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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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FOR ANNUAL AND TRANSITION REPORT
PURSUANT TO SECTIONS 13 OF 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER: 000-27267
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I/OMAGIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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NEVADA 33-0773180
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
4 MARCONI, IRVINE, CA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 707-4800
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers in response to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |_| No |X|
The aggregate market value of the voting common equity held by
nonaffiliates of the registrant computed by reference to the closing sale price
of such stock, was approximately $2,000,000, as of March 31, 2005, the last
business day of the registrant's most recently completed fiscal quarter. The
registrant has no non-voting common equity.
The number of shares of the registrant's common stock, $.001 par value,
outstanding as of May 12, 2005 was 4,529,672.
DOCUMENTS INCORPORATED BY REFERENCE: None.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business........................................................... 2
Item 2. Properties......................................................... 15
Item 3. Legal Proceedings.................................................. 15
Item 4. Submission of Matters to a Vote of Security Holders................ 16
PART II
Item 5. Market For Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.................. 17
Item 6. Selected Financial Data............................................ 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................... 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk......... 46
Item 8. Financial Statements and Supplementary Data........................ 46
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................... 46
Item 9A. Controls and Procedures............................................ 46
Item 9B. Other Information.................................................. 46
PART III
Item 10. Directors and Executive Officers of the Registrant................. 47
Item 11. Executive Compensation............................................. 48
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.................................... 50
Item 13. Certain Relationships and Related Transactions..................... 52
Item 14. Principal Accountant Fees and Services............................. 54
PART IV
Item 15. Exhibits, Financial Statement Schedules............................ 54
Index to Consolidated Financial Statements and Supplemental Information......F-1
Index To Exhibits
Signatures
Exhibits Attached to This Report
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PART I
ITEM 1. BUSINESS.
INTRODUCTORY NOTE
This Annual Report on Form 10-K contains "forward-looking statements."
These forward-looking statements include, but are not limited to, statements
relating to our anticipated financial performance, business prospects, new
developments, new strategies and similar matters, and/or statements preceded by,
followed by or that include the words "believe," "may," "could," "expect,"
"anticipate," "estimate," "intend," "plan," "seek," or similar expressions. We
have based these forward-looking statements on our current expectations and
projections about future events, based on the information currently available to
us. These forward-looking statements are subject to risks, uncertainties and
assumptions, including those described under the heading "Risk Factors" in Item
7 of this Annual Report on Form 10-K that may affect the operations,
performance, development and results of our business. You are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date stated, or if no date is stated, as of the date of this Annual Report
on Form 10-K. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or any other reason except as we may be required to do under applicable
law. In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this Annual Report on Form 10-K may not occur.
Interested readers can access our Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q, current reports on Form 8-K, and any amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934, as amended, through the United States Securities and
Exchange Commission's website at http://www.sec.gov. These reports can be
accessed free of charge.
We own or have rights to use all of the product names, brand names and
trademarks that we use in conjunction with the sale of our products, including
our I/OMagic(R), Hi-Val(R) and Digital Research Technologies(R) brand names and
related logos, and our "MediaStation," "DataStation," Digital Photo Library(TM),
EasyPrint(TM) and GigaBank(TM) product names. In addition, this report refers to
other product names, trade names and trademarks that are the property of their
respective owners.
For purposes of this Annual Report, unless the context indicates otherwise,
references to "we," "us," "our," "I/OMagic," and the "Company" means or refers
to I/OMagic Corporation.
COMPANY OVERVIEW
We operate primarily in the data storage industry and, to a much lesser
extent, we also sell digital entertainment and other products. We sell our
products primarily in the United States and, to a much lesser extent, in Canada,
together known as the North American retail marketplace. During 2004, sales
generated within the United States accounted for approximately 98.2% of our net
sales and sales generated within Canada accounted for approximately 1.8% of our
net sales. For the years ended December 31, 2003 and 2002 sales generated within
the United States accounted for approximately 98.5 % and 99.0%, respectively, of
our net sales and sales generated within Canada accounted for approximately 1.5%
and 1.0%, respectively, of our net sales.
Our product offerings predominantly consist of optical data storage
products and portable magnetic data storage products. Our optical data storage
products include recordable compact disc, or CD, drives and recordable digital
video or versatile disc, or DVD, drives. Our CD and DVD drives are primarily for
use with personal computers, or PCs. Although we have sold various media in the
past, such as floppy disks and CDs, we do not currently sell media products. Our
portable magnetic data storage products, which we call our GigaBank(TM)
products, consist of compact and portable universal serial bus, or USB, hard
disk drives that plug into any standard USB port and that provide from 2.2
gigabytes, or 2,200 megabytes, to up to 100 gigabytes, or 100,000 megabytes, of
storage capacity, depending on the user's operating system and other factors. We
have designed our GigaBank(TM) products as cost-effective portable alternatives
to flash media devices and standard hard disk drives. Our data storage products
accounted for approximately 99% of our net sales for 2004. We also sell digital
entertainment and other products, which accounted for only approximately 1% of
our net sales for that period.
For the years ended December 31, 2004 and 2003, we believe that we achieved
the number three and one market shares, respectively, in both unit and dollar
sales of "after-market" compact disc rewritable, or CD-RW, drives in North
America. "After-market" products are products not built into a PC at the time of
its initial purchase. We launched our dual-format recordable DVD drives in July
2003. We believe that we were able to achieve the number two market share in
both unit and dollar sales of after-market recordable DVD drives in North
America during 2004. We believe that the markets for DVD-based data storage
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products and for compact and portable magnetic data storage devices, such as our
GigaBank(TM) products, will experience significant growth over the next few
years and that we are in a position to benefit from this growth in terms of
sales and market share.
We sell our products through computer, consumer electronics and office
supply superstores and other major North American retailers, including Best Buy,
Best Buy Canada, Circuit City, CompUSA, Fred Meyer Stores, Microcenter, Office
Depot, RadioShack, Staples, and Target. We sell our products in over 10,000
retail locations throughout North America. Our retailers collectively operate
retail locations throughout North America. We also have relationships with other
retailers, catalog companies and Internet retailers such as Buy.com, Dell, PC
Mall and Tiger Direct.
Our sales have historically been seasonal. The seasonality of our sales is
in direct correlation to the seasonality experienced by our retailers and the
seasonality of the consumer electronics industry. After adjusting for the
addition of new retailers, our fourth quarter has historically generated the
strongest sales, which correlates to well-established consumer buying patterns
during the Thanksgiving through Christmas holiday season. Our first and third
quarters have historically shown some strength from time to time based on
post-holiday season sales in the first quarter and back-to-school sales in the
third quarter. Our second quarter has historically been our weakest quarter for
sales, again following well-established consumer buying patterns.
Our most significant retailers during the past few years have been Best
Buy, Circuit City, CompUSA, Office Depot and Staples. Collectively, these five
retailers accounted for 80% of our net sales during 2004, including 32%, 17%,
11%, 10% and 10% of our total net sales for that period which were generated
from Staples, Circuit City, Best Buy, Office Depot and CompUSA, respectively.
We market our products primarily under one brand name. Our primary brand
name is I/OMagic(R). We also, from time to time, market products under our
Hi-Val(R) and Digital Research Technologies(R) brand names. We sell our data
storage products primarily under our I/OMagic(R) brand name, bundling various
hardware devices with different software applications to meet different consumer
needs.
We do not directly manufacture any of the products that we sell. We
subcontract manufacture or source our products in Asia, predominantly in Taiwan
and China, which allows us to offer products at highly competitive prices. Most
of our subcontract manufacturers and suppliers have substantial product
development resources and facilities, and are among the major component
manufacturers and suppliers in their product categories, which we believe
affords us substantial flexibility in offering new and enhanced products. Some
of our largest subcontract manufacturers and suppliers are also our
stockholders, including Behavior Tech Computer Corp. and its affiliated
companies, or BTC, and Lung Hwa Electronics Co., Ltd. BTC and Lung Hwa
Electronics also provide us with significant trade lines of credit. We believe
that BTC is among the largest optical storage drive manufacturers in the world
and Lung Hwa Electronics is a supplier of USB hard disk drives, including some
of our GigaBank(TM) products, as well as a major manufacturer of digital
entertainment products. Certain of these subcontract manufacturers and suppliers
provide us with significant benefits by allowing us to purchase products on
terms more advantageous than we believe are generally available in our industry.
These advantageous terms include generous trade lines of credit and extended
payment terms which allows us to utilize more capital resources for other
aspects of our business. See "Management," and "Certain Relationships and
Related Transactions."
I/OMagic Corporation was incorporated under the laws of the State of Nevada
in October 1992. We have one subsidiary, IOM Holdings, Inc., a Nevada
corporation. Our principal executive offices are located in Irvine, California
and our main telephone number is (949) 707-4800.
INDUSTRY OVERVIEW
Storing, managing, protecting, retrieving and transferring data has become
critical to individuals and businesses due to their increasing dependence on and
participation in data-intensive activities. The data storage industry is growing
in response to the needs of individuals and businesses to store, manage,
protect, retrieve and transfer increasing amounts of data resulting from:
o the growth in the number of PCs, and the increase in the number, size
and complexity of computer networks and software programs;
o the emergence and development of new data-intensive activities, such
as e-mail, e-commerce, and the increasing availability of products and
services over the Internet, together with the rise in bandwidth
available to access and download data from over the Internet; and
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o the existence and availability of increasing amounts of digital
entertainment data, such as music, movie, photographic, video game and
other multi-media data.
Traditional PC data generally includes document, e-mail, financial and
historical, software program and other data. The data storage industry has grown
significantly over the last two decades as the PC has become a virtually
indispensable tool in the home and office, resulting in increasing amounts of
traditional PC data. As a result of these and other developments, traditional PC
data storage requirements have correspondingly increased.
Digital entertainment data generally includes music, photographic, movie
and video game data. For nearly two decades, music has been offered on CDs as
the prevailing standard. In the mid-to-late 1990s, the ability to copy CDs, and
to download, remix, and copy or "burn" music to a personalized CD began to gain
popularity and made the recordable CD drive, or "CD burner," a desirable
component of the PC. With the growth and acceptance of the Internet and the
advent of on-line music availability, the demand for on-line music has increased
and as a result, the demand for faster and easier data storage and retrieval has
grown.
We believe that the increasing amount of traditional PC and digital
entertainment data that is being generated and used is stimulating increased
demand for products offering data storage, management, protection, retrieval and
transfer. We also believe that those products that offer flexibility and
high-capacity storage in a cost-effective, user-friendly manner are in highest
demand.
KEY FACTORS DRIVING GROWTH IN THE DATA STORAGE INDUSTRY
We believe that the following factors, among others, are driving and will
continue to drive growth in the data storage industry:
o INCREASED DATA-INTENSIVE USE OF THE INTERNET. As individuals and
businesses continue to increase their data-intensive use of the
Internet for communications, commerce and data retrieval, the
corresponding need to utilize data storage devices for the storage,
management, protection, retrieval and transfer of data -- especially
high-capacity, cost-effective data storage devices -- will continue to
grow. In addition, bandwidth is increasing and is expected to continue
to increase. Increasing bandwidth allows faster data transfer rates
over the Internet and makes use of the Internet for data-intensive
activities more convenient and cost-effective.
o GROWTH IN NEW TYPES OF DATA. The growth in new types of data such as
music, photographic, movie, and video game data, including
high-resolution audio and video data, requires far greater storage
capacity than traditional PC text data. We believe that individual
consumers and businesses increasingly depend on their abilities to
store, manage, protect, retrieve and transfer these types of data
using data storage devices.
o GROWTH IN THE CRITICAL IMPORTANCE OF DATA. Business databases contain
information about customers, suppliers, competitors and industry
trends that may be analyzed and potentially transformed into a
valuable asset and a competitive advantage. Efficiently storing,
managing, protecting, retrieving and transferring this information has
become increasingly important to many businesses.
o DECREASE IN THE COST OF STORING DATA. The cost of data storage
continues to decrease with advances in technology and improved
manufacturing processes. This decrease in cost encourages and enables
individuals and businesses to purchase more data storage media and
devices.
o CONVERGENCE OF TECHNOLOGIES. Product offerings are beginning to embody
the convergence of data storage and digital entertainment playback
technologies. For instance, a digital video recorder, or DVR, can
operate as the primary tool for storage, management, protection,
retrieval and transfer of traditional PC data as well as digital
entertainment data such as music, photos, movies, video games and
other multi-media.
TYPES OF DATA STORAGE MEDIA
The following types of data storage media are the principal means through
which traditional PC data as well as digital entertainment data can be stored,
managed, protected, retrieved and transferred:
o MAGNETIC. Magnetic data storage drives store digital data by
magnetically altering minutely small areas of a magnetic media surface
so that specific areas represent either a "1" or a "0." Indeed, all
digital data is comprised of different combinations of "1s" and "0s"
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regardless of the media on which the data is stored. Examples of
magnetic data storage media include floppy disks, Zip(R) disks,
magnetic tape and hard disk drives, including compact and portable
hard disk drives, such as our GigaBank(TM) products.
o OPTICAL. Optical data storage drives store digital data by using
lasers to alter minutely small areas of an optical media surface.
Examples of optical data storage media include CDs and DVDs.
o SOLID STATE. Solid state storage devices store digital data by
applying electronic charges to alter minutely small areas of a memory
chip or card. Examples of solid state media include flash memory
chips, flash memory cards and thumbdrives. Thumbdrives are more
commonly known as universal serial bus, or USB, drives which are
small, portable flash memory devices that plug into any standard USB
drive. Solid state media is typically used for digital data storage in
digital cameras, personal digital assistants, or PDAs, cellular phones
and MP3 players.
RELATIVE ADVANTAGES AND DISADVANTAGES OF TYPES OF DATA STORAGE MEDIA
Each of the principal types of data storage media generally available to
consumers has certain advantages and disadvantages. These include:
MAGNETIC MEDIA
o HARD DISKS. Hard disks are fixed media and typically are not
removable, thus prohibiting the physical transport of data and
portability of the drive itself. Relative to other available media,
hard disks have high capacity, holding up to approximately 500
gigabytes, or 500,000 megabytes, depending on the user's operating
system and other factors, and offer a low cost per megabyte. Hard
disks have a fixed storage capacity and are not scalable. Hard disks
offer fast data access times and data transfer rates and generally
good reliability, but data protection and retrieval is dependent on
drive reliability. Hard disks require another device or medium for
data back-up purposes or for data transportability; however certain
hard disk drives, such as our GigaBank(TM) products, allow physical
transport of data and drive portability.
o FLOPPY DISKS. Floppy disks are removable media allowing physical
transport of data. External floppy disk drives allow portability of
the drive itself. Floppy disks benefit from being "legacy" products
with a large existing user base and a low cost per unit for a floppy
disk. Relative to other available media, floppy disks have extremely
low capacity, holding up to approximately 1.44 megabytes per disk
depending on the user's operating system and other factors, and
represent a very high cost per megabyte. In addition, floppy disks
typically employ older, less efficient storage, management,
protection, retrieval and transfer technology, and offer moderate data
access times and data transfer rates, moderate reliability and a
tendency towards degradation over time which risks the loss of data
stored on the disk.
o ZIP(R) DISKS. Zip(R) disks are removable media allowing physical
transport of data. External Zip(R) disk drives allow portability of
the drive itself. Relative to other available media, Zip(R) disks have
moderate capacity, holding up to approximately 750 megabytes per disk
depending on the user's operating system and other factors, and
represent a moderate cost per megabyte. Zip(R) disks themselves have a
moderate cost per unit and offer moderate data access times and data
transfer rates. A special Zip(R) drive is required to utilize Zip(R)
disk technology and media.
o MAGNETIC TAPE. Magnetic tape is removable media allowing physical
transport of data. Magnetic tape drives are typically larger than
other storage drives, making them comparatively less portable.
Relative to other available media, magnetic tape has moderate to high
capacity, holding up to approximately 80 gigabytes, or 80,000
megabytes, depending on the user's operating system and other factors,
and represents a moderate cost per megabyte. While magnetic tape
itself is not expensive, magnetic tape drives have a high cost per
unit. Magnetic tape media typically employs older, less efficient
storage, management, protection, retrieval and transfer technology,
and offers slow data access times but fast data transfer rates,
moderate reliability and a tendency towards degradation over time
which risks the loss of data stored on the tape.
OPTICAL MEDIA
o COMPACT DISCS. CDs are removable media allowing physical transport of
data. External CD drives allow portability of the drive itself.
Relative to other available media, CDs have moderate capacity, holding
up to approximately 700 megabytes, depending on the user's operating
system and other factors, and offer virtually unlimited storage
capacity with the use of additional low cost CDs. CDs offer only
moderate data access times and data transfer rates as compared to hard
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disk technologies; however, new technology continues to improve data
access times for this media. CDs are also compatible with numerous
devices ranging from PCs to CD and DVD players typically found in the
home and office. Unlike hard disks, the integrity of data protection
and retrieval is not drive-dependent, since a reliability problem with
an optical drive will not affect digital data already stored on a CD,
and ease of transport allows access to data using another drive if a
problem exists with a user's primary drive unit. In addition, unlike
magnetic media, use of CDs results in limited or no degradation of the
CD itself.
o DIGITAL VIDEO OR DIGITAL VERSATILE DISCS. The relative advantages and
disadvantages of DVD drives and media are generally the same as for CD
drives and media. However, as compared to other available media, DVDs
are moderate to high capacity, holding up to approximately 4.3
gigabytes, or 4,300 megabytes, on a single-layer DVD drive and up to
8.5 gigabytes, or 8,500 megabytes, on a double-layer DVD drive,
depending on the user's operating system and other factors.
SOLID STATE MEDIA
o FLASH MEMORY CHIPS. Flash memory chips are generally not removable
media. Typically, flash memory chips are used in portable devices such
as digital cameras, PDAs and cellular phones. Relative to other
available media, flash memory chips have moderate capacity, holding up
to approximately 2 gigabyte, or 2,000 megabytes, depending on the
user's operating system and other factors, and offer very high cost
per megabyte and high cost per unit. Flash memory chips are highly
reliable, consume very little power and offer very fast data access
times and data transfer rates, but require another device or medium
for data back-up purposes.
o FLASH MEMORY CARDS. The relative advantages and disadvantages of flash
memory cards are generally the same as for flash memory chips.
However, flash memory cards are removable media allowing physical
transport of data.
INDUSTRY CHALLENGES AND TRENDS
We believe that the challenges currently facing the data storage industry
include:
o NEED FOR HIGH-CAPACITY, COST-EFFECTIVE AND FLEXIBLE MEDIA AND RELATED
DATA STORAGE DEVICES. We believe that, as a result of the rapid growth
in data and in new applications requiring or using high data-content
movies, photos, music and games and other multi-media content, the
data storage industry needs to offer higher capacity, more
cost-effective and flexible media and data storage devices. To meet
this need, the data storage industry has shifted its product offerings
to DVD-based technologies as well as to compact and portable hard disk
drives such as our GigaBank(TM) products.
o NEED TO IDENTIFY AND SATISFY CONSUMER DEMANDS AND PREFERENCES. The
data storage industry is characterized in part by rapidly changing
consumer demands and preferences for higher levels of product
performance and functionality. We believe that, to be successful,
companies in this industry must closely identify changes in consumer
demands and preferences and introduce both new and enhanced data
storage products to provide higher levels of performance and
functionality than existing products.
We believe that trends in the data storage industry include the trend
toward higher capacity optical storage media and related drives, including the
trend away from CD-based media and devices and towards DVD-based media and
devices. We believe that unit sales of recordable CD drives in the North
American retail marketplace declined to approximately 1.5 million in 2004 from
approximately 3.5 million in 2003, while unit sales of recordable DVD drives
grew to approximately 2.2 million in 2004 from approximately 1.1 million in
2003. This decline in unit sales of recordable CD drives represents a 57%
decrease in 2004 from 2003 and the growth in unit sales of recordable DVD drives
represents in excess of a 100% increase in 2004 from 2003.
Another trend in the data storage industry is the progression toward
smaller, more portable hard disk drives such as our GigaBank(TM) products.
Developing trends in the data storage industry include the early adoption
of super-high-capacity optical data storage devices using technology such as
Blu-ray DVD or High-definition DVD. Blu-ray DVD technology is expected to expand
DVD capacity up to tenfold and is expected to allow, for the first time in a
device widely available to consumers, the storage and retrieval of high
definition videos and images for playback on high-definition DVD players and
compatible televisions and monitors. A competing new technology also exists
called High-definition DVD, or HD-DVD. The storage capacity of HD-DVD is limited
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to approximately 60% of a Blu-ray DVD. Proponents of HD-DVD technology contend,
however, that it has less compatibility problems with existing DVD technology as
compared to Blu-ray DVD technology and that data compression software reduces
the importance of the greater storage capacity offered by Blu-ray DVD
technology.
It is not yet clear whether Blu-ray DVD or HD-DVD will become the dominant
technology, if they will coexist, or if a new technology will emerge.
Nonetheless, we believe that the increased performance offered by these
technologies will likely result in increased consumer demand for optical data
storage devices. Furthermore, we believe that regardless of which technology
becomes the dominant technology, we will be able to incorporate either
technology into our product offerings in much the same way as we do today with
the large number of format types ranging from recordable and rewritable CD-based
products to DVD-based products.
THE I/OMAGIC SOLUTION
We sell optical and magnetic data storage products in the North American
retail marketplace. We believe that we possess a combination of core
competencies that provide us with a competitive advantage, including the ability
to successfully identify consumer needs and preferences, use our sales and
distribution channels to sell new and enhanced products, efficiently bring to
market newly developed products and enhanced products, efficiently manage our
product supply chain, and use our brands and merchandising efforts to market and
sell data storage products. In addition, we sell digital entertainment and other
products in the North American retail marketplace.
Successfully executing our core competencies yields substantial benefits
including the ability to:
o rapidly bring both new and enhanced products to market in a
cost-effective manner;
o offer high-value products which combine performance, functionality and
reliability at competitive prices; and
o establish and maintain a large market presence for our core data
storage product offerings resulting in significant market share.
We work closely with our retailers to promote our products, monitor
consumer demands and preferences and stay at the forefront of the market for
data storage products. We also work closely with our subcontract manufacturers
and suppliers and benefit from their substantial research and development
resources and economies of scale. As a result of working with our retailers,
subcontract manufacturers and suppliers, we are able to rapidly bring new and
enhanced data storage products to market in a cost-effective manner.
The market intelligence we gain through consultation with our retailers,
subcontract manufacturers and suppliers enables us to deliver products that
combine performance and functionality demanded by the marketplace. Obtaining
these products through our subcontract manufacturers and suppliers, along with
efficient management of our supply chain, allows us to offer these products at
competitive prices.
We sell our products through computer, consumer electronics and office
supply superstores and other retailers who collectively operate retail locations
throughout North America. Our network of retailers enables us to offer products
to consumers across North America, including nearly every major metropolitan
market in the United States. Over the past three years, our largest retailers
have included Best Buy, Circuit City, CompUSA, Staples, Office Depot and
OfficeMax.
As a result of our access to a large retail network, we believe that we
have established and will maintain a large market presence for our core data
storage product offerings, resulting in significant market share. We believe
that in 2004 and 2003 we achieved the number three and number one market shares,
respectively, in both unit and dollar sales of CD-RW drives in North America. We
believe that the data storage industry is shifting from CD-based products to
DVD-based products. As a result, we launched our dual-format recordable DVD
drives in July 2003. We believe that in 2004 and 2003 we achieved the number two
and number four market shares, respectively, in both unit and dollar sales of
recordable DVD drives in North America.
Historically, we focused on optical data storage products, such as CD and
DVD drives. We continue to focus on optical data storage products but also focus
on a line of portable magnetic data storage products, called our GigaBank(TM)
products, which are compact and portable universal serial bus, or USB, hard disk
drives that plug into any standard USB port, to respond to the demands and
preferences of the data storage marketplace. We believe that the market for data
storage products, especially "after-market" devices that can be purchased
separately from and easily used in conjunction with a standard PC, has shifted
its demand largely to optical media and drives as well as to compact and
portable hard disk drives. We believe that optical media and drives represent
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the optimal combination of high-capacity storage capability, cost-effectiveness
and flexibility. Magnetic hard-disk and drive technology is the closest
competitor to optical media in the contexts of storage capacity,
cost-effectiveness and flexibility. However, while the storage capacity of any
given hard disk is fixed, optical media has virtually unlimited storage capacity
through the addition of low-cost CDs or DVDs. Moreover, optical media has far
more flexibility than hard disk media, allowing users to store music, photos and
movies utilizing a stand-alone recorder or a desktop or laptop PC and then play
them back on standalone CD or DVD players. In addition, hard disk media is
usually built into a PC, lacking effective portability and ease of physical
transport of data. However, since late 2004, we have also focused on our
GigaBank(TM) products as a cost-effective portable alternative to flash media
devices and standard hard disk drives.
We believe that our focus on optical data storage products and our
GigaBank(TM) products is also consistent with the proliferation of digital
entertainment devices. Digital cameras, MP3 players and other digital
entertainment devices are well-complemented by the use of optical media for data
back-up and high-capacity storage purposes. Existing solid state media, while
convenient in many respects, offers relatively low storage capacity and
relatively poor cost effectiveness. Accordingly, optical media, with its high
storage capacity, cost effectiveness and convenience, together with a related
drive unit, is a complementary product for consumers who desire to store,
manage, protect, retrieve and transfer digital data used in conjunction with
their digital entertainment devices. In addition, for greater storage capacity
and portability at cost-effective prices, we offer our GigaBank(TM) products.
OUR STRATEGY
Our primary goal is to remain a leading provider of optical data storage
products and to expand our market share of portable magnetic data storage
products. Our business strategy to achieve this goal includes the following
elements:
o CONTINUE TO DEVELOP AND SOLIDIFY OUR NORTH AMERICAN RETAIL NETWORK. We
have developed, and plan to continue to develop and solidify, close
working relationships with leading North American computer, consumer
electronic and office supply superstores and other retailers. These
retailers carry many of the products that we sell. As we offer both
new and enhanced data storage, digital entertainment and other
products, we intend to continue to utilize our existing relationships
with these retailers to offer and sell these products to consumers.
o CONTINUE TO DEVELOP AND EXPAND OUR STRATEGIC SUBCONTRACT AND SUPPLY
RELATIONSHIPS. We have developed, and plan to continue to develop and
expand, strategic relationships with subcontract manufacturers and
suppliers, such as Behavior Tech Computer Corp. and Lung Hwa
Electronics Co, Ltd. in Asia. These relationships allow us to enhance
our product offerings and benefit from these subcontract
manufacturers' and suppliers' continued development of new and
improved data storage, digital entertainment and other products. Some
of these relationships are particularly strong because some of our
subcontract manufacturers and suppliers are also our stockholders. We
plan to continue to develop and explore other subcontract manufacturer
and supplier relationships as well. By continuing to subcontract
manufacture and source our products, we intend to continue to increase
our operating leverage by delivering products incorporating new
technology without having to make the substantial investment in, or
having to incur the fixed costs associated with product development
and manufacturing in an industry characterized by rapid product
innovation and obsolescence.
o CONTINUE TO DEVELOP AND OFFER HIGH VALUE PRODUCTS. We intend to
continue to work in conjunction with our retailers, subcontract
manufacturers and suppliers to enhance existing products and develop
new products to satisfy consumer demands and preferences. We believe
that our target consumers seek high value products that combine
performance, functionality and reliability at prices competitive with
other leading products offered in the marketplace. We believe that our
core competencies such as our ability to efficiently bring to market
newly developed products and enhanced products and to efficiently
manage our product supply chain will enable us to enhance our products
and offer new products in a cost-effective and timely manner. We
intend to continue to focus on high value product offerings by
promoting and offering our products that are affordable alternatives
to higher-priced products offered by some of our competitors.
o EXPAND INTO NEW SALES CHANNELS. We plan to expand our market
penetration beyond our existing retailers into new sales channels to
include corporate and government procurers, value-added resellers and
value-added distributors. In addition, through our company websites
located at http://www.iomagic.com, http://www.dr-tech.com and
http://www.hival.com, we plan to increase sales of our products over
the Internet by continuing to offer select products for direct
purchase by consumers, conduct special promotions and offer downloads
to existing and potential purchasers of our products.
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o MARKET PRODUCTS TO OUR EXISTING CONSUMER BASE. We intend to market
new, enhanced and current products to existing purchasers of our
products. We also believe that existing users of our products can be
an important source of referrals for potential new purchasers of our
products.
OUR PRODUCTS
We have two primary data storage product categories: our optical data
storage product category and our portable magnetic data storage product
category. Our optical data storage products consist of a range CD and DVD drives
that store traditional PC data as well as music, photos, movies, games and other
multi-media. These products are designed principally for general data storage
purposes. Our portable magnetic data storage products consist of a range of hard
disk drives that we call our GigaBank(TM) products.
OUR OPTICAL DATA STORAGE PRODUCTS
Our optical data storage products are based on one or more of the following
technology formats which allow the storage, management, protection, retrieval
and transfer of data:
TECHNOLOGY MEANING DATA STORAGE AND RETRIEVAL CAPABILITY(1)
- ---------- ------- ----------------------------------------
CD-ROM Compact Disc-Read Only Memory Retrieval only
CD-R Compact Disc-Recordable Retrieval and single-session storage
CD-RW Compact Disc-Rewritable Retrieval and multi-session storage
DVD-ROM Digital Video Disc-Read Only Memory Retrieval only
DVD-R or Digital Video Disc-Recordable Retrieval and single-session storage
DVD+R
DVD-RW or Digital Video Disc-Rewritable Retrieval and multi-session storage and backward
DVD+RW compatibility with CDs
DVD+/-RW+/-R Dual Format Digital Video Disc-Rewritable Retrieval and multi-session storage and backward
and Recordable compatibility with CDs and DVD-Rs
CD-RW+DVD Compact Disc-Rewritable DVD Retrieval and multi-session storage and backward
compatibility with CDs and DVD-ROMs
- ------------
(1) Single-session storage media and devices allow storage on a disc only a
single time, whereas multi-session storage media and devices allow repeated
storage, erasure and re-storage of data. Backward compatible devices permit
the use of media based on older technology in devices employing newer
technology, such as DVD-based devices which permit the use of CD media.
Many of the technologies identified in the table above are competing
formats. We seek to deliver optical data storage products that enable the
storage, management, protection, retrieval and transfer of data to and from all
major formats to satisfy the needs of consumers regardless of their choice of
format. Because certain formats ultimately may be rejected or disfavored by the
marketplace, we do not base our products on a single format or on a small number
of formats. We seek to offer products that are cross-compatible over numerous
formats to offer the most comprehensive solution available to the broadest range
of consumers.
Our optical data storage products currently include:
o Internal and external optical data storage drives based on the
following technologies: CD-ROM, CD-RW, DVD-ROM, DVD+R, DVD+RW,
DVD+/-RW+/-R or CD-RW+DVD;
o External CD-RW and DVD+RW drives that integrate a recordable drive and
a built-in seven-in-one, or 7-n-1, digital media card reader with a
proprietary external casing that features a three-way adjustable
lighting system allowing the user to adjust the lighting to blue, red
or purple, which we call our MediaStation devices; our 7-n-1 digital
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media card reader supports seven different types of solid state memory
devices: CompactFlash, Microdrives(R), Multimedia Card, Secure
Digital, Memory Stick, Memory Stick Pro and SmartMedia;
o Internal dual format DVD recordable drives that integrate a recordable
drive and a built-in 7-n-1 digital media card reader; and
o Disc duplicator systems that are stand-alone units that do not require
a computer connection and that copy information from a source disc,
such as a CD or DVD, to a compatible target disc.
We also offer optical data storage products that use double-layer DVD
technology, which doubles DVD capacity to approximately 8.5 gigabytes, or 8,500
megabytes, depending on the user's operating system and other factors. We plan
to continue our efforts to enhance our optical data storage products by
increasing performance and functionality as well as reducing the size of their
drive units and enclosures to increase portability and ergonomics.
We believe that sales of recordable CD drives in the North American retail
marketplace declined to approximately $95 million in 2004 from approximately
$266 million in 2003. This decline represents a 64% decrease in sales in 2004
from 2003. However, this decline was partially offset by the growth in
recordable DVD drives. We also believe that sales of recordable DVD drives in
the North American retail marketplace increased to approximately $297 million in
2004 from approximately $235 million in 2003. This growth represents a 26%
increase in sales in 2004 from 2003. In addition, we believe that unit sales of
DVD recordable drives increased to approximately 2.2 million units in 2004 from
approximately 1.0 million units in 2003. This growth represents in excess of a
100% increase in unit sales in 2004 from 2003.
OUR PORTABLE MAGNETIC DATA STORAGE PRODUCTS
Our existing and planned portable magnetic data storage products currently
include.
o GigaBank(TM) USB hard disk drives with dimensions measuring 2.0"W x
2.5"L x 0.5"D that provide from up to 2.2 gigabytes, or 2,200
megabytes, to up to 8.0 gigabytes, or 8,000 megabytes, of storage
capacity, depending on the user's operating system and other factors;
o GigaBank(TM)ELITE USB hard disk drives with dimensions measuring
2.75"W x 4.5"L x 0.625"D that provide from up to 40 gigabytes, or
40,000 megabytes, to up to 80 gigabytes, or 80,000 megabytes, of
storage capacity, depending on the user's operating system and other
factors; and
o GigaBank(TM)PREMIER USB hard disk drives with dimensions measuring
3.5"W x 5.75"L x 1.0"D that provide from up to 80 gigabytes, or 80,000
megabytes, to up to 120 gigabytes, or 120,000 megabytes, of storage
capacity, depending on the user's operating system and other factors.
The growth in the availability of digital data, such as movie, photographic
and music data has generated new data storage applications and created
significant demand for portable data storage devices. The typical portable data
storage device is compact, often small enough to fit in a pocket, consumes low
power, is durable, re-writable and is versatile due to its ease of operation. In
addition, most of these portable data storage devices do not require a separate
power source other than through a standard USB port. USB portable storage
devices, such as USB flash drives and compact USB hard disk drives, that compete
with our CD- and DVD-based data storage products were introduced in late 2002
and sales of these devices have continued to represent an increased share of the
market for data storage products. In the third quarter of 2004, we began selling
our GigaBank(TM) products, which are compact and portable external hard disk
drives with a built-in USB connector.
Our GigaBank(TM) products are designed to provide cost-effective portable
alternatives to flash media devices and standard hard disk drives. We believe
that our GigaBank(TM) line of products represents a substantial opportunity for
sales growth. We also believe that sales of our GigaBank(TM) products will, over
the next twelve months, grow as a percentage of our net sales.
OUR DIGITAL ENTERTAINMENT AND OTHER PRODUCTS
Our digital entertainment and other products currently include:
o External floppy disk drives that integrate a floppy disk drive and a
built-in 7-n-1, digital media card reader with a proprietary external
casing that features a three-way adjustable lighting system allowing
the user to adjust the lighting to blue, red or purple, which we call
our DataStation devices;
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o Case enclosures for external or portable data storage drives;
o Our Digital Photo Library(TM) system, which consists of 20 gigabyte
palm-sized portable external hard disk drives with built-in 7-n-1
media card readers that facilitate the convenient storage of
high-resolution digital music, photos and movies and other data files,
enabling the transfer of these files from a flash memory card to a
hard disk drive and eliminating the need for purchasing multiple, less
cost-effective flash memory cards; and
o Do-it-yourself digital photo accessories such as our EasyPrint(TM)
line of products that allow users to create personalized photo frames,
key chains, magnets and pocket-sized photo albums from their own
digital photos using our proprietary photo-enhancing and printing
software.
We believe that the markets for digital entertainment and other consumer
electronics and peripheral products are expanding. We intend to continue to
monitor these markets and develop and sell digital entertainment and other
consumer electronics and peripheral products as we are able to identify products
that we believe we can sell competitively. Currently, our digital entertainment
and other consumer electronics and peripheral products represent only a minor
product category. These products accounted for only approximately 1% of our net
sales during 2004 and approximately 6% of our net sales during 2003.
PRODUCT WARRANTIES
Our products are subject to limited warranties of up to one year in
duration. These warranties cover only repair or replacement of the product. Our
subcontract manufacturers and suppliers provide us with warranties of a duration
at least as long as the warranties provided to consumers. The warranties
provided by our subcontract manufacturers and suppliers cover repair or
replacement of the product.
PRODUCT OFFERINGS
Our product offerings are primarily directed toward satisfying the demands
of the North American retail marketplace for data storage products. We also sell
digital entertainment and other products in the North American retail
marketplace. We operate in industries that are subject to rapid technological
change, product obsolescence and rapid changes in consumer demands and
preferences. We attempt to anticipate and respond to these changes by focusing
on the following primary objectives:
o ENHANCEMENT OF EXISTING PRODUCTS. We seek to offer products with
increased performance and expanded functionality to satisfy existing
and emerging consumer demands and preferences. Our enhanced product
offerings are directed toward, among other things, offering increased
data storage and retrieval speeds, and enhanced user-friendliness and
ease of product installation. These product offerings are also focused
on products with reduced manufacturing costs to enable us to maintain
and improve gross margins while continuing to offer high-value
products to consumers.
o DEVELOPMENT OF NEW PRODUCTS. We seek to offer new products that, among
other things, use existing technology and adopt new technology to
satisfy existing and emerging consumer demands and preferences. Our
new product offerings typically focus on the implementation of
existing technology to offer products that are compatible with a wide
range of formats. These offerings also typically include
implementation of new technology to offer products that deliver better
solutions to the core needs of the data storage marketplace such as
high-capacity, cost-effective, flexible and portable data storage,
management, protection, retrieval and transfer.
Our retailers, subcontract manufacturers and our suppliers play an
important role in the enhancement of our existing products and the development
of new products. We work closely with our retailers, subcontract manufacturers
and our suppliers to identify existing market trends, predict future market
trends and monitor the sales performance of our products.
Many of our retailers are among the largest computer, consumer electronics
and office supply retailers in North America. Over the past three years, our
retailers have included Best Buy, Circuit City, CompUSA, Office Depot,
OfficeMax, RadioShack and Staples. Through their close contact with the
marketplace for data storage products, our retailers are able to provide us with
important information about consumer demands and preferences.
Many of our subcontract manufacturers and suppliers have substantial
product development resources and facilities in Asia, and are among the major
component manufacturers and suppliers in their product categories. Some of our
largest subcontract manufacturers and suppliers are also our stockholders,
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including BTC and Lung Hwa Electronics. We believe that BTC is among the largest
optical storage drive manufacturers in the world and Lung Hwa Electronics is a
supplier of USB hard disk drives, including some of our GigaBank(TM) products,
as well as a major manufacturer of digital entertainment products. These
subcontract manufacturers and suppliers expend substantial resources on
research, development and design of new technologies and efficient manufacturing
processes.
Our Irvine, California headquarters houses a product development team that
coordinates and manages the subcontract logistics and product development
efforts of our subcontract manufacturers and suppliers in Asia. At our Irvine
facility, we also develop user manuals, product packaging and marketing
literature as well as installation guides and supplemental materials, including
software and hardware designed to permit user-friendly product installation.
We do not have a traditional research and development program. Instead, we
work closely with our retailers, subcontract manufacturers and suppliers and
conduct various other activities in connection with the enhancement of our
existing products and the offering of new products. We have not, in any
reporting period, made any material expenditures on research and development
activities relating to the development of new products, services or techniques
or the improvement of existing products, services or techniques. Our efforts are
largely directed at the evaluation of new products and enhancements to existing
products rather than the actual development of new products or product
enhancements.
Our representatives meet frequently with our subcontract manufacturers,
suppliers and our retailers to identify and discuss emerging trends and to
address the sales performance of our products. We provide and receive
product-related input to and from our subcontract manufacturers, suppliers and
our retailers. Much of the input that we provide arises from our technical
service department, which is responsible for assisting end-users in installing
and successfully utilizing our products. Problems in the installation or
utilization of our products are reported to management by our technical service
department and often provide the basis for existing product enhancements. New
products are developed and offered by our subcontract manufacturers and
suppliers, and offered by us and in turn by our retailers largely on the basis
of market research and trends identified in the data storage, digital
entertainment and computer peripheral industries. We also monitor industry trade
publications and technical papers to understand emerging trends and new
technologies and to plan for new product offerings.
We believe that these activities assist us in attempting to achieve our
goal of being among the first-to-market with new and enhanced product offerings
based on established technologies.
OPERATIONS
We do not directly manufacture any of the products that we sell. We
subcontract manufacture or source our data storage, digital entertainment and
other products. We believe that by outsourcing the manufacturing of our products
to our subcontract manufacturers or sourcing them from our suppliers, we benefit
from:
o LOWER OVERHEAD COSTS. By subcontract manufacturing or sourcing our
products we believe that we benefit from lower overhead costs
resulting from the elimination of capital expenditures related to
owning and operating manufacturing facilities, such as expenditures
related to acquiring a manufacturing plant, property and equipment,
and staffing, as well as the ongoing cash requirements to fund such an
operation.
o ECONOMIES OF SCALE. By subcontract manufacturing or sourcing our
products with some of the largest production facilities available in
the industry, we believe that we benefit from our subcontract
manufacturers' and suppliers' economies of scale, which enable us to
keep unit production costs low, our supply chain management efficient
and our expansion or contraction of product orders flexible in
response to changing consumer demands and preferences.
o ENGINEERING AND MANUFACTURING RESOURCES. By subcontract manufacturing
our products we believe that we benefit from our subcontract
manufacturers' substantial engineering and manufacturing resources,
which aid us in offering new and enhanced products and enable us to
rapidly bring them to market in a cost-effective manner.
o DIVERSIFICATION OF MANUFACTURING RISKS. By subcontract manufacturing
to, or sourcing our products from, a group of manufacturers or
suppliers, we believe that we are able to diversify the risks
associated with employing a single manufacturer or supplier. We also
believe that we are potentially able to expand our opportunities with
respect to new products as they arise by virtue of the varying
expertise of those manufacturers and suppliers.
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o REDUCTION OF POTENTIAL LIABILITIES. By subcontract manufacturing or
sourcing our products we believe that we reduce potential significant
liabilities associated with direct product manufacturing, including
environmental liabilities and liabilities resulting from warranty
claims. We believe that the reduction in potential liabilities
decreases our business risks and results in tangible economic benefits
such as cost savings related to insurance and the operation of
compliance programs.
We believe that the relatively low overhead costs resulting from
subcontract manufacturing or sourcing the products we offer for sale, the
economies of scale of our subcontract manufacturers and suppliers, and the
engineering and manufacturing resources of our subcontract manufacturers enable
us to offer products combining high levels of performance, functionality and
reliability at prices competitive with other leading products offered in the
marketplace.
We utilize a subcontract logistics and product development consultant
located in Taipei, Taiwan. Our consultant assists us in identifying new
products, qualifying prospective manufacturing facilities and coordinating
product purchases and shipments from some of our subcontract manufacturers and
suppliers. The majority of our products are shipped directly by our subcontract
manufacturers or suppliers to our packaging, storage and distribution facility
in Irvine. These products are then packaged and shipped by us either directly to
retail locations across North America or to a centralized distribution center.
Product shipments are primarily made through major commercial carriers.
QUALITY CONTROL
Our primary subcontract manufacturers and suppliers are among the major
computer and electronic component manufacturers and suppliers in Asia who we
believe have rigorous quality control and shipping guidelines. We regularly
inspect and test product samples, periodically tour our subcontract
manufacturing and supply facilities, monitor defective product returns and test
defective products.
SALES AND MARKETING
We believe that during 2004 and 2003 we ranked as number three and number
one, respectively, in unit and dollar sales of CD-RW drives in the North
American retail marketplace, competing against companies such as Memorex, Sony
and TDK. Our goal is to achieve and maintain a similar ranking for our DVD-based
products and our GigaBank(TM) products.
We primarily sell our products through retailers who collectively operate
locations throughout North America. These include nationally-recognized
computer, consumer electronics and office supply superstores. In addition, we
sell our products through Internet retailers and mail order catalogs.
Our North American retailers include Best Buy, Best Buy Canada, Circuit
City, CompUSA, Fred Meyer Stores, Microcenter, Office Depot, RadioShack,
Staples, and Target. We also have relationships with other retailers and with
catalog companies and Internet retailers such as Buy.com, Dell, PC Mall and
Tiger Direct.
We cooperate with our retailers to promote our products and brand names. We
participate in co-sponsored events with our retailers and industry trade shows
such as CES(R) and RetailVision(R). We participate in these events and trade
shows in order to develop new relationships with potential retailers and
maintain close relationships with our existing retailers. We also fund
co-operative advertising campaigns, develop custom product features and
promotions, provide direct personal contact with our sales representatives and
develop and procure certain products as requested by our retailers. We cooperate
with our retailers to use point-of-sale and mail-in rebate promotions to
increase sales of our products. We also utilize sales circulars and our close
working relationships with our significant retailers to obtain national exposure
for our products and our brands. We believe that these marketing efforts help
generate additional shelf-space for our products with our major retailers,
promote retail traffic and sales of our products, and enhance our goodwill with
these retailers.
We maintain a large database containing information regarding many
end-users of our products. Through a targeted, direct marketing strategy, we
intend to offer these end-users other products to establish repeat end-user
customers, increase our product sales and promote brand loyalty.
We plan to expand our market penetration beyond traditional and Internet
retailers to include corporate and government procurers, value-added resellers
and value-added distributors. We currently sell and plan to continue to sell
products, conduct special promotions, and offer downloads on our company
websites to existing and potential end-user customers. Our websites are located
at http://www.iomagic.com, http://www.dr-tech.com and http://www.hival.com.
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COMPETITION
We operate primarily in the highly-competitive data storage industry. We
believe that our data storage products compete with other types of data storage
devices such as internal, external and portable hard disk drives, magnetic tape
drives, floppy disk drives and flash memory devices, as well as internal and
external optical data storage products offered by other companies.
Companies that offer products similar to our optical data storage products
include BenQ, Hewlett-Packard, Lite-On, Memorex, Philips Electronics, Samsung
Electronics, Sony and TDK. We also indirectly compete against original equipment
manufacturers such as Dell and Hewlett-Packard to the extent that they
manufacture their own computer peripheral products or incorporate the
functionalities offered by our products directly into PCs. Companies that offer
products similar to our portable magnetic data storage products include PNY
Technologies, Sony, Seagate Technology and Western Digital.
We believe that our ability to compete in the data storage industry depends
on many factors, including the following:
o PRODUCT VALUE. The performance, functionality, reliability and price
of our products are critical elements of our ability to compete. We
believe that we offer, and that our target consumers seek, products
that combine higher levels of performance, functionality and
reliability at lower prices than other leading products offered in the
marketplace. We focus on offering these high value products by
positioning them as affordable alternatives to products offered by
leading brands such as Hewlett-Packard, Memorex, TDK and Sony.
o MARKET PENETRATION. Market penetration and brand recognition are
critical elements of our ability to compete. Most consumers purchase
products similar to ours from off-the-shelf retailers such as large
computer, consumer electronics and office supply superstores. Market
penetration in the industries in which we compete is typically based
on the number of retailers who offer a company's products and the
amount of shelf-space allocated to those products. We believe that our
broad-based, high value product offerings, our retailer support, our
consumer support and our cooperative marketing and other promotional
efforts promote close working relationships with our retailers and
improve our ability to obtain critical shelf-space which enables us to
establish, maintain and increase market penetration.
o PRODUCT ENHANCEMENT AND DEVELOPMENT AND TIME-TO-MARKET. Enhancement of
our existing products, development of new products and rapid
time-to-market to satisfy evolving consumer demands and preferences
are key elements of our ability to compete. Consumers continuously
demand higher levels of performance and functionality in data storage
products. We attempt to compete successfully by bringing products with
higher levels of performance and functionality rapidly to market to
satisfy changing consumer demands and preferences. We believe that the
research and development efforts and economies of scale of our major
subcontract manufacturers and suppliers enable us to rapidly introduce
enhanced products and new products offering higher levels of
performance and functionality. Our products are often among the
first-to-market with new features and technology to be made widely
available to consumers.
INTELLECTUAL PROPERTY
We currently rely on a combination of contractual rights, copyrights,
trademarks and trade secrets to protect our proprietary rights. I/OMagic(R),
Hi-Val(R) and Digital Research Technologies(R) are our registered trademarks. We
also sell products under various product names such as MediaStation,
DataStation, Digital Photo Library(TM), EasyPrint(TM) and GigaBank(TM). As we
develop new products, we may file federal trademark applications covering the
trademarks under which we sell those products. There can be no assurance that we
will eventually secure a registered trademark covering these products. We
currently do not have any issued or pending patents.
We own, license or have otherwise obtained the right to use certain
technologies incorporated in our products. We may receive infringement claims
from third parties relating to our products and technologies. In those cases, we
intend to investigate the validity of the claims and, if we believe the claims
have merit, to respond through licensing or other appropriate actions. To the
extent claims relate to technology included in components purchased from
third-party vendors for incorporation into our products, we would forward those
claims to the appropriate vendor. If we or our product manufacturers are unable
to license or otherwise provide any necessary technology on a cost-effective
basis, we could be prohibited from marketing products containing that
technology, incur substantial costs in redesigning products incorporating that
technology, or incur substantial costs defending any legal action taken against
us.
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We have been, and may in the future be, notified of claims asserting that
we may be infringing certain patents, trademarks and other intellectual property
rights of third parties. We cannot predict the outcome of such claims and there
can be no assurance that such claims will be resolved in our favor. An
unfavorable resolution of such claims may have a material adverse effect on our
business, prospects, financial condition and results of operations. The data
storage industry, has been characterized by significant litigation relating to
infringement of patents and other intellectual property rights. We have in the
past been engaged in infringement litigation, both as plaintiff and defendant.
There can be no assurance that future intellectual property claims will not
result in litigation.
If infringement is established, we may be required to pay substantial
damages or we may be enjoined from manufacturing and selling an infringing
product. In addition, the costs of engaging in the prosecution or defense of
intellectual property claims may be substantial regardless of the outcome.
A number of our agreements with our retailers provide that we will defend,
indemnify and hold harmless our retailers from damages and costs that arise from
product warranty claims or claims for injury or damage resulting from defects in
our products. If such claims are asserted against us, our insurance coverage may
not be adequate to cover the costs associated with our defense of those claims
or any resulting liability we would incur if those claims are successful. A
successful claim brought against us for product defects that is in excess of, or
excluded from, our insurance coverage could have a material adverse affect on
our business and results of operations.
GOVERNMENT REGULATION
Our products are designed by our subcontract manufacturers to comply with a
significant number of regulations and industry standards, some of which are
evolving as new technologies are deployed. We believe that we are currently in
compliance with each applicable regulation and industry standard. In the United
States, our products must comply with various regulations defined by the United
States Federal Communications Commission, or FCC, and Underwriters Laboratories,
or other nationally recognized test laboratories. We also must comply with
numerous import/export regulations. The regulatory process in the United States
can be time-consuming and can require the expenditure of substantial resources.
We cannot assure you that the FCC will grant the requisite approvals for any of
our products on a timely basis, or at all. The failure of our products to
comply, or delays in compliance, with the various existing and evolving
standards could negatively impact our ability to sell our products. United
States regulations regarding the manufacture and sale of data communications
devices are subject to future change. We cannot predict what impact, if any,
such changes may have upon our business.
EMPLOYEES
As of May 12, 2005, we had approximately 53 full-time employees and one
part-time employee. We have no collective bargaining agreements with our
employees. We believe that our relationship with our employees is good.
ITEM 2. PROPERTIES
Our corporate headquarters is located in Irvine, California in a leased
facility of approximately 55,000 square feet. This facility contains all of our
operations, including sales, marketing, finance, administration, production,
shipping and receiving. The lease term began on September 1, 2003 and expires on
August 31, 2006, with an option to extend the lease for another three year term
upon providing notice 60 days prior to expiration of the current lease term. Our
monthly lease payments are $25,480, $26,244, and $27,032 during the first,
second, and third years of the lease, respectively. Under the option to extend
the lease, monthly lease payments would be determined according to the then
prevailing market price for the first year, and an increase of 3% per annum for
years two and three. We believe this facility is adequate for our anticipated
business purposes for the foreseeable future. We have no other leased or owned
real property.
ITEM 3. LEGAL PROCEEDINGS
HI-VAL, INC.
On August 2, 2001, Mark and Mitra Vakili filed a complaint in the Superior
Court of the State of California for the County of Orange against Tony Shahbaz,
our Chairman, President, Chief Executive Officer and Secretary. This complaint
was later amended to add Alex Properties and Hi-Val, Inc. as plaintiffs, and
I/OMagic, IOM Holdings, Inc., Steel Su, a director of I/OMagic, and Meilin Hsu,
an officer of Behavior Tech. Computer Corp., as defendants. The final amended
complaint alleged causes of action based upon breach of contract, fraud, breach
of fiduciary duty and negligent misrepresentation and sought monetary damages
and rescission. As a result of successful motions for summary judgment,
I/OMagic, Mr. Su and Ms. Hsu were dismissed as defendants. On February 18, 2003,
a jury verdict adverse to the remaining defendants was rendered, and on or about
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March 28, 2003, all parties to the action entered into a Settlement Agreement
and Release which settled this action prior to the entry of a final judgment. As
part of the Settlement Agreement and Release, Mr. Shahbaz and Mr. Su
relinquished their interests in Alex Properties and the Vakilis relinquished
66,667 shares of our common stock, of which 13,333 shares were transferred to a
third party designated by the Vakilis. In addition, we agreed to make payments
totaling $4.0 million in cash and entered into a new written lease agreement
with Alex Properties relating to the real property in Santa Ana, California,
which we physically occupied. On September 30, 2003, pursuant to the terms of
the lease agreement, we vacated this real property. During the latter part of
2003 and continuing into the first quarter of 2004, Mark and Mitra Vakili and
Alex Properties alleged that we had improperly caused damage to the Santa Ana
facility. On or about February 15, 2004, all parties to the original Settlement
Agreement and Release executed a First Amendment to Settlement Agreement and
Release, releasing all defendants from all of these new claims conditioned upon
the making of the final $1.0 million payment under the Settlement Agreement and
Release by February 17, 2004, rather than on the original due date of March 15,
2004. We made this payment, and a dismissal of the case was filed with the court
on March 8, 2004.
HORWITZ AND BEAM
On May 30, 2003, I/OMagic and IOM Holdings, Inc. filed a complaint for
breach of contract and legal malpractice against Lawrence W. Horwitz, Gregory B.
Beam, Horwitz & Beam, Lawrence M. Cron, Horwitz & Cron, Kevin J. Senn and Senn
Palumbo Mealemans, LLP, our former attorneys and their respective law firms, in
the Superior Court of the State of California for the County of Orange. The
complaint seeks damages of $15 million arising out of the defendants'
representation of I/OMagic and IOM Holdings, Inc. in an acquisition transaction
and in a separate arbitration matter. On November 6, 2003, we filed our First
Amended Complaint against all defendants. Defendants have responded to our First
Amended Complaint denying our allegations. Defendants Lawrence W. Horwitz and
Lawrence M. Cron have also filed a Cross-Complaint against us for attorneys'
fees in the approximate amount of $79,000. We have denied their allegations in
the Cross-Complaint. As of the date of this report, discovery has commenced and
a trial date in this action has been set for September 12, 2005. The outcome of
this action is presently uncertain. However, we believe that all of our claims
are meritorious.
MAGNEQUENCH INTERNATIONAL, INC.
On March 15, 2004, Magnequench International, Inc., or plaintiff, filed an
Amended Complaint for Patent Infringement in the United States District Court of
the District of Delaware against, among others, I/OMagic, Sony Corp., Acer Inc.,
Asustek Computer, Inc., Iomega Corporation, LG Electronics, Inc., Lite-On
Technology Corporation and Memorex Products, Inc., or defendants. The complaint
seeks to permanently enjoin defendants from, among other things, selling
products that allegedly infringe one or more claims of plaintiff's patents. The
complaint also seeks damages of an unspecified amount, and treble damages based
on defendants' alleged willful infringement. In addition, the complaint seeks
reimbursement of plaintiff's costs as well as reasonable attorney's fees, and a
recall of all existing products of defendants that infringe one or more claims
of plaintiff's patents that are within the control of defendants or their
wholesalers and retailers. Finally, the complaint seeks destruction (or
reconfiguration to non-infringing embodiments) of all existing products in the
possession of defendants that infringe one or more claims of plaintiff's
patents. On March 9, 2005, we entered into a Settlement Agreement with
Magnequench International, Inc., releasing all claims against us in exchange for
certain information and covenants by us, including disclosure of identities of
certain of our suppliers of alleged infringing products, a covenant to provide
sample products for testing purposes and a covenant to not source products from
suppliers of alleged infringing products, provided that, among other
limitations, another supplier makes those products available to us in sufficient
quantities. A dismissal of the case was filed with the court on April 15, 2005.
OFFICEMAX NORTH AMERICA, INC.
On May 6, 2005, OfficeMax North America, Inc., or plaintiff, filed a
Complaint for Declaratory Judgment in the United States District Court of the
Northern District of Ohio against I/OMagic. The complaint seeks declaratory
relief regarding whether plaintiff is still obligated to us under certain
previous agreements between the parties. The complaint also seeks plaintiff's
costs as well as reasonable attorneys' fees. The complaint arises out of our
contentions that plaintiff is still obligated to us under an agreement entered
into in May 2001 and plaintiff's contention that it has been released from such
obligation. As of the date of this report, we have not filed a response. The
outcome of this action is presently uncertain. However, at this time, we do not
expect the defense or outcome of this action to have a material adverse affect
on our business, financial condition or results of operations.
-16-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our 2004 annual meeting of stockholders on December 21, 2004. As of
the close of business on November 22, 2004, the record date for the meeting, we
had outstanding 4,529,672 shares of common stock. A total of 2,449,638 shares of
common stock were represented in person or by proxy at the meeting and
constituted a quorum. At the meeting, the following three proposals were
presented and voted on:
(1) to elect the following five directors: Tony Shahbaz, Anthony Andrews,
Steel Su, Daniel Hou and Daniel Yao.
o All nominees were re-elected by a vote of 2,448,372 shares "for" and
1,266 shares "withheld."
(2) to ratify the selection of Singer Lewak Greenbaum & Goldstein LLP as
our independent certified public accountants to audit our financial statements
for the year ending December 31, 2004:
o This proposal was approved by a vote of 2,449,618 shares "for" and 20
shares "against" with no abstentions.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION
Our common stock has been traded on the OTC Bulletin Board under the symbol
"IOMG" since December 20, 2002. Prior to that, it traded on the OTC Bulletin
Board under the symbol "IOMC" since March 25, 1996. The table below shows for
each fiscal quarter indicated the high and low closing bid prices for shares of
our common stock. This information has been obtained from the OTC Bulletin
Board. The prices shown reflect inter-dealer prices, without retail mark-up,
mark-down, or commission and may not necessarily represent actual transactions.
PRICE RANGE
-----------
LOW HIGH
--- ----
2003:
First Quarter (January 1 - March 31)......... $ 3.00 $ 10.00
Second Quarter (April 1 - June 30)........... 3.50 11.00
Third Quarter (July 1 - September 30)........ 4.98 7.99
Fourth Quarter (October 1 - December 31)..... 3.50 7.00
2004:
First Quarter................................ $ 4.20 $ 3.00
Second Quarter............................... 4.50 3.45
Third Quarter................................ 4.45 3.50
Fourth Quarter............................... 3.60 3.00
SECURITY HOLDERS
As of May 12, 2005, we had 4,529,672 shares of common stock outstanding
held of record by approximately 70 shareholders. These holders of record include
depositories that hold shares of stock for brokerage firms which, in turn, hold
shares of stock for numerous beneficial owners.
DIVIDENDS
We have not paid dividends on our common stock to date. Our line of credit
with GMAC Commercial Finance prohibits the payment of cash dividends on our
common stock. We currently intend to retain future earnings to fund the
development and growth of our business and, therefore, do not anticipate paying
cash dividends on our common stock within the foreseeable future. Any future
payment of dividends on our common stock will be determined by our board of
directors and will depend on our financial condition, results of operations,
contractual obligations and other factors deemed relevant by our board of
directors.
RECENT SALES OF UNREGISTERED SECURITIES
In March 2004, we issued warrants to purchase 10,000 shares of common stock
at an exercise price of $4.00 per share to an investor relations firm in
connection with services to be rendered. The warrants expire on September 9,
2005.
In March 2004, we issued warrants to purchase 10,000 shares of common stock
at an exercise price of $6.00 per share to an investor relations firm in
connection with services to be rendered. The warrants expire on September 9,
2005.
In March 2004, we issued options to purchase an aggregate of 64,375 shares
of common stock under our 2002 Stock Option Plan at an exercise price of $3.50
per share to certain of our officers, directors and employees. The options
expire on March 9, 2014.
In March 2004, we issued options to purchase an aggregate of 62,000 shares
of common stock under our 2002 Stock Option Plan at an exercise price of $3.85
per share to certain of our officers, directors and employees. The options
expire on March 9, 2009.
-18-
The issuances of our securities in the above-referenced transactions were
effected in reliance upon the exemption from registration under Section 4(2) of
the Securities Act of 1933, as amended, as transactions not involving a public
offering. Exemption from the registration provisions of the Securities Act is
claimed on the basis that such transactions did not involve any public offering
and the purchasers were sophisticated with access to the kind of information
registration would provide including our most recent Annual Report on Form 10-K
and our most recent Quarterly Report on Form 10-Q.
ITEM 6. SELECTED FINANCIAL DATA
The following financial information should be read in conjunction with the
consolidated audited financial statements and the notes to those statements
beginning on page F-1 of this report, and the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this report. The consolidated statements of operations
data for the years ended December 31, 2004, 2003 and 2002 and the consolidated
balance sheet data at December 31, 2004, 2003 and 2002 are derived from, and are
qualified in their entirety by reference to, the consolidated audited financial
statements beginning on page F-1 of this report. The consolidated statements of
operations data with respect to the years ended December 31, 2001 and 2000 and
the consolidated balance sheet data at December 31, 2001 and 2000 are derived
from, and are qualified in their entirety by reference to, our audited financial
statements not included in this report. The historical results that appear below
are not necessarily indicative of results to be expected for any future periods.
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(AS RESTATED) (AS RESTATED) (AS RESTATED) (AS RESTATED)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales ..................................... $ 44,396,551 $ 63,587,454 $ 80,952,712 $ 68,112,311 $ 61,048,101
Cost of sales ................................. 41,418,750 54,643,371 73,564,456 61,951,641 53,126,489
------------- ------------- ------------- ------------- -------------
Gross profit .................................. 2,977,801 8,944,083 7,388,256 6,160,670 7,921,612
Operating expenses ............................ 10,881,017 9,236,912 10,022,445 10,180,839 10,126,111
------------- ------------- ------------- ------------- -------------
Income (loss) from operations ................. (7,903,216) (292,829) (2,634,189) (4,020,169) (2,204,499)
Total other expense ........................... (151,116) (194,337) (5,525,033) (376,431) (4,963,286)
------------- ------------- ------------- ------------- -------------
Loss from operations before income taxes ...... (8,054,332) (487,166) (8,159,222) (4,396,600) (7,167,785)
Income tax (benefit) expense .................. 2,532 (27,148) 685,372 981,266 (999,600)
============= ============= ============= ============= =============
Net loss ...................................... $ (8,056,864) $ (460,018) $ (8,844,594) $ (5,377,866) $ (6,168,185)
============= ============= ============= ============= =============
Basic loss per share .......................... $ (1.78) $ (0.10) $ (1.95) $ (1.19) $ (2.35)
============= ============= ============= ============= =============
Diluted loss per share ........................ $ (1.78) $ (0.10) $ (1.95) $ (1.19) $ (2.35)
============= ============= ============= ============= =============
Weighted-average shares outstanding, basic .... 4,529,672 4,529,672 4,528,894 4,528,341 2,629,894
============= ============= ============= ============= =============
Weighted-average shares outstanding, diluted .. 4,529,672 4,529,672 4,528,894 4,528,341 2,629,894
============= ============= ============= ============= =============
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents ..................... $ 3,587,807 $ 4,005,705 $ 5,138,111 $ 4,423,623 $ 3,502,546
Working capital ............................... 7,527,474 11,051,270 11,524,146 19,272,671 22,402,110
Total assets .................................. 27,466,743 40,112,792 41,757,969 54,925,501 53,098,438
Stockholders' equity .......................... 8,361,967 16,418,832 16,962,536 17,848,830 23,222,971
Redeemable convertible preferred stock ........ $ -- $ -- $ -- $ 9,000,000 $ 9,000,000
============= ============= ============= ============= =============
No cash dividends on our common stock were declared during any of the
periods presented above.
Various factors materially affect the comparability of the information
presented in the above table. These factors relate primarily to the acquisition
of the assets of Hi-Val, Inc. and Digital Research Technologies. Each of the
years ended December 31, 2004, 2003, 2002, 2001 and 2000 were significantly
affected by our acquisition of IOM Holdings, Inc. in December 2000. IOM
Holdings, Inc. acquired the assets of Hi-Val, Inc. in March 2000 and the assets
of Digital Research Technologies in November 2000. In addition, certain years
were affected by management's decisions regarding income tax expense or benefit.
The financial data for 2000 reflects the contribution by our Hi-Val(R)- and
Digital Research Technologies(R)-branded products of an aggregate of $13.8
million, or 22.7%, of our total net sales for 2000, and an increase in net loss
of $4.0 million. Our I/OMagic(R)-branded products contributed $47.0 million, or
77.3%, of our total net sales for 2000. We also recorded an income tax benefit
of $1.0 million relating to deferred tax assets. We have restated, among other
items, our net sales, cost of sales, gross profit, net loss, basic and diluted
loss per common share and stockholders' equity for 2000. Our net sales were
previously reported as $60,805,437 and have been increased by $242,664 to
$61,048,101. Our gross profit was previously reported as $7,678,948 and has been
increased by $242,664 to $7,921,612. Our net loss was previously reported as
$6,410,849 and has been reduced by $242,664 to $6,168,185. Our basic and diluted
loss per common share was previously reported as $2.44 and has been reduced by
$0.09 to $2.35. Our stockholders' equity was previously reported as $22,659,571
and has been increased by $563,400 to $23,222,971. See our consolidated
financial statements - "Note 2 - Restatement of 2000, 2001, 2002 and 2003
Financial Statements" included elsewhere in this report.
-19-
The financial data for 2001 reflects the contribution by our Hi-Val(R)- and
Digital Research Technologies(R)-branded products of an aggregate of $41.5
million, or 61.0%, of our total net sales for 2001, and $2.5 million of gross
margin. Our I/OMagic(R)-branded products contributed $26.6 million, or 39.0%, of
our total net sales for 2001, and $3.6 million of gross margin. We increased our
inventory reserve by $400,000 and recorded a reserve against $851,000 in
accounts receivable relating to accounts receivable acquired as part of the
acquisition of the assets of Hi-Val, Inc. In addition, we also amortized $1.9
million of the value of our Hi-Val(R) and Digital Research Technologies(R)
trademarks. In aggregate, we had $3.2 million in acquisition-related reserves
and expenses during 2001. We have restated, among other items, our net sales,
cost of sales, gross profit, net loss, basic and diluted loss per common share
and stockholders' equity for 2001. Our net sales were previously reported as
$67,788,959 and have been increased by $323,352 to $68,112,311. Our gross profit
was previously reported as $5,012,625 and has been increased by $1,148,045 to
$6,160,670. Our net loss was previously reported as $5,547,645 and has been
decreased by $169,779 to $5,377,866. Our basic and diluted loss per common share
was previously reported as $1.23 and has been decreased by $0.04 to $1.19. Our
stockholders' equity was previously reported as $17,115,651 and has been
increased by $733,179 to $17,848,830. See our consolidated financial statements
- - "Note 2 - Restatement of 2000, 2001, 2002 and 2003 Financial Statements"
included elsewhere in this report.
The financial data for 2002 reflects the contribution by our Hi-Val(R)- and
Digital Research Technologies(R)-branded products of an aggregate of $45.4
million, or 56.1%, of our total net sales for 2002, and $2.5 million of gross
margin. Our I/OMagic(R)-branded products contributed $35.5 million, or 43.9%, of
our total net sales for 2002, and $4.9 million of gross margin. We increased our
inventory reserve by $2.1 million and recorded a reserve against $1.3 million in
accounts receivable primarily related to accounts receivable acquired as part of
the acquisition of IOM Holdings, Inc. We also amortized $916,000 of the value of
our Hi-Val(R) and Digital Research Technologies(R) trademarks and recorded a
reserve against $1.7 million in deferred tax assets. In addition, we incurred
$5.2 million for acquisition-related legal settlement costs and related legal
fees. See "Business - Legal Proceedings" and our consolidated financial
statements - "Note 12 - Commitments and Contingencies" included elsewhere in
this report. In the aggregate, in 2002 we had $11.2 million in
acquisition-related reserves and expenses or that otherwise resulted from
one-time events during 2002. We have restated, among other items, our net sales,
cost of sales, gross profit, net loss, basic and diluted loss per common share
and stockholders' equity for 2002. Our net sales were previously reported as
$83,529,708 and have been reduced by $2,576,996 to $80,952,712. Our gross profit
was previously reported as $8,863,885 and has been reduced by $1,475,629 to
$7,388,256. Our net loss was previously reported as $8,347,231 and has been
increased by $497,363 to $8,844,594. Our basic and diluted loss per common share
was previously reported as $1.84 and has been increased by $0.11 to $1.95. Our
stockholders' equity was previously reported as $16,726,720 and has been
increased by $235,816 to $16,962,536. See our consolidated financial statements
- - "Note 2 - Restatement of 2000, 2001, 2002 and 2003 Financial Statements"
included elsewhere in this report.
The financial data for 2003 reflects the contribution by our Hi-Val(R)- and
Digital Research Technologies(R)-branded products of an aggregate of $24.7
million, or 38.8%, of our total net sales for 2003, and $3.3 million of gross
margin. Our I/OMagic(R)-branded products contributed $38.9 million, or 61.2%, of
our total net sales for 2003, and $5.7 million of gross margin. We recorded a
reserve against $1.5 million in accounts receivable primarily related to
accounts receivable acquired as part of the acquisition of IOM Holdings, Inc.,
and we amortized $579,000 of the value of our Hi-Val(R) and Digital Research
Technologies(R) trademarks, for an aggregate of $2.1 million in
acquisition-related reserves and expenses during 2003. We have restated, among
other items, our net sales, cost of sales, gross profit, net loss, basic and
diluted loss per common share and stockholders' equity for 2003. Our net sales
were previously reported as $62,222,513 and have been increased by $1,364,941 to
$63,587,454. Our gross profit was previously reported as $9,138,784 and has been
reduced by $194,701 to $8,944,083. Our net loss was previously reported as
$265,317 and has been increased by $194,701 to $460,018. Our basic and diluted
loss per common share was previously reported as $0.06 and has been increased by
$0.04 to $0.10. Our stockholders' equity was previously reported as $16,377,717
and has been increased by $41,115 to $16,418,832. See our consolidated financial
statements - "Note 2 - Restatement of 2000, 2001, 2002 and 2003 Financial
Statements" included elsewhere in this report.
The financial data for 2004 reflects the contribution by our Hi-Val(R)- and
Digital Research Technologies(R)-branded products of an aggregate of $7.5
million, or 16.9%, of our total net sales for 2004, and $705,000 of gross
margin. Our I/OMagic(R)-branded products contributed $36.9 million, or 83.1%, of
our total net sales for 2004, and $2.3 million of gross margin. We amortized
$579,000 of the value of our Hi-Val(R) and Digital Research Technologies(R)
trademarks and we recorded an impairment of the Hi-Val(R) and Digital Research
Technologies(R) trademarks of $3.7 million to reduce the net book value to
$500,000 based on a valuation conducted by an independent third party as of year
end 2004, for an aggregate of $4.3 million in acquisition-related expenses
during 2004.
-20-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
CONSOLIDATED AUDITED FINANCIAL STATEMENTS AND THE RELATED NOTES AND THE OTHER
FINANCIAL INFORMATION INCLUDED ELSEWHERE IN THIS REPORT. THIS DISCUSSION
CONTAINS FORWARD-LOOKING STATEMENTS REGARDING THE DATA STORAGE AND DIGITAL
ENTERTAINMENT INDUSTRIES AND OUR EXPECTATIONS REGARDING OUR FUTURE PERFORMANCE,
LIQUIDITY AND CAPITAL RESOURCES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE EXPRESSED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF ANY NUMBER OF
FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND UNDER OTHER CAPTIONS
CONTAINED ELSEWHERE IN THIS REPORT.
OVERVIEW
We are a leading provider of optical data storage products and also sell a
range of portable magnetic data storage products which we call our GigaBank(TM)
products. In addition, and to a much lesser extent, we sell digital
entertainment and other products. Our data storage products collectively
accounted for approximately 99% of our net sales in 2004 and our digital
entertainment and other products collectively accounted for only approximately
1% of our net sales in 2004.
Our data storage products consist of a range of products that store
traditional PC data as well as music, photos, movies, games and other
multi-media content. These products are designed principally for general data
storage purposes. Our digital entertainment products consist of a range of
products that focus on digital music, photos and movies. These products are
designed principally for entertainment purposes.
We sell our products through computer, consumer electronics and office
supply superstores and other retailers in over 10,000 retail locations
throughout North America. Our network of retailers enables us to offer products
to consumers across North America, including every major metropolitan market in
the United States. Over the last three years, our largest retailers have
included Best Buy, Circuit City, CompUSA, Office Depot, OfficeMax and Staples.
Our principle brand is I/OMagic(R), however, from time to time, we also sell
products under our Hi-Val(R) and Digital Research Technologies(R) brand names.
Our net sales declined by $19.2 million, or 30.2%, to $44.4 million in 2004
from $63.6 million in 2003 and our net loss increased by $7.6 million, or
1,652%, to $8.1 million in 2004 from $460,000 in 2003. We believe that this
significant decline in our operating results is due, in large part, to the
following factors:
o DECREASED SALES. As discussed further below, we believe that our
substantial decline in net sales in 2004 as compared to 2003 was
primarily due to the following factors:
o the rapid and continued decline in sales of our CD-based
products;
o slower than anticipated growth in sales of our DVD-based
products; and
o sales to Best Buy, our largest customer in 2003 and 2002,
declined substantially in 2004 due to the expanded operation of
private label programs, and we did not sell any products to
OfficeMax in 2004 as compared to substantial sales of products to
OfficeMax in 2003.
o DECREASED GROSS MARGINS. Our gross margins declined by 52.5% to 6.7%
in 2004 as compared to gross margins of 14.1% in 2003. This decline
was primarily due to an increase in our reserve for slow-moving and
obsolete inventory to $2.0 million in 2004 from $125,000 in 2003.
o IMPAIRMENT OF TRADEMARKS. In 2004, we recorded an impairment of our
Hi-Val(R) and Digital Research Technologies(R) trademarks in the
amount of $3.7 million after determining their value to be
significantly impaired. Sales of Hi-Val(R)- and Digital Research
Technologies(R)-branded products declined by $16.4 million, or 68.0%,
to $7.6 million in 2004 from $24.8 million in 2003. In addition, we
reduced our forecasts for sales of Hi-Val(R)- and Digital Research
Technologies(R)-branded products in future years.
We believe that the significant decline in our net sales during 2004 as
compared to 2003 resulted in part from the rapid and continued decline in sales
of our CD-based products. We elected to de-emphasize CD-based products because
we believe that they are included as a standard component in most new computer
systems and because DVD-based products are backward-compatible with CDs.
Predominantly based on market forces, but also partly as a result of our
decision to de-emphasize CD-based products, our sales of recordable CD-based
products declined by 76.1% to $7.1 million in 2004 from $29.7 million in 2003.
Sales of our recordable DVD-based products increased by 50.0% to $29.4 million
in 2004 from $19.6 million in 2003. These results suggest that our sales of
recordable CD-based products declined by $22.6 million in 2004 as compared to
-21-
2003, which decline was only partially offset by an increase in sales of our
recordable DVD-based products by $9.8 million for the same periods, resulting in
an overall decline of sales of our recordable optical data storage products of
$12.8 million in 2004 as compared to 2003.
Also, an industry-wide decline in CD-based product sales occurred more
rapidly than the industry-wide increase in sales of DVD-based data storage
products. We believe that lower than expected demand for DVD-based products
resulted in part from slower than anticipated growth in DVD-compatible
applications and infrastructure. Also, the market for DVD-based products was
extremely competitive during 2004 and was characterized by abundant product
supplies. We believe that, based on industry forecasts that predicted
significant sales growth of DVD-based data storage products, suppliers produced
quantities of these products that were substantial and excessive relative to the
ultimate demand for those products. As a result of these relatively substantial
and excessive quantities, the market for DVD-based data storage products
experienced intense competition and downward pricing pressures resulting in
lower than expected overall dollar sales. The effects of these factors on sales
of our DVD-based products were substantially similar in this regard to that of
the data storage industry.
Two additional factors that we believe contributed to the decline in our
sales in 2004 as compared to 2003 were very short product life-cycles and the
imminent availability of double-layer recordable DVD drives, which can increase
storage capacity to up to twice the capacity of single-layer recordable DVD
drives. We believe that these factors led consumers to delay purchases in
anticipation of products incorporating faster drive speeds, which allow users to
more quickly store and access data, and new technologies. During 2004, DVD
drives of increasing speeds were introduced into the marketplace in very rapid
succession. However, during this time, we expected our DVD-based products to
experience longer product life-cycles similar in duration to the life-cycles of
our CD-based products. We believe that consumer perception of shorter product
life-cycles led consumers to delay purchases in anticipation of succeeding
products incorporating faster data storage and access speeds. In addition, we
expected that double-layer recordable DVD drives would be available commencing
in the fourth quarter of 2004; however, the market's transition from
single-layer to double-layer recordable DVD drives began earlier than expected
in the third quarter of 2004, confirming what we believe were consumer
expectations regarding the imminent availability of products incorporating
double-layer recordable DVD technology. We began selling our double-layer
recordable DVD drives at the end of the third quarter of 2004; however, sales of
our double-layer recordable DVD drives have not been as robust as expected
partially as a result of the lack of reasonably-priced DVD media.
USB portable data storage devices, such as USB flash drives and compact USB
hard disk drives that compete with our CD- and DVD-based data storage products
were introduced in late 2002 and sales of these devices, as well as Apple's
Ipod(R) and other MP3 players, have continued to represent an increasing share
of the market for data storage products. We believe that these portable data
storage devices, which are an alternative to optical data storage products, have
accordingly caused a decline in the relative market share of CD- and DVD-based
optical data storage products and likewise caused a decline in our sales of CD-
and DVD-based products in 2004. In the third quarter of 2004, we began selling
our GigaBank(TM) products, which are compact and portable hard disk drives with
a built-in USB connector, to complement our optical data storage products.
Another factor contributing significantly to the decline in our net sales
during 2004 as compared to 2003 was the continued and expanded operation of
private label programs by Best Buy. Our sales to Best Buy, who was our largest
retailer during 2003 and 2002, declined in 2004 to $5.0 million, representing a
decrease of 72.5% from $18.2 million in 2003. We believe that this decrease
reflects, at least in part, Best Buy's increased sales of private label products
that compete with products that we sell. Although we expect this decline in
sales to Best Buy to continue in subsequent reporting periods as a result of
continued private label programs, management intends to use its best efforts to
insure that we retain Best Buy as one of our major retailers. Management is
currently in discussions with Best Buy regarding the sale of other products not
currently sold to, or private-labeled by, Best Buy. However, there can be no
assurance that we will be successful in selling any of these products, or any
products at all, to Best Buy. If our sales to Best Buy continue to decline, our
business and results of operations will continue to be materially and adversely
affected.
Our business focus is predominantly on DVD-based optical data storage
products. In addition to CD- and DVD-based optical data storage products, we
also focus on and sell a line of GigaBank(TM) products, which are compact and
portable hard disk drives with a built-in USB connector. We expect to broaden
our range of data storage products by expanding our GigaBank(TM) product line
and we anticipate that sales of these devices will increase as a percentage of
our total net sales over the next twelve months. In the fourth quarter of 2004,
our GigaBank(TM) products accounted for approximately 27.0% of our total net
sales, and for the year ended December 31, 2004, with only approximately three
months of sales our GigaBank(TM) products, accounted for approximately 8.7% of
our total net sales.
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One of our core strategies is to be among the first-to-market with new and
enhanced product offerings based on established technologies. We expect to apply
this strategy, as we have done in the contexts of CD- and DVD-based technologies
and for our GigaBank(TM) products, to next-generation super-high capacity
optical data storage devices using technology such as Blu-ray DVD or
High-definition DVD. This strategy extends not only to new products, but also to
enhancements of existing products. We believe that by employing this strategy,
we will be able to maintain relatively high average selling prices and margins
and avoid relying on the highly competitive market of last-generation and older
devices.
Our business faces the significant risk that certain of our retailers will
implement a private label or direct import program, or expand their existing
programs, especially for higher margin products. Our retailers may believe that
higher profit margins can be achieved if they implement a direct import or
private label program, excluding us from the sales channel. For example, as
noted above, our sales to Best Buy, who was our largest retailer during 2003 and
2002, declined in 2004 to $5.0 million, representing a decrease of 72.5% from
$18.2 million in 2003. We believe that this decrease reflects, at least in part,
Best Buy's increased sales of private label products that compete with products
that we sell. Our challenge will be to deliver products and provide service to
our retailers in a manner and at a level that makes private label or direct
importation of products less attractive to our retailers, while maintaining
product margins at levels sufficient to allow for profitability that meets or
exceeds our goals.
OPERATING PERFORMANCE AND FINANCIAL CONDITION
We focus on numerous factors in evaluating our operating performance and
our financial condition. In particular, in evaluating our operating performance,
we focus primarily on net sales, net product margins, net retailer margins,
rebates and sales incentives, and inventory turnover as well as operating
expenses and net income.
NET SALES. Net sales is a key indicator of our operating performance. We
closely monitor overall net sales, as well as net sales to individual retailers,
and seek to increase net sales by expanding sales to additional retailers and
expanding sales to existing retailers both by increasing sales of existing
products and introducing new products. Management monitors net sales on a weekly
basis, but also considers sales seasonality, promotional programs and product
life-cycles in evaluating weekly sales performance. As net sales increase or
decrease from period to period, it is critical for management to understand and
react to the various causes of these fluctuations, such as successes or failures
of particular products, promotional programs, product pricing, retailer
decisions, seasonality and other causes. Where possible, management attempts to
anticipate potential changes in net sales and seeks to prevent adverse changes
and stimulate positive changes by addressing the expected causes of adverse and
positive changes. We believe that our good working relationships with our
retailers enable us to monitor closely consumer acceptance of particular
products and promotional programs which in turn enable us to better anticipate
changes in market conditions.
NET PRODUCT MARGINS. Net product margins, from product-to-product and
across all of our products as a whole, is an important measurement of our
operating performance. We monitor margins on a product-by-product basis to
ascertain whether particular products are profitable or should be phased out as
unprofitable products. In evaluating particular levels of product margins on a
product-by-product basis, we focus on attaining a level of net product margin
sufficient to contribute to normal operating expenses and to provide a profit.
The level of acceptable net product margin for a particular product depends on
our expected product sales mix. However, we occasionally sell products for
certain strategic reasons to, for example, complete a product line or for
promotional purposes, without a rigid focus on historical product margins or
contribution to operating expenses or profitability.
NET RETAILER MARGINS. We seek to manage profitability on a retailer level,
not solely on a product level. Although we focus on net product margins on a
product-by-product basis and across all of our products as a whole, our primary
focus is on attaining and building profitability on a retailer-by-retailer
level. For this reason, our mix of products is likely to differ among our
various retailers. These differences result from a number of factors, including
retailer-to-retailer differences, products offered for sale and promotional
programs.
REBATES AND SALES INCENTIVES. Rebates and sales incentives offered to
customers and retailers are an important aspect of our business and are
instrumental in obtaining and maintaining market leadership through competitive
pricing in generating sales on a regular basis as well as stimulating sales of
slow moving products. We focus on rebates and sales incentives costs as a
proportion of our total net sales to ensure that we meet our expectations of the
costs of these programs and to understand how these programs contribute to our
profitability or result in unexpected losses.
INVENTORY TURNOVER. Our products' life-cycles typically range from 3-12
months, generating lower average selling prices as the cycles mature. We attempt
to keep our inventory levels at amounts adequate to meet our retailers' needs
while minimizing the danger of rapidly declining average selling prices and
inventory financing costs. By focusing on inventory turnover levels, we seek to
identify slow-moving products and take appropriate actions such as
implementation of rebates and sales incentives to increase inventory turnover.
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Our use of a consignment sales model with certain retailers results in
increased amounts of inventory that we must carry and finance. Our use of a
consignment sales model results in greater exposure to the danger of declining
average selling prices, however our consignment sales model allows us to more
quickly and efficiently implement promotional programs and pricing adjustments
to sell off slow-moving inventory and prevent further price erosion.
Our targeted inventory turno