##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-QSB
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2005
 o
    
    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  000-26698
 DATAWAVE SYSTEMS INC.
  Delaware
    
    98-0186455(State or other Jurisdiction of incorporation or
organization)
    
    (IRS Employer Identification No.)
 Wayne Interchange Plaza One
145 Route 46 West, 3 rd Floor
Wayne, NJ 07470
 (973) 774-5000
  (none)
 Common Shares
 þ o
  o þ




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##### 



DATAWAVE SYSTEMS INC.
 FORM 10-QSB
 TABLE OF CONTENTS
 PART I FINANCIAL INFORMATIONItem 1
  Financial Statements
    
    
    1Item 2
  Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3   Controls and Procedures
    
    
    23PART II OTHER INFORMATIONItem 6   Exhibits
    
    
    24
  - ii -




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- iii -




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##### 



PART I FINANCIAL INFORMATION
 
 Item 1 Financial Statements.
 DATAWAVE SYSTEMS INC.
 CONSOLIDATED BALANCE SHEETS
As at September 30, 2005 and March 31, 2005
(Expressed in United States dollars, except share amounts)
(Unaudited)
 September 30
    
    
    March 312005
    
    
    2005AssetsCurrentCash and cash equivalents
    
    $
    5,172,927
    
    
    $
    4,560,512Accounts receivable and other (Note 3 (a))
    
    
    7,026,079
    
    
    
    7,366,712Inventories (Note 3 (b))
    
    
    5,954,265
    
    
    
    4,155,614Prepaid expenses and deposits
    
    
    514,876
    
    
    
    336,800Total current assets
    
    
    18,668,147
    
    
    
    16,419,638Machinery and equipment, net (Note 3 (c))
    
    
    2,518,106
    
    
    
    2,453,571Equity investment (Note 3(e))
    
    
    103,849
    
    
    
    39,387Goodwill
    
    
    1,885,429
    
    
    
    1,857,985Intangible assets, net
    
    
    996,309
    
    
    
    1,079,843Other assets
    
    
    209,252
    
    
    
    225,575Total assets
    
    $
    24,381,092
    
    
    $
    22,075,999LiabilitiesCurrent
Accounts payable and accrued liabilities (Note 3 (d))
    
    $
    15,846,117
    
    
    $
    14,547,422Deferred revenue
    
    
    1,252,984
    
    
    
    839,303Other current liabilities
    
    
    137,952
    
    
    
    109,346Total current liabilities
    
    
    17,237,053
    
    
    
    15,496,071Deferred income taxes
    
    
    322,437
    
    
    
    309,509Deferred inducement
    
    
    353,854
    
    
    
    342,184Convertible promissory note
    
    
    600,000
    
    
    
    600,000Other liabilities
    
    
    
    
    
    
    61,668Total liabilities
    
    
    18,513,344
    
    
    
    16,809,432Shareholders equityCommon sharesAuthorized, 100,000,000 common shares, $0.001 par value
Issued, 46,826,834 shares issued and outstanding at
September 30, 2005 and March 31, 2005
    
    
    46,827
    
    
    
    46,827Additional paid-in capital
    
    
    17,920,408
    
    
    
    17,920,408Accumulated other comprehensive income
    
    
    631,491
    
    
    
    465,048Accumulated deficit
    
    
    (12,730,978
    )
    
    
    (13,165,716
    )Total shareholders equity
    
    
    5,867,748
    
    
    
    5,266,567Total liabilities and shareholders equity
    
    $
    24,381,092
    
    
    $
    22,075,999
  - 1 -




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##### 



DATAWAVE SYSTEMS INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
Three and six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 Three months ended September 30,
    
    
    
    Six months ended September 30,2005
    
    
    
    2004
    
    
    
    2005
    
    
    
    2004RevenueSales
    
    $
    6,333,326
    
    
    $
    3,470,894
    
    
    $
    11,386,914
    
    
    $
    6,235,101Net agency sales (Note 5)
    
    
    2,018,358
    
    
    
    1,840,027
    
    
    
    3,917,176
    
    
    
    3,611,429Total revenue
    
    
    8,351,684
    
    
    
    5,310,921
    
    
    
    15,304,090
    
    
    
    9,846,530Cost of revenues (exclusive of
depreciation and amortization)
    
    
    5,627,202
    
    
    
    3,282,883
    
    
    
    10,186,565
    
    
    
    5,929,9372,724,482
    
    
    
    2,028,038
    
    
    
    5,117,525
    
    
    
    3,916,593Operating costs and expensesGeneral and administrative
    
    
    1,054,193
    
    
    
    819,880
    
    
    
    2,002,461
    
    
    
    1,578,668Selling and marketing
    
    
    468,757
    
    
    
    399,384
    
    
    
    1,050,305
    
    
    
    826,374Product development
    
    
    397,160
    
    
    
    331,146
    
    
    
    793,733
    
    
    
    621,401Depreciation and amortization
    
    
    369,284
    
    
    
    303,039
    
    
    
    738,471
    
    
    
    552,649Merger costs
    
    
    
    
    
    
    93,873
    
    
    
    
    
    
    
    167,015Total operating costs and expenses
    
    
    2,289,394
    
    
    
    1,947,322
    
    
    
    4,584,970
    
    
    
    3,746,107Operating income
    
    
    435,088
    
    
    
    80,716
    
    
    
    532,555
    
    
    
    170,486Other income
    
    
    38,270
    
    
    
    3,454
    
    
    
    73,134
    
    
    
    2,894Gain on foreign exchange
    
    
    9,755
    
    
    
    39,210
    
    
    
    9,752
    
    
    
    35,783Income before income taxes
    
    
    483,113
    
    
    
    123,380
    
    
    
    615,441
    
    
    
    209,163Income taxes
    
    
    (216,460
    )
    
    
    
    
    
    
    (245,165
    )
    
    
    Equity income from investee (Note
3(e))
    
    
    30,214
    
    
    
    35,367
    
    
    
    64,462
    
    
    
    31,812Net income
    
    $
    296,867
    
    
    $
    158,747
    
    
    $
    434,738
    
    
    $
    240,975Net income per share basic
    
    $
    0.01
    
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    0.01 diluted
    
    $
    0.01
    
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    0.01Weighted-average number of common
shares basic
    
    
    46,826,834
    
    
    
    43,889,334
    
    
    
    46,826,834
    
    
    
    43,889,334 diluted
    
    
    56,562,342
    
    
    
    43,889,334
    
    
    
    56,484,807
    
    
    
    43,889,334
  - 2 -




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##### 



DATAWAVE SYSTEMS INC.
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
As at September 30, 2005 and March 31,2005
(Expressed in United States dollars, except share amounts)
(Unaudited)
 Accumulated OtherNumber of Common
    
    
    
    Additional Paid-in
    
    Comprehensive
    
    
    
    Total Shareholders'Shares
    
    Common Shares
    
    Capital
    
    Income
    
    Accumulated Deficit
    
    EquityBalance, April 1, 2004
    
    
    43,889,334
    
    
    $
    15,006,743
    
    
    $
    2,725,492
    
    
    $
    277,966
    
    
    $
    (13,829,163
    )
    
    $
    4,181,038Issuance of shares
    
    
    2,937,500
    
    
    
    235,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    235,000Reclassification to
additional paid-in
capital on emigration
    
    
    
    
    
    
    (15,194,916
    )
    
    
    15,194,916
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    663,447
    
    
    
    663,447Foreign currency
translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    187,082
    
    
    
    
    
    
    
    187,082Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    850,529Balance, March 31, 2005
    
    
    46,826,834
    
    
    
    46,827
    
    
    
    17,920,408
    
    
    
    465,048
    
    
    
    (13,165,716
    )
    
    
    5,266,567Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    434,738
    
    
    
    434,738Foreign currency
translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    166,443
    
    
    
    
    
    
    
    166,443Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    601,181Balance, September 30, 2005
    
    
    46,826,834
    
    
    $
    46,827
    
    
    $
    17,920,408
    
    
    $
    631,491
    
    
    $
    (12,730,978
    )
    
    $
    5,867,748
  - 3 -




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DATAWAVE SYSTEMS INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 Six months ended September 30,2005
    
    
    2004Operating activitiesNet income
    
    $
    434,738
    
    
    $
    240,975Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    738,471
    
    
    
    552,649Equity income from investee
    
    
    (64,462
    )
    
    
    (31,812
    )Amortization of lease inducement
    
    
    12,735
    
    
    
    10,809Net change in non-cash operating assets and liabilitiesAccounts receivable and other
    
    
    340,633
    
    
    
    (726,861
    )Inventories
    
    
    (1,798,651
    )
    
    
    (1,909,826
    )Prepaid expenses and deposits
    
    
    (178,076
    )
    
    
    91,725Accounts payable and accrued liabilities
    
    
    1,298,695
    
    
    
    3,477,588Deferred revenue
    
    
    413,681
    
    
    
    352,387Net cash provided by operating activities
    
    
    1,197,764
    
    
    
    2,057,634Investing activityPurchase of machinery and equipment
    
    
    (698,891
    )
    
    
    (660,707
    )Net cash used in investing activity
    
    
    (698,891
    )
    
    
    (660,707
    )Financing activityRepayment of capital lease obligations
    
    
    (34,127
    )
    
    
    (31,637
    )Net cash used in financing activity
    
    
    (34,127
    )
    
    
    (31,637
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    147,669
    
    
    
    32,235Increase in cash
    
    
    612,415
    
    
    
    1,397,525Cash and cash equivalents, beginning of period
    
    
    4,560,512
    
    
    
    852,406Cash and cash equivalents, end of period
    
    $
    5,172,927
    
    
    $
    2,249,931
  - 4 -




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DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 1.
    
    DESCRIPTION OF BUSINESSDataWave Systems Inc. (the Company or DataWave) sells and distributes prepaid products
using proprietary systems for activating products at the point-of-sale. DataWave designs,
develops, produces, owns and manages a proprietary, intelligent, automated, direct
merchandising network (the DataWave System). The DataWave System is comprised of
point-of-sale-activation (POSA) terminals, free-standing smart machines (DTMs), and
cash registers or web-based applications. All of these devices are connected to proprietary
server and database systems through wireless, land line wide area networks or host-to-host
connectivity, and are capable of dispensing multiple prepaid products and services. In
addition, DataWave sells prepaid calling cards and point-of-sale activated prepaid cellular
personal identification numbers (PINs) on a wholesale basis to certain retail operators
and other customers.2.
    
    SIGNIFICANT ACCOUNTING POLICIES
 (a)
    
    Basis of presentationThese unaudited consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States and pursuant to
the rules and regulations of the United States Securities and Exchange Commission
for the presentation of interim financial information. Accordingly, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with United States generally accepted accounting principles
have been condensed, or omitted, pursuant to such rules and regulations. These
financial statements do not include all disclosures required for annual financial
statements and should be read in conjunction with the Companys audited consolidated
financial statements and notes thereto included as part of the Companys 2005 Annual
Report on Form 10-KSB. All amounts herein are expressed in United States dollars
unless otherwise noted.In the opinion of management, all adjustments (including reclassifications and
normal recurring adjustments) necessary to present fairly the financial position,
results of operations and cash flows at September 30, 2005 and for all periods
presented, have been made. Interim results are not necessarily indicative of results
for a full year.(b)
    
    Use of estimatesThe preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and reported amounts
of revenues and expenses during the reporting period. Estimates are used for, but
not limited to, accounting for doubtful accounts, assessing the recoverability of
machinery and equipment, intangibles and goodwill, amortization, valuation allowance
for deferred income tax assets, accruals for cost of time in excess of amounts
billed by service providers, income taxes and contingencies. Actual results could
differ from those estimates.(c)
    

    Stock-based compensationIn accordance with SFAS No. 148, Accounting for Stock-Based Compensation-Transition
and Disclosurethe Company provides pro-forma information regarding net income and
net income per share for stock-based awards granted or modified after December 31,
1994 as if the awards to employees had been accounted for under the fair value
method prescribed by SFAS No. 123, Accounting for Stock Based Compensation.
 - 5 -




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DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 2.
    
    SIGNIFICANT ACCOUNTING POLICIES
 (c)
    

    Stock-based compensation (continued)The fair value of the Companys stock-based awards to employees was estimated using
a Black-Scholes option pricing model. The Black-Scholes model was developed for use
in estimating the fair value of traded options that have no vesting restrictions and
are fully transferable.In addition, the Black-Scholes model requires the input of highly subjective
assumptions including the expected stock price volatility. Because the Companys
stock-based awards to employees have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in managements opinion, the existing
models do not necessarily provide a reliable measure of the fair value of its
stock-based awards to employees.The fair value of the Companys stock-based awards to employees was estimated
assuming no expected dividends and using the following weighted-average assumptions:
 Sept. 30,
    
    Sept. 30,2005
    
    2004Expected life (years)
    
    
    3.35
    
    
    
    Expected volatility
    
    
    136.0
    %
    
    
    Risk-free interest rate
    
    
    4.25
    %
    
    
    
 The weighted-average estimated fair values of employee stock options granted during
the period ending September 30, 2005 and 2004 were $0.06 and $Nil per share,
respectively.No options were granted in the three months ended September 30, 2004 but if the
computed fair values of previously granted awards had been amortized to expense over
the vesting period of the awards as prescribed by SFAS 123, net income and net
income per share would have been:
 Three Months
    
    Three MonthsEnded
    
    EndedSept. 30, 2005
    
    
    
    Sept. 30, 2004Net income  as reported
    
    $
    296,867
    
    
    $
    158,747Add: Stock-based employee compensation
expense (recovery) included in reported net
income
    
    
    
    
    
    
    Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards
    
    
    (29,963
    )
    
    
    (8,375
    )Pro-forma net income
    
    $
    266,904
    
    
    $
    150,372Net income per share  as reportedBasic
    
    $
    0.01
    
    
    $
    0.00Diluted
    
    $
    0.01
    
    
    $
    0.00Net income per share  pro-formaBasic
    
    $
    0.01
    
    
    $
    0.00Diluted
    
    $
    0.01
    
    
    $
    0.00
 - 6 -




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DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 2.
    
    SIGNIFICANT ACCOUNTING POLICIES
 (c)
    
    Stock-based compensation (continued)
 Six Months
    
    Six MonthsEnded
    
    EndedSept. 30, 2005
    
    
    
    Sept. 30, 2004Net income  as reported
    
    $
    434,738
    
    
    $
    240,975Add: Stock-based employee compensation
expense (recovery) included in reported net
income
    
    
    
    
    
    
    Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards
    
    
    (35,164
    )
    
    
    (8,375
    )Pro-forma net income
    
    $
    399,574
    
    
    $
    232,600Net income per share  as reportedBasic
    
    $
    0.01
    
    
    $
    0.01Diluted
    
    $
    0.01
    
    
    $
    0.01Net income per share  pro-formaBasic
    
    $
    0.01
    
    
    $
    0.01Diluted
    
    $
    0.01
    
    
    $
    0.01
 3.
    
    BALANCE SHEET DETAILS
 (a)
    
    Accounts receivable and other
 September 30,
    
    
    March 31,2005
    
    
    2005Trade accounts receivable  POSA
    
    $
    4,855,339
    
    
    $
    4,499,592Trade accounts receivable  prepaid long distance
    
    
    1,987,872
    
    
    
    2,638,597Less allowance for doubtful accounts
    
    
    (17,901
    )
    
    
    (96,360
    )Other receivables
    
    
    200,769
    
    
    
    324,883$
    7,026,079
    
    
    $
    7,366,712
 (b)
    
    Inventories
 September 30,
    
    
    March 31,2005
    
    
    2005PINs and cellular time
    
    $
    5,403,752
    
    
    $
    3,274,233Cards and long-distance phone time
    
    
    376,815
    
    
    
    646,139Part and supplies
    
    
    173,698
    
    
    
    235,242$
    5,954,265
    
    
    $
    4,155,614
 - 7 -




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DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 3.
    
    BALANCE SHEET DETAILS (Continued)
 (c)
    
    Machinery and equipment
 September 30, 2005Accumulated
    
    Net BookCost
    
    Depreciation
    
    ValueVending equipment
    
    $
    3,811,247
    
    
    $
    3,376,109
    
    
    $
    435,138POSA equipment
    
    
    2,383,237
    
    
    
    1,580,233
    
    
    
    803,004Computer equipment
and software
    
    
    2,175,699
    
    
    
    1,294,151
    
    
    
    881,548Other
    
    
    573,716
    
    
    
    175,300
    
    
    
    398,416$
    8,943,899
    
    
    $
    6,425,793
    
    
    $
    2,518,106
 March 31, 2005Accumulated
    
    Net BookCost
    
    Depreciation
    
    ValueVending equipment
    
    $
    3,796,883
    
    
    $
    3,336,090
    
    
    $
    460,793POSA equipment
    
    
    1,969,809
    
    
    
    1,207,702
    
    
    
    762,107Computer equipment
and software
    
    
    1,921,569
    
    
    
    1,102,811
    
    
    
    818,758Other
    
    
    553,887
    
    
    
    141,974
    
    
    
    411,913$
    8,242,148
    
    
    $
    5,788,577
    
    
    $
    2,453,571
 (d)
    
    Accounts payable and accrued liabilities
 September 30,
    
    March 31,2005
    
    2005Trade accounts payable  PINs and cellular
time
    
    $
    9,645,088
    
    
    $
    8,663,602Trade accounts payable  prepaid long distance
    
    
    2,777,893
    
    
    
    3,209,064Trade accounts payable  other
    
    
    553,501
    
    
    
    500,659Accrued compensation and benefits
    
    
    68,937
    
    
    
    56,620Co-op and rebate accruals
    
    
    691,628
    
    
    
    312,993Other
    
    
    2,109,070
    
    
    
    1,804,484$
    15,846,117
    
    
    $
    14,547,422
 (e)
    
    Equity InvestmentThe Company has an equity investment in Nextwave Card Corp (NCC). For the three
and six month period ended September 30, 2005, DataWave recorded equity investment
income of $30,214 and $64,462 respectively (2004  $35,367 and $31,812
respectively).At September 30, 2005, DataWaves cumulative share of equity investment income was
$103,849 (March 31, 2005  $39,387).
 - 8 -




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##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 4.
    
    COMMON SHARES
 (a)
    
    Net income per shareThe following table sets out the computation of basic and diluted net income per
common share. Basic income per share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
income per share is calculated by dividing net income by the sum of the weighted
average number of common shares outstanding and all additional common shares that
would have been outstanding if potentially dilutive common shares had been issued
during the period. The treasury stock method is used to calculate the dilutive
effect of options and warrants.
 Three months ended September 30,2005
    
    
    2004Numerator:Net income
    
    $
    296,867
    
    
    $
    158,747Denominator:Weighted average common shares outstanding
    
    
    46,826,834
    
    
    
    43,889,334Effect of dilutive securitiesStock Options
    
    
    2,235,508
    
    
    
    Convertible
promissory note
(non-interest
bearing)
    
    
    7,500,000
    
    
    
    Diluted weighted average common shares
outstanding
    
    
    56,562,342
    
    
    
    43,889,334Basic net income per share
    
    $
    0.01
    
    
    $
    0.00Diluted net income per share
    
    $
    0.01
    
    
    $
    0.00
 - 9 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 4.
    
    COMMON SHARES (Continued)
 (a)
    
    Net income per share (Continued)
 Six months ended September 30,2005
    
    
    2004Numerator:Net income
    
    $
    434,738
    
    
    $
    240,975Denominator:Weighted average common shares outstanding
    
    
    46,826,834
    
    
    
    43,889,334Effect of dilutive securitiesStock Options
    
    
    2,157,973
    
    
    
    Convertible
promissory note
(non-interest
bearing)
    
    
    7,500,000
    
    
    
    Diluted weighted average common shares
outstanding
    
    
    56,484,807
    
    
    
    43,889,334Basic net income per share
    
    $
    0.01
    
    
    $
    0.01Diluted net income per share
    
    $
    0.01
    
    
    $
    0.01
 For the three and six month period ended September 30, 2005, securities not included
in the diluted net income per share computation were 902,500 options (September 30,
2004  872,500).
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES
 (a)
    
    Segmented informationDataWave manufactures and operates prepaid calling card merchandising machines and
re-sells long distance telephone time through prepaid and other calling cards
distributed through its machines, at retail locations and on a wholesale basis to
third parties. DataWave considers its business to consist of one reportable
operating segment, therefore these consolidated financial statements have not been
segmented.DataWaves revenues are primarily generated from the resale of prepaid long distance
and cellular telephone time, principally from the sale of prepaid calling cards and
point-of-sale activated PINs. Sales of prepaid calling cards and point-of-sale
activated PINs under third party brands where DataWave is not the primary obligor of
the related phone service and has no significant continuing obligation with respect
to operation of the card subsequent to sale are recognized at the date of sale on a
net basis.DataWave has total sales, net agency sales, and costs of revenues (exclusive of
depreciation and amortization) analyzed by product, as follows:
 - 10 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)
 (a)
    
    Segmented information (Continued)
 Prepaid
    
    
    
    
    
    PrepaidLong
    
    Prepaid
    
    Internet
    
    Fees andDistance
    
    Cellular
    
    Products
    
    Service
    
    Other
    
    TotalThree months ended
September 30, 2005Canada
    
    $
    4,058,949
    
    
    $
    
    
    
    $
    4,011
    
    
    $
    619,605
    
    
    $
    22,360
    
    
    $
    4,704,925U.S.
    
    
    1,535,737
    
    
    
    
    
    
    
    
    
    
    
    75,164
    
    
    
    11,988
    
    
    
    1,622,889Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,512
    
    
    
    5,512Sales
    
    
    5,594,686
    
    
    
    
    
    
    
    4,011
    
    
    
    694,769
    
    
    
    39,860
    
    
    
    6,333,326Canada
    
    
    
    
    
    
    37,545,988
    
    
    
    52,934
    
    
    
    
    
    
    
    
    
    
    
    37,598,922U.S.
    
    
    2,301,857
    
    
    
    750,925
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,052,782Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    2,301,857
    
    
    
    38,296,913
    
    
    
    52,934
    
    
    
    
    
    
    
    
    
    
    
    40,651,704Less payments to
suppliers
    
    
    (1,159,763
    )
    
    
    (37,423,415
    )
    
    
    (50,168
    )
    
    
    
    
    
    
    
    
    
    
    (38,633,346
    )Net agency sales
    
    
    1,142,094
    
    
    
    873,498
    
    
    
    2,766
    
    
    
    
    
    
    
    
    
    
    
    2,018,358Canada
    
    
    4,058,949
    
    
    
    832,671
    
    
    
    6,777
    
    
    
    619,605
    
    
    
    22,360
    
    
    
    5,540,362U.S.
    
    
    2,677,831
    
    
    
    40,827
    
    
    
    
    
    
    
    75,164
    
    
    
    11,988
    
    
    
    2,805,810Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,512
    
    
    
    5,512Total revenue
    
    
    6,736,780
    
    
    
    873,498
    
    
    
    6,777
    
    
    
    694,769
    
    
    
    39,860
    
    
    
    8,351,684Cost of revenues
    
    
    5,516,417
    
    
    
    
    
    
    
    3,444
    
    
    
    107,341
    
    
    
    
    
    
    
    5,627,202Margin
    
    $
    1,220,363
    
    
    $
    873,498
    
    
    $
    3,333
    
    
    $
    587,428
    
    
    $
    39,860
    
    
    $
    2,724,482Three months ended
September 30, 2004Canada
    
    $
    2,449,341
    
    
    $
    
    
    
    $
    
    
    
    $
    547,544
    
    
    $
    
    
    
    $
    2,996,885U.S.
    
    
    391,080
    
    
    
    
    
    
    
    
    
    
    
    83,867
    
    
    
    (19,074
    )
    
    
    455,873Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,136
    
    
    
    18,136Sales
    
    
    2,840,421
    
    
    
    
    
    
    
    
    
    
    
    631,411
    
    
    
    (938
    )
    
    
    3,470,894Canada
    
    
    
    
    
    
    22,081,792
    
    
    
    96,900
    
    
    
    
    
    
    
    
    
    
    
    22,178,693U.S.
    
    
    1,619,694
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,619,694Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    1,619,694
    
    
    
    22,081,792
    
    
    
    96,900
    
    
    
    
    
    
    
    
    
    
    
    23,798,387Less payments to
suppliers
    
    
    (205,708
    )
    
    
    (21,660,715
    )
    
    
    (91,937
    )
    
    
    
    
    
    
    
    
    
    
    (21,958,360
    )Net agency sales
    
    
    1,413,986
    
    
    
    421,079
    
    
    
    4,963
    
    
    
    
    
    
    
    
    
    
    
    1,840,027Canada
    
    
    2,449,341
    
    
    
    421,079
    
    
    
    4,963
    
    
    
    547,544
    
    
    
    
    
    
    
    3,422,926U.S.
    
    
    1,805,066
    
    
    
    
    
    
    
    
    
    
    
    83,867
    
    
    
    (19,074
    )
    
    
    1,869,859Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,136
    
    
    
    18,136Total revenue
    
    
    4,254,407
    
    
    
    421,079
    
    
    
    4,963
    
    
    
    631,411
    
    
    
    (938
    )
    
    
    5,310,921Cost of revenues
    
    
    3,201,805
    
    
    
    
    
    
    
    
    
    
    
    81,078
    
    
    
    
    
    
    
    3,282,883Margin
    
    $
    1,052,602
    
    
    $
    421,079
    
    
    $
    4,963
    
    
    $
    550,333
    
    
    $
    (938
    )
    
    $
    2,028,038
 - 11 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)
 (a)
    
    Segmented information (Continued)
 Prepaid
    
    
    
    
    
    PrepaidLong
    
    Prepaid
    
    Internet
    
    Fees andDistance
    
    Cellular
    
    Products
    
    Service
    
    Other
    
    TotalSix months ended
September 30, 2005Canada
    
    $
    7,412,540
    
    
    $
    
    
    
    $
    7,565
    
    
    $
    1,173,277
    
    
    $
    22,360
    
    
    $
    8,615,742U.S.
    
    
    2,587,101
    
    
    
    
    
    
    
    
    
    
    
    75,164
    
    
    
    96,159
    
    
    
    2,758,424Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,748
    
    
    
    12,748Sales
    
    
    9,999,641
    
    
    
    
    
    
    
    7,565
    
    
    
    1,248,441
    
    
    
    131,267
    
    
    
    11,386,914Canada
    
    
    
    
    
    
    68,624,081
    
    
    
    109,270
    
    
    
    
    
    
    
    
    
    
    
    68,733,351U.S.
    
    
    4,499,106
    
    
    
    1,121,305
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,620,411Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    4,499,106
    
    
    
    69,745,386
    
    
    
    109,270
    
    
    
    
    
    
    
    
    
    
    
    74,353,762Less payments to
suppliers
    
    
    (2,046,756
    )
    
    
    (68,286,122
    )
    
    
    (103,708
    )
    
    
    
    
    
    
    
    
    
    
    (70,436,586
    )Net agency sales
    
    
    2,452,350
    
    
    
    1,459,264
    
    
    
    5,562
    
    
    
    
    
    
    
    
    
    
    
    3,917,176Canada
    
    
    7,412,540
    
    
    
    1,410,377
    
    
    
    13,127
    
    
    
    1,173,277
    
    
    
    22,360
    
    
    
    10,031,681U.S.
    
    
    5,039,451
    
    
    
    48,887
    
    
    
    
    
    
    
    75,164
    
    
    
    96,159
    
    
    
    5,259,661Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,748
    
    
    
    12,748Total revenue
    
    
    12,451,991
    
    
    
    1,459,264
    
    
    
    13,127
    
    
    
    1,248,441
    
    
    
    131,267
    
    
    
    15,304,090Cost of revenues
    
    
    9,973,799
    
    
    
    
    
    
    
    6,360
    
    
    
    206,406
    
    
    
    
    
    
    
    10,186,565Margin
    
    $
    2,478,192
    
    
    $
    1,459,264
    
    
    $
    6,767
    
    
    $
    1,042,035
    
    
    $
    131,267
    
    
    $
    5,117,525Six months ended
September 30, 2004Canada
    
    $
    4,243,931
    
    
    $
    
    
    
    $
    
    
    
    $
    1,017,922
    
    
    $
    
    
    
    $
    5,261,853U.S.
    
    
    824,840
    
    
    
    
    
    
    
    
    
    
    
    96,169
    
    
    
    15,112
    
    
    
    936,121Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37,127
    
    
    
    37,127Sales
    
    
    5,068,771
    
    
    
    
    
    
    
    
    
    
    
    1,114,091
    
    
    
    52,239
    
    
    
    6,235,101Canada
    
    
    
    
    
    
    40,683,688
    
    
    
    140,451
    
    
    
    
    
    
    
    
    
    
    
    40,824,139U.S.
    
    
    3,067,008
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,067,008Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    3,067,008
    
    
    
    40,683,688
    
    
    
    140,451
    
    
    
    
    
    
    
    
    
    
    
    43,891,147Less payments to
suppliers
    
    
    (266,959
    )
    
    
    (39,879,256
    )
    
    
    (133,503
    )
    
    
    
    
    
    
    
    
    
    
    (40,279,718
    )Net agency sales
    
    
    2,800,049
    
    
    
    804,432
    
    
    
    6,948
    
    
    
    
    
    
    
    
    
    
    
    3,611,429Canada
    
    
    4,243,931
    
    
    
    804,432
    
    
    
    6,948
    
    
    
    1,017,922
    
    
    
    
    
    
    
    6,073,233U.S.
    
    
    3,624,889
    
    
    
    
    
    
    
    
    
    
    
    96,169
    
    
    
    15,112
    
    
    
    3,736,170Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37,127
    
    
    
    37,127Total revenue
    
    
    7,868,820
    
    
    
    804,432
    
    
    
    6,948
    
    
    
    1,114,091
    
    
    
    52,239
    
    
    
    9,846,530Cost of revenues
    
    
    5,784,883
    
    
    
    
    
    
    
    
    
    
    
    145,054
    
    
    
    
    
    
    
    5,929,937Margin
    
    $
    2,083,937
    
    
    $
    804,432
    
    
    $
    6,948
    
    
    $
    969,037
    
    
    $
    52,239
    
    
    $
    3,916,593
 - 12 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Six month period ended September 30, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)
 (b)
    
    Concentration of sales and economic dependenceThe Company is dependent on a small number of customers for revenues from
point-of-sale activation products and future results depend significantly on these
strategic relationships.For the six months ended September 30, 2005, the top ten customers accounted for 67%
of revenues (sales and net agency sales) (2004  62%). The Company actively seeks
to expand its customer base for point-of-sale activation products to mitigate this
risk.
 - 13 -




---



##### 



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 You should read the following discussion and analysis in conjunction with our consolidated
financial statements and related notes included elsewhere in this Report. Except for historical
information, the following discussion contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. See Note Regarding Forward Looking Statements
above.
 Overview
  Managements Summary
     - 14 -




---



##### 



Selected Financial Operating Data for the Three Month Periods Ended September 30, 2005 and 2004
 Three months Ended September, 302005
    
    2004
    
    2005
    
    2004$000
    
    $000
    
    Percentage of RevenueRevenueSales
    
    $
    6,333
    
    
    $
    3,471
    
    
    
    75.8
    %
    
    
    65.4
    %Net agency sales
    
    
    2,018
    
    
    
    1,840
    
    
    
    24.2
    %
    
    
    34.6
    %Total revenue
    
    
    8,351
    
    
    
    5,311
    
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenues (exclusive
of depreciation and
amortization)
    
    
    5,627
    
    
    
    3,283
    
    
    
    67.4
    %
    
    
    61.8
    %Gross margin
    
    
    2,724
    
    
    
    2,028
    
    
    
    32.6
    %
    
    
    38.2
    %Operating costs and expensesGeneral and administrative
    
    
    1,054
    
    
    
    820
    
    
    
    12.6
    %
    
    
    15.5
    %Selling and marketing
    
    
    469
    
    
    
    399
    
    
    
    5.6
    %
    
    
    7.5
    %Product development
    
    
    397
    
    
    
    331
    
    
    
    4.8
    %
    
    
    6.2
    %Merger costs
    
    
    
    
    
    
    94
    
    
    
    
    
    
    
    1.8
    %Depreciation and amortization
    
    
    369
    
    
    
    303
    
    
    
    4.4
    %
    
    
    5.7
    %Total operating costs and expenses
    
    
    2,289
    
    
    
    1,947
    
    
    
    27.4
    %
    
    
    36.7
    %Operating income
    
    
    435
    
    
    
    81
    
    
    
    5.2
    %
    
    
    1.5
    %Other income (loss)
    
    
    38
    
    
    
    4
    
    
    
    0.5
    %
    
    
    0.1
    %Foreign exchange (loss)
    
    
    10
    
    
    
    39
    
    
    
    0.1
    %
    
    
    0.7
    %Income before income taxes
    
    
    483
    
    
    
    124
    
    
    
    5.8
    %
    
    
    2.3
    %Income taxes
    
    
    (216
    )
    
    
    
    
    
    
    (2.6
    )%
    
    
    0.0
    %Equity gain (loss) from investee
    
    
    30
    
    
    
    35
    
    
    
    0.4
    %
    
    
    0.7
    %Net income
    
    $
    297
    
    
    $
    159
    
    
    
    3.6
    %
    
    
    3.0
    %
 Three Months Ended September 30, 2005 compared to the Three Months Ended September 30, 2004
 Revenues
    - 15 -




---



##### 



Cost of Revenue (exclusive of depreciation and amortization)
     General and Administrative Expenses
  - 16 -




---



##### 




    
    salaries increased by $148,000 as a result of hiring additional staff in operations
and finance, including legal counsel;
    
    accounting, audit and consulting fees increased by $28,000;
    
    investor relations fees increased by $48,000, as a result of obtaining the services
of an investor relations firm; and
    
    occupancy costs including rent and telecommunication increased by $10,000.
 Selling and Marketing Expense
  Product Development
   Depreciation and Amortization
    - 17 -




---



##### 



Selected Financial Operating Data for the Six Month Periods Ended September 30, 2005 and 2004
 Six months Ended September, 302005
    
    2004
    
    2005
    
    2004$000
    
    $000
    
    Percentage of RevenueRevenueSales
    
    $
    11,387
    
    
    $
    6,235
    
    
    
    74.4
    %
    
    
    63.3
    %Net agency sales
    
    
    3,917
    
    
    
    3,612
    
    
    
    25.6
    %
    
    
    36.7
    %Total revenue
    
    
    15,304
    
    
    
    9,847
    
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenues (exclusive
of depreciation and
amortization)
    
    
    10,186
    
    
    
    5,930
    
    
    
    66.6
    %
    
    
    60.2
    %Gross margin
    
    
    5,118
    
    
    
    3,917
    
    
    
    33.4
    %
    
    
    39.8
    %Operating costs and expensesGeneral and administrative
    
    
    2,002
    
    
    
    1,579
    
    
    
    13.1
    %
    
    
    16.1
    %Selling and marketing
    
    
    1,050
    
    
    
    826
    
    
    
    6.9
    %
    
    
    8.4
    %Product development
    
    
    794
    
    
    
    621
    
    
    
    5.2
    %
    
    
    6.3
    %Merger costs
    
    
    
    
    
    
    167
    
    
    
    0.0
    %
    
    
    1.7
    %Depreciation and amortization
    
    
    739
    
    
    
    553
    
    
    
    4.8
    %
    
    
    5.6
    %Total operating costs and expenses
    
    
    4,585
    
    
    
    3,746
    
    
    
    30.0
    %
    
    
    38.1
    %Operating income
    
    
    533
    
    
    
    171
    
    
    
    3.4
    %
    
    
    1.7
    %Other income (loss)
    
    
    73
    
    
    
    3
    
    
    
    0.5
    %
    
    
    0.0
    %Foreign exchange (loss)
    
    
    9
    
    
    
    35
    
    
    
    0.1
    %
    
    
    0.4
    %Income before income taxes
    
    
    615
    
    
    
    209
    
    
    
    4.0
    %
    
    
    2.1
    %Income taxes
    
    
    (245
    )
    
    
    
    
    
    
    (1.6
    )%
    
    
    0.0
    %Equity gain (loss) from investee
    
    
    64
    
    
    
    32
    
    
    
    0.4
    %
    
    
    0.3
    %Net income
    
    $
    434
    
    
    $
    241
    
    
    
    2.8
    %
    
    
    2.4
    %
 Six Months Ended September 30, 2005 compared to the Six Months Ended September 30, 2004
 Revenues
   - 18 -




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##### 



As at September30, 2005
    
    As at March31, 2005CanadaPOSA terminals (owned)
    
    
    4,385
    
    
    
    3,858POSA terminals (serviced or host to host)
    
    
    497
    
    
    
    501United StatesDTMs
    
    
    884
    
    
    
    913Traditional machine units
    
    
    7
    
    
    
    7Over-the counter units (terminals)
    
    
    
    
    
    
    POSA terminals (owned)
    
    
    109
    
    
    
    27POSA terminals (serviced or host to host)
    
    
    159
    
    
    
    159MexicoPOSA terminals (serviced or host to host)
    
    
    200
    
    
    
    200Total
    
    
    6,241
    
    
    
    5,665
     Cost of Revenue (exclusive of depreciation and amortization)
   - 19 -




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##### 



General and Administrative Expenses
  
    
    salaries increased by $224,000 as a result of hiring additional staff in operations
and finance, including legal counsel;
    
    accounting, audit and consulting fees increased by $96,000;
    
    investor relations fees increased by $70,000, as a result of obtaining the services
of an investor relations firm; and
    
    occupancy costs including rent and telecommunication increased by $33,000.
 Selling and Marketing Expense
  Product Development
   Depreciation and Amortization
   - 20 -




---



##### 



Liquidity and Capital Resources
    
    
    net income for the period was $435,000:
    
    accounts payable and accrued liabilities increased by $1,298,000, including an
increase of $981,000 for wireless products (PINs and cellular airtime), and an increase
in other accounts payable and accrued liabilities of $748,000, offset by a decrease of
$431,000 for prepaid long distance products. All wireless accounts payable balances
were paid by the end of October 2005;
    
    accounts receivable decreased by $341,000, and prepaid expenses and deposits
increased by $178,000;
    
    inventories increased by $1,799,000, primarily for prepaid cellular PINs products.
Inventories of prepaid cellular PINs at September 30, 2005 were $5,403,000; cellular
PIN inventory is maintained at approximately ten days sales (ten days sales (gross
proceeds of sales) for the same period last year) and the increase is the result of
increased sales activity;
    
    depreciation, amortization and other operating expense net of equity income for the
period was $687,000; and
    
    deferred revenue increased by $414,000, mainly due to an increase in non-activated
PINs.
   Future Capital Needs and Resources
  - 21 -




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##### 



Trend Information
     Off-Balance Sheet Arrangements
  - 22 -




---



##### 



Item 3 Controls and Procedures.
  Evaluation of disclosure controls and procedures
  No significant changes in internal controls
  - 23 -




---



##### 



PART II            OTHER INFORMATION
 
 Item 6 Exhibits
  ExhibitNumber
    
    
    
    
    
    Description3.1
    
    
    (1
    )
    
    State of Delaware Certificate of Domestication of DataWave Systems Inc.3.2
    
    
    (1
    )
    
    State of Delaware Certificate of Incorporation of DataWave Systems Inc.3.3
    
    
    (1
    )
    
    Bylaws of DataWave Systems Inc.31.1
    
    
    **
    
    
    Certification pursuant to Section 302 of the Sarbanes  Oxley Act of 2002 of Joshua
Emanuel31.2
    
    
    **
    
    
    Certification pursuant to Section 302 of the Sarbanes  Oxley Act of 2002 of John Gunn32.1
    
    
    **
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
Of The Sarbanes-Oxley Act Of 2002 of Josh Emanuel32.2
    
    
    **
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
Of The Sarbanes-Oxley Act Of 2002 of John Gunn
 
 **
    
    Filed herewith(1)
    
    Previously filed as an exhibit to, and incorporated herein by reference from, the Companys
8K report filed on March 1, 2004. - 24 -




---



##### 



SIGNATURES
  DataWave Systems Inc.(Registrant)By
    /s/ Joshua EmanuelChairman and Chief Executive Officer Date November 9, 2005By
    /s/  John GunnGeneral Manager, Chief Financial Officer Date November 9, 2005 - 25 -