    | )
|Loss on sale of property and equipment                                              |  |      | 33       |      |   | 106      |   |   | 28      |  
|Stock-based compensation                                                            |  |      |         |      |   | 8        |   |   |        |  
|Changes in operating assets and liabilities:                                        |  |      |          |      |   |          |   |   |         |  
|Trade accounts receivable                                                           |  |      | (2,505   | )    |   | (3,941   | ) |   | 401     |  
|Inventories                                                                         |  |      | 775      |      |   | (4,061   | ) |   | (293    | )
|Prepaid expenses and other current assets                                           |  |      | (822     | )    |   | 11       |   |   | (88     | )
|Trade accounts payable                                                              |  |      | 696      |      |   | 2,352    |   |   | (111    | )
|Income taxes payable                                                                |  |      | 51       |      |   | (147     | ) |   | 2,625   |  
|Accrued compensation                                                                |  |      | 596      |      |   | 641      |   |   | 371     |  
|Other accrued expenses and other current liabilities                                |  |      | 1        |      |   | (95      | ) |   | 157     |  
|Deferred income and customer deposits                                               |  |      | 710      |      |   | 27       |   |   | 471     |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Net
  cash provided by operating activities                                         |  |      | 11,739   |      |   | 5,126    |   |   | 11,903  |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Cash flows from investing activities:                                               |  |      |          |      |   |          |   |   |         |  
|Purchases of marketable securities                                                  |  |      | (246,303 | )    |   | (194,356 | ) |   | (52,463 | )
|Maturities of marketable securities                                                 |  |      | 239,535  |      |   | 176,981  |   |   | 49,613  |  
|Purchases of property and equipment                                                 |  |      | (1,328   | )    |   | (2,206   | ) |   | (782    | )
|Proceeds from the sale of property and equipment                                    |  |      | 5        |      |   |         |   |   | 1       |  
|Other non-current assets                                                            |  |      | (53      | )    |   | (105     | ) |   | 27      |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Net
  cash used in investing activities                                             |  |      | (8,144   | )    |   | (19,686  | ) |   | (3,604  | )
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Cash flows from financing activities:                                               |  |      |          |      |   |          |   |   |         |  
|Principal payments on capital lease obligations                                     |  |      | (11      | )    |   |         |   |   |        |  
|Proceeds from stock option exercises                                                |  |      | 1,845    |      |   | 994      |   |   | 952     |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Net
  cash provided by financing activities                                         |  |      | 1,834    |      |   | 994      |   |   | 952     |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Effect of exchange rate changes on cash                                             |  |      | (260     | )    |   | 145      |   |   | 151     |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Net increase (decrease) in cash and cash equivalents                                |  |      | 5,169    |      |   | (13,421  | ) |   | 9,402   |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Cash and cash equivalents, beginning of year                                        |  |      | 13,320   |      |   | 26,741   |   |   | 17,339  |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Cash and cash equivalents, end of year                                              |  | $    | 18,489   |      | $ | 13,320   |   | $ | 26,741  |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Supplemental disclosures of net cash paid during the period for:                    |  |      |          |      |   |          |   |   |         |  
|Income taxes                                                                        |  | $    | 7,000    |      | $ | 4,884    |   | $ | 1,809   |  
|                                                                                    |  |      |          |      |   |          |   |   |         |  
|Non-cash transactions:                                                              |  |      |          |      |   |          |   |   |         |  
|Income tax reductions relating to exercise of stock options                         |  | $    | 868      |      | $ | 522      |   | $ | 1,052   |  
|Unrealized net gains (losses) from available-for-sale securities                    |  | $    | 40       |      | $ | (56      | ) | $ | 7       |  
|Capital lease obligations                                                           |  | $    | 12       |      | $ |         |   | $ |        |  

See accompanying notes to consolidated financial statements.

29

---



RIMAGE
CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

1)     Nature
of Business and Summary of Significant Accounting Policies

Basis of
Presentation and Nature of Business

The consolidated financial statements include the accounts
of Rimage Corporation and its subsidiaries, collectively hereinafter referred
to as Rimage or the Company. All material intercompany accounts and
transactions have been eliminated upon consolidation.

The Company develops, manufactures and distributes
high performance CD-Recordable (CD-R) and DVD-Recordable (DVD-R) publishing and
duplication systems.

Revenue
Recognition

Revenue for product sales, which do not include any
requirement for installation or training, is recognized on shipment, at which point
the following criteria of SAB Topic 13(A)(1) have been satisfied:

| |   |                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Persuasive evidence of an arrangement exists. Orders
  are received for all sales and sales invoices are mailed on shipment.                                                                                                                              
| |  | Delivery has occurred. Product has been transferred to
  the customer or the customers designated delivery agent.                                                                                                                                        
| |  | The vendors price is fixed or determinable. All
  sales prices are fixed at the time of the sale (shipment).                                                                                                                                             
| |  | Collectibility is probable. All sales are made on the
  basis that collection is expected in line with the Companys standard payment
  terms, which are consistent with industry practice in the geographies in
  which the Company markets its products.

A standard product sale by the Company does not
require a commitment on the Companys part to provide installation, set-up or
training. When such services are requested, value-added resellers generally
arrange and perform the service directly with the customer, with no financial
interest or obligation on the part of the Company. In the limited situations in
which the Company does provide installation or training services for customers,
the Company charges separately for the service based upon its published list
prices, and recognizes the associated service revenue upon the successful
completion of the service.

Revenue for maintenance agreements is recognized on a
straight-line basis over the life of the contracts (commencing once the period
covered by standard warranty expires).

Emerging Issues Task Force (EITF) Issue No.
00-21,
Revenue Arrangements with Multiple Deliverables provides revenue recognition
guidance for arrangements with multiple deliverables, and the criteria to
determine if items in a multiple deliverable agreement should be accounted for
separately. The elements of the Companys sales transactions are clearly and
separately stated and sufficient evidence of their fair value exists to
separately account for the elements.

Sales
Returns

An allowance for sales returns is recorded by the
Company based upon historical trends, timing of new product introductions, and
other factors. A return policy is in place with the Companys distributors to
restrict the volume of returned products.

Cash
Equivalents

All short-term investments with original maturities of
three months or less at date of purchase are considered cash equivalents.

Marketable
Securities

Marketable securities generally consist of U.S.
Treasury and money market securities, municipal securities and corporate
securities with long-term credit ratings of AAA and short-term credit ratings
of A-1. Marketable securities are classified as short-term or long-term in the
balance sheet based on their effective maturity date. All marketable securities
have maturities of three to twelve months and are classified as
available-for-sale. Available-for-sale

30

---



securities are recorded at fair value and any
unrealized holding gains and losses, net of the related tax effect, are
excluded from earnings and are reported as a separate component of accumulated
other comprehensive income (loss) until realized.

Sources of Supply

Many of the purchased components used to assemble the
Companys products are standard parts and are readily available. Other
components and subassemblies are manufactured to the Companys
specifications. Although the Company believes it has identified alternative
assembly contractors for most of its subassemblies, an actual change in such
contractors would likely require a period of training and test. Accordingly, a
sudden interruption in a supply relationship or the production capacity of one
or more of such contractors could result in the Companys inability to deliver
one or more products for a period of several months.

Inventories

Inventories are stated at the lower of cost
or market. Cost is determined primarily on a first-in, first-out (FIFO) basis. The Company
records reserves for potentially excess, obsolete and slow moving inventory
based upon historical loss trends, expected product lives and forecasted sales
demand.

Property
and Equipment

Property and equipment are stated at cost and
depreciated on a straight-line basis over periods of two to seven years. Leasehold improvements are amortized using the straight-line method over the
shorter of the propertys useful life or term of the underlying lease. Repairs
and maintenance costs are charged to operations as incurred.

Product Warranty

The Companys non-consumable products are warranted to
the end-user to ensure end-user confidence in design, workmanship and overall
quality. Warranty lengths vary by product type, ranging from periods of six to
twelve months. Warranty covers parts, labor and other associated expenses. The
Company performs the majority of warranty work, while authorized distributors
and dealers also perform some warranty work. Warranty expense is accrued at the
time of sale based on an analysis of historical claims experience, which
includes labor, freight and parts costs, with consideration of the proportion
of parts that can be re-used.

The warranty reserve rollforward, including provisions
and claims, is as follows for the years ended December 31, 2005, 2004 and 2003
(in thousands):

|                  |  |                     |     |                       |   |                   |  |                           |      |                  |   |    |   |  |   |     | 
|----------------- |  | ------------------- | --- | --------------------- | - | ----------------- |  | ------------------------- | ---- | ---------------- | - | -- | - |  | - | --- | 
|Years ended:      |  | Beginning
  Balance |     | Warranty
  Provisions |   | Warranty
  Claims |  | Foreign
  Exchange Impact |      | Ending
  Balance |  
|                  |  |                     |     |                       |   |                   |  |                           |      |                  |  
|                  |  |                     |     |                       |   |                   |  |                           |      |                  |   |    |   |  |   |     | 
|December 31, 2005 |  | $                   | 187 |                       | $ | 905               |  | $                         | (767 | )                | $ | (8 | ) |  | $ | 317 | 
|                  |  |                     |     |                       |   |                   |  |                           |      |                  |   |    |   |  |   |     | 
|December 31, 2004 |  | $                   | 172 |                       | $ | 510               |  | $                         | (498 | )                | $ | 3  |   |  | $ | 187 | 
|                  |  |                     |     |                       |   |                   |  |                           |      |                  |   |    |   |  |   |     | 
|December 31, 2003 |  | $                   | 170 |                       | $ | 283               |  | $                         | (287 | )                | $ | 6  |   |  | $ | 172 | 

Stock Based Compensation

As permitted by SFAS No. 123, Accounting for
Stock-Based
Compensation, the Company applies the intrinsic-value method prescribed in
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, to account for the issuance of stock incentives to
employees and directors. Accordingly, no compensation expense related to
employees and directors stock incentives has been recognized in the financial
statements as all options granted under stock incentive plans had an exercise
price equal to the market value of the underlying common stock on the date of
grant. Had compensation costs for the Companys stock incentive plans been
determined based on the fair value of the awards on the date of grant,
consistent with the provisions of SFAS No. 123, the Companys 2005, 2004 and 2003
net income and basic and diluted earnings per share would have been adjusted to
the proforma amounts stated in the following table (in thousands, except for
per share data):

31

---



|                                                |  |      |        |      |   |       |   |   |       |  
|----------------------------------------------- |  | ---- | ------ | ---- | - | ----- | - | - | ----- | -
|                                                |  | 2005 |        | 2004 |   | 2003  |  
|                                                |  |      |        |      |   |       |  
|Net income:                                     |  |      |        |      |   |       |   |   |       |  
|As reported                                     |  | $    | 11,368 |      | $ | 9,072 |   | $ | 7,666 |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Stock-based
  employee compensation, net of tax |  |      | (1,122 | )    |   | (664  | ) |   | (444  | )
|                                                |  |      |        |      |   |       |   |   |       |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Proforma                                        |  | $    | 10,246 |      | $ | 8,408 |   | $ | 7,222 |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Basic net income
  per share:                   |  |      |        |      |   |       |   |   |       |  
|As reported                                     |  | $    | 1.19   |      | $ | 0.98  |   | $ | 0.86  |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Stock-based
  employee compensation, net of tax |  |      | (0.11  | )    |   | (0.07 | ) |   | (0.05 | )
|                                                |  |      |        |      |   |       |   |   |       |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Proforma                                        |  | $    | 1.08   |      | $ | 0.91  |   | $ | 0.81  |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Diluted net
  income per share:                 |  |      |        |      |   |       |   |   |       |  
|As reported                                     |  | $    | 1.10   |      | $ | 0.91  |   | $ | 0.79  |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Stock-based
  employee compensation, net of tax |  |      | (0.10  | )    |   | (0.05 | ) |   | (0.05 | )
|                                                |  |      |        |      |   |       |   |   |       |  
|                                                |  |      |        |      |   |       |   |   |       |  
|Proforma                                        |  | $    | 1.00   |      | $ | 0.86  |   | $ | 0.74  |  
|                                                |  |      |        |      |   |       |   |   |       |  

The following table calculates the fair market value
of options granted on the date of grant using the Black-Scholes option pricing
model (in thousands, except for per share data):

|                                        |  |      |              |      |   |              |   |   |              |   | 
|--------------------------------------- |  | ---- | ------------ | ---- | - | ------------ | - | - | ------------ | - | 
|                                        |  |      |              |      |   |              |   |  
|                                        |  | 2005 |              | 2004 |   | 2003         |   |  
|                                        |  |      |              |      |   |              |   |  
|                                        |  |      |              |      |   |              |   |   |              |   | 
|Number of
  options granted             |  |      | 316          |      |   | 214          |   |   | 177          |   | 
|                                        |  |      |              |      |   |              |   |   |              |   | 
|Fair market
  value of options granted  |  | $    | 2,002        |      | $ | 997          |   | $ | 618          |   | 
|                                        |  |      |              |      |   |              |   |   |              |   | 
|Per share
  weighted average fair value |  | $    | 6.34         |      | $ | 4.67         |   | $ | 3.49         |   | 
|                                        |  |      |              |      |   |              |   |   |              |   | 
|Volatility
range                        |  |      | 26.0 to 51.6 | %    |   | 26.9 to 34.6 | % |   | 34.8 to 39.2 | % | 
|                                        |  |      |              |      |   |              |   |   |              |   | 
|Risk-free
  interest rate range         |  |      | 3.78 to 4.56 | %    |   | 2.96 to 3.93 | % |   | 2.30 to 2.98 | % | 
|                                        |  |      |              |      |   |              |   |   |              |   | 
|Expected
life of
  options in years     |  |      | 5.0          |      |   | 5.0          |   |   | 5.0          |   | 
|                                        |  |      |              |      |   |              |   |   |              |   | 

In connection with the
adoption of Statement of Financial Accounting Standards No. 123 (Revised 2004),
Share-Based Payment (SFAS No. 123R), the Company will begin expensing stock
options and other equity awards in 2006 based on their grant date fair values.

Research
and Development Costs

Research and development costs relate to hardware and
software development and enhancements to existing products. All such costs are
expensed as incurred.

Income
Taxes

Deferred tax assets and liabilities are recognized for
the estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a

32

---



change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is provided to
offset deferred tax assets if, based on the available evidence, it is more
likely than not that some or all of the deferred tax asset will not be
realized.

Net
Income Per Share

Basic income per share is calculated as income
available to common stockholders divided by the weighted average number of
common shares outstanding for the period. Diluted income per share is
calculated by dividing income by the weighted average number of common and
assumed conversion shares outstanding during each period. Assumed conversion
shares result from dilutive stock options and are computed using the treasury
stock method.

Foreign
Currency Translation / Transactions

The functional currency for each of the Companys
foreign subsidiaries is the respective local currency. The assets and
liabilities of the Companys foreign subsidiaries are translated into U.S.
dollars using period-end exchange rates, while revenues and expenses are
translated at average exchange rates prevailing during the year. The resulting
translation adjustments are recorded as a separate component of stockholders
equity in accumulated other comprehensive income (loss).

The Company enters into forward foreign exchange
contracts to hedge inter-company receivables denominated in Euros arising from
sales to its subsidiary in Germany. Gains or losses on forward foreign exchange
contracts are calculated at each period end and are recognized in net income in
the period in which they arose. The fair value of forward foreign exchange
contracts is recorded in other current assets or other current liabilities
depending on whether the net amount is a gain or a loss.

Comprehensive
Income

Comprehensive income consists of the Companys net
income, foreign currency translation adjustments, and unrealized holding gains
and losses from available-for-sale marketable securities and is presented in
the consolidated statements of stockholders equity and comprehensive income.

Operating
Leases

The Company leases its facilities and some of its
equipment under non-cancelable operating lease arrangements. The rental payments
under these leases are charged to expense as incurred.

Use of Estimates

The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from estimates on items such as allowance for doubtful accounts and sales
returns, inventory reserves, deferred tax assets, and warranty reserves.

Reclassifications

Certain prior period amounts in the Consolidated
Statements of Cash Flows and Notes to Consolidated Financial Statements have
been reclassified to conform with the current year presentation.

New
Accounting Pronouncements

In December
2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standard (SFAS) No. 123 (Revised 2004), Share-Based
Payment.  SFAS No 123R is a revision of SFAS No. 123, Accounting for
Stock-Based Compensation and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock
Issued to Employees and its related implementation guidance. SFAS No. 123R
focuses primarily on accounting for transactions in which an entity obtains
employee services through share-based payment transactions. SFAS No 123R
requires a public entity to measure the cost of employee services received in
exchange for the award of equity instruments based on the fair value of the
award at the date of grant. The cost will be recognized over the period during
which an employee is required to provide services in exchange for the
award. This Statement also amends SFAS No. 95, Statement of Cash Flows, to
require that excess tax benefits be reflected as financing cash inflows rather
than operating cash inflows. The Company will adopt the provisions of SFAS No. 123R effective with the first quarter of 2006 using the modified prospective
method. While the Company cannot precisely determine the impact on net earnings
that may result from the adoption of SFAS No 123R, estimated compensation
expense related to the years ended December 31, 2005, 2004 and 2003 can be
found in the

33

---



notes to
the Consolidated Financial Statements included in this Form 10-K. The ultimate
amount of future compensation expense will be dependent on the number of option
shares granted during each year, their timing and vesting period and the
volatility of the Companys common stock, among other factors. The Company has
not completed its evaluation of the impact of adopting SFAS No. 123R, but
expects the adoption to have an adverse impact on net earnings and net income
per share.

FASB
Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations, was issued in March 2005, and provides clarification on certain
provisions of SFAS No. 143, Accounting for Asset Retirement Obligations. Under
Interpretation No. 47, an entity is required to recognize a liability for the
fair value of a conditional asset retirement obligation if the fair value of
the liability can be reasonably estimated. The fair value of a liability for a
conditional asset retirement obligation should be recognized when incurred,
generally upon acquisition, construction, development or through the normal
operation of the asset. This Interpretation also clarifies when an entity would
have sufficient information to reasonably estimate the fair value of an asset
retirement obligation. Interpretation No. 47 was effective for the Company in
fiscal year 2005, and did not have an impact on the Companys consolidated
financial statements.

In November
2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No.
 43, Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4,
Inventory Pricing, to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling charges and spoilage. This Statement
requires that those items be recognized as current period charges regardless of
whether they meet the criterion of so abnormal which was the criterion
specified in ARB No. 43. In addition, this Statement requires that allocation of
fixed production overheads to the cost of production be based on normal
capacity of the production facilities. The provisions under SFAS No. 151 are
effective for the Company beginning January 1, 2006, and shall be applied
prospectively. The Company does not expect that the adoption of this
pronouncement will have a significant impact on its consolidated financial
statements.

In May
2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections. SFAS No. 154 replaces APB No. 20, Accounting Changes, and SFAS
No. 3, Reporting Changes in Interim Financial Statements. SFAS No. 154 requires
retrospective application to prior periods financial statements of voluntary
changes in accounting principle unless it is impracticable to do
so. Retrospective application refers to the application of a different
accounting principle to previously issued financial statements as if that
principle had always been used. Statement No. 154s retrospective-application
requirement replaces APB 20s requirement to recognize most voluntary changes
in accounting principle by including in net income of the period of the change
the cumulative effect of changing to the new accounting principle. This
Statement is effective for the Company for accounting changes and corrections
of errors made beginning January 1, 2006. The Company does not currently expect
the adoption of this pronouncement to have a significant impact on its
consolidated financial statements.

2)     Marketable
Securities

The amortized cost, gross unrealized holding gains,
gross unrealized holding losses and fair value of available-for-sale securities
by major security type and class of security at December 31, 2005 and 2004 are
reflected in the following table (in thousands). Unrealized holding gains and
losses are included in accumulated other comprehensive income (loss) until
realized.

| |                            |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
| | -------------------------- |  | ----------------- | ------ | ------------------------------------ |  | ------------------------------------- |  | ---------- | --- | - |  | ------ | 
| |                            |  | Amortized 
  cost |        | Gross 
  unrealized 
  holding gains |  | Gross 
  unrealized 
  holding losses |  | Fair value |    
| |                            |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
| | At December
31,
  2005     |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
| | Municipal
  securities     |  | $                 | 12,930 |                                      |  |                                      |  |            | (21 | ) |  | 12,909 | 
| | Money market
  securities  |  |                   | 33,085 |                                      |  | 2                                     |  |            | (14 | ) |  | 33,073 | 
| |                            |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
|
| | Total                      |  | $                 | 46,015 |                                      |  | 2                                     |  |            | (35 | ) |  | 45,982 | 
| |                            |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
| |                            |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
| | At December
31,
  2004     |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
| | U.S. Treasury
  securities |  | $                 | 13,773 |                                      |  |                                      |  |            | (56 | ) |  | 13,717 | 
| | Municipal
  securities     |  |                   | 10,224 |                                      |  | 1                                     |  |            | (10 | ) |  | 10,215 | 
| | Money market
  securities  |  |                   | 13,246 |                                      |  |                                      |  |            | (5  | ) |  | 13,241 | 
| | Corporate
  securities     |  |                   | 2,004  |                                      |  |                                      |  |            | (2  | ) |  | 2,002  | 
| |                            |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 
|
| | Total                      |  | $                 | 39,247 |                                      |  | 1                                     |  |            | (73 | ) |  | 39,175 | 
| |                            |  |                   |        |                                      |  |                                       |  |            |     |   |  |        | 

34

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3)     Inventories

Inventories consisted of the following as of December
31 (in thousands):

|                                             |  |      |       |      |  |       | 
|-------------------------------------------- |  | ---- | ----- | ---- |  | ----- | 
|                                             |  | 2005 |       | 2004 | 
|                                             |  |      |       |      | 
|                                             |  |      |       |      |  |       | 
|Finished goods
  and demonstration equipment |  | $    | 1,562 |      |  | 1,385 | 
|Work-in-process                              |  |      | 290   |      |  | 480   | 
|Purchased parts
  and subassemblies          |  |      | 4,769 |      |  | 5,531 | 
|                                             |  |      |       |      |  |       | 
|                                             |  | $    | 6,621 |      |  | 7,396 | 
|                                             |  |      |       |      |  |       | 

4)     Property
and Equipment

Property and equipment consisted of the following as
of December 31 (in thousands):

|                                               |  |      |        |      |  |        |  
|---------------------------------------------- |  | ---- | ------ | ---- |  | ------ | -
|                                               |  | 2005 |        | 2004 | 
|                                               |  |      |        |      | 
|                                               |  |      |        |      |  |        |  
|Manufacturing
  equipment                      |  | $    | 3,217  |      |  | 2,965  |  
|Development
  fixtures and equipment           |  |      | 613    |      |  | 589    |  
|Data equipment
  and furniture                 |  |      | 2,303  |      |  | 2,044  |  
|Leasehold
  improvements                       |  |      | 1,019  |      |  | 733    |  
|                                               |  |      |        |      |  |        |  
|                                               |  |      | 7,152  |      |  | 6,331  |  
|Less accumulated depreciation and amortization |  |      | (4,627 | )    |  | (3,945 | )
|                                               |  |      |        |      |  |        |  
|                                               |  | $    | 2,525  |      |  | 2,386  |  
|                                               |  |      |        |      |  |        |  

Depreciation and amortization expense was $1,228,000,
$919,000 and $930,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

5)     Credit
Agreement

On March 29, 2004, the Company entered into a term
note agreement (the Credit Agreement) with a bank. The Credit Agreement was
amended effective June 30, 2005, and allows for advances under an unsecured
revolving loan up to a maximum advance of $10 million and a foreign exchange
facility which allows for foreign exchange contracts up to an aggregate of $5
million. The Credit Agreement, as amended, is effective until July 1, 2006. The
outstanding principal balance of the note bears interest at a fluctuating rate
per annum equal to the Prime Rate in effect from time to time, or at a fixed
rate per annum at one and one-half percent (1.50%) above LIBOR in effect on the
first day of the applicable fixed rate term. No amounts were outstanding under
the Credit Agreement at December 31, 2005 and 2004.

The Credit Agreement contains various covenants
pertaining to minimum tangible net worth, minimum EBITDA and minimum
unencumbered liquid assets. The Company was in compliance with all covenants as
of December 31, 2005.

35

---



6)     Income Taxes

The provision
for income tax expense (benefit) consists of the following (in thousands):

|               |  |                          |       |      |  |       |  |  |       |  
|-------------- |  | ------------------------ | ----- | ---- |  | ----- |  |  | ----- | -
|               |  | Year ended
  December 31 |      
|               |  |                          |      
|               |  | 2005                     |       | 2004 |  | 2003  | 
|               |  |                          |       |      |  |       | 
|               |  |                          |       |      |  |       |  |  |       |  
|Current:       |  |                          |       |      |  |       |  |  |       |  
|U.S. Federal   |  | $                        | 5,687 |      |  | 3,817 |  |  | 3,686 |  
|State          |  |                          | 1,026 |      |  | 611   |  |  | 690   |  
|Foreign        |  |                          | 354   |      |  | 309   |  |  | 285   |  
|               |  |                          |       |      |  |       |  |  |       |  
|Total current  |  |                          | 7,067 |      |  | 4,737 |  |  | 4,661 |  
|               |  |                          |       |      |  |       |  |  |       |  
|               |  |                          |       |      |  |       |  |  |       |  
|Deferred:      |  |                          |       |      |  |       |  |  |       |  
|U.S. Federal   |  |                          | (328  | )    |  | 193   |  |  | (205  | )
|State          |  |                          | (64   | )    |  | 41    |  |  | (50   | )
|               |  |                          |       |      |  |       |  |  |       |  
|Total deferred |  |                          | (392  | )    |  | 234   |  |  | (255  | )
|               |  |                          |       |      |  |       |  |  |       |  
|               |  |                          |       |      |  |       |  |  |       |  
|               |  | $                        | 6,675 |      |  | 4,971 |  |  | 4,406 |  
|               |  |                          |       |      |  |       |  |  |       |  

Actual current
tax liabilities are lower than the associated expense reflected for 2005 and
2004 by $868,000 and $522,000, respectively, due to the impact of stock option
deduction benefits recorded as credits to additional paid-in capital in
equity.

Total tax
expense differs from the expected tax expense, computed by applying the federal
statutory rate of 35% to earnings before income taxes as follows (in
thousands):

|                                                      |  |      |       |      |  |       |   |  |       |  
|----------------------------------------------------- |  | ---- | ----- | ---- |  | ----- | - |  | ----- | -
|                                                      |  |      |       |      |  |       |  
|                                                      |  | 2005 |       | 2004 |  | 2003  |  
|                                                      |  |      |       |      |  |       |  
|                                                      |  |      |       |      |  |       |   |  |       |  
|Expected income tax
  expense                         |  | $    | 6,315 |      |  | 4,915 |   |  | 4,225 |  
|State income taxes, net of
  federal tax effect       |  |      | 625   |      |  | 424   |   |  | 423   |  
|Extraterritorial income
  exclusion                   |  |      | (110  | )    |  | (154  | ) |  | (138  | )
|Section 199 manufacturers
  deduction                |  |      | (101  | )    |  |      |   |  |      |  
|Federal R&D credit                                    |  |      | (115  | )    |  | (138  | ) |  | (94   | )
|Taxes on foreign income at
  rates different than 35% |  |      | 89    |      |  | 31    |   |  | 28    |  
|Benefit of lower federal
  tax bracket                |  |      | (44   | )    |  | (113  | ) |  | (121  | )
|Other, net                                            |  |      | 16    |      |  | 6     |   |  | 83    |  
|                                                      |  |      |       |      |  |       |   |  |       |  
|                                                      |  |      |       |      |  |       |   |  |       |  
|                                                      |  | $    | 6,675 |      |  | 4,971 |   |  | 4,406 |  
|                                                      |  |      |       |      |  |       |   |  |       |  

The American
Jobs Creation Act, signed into law in October 2004 and effective for the
Company beginning in 2005, replaces the extraterritorial income exclusion over
time with a manufacturers tax deduction for domestic manufacturing and
production activities.  The
manufacturers tax deduction is expected to have an approximate two percentage
point impact on the Companys effective tax rate after the full phase-in of the
deduction in 2010.

36

---



The tax
effects of temporary differences that give rise to significant portions of
deferred tax assets (liabilities) as of December 31, are presented below (in
thousands):

|                                                         |  |      |       |      |  |       |   |  |       | 
|-------------------------------------------------------- |  | ---- | ----- | ---- |  | ----- | - |  | ----- | 
|                                                         |  | 2005 |       | 2004 |  | 2003  |  
|                                                         |  |      |       |      |  |       |  
|                                                         |  |      |       |      |  |       |   |  |       | 
|Inventory reserves                                       |  | $    | 354   |      |  | 262   |   |  | 330   | 
|Accounts receivable
  reserves                           |  |      | 303   |      |  | 203   |   |  | 290   | 
|Gross margin recognition
  on sale to foreign subsidiary |  |      | 394   |      |  | 292   |   |  | 273   | 
|Unrealized foreign
  exchange loss                       |  |      | (10   | )    |  | 81    |   |  | 122   | 
|Deferred maintenance
  revenue                           |  |      | 82    |      |  | 76    |   |  | 71    | 
|Accrued payroll                                          |  |      | 108   |      |  | 88    |   |  | 66    | 
|Warranty accrual                                         |  |      | 104   |      |  | 53    |   |  | 50    | 
|Amortization                                             |  |      | 47    |      |  | 16    |   |  | 10    | 
|Fixed assets                                             |  |      | (28   | )    |  | (138  | ) |  | 6     | 
|Other                                                    |  |      | 43    |      |  | 72    |   |  | 21    | 
|                                                         |  |      |       |      |  |       |   |  |       | 
|Total net deferred tax
  assets                          |  | $    | 1,397 |      |  | 1,005 |   |  | 1,239 | 
|                                                         |  |      |       |      |  |       |   |  |       | 

The Company
has established a full valuation allowance on the tax benefit of losses
(totaling approximately $157,000) generated by a new subsidiary in Japan.  The valuation allowance was calculated in
accordance with the provisions of SFAS No. 109, Accounting for Income Taxes,
which requires that a valuation allowance be established or maintained when it
is more likely than not that all or a portion of deferred tax assets will not
be realized.  The Company believes that
it is more likely than not that the future results of its U.S. and European
operations will generate sufficient taxable income to realize the tax benefits
related to the Companys net deferred tax assets.

At the time of
filing this Annual Report on Form 10-K, the Internal Revenue Service was
conducting an audit of the Companys federal tax returns for tax years 2003 and
2004.

7)     Stockholders Equity

Stock Options

The Companys
1992 Stock Option Plan (the Plan), initially approved by shareholders in May
2003, provides for the grant of incentive stock options, non-qualified stock
options and restricted stock awards to certain key administrative, managerial
and executive employees and the automatic periodic grants of stock options to
non-employee directors. The exercise price of stock options granted under the
Plan is equal to the market value on the date of grant.  Options issued to employees through December
31, 2005 generally become exercisable over a two-year period and terminate ten
years from the date of grant.  Stock
options granted to non-employee directors vest six months from the date of
grant and terminate ten years from the date of grant.  Effective May 17, 2005, the Plan was amended to expand the types
of awards available under the Plan to include deferred stock awards, stock
appreciation rights and performance stock.
Pursuant to the Plan, the following stock options are currently issued and
outstanding (in thousands, except per share data):

37

---



|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|--------------------------------------------- |  | ------------------------------ | ---- | --------------------- |  | ----------------------------------- | ----- | - |  | - | ----- |  | 
|                                              |  | Shares
  available
  for grant |      | Options
  outstanding |  | Weighted
  average
  exercise price |      
|                                              |  |                                |      |                       |  |                                     |       |   |  |  
|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|Balance at December 31,
  2002                |  |                                | 293  |                       |  |                                     | 1,424 |   |  | $ | 4.76  |  | 
|Additional shares
  available                 |  |                                | 400  |                       |  |                                     |      |   |  |   |      |  | 
|Shares eliminated due to
  plan consolidation |  |                                | (25  | )                     |  |                                     |      |   |  |   |      |  | 
|Granted                                       |  |                                | (177 | )                     |  |                                     | 177   |   |  |   | 9.62  |  | 
|Exercised                                     |  |                                |     |                       |  |                                     | (356  | ) |  |   | 2.15  |  | 
|Canceled                                      |  |                                | 10   |                       |  |                                     | (10   | ) |  |   | 9.89  |  | 
|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|Balance at December 31,
  2003                |  |                                | 501  |                       |  |                                     | 1,235 |   |  | $ | 6.17  |  | 
|Granted                                       |  |                                | (214 | )                     |  |                                     | 214   |   |  |   | 14.09 |  | 
|Exercised                                     |  |                                |     |                       |  |                                     | (165  | ) |  |   | 3.67  |  | 
|Canceled                                      |  |                                | 6    |                       |  |                                     | (6    | ) |  |   | 13.45 |  | 
|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|Balance at December 31,
  2004                |  |                                | 293  |                       |  |                                     | 1,278 |   |  | $ | 7.78  |  | 
|Additional shares
  available                 |  |                                | 500  |                       |  |                                     |      |   |  |   |      |  | 
|Granted                                       |  |                                | (315 | )                     |  |                                     | 315   |   |  |   | 19.34 |  | 
|Exercised                                     |  |                                |     |                       |  |                                     | (242  | ) |  |   | 6.49  |  | 
|Canceled                                      |  |                                | 11   |                       |  |                                     | (11   | ) |  |   | 16.10 |  | 
|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|                                              |  |                                |      |                       |  |                                     |       |   |  |   |       |  | 
|Balance at December 31,
  2005                |  |                                | 489  |                       |  |                                     | 1,340 |   |  | $ | 10.67 |  | 

The following
table summarizes information concerning stock options outstanding and
exercisable options at December 31, 2005 (in thousands, except per share data):

|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     |  |   |       |  |       |  |  |   |       | 
|---------------------- | ----- | --------------------- | - | ----------------------------------- |  | ----------------------------------- |  | --------------------- | ---- | ----------------------------------- |  | - | ----- |  | ----- |  |  | - | ----- | 
|OPTIONS
  OUTSTANDING  |       | OPTIONS
  EXERCISABLE |  
|                       |       |                       |  
|Exercise
  Price Range |       | Number
  Outstanding  |   | Weighted
  Average
  Remaining Life |  | Weighted
  Average
  Exercise Price |  | Number 
  Exercisable |      | Weighted
  Average
  Exercise Price | 
|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     | 
|$                      | 1.33  |                      | $ | 2.67                                |  | 285                                 |  |                       | 1.29 |                                     |  | $ | 2.12  |  | 286   |  |  | $ | 2.12  | 
|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     |  |   |       |  |       |  |  |   |       | 
|$                      | 2.68  |                      | $ | 9.00                                |  | 304                                 |  |                       | 5.98 |                                     |  | $ | 7.89  |  | 304   |  |  | $ | 7.89  | 
|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     |  |   |       |  |       |  |  |   |       | 
|$                      | 9.01  |                      | $ | 13.60                               |  | 276                                 |  |                       | 5.07 |                                     |  | $ | 10.60 |  | 265   |  |  | $ | 10.50 | 
|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     |  |   |       |  |       |  |  |   |       | 
|$                      | 13.61 |                      | $ | 17.00                               |  | 170                                 |  |                       | 7.87 |                                     |  | $ | 14.45 |  | 129   |  |  | $ | 14.54 | 
|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     |  |   |       |  |       |  |  |   |       | 
|$                      | 17.01 |                       | $ | 19.95                               |  | 202                                 |  |                       | 9.16 |                                     |  | $ | 18.21 |  | 66    |  |  | $ | 18.21 | 
|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     |  |   |       |  |       |  |  |   |       | 
|$                      | 19.95 |                      | $ | 29.14                               |  | 103                                 |  |                       | 9.44 |                                     |  | $ | 21.70 |  | 84    |  |  | $ | 21.04 | 
|                       |       |                       |   |                                     |  |                                     |  |                       |      |                                     |  |   |       |  |       |  |  |   |       | 
|                      
|                       |       |                       |   |                                     |  | 1,340                               |  |                       | 5.78 |                                     |  | $ | 10.67 |  | 1,134 |  |  | $ | 9.38  | 

In connection
with the acquisition of Cedar Technologies in March 2000, the Company assumed
sponsorship of Cedars employee stock option plan.  The plan was not approved by Rimages shareholders and no
additional grants were issued from the plan subsequent to the acquisition.  As of December 31, 2005, the plan was
inactive and no shares were outstanding under the plan.  Exercises of options and warrants originally
issued and outstanding under the plan totaled 69,113 shares in 2004 and 8,628
shares in 2003.  Additionally, 312
shares expired unexercised in 2004.

Employee Stock Purchase Plan

In February
2001, the Companys board of directors adopted, and in May 2001 the
shareholders approved, the Employee Stock Purchase Plan (the Plan). A total
of 300,000 common shares were reserved for issuance under the Plan. After a
minimum six-month waiting period, the Plan allows employees to elect, at one
year intervals, to contribute between 1% and 10% of their compensation, subject
to certain limitations, to purchase shares of common

38

---



stock at 85%
of the lower of fair market value of such shares on the first or last business
day of each one year period. As of December 31, 2005, 115,945 shares have been
issued under the Plan.

Preferred Stock Purchase Rights

On September 16, 2003, the Companys Board of
Directors adopted a shareholder rights plan and declared a dividend of one
preferred share purchase right (a Right) for each share of common stock of
the Company outstanding on October 6, 2003 and with respect to each share
of common stock issued thereafter.
The rights become exercisable only after any person or group (the
Acquiring Person) becomes or would become the beneficial owner of 15% or more
of the Companys outstanding common stock.

Each Right
entitles the registered holder to purchase from the Company 1/100 of a Series A
Junior Participating Preferred Share at a price of $100.00 per 1/100 of a
Preferred Share, subject to adjustment.
In the event that any person or group becomes an Acquiring Person, each
holder of a Right, other than Rights that are or were beneficially owned by the
Acquiring Person (which will thereafter be void), will thereafter have the
right to receive, upon exercise thereof at the then current exercise price of
the Right, that number of Common Shares having a market value of two times the
exercise price of the Right, subject to certain possible adjustments.  If the Company is acquired in certain
mergers or other business combination transactions, or 50% or more of the
assets or earning power of the Company and its subsidiaries (taken as a whole)
are sold, each holder of a Right (other than Rights that have become void under
the terms of the Rights Agreement) will thereafter have the right to receive,
upon exercise of the Right at the then current exercise price of the Right, the
number of common shares of the acquiring company (or, in certain cases, on of
its affiliates) having a market value of two times the exercise price of the
Right. At any time prior to the time that a person or group has become an
Acquiring Person, the Companys Board of Directors may redeem the Rights in
whole, but not in part, at a price of $.001 per Right, subject to adjustment,
payable in cash. The Rights will expire at the close of business on September
16, 2013, unless extended or earlier redeemed by the Company.

No preferred
shares have been issued or are outstanding under the shareholder rights plan as
of December 31, 2005.

8)     Net
Income Per Share

The following
table identifies the components of net income per basic and diluted share (in
thousands, except for per share amounts).
A total of 623, 2,743, and 6,274 assumed conversion shares during 2005,
2004, and 2003, respectively, were excluded from the net income per share
computation as their effect was anti-dilutive.

|                                 |  |            |        |                                           |  |                    |  |   |       |  
|-------------------------------- |  | ---------- | ------ | ----------------------------------------- |  | ------------------ |  | - | ----- | -
|                                 |  | Net Income |        | Weighted
  Average
  Shares
  Outstanding |  | Per Share
  Amount | 
|                                 |  |            |        |                                           |  |                    | 
|2005:                            |  |            |        |                                           |  |                    |  |   |       |  
|Basic                            |  | $          | 11,368 |                                           |  | 9,530              |  | $ | 1.19  |  
|Dilutive effect of stock options |  |            |       |                                           |  | 782                |  |   | (0.09 | )
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|Diluted                          |  | $          | 11,368 |                                           |  | 10,312             |  | $ | 1.10  |  
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|2004:                            |  |            |        |                                           |  |                    |  |   |       |  
|Basic                            |  | $          | 9,072  |                                           |  | 9,290              |  | $ | 0.98  |  
|Dilutive effect of stock options |  |            |       |                                           |  | 642                |  |   | (0.07 | )
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|Diluted                          |  | $          | 9,072  |                                           |  | 9,932              |  | $ | 0.91  |  
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|2003:                            |  |            |        |                                           |  |                    |  |   |       |  
|Basic                            |  | $          | 7,666  |                                           |  | 8,931              |  | $ | 0.86  |  
|Dilutive effect of stock options |  |            |       |                                           |  | 812                |  |   | (0.07 | )
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|                                 |  |            |        |                                           |  |                    |  |   |       |  
|Diluted                          |  | $          | 7,666  |                                           |  | 9,743              |  | $ | 0.79  |  
|                                 |  |            |        |                                           |  |                    |  |   |       |  

39

---



9)     Lease Commitments

The Company leases its facilities and some of
its equipment under non-cancelable operating lease arrangements. The rental
payments under these leases are charged to expense as incurred. The following
is a schedule of future minimum lease payments, excluding property taxes and
other operating expenses, required under all non-cancelable operating leases
(in thousands):

|                           |  |                            |       | 
|-------------------------- |  | -------------------------- | ----- | 
|Year ending December 31    |  | Total
  operating
  leases |      
|                           |  |                            |      
|                           |  |                            |       | 
|2006                       |  | $                          | 769   | 
|2007                       |  |                            | 551   | 
|2008                       |  |                            | 339   | 
|2009                       |  |                            | 50    | 
|2010                       |  |                            | 4     | 
|                           |  |                            |       | 
|                           |  |                            |       | 
|Net minimum lease payments |  | $                          | 1,713 | 
|                           |  |                            |       | 

Rent expense under operating leases amounted
to approximately $870,000, $858,000, and $805,000 for the years ended December
31, 2005, 2004, and 2003, respectively.

10)     Profit
Sharing and Savings Plan

Rimage has a
profit sharing and savings plan under Section 401(k) of the Internal Revenue
Code. The plan allows employees to contribute up to 16% of pretax compensation.
The Company matches a percentage of employees contributions. Matching
contributions totaled $278,000, $235,000, and $191,000 in 2005, 2004, and 2003,
respectively.

11)     Business
Segment Information / Major Customers

The Company
has identified one reportable operating segment consisting of CD-R and DVD-R publishing
systems required for producing discs with customized digital content on an
on-demand basis. The Companys publishing systems, which include equipment to
handle a full range of low-to-high production volumes, incorporate robotics,
software and custom printing technology for disc labeling. The Companys
hardware products consist of two primary product lines: The Producer line,
which accommodates higher volume CD-R and DVD-R production requirements, and
the Desktop line of lower-cost products for office and other desktop
applications. Rimage focuses its CD-R and DVD-R publishing solutions on a set
of vertical markets with special needs for customized, on-demand digital
information, including digital photography, medical imaging, banking and
finance, government and business offices. Rimage utilizes the following
principal means of distributing its products: Direct sales using its own sales
force, primarily in Europe; a two tier distribution system of distributors to
value added resellers in Europe, the U.S. and Latin America; and a distributor
to end-user system in Asia Pacific and in some areas in Europe. The Companys
hardware products are assembled from components purchased from third party
suppliers.  Components include
CD-R/DVD-R drives, circuit boards, electric motors, machined and molded parts,
precision sheet metal assemblies, and other mechanical parts.

Two of the
Companys unaffiliated customers provided more than 10% of consolidated
revenues in 2005, generating approximately $11,791,000 and $10,664,000 of
sales, respectively. Accounts receivable balances at December 31, 2005 from
these customers amounted to $1,518,000 and $1,243,000 respectively. Two
unaffiliated customers also generated more than 10% of consolidated revenues in
2004, contributing approximately $8,914,000 and $8,793,000 to total sales.
Related accounts receivable balances with these customers totaled $1,442,000
and $1,332,000, respectively, as of December 31, 2004. The Company derived
approximately $8,379,000 and $6,276,000 of its 2003 sales from two unaffiliated
customers. Customers generating more than 10% of the Companys revenues each
year were distributors or strategic partners of the Company.

40

---



The Companys revenues from
each of its principal geographic regions were as follows (in thousands): Year Ended December 31,2005

2004

2003North America

$
63,152

$
43,864

$
30,938Europe


26,798


23,144


19,888Other


5,460


3,840


2,971Total

$
95,410

$
70,848

$
53,797 The Companys revenues from
each of its principal products and  services were as follows (in thousands): Year Ended December 31,2005

2004

2003Equipment:Producer

$
48,428

$
36,186

$
31,133Desktop


10,692


7,887


6,403Total


59,120


44,073


37,536Consumables, parts and
repairs


32,737


23,628


13,606Maintenance Contracts


3,553


3,147


2,655Total

$
95,410

$
70,848

$
53,797 Long-lived assets of the
Company were located as follows (in thousands): December
  31, 2005

December
  31, 2004North America

$
2,352

$
2,151Germany


159


235Japan


14


Total

$
2,525

$
2,386 12)     Related Party Transactions One of the Companys
non-employee directors is also a director of one of the Companys vendors, a
supplier of printed circuit boards used in the assembly of the Companys CD-R
and DVD-R publishing systems.  The
Company purchased component parts from this supplier approximating $2.2
million, $1.5 million and $1.1 million for the years ended December 31, 2005,
2004 and 2003, respectively.
Outstanding accounts payable with this supplier totaled approximately
$127,000 and $206,000 at December 31, 2005 and 2004, respectively, payable under
standard 30-day payment terms. 13)     Commitments and
Contingencies The Company is exposed to a
number of asserted and unasserted claims encountered in the normal course of
business. In the opinion of management, the resolution of these matters will
not have a material adverse effect on the Companys financial position or
results of operations. At December 31, 2005, the
Company had $9.9 million of non-cancelable purchase order commitments to a
supplier of the Company for delivery of inventory during 2006.  This amount does not represent all anticipated
inventory purchase requirements for 2006, but represents only those items for
which the Company is contractually obligated. 41   14)     Fair Value of
Financial Instruments

The following methods and
assumptions were used by the Company in estimating the fair value of its
financial instruments.

Cash and cash equivalents: The
carrying amount approximates fair value because of the short maturity of those
instruments.

Marketable securities: The fair
values are determined using quoted market prices.

Foreign currency forward
exchange contracts: The fair value is the amount the Company would receive or
pay to terminate the contracts at the reporting date. The fair value of foreign
currency forward exchange contracts at December 31, 2005 was a net gain of $25,000
recorded in other current assets, and at December 31, 2004, a net loss of
$210,000 recorded in other current liabilities.

Trade accounts receivable and accounts payable:  The carrying
amount approximates fair value
because of the short maturity of those instruments.

42

15)     Supplemental
Quarterly Data  Unaudited (dollars in thousands, except per share data)

2005

2004Fourth

Third

Second

First

Fourth

Third

Second

FirstRevenues

$
24,266


27,962


22,307


20,875


20,894


17,879


17,631


14,444Cost of revenues


13,459


14,571


12,662


11,265


11,064


10,029


9,564


7,370Gross
profit


10,807


13,391


9,645


9,610


9,830


7,850


8,067


7,074Operating expenses:Research and
development


1,335


1,399


1,499


1,279


1,168


1,010


1,227


1,125Selling,
general and administrative


6,233


5,937


4,787


4,360


4,279


3,708


3,658


3,211Total operating
expenses


7,568


7,336


6,286


5,639


5,447


4,718


4,885


4,336Operating income


3,239


6,055


3,359


3,971


4,383


3,132


3,182


2,738Other income
(expense):Interest,
net


537


400


333


274


216


174


124


143Gain (loss) on
currency exchange


(21
)

(40
)

(6
)

(67
)

42





(14
)

(10
)Other,
net


8





7


(6
)

(4
)

17


(93
)

13Total other income,
net


524


360


334


201


254


191


17


146Income before income
taxes


3,763


6,415


3,693


4,172


4,637


3,323


3,199


2,884Income tax expense


1,459


2,330


1,405


1,481


1,538


1,213


1,168


1,052Net income

$
2,304


4,085


2,288


2,691


3,099


2,110


2,031


1,832Net income per basic
share

$
0.24


0.43


0.24


0.29


0.33


0.23


0.22


0.20Net income per diluted
share

$
0.22


0.39


0.22


0.27


0.31


0.21


0.20


0.18ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.    CONTROLS AND PROCEDURES


a)          
Evaluation of Disclosure Controls and Procedures



The Companys Chief Executive Officer,
Bernard P. Aldrich, and the Companys Chief Financial Officer, Robert M. Wolf,
have evaluated the Companys disclosure controls and procedures as of the end
of the period covered by this report.
Based upon such evaluation, they have concluded that these disclosure
controls and procedures are effective.


(b)          Changes
in Internal Control Over Financial Reporting

There have been no changes in internal controls over financial reporting
that occurred during the fiscal quarter covered by this report that have
materially affected, or are reasonable likely to materially affect, the
Companys internal control over financial reporting.

43


ITEM 9B.    OTHER
INFORMATION

None.

PART III

ITEM 10.    DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT

The
information required by this item is incorporated herein by reference to the
following sections of the Companys Proxy Statement for its 2006 Annual Meeting
of Shareholders, which will be filed with the Securities and Exchange
Commission pursuant to Regulation 14A within 120 days after the close
of the fiscal year for which this report is filed (the Proxy Statement):

| |   |                                                                      
| | - | ---------------------------------------------------------------------
| |  | Ownership of
  Voting Securities by Principal Holders and Management;
| |   |                                                                      
| |  | Proposal
  1Election of Directors;                                  
| |   |                                                                      
| |  | Nominees for
  Election of Directors;                                
| |   |                                                                      
| |  | Executive
  Officers of the Company;                                 
| |   |                                                                      
| |  | Executive
  Compensation;                                            
| |   |                                                                      
| |  | Section
  16(a) Beneficial Ownership Reporting Compliance;           
| |   |                                                                      
| |  | Corporate
  Governance; and                                          
| |   |                                                                      
| |  | Code of
  Ethics.                                                    

ITEM 11.    EXECUTIVE
COMPENSATION

The
information required by this item is incorporated herein by reference to the
section of the Companys Proxy Statement entitled Executive Compensation.

ITEM 12.    SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED  STOCKHOLDER MATTERS

The
information required by this item is incorporated herein by reference to the
section of the Companys Proxy Statement entitled Ownership of Voting
Securities by Principal Holders and Management.

ITEM 13.    CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS

Not
Applicable.

ITEM 14.    PRINCIPAL
ACCOUNTANT FEES AND SERVICES

The
information required by this item is incorporated herein by reference to the
section of the Companys Proxy Statement entitled Relationship with
Independent Accountants.

44

---



PART IV

ITEM 15.    EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES

|    |                                                                                           |                      
|--- | ----------------------------------------------------------------------------------------- | ---------------------
|(a) | (1) Financial
  Statements.See Part II, Item 8 of this report.                            |                      
|    |                                                                                           |                      
|    | (2) Financial
  Statement Schedules.                                                      |                      
|    |                                                                                           | Page in thisForm 10-K
|    |                                                                                           |                      
|    |                                                                                           |                      
|    | Report of
  Independent Registered Public Accounting Firm on Financial Statement Schedule | 46                   
|    |                                                                                           |                      
|    | (3) Exhibits.
  See Index to Exhibits on page 48 of this report.                          |                      
|    |                                                                                           |                      
|(b) | See Index to Exhibits on page 48 of this
  report.                                        |                      

45

---



Report of Independent Registered Public
Accounting Firm

The Board of Directors and Stockholders
Rimage Corporation:

Under date of March 15, 2006, we reported on the consolidated balance
sheets of Rimage Corporation and subsidiaries as of December 31, 2005 and 2004,
and the related consolidated statements of income, stockholders equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 2005, as contained in the 2005 Annual Report. These
consolidated financial statements and our report thereon are incorporated by
reference in the annual report on Form 10-K for the year 2005. In connection
with our audits of the aforementioned consolidated financial statements, we
also audited the related financial statement schedule as listed in the
accompanying index. This financial statement schedule is the responsibility of
the Companys management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.

In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Minneapolis, Minnesota
March 15, 2006

46

---



SIGNATURES

Pursuant
to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereto duly authorized.

|                      |                    |     |                           | 
|--------------------- | ------------------ | --- | ------------------------- | 
|Dated: March 15, 2006 | RIMAGE CORPORATION
|                      |                   
|                      |                    | By: | /s/ Bernard
  P. Aldrich 
|                      |                    |     |                           | 
|                      |                    |     | Bernard
  P. Aldrich     
|                      |                    |     | Chief
  Executive Officer
|                      |                    |     |                          
|                      |                    | By: | /s/ Robert
  M. Wolf     
|                      |                    |     |                           | 
|                      |                    |     | Robert
  M. Wolf         
|                      |                    |     | Chief
  Financial Officer

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated. Each person whose signature appears
below constitutes and appoints Bernard P. Aldrich and Robert M. Wolf as his
true and lawful attorneys-in-fact and agents, each acting alone, with full
power of substitution and re-substitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this Annual
Report on Form 10-K and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the U.S. Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, each acting alone,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all said attorneys-in-fact and agents, each acting alone, or his
substitute or substitutes, may lawfully do or cause to be done by virtue
thereof.

|                             |                                                                                                  |                  |  |      | 
|---------------------------- | ------------------------------------------------------------------------------------------------ | ---------------- |  | ---- | 
|Signature                    |                                                                                                  | Title            |  | Date | 
|                             |                                                                                                  |                  |  |      | 
|                            
|/s/ Bernard
  P. Aldrich     | Chief Executive Officer and
  Director (principal executive officer)                             | March 15, 2006  
|                             |                                                                                                 
|Bernard P. Aldrich           |                                                                                                 
|                             |                                                                                                  |                 
|/s/ David J.
  Suden         | Chief Technical Officer & Director                                                               | March 15,
  2006
|                             |                                                                                                  |                 
|David J. Suden               |                                                                                                  |                 
|                             |                                                                                                  |                 
|/s/ Robert
  M. Wolf         | Chief Financial Officer (principal
  financial and accounting officer
  and Corporate Secretary) | March 15, 2006  
|                            
|Robert M. Wolf              
|                             |                                                                                                  |                 
|/s/ James L.
  Reissner      | Director, Chairman of the Board                                                                  | March 15,
  2006
|                             |                                                                                                  |                 
|James L. Reissner            |                                                                                                  |                 
|                             |                                                                                                  |                 
|/s/ Thomas
  F. Madison      | Director                                                                                         | March 15,
  2006
|                             |                                                                                                  |                 
|Thomas F. Madison            |                                                                                                  |                 
|                             |                                                                                                  |                 
|/s/ Steven
  M. Quist        | Director                                                                                         | March 15,
  2006
|                             |                                                                                                  |                 
|Steven M. Quist              |                                                                                                  |                 
|                             |                                                                                                  |                 
|/s/ Lawrence
  M. Benveniste | Director                                                                                         | March 15,
  2006
|                             |                                                                                                  |                 
|Lawrence M. Benveniste       |                                                                                                  |                 
|                             |                                                                                                  |                 
|/s/ Philip
  D. Hotchkiss    | Director                                                                                         | March 15,
  2006
|                             |                                                                                                  |                 
|Philip D. Hotchkiss          |                                                                                                  |                 

47

---



INDEX TO EXHIBITS

|           |                                                                                                                                                                                                                                                                               
|---------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|           |                                                                                                                                                                                                                                                                               
|ExhibitNo. | Description                                                                                                                                                                                                                                                                   
|           |                                                                                                                                                                                                                                                                               
|3.1        | 1992
  Restated Articles of Incorporation of Rimage Corporation (Incorporated herein
  by reference to Exhibit 3.1 to the Companys Registration Statement on Form
  SB-2 (File No. 33-22558)).                                                                               
|           |                                                                                                                                                                                                                                                                               
|3.2        | Articles of
  Amendment to 1992 Restated Articles of Incorporation of Rimage Corporation
  (Incorporated herein by reference to Exhibit 4.2 to the Companys
  Registration Statement on Form S-8 (File No. 333-69550)).                                                      
|           |                                                                                                                                                                                                                                                                               
|3.3        | Bylaws of
  Rimage Corporation (Incorporated herein by reference to Exhibit 3.2 to the
  Companys Registration Statement on Form SB-2 (File No. 33-22558)).                                                                                                                  
|           |                                                                                                                                                                                                                                                                               
|3.4        | Rights
  Agreement dated as of September 17, 2003 between Rimage Corporation and Wells
  Fargo Bank, as Rights Agent (Incorporated by reference to Exhibit 1 to the
  Companys Registration Statement on Form 8-A (File No. 000-20728)).                                     
|           |                                                                                                                                                                                                                                                                               
|10.1       | Rimage
  Corporation Amended and Restated 1992 Stock Option Plan (As amended through
  May 17, 2005) * (Incorporated by reference to Exhibit 4.1 to the Companys
  Registration Statement on Form S-8 (File No. 333-127244)).                                                
|           |                                                                                                                                                                                                                                                                               
|10.2       | Rimage
  Corporation 2001 Stock Option Plan for Non-Employee Directors * (Incorporated
  by reference to exhibit of same number to the Companys Annual Report on Form
  10-K for the year ended December 31, 2001).                                                          
|           |                                                                                                                                                                                                                                                                               
|10.3       | Rimage
  Corporation 2001 Employee Stock Purchase Plan * (Incorporated by reference to
  exhibit of same number to the Companys Annual Report on Form 10-K for the
  year ended December 31, 2001).                                                                          
|           |                                                                                                                                                                                                                                                                               
|10.4       | Lease dated
  July 31, 2004, between Rimage Corporation and 7725 Washington Avenue Corporation
  (Incorporated by reference to Exhibit 10.1 of the Companys Quarterly Report
  on Form 10Q for the quarter ended June 30, 2004).                                             
|           |                                                                                                                                                                                                                                                                               
|10.5       | Form of
  Severance/Change in Control Letter Agreement dated November 5, 2004, between
  the Company and certain executive officers * (Incorporated by reference to
  Exhibit 10.1 of the Companys Quarterly Report on Form 10-Q for the quarter
  ended September 30, 2004).
|           |                                                                                                                                                                                                                                                                               
|10.6       | Credit
  Agreement, dated March 29, 2004, by and between the Company and Wells Fargo
  Bank, National Association (Incorporated by reference to exhibit of same
  number to the Companys Annual Report on Form 10-K for the year ended
  December 31, 2004).                 
|           |                                                                                                                                                                                                                                                                               
|10.7       | First
  Amendment to Credit Agreement, dated June 30, 2005, by and between the
  Company and Wells Fargo Bank, National Association.                                                                                                                                          
|           |                                                                                                                                                                                                                                                                               
|10.8       | Revolving
  Line of Credit Note, dated June 30, 2005, in the principal amount of
  $10,000,000 issued to the Company by Wells Fargo Bank, National Association.                                                                                                               
|           |                                                                                                                                                                                                                                                                               
|21.1       | Subsidiaries
  of Rimage Corporation.                                                                                                                                                                                                                                         
|           |                                                                                                                                                                                                                                                                               
|23.1       | Consent of
  Independent Registered Public Accounting Firm.                                                                                                                                                                                                                   
|           |                                                                                                                                                                                                                                                                               
|31.1       | Certificate
  of Chief Executive Officer pursuant to Rules 13d-14(a) and 15d-14(a) of the
  Exchange Act.                                                                                                                                                                     
|           |                                                                                                                                                                                                                                                                               
|31.2       | Certificate
  of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the
  Exchange Act.                                                                                                                                                                     
|           |                                                                                                                                                                                                                                                                               
|32         | Certification
  Pursuant to 18 U.S.C. §1350.                                                                                                                                                                                                                                  

*       Indicates a
management contract or compensatory plan or arrangement

48

---



Schedule II

RIMAGE
CORPORATION
Valuation and Qualifying Accounts
(in thousands)

|                                        |  |                          |     |      |   |      |   |   |      |  
|--------------------------------------- |  | ------------------------ | --- | ---- | - | ---- | - | - | ---- | -
|Allowance
  for Doubtful Accounts       |  |                          |    
|Receivable
  and Sales Returns:         |  | Years ended December 31, |    
|                                        |  | 2005                     |     | 2004 |   | 2003 |  
|                                        |  |                          |     |      |   |      |  
|                                        |  |                          |     |      |   |      |   |   |      |  
|Balance at beginning of year            |  | $                        | 600 |      | $ | 887  |   | $ | 635  |  
|                                        |  |                          |     |      |   |      |   |   |      |  
|Write-offs and other adjustments        |  |                          | (77 | )    |   | (166 | ) |   | 1    |  
|Recoveries                              |  |                          | (91 | )    |   | (158 | ) |   | (151 | )
|Additions charged to costs and expenses |  |                          | 422 |      |   | 37   |   |   | 402  |  
|                                        |  |                          |     |      |   |      |   |   |      |  
|                                        |  |                          |     |      |   |      |   |   |      |  
|Balance at end of year                  |  | $                        | 854 |      | $ | 600  |   | $ | 887  |  
|                                        |  |                          |     |      |   |      |   |   |      |  

See
accompanying report of Independent Registered Public Accounting Firm.

49

---