EXHIBIT 10









EXHIBIT 10.9




 




I/OMagic Corporation 2001 Incentive and

Nonstatutory Stock Option Plan




Dated




September 29, 2001




 




 





























 




I/OMagic

Corporation




 




2001

INCENTIVE AND NONSTATUTORY STOCK OPTION PLAN




 




1.             Purpose




 




This Incentive

and Nonstatutory Stock Option Plan (the “Plan”) is intended to further the

growth and financial success of I/OMagic Corporation, a Nevada corporation (the

“Corporation”) by providing additional incentives to selected employees,

directors, and consultants to the Corporation or parent corporation or

subsidiary corporation of the Corporation as those terms are defined in

Sections 424(e) and 424(f) of the Internal Revenue Code of 1986, as amended

(the “Code”) (such parent corporations and subsidiary corporations hereinafter

collectively referred to as “Affiliates”) so that such employees and

consultants may acquire or increase their proprietary interest in the

Corporation.  Stock options granted

under the Plan (hereinafter “Options”) may be either “Incentive Stock Options,”

as defined in Section 422A of the Code and any regulations promulgated under

said Section, or “Nonstatutory Options” at the discretion of the Board of

Directors of the Corporation (the “Board”) and as reflected in the respective

written stock option agreements granted pursuant hereto.




 




2.             Administration




 




The Plan shall

be administered by the Board of Directors of the Corporation; provided however,

that the Board may delegate such administration to a committee of not fewer

than three (3) members (the “Committee”), at least two (2) of whom are members

of the Board and all of whom are disinterested administrators, as contemplated

by Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended

(“Rule 16b-3”); and provided further, that the foregoing requirement for disinterested

administrators shall not apply prior to the date of the first registration of

any of the securities of the Corporation under the Securities Act of 1933, as

amended.




 




Subject to the

provisions of the Plan, the Board and/or the Committee shall have authority to

(a) grant, in its discretion, Incentive Stock Options in accordance with

Section 422A of the Code or Nonstatutory Options; (b) determine in good faith

the fair market value of the stock covered by an Option; (c) determine which

eligible persons shall be granted Options and the number of shares to be

covered thereby and the term thereof; (d) construe and interpret the Plan; (e)

promulgate, amend and rescind rules and regulations relating to its

administration, and correct defects, omissions, and inconsistencies in the Plan

or any Option; (f) consistent with the Plan and with the consent of the

optionee, as appropriate, amend any outstanding Option or amend the exercise

date or dates thereof; (g) determine the duration and purpose of leaves of absence

which may be granted to optionholders without constituting termination of their

employment for the purpose of the Plan; and (h) make all other determinations

necessary or advisable for the Plan’s administration.  The interpretation and construction by the Board of any

provisions of the Plan or of any Option it shall be conclusive and final.  No member of the Board or the Committee

shall be liable for any action or determination made in good faith with respect

to the Plan or any Option.




 




3.                                       Eligibility




 




The persons who shall be eligible to receive Options shall

be employees, directors, or consultants of the Corporation or any of its

Affiliates (“Optionees”).  The term

consultant shall mean any person who is engaged by the Corporation to render

services and is compensated for such services, and any director of the

Corporation whether or not compensated for such services; provided that, if the

Corporation registers any of its securities pursuant to the Securities Act of

1933, as amended (the “Act”), the term consultant shall thereafter not include

directors who are not compensated for their services or are paid only a

director fee by the Corporation.




 




(a)           Incentive Stock Options.  Incentive Stock Options may only be issued

to employees of the 




 




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Corporation or its

Affiliates.  Incentive Stock Options may

be granted to officers, whether or not they are directors, but a director shall

not be granted an Incentive Stock Option unless such director is also an employee

of the Corporation.  Payment of a

director fee shall not be sufficient to constitute employment by the

Corporation.  Any grant of option to an

officer or director of the Corporation subsequent to the first registration of

any of the securities of the Corporation under the Act shall comply with the

requirements of Rule 16b-3.  An optionee

may hold more than one Option.




 




The

Corporation shall not grant an Incentive Stock Option under the Plan to any

employee if such grant would result in such employee holding the right to

exercise for the first time in any one calendar year, under all options granted

to such employee under the Plan or any other stock option plan maintained by

the Corporation or any Affiliate, with respect to shares of stock having an aggregate

fair market value, determined as of the date of the Option is granted, in

excess of one hundred thousand dollars ($100,000).  Should it be determined that an Incentive Stock Option granted

under the Plan exceeds such maximum for any reason other than a failure in good

faith to value the stock subject to such option, the excess portion of such

option shall be considered a Nonstatutory Option.  If, for any reason, an entire option does not qualify as an

Incentive Stock Option by reason of exceeding such maximum, such option shall

be considered a Nonstatutory Option.




 




(b)           Nonstatutory Option.  The provisions of the foregoing Section 3(a)

shall not apply to any option designated as a “Nonstatutory Stock Option

Agreement” or which sets forth the intention of the parties that the option be

a Nonstatutory Option.




 




4.                                       Stock




 




The stock

subject to Options shall be the shares of the Corporation’s authorized but

unissued or reacquired Common Stock (the “Stock”).




 




(a)           Number

of Shares.  Subject to adjustment as

provided in Paragraph 5(h) of this Plan, the total number of shares of Stock

which may be purchased through exercise of Options granted under this Plan

shall not exceed three million five hundred thousand (3,500,000) shares.  If any Option shall for any reason terminate

or expire, any shares allocated thereto but remaining unpurchased upon such

expiration or termination shall again be available for the grant of Options

with respect thereto under this Plan as though no Option had been granted with

respect to such shares.




 




(b)           Reservation of Shares.  The Corporation shall reserve and keep

available at all times during the term of the Plan such number of shares as

shall be sufficient to satisfy the requirements of the Plan.  If, after reasonable efforts, which efforts

shall not include the registration of the Plan or Options under the Act, the

Corporation is unable to obtain authority from any applicable regulatory body,

which authorization is deemed necessary by legal counsel for the Corporation

for the lawful issuance of shares hereunder, the Corporation shall be relieved

of any liability with respect to its failure to issue and sell the shares for

which such requisite authority was so deemed necessary unless and until such

authority is obtained.




 




5.             Terms and Conditions of Options




 




Options

granted hereunder shall be evidenced by agreements between the Corporation and

the respective Optionees, in such form and substance as the Board or Committee

shall from time to time approve.  Such

agreements need not be identical, and in each case may include such provisions

as the Board or Committee may determine, but all such agreements shall be

subject to and limited by the following terms and conditions:




 




(a)           Number of Shares:  Each Option shall state the number of shares

to which it pertains.




 




(b)           Option Price:  Each Option shall state the Option Price,

which shall be determined as follows:




 




(i)            Any Option granted to a person who

at the time the Option is granted owns (or is deemed to own pursuant to Section

424(d) of the Code) stock possessing more than ten percent (10%) of the total

combined voting power of value of all classes of stock of the Corporation, or

of any Affiliate, (“Ten Percent Holder”) shall have an Option Price of no less

than $1.10 per share; and




 




(ii)           Incentive Stock Options granted to a

person who at the time the Option is granted is 




 




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not a Ten Percent Holder shall

have an Option price of no less than $1.00 per share




 




(iii)          Nonstatutory Options granted to a

person who at the time the Option is granted is not a Ten Percent Holder shall

have an Option Price determined by the Board as of the date of grant.




 




(c)           Medium

and Time of Payment:  To the extent

permissible by applicable law, the Option price shall be paid, at the

discretion of the Board, at either the time of grant or the time of exercise of

the Option (i) in cash or by check, (ii) by delivery of other common stock of

the Corporation, provided such tendered stock was not acquired directly or

indirectly from the Corporation, or, if acquired from the Corporation, has been

held by the Optionee for more than six (6) months, (iii) by the Optionee’s

promissory note in a form satisfactory to the Corporation and bearing interest

at a rate determined by the Board, in its sole discretion, but in no event less

than 6% per annum, or (iv) such other form of legal consideration permitted by

State law as may be acceptable to the Board.




 




(d)           Term and Exercise of Options:  Any Option granted to an Employee of the

Corporation shall become exercisable over a period of no longer than ten (10)

years, and no less than twenty percent (20%) of the shares covered thereby

shall become exercisable annually.  No

Option shall be exercisable, in whole or in part, prior to one (1) year from

the date it is granted unless the Board shall specifically determine otherwise,

as provided herein.  In no event shall

any Option be exercisable after the expiration of ten (10) years from the date

it is granted.  Unless otherwise

specified by the Board or the Committee in the resolution authorizing such

option, the date of grant of an Option shall be deemed to be the date upon

which the Board or the Committee authorizes the granting of such Option.




 




Each Option

shall be exercisable to the nearest whole share, in installments or otherwise,

as the respective option agreements may provide.  During the lifetime of an Optionee, the Option shall be

exercisable only by the Optionee and shall not be assignable or transferable by

the Optionee, and no other person shall acquire any rights therein.  To the extent not exercised, installments

(if more than one) shall accumulate, but shall be exercisable, in whole or in

part, only during the period for exercise as stated in the option agreement,

whether or not other installments are then exercisable.




 




Each Option

granted hereunder shall not be exercisable, unless and until the Corporation

lists upon a national stock exchange.




 




(e)           Termination of Status as Employee,

Director, or Consultant:  If

Optionee’s status as an employee, director, or consultant shall terminate for

any reason other than Optionee’s death, then the Optionee (or if the Optionee

shall die after such termination, but prior to exercise, Optionee’s personal

representative or the person entitled to succeed to the Option) shall have the

right to exercise any vested Options, in whole or in part, at any time within

thirty (30) days after such termination (or in the event Optionee’s termination

was caused by permanent disability (within the meaning of Section 22(e)(3) of

the Code) this 30-day period shall be extended to six (6) months) or the

remaining term of the Option, whichever is the lesser; provided, however, that

with respect to Nonstatutory Options, the Board may specify such longer period,

not to exceed six (6) months, for exercise following termination as the Board

deems reasonable and appropriate.  The

Option may be exercised only with respect to installments that the Optionee

could have exercised at the date of termination of employment.  Nothing contained herein or in any Option

granted pursuant hereto shall be construed to affect or restrict in any way the

right of the Corporation to terminate the employee of an Optionee with or

without cause.




(f)            Death

of Optionee: If an Optionee dies while employed or engaged as a director or

consultant by the Corporation or an Affiliate, the portion of such Optionee’s

Option or Options which were exercisable at the date of death may be exercised,

in whole or in part, by the estate of the decedent or by a person succeeding to

the right to exercise such Option or Options, at any time within the remaining

term of the Option, but only to the extent, that Optionee could have exercised

the Option as of the date of Optionee’s death; provided, in any case, that the

Option may be so exercised only to the extent that the Option has not

previously been exercised by Optionee.




 




(g)           Nontransferability of Option:

No Option shall be transferable by the Optionee, except by will or by the laws

of descent and distribution.




 




(h)           Recapitalization:  Subject to any required action by the

stockholders, the number of shares of common stock covered by each outstanding

Option, and the price per share thereof set forth in each such Option, shall be






 




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proportionately adjusted for

any increase or decrease in the number of issued shares of common stock of the

Corporation resulting from a subdivision or consolidation of shares or the

payment of a stock dividend, or any other increase or decrease in the number of

such shares affected without receipt of consideration by the Corporation.




 




Subject to any

required action by the stockholders, if the Corporation shall be the surviving

entity in any merger or consolidation, each outstanding Option thereafter shall

pertain to and apply to the securities to which a holder of shares of common

stock equal to the shares subject to the Option would have been entitled by

reason of such merger or consolidation. 

A dissolution or liquidation of the Corporation or a merger or

consolidation in which the Corporation is not the surviving entity shall cause

each outstanding Option to terminate on the effective date of such dissolution,

liquidation, merger or consolidation. 

In such event, if the entity which shall be the surviving entity does

not tender to Optionee an offer, for which it has no obligation to do so, to

substitute for any unexercised Option a stock option or capital stock of such

surviving entity, as applicable, which on an equitable basis shall provide the Optionee

with substantially the same economic benefit as such unexercised Option, then

the Board may grant to such Optionee, but shall not be obligated to do so, the

right for a period commencing thirty (30) days prior to and ending immediately

prior to such dissolution, liquidation, merger or consolidation or during the

remaining term of the Option, whichever is the lesser, to exercise any

unexpired Option or Options, without regard to the installment provisions of

Paragraph 5(d) of this Plan; provided, that any such right granted shall be

granted to all Optionees not receiving an offer to substitute on a consistent

basis, and provided further, that any such exercise shall be subject to the

consummation of such dissolution, liquidation, merger or consolidation.




 




In the event of a change in the common stock

of the Corporation as presently constituted, which is limited to a change of

all of its authorized shares without par value into the same number of shares

with a par value, the shares resulting from any such change shall be deemed to

be the common stock within the meaning of this Plan.




 




To the extent that the foregoing adjustments

relate to stock or securities of the Corporation, such adjustments shall be

made by the Board, whose determination in that respect shall be final, binding

and conclusive.  Except as expressly

provided in this Paragraph 5(h), the Optionee shall have no rights by reason of

any subdivision or consolidation of shares of stock or any class or the payment

of any stock dividend or any other increase or decrease in the number of shares

of stock of any class, and the number or price of shares of common stock

subject to any Option shall not be affected by, and no adjustment shall be made

by reason of, any dissolution, liquidation, merger or consolidation, or any

issue by the Corporation of shares of stock of any class or securities

convertible into shares of stock of any class.




 




The grant of

an Option pursuant to the Plan shall not affect in any way the right or power

of the Corporation to make any adjustments, reclassifications, reorganizations

or changes in its capital or business structure or to merge, consolidate,

dissolve, or liquidate or to sell or transfer all or any part of its business

or assets.




 




(i)            Rights as a Stockholder:  An Optionee shall have no rights as a

stockholder with respect to any shares covered by an Option until the date of

the issuance of a stock certificate to Optionee for such shares.  No adjustment shall be made for dividends

(ordinary or extraordinary, whether in cash, securities or other property) or

distributions or other rights for which the record date is prior to the date

such stock certificate is issued, except as expressly provided in Paragraph

5(h) hereof.




 




(j)            Modification, Acceleration,

Extension, and Renewal of Options: 

Subject to the terms and conditions and within the limitations of the

Plan, the Board may modify an Option, or once an Option is exercisable,

accelerate the rate at which it may be exercised, and may extend or renew

outstanding Options granted under the Plan or accept the surrender of

outstanding Options (to the extent not theretofore exercised) and authorize the

granting of new Options in substitution for such Options, provided such action

is permissible under Section 422A of the Code and state law.




 




Notwithstanding

the foregoing provisions of this Paragraph 5(j), however, no modification of an

Option shall, without the consent of the Optionee, alter to the Optionee’s

detriment or impair any rights or obligations under any Option theretofore

granted under the Plan.




 




(k)           Investment Intent:  Unless and until the issuance and sale of

the shares subject to the Plan are registered under the Act, each Option under

the Plan shall provide that the purchases of stock thereunder shall be for

investment purposes and not with a view to, or for resale in connection with,

any distribution thereof.  Further,

unless the




 




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issuance and sale of the stock

have been registered under the Act, each Option shall provide that no shares

shall be purchased upon the exercise of such Option unless and until (i) any

then applicable requirements of state and federal laws and regulatory agencies

shall have been fully complied with to the satisfaction of the Corporation and its

counsel, and (ii) if requested to do so by the Corporation, the person

exercising the Option shall (i) give written assurances as to knowledge and

experience of such person (or a representative employed by such person) in

financial and business matters and the ability of such person (or

representative) to evaluate the merits and risks of exercising the Option, and

(ii) execute and deliver to the Corporation a letter of investment intent, all

in such form and substance as the Corporation may require.  If shares are issued upon exercise of an

Option without registration under the Act, subsequent registration of such

shares shall relieve the purchaser thereof of any investment restrictions or

representations made upon the exercise of such Options.




 




(l)            Exercise Before Exercise Date:  At the discretion of the Board, the Option

may, but need not, include a provision whereby the Optionee may elect to

exercise all or any portion of the Option prior to the stated exercise date of

the Option or any installment thereof. 

Any shares so purchased prior to the stated exercise date shall be

subject to repurchase by the Corporation upon termination of Optionee’s

employment as contemplated by Paragraphs 5(e), 5(f) and 5(g) hereof prior to

the exercise date stated in the Option and such other restrictions and

conditions as the Board or Committee may deem advisable.




 




(m)          Other Provisions:  The Option agreements authorized under this

Plan shall contain such other provisions, including, without limitation,

restrictions upon the exercise of the Options, as the Board or the Committee

shall deem advisable.  Shares shall not

be issued pursuant to the exercise of an Option, if the exercise of such Option

or the issuance of shares thereunder would violate, in the opinion of legal counsel

for the Corporation, the provisions of any applicable law or the rules or

regulations of any applicable governmental or administrative agency or body,

such as the Act, the Securities Exchange Act of 1934, the rules promulgated

under the foregoing or the rules and regulations of any exchange upon which the

shares of the Corporation are listed.




 




6.             Availability of Information




 




During the term of the Plan and any

additional period during which an Option granted pursuant to the Plan shall be

exercisable, the Corporation shall make available, not later than one hundred

and twenty (120) days following the close of each of its fiscal years, such

financial and other information regarding the Corporation as is required by the

bylaws of the Corporation and applicable law to be furnished in an annual

report to the stockholders of the Corporation.




 




7.             Effectiveness of Plan; Expiration




 




Subject to

approval by the stockholders of the Corporation, this Plan shall be deemed

effective as of the date it is adopted by the Board.  The Plan shall expire on December 31, 2001, but such expiration

shall not affect the validity of outstanding Options.




 




8.             Amendment and Termination of the Plan




 




The Board may,

insofar as permitted by law, from time to time, with respect to any shares at

the time not subject to Options, suspend or terminate the Plan or revise or

amend it in any respect whatsoever, except that without the approval of the

stockholders of the Corporation, no such revision or amendment shall (i)

increase the number of shares subject to the Plan, (ii) decrease the price at

which Options may be granted, (iii) materially increase the benefits to

Optionees, or (iv) change the class of persons eligible to receive Options

under this Plan; provided, however, no such action shall alter or impair the

rights and obligations under any Option outstanding as of the date thereof

without the written consent of the Optionee thereunder.  No Option may be granted while the Plan is

suspended or after it is terminated, but the rights and obligations under any

Option granted while the Plan is in effect shall not be impaired by suspension

or termination of the Plan.




 




9.             Indemnification of Board




 




In addition to

such other rights or indemnifications as they may have as directors or

otherwise, and to the extent allowed by applicable law, the members of the

Board and the Committee shall be indemnified by the Corporation against the

reasonable expenses, including attorneys’ fees, actually and necessarily

incurred in connection with the defense of any 




 




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claim, action, suit or

proceeding, or in connection with any appeal thereof, to which they or any of

them may be a party by reason of any action taken, or failure to act, under or

in connection with the Plan or any Option granted thereunder, and against all

amounts paid by them in settlement thereof (provided such settlement is

approved by independent legal counsel selected by the Corporation) or paid by

them in satisfaction of a judgment in any such claim, action, suit or

proceeding, except in any case in relation to matters as to which it shall be

adjudged in such claim, action, suit or proceeding that such Board member is

liable for negligence or misconduct in the performance of  his or her duties; provided that within

sixty (60) days after institution of any such action, suit or Board proceeding

the member involved shall offer the Corporation, in writing, the opportunity,

at its own expense, to handle and defend the same.




 




10.           Application of Funds




 




The proceeds

received by the Corporation from the sale of common stock pursuant to the

exercise of Options will be used for general corporate purposes.




 




11.           No Obligation to Exercise Option




 




The granting

of an Option shall impose no obligation upon the Optionee to exercise such

Option.




 




12.           Notices




 




All notice,

requests, demand, and other communications pursuant this Plan shall be in

writing and shall be deemed to have been duly given on the date of service if

served personally on the party to whom notice is to be given, or on the third

day following the mailing thereof to the party to whom notice is to be given,

by first class mail, registered or certified, postage prepaid.




 




13.           Financial Statements




 




Optionees

under this Plan shall receive financial statements annually regarding the

Corporation during the period the options are outstanding.  The financial statements provided need not

comply with Title 10, Section 260.613 of the Nevada Code of Regulations.




 




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* * * * *




The foregoing

Incentive and Nonstatutory Stock Option Plan was duly adopted and approved by

the Board of Directors on September 29, 2001.




 




 




	

   


  	

    /s/ Tony Shahbaz


  	

   


  
	

   


  	

  Tony

  Shahbaz, Secretary


  
	

   


  	

   


  





 




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NUMBER




I/OMagic

Corporation




 




NONSTATUTORY

STOCK OPTION AGREEMENT




 




This

NONSTATUTORY STOCK OPTION AGREEMENT is made and entered into as of this

       day of

                    ,

2001, by and between I/OMagic Corporation, a Nevada corporation (“Company”),

and                                            

(referred to herein as the “Optionee”), with reference to the following

recitals of facts:




 




WHEREAS, the

Board has authorized the granting to Optionee of a nonstatutory stock option

(“Option”) to purchase shares of common stock of the Company (the “Shares”)

upon the terms and conditions hereinafter stated; and




 




WHEREAS, the

Board and stockholders of the Company have heretofore adopted a 2001 Incentive

and Nonstatutory Stock Option Plan (the “Plan”), pursuant to which this Option

is being granted;




 




WHEREAS, it is

the intention of the parties that this Option be a Nonstatutory Stock Option;




 




NOW,

THEREFORE, in consideration of the covenants herein set forth, the parties

hereto agree as follows:




 




1.             Shares; Price.  The Company hereby grants to Optionee the

right to purchase, upon and subject to the terms and conditions herein

stated,              Shares for cash (or

other consideration acceptable to the Board of Directors of the Company, in

their sole and absolute discretion) at the price of $        per Share, such price being determined in accordance with

the Plan.




 




2.             Term of Option; Continuation of

Employment.  This Option shall

expire, and all rights hereunder to purchase the Shares shall terminate, ten

(10) years from the date hereof.  This

Option shall earlier terminate subject to Paragraphs 5 and 6 hereof if, and as

of the date, Optionee ceases to be an employee, director, or consultant of the

Company.  Nothing contained herein shall

be construed to interfere in any way with the right of the Company to terminate

the employment or engagement, as applicable, of Optionee or to increase or

decrease the compensation of Optionee from the rate in existence at the date

hereof.




 




3.             Vesting of Option.  Subject to the provisions of Paragraphs 5

and 6 hereof, this Option shall vest and become exercisable during the term of

Optionee’s employment or engagement in whole or in part beginning on the date

of this Agreement.




 




4.             Exercise.  This Option shall be exercised by delivery

to the Company of (a) a written notice of exercise stating the number of Shares

being purchased (in whole shares only) and such other information set forth on

the form of Notice of Exercise attached hereto as Appendix A, (b) a check or

cash in the amount of the purchase price of the Shares covered by the notice,

and (c) a written statement as provided for in Paragraph 11 hereof.  This Option shall not be assignable or

transferable, except by will or by the laws of descent and distribution, and

shall be exercisable only by Optionee during his or her lifetime.




 




5.             Termination of Employment or

Engagement.  If Optionee shall cease

to serve as an employee, director, or consultant of the Company for any reason,

whether voluntarily or involuntarily, other than by his or her death or the

conclusion of the term of a written consulting agreement, provided such term

exceeds one year, Optionee shall have the right at any time within thirty (30)

days after date Optionee ceases to be an employee, director, or consultant of the

Company, or the remaining term of this Option, whichever is the lesser, to

exercise in whole or in part this Option to the extent, but only to the extent,

that this Option was exercisable as of the last day of employment or

engagement, as applicable, and had not previously been exercised; provided,

however, that if Optionee’s termination of employment or engagement was caused

by permanent disability disabled (within the meaning of Section 22(e)(3) of the

Code), the foregoing thirty (30) day period shall be extended to six (6)

months.




 




Notwithstanding

anything herein to the contrary, all rights under this Option shall expire in

any event on the date specified in Paragraph 2 hereof.




 




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6.             Death of Optionee.  If the Optionee shall die while an employee,

director, or consultant of the Company, Optionee’s personal representative or

the person entitled to Optionee’s rights hereunder may at any time during the

remaining term of this Option, exercise this Option and purchase Shares to the

extent, but only to the extent, that Optionee could have exercised this Option

as of the date of Optionee’s death; provided, in any case, that this Option may

be so exercised only to the extent that this Option has not previously been

exercised by Optionee.




 




7.             No Rights as Stockholder.  Optionee shall have no rights as a

stockholder with respect to the Shares covered by any installment of this

Option until the date of the issuance of a stock certificate to Optionee, and

no adjustment will be made for dividends or other rights for which the record

date is prior to the date such stock certificate or certificates are issued

except as provided in Paragraph 8 hereof.




 




8.             Recapitalization.  Subject to any required action by the

stockholders of the Company, the number of Shares covered by this Option, and

the price per Share thereof, shall be proportionately adjusted for any increase

or decrease in the number of issued Shares resulting from a subdivision or

consolidation of shares or the payment of a stock dividend, or any other

increase or decrease in the number of such shares affected without receipt of

consideration by the Company; provided however that the conversion of any

convertible securities of the Company shall not be deemed having been “effected

without receipt of consideration by the Company.”




 




In the event

of a proposed dissolution or liquidation of the Company, a merger or

consolidation in which the Company is not the surviving entity, or a sale of

all or substantially all of the assets of the Company, this Option shall

terminate immediately prior to the consummation of such proposed action, unless

otherwise provided by the Board.  The

Board may, at its sole and absolute discretion and without obligation, declare

that this Option shall terminate as of a date fixed by the Board and grant

Optionee the right for a period commencing thirty (30) days prior to and ending

immediately prior to such date, or during the remaining term of this Option,

whichever occurs sooner, to exercise this Option as to all or any part of the

Shares, without regard to the installment provision of Paragraph 3; provided,

however, that such exercise shall be subject to the consummation of such

dissolution, liquidation, merger, consolidation or sale.




 




Subject to any

required action by the stockholders of the Company, if the Company shall be the

surviving entity in any merger or consolidation, this Option thereafter shall

pertain to and apply to the securities to which a holder of Shares equal to the

Shares subject to this Option would have been entitled by reason of such merger

or consolidation, and the vesting provisions of Section 3 shall continue to

apply.




 




In the event

of a change in the Shares of the Company as presently constituted, which is

limited to a change of all of its authorized Shares without par value into the

same number of Shares with a par value, the Shares resulting from any such

change shall be deemed to be the Shares within the meaning of this Agreement.




 




To the extent

that the foregoing adjustments relate to shares or securities of the Company,

such adjustments shall be made by the Board, whose determination in that

respect shall be final, binding and conclusive.  Except as hereinbefore expressly provided, Optionee shall have no

rights by reason of any subdivision or consolidation of share of stock of any

class or the payment of any stock dividend or any other increase or decrease in

the number of shares of stock of any class, and the number and price of shares

subject to this Option shall not be affected by, and no adjustments shall be

made by reason of, any dissolution, liquidation, merger or consolidation, or

any issue by the Company of shares of stock of any class or securities

convertible into shares of stock of any class.




 




The grant of this

Option shall not affect in any way the right or power of the Company to make

adjustments, reclassifications, reorganizations or changes in its capital or

business structure or to merge, consolidate, dissolve or liquidate or to sell

or transfer all or any part of its business or assets.




 




9.             Taxation upon Exercise of Option.  Optionee understands that, upon exercise of

this Option, Optionee may recognize income, for federal and state income tax

purposes, in an amount equal to the amount by which the fair market value of

the Shares, determined as of the date of exercise, exceeds the exercise

price.  The acceptance of the Shares by

Optionee shall constitute an agreement by Optionee to report such income in

accordance with then applicable law and to cooperate with Company in

establishing the amount of such income and corresponding deduction to the

Company for its income tax purposes. 

Withholding for federal or state income and employment tax purposes will

be made, if and as required by law, from Optionee’s then current compensation,

or, if such current compensation is




 




2





























 




insufficient to satisfy

withholding tax liability, the Company may require Optionee to make cash

payment to cover such liability as a condition of the exercise of this Option.




 




10.           Modification, Extension and

Renewal of Options.  The Board may

modify, extend or renew this Option or accept the surrender thereof (to the

extent not theretofore exercised) and autho0rize the granting of a new option

in substitution therefore (to the extent not theretofore exercised), subject at

all times to the Plan.  Notwithstanding

the foregoing provisions of this Paragraph 10, no modification shall, without

the consent of the Optionee, alter to the Optionee’s detriment or impair any

rights of Optionee hereunder.




 




11.           Investment Intent; Restrictions on

Transfer.  Optionee represents and

agrees that if Optionee exercises this Option in whole or in part, Optionee

will in each case acquire the Shares upon such exercise for the purpose of

investment and not with a view to, or for resale in connection with, any

distribution thereof; and that upon such exercise of this Option in whole or in

part, Optionee (or any person or persons entitled to exercise this Option under

the provisions of Paragraphs 5 and 6 hereof) shall furnish to the Company a

written statement to such effect, satisfactory to the Company in form and

substance.  The Company, at its option,

may include a legend on each certificate representing Shares issued pursuant to

any exercise of this Option, stating in effect that such Shares have not been

registered under the Securities Act of 1933, as amended (the “Act”), and that

the transferability thereof is restricted. 

If the Shares represented by this Option are registered under the Act,

either before or after the exercise of this Option in whole or in part, the

Optionee shall be relieved of the foregoing investment representation and

agreement and shall not be required to furnish the Company with the foregoing written

statement.




 




Optionee

further represents that Optionee has had access to the financial statements or

books and records of the Company, has had the opportunity to ask questions of

the Company concerning its business, operations and financial condition, and to

obtain additional information reasonably necessary to verify the accuracy of

such information, and further represents that Optionee has either such

experience and knowledge in investment, financial and business matters or has

investments similar to the stock of the Company such that Optionee is capable

of evaluating the merits and risks thereof and has the capacity to protect his

or her own interest in connection therewith.




 




12.           Registration Rights.




 




a.             Piggyback

Registration Rights.  If the Company

at any time proposes to register any of its securities under the Act, including

under an S-8 Registration Statement, an SB-2 Registration Statement or

otherwise, it will each such time give written notice to all holders of

outstanding or exercised options of its intention so to do.  Upon the written request of a holder or

holders of any such outstanding or exercised options given within thirty (30)

days after receipt of any such notice, the Company will use its best efforts to

cause all such outstanding or exercised options, the holders of which shall

have so requested registration thereof, to be registered under the Act (with

the securities which the Company at the time propose to register), all to the

extent requisite to permit the sale or other disposition by the prospective

Sellers of the outstanding or exercised options so registered; provided,

however, that the Company may, as a condition precedent to its effecting such

registration, require each prospective Seller to agree with the Company and the

managing underwriter or underwriters of the offering to be made by the Company

in connection with such registration that such Seller will not sell any

securities of the same class or convertible into the same class as those

registered by the Company (including any class into which the securities

registered by the Company are convertible) for such reasonable period after

such registration becomes effective as shall then be specified in writing by

such underwriter or underwriters if in the opinion of such underwriter or

underwriters the Company’s offering would be materially adversely affected in

the absence of such an agreement.




 




b.             Procedures.  In connection with the registration of any

securities pursuant to Section 12.a. hereof, the Company and the Optionee covenant

and agree as follows:




 




(i)            The Company shall pay all costs,

fees, and expenses incurred by the Company and the Optionee in connection with

the Registration Statement and the offering thereunder including, without

limitation, the Company’s legal fees and expenses of counsel, accounting fees,

printing expenses, and blue sky fees and expenses (but excluding discounts or

selling commissions of any underwriter or broker dealer acting on behalf of the

company or the Optionee).




 




3





























 




(ii)           The Company shall take all necessary

action which may be reasonably required in qualifying or registering the

securities included in the Registration Statement for offering and sale under

the securities or blue sky laws of all states reasonably requested by Optionee,

provided that the Company shall not be obligated to qualify as a foreign

corporation to do business under the laws of any such jurisdiction.




 




(iii)          The Company shall indemnify Optionee

and each person, if any, who controls Optionee within the meaning of Section 15

of the Act or Section 20(a) of the Securities Exchange Act of 1934 (the

“Exchange Act”), against all loss, claim, damage, expense or liability

(including all expenses reasonably incurred in investigating, preparing or

defending against any claim whatsoever) to which any of them may become subject

under the Act, the Exchange Act or otherwise, arising from the Registration

Statement.




 




(iv)          The Company shall, as soon as

practicable after the effective date of the Registration Statement, and in any

event within fifteen (15) months thereafter, make “generally available to its

security holders” (within the meaning of Rule 158 under the Act) an earnings

statement  (which need not be audited)

complying with Section 11(a) of the Act and covering a period of at least

twelve (12) consecutive months beginning after the effective date of the

Registration Statement.




 




(v)           The Company shall (A) deliver

promptly to Optionee and its counsel, upon request, copies of all correspondence

between the Commission and the Company, its counsel, or auditors and all

memoranda relating to discussions with the Commission or its staff with respect

to the Registration Statement; and (B) permit Optionee and its counsel to

perform such investigation, upon reasonable advance notice, with respect to

information contained in or omitted from the Registration Statement, as it

deems reasonably necessary to comply with applicable securities laws or rules

of the National Association of Securities Dealers, Inc.  Such investigation shall include, but not be

limited to, access to financial and accounting information and opportunities to

discuss the business of the Company with the Company’s officers and independent

auditors, all to such reasonable extent, at such reasonable times and as often

as Optionee and its counsel shall reasonably request.




 




(vi)          The Company shall cause all securities

of Optionee registered pursuant to a Registration Statement to be listed on any

national securities exchange or quoted on any automated quotation system on

which similar securities of the Company are listed or quoted.




 




13.           Stand-off Agreement.  Optionee agrees that in connection with any

registration of the Company’s securities, that upon the request of the Company

or any underwriter managing an underwritten offering of the Company’s

securities, that Optionee shall not sell, short any sale of, loan, grant an

option for, or otherwise dispose of any of the Shares (other than Shares

included in the offering) without the prior written consent of the Company or

such managing underwriter, as applicable, for a period of at least one hundred

eighty (180) days following the effective date of registration of such

offering.




 




14.           Notices.  Any notice required to be given pursuant to

this Option or the Plan shall be in writing and shall be deemed to be delivered

upon receipt or, in the case of notices by the Company, five (5) days after

deposit in the U.S.  mail, postage

prepaid, addressed to Optionee at the address last provided to the Company by

Optionee for his or her employee records.




 




15.           Agreement Subject to Plan;

Applicable Law.  This Agreement is

made pursuant to the Plan and shall be interpreted to comply therewith.  A copy of such Plan is available to

Optionee, at no charge, at the principal office of the Company.  Any provision of this Agreement inconsistent

with the Plan shall be considered void and replaced with the applicable

provision of the Plan.  This Agreement

has been granted, executed and delivered in the State of California, and the

interpretation and enforcement shall be governed by the laws thereof and

subject to the exclusive jurisdiction of the courts therein.




 




IN WITNESS

WHEREOF, the parties hereto have executed this Agreement as of the date first

above written.




 




	

  I/OMagic Corporation


  	

   


  
	

   


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

  BY: Tony

  Shahbaz, President


  	

   


  	

  ,Optionee


  	

   


  
					





 




4





























 




Appendix A




 




NOTICE

OF EXERCISE




 




I/OMagic Corporation




1300 Wakeham




Santa Ana, California 92705




 




 




	

   


  	

   


  	

   


  
	

   


  	

  (date)


  	

   


  





 




Re: 

Nonstatutory Stock Option




 




Notice is

hereby given pursuant to Section 4 of my Nonstatutory Stock Option Agreement

that I elect to purchase the number of shares set forth below at the exercise

price set forth in my option agreement:




 




	

  Stock Option

  dated:


  	

   


  	

   


  
	

   


  	

   


  	

   


  
	

  Number of

  shares being purchased:


  	

   


  	

   


  
	

   


  	

   


  	

   


  
	

  Option

  Exercise Price:


  	

   


  	

  $


  	

   


  





 




A check in the

amount of the aggregate price of the shares being purchased is attached.




 




I hereby

confirm that such shares are being acquired by me for my own account for

investment purposes, and not with a view to, or for resale in connection with,

any distribution thereof.




 




Further, I

understand that, as a result of this exercise of rights, I will recognize

income in an amount equal to the amount by which the fair market value of the

Shares exceeds the exercise price.  I

agree to report such income in accordance with then applicable law and to

cooperate with Company in establishing the withholding and corresponding

deduction to the Company for its income tax purposes.




 




I agree to

provide to the Corporation such additional documents or information as may be

required pursuant to the Corporation’s 2001 Incentive and Nonstatutory Stock

Option Plan.




 




	

   


  	

   


  	

   


  
	

   


  	

  (Signature)


  	

   


  
	

   


  	

   


  	

   


  
	

   


  	

   


  	

   


  
	

   


  	

  (Name of Optionee)


  	

   


  





 





























 




I/OMagic

Corporation




 




Number




INCENTIVE STOCK OPTION AGREEMENT




 




This INCENTIVE

STOCK OPTION AGREEMENT is made and entered into as of this       day of                , 2001, by and between I/OMagic Corporation, a

Nevada corporation (“Company”), and                                (referred to herein as the

“Optionee”), with reference to the following recitals of facts:




 




WHEREAS, the

Board has authorized the granting to Optionee of an incentive stock option

(“Option”) to purchase shares of common stock of the Company (the “Shares”)

upon the terms and conditions hereinafter stated; and




 




WHEREAS, the

Board and stockholders of the Company have heretofore adopted a 2000 Incentive

and Nonstatutory Stock Option Plan (the “Plan”), pursuant to which this Option

is being granted;




 




WHEREAS, it is

the intention of the parties that this Option be an Incentive Stock Option (a

Qualified Stock Option);




 




NOW,

THEREFORE, in consideration of the covenants herein set forth, the parties

hereto agree as follows:




 




1.             Shares; Price.  The Company hereby grants to Optionee the

right to purchase, upon and subject to the terms and conditions herein

stated,         Shares for cash (or

other consideration acceptable to the Board of Directors of the Company, in

their sole and absolute discretion) at the price of $     per Share, such price being not less than the fair market

value per share of the Shares covered by these Options as of the date hereof

and as determined by the Board of Directors of the Company.




 




2.             Term of Option; Continuation of

Employment.  This Option shall

expire, and all rights hereunder to purchase the Shares shall terminate, ten

(10) years from the date hereof.  This

Option shall earlier terminate subject to Paragraphs 5 and 6 hereof if, and as

of the date, Optionee ceases to be an employee of the Company.  Nothing contained herein shall be construed

to interfere in any way with the right of the Company to terminate the

employment or engagement, as applicable, of Optionee or to increase or decrease

the compensation of Optionee from the rate in existence at the date hereof.




 




3.             Vesting of Option.  Subject to the provisions of Paragraphs 5

and 6 hereof, this Option shall vest and become exercisable during the term of

Optionee’s employment or engagement in whole or in part beginning on the date

of this Agreement.




 




4.             Exercise.  This Option shall be exercised by delivery

to the Company of (a) a written notice of exercise stating the number of Shares

being purchased (in whole shares only) and such other information set forth on

the form of Notice of Exercise attached hereto as Appendix A, (b) a check or

cash in the amount of the purchase price of the Shares covered by the notice,

and (c) a written statement as provided for in Paragraph 11 hereof.  This Option shall not be assignable or transferable,

except by will or by the laws of descent and distribution, and shall be

exercisable only by Optionee during his or her lifetime.




 




5.             Termination of Employment or

Engagement.  If Optionee shall cease

to serve as an employee of the Company for any reason, whether voluntarily or

involuntarily, other than by his or her death or the conclusion of the term of

a written consulting agreement, provided such term exceeds one year, Optionee

shall have the right at any time within thirty (30) days after date Optionee

ceases to be an employee of the Company, or the remaining term of this Option,

whichever is the lesser, to exercise in whole or in part this Option to the

extent, but only to the extent, that this Option was exercisable as of the last

day of employment or engagement, as applicable, and had not previously been

exercised; provided, however, that if Optionee’s termination of employment or

engagement was caused by permanent disability (within the meaning of Section

22(e)(3) of the Code), the foregoing thirty (30) day period shall be extended

to six (6) months; or




 





























 




Notwithstanding

anything herein to the contrary, all rights under this Option shall expire in

any event on the date specified in Paragraph 2 hereof.




 




6.             Death of Optionee.  If the Optionee shall die while an employee

of the Company, Optionee’s personal representative or the person entitled to

Optionee’s rights hereunder may at any time during the remaining term of this

Option, exercise this Option and purchase Shares to the extent, but only to the

extent, that Optionee could have exercised this Option as of the date of

Optionee’s death; provided, in any case, that this Option may be so exercised

only to the extent that this option has not previously been exercised by

Optionee.




 




7.             No Rights as Stockholder.  Optionee shall have no rights as a

stockholder with respect to the Shares covered by any installment of this

Option until the date of the issuance of a stock certificate to Optionee, and

no adjustment will be made for dividends or other rights for which the record

date is prior to the date such stock certificate or certificates are issued

except as provided in Paragraph 8 hereof.




 




8.             Recapitalization.  Subject to any required action by the

stockholders of the Company, the number of Shares covered by this Option, and

the price per Share thereof, shall be proportionately adjusted for any increase

or decrease in the number of issued Shares resulting from a subdivision or

consolidation of shares or the payment of a stock dividend, or any other

increase or decrease in the number of such shares affected without receipt of

consideration by the Company; provided however that the conversion of any

convertible securities of the Company shall not be deemed having been “effected

without receipt of consideration by the Company.”




 




In the event of

a proposed dissolution or liquidation of the Company, a merger or consolidation

in which the Company is not the surviving entity, or a sale of all or

substantially all of the assets of the Company, this Option shall terminate

immediately prior to the consummation of such proposed action, unless otherwise

provided by the Board.  The Board may,

at its sole and absolute discretion and without obligation, declare that this

Option shall terminate as of a date fixed by the Board and grant Optionee the

right for a period commencing thirty (30) days prior to and ending immediately

prior to such date, or during the remaining term of this Option, whichever

occurs sooner, to exercise this Option as to all or any part of the Shares,

without regard to the installment provision of Paragraph 3; provided, however,

that such exercise shall be subject to the consummation of such dissolution,

liquidation, merger, consolidation or sale.




 




Subject to any

required action by the stockholders of the Company, if the Company shall be the

surviving entity in any merger or consolidation, this Option thereafter shall

pertain to and apply to the securities to which a holder of Shares equal to the

Shares subject to this Option would have been entitled by reason of such merger

or consolidation, and the vesting provisions of Section 3 shall continue to

apply.




 




In the event

of a change in the Shares of the Company as presently constituted, which is

limited to a change of all of its authorized Shares without par value into the

same number of Shares with a par value, the Shares resulting from any such

change shall be deemed to be the Shares within the meaning of this Agreement.




 




To the extent

that the foregoing adjustments relate to shares or securities of the Company,

such adjustments shall be made by the Board, whose determination in that

respect shall be final, binding and conclusive.  Except as hereinbefore expressly provided, Optionee shall have no

rights by reason of any subdivision or consolidation of share of stock of any

class or the payment of any stock dividend or any other increase or decrease in

the number of shares of stock of any class, and the number and price of shares

subject to this Option shall not be affected by, and no adjustments shall be

made by reason of, any dissolution, liquidation, merger or consolidation, or

any issue by the Company of shares of stock of any class or securities

convertible into shares of stock of any class.




 




The grant of

this Option shall not affect in any way the right or power of the Company to

make adjustments, reclassifications, reorganizations or changes in its capital

or business structure or to merge, consolidate, dissolve or liquidate or to

sell or transfer all or any part of its business or assets.




 




9.             Taxation upon Exercise of Option.  Optionee understands that, upon exercise of

this Option, Optionee may recognize income, for federal and state income tax

purposes, in an amount equal to the amount by which the fair market value of

the Shares, determined as of the date of exercise, exceeds the exercise

price.  The acceptance of the Shares by

Optionee shall constitute an agreement by Optionee to report such income in

accordance with then applicable law and to cooperate with Company in

establishing the amount of such income and corresponding deduction to the 




 




2





























 




Company for its income tax

purposes.  Withholding for federal or

state income and employment tax purposes will be made, if and as required by

law, from Optionee’s then current compensation, or, if such current

compensation is insufficient to satisfy withholding tax liability, the Company

may require Optionee to make cash payment to cover such liability as a

condition of the exercise of this Option.




 




10.           Modification, Extension and

Renewal of Options.  The Board may

modify, extend or renew this Option or accept the surrender thereof (to the

extent not theretofore exercised) and authorize the granting of a new option in

substitution therefore (to the extent not theretofore exercised), subject at

all times to the Plan.  Notwithstanding

the foregoing provisions of this Paragraph 10, no modification shall, without

the consent of the Optionee, alter to the Optionee’s detriment or impair any

rights of Optionee hereunder.




 




11.           Investment Intent; Restrictions on

Transfer.  Optionee represents and

agrees that if Optionee exercises this Option in whole or in part, Optionee

will in each case acquire the Shares upon such exercise for the purpose of

investment and not with a view to, or for resale in connection with, any

distribution thereof; and that upon such exercise of this Option in whole or in

part, Optionee (or any person or persons entitled to exercise this Option under

the provisions of Paragraphs 5 and 6 hereof) shall furnish to the Company a

written statement to such effect, satisfactory to the Company in form and

substance.  The Company, at its option,

may include a legend on each certificate representing Shares issued pursuant to

any exercise of this Option, stating in effect that such Shares have not been

registered under the Securities Act of 1933, as amended (the “Act”), and that

the transferability thereof is restricted. 

If the Shares represented by this Option are registered under the Act,

either before or after the exercise of this Option in whole or in part, the

Optionee shall be relieved of the foregoing investment representation and

agreement and shall not be required to furnish the Company with the foregoing

written statement.




 




Optionee

further represents that optionee has had access to the financial statements or

books and records of the Company, has had the opportunity to ask questions of

the Company concerning its business, operations and financial condition, and to

obtain additional information reasonably necessary to verify the accuracy of

such information, and further represents that Optionee (either such experience

and knowledge in investment, financial and business matters in investments

similar to the stock of the Company that Optionee is capable of evaluating the

merits and risks thereof and has the capacity to protect his or her own

interest in connection therewith.




 




12.           Registration Rights.




 




a.             Piggyback Registration Rights.  If the Company at any time proposes to

register any of its securities under the Act, including under an S-8

Registration Statement, an SB-2 Registration Statement or otherwise, it will

each such time give written notice to all holders of outstanding or exercised

options of its intention so to do.  Upon

the written request of a holder or holders of any such outstanding or exercised

options given within thirty (30) days after receipt of any such notice, the

Company will use its best efforts to cause all such outstanding or exercised

options, the holders of which shall have so requested registration thereof, to be

registered under the Act (with the securities which the Company at the time

propose to register), all to the extent requisite to permit the sale or other

disposition by the prospective Sellers of the outstanding or exercised options

so registered; provided, however, that the Company may, as a condition

precedent to its effecting such registration, require each prospective Seller

to agree with the Company and the managing underwriter or underwriters of the

offering to be made by the Company in connection with such registration that

such Seller will not sell any securities of the same class or convertible into

the same class as those registered by the Company (including any class into

which the securities registered by the Company are convertible) for such reasonable

period after such registration becomes effective as shall then be specified in

writing by such underwriter or underwriters if in the opinion of such

underwriter or underwriters the Company’s offering would be materially

adversely affected in the absence of such an agreement.




 




b.             Procedures.  In connection with the registration of any

securities pursuant to Section 12.a. hereof, the Company and the Optionee

covenant and agree as follows:




 




(i)            The Company shall pay all costs,

fees, and expenses incurred by the Company and the Optionee in connection with

the Registration Statement and the offering thereunder including, without

limitation, the Company’s legal fees and expenses of counsel, accounting fees,

printing expenses, and blue sky fees and expenses (but excluding discounts or

selling commissions of any underwriter or broker dealer acting on behalf of the

company or the Optionee).




 




3





























 




(ii)           The Company shall take all necessary

action which may be reasonably required in qualifying or registering the

securities included in the Registration Statement for offering and sale under

the securities or blue sky laws of all states reasonably requested by Optionee,

provided that the Company shall not be obligated to qualify as a foreign

corporation to do business under the laws of any such jurisdiction.




 




(iii)          The Company shall indemnify Optionee

and each person, if any, who controls Optionee within the meaning of Section 15

of the Act or Section 20(a) of the Securities Exchange Act of 1934 (the

“Exchange Act”), against all loss, claim, damage, expense or liability

(including all expenses reasonably incurred in investigating, preparing or

defending against any claim whatsoever) to which any of them may become subject

under the Act, the Exchange Act or otherwise, arising from the Registration

Statement.




 




(iv)          The Company shall, as soon as

practicable after the effective date of the Registration Statement, and in any

event within fifteen (15) months thereafter, make “generally available to its

security holders” (within the meaning of Rule 158 under the Act) an earnings

statement  (which need not be audited)

complying with Section 11(a) of the Act and covering a period of at least twelve

(12) consecutive months beginning after the effective date of the Registration

Statement.




 




(v)           The Company shall (A) deliver

promptly to Optionee and its counsel, upon request, copies of all

correspondence between the Commission and the Company, its counsel, or auditors

and all memoranda relating to discussions with the Commission or its staff with

respect to the Registration Statement; and (B) permit Optionee and its counsel

to perform such investigation, upon reasonable advance notice, with respect to

information contained in or omitted from the Registration Statement, as it

deems reasonably necessary to comply with applicable securities laws or rules

of the National Association of Securities Dealers, Inc.  Such investigation shall include, but not be

limited to, access to financial and accounting information and opportunities to

discuss the business of the Company with the Company’s officers and independent

auditors, all to such reasonable extent, at such reasonable times and as often

as Optionee and its counsel shall reasonably request.




 




(vi)          The Company shall cause all securities

of Optionee registered pursuant to a Registration Statement to be listed on any

national securities exchange or quoted on any automated quotation system on

which similar securities of the Company are listed or quoted.




 




13.           Stand-off Agreement.  Optionee agrees that in connection with any

registration of the Company’s securities, that upon the request of the Company

or any underwriter managing an underwritten offering of the Company’s

securities, that Optionee shall not sell, short any sale of, loan, grant an

option for, or otherwise dispose of any of the Shares (other than Shares

included in the offering) without the prior written consent of the Company or

such managing underwriter, as applicable, for a period of at least one hundred

eighty (180) days following the effective date of registration of such

offering.




 




14.           Notices.  Any notice required to be given pursuant to

this Option or the Plan shall be in writing and shall be deemed to be delivered

upon receipt or, in the case of notices by the Company, five (5) days after

deposit in the U.S. mail, postage prepaid, addressed to Optionee at the address

last provided to the Company by Optionee for his or her employee records.




 




15.           Agreement Subject to Plan;

Applicable Law.  This Agreement is

made pursuant to the Plan and shall be interpreted to comply therewith.  A copy of such Plan is available to

Optionee, at no charge, at the principal office of the Company.  Any provision of this Agreement inconsistent

with the Plan shall be considered void and replaced with the applicable

provision of the Plan.  This Agreement

has been granted, executed and delivered in the State of California, and the

interpretation and enforcement shall be governed by the laws thereof and

subject to the exclusive jurisdiction of the courts therein.




 




IN WITNESS

WHEREOF, the parties hereto have executed this Agreement as of the date first

above written.




 




	

  I/OMagic Corporation


  	

   


  
	

   


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

  BY: Tony

  Shahbaz, President


  	

   


  	

  , Optionee


  	

   


  
					





 




4





























 




Appendix A




 




NOTICE

OF EXERCISE




 




I/OMagic Corporation




1300 Wakeham




Santa Ana, California 92705




 




	

   


  	

   


  	

   


  
	

   


  	

  (date)


  	

   


  





 




Re: Incentive Stock Option




 




Notice is

hereby given pursuant to Section 4 of my Incentive Stock Option Agreement that

I elect to purchase the number of shares set forth below at the exercise price

set forth in my option agreement:




 




	

  Stock Option

  dated:


  	

   


  	

   


  
	

   


  	

   


  	

   


  
	

  Number of

  shares being purchased:


  	

   


  	

   


  
	

   


  	

   


  	

   


  
	

  Option

  Exercise Price:


  	

   


  	

  $


  	

   


  





 




A check in the

amount of the aggregate price of the shares being purchased is attached.




 




I hereby

confirm that such shares are being acquired by me for my own account for

investment purposes, and not with a view to, or for resale in connection with,

any distribution thereof.




 




Further, I

understand that, as a result of this exercise of rights, I will recognize

income in an amount equal to the amount by which the fair market value of the

Shares exceeds the exercise price.  I

agree to report such income in accordance with then applicable law and to cooperate

with Company in establishing the withholding and corresponding deduction to the

Company for its income tax purposes.




 




I agree to

provide to the Corporation such additional documents or information as may be

required pursuant to the Corporation’s 2001 Incentive and Nonstatutory Stock

Option Plan.




 




	

   


  	

   


  	

   


  
	

   


  	

  (Signature)


  	

   


  
	

   


  	

   


  	

   


  
	

   


  	

   


  	

   


  
	

   


  	

  (Name of Optionee)


  	

   


  





 





























 




I/OMAGIC CORPORATION




AND SUBSIDIARY




CONTENTS




December 31, 2001




 




 




 




	

  REPORT OF INDEPENDENT CERTIFIED PUBLIC

  ACCOUNTANTS


  
	

   


  
	

  CONSOLIDATED FINANCIAL STATEMENTS


  
	

   


  
	

  Consolidated Balance Sheets


  
	

   


  
	

  Consolidated Statements of Operations


  
	

   


  
	

  Consolidated Statements of Stockholders’

  Equity


  
	

   


  
	

  Consolidated Statements of Cash Flows


  
	

   


  
	

  Notes to Consolidated Financial Statements


  
	

   


  
	

  SUPPLEMENTAL INFORMATION


  
	

   


  
	

  Report of Independent Certified Public Accountants on Financial

  Statement Schedules


  
	

   


  
	

  Valuation and Qualifying Accounts - Schedule

  II


  





 





























 




REPORT OF INDEPENDENT

CERTIFIED PUBLIC ACCOUNTANTS




 




To the Board of Directors




I/OMagic Corporation and

subsidiary




Santa Ana, California




 




We have audited the

accompanying consolidated balance sheets of I/OMagic Corporation and subsidiary

as of December 31, 2001 and 2000, and the related consolidated statements of

operations, stockholders’ equity and cash flows for each of the three years in

the period ended December 31, 2001. These financial statements are the

responsibility of the Company’s management. Our responsibility is to express an

opinion on these financial statements based on our audits.




 




We conducted our audits in

accordance with auditing standards generally accepted in the United States of

America. 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 consolidated financial position of I/OMagic Corporation

and subsidiary as of December 31, 2001 and 2000, and the results of their

operations and their cash flows for each of the three years in the period ended

December 31, 2001 in conformity with accounting principles generally accepted

in the United States of America.




 




 




	

  SINGER LEWAK

  GREENBAUM & GOLDSTEIN LLP


  
	

   


  
	

  Los Angeles,

  California


  
	

  February 15,

  2002


  





 




The accompanying notes are an integral part of these financial

statements.




 




F-1





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED BALANCE SHEETS




December

31,




 




ASSETS




	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Current

  assets


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Cash and cash equivalents


  	

   


  	

  $


  	

  4,423,623


  	

   


  	

  $


  	

  3,502,546


  	

   


  
	

  Accounts receivable, net of allowance for

  doubtful


  accounts of $2,679,118 and $2,106,518


  	

   


  	

  27,844,543


  	

   


  	

  18,109,794


  	

   


  
	

  Accounts receivable from related parties


  	

   


  	

  —


  	

   


  	

  84,710


  	

   


  
	

  Inventory, net of allowance for obsolete

  inventory


  of $558,703 and $1,834,427


  	

   


  	

  10,377,287


  	

   


  	

  6,783,715


  	

   


  
	

  Inventory in transit


  	

   


  	

  1,634,420


  	

   


  	

  13,011,000


  	

   


  
	

  Current portion of deferred income taxes


  	

   


  	

  1,556,000


  	

   


  	

  1,556,000


  	

   


  
	

  Income tax receivable


  	

   


  	

  34,311


  	

   


  	

  34,311


  	

   


  
	

  Prepaid expenses and other current assets


  	

   


  	

  2,292,424


  	

   


  	

  184,523


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total current

  assets


  	

   


  	

  48,162,608


  	

   


  	

  43,266,599


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Property and equipment, net


  	

   


  	

  1,266,216


  	

   


  	

  1,427,772


  	

   


  
	

  Trademark, net of

  accumulated amortization 


  of $3,375,976 and $1,446,852


  	

   


  	

  6,269,703


  	

   


  	

  8,198,827


  	

   


  
	

  Deferred income taxes, net of

  current portion


  	

   


  	

  165,000


  	

   


  	

  165,000


  	

   


  
	

  Other assets


  	

   


  	

  40,240


  	

   


  	

  40,240


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total assets


  	

   


  	

  $


  	

  55,903,767


  	

   


  	

  $


  	

  53,098,438


  	

   


  





 




The accompanying notes are an integral part of these financial

statements.




 




F-2





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED

BALANCE SHEETS




December

31,




 




LIABILITIES AND

STOCKHOLDERS’ EQUITY




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Current liabilities


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Line of credit


  	

   


  	

  $


  	

  9,622,241


  	

   


  	

  $


  	

  6,996,969


  	

   


  
	

  Current portion of capital lease

  obligations


  	

   


  	

  10,978


  	

   


  	

  27,121


  	

   


  
	

  Accounts payable and accrued expenses


  	

   


  	

  12,027,498


  	

   


  	

  5,584,951


  	

   


  
	

  Accounts payable to related parties


  	

   


  	

  5,521,720


  	

   


  	

  6,586,761


  	

   


  
	

  Reserves for customer returns and

  allowances


  	

   


  	

  2,605,679


  	

   


  	

  2,232,087


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total current liabilities


  	

   


  	

  29,788,116


  	

   


  	

  21,427,889


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Capital lease obligations, net of current

  portion


  	

   


  	

  —


  	

   


  	

  10,978


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total liabilities


  	

   


  	

  29,788,116


  	

   


  	

  21,438,867


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Commitments and contingencies


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Redeemable convertible

  preferred stock
10,000,000 shares authorized, $0.001 par value


  Series A, 1,000,000 shares authorized


  875,000 and 875,000 shares issued and outstanding


  	

   


  	

  875


  	

   


  	

  875


  	

   


  
	

  Series B, 1,000,000 shares authorized 


  250,000 and 250,000 shares issued and outstanding


  	

   


  	

  250


  	

   


  	

  250


  	

   


  
	

  Additional paid-in capital


  	

   


  	

  8,998,875


  	

   


  	

  8,998,875


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total redeemable convertible preferred

  stock


  	

   


  	

  9,000,000


  	

   


  	

  9,000,000


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Stockholders’ equity


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Class A common stock, $0.001 par value


  100,000,000 shares authorized


  67,930,291 and 67,917,791 shares issued and outstanding


  	

   


  	

  67,931


  	

   


  	

  67,918


  	

   


  
	

  Additional paid-in capital


  	

   


  	

  31,493,957


  	

   


  	

  31,493,345


  	

   


  
	

  Deferred compensation


  	

   


  	

  —


  	

   


  	

  (3,100


  	

  )


  
	

  Accumulated deficit


  	

   


  	

  (14,446,237


  	

  )


  	

  (8,898,592


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total stockholders’ equity


  	

   


  	

  17,115,651


  	

   


  	

  22,659,571


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total liabilities

  and stockholders’ equity


  	

   


  	

  $


  	

  55,903,767


  	

   


  	

  $


  	

  53,098,438


  	

   


  





 




The accompanying notes are an integral part of these financial

statements.




 




F-3





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED STATEMENTS OF OPERATIONS




For

the Years Ended December 31,




 




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  	

  1999


  	

   


  
	

  Net sales


  	

   


  	

  $


  	

  67,788,959


  	

   


  	

  $


  	

  60,805,437


  	

   


  	

  $


  	

  36,661,092


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Cost of sales


  	

   


  	

  62,776,334


  	

   


  	

  53,126,489


  	

   


  	

  31,419,757


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Gross profit


  	

   


  	

  5,012,625


  	

   


  	

  7,678,948


  	

   


  	

  5,241,335


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Operating expenses


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Selling, marketing, and advertising


  	

   


  	

  1,487,828


  	

   


  	

  2,180,685


  	

   


  	

  1,295,189


  	

   


  
	

  General and administrative


  	

   


  	

  6,461,112


  	

   


  	

  6,276,761


  	

   


  	

  2,490,272


  	

   


  
	

  Depreciation and amortization


  	

   


  	

  2,231,899


  	

   


  	

  1,668,665


  	

   


  	

  51,832


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total operating expenses


  	

   


  	

  10,180,839


  	

   


  	

  10,126,111


  	

   


  	

  3,837,293


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Income (loss) from operations


  	

   


  	

  (5,168,214


  	

  )


  	

  (2,447,163


  	

  )


  	

  1,404,042


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Other income (expense)


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Interest income


  	

   


  	

  31,780


  	

   


  	

  59,600


  	

   


  	

  16,087


  	

   


  
	

  Interest expense


  	

   


  	

  (418,381


  	

  )


  	

  (1,272,079


  	

  )


  	

  (13,994


  	

  )


  
	

  Forgiveness of amounts due from related

  party


  	

   


  	

  —


  	

   


  	

  (3,802,917


  	

  )


  	

  —


  	

   


  
	

  Income from related party


  	

   


  	

  —


  	

   


  	

  —


  	

   


  	

  24,000


  	

   


  
	

  Other income


  	

   


  	

  10,170


  	

   


  	

  52,110


  	

   


  	

  4,163


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total other income (expense)


  	

   


  	

  (376,431


  	

  )


  	

  (4,963,286


  	

  )


  	

  30,256


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Income (loss) before provision for (benefit from) income taxes


  	

   


  	

  (5,544,645


  	

  )


  	

  (7,410,449


  	

  )


  	

  1,434,298


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Provision for (benefit from) income taxes


  	

   


  	

  3,000


  	

   


  	

  (999,600


  	

  )


  	

  (428,500


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net income (loss)


  	

   


  	

  $


  	

  (5,547,645


  	

  )


  	

  $


  	

  (6,410,849


  	

  )


  	

  $


  	

  1,862,798


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Basic and diluted earnings (loss) per share


  	

   


  	

  $


  	

  (0.08


  	

  )


  	

  $


  	

  (0.16


  	

  )


  	

  $


  	

  0.06


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Basic weighted-average shares outstanding


  	

   


  	

  67,925,120


  	

   


  	

  39,448,410


  	

   


  	

  31,757,039


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Diluted weighted-average shares outstanding


  	

   


  	

  67,925,120


  	

   


  	

  39,448,410


  	

   


  	

  31,880,921


  	

   


  





 




The accompanying notes are an integral part of these financial

statements.




 




F-4





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED STATEMENTS OF STOCKHOLDERS’

EQUITY




For

the Years Ended December 31,




 




 




	

   


  	

   


  	

   


  	

   


  	

  Additional

  


  Paid-In


  Capital


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  Class A

  Common Stock


  	

   


  	

   


  	

  Deferred 


  Compensation


  	

   


  	

   


  	

   


  	

  Accumulated


  Deficit


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  Shares


  	

   


  	

  Amount


  	

   


  	

   


  	

   


  	

  Treasury

  Stock


  	

   


  	

   


  	

  Total


  	

   


  
	

  Balance, December 31, 1998


  	

   


  	

  14,879,546


  	

   


  	

  $


  	

  14,880


  	

   


  	

  $


  	

  5,305,681


  	

   


  	

  $


  	

  (27,900


  	

  )


  	

  $


  	

  (165,000


  	

  )


  	

  $


  	

  (4,350,541


  	

  )


  	

  $


  	

  777,120


  	

   


  
	

  Issuance of common stock in connection with the exercise of warrants

  and stock options


  	

   


  	

  760,826


  	

   


  	

  762


  	

   


  	

  106,383


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  107,145


  	

   


  
	

  Common stock issued for inventory


  	

   


  	

  16,666,667


  	

   


  	

  16,667


  	

   


  	

  4,983,333


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  5,000,000


  	

   


  
	

  Amortization of deferred compensation


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  12,400


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  12,400


  	

   


  
	

  Tax benefit related to the exercise of

  non-statutory stock options


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  116,500


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  116,500


  	

   


  
	

  Net income


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  1,862,798


  	

   


  	

  1,862,798


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Balance, December 31, 1999


  	

   


  	

  32,307,039


  	

   


  	

  32,309


  	

   


  	

  10,511,897


  	

   


  	

  (15,500


  	

  )


  	

  (165,000


  	

  )


  	

  (2,487,743


  	

  )


  	

  7,875,963


  	

   


  
	

  Issuance of common stock in connection with

  the exercise of warrants


  	

   


  	

  82,858


  	

   


  	

  82


  	

   


  	

  52,933


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  53,015


  	

   


  
	

  Common stock issued for inventory


  	

   


  	

  11,362,262


  	

   


  	

  11,362


  	

   


  	

  12,988,638


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  13,000,000


  	

   


  
	

  Common stock issued for cash


  	

   


  	

  632,912


  	

   


  	

  633


  	

   


  	

  1,999,367


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  2,000,000


  	

   


  
	

  Common stock issued for legal services


  	

   


  	

  40,000


  	

   


  	

  40


  	

   


  	

  59,960


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  60,000


  	

   


  
	

  Common stock issued for services rendered


  	

   


  	

  42,720


  	

   


  	

  42


  	

   


  	

  —


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  42


  	

   


  
	

  Treasury stock retired


  	

   


  	

  (550,000


  	

  )


  	

  (550


  	

  )


  	

  (164,450


  	

  )


  	

   


  	

   


  	

  165,000


  	

   


  	

   


  	

   


  	

  —


  	

   


  
	

  Common stock issued in connection with the

  acquisition of IOM Holdings, Inc.


  	

   


  	

  24,000,000


  	

   


  	

  24,000


  	

   


  	

  5,976,000


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  6,000,000


  	

   


  
	

  Amortization of deferred compensation


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  12,400


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  12,400


  	

   


  
	

  Tax benefit related to the exercise of

  non-statutory stock options


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  69,000


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  69,000


  	

   


  
	

  Net loss


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  (6,410,849


  	

  )


  	

  (6,410,849


  	

  )


  
																						





 




The accompanying notes are an integral part of these financial

statements.




 




F-5





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED

STATEMENTS OF STOCKHOLDERS' EQUITY




For

the Years Ended December 31,




 




 




	

   


  	

   


  	

  Class A

  Common Stock


  	

   


  	

  Additional


  	

   


  	

  Deferred


  	

   


  	

   


  	

   


  	

  Accumulated


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  Shares


  	

   


  	

  Amount


  	

   


  	

   Paid-In Capital


  	

   


  	

  Compensation


  	

   


  	

  TreasuryStock


  	

   


  	

  Deficit


  	

   


  	

  Total


  	

   


  
	

  Balance, December 31, 2000


  	

   


  	

  67,917,791


  	

   


  	

  $


  	

  67,918


  	

   


  	

  $


  	

  31,493,345


  	

   


  	

  $


  	

  (3,100


  	

  )


  	

  $


  	

  —


  	

   


  	

  $


  	

  (8,898,592


  	

  )


  	

  $


  	

  22,659,571


  	

   


  
	

  Issuance of common stock in connection with

  the exercise of warrants


  	

   


  	

  12,500


  	

   


  	

  13


  	

   


  	

  612


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  625


  	

   


  
	

  Amortization of deferred compensation


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  3,100


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  3,100


  	

   


  
	

  Net loss


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

  (5,547,645


  	

  )


  	

  (5,547,645


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Balance,

  December 31, 2001


  	

   


  	

  67,930,291


  	

   


  	

  $


  	

  67,931


  	

   


  	

  $


  	

  31,493,957


  	

   


  	

  $


  	

  —


  	

   


  	

  $


  	

  —


  	

   


  	

  $


  	

  (14,446,237


  	

  )


  	

  $


  	

  17,115,651


  	

   


  
																													





 




The accompanying notes are an integral part of these financial

statements.




 




F-6





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED STATEMENTS OF CASH FLOWS




For

the Years Ended December 31,




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  	

  1999


  	

   


  
	

  Cash flows from operating activities


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net income (loss)


  	

   


  	

  $


  	

  (5,547,645


  	

  )


  	

  $


  	

  (6,410,849


  	

  )


  	

  $


  	

  1,862,798


  	

   


  
	

  Adjustments to reconcile net income (loss)

  to net 


  cash provided by (used in) operating activities


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Depreciation and amortization


  	

   


  	

  302,775


  	

   


  	

  221,813


  	

   


  	

  51,832


  	

   


  
	

  Amortization of trademark


  	

   


  	

  1,929,124


  	

   


  	

  1,446,852


  	

   


  	

  —


  	

   


  
	

  Amortization of deferred compensation


  	

   


  	

  3,100


  	

   


  	

  12,400


  	

   


  	

  12,400


  	

   


  
	

  Provision for allowance for doubtful

  accounts


  	

   


  	

  572,600


  	

   


  	

  212,993


  	

   


  	

  24,821


  	

   


  
	

  Reserves for customer returns and

  allowances


  	

   


  	

  373,592


  	

   


  	

  1,086,519


  	

   


  	

  922,189


  	

   


  
	

  Provision for obsolete inventory


  	

   


  	

  (1,275,724


  	

  )


  	

  575,722


  	

   


  	

  3,363


  	

   


  
	

  Forgiveness of amounts due from related

  party


  	

   


  	

  —


  	

   


  	

  3,802,917


  	

   


  	

  —


  	

   


  
	

  Interest imputed on notes payable


  	

   


  	

  —


  	

   


  	

  477,181


  	

   


  	

  —


  	

   


  
	

  Provision for deferred income taxes


  	

   


  	

  —


  	

   


  	

  (1,070,000


  	

  )


  	

  (651,000


  	

  )


  
	

  Note payable to related party


  	

   


  	

  —


  	

   


  	

  —


  	

   


  	

  (345,500


  	

  )


  
	

  Tax effect of exercised options


  	

   


  	

  —


  	

   


  	

  69,000


  	

   


  	

  116,500


  	

   


  
	

  (Increase) decrease in


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Accounts receivable


  	

   


  	

  (10,307,349


  	

  )


  	

  (5,219,800


  	

  )


  	

  (6,363,758


  	

  )


  
	

  Accounts receivable from related parties


  	

   


  	

  84,710


  	

   


  	

  4,342,607


  	

   


  	

  (6,561,738


  	

  )


  
	

  Inventory


  	

   


  	

  9,058,732


  	

   


  	

  3,853,216


  	

   


  	

  2,412,050


  	

   


  
	

  Prepaid expenses and other current assets


  	

   


  	

  (2,107,901


  	

  )


  	

  (135,403


  	

  )


  	

  11,588


  	

   


  
	

  Due from related party


  	

   


  	

  —


  	

   


  	

  (2,108,220


  	

  )


  	

  —


  	

   


  
	

  Other assets


  	

   


  	

  —


  	

   


  	

  (18,752


  	

  )


  	

  (328


  	

  )


  
	

  Increase (decrease) in


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Accounts payable and accrued expenses


  	

   


  	

  6,442,547


  	

   


  	

  3,774,351


  	

   


  	

  7,526,956


  	

   


  
	

  Income taxes payable


  	

   


  	

  —


  	

   


  	

  (140,311


  	

  )


  	

  106,000


  	

   


  
	

  Due to related parties


  	

   


  	

  (1,065,041


  	

  )


  	

  (4,898,948


  	

  )


  	

  1,735,377


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net cash provided by (used in) operating

  activities


  	

   


  	

  (1,536,480


  	

  )


  	

  (126,712


  	

  )


  	

  863,550


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Cash flows from investing activities


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Purchase of property and equipment


  	

   


  	

  (141,219


  	

  )


  	

  (220,242


  	

  )


  	

  (174,290


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net cash used in investing activities


  	

   


  	

  (141,219


  	

  )


  	

  (220,242


  	

  )


  	

  (174,290


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Cash flows from financing activities


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net borrowings on line of credit


  	

   


  	

  2,625,272


  	

   


  	

  118,634


  	

   


  	

  —


  	

   


  
	

  Payments on capital lease obligations


  	

   


  	

  (27,121


  	

  )


  	

  (17,804


  	

  )


  	

  (5,787


  	

  )


  
	

  Payments on notes payable


  	

   


  	

  —


  	

   


  	

  (247,909


  	

  )


  	

  (250,000


  	

  )


  
	

  Proceeds from issuance of stock


  	

   


  	

  —


  	

   


  	

  2,000,000


  	

   


  	

  —


  	

   


  
	

  Proceeds from exercise of warrants


  	

   


  	

  625


  	

   


  	

  53,057


  	

   


  	

  107,145


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net cash provided by (used in) financing

  activities


  	

   


  	

  2,598,776


  	

   


  	

  1,905,978


  	

   


  	

  (148,642


  	

  )


  
											





 




The accompanying notes are an integral part of these financial

statements.




 




F-7





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED

STATEMENTS OF CASH FLOWS




For

the Years Ended December 31,




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  	

  1999


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net increase in cash and cash equivalents


  	

   


  	

  $


  	

  921,077


  	

   


  	

  $


  	

  1,559,024


  	

   


  	

  $


  	

  540,618


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Cash and cash equivalents,

  beginning of year


  	

   


  	

  3,502,546


  	

   


  	

  1,943,522


  	

   


  	

  1,402,904


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Cash and cash equivalents, end

  of year


  	

   


  	

  $


  	

  4,423,623


  	

   


  	

  $


  	

  3,502,546


  	

   


  	

  $


  	

  1,943,522


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Supplemental disclosures of cash flow information


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Interest paid


  	

   


  	

  $


  	

  396,868


  	

   


  	

  $


  	

  794,898


  	

   


  	

  $


  	

  13,994


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Income taxes paid


  	

   


  	

  $


  	

  3,000


  	

   


  	

  $


  	

  27,500


  	

   


  	

  $


  	

  800


  	

   


  





 




Supplemental

schedule of non-cash investing and financing activities




During the year ended December

31, 2000, the Company entered into the following non-cash transactions:




 




•                  Received

$5,000,000 in inventory for 6,250,000 shares of common stock.




 




•                  Received

$8,000,000 in inventory for 5,112,262 shares of common stock.




 




•                  Received

$5,011,000 in inventory and a reduction in accounts payable of $989,000 for

125,000 shares of IOM Holdings, Inc., which were later converted into 4,800,000

shares of I/OMagic Corporation.




 




•                  Received

$1,003,413 in inventory in exchange for a reduction in accounts receivable of

the same amount.




 




•                  Issued 1,125,000

shares of preferred stock in exchange for $9,000,000 of debt.




 




•                  Received $60,000

in legal services for 40,000 shares of common stock.




 




•                  Cancelled

550,000 shares of treasury stock outstanding totaling $165,000.




 




•                  Issued

24,000,000 shares of common stock in exchange for 100% of the issued and

outstanding shares of IOM Holdings, Inc.




 




 




The accompanying notes are an integral part of these financial

statements.




 




F-8





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




CONSOLIDATED

STATEMENTS OF CASH FLOWS




For

the Years Ended December 31,




 




During the year ended December 31, 1999, the

Company entered into the following non-cash transactions:




 




•                  Received

$5,000,000 in inventory for 16,666,667 shares of common stock.




 




•                  Reflected the

reduction of a related party note payable as a reduction to cost of sales of

$345,500.




 




 




The accompanying notes are an integral part of these financial

statements.




 




F-9





























 




I/OMAGIC

CORPORATION




AND

SUBSIDIARY




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




December

31, 2001




 




NOTE 1 - ORGANIZATION AND BUSINESS




 




I/OMagic

Corporation (“I/OMagic”), a Nevada corporation, and its subsidiary

(collectively, the “Company”) develop, manufacture through subcontractors,

market, and distribute multimedia and communication card devices for portable

and desktop computers.  The Company

sells its products in the United States to distributors and retail customers.




 




In March 1996,

I/OMagic Corporation, a California corporation (“I/OMagic California”),

originally incorporated on September 30, 1993, entered into a Plan of Exchange

and Acquisition Agreement (the “Acquisition Agreement”) with Silvercrest

International, Inc. (“Silvercrest”), a Nevada corporation.  Silvercrest subsequently changed its name to

I/OMagic Corporation, a Nevada corporation.




 




Acquisitions




 




Hi-Val, Inc.




On March 29, 2000, IOM Holdings, Inc.

(“IOMH”) acquired certain assets of Hi-Val, Inc. (“Hi-Val”) for the benefit of

Hi-Val’s creditors pursuant to Section 493.010 of the California Code of Civil

Procedures. The purchase price for the assets was $15,878,335; however, total

consideration was adjusted to $15,401,154, based on imputed interest.  The purchase price was paid as follows: (i)

$6,878,335 through the revolving line of credit, (ii) $7,000,000 notes payable

at 0% interest (imputed to $6,522,819 based on 9.5% interest), and (iii)

$2,000,000 notes payable at prime (9.5% as of December 31, 2000), plus 0.5%

issued to IOMH’s lending institution. 

IOMH recorded $9,645,679 in excess of cost over fair value of net assets

acquired, identified as a trademark, which is being amortized on a

straight-line basis over five years. 

The acquisition was accounted for by the purchase method.




 




For financial statement purposes, the

acquisition occurred on April 1, 2000. 

The assets acquired were as follows:




 








	

  Accounts receivable


  	

   


  	

  $


  	

  2,987,637


  	

   


  
	

  Inventory


  	

   


  	

  1,890,818


  	

   


  
	

  Due from related party


  	

   


  	

  563,689


  	

   


  
	

  Property and equipment


  	

   


  	

  1,173,654


  	

   


  
	

  Liabilities assumed


  	

   


  	

  (860,323


  	

  )


  
	

  Trademark


  	

   


  	

  9,645,679


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  15,401,154


  	

   


  










 




F-10





























 




IOM Holdings, Inc.




On December 31, 2000, I/OMagic acquired 100%

of the issued and outstanding shares of IOM Holdings, Inc., a Nevada corporation,

for 24,000,000 restricted shares of common stock.  The entities were under common control; therefore, the

acquisition has been accounted for in a manner similar to a

pooling-of-interests.




 




 




NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING

POLICIES




 




Principles of Consolidation




The

consolidated financial statements include the accounts of I/OMagic Corporation

and its subsidiary, IOM Holdings, Inc. 

All material intercompany accounts and transactions have been

eliminated.




 




Revenue Recognition




For transactions

satisfying the conditions for revenue recognition under Statement of Financial

Accounting Standards (“SFAS”) No. 48, “Revenue Recognition when Right of Return

Exists,” product revenue is recorded at the time of shipment, net of estimated

allowances and returns.  For

transactions not satisfying the conditions for revenue recognition under SFAS

No. 48, product revenue is deferred until the conditions are met, net of an

estimate for cost of sales.  For the

years ended December 31, 2001, 2000, and 1999, the Company had reserves for

sales returns totaling $861,831, $315,015, and $191,326, respectively.




 




The Company

performs periodic credit evaluations of its customers and maintains allowances

for potential credit losses based on management’s evaluation of historical

experience and current industry trends. 

Although the Company expects to collect amounts due, actual collections

may differ.




 




Comprehensive Income




The Company

utilizes SFAS No. 130, “Reporting Comprehensive Income”.  This statement establishes standards for

reporting comprehensive income and its components in a financial

statement.  Comprehensive income as

defined includes all changes in equity (net assets) during a period from

non-owner sources.  Examples of items to

be included in comprehensive income, which are excluded from net income,

include foreign currency translation adjustments and unrealized gains and

losses on available-for-sale securities. 

For the years ended December 31, 2001, 2000, and 1999, comprehensive

income is not presented in the Company’s financial statements since the Company

did not have any of the items of comprehensive income in any period presented.




 




F-11





























 




Cash and Cash Equivalents




For purposes of the statements of cash flows,

the Company considers all highly liquid investments purchased with original

maturities of three months or less to be cash equivalents.




 




Inventory




Inventory is

stated at the lower of cost, using the weighted-average method, which

approximates the first-in, first-out method or market.




 




Property and Equipment




Property and

equipment are recorded at cost, less accumulated depreciation and

amortization.  Depreciation and

amortization are provided using the straight-line method over estimated useful

lives as follows:




 








	

  Computer

  equipment and software


  	

   


  	

  5 years


  
	

  Warehouse

  equipment


  	

   


  	

  7 years


  
	

  Office

  furniture and equipment


  	

   


  	

  5 to 7 years


  
	

  Equipment

  under capital leases


  	

   


  	

  5 years


  
	

  Vehicles


  	

   


  	

  5 years


  
	

  Leasehold

  improvements


  	

   


  	

  Estimated useful life or lease term


  whichever is shorter


  










 




Expenditures for major renewals and

betterments that extend the useful lives of property and equipment are

capitalized.  Expenditures for

maintenance and repairs are charged to expense as incurred.




 




Depreciation expense on assets acquired under

capital leases is included with depreciation expense on owned assets.




 




Trademark




The trademark is being amortized over a

five-year period.  The Company

continually evaluates whether events or circumstances have occurred that

indicate the remaining estimated value of the trademark may not be

recoverable.  When factors indicate that

the value the trademark may be impaired, the Company estimates the remaining

value and reduces the trademark to that amount.




 




F-12





























 




Accounting for the Impairment of Long-Lived Assets




The Company

adopted SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and

for Long-Lived Assets to be Disposed of.” 

SFAS No. 121 requires impairment losses to be recorded on long-lived assets

used in operations when indicators of impairment are present and the

undiscounted cash flows estimated to be generated by those assets are less than

the assets’ carrying amount.  Management

determined that there was not any impairment of long-lived assets during the

years ended December 31, 2001, 2000, and 1999.




 




Fair Value of Financial Instruments




The Company

measures its financial assets and liabilities in accordance with generally

accepted accounting principles.  For

certain of the Company’s financial instruments, including cash and cash

equivalents, accounts receivable, and accounts payable and accrued expenses,

the carrying amounts approximate fair value due to their short maturities.  The amounts shown for capital lease

obligations also approximate fair value because interest rates offered to the

Company for debt of similar maturities are substantially the same.




 




Stock-Based Compensation




SFAS No. 123,

“Accounting for Stock-Based Compensation,” establishes and encourages the use

of the fair value based method of accounting for stock-based compensation

arrangements under which compensation cost is determined using the fair value

of stock-based compensation determined as of the date of grant and is

recognized over the periods in which the related services are rendered. The

statement also permits companies to elect to continue using the current

implicit value accounting method specified in Accounting Principles Bulletin

(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account

for stock-based compensation issued to employees. The Company has elected to

use the implicit value based method and has disclosed the pro forma effect of

using the fair value based method to account for its stock-based compensation.  For stock-based compensation issued to

non-employees, the Company uses the fair value method of accounting under the

provisions of SFAS No. 123.




 




Advertising

Costs




The Company

expenses advertising costs as incurred. 

For the years ended December 31, 2001, 2000, and 1999, advertising costs

were $120,577, $218,956, and $11,345, respectively.




 




F-13





























 




Income Taxes




Deferred

income taxes are recognized for the tax consequences in future years of

differences between the tax basis of assets and liabilities and their financial

reporting amounts at each period end, based on enacted tax laws and statutory

tax rates applicable to the periods in which the differences are expected to

affect taxable income. Valuation allowances are established, when necessary, to

reduce deferred tax assets to the amount expected to be realized. The provision

for income taxes represents the tax payable for the period, if any, and the

change during the period in deferred tax assets and liabilities.




 




Earnings (Loss) Per Share




The Company

calculates earnings (loss) per share in accordance with SFAS No. 128, “Earnings

Per Share.”  SFAS No. 128 replaced the

presentation of primary and fully diluted earnings (loss) per share with the

presentation of basic and diluted earnings (loss) per share.  Basic earnings (loss) per share excludes

dilution and is calculated by dividing income (loss) available to common

stockholders by the weighted-average number of common shares outstanding for

the period.  Diluted earnings (loss) per

share includes the potential dilutive effects that could occur if securities or

other contracts to issue common stock were exercised or converted into common

stock (“potential common stock”) that would then share in the earnings (loss)

of the Company.




 




As of December

31, 1999, the Company had potential common stock as follows:




 








	

  Weighted-average

  common shares outstanding during the period


  	

   


  	

  31,757,039


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

  Incremental shares assumed to be outstanding since the beginning


  of the period related to stock options and warrants outstanding


  	

   


  	

  123,882


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

  Fully diluted weighted-average common shares and potential common

  stock


  	

   


  	

  31,880,921


  	

   


  










 




Since the

Company had net losses for the years ended December 31, 2001 and 2000, basic

and diluted shares are the same.




 




Reclassifications




Certain amounts included in the 2000 and 1999 financial statements have

been reclassified to conform with the current year presentation.  Such reclassification did not have any

effect on reported net income (loss).




 




F-14





























 




Estimates




The

preparation of financial statements requires management to make estimates and

assumptions that affect the reported amounts of assets and liabilities and

disclosure of contingent assets and liabilities at the date of the financial

statements and the reported amounts of revenue and expenses during the

reporting period.  Actual results could

differ from those estimates.




 




Recently Issued Accounting Pronouncements




In July 2001, the Financial Accounting

Standards Board (“FASB”) issued SFAS No. 141, “Business Combinations.”  This statement addresses financial

accounting and reporting for business combinations and supersedes APB Opinion

No. 16, “Business Combinations,” and SFAS No. 38, “Accounting for

Pre-Acquisition Contingencies of Purchased Enterprises.” All business

combinations in the scope of this statement are to be accounted for using one

method, the purchase method.  The

provisions of this statement apply to all business combinations initiated after

June 30, 2001.  Use of the

pooling-of-interests method for those business combinations is prohibited.  This statement also applies to all business

combinations accounted for using the purchase method for which the date of

acquisition is July 1, 2001 or later.




 




In July 2001, the FASB issued SFAS No. 142,

“Goodwill and Other Intangible Assets.” 

This statement addresses financial accounting and reporting for acquired

goodwill and other intangible assets and supersedes APB Opinion No. 17, “Intangible

Assets.”  It addresses how intangible

assets that are acquired individually or with a group of other assets (but not

those acquired in a business combination) should be accounted for in financial

statements upon their acquisition.  This

statement also addresses how goodwill and other intangible assets should be

accounted for after they have been initially recognized in the financial

statements.  It is effective for fiscal

years beginning after December 15, 2001. 

Early application is permitted for entities with fiscal years beginning

after March 15, 2001, provided that the first interim financial statements have

not been issued previously.




 




In June 2001, the FASB issued SFAS No. 143,

“Accounting for Asset Retirement Obligations.” 

This statement applies to legal obligations associated with the

retirement of long-lived assets that result from the acquisition, construction,

development, and/or the normal operation of long-lived assets, except for

certain obligations of lessees.  This

statement is not applicable to the Company.




 




F-15





























 




In August 2001, the FASB issued SFAS No. 144,

“Accounting for the Impairment or Disposal of Long-Lived Assets.”  This statement addresses financial

accounting and reporting for the impairment or disposal of long-lived

assets.  This statement replaces SFAS

No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived

Assets to be Disposed of,” the accounting and reporting provisions of APB No.

30, “Reporting the Results of Operations - Reporting the Effects of Disposal of

a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring

Events and Transactions,” for the disposal of a segment of a business, and

amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,”

to eliminate the exception to consolidation for a subsidiary for which control

is likely to be temporary.    The

Company does not expect adoption of SFAS No. 144 to have a material impact, if

any, on its financial position or results of operations.




 




NOTE 3 - RISKS AND UNCERTAINTIES




 




Technological Obsolescence




The computer

industry is characterized by rapid technological advancement and change. Should

demand for the Company’s products prove to be significantly less than

anticipated, the ultimate realizable value of such products could be

substantially less than the amounts reflected in the accompanying balance

sheets.




 




Reliance on Independent and Related Party Manufacturers/Subcontractors




The Company

does not maintain its own manufacturing or production facilities and does not

intend to do so in the foreseeable future. 

The Company anticipates that its products will be manufactured, and

independent companies, some of which are stockholders of the Company, will

supply its raw materials and components. 

Many of these independent companies may manufacture and supply products

for the Company’s existing and potential competitors.  As is customary in the manufacturing industry, the Company does

not have any material ongoing licensing or other supply agreements with its

manufacturers and suppliers.  Typically,

the purchase order is the Company’s “agreement” with the manufacturer.  Therefore, any of these companies could

terminate its relationship with the Company at any time.  In the event the Company was to have difficulties

with its present manufacturers and suppliers, the Company could experience

delays in supplying products to its customers.




 




F-16





























 




Reliance on Retail Distributors




The Company’s

success will depend to a significant extent upon the ability to develop and

maintain a multi-channel distribution system with retail distributors to sell

the Company’s products in the marketplace. 

There can be no assurance that the Company will be successful in

obtaining and retaining the retail distributors it requires to continue to grow

and expand its marketing and sales efforts.




 




NOTE 4 - CONCENTRATIONS OF RISK




 




Cash and Cash Equivalents




The Company

maintains its cash and cash equivalent balances in several banks located in

Southern California and a financial institution that from time to time exceed

amounts insured by the Federal Deposit Insurance Corporation up to $100,000 per

bank and by the Securities Investor Protection Corporation up to $3,000,000 per

financial institution. As of December 31, 2001 and 2000, balances totaling

$4,904,747 and $3,563,908, respectively, were uninsured.  The Company has not experienced any losses

in such accounts and believes it is not exposed to any significant credit risk

on cash.




 




In connection

with the Company’s revolving line of credit, the Company has agreed to a

compensating balance of $750,000.




 




Customers




 




During the

year ended December 31, 2001, the Company had net sales to four major customers

that represented 36%, 20%, 15%, and 14% of net sales.  As of December 31, 2001, the Company had four customers that

accounted for 25%, 23%, 18%, and 15% of accounts receivable.




 




During the

year ended December 31, 2000, the Company had net sales to four major customers

that represented 27%, 19%, 15%, and 14% of net sales.  As of December 31, 2000, the Company had three customers that

accounted for 27%, 19%, and 18% of accounts receivable.




 




During the

year ended December 31, 1999, the Company had sales to three major customers

that represented 32%, 26%, and 17% of net sales.  During the year ended December 31, 1999, the Company had sales to

two related party customers that represented 23% and 16% of net sales.  As of December 31, 1999, the Company had

three customers that accounted for 19%, 17%, and 12% of accounts receivable.




 




F-17





























 




Suppliers




During the

year ended December 31, 2001, the Company purchased inventory from two related

party vendors that represented 26% and 14% of purchases.  As of December 31, 2001, there were two

suppliers that represented 51% and 42% of accounts payable.




 




During the

year ended December 31, 2000, the Company purchased inventory from one related

party vendor that represented 47% of purchases.  As of December 31, 2000, there was one supplier that represented

32% of accounts payable.




 




During the

year ended December 31, 1999, the Company purchased inventory from two related

party vendors that represented 28% and 20% of purchases.  As of December 31, 1999, there were two suppliers

that represented 11% and 14% of accounts payable.




 




NOTE

5 - INVENTORY




 




Inventory as of December 31

consisted of the following:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Component parts


  	

   


  	

  $


  	

  5,243,285


  	

   


  	

  $


  	

  5,343,713


  	

   


  
	

  Finished goods


  	

   


  	

  5,692,705


  	

   


  	

  3,256,203


  	

   


  
	

  Work in process


  	

   


  	

  —


  	

   


  	

  18,226


  	

   


  
	

  Reserves for inventory


  	

   


  	

  (558,703


  	

  )


  	

  (1,834,427


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  10,377,287


  	

   


  	

  $


  	

  6,783,715


  	

   


  





 




NOTE

6 - PROPERTY AND EQUIPMENT




 




Property and equipment as of December 31

consisted of the following:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Computer equipment and software


  	

   


  	

  $


  	

  957,079


  	

   


  	

  $


  	

  817,823


  	

   


  
	

  Warehouse equipment


  	

   


  	

  78,465


  	

   


  	

  69,673


  	

   


  
	

  Office furniture and equipment


  	

   


  	

  161,339


  	

   


  	

  168,168


  	

   


  
	

  Equipment under capital lease


  	

   


  	

  94,136


  	

   


  	

  94,136


  	

   


  
	

  Vehicles


  	

   


  	

  6,707


  	

   


  	

  6,707


  	

   


  
	

  Leasehold improvements


  	

   


  	

  651,187


  	

   


  	

  651,187


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  1,948,913


  	

   


  	

  1,807,694


  	

   


  
	

  Less accumulated depreciation and

  amortization


  	

   


  	

  682,697


  	

   


  	

  379,922


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  1,266,216


  	

   


  	

  $


  	

  1,427,772


  	

   


  





 




F-18





























 




For the years

ended December 31, 2001, 2000, and 1999, depreciation and amortization expense

was $302,775, $221,813, and $51,832, respectively.




 




 




NOTE 7 - ACCOUNTS

PAYABLE AND ACCRUED EXPENSES




 




Accounts payable and

accrued expenses as of December 31 consisted of the following:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Accounts payable


  	

   


  	

  $


  	

  363,192


  	

   


  	

  $


  	

  2,514,712


  	

   


  
	

  Accrued rebates and marketing


  	

   


  	

  10,365,995


  	

   


  	

  2,086,418


  	

   


  
	

  Accrued compensation and related benefits


  	

   


  	

  452,517


  	

   


  	

  546,170


  	

   


  
	

  Other


  	

   


  	

  845,794


  	

   


  	

  437,651


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  12,027,498


  	

   


  	

  $


  	

  5,584,951


  	

   


  





 




NOTE 8 - LINE OF CREDIT




 




The Company

maintains a revolving line of credit with a financial institution that allows

it to borrow a maximum of $14,000,000 with a sub-limit of $13,000,000.  The line of credit originally expired April

9, 2002; however, subsequent to December 31, 2001, the line of credit was

extended to December 31, 2002.  The line

is secured by a UCC filing on substantially all of the Company’s assets.




 




Within the

sub-limit, up to $13,000,000 is available with maturities up to 150 days,

$10,000,000 is available with maturities of up to 60 days, and $6,000,000 is

available for issuance of letters of credit against 50% of eligible inventory

with maturities of up to 60 days.  Each

advance over a total outstanding line balance of $4,000,000 is subject to the

above maturity periods.




 




Within the

line of credit, a sub-line of $1,000,000 is available for uncollected funds

availability.




 




The

availability of the line of credit is subject to the borrowing base, which is

65% of eligible receivables.  Advances

on the line of credit bear interest at the Wall Street Journal Prime (4.75% as

of December 31, 2001), plus 0.25%.  As

of December 31, 2001, the outstanding balance under the revolving line of

credit was $9,622,241.




 




F-19





























 




The line of

credit provides for the maintenance of certain financial covenants and a

compensating cash balance of $750,000, of which the Company was in compliance

at December 31, 2001.




 




At December

31, 2000, the Company maintained a credit facility with a financial institution

that allowed it to borrow a maximum of $20,000,000.  The line was secured by a UCC filing on substantially all of the

Company’s assets.  The line of credit

expired April 25, 2001.




 




NOTE 9 - NOTE PAYABLE TO RELATED PARTY




 




The Company

had a note payable to a related party that represented a convertible promissory

note to a stockholder for inventory purchases. 

The note bore interest at 8% and matured March 1, 1997.  In March 1999, the statute of limitations

for collection on this note expired.




 




During the

year ended December 31, 1999, the Company reflected a reduction to cost of

sales of $345,500 of the total debt and related interest.  Management does not believe any litigation

will arise and has had no contact with the counter-party.




 




Pursuant to

the terms of the note payable, in the event the Company or its assets were sold

or the Company commenced an offering of common stock, as defined, the note

holder had the right to convert the outstanding balance, including all accrued

interest thereon, into shares of the Company’s common stock.  The conversion factor was defined as either

the price per share in the event of sale or the initial public offering price,

as defined, divided by 1.5.




 




NOTE 10 - CREDIT LINES FROM RELATED PARTIES




 




In connection

with a 1997 Strategic Alliance Agreement (the “1997 Strategic Alliance

Agreement”), the Company also has available a line of credit through another

stockholder and supplier for borrowings up to $2,000,000. Borrowings are

non-interest-bearing and are due 75 days from the date of the borrowing. The

credit agreement can be mutually terminated at any time.  As of December 31, 2001 and 2000, the line

of credit was unused.




 




F-20





























 




In connection

with an April 1999 subscription agreement, the Company also has available an

additional line of credit through a stockholder and supplier that provides a

trade credit facility of up to $5,000,000 carrying net 75 day terms, as

defined.  As of December 31, 2001 and

2000, there was $2,993,578 and $6,586,761, respectively, outstanding under this

arrangement, which is included in accounts payable to related parties in the

accompanying balance sheets.




 




NOTE 11 - COMMITMENTS AND CONTINGENCIES




 




Leases




The Company

leases its facilities from an officer of the Company and certain equipment

under non-cancelable, operating lease agreements, which require initial minimum

monthly payments of $44,584 and expire through March 2010.  For the years ended December 31, 2001, 2000,

and 1999, rent expense was $529,653, $467,572, and $119,257, respectively, and

is included in general and administrative expenses in the accompanying

statements of operations.




 




Future

aggregate minimum annual lease payments under operating lease arrangements were

as follows as of December 31, 2001:




 




	

  Year Ending December 31,


  	

   


  	

   


  	

   


  
	

  2002


  	

   


  	

  $


  	

  434,132


  	

   


  
	

  2003


  	

   


  	

  384,738


  	

   


  
	

  2004


  	

   


  	

  385,323


  	

   


  
	

  2005


  	

   


  	

  382,296


  	

   


  
	

  2006


  	

   


  	

  410,970


  	

   


  
	

  Thereafter


  	

   


  	

  1,596,084


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  3,593,543


  	

   


  





 




Capital lease obligations at December 31

consisted of the following:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  14.4% equipment lease

  - payable in monthly


  installments of $1,661 including interest and 


  maturing in January 2002.


  	

   


  	

  $


  	

  1,661


  	

   


  	

  $


  	

  19,880


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  14.4% equipment lease

  - payable in monthly 


  installments of $911 including interest and 


  maturing in November 2002.


  	

   


  	

  $


  	

  9,317


  	

   


  	

  $


  	

  18,219


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  10,978


  	

   


  	

  38,099


  	

   


  
	

  Less current portion


  	

   


  	

  10,978


  	

   


  	

  27,121


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Long-term portion


  	

   


  	

  $


  	

  —


  	

   


  	

  $


  	

  10,978


  	

   


  





 




F-21





























 




 




Future minimum payments under the capital lease

obligations at December 31, 2001 were as follows:




 




	

  Year

  Ending December 31,


  	

   


  	

   


  	

   


  
	

  2002


  	

   


  	

  $


  	

  11,682


  	

   


  
	

  Less amount representing interest


  	

   


  	

  704


  	

   


  
	

   


  	

   


  	

   


  	

   


  
	

  Present value of future minimum lease payments


  	

   


  	

  $


  	

  10,978


  	

   


  





 




The

following is an analysis of the leased equipment under capital leases as of

December 31, which is included in property and equipment:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Equipment


  	

   


  	

  $


  	

  94,136


  	

   


  	

  $


  	

  94,136


  	

   


  
	

  Less accumulated depreciation


  	

   


  	

  32,948


  	

   


  	

  14,120


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  61,188


  	

   


  	

  $


  	

  80,016


  	

   


  





 




Interest

expense was insignificant for the years ended December 31, 2001, 2000, and

1999.




 




F-22





























 




Service Agreements




Periodically,

the Company enters into various agreements for services including, but not

limited to, public relations, financial consulting, and manufacturing

consulting.  The agreements generally

are ongoing until such time they are terminated, as defined. Compensation for

services is paid either on a fixed monthly rate or based on a percentage, as

specified, and may be payable in shares of the Company’s common stock.  During the years ended December 31, 2001,

2000, and 1999, the Company was party to one such agreement. During the years

ended December 31, 2001, 2000, and 1999, the Company incurred $383,395,

$350,457, and $217,167, respectively, in connection with such

arrangements.  Such is included in

general and administrative expenses in the accompanying statements of

operations.




 




License and Operating Agreement




In September

2000, the Company entered into a license and operating agreement with a related

party.  The terms of the agreement allow

the Company to liquidate the inventory currently owned by the related party in

exchange for 50% of the profits.  The

agreement terminates upon the liquidation of 100% of the inventory, at which

time the Company will have the option to purchase the trade name from the

related party for $100.




 




Employment Contract




I/OMagic

California has entered into an employment contract with one of its officers,

which expires upon written termination. 

The agreement calls for a minimum base salary and provides for certain

expense allowances.  In addition, the

agreement provides for a bonus based on the “net profits” of I/OMagic

California, as defined.  The bonus

amount ranges from $20,000 to $70,000 for net profits up to $500,000.  For net profits in excess of $500,000, the

bonus is 7% of such excess.  For the

years ended December 31, 2001, 2000, and 1999, bonuses totaling $0, $165,396,

and $0, respectively, were paid under the terms of this agreement.  As of December 31, 2001 and 2000, the

accrued bonuses were approximately $98,000 for each year and are included in

accounts payable and accrued expenses in the accompanying balance sheets.




 




Retail Agreements




In connection

with certain retail agreements, the Company has agreed to pay for certain

marketing development and advertising on an ongoing basis.  Marketing development and advertising costs

are generally agreed upon at the time of the event.  The Company also records a liability for co-op marketing based on

management’s evaluation of historical experience and current industry and

Company trends.




 




F-23





























 




In May 2001, the Company entered into an agreement to provide marketing

and promotional funds to a customer up to 10% of the net sales to this customer

for a 24-month period, which subsequently has been adjusted to 17%.  During the year ended December 31, 2001, the

Company paid $6,068,479, of which $3,874,944 was expensed based on 17% of the

net sales related to this agreement. 

The remaining payment of $2,193,535 is included in prepaid expenses and

other current assets in the accompanying consolidated balance sheet.




 




For the years

ended December 31, 2001, 2000, and 1999, the Company incurred $2,890,502,

$1,386,261, and $1,218,423, respectively, related to these agreements. These

amounts are netted against revenue in the accompanying statements of

operations.




 




Litigation




The Company

and its President have been named as defendants in a lawsuit relating to an

Asset Purchase Agreement executed by IOMH and Hi-Val in June 1999 for the

purchase and sale of Hi-Val’s assets to IOMH. 

The causes of action are for breach of contract, fraud, and negligent

misrepresentation.  The allegations are

that IOMH and other defendants failed to deliver the consideration due under

the Asset Purchase Agreement after taking control of Hi-Val.  The fraud and negligent misrepresentation

claims are based on alleged representations made by IOMH and others to induce

Hi-Val and its President to enter into the Asset Purchase Agreement.  The damages claimed by the plaintiffs in the

causes of action are for $27,000,000. 

Punitive damages are claimed on the fraud cause of action.




 




The Company

has vigorously denied the claims and intends to aggressively defend the

action.  Based on the assertion of the

Company’s legal counsel, the action of the plaintiffs is at an early stage of

litigation, and only limited discovery has been conducted. Accordingly, an

estimate of the outcome of the action cannot be made at this time.




 




F-24





























 




NOTE 12 - REDEEMABLE CONVERTIBLE PREFERRED

STOCK




 




During

December 2000, the Company amended its Articles of Incorporation to authorize

10,000,000 shares of preferred stock, of which 1,000,000 shares are designated

as Series A preferred stock.  These

stockholders have no voting powers and are entitled to receive dividends on an

equal basis with the holders of common stock of the Company. In the event of a

liquidation, dissolution, or winding up of the Company, the holders of each

share of preferred stock will be entitled to be paid out of the assets of the

Company available for distribution to stockholders prior to any distribution to

any class of shares at a liquidation preference per share equal to the stated

value of the preferred stock, plus accrued dividends.




 




Each share of

preferred stock may be converted by the holder based upon the weighted-average

trading price during the 20 trading days prior to the date of the Company

receiving notice.  However, the

weighted-average trading price will not be less than $2.50 per share nor

greater than $7 per share.  The Company

has the right to force conversion of the preferred stock on the date on which

the Company’s common stock closed at or above a bid price of $3 per share

during 15 consecutive trading days. 

However, the conversion will not be less than $2.50 per share nor

greater than $7 per share.  Finally, if

the issued shares of preferred stock have been outstanding for three years, the

Company will be obligated to redeem any issued shares at the stated value of $8

per share.




 




In addition,

the Company designated 1,000,000 shares as Series B preferred stock.  The Series B stockholder has the same rights

as the Series A holders, except the Company will be obligated to redeem any

issued shares which have been outstanding for two years.




 




On January 22, 2001, the Company issued 875,000 shares of Series A

preferred stock to its financial institution for $7,000,000 in exchange for

amounts owed under long-term debt.  As

of December 31, 2000, the shares were presented as outstanding on the balance

sheet, and the related debt was eliminated.




 




On January 22, 2001, the Company issued 250,000 shares of Series B

preferred stock to its financial institution for $2,000,000 in exchange for

amounts owed under long-term debt.  As

of December 31, 2000, the shares were presented as outstanding on the balance

sheet, and the related debt was eliminated.




 




F-25





























 




NOTE 13 - COMMON STOCK




 




Amendment to Articles of Incorporation




On January 12,

2001, the Company amended its Articles of Incorporation to increase the number

of authorized common shares from 50,000,000 to 100,000,000.




 




Common Stock Issued for Services




During the year ended December 31, 2000, the Company issued 40,000

shares of common stock for $60,000 in legal services, which represented the

fair market value of the services rendered.




 




Common Stock Issued in Connection

with the Exercise of Warrants




During the year ended December 31, 2001, the Company issued an

aggregate of 12,500 shares of common stock in connection with the exercise of

warrants for cash of $625, or at a per share price of $0.05.




 




During the

year ended December 31, 2000, the Company issued an aggregate of 82,858

restricted shares of common stock in connection with the exercise of warrants

for cash of $53,015, or at a per share price ranging from $0.05 to $2 per

share.




 




During the

year ended December 31, 1999, the Company issued an aggregate of 760,826

restricted shares of common stock in connection with the exercise of warrants

for cash totaling $107,145, or at a per share price ranging from $0.01 to $0.70

per share.




 




Common Stock Issued in Exchange for Inventory




On February 3,

1999, the Company issued 16,666,667 shares of restricted common stock to a

stockholder and supplier valued at $0.30 per share for $5,000,000 of inventory,

as defined (valued at transferor’s cost basis).  In connection with this transaction, the stockholder and vendor

established a $5,000,000 line of credit. 

No value was assigned to the establishment of the line of credit as such

line was deemed to not carry any market value.




 




On January 4,

2000, the Company issued 6,250,000 shares of restricted common stock to a stockholder

and vendor, valued at $0.80 per share, for $5,000,000 of inventory, as defined

(valued at transferor’s cost basis).




 




On December

10, 2000, the Company issued 5,112,262 shares of restricted common stock to a

stockholder and vendor, valued at $1.56 per share, for $8,000,000 of inventory,

as defined (valued at transferor’s cost basis).




 




F-26





























 




Common Stock Issued for Cash




On March 7,

2000, the Company issued 632,912 shares of restricted common stock to a stockholder

and vendor, valued at $3.16, for $2,000,000 in cash.




 




Generally, all

new issuances of common stock made by the Company carry registration rights.




 




NOTE 14 - WARRANTS AND STOCK OPTIONS




 




Warrants




In connection

with an October 1995 private placement of notes payable and warrants, the

Company issued 805,000 A Warrants to purchase common stock for $0.05 per share

exercisable for five years from the date of issuance, and 805,000 B Warrants to

purchase common stock for $0.95 per share exercisable for five years from the

date of issuance.  For every 30 days the

B Warrants were outstanding, commencing six months from the date of issuance,

the B Warrant holders were entitled to a $0.04 discount on the exercise price

per month to a minimum exercise price of $0.50 per share.  Interest expense ascribed to the warrants

was deemed to be insignificant and recording such was not deemed appropriate by

management as the value of the Company was nominal prior to the effective date

of the Acquisition Agreement, the consummation of which was not assured.  During the years ended December 31, 2001,

2000, and 1999, A Warrants aggregating 12,500, 25,000, and 360,513,

respectively, have been exercised. Through December 31, 2001, A Warrants

aggregating 803,013 have been exercised. 

As of December 31, 2001, the remaining 1,987 outstanding warrants

expired.




 




In connection

with an October 1995 private placement for placement agent services, the

Company issued 125,125 A Warrants to purchase common stock for $0.10 per share

exercisable for five years from the date of issue and 125,125 B Warrants to

purchase common stock for $1.10 per share exercisable for five years from the

date of issue. During the years ended December 31, 2001, 2000, and 1999, 0,

17,858, and 5,313, respectively, of these A Warrants were exercised.  Through December 31, 2000, 95,715 of these A

Warrants were exercised.  As of December

31, 2000, the remaining 29,410 outstanding warrants expired.




 




F-27





























 




In October

1995, the Company issued to an officer 340,000 warrants to purchase restricted

shares of common stock for $0.01 per share exercisable for five years from the

date of grant.  No compensation expense

was charged to operations as the fair value of the shares and services received

was nominal. Fair value was determined by management to be the amount that

would have been paid had the Company paid cash for such services.  In addition, expense was not deemed

appropriate by management as the value of the Company was nominal prior to the

effective date of the Acquisition Agreement, the consummation of which was not

assured. These warrants carry piggyback registration rights, as defined.  During the years ended December 31, 2001, 2000,

and 1999, warrants totaling 0, 0, and 140,000, respectively, were exercised.




 




Through

December 31, 1996, the Company issued an aggregate 100,000 warrants to purchase

restricted shares of common stock for $1.65 per share exercisable five years

from the date of grant to a consultant for services provided. Compensation

expense related to these warrants, as determined by management to be the fair

value of services received had the Company paid cash, was insignificant.  For the years ended December 31, 2000 and

1999, none of these warrants have been exercised.  As of December 31, 2000, none of the remaining warrants were

exercised, and such warrants expired.




 




During the

year ended December 31, 1997, the Company issued to outside parties 162,465

warrants to purchase restricted shares of common stock at a per share price

ranging from $1 to $2.24 exercisable up to five years from the date of grant.

These warrants carry registration rights, as defined.  The Company recorded $42,465 of legal and consulting expense to

reflect the fair value of the services received. During the years ended

December 31, 1999 and 1998, warrants totaling 127,465 and 35,000, respectively,

expired.




 




During the

year ended December 31, 1998, the Company issued to outside consultants 30,000

warrants to purchase restricted shares of common stock at a per share price of

$0.01 or $1 exercisable up to five years from the date of grant.  These warrants carry registration rights, as

defined.  The Company recorded $20,163

of consulting expense to reflect the fair value of the services received, of

which $5,163 represents the difference between the fair market value of the

underlying common shares and the exercise price of the warrants, and the

remaining $15,000 represents the fair value of the services received had the

Company paid cash for such services. During the year ended December 31, 1998,

warrants to purchase 15,000 shares of common stock at $0.01 were

exercised.  During the year ended

December 31, 1999, warrants to purchase 5,000 shares of common stock were

exercised, and warrants to purchase 5,000 shares of common stock expired.




 




F-28





























 




During the

years ended December 31, 2001, 2000, and 1999, the Company issued options to

purchase 120,000, 40,000, and 200,000 shares, respectively, of restricted

common stock to the Company’s law firm and a consultant, respectively.  The options are exercisable at prices

ranging from $0.30 to $2 (fair market value or higher) per share for one year.

Management of the Company determined that no additional amounts would have been

paid to such law firm for services as invoiced services are paid in cash.  Accordingly, the Company recorded no legal

or consulting expense. During the years ended December 31, 2001, 2000, and 1999,

0, 40,000, and 200,000 options, respectively, were exercised.




 




During the

year ended December 31, 2000, the Company issued warrants to purchase 150,000

shares of common stock to a public relations firm.  The warrants are exercisable at prices ranging from $2 to $4

(fair market value or higher).  Warrants

for 60,000 of these shares are restricted. 

The warrants expire between six and 12 months from the date of

grant.  During the years ended December

31, 2001 and 2000, 60,000 and 90,000 warrants, respectively, expired.




 




Stock Option Plans




The Company

has six incentive stock option and non-qualified stock option plans (the

“Plans”), as amended for directors, officers, key employees, and

consultants.  The Plans are the 1996,

1997, 1998, 1999, 2000, and 2001 Incentive and Non-Statutory Stock Option

Plans.  The total number of shares which

may be purchased through the exercise of options granted through the Plans will

not exceed 750,000, 1,000,000, 1,401,976, 1,500,000, 1,000,000 and 3,500,000,

respectively.  The Plans are intended to

further the growth and financial success of the Company by providing additional

incentives to selected employees of and consultants to the Company.




 




The Plans

provide for the granting of options for common shares at exercise prices equal

to or exceeding the fair market value at the date of grant as determined by the

Board of Directors.  Options become

exercisable over a period of three to five years from the date of grant, and

not less than 20% will become exercisable annually as determined by the Board

of Directors.  None of the options

granted are exercisable prior to one year from the date of grant unless

specified by the Board of Directors. 

Options are not to be exercisable after 10 years from the date of grant

for any reason.




 




F-29





























 




Options

granted under the Plans may be either “incentive stock options,” within the

meaning of Section 422 of the Internal Revenue Code, or “non-qualified stock

options,” as determined by the Board of Directors at the time of grant.  Incentive stock options may not be granted

to any person who owns stock possessing more than 10% of the combined voting

power of all classes of the Company’s stock or its parent (“10% Stockholders”)

unless the exercise price is at least equal to 110% of fair market value on the

date of grant.




 




The exercise

price in the case of incentive stock options granted under the Plans must be at

least equal to the fair market value of the common stock as of the date of

grant.  Incentive stock options may not

be granted to an optionee under the Plans if the aggregate fair market value,

as determined on the date of grant, of the stock with respect to which

incentive stock options are exercisable by such optionee in any calendar year

under the Plans exceeds $100,000.




 




Under the

1996, 1997, and 1998 Plans, incentive stock options granted to a 10%

Stockholder is not exercisable after the expiration of five years.




 




In April 1996,

the Company issued options to purchase restricted shares of common stock at

$0.01 per share, which was below market, to two employees, resulting in the

Company recording deferred compensation of $124,000, which was being amortized

over five years, the vesting period of the options.  During the year ended December 31, 1997, one of the employees

left the Company and forfeited his options. 

Accordingly, the Company reversed the deferred compensation relating to

this employee.  During the years ended

December 31, 2001 and 2000, 0 and 50,000, respectively, of these options were

exercised.




 




As of December

31, 2001, 2000, and 1999, the balance of deferred compensation totaled $0,

$3,100, and $15,500, respectively.




 




F-30





























 




The following

summarizes options and warrants granted and outstanding through December 31,

2001:




 




	

   


  	

   


  	

  Number of

  Shares


  	

   


  	

  Total


  	

   


  	

  Weighted-


  Average


  Exercise


  Price


  	

   


  
	

  Employee


  	

   


  	

  Non-


  Employee


  
	

  Outstanding, December 31, 1998


  	

   


  	

  700,000


  	

   


  	

  2,744,234


  	

   


  	

  3,444,234


  	

   


  	

  $


  	

  1.80


  	

   


  
	

  Granted


  	

   


  	

  —


  	

   


  	

  200,000


  	

   


  	

  200,000


  	

   


  	

  $


  	

  0.30


  	

   


  
	

  Exercised


  	

   


  	

  (50,000


  	

  )


  	

  (710,826


  	

  )


  	

  (760,826


  	

  )


  	

  $


  	

  0.11


  	

   


  
	

  Expired, cancelled


  	

   


  	

  (50,000


  	

  )


  	

  (1,654,828


  	

  )


  	

  (1,704,828


  	

  )


  	

  $


  	

  2.10


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Outstanding, December 31, 1999


  	

   


  	

  600,000


  	

   


  	

  578,580


  	

   


  	

  1,178,580


  	

   


  	

  $


  	

  2.30


  	

   


  
	

  Granted


  	

   


  	

  1,682,500


  	

   


  	

  532,500


  	

   


  	

  2,215,000


  	

   


  	

  $


  	

  2.19


  	

   


  
	

  Exercised


  	

   


  	

  —


  	

   


  	

  (82,858


  	

  )


  	

  (82,858


  	

  )


  	

  $


  	

  0.64


  	

   


  
	

  Expired, cancelled


  	

   


  	

  —


  	

   


  	

  (625,722


  	

  )


  	

  (625,722


  	

  )


  	

  $


  	

  3.22


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Outstanding, December 31, 2000


  	

   


  	

  2,282,500


  	

   


  	

  402,500


  	

   


  	

  2,685,000


  	

   


  	

  $


  	

  2.03


  	

   


  
	

  Granted


  	

   


  	

  1,753,000


  	

   


  	

  200,000


  	

   


  	

  1,953,000


  	

   


  	

  $


  	

  1.03


  	

   


  
	

  Exercised


  	

   


  	

  —


  	

   


  	

  (12,500


  	

  )


  	

  (12,500


  	

  )


  	

  $


  	

  0.05


  	

   


  
	

  Expired, cancelled


  	

   


  	

  (115,000


  	

  )


  	

  (60,000


  	

  )


  	

  (175,000


  	

  )


  	

  $


  	

  3.06


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Outstanding, 


  December 31, 2001


  	

   


  	

  3,920,500


  	

   


  	

  530,000


  	

   


  	

  4,450,500


  	

   


  	

  $


  	

  1.55


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Exercisable,


  December 31, 2001


  	

   


  	

  1,447,341


  	

   


  	

  157,976


  	

   


  	

  1,605,317


  	

  *


  	

  $


  	

  1.74


  	

   


  





 






















*                                         Included in

the exercisable options at December 31, 2001 are 271,250 options which have

vested, but are not exercisable until the Company has a NASDAQ listing.




 




F-31





























 




The following

table is a summary of the stock options and warrants as of December 31, 2001:




 




	

  Range of


  Exercise


  Prices


  	

   


  	

  Stock

  Options


  and Warrants


  Outstanding


  	

   


  	

  Stock

  Options


  and Warrants


  Exercisable


  	

   


  	

  Weighted-


  Average


  Remaining


  Contractual


  Life


  	

   


  	

  Weighted-


  Average


  Exercise


  Price of


  Options and


  Warrants


  Outstanding


  	

   


  	

  Weighted-


  Average


  Exercise


  Price of


  Options and


  Warrants


  Exercisable


  	

   


  
	

  $


  	

  1.00 - 1.82


  	

   


  	

  2,553,000


  	

   


  	

  767,250


  	

   


  	

  3.85 years


  	

   


  	

  $


  	

  1.13


  	

   


  	

  $


  	

  1.32


  	

   


  
	

  $


  	

  2.00 - 2.25


  	

   


  	

  1,747,500


  	

   


  	

  762,067


  	

   


  	

  3.21 years


  	

   


  	

  $


  	

  2.03


  	

   


  	

  $


  	

  2.03


  	

   


  
	

  $


  	

  3.00 - 3.50


  	

   


  	

  150,000


  	

   


  	

  76,000


  	

   


  	

  3.21 years


  	

   


  	

  $


  	

  3.03


  	

   


  	

  $


  	

  3.03


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  4,450,500


  	

   


  	

  1,605,317


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  





 




Pro forma

information regarding net loss and loss per share is required by SFAS No. 123

and has been determined as if the Company had accounted for its employee stock

options under the fair value method of SFAS No. 123.  The fair value for these options was estimated at the date of

grant using the Black-Scholes option pricing model with the following

weighted-average assumptions for the years ended December 31, 2001 and 2000:  risk free interest rates of 4.6% and 6.4%,

respectively; dividend yields of 0% and 0%, respectively; expected volatility

of 100% and 70%, respectively; and expected lives of four and four years,

respectively.  For the years ended

December 31, 2001 and 2000, 1,953,000 and 2,215,000 options, respectively, were

granted.  For the year ended December

31, 1999, no options were granted.




 




The

Black-Scholes option valuation model was developed for use in estimating the

fair value of traded options, which have no vesting restrictions and are fully

transferable.  In addition, option

valuation models require the input of highly subjective assumptions including

the expected stock price volatility. 

Because the Company’s employee stock options have characteristics significantly

different from those of traded options, and because changes in the subjective

input assumptions can materially affect the fair value estimate, in

management’s opinion, the existing models do not necessarily provide a reliable

single measure of the fair value of its employee stock options.




 




F-32





























 




For purposes

of pro forma disclosures, the estimated fair value of the options is amortized

to expense over the options vesting period. 

Adjustments are made for options forfeited prior to vesting.  The effect on compensation expense, net

loss, and net loss per common share had compensation costs for the Company’s

stock option plans been determined based on a fair value at the date of grant

consistent with the provisions of SFAS No. 123 for the years ended December 31,

2001 and 2000 is as follows:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Net loss


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  As reported


  	

   


  	

  $


  	

  (5,547,645


  	

  )


  	

  $


  	

  (6,410,849


  	

  )


  
	

  Pro forma


  	

   


  	

  $


  	

  (5,880,664


  	

  )


  	

  $


  	

  (6,790,152


  	

  )


  
	

  Basic and diluted loss per common share


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  As reported


  	

   


  	

  $


  	

  (0.08


  	

  )


  	

  $


  	

  (0.16


  	

  )


  
	

  Pro forma


  	

   


  	

  $


  	

  (0.09


  	

  )


  	

  $


  	

  (0.17


  	

  )


  





 




For the year ended, December 31, 1999, there

was not any effect on compensation expense.




 




NOTE 15 - INCOME TAXES




 




The components

of the income tax provision (benefit) for the years ended December 31 were as

follows:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  	

  1999


  	

   


  
	

  Current


  	

   


  	

  $


  	

  3,000


  	

   


  	

  $


  	

  2,400


  	

   


  	

  $


  	

  222,500


  	

   


  
	

  Deferred


  	

   


  	

  —


  	

   


  	

  (1,002,000


  	

  )


  	

  (651,000


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  3,000


  	

   


  	

  $


  	

  (999,600


  	

  )


  	

  $


  	

  (428,500


  	

  )


  





 




F-33





























 




Income tax expense

(benefit) for the years ended December 31 differed from the amounts computed

applying the federal statutory rate of 34% to pre-tax income as a result of:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  	

  1999


  	

   


  
	

  Computed “expected” tax  expense (benefit)


  	

   


  	

  $


  	

  (1,885,000


  	

  )


  	

  $


  	

  (2,520,000


  	

  )


  	

  $


  	

  488,000


  	

   


  
	

  Income in income taxes resulting from


  Expenses not deductible for tax purposes


  	

   


  	

  18,000


  	

   


  	

  12,000


  	

   


  	

  4,000


  	

   


  
	

  Change in beginning of the year balance of

  the valuation allowance for deferred tax assets allocated to income tax

  expense


  	

   


  	

  2,090,000


  	

   


  	

  1,789,000


  	

   


  	

  (986,000


  	

  )


  
	

  State and local income taxes, net of tax

  benefit


  	

   


  	

  (220,000


  	

  )


  	

  (280,600


  	

  )


  	

  65,500


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total


  	

   


  	

  $


  	

  3,000


  	

   


  	

  $


  	

  (999,600


  	

  )


  	

  $


  	

  (428,500


  	

  )


  





 




Significant

components of the Company’s deferred tax assets and liabilities for federal income

taxes at December 31 consisted of the following:




 




	

   


  	

   


  	

  2001


  	

   


  	

  2000


  	

   


  
	

  Deferred tax assets


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Net operating loss carryforward


  	

   


  	

  $


  	

  3,833,000


  	

   


  	

  $


  	

  2,818,000


  	

   


  
	

  Allowance for doubtful accounts


  	

   


  	

  367,000


  	

   


  	

  122,000


  	

   


  
	

  Allowances for sales returns


  	

   


  	

  369,000


  	

   


  	

  135,000


  	

   


  
	

  Allowances for price protection


  	

   


  	

  747,000


  	

   


  	

  732,000


  	

   


  
	

  Accrued compensation


  	

   


  	

  91,000


  	

   


  	

  68,000


  	

   


  
	

  Amortization of trademark


  	

   


  	

  964,000


  	

   


  	

  413,000


  	

   


  
	

  Inventory


  	

   


  	

  423,000


  	

   


  	

  231,000


  	

   


  
	

  Other


  	

   


  	

  4,000


  	

   


  	

  3,000


  	

   


  
	

  Valuation allowance


  	

   


  	

  (4,709,000


  	

  )


  	

  (2,580,000


  	

  )


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total deferred tax assets


  	

   


  	

  2,089,000


  	

   


  	

  1,942,000


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Deferred tax liabilities


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  State tax


  	

   


  	

  353,000


  	

   


  	

  221,000


  	

   


  
	

  Other


  	

   


  	

  15,000


  	

   


  	

  —


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Total deferred tax liabilities


  	

   


  	

  368,000


  	

   


  	

  221,000


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

  1,721,000


  	

   


  	

  1,721,000


  	

   


  
	

  Less current portion


  	

   


  	

  1,556,000


  	

   


  	

  1,556,000


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Long-term portion


  	

   


  	

  $


  	

  165,000


  	

   


  	

  $


  	

  165,000


  	

   


  





 




F-34





























 




As of December

31, 2001 and 2000, the valuation allowance for deferred tax assets, totaled

approximately $4,709,000 and $2,580,000, respectively.  For the years ended December 31, 2001, 2000,

and 1999, the net change in the valuation allowance was $2,129,000 (increase),

$2,270,000 (increase), and $996,000 (decrease), respectively.




 




As of December 31, 2001, the Company had net

operating loss carryforwards for federal income tax purposes of approximately

$10,000,000.  The net operating loss

carryforwards expire through 2021.  The

utilization of net operating loss carryforwards may be limited due to the

ownership change under the provisions of Internal Revenue Code Section 382 and

similar state provisions.




 




NOTE 16 - RELATED PARTY TRANSACTIONS




 




During the

year ended December 31, 1999, the Company had sales totaling $6,943,495 to

related parties.




 




During the years ended December 31, 2001, 2000, and 1999, the Company

had purchases from related parties totaling $22,031,190, $31,004,756, and

$15,870,093, respectively.




 




During the

year ended December 31, 1999, the Company purchased inventory totaling

$2,382,252 on behalf of a related party. 

During the year ended December, 31, 1999, such inventory was sold at

cost plus handling expenses resulting in other income to the Company of

$24,000.




 




NOTE 17 - SUBSEQUENT EVENT




 




On February 12, 2002, the Company announced approval by the Board of

Directors of the Company to redeem its own stock in open market transactions of

up to $500,000.




 




F-35





























 




SUPPLEMENTAL

INFORMATION




 




F-36





























 




REPORT

OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS




ON

FINANCIAL STATEMENT SCHEDULES




 




To the Board of Directors




I/OMagic Corporation and

subsidiary




Santa Ana, California




 




Our audits were made for the

purpose of forming an opinion on the basic consolidated financial statements

taken as a whole.  The consolidated

supplemental schedule II is presented for purposes of complying with the

Securities and Exchange Commission’s rules and is not a part of the basic

consolidated financial statements.  This

schedule has been subjected to the auditing procedures applied in our audits of

the basic consolidated financial statements and, in our opinion, is fairly

stated in all material respects in relation to the basic consolidated financial

statements taken as a whole.




 




 




SINGER LEWAK GREENBAUM &

GOLDSTEIN LLP




 




Los Angeles, California




February 15, 2002




 




F-37





























 




I/OMAGIC CORPORATION




AND SUBSIDIARY




VALUATION AND QUALIFYING ACCOUNTS - SCHEDULE

II




For the Years Ended

December 31,




 




 




	

   


  	

   


  	

  Balance,


  Beginning


  of Year


  	

   


  	

  Additions


  (Deductions)


  Charged to


  Operations


  	

   


  	

  Additions


  (Deductions)


  from


  Reserve


  	

   


  	

  Balance,


  End


  of Year


  	

   


  
	

  Allowance for doubtful accounts


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  December 31, 2001


  	

   


  	

  $


  	

  2,106,518


  	

   


  	

  $


  	

  850,937


  	

   


  	

  $


  	

  (278,337


  	

  )


  	

  $


  	

  2,679,118


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  December 31, 2000


  	

   


  	

  $


  	

  71,193


  	

   


  	

  $


  	

  2,420,210


  	

   


  	

  $


  	

  (384,885


  	

  )


  	

  $


  	

  2,106,518


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  December 31, 1999


  	

   


  	

  $


  	

  46,372


  	

   


  	

  $


  	

  24,821


  	

   


  	

  $


  	

  —


  	

   


  	

  $


  	

  71,193


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  Reserve for inventory


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  December 31, 2001


  	

   


  	

  $


  	

  1,834,427


  	

   


  	

  $


  	

  410,000


  	

   


  	

  $


  	

  (1,685,724


  	

  )


  	

  $


  	

  558,703


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  December 31, 2000


  	

   


  	

  $


  	

  138,007


  	

   


  	

  $


  	

  2,716,303


  	

   


  	

  $


  	

  (1,019,883


  	

  )


  	

  $


  	

  1,834,427


  	

   


  
	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  	

   


  
	

  December 31, 1999


  	

   


  	

  $


  	

  134,644


  	

   


  	

  $


  	

  192,363


  	

   


  	

  $


  	

  (189,000


  	

  )


  	

  $


  	

  138,007


  	

   


  





 




F-38