# UNITED STATESSECURITIES AND
EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

# FORM 10-QSB

|[X] | Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act           of 1934
|--- | -------------------------------------------------------------------------------------------------

for the quarterly period ended
December 31, 2004

|[   ] | 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
0-26698

DATAWAVE SYSTEMS INC. (Exact name of
Registrant as specified in its charter)

|                                                |                                  
|----------------------------------------------- | ---------------------------------
|YUKON, CANADA                                   | 98-0186455                       
|(Jurisdiction of incorporation or organization) | (IRS Employer Identification No.)

SUITE 110, 13575
COMMERCE PARKWAY, RICHMOND, BRITISH COLUMBIA V6V 2L1 (Address of principal
executive offices)

604.295.1800 (Registrants
telephone number, including area code)

Securities registered or to be
registered pursuant to Section 12(b) of the Act:

Title of each Class              
                     Name of each exchange on which registeredNone

Securities registered or to be
registered pursuant to Section 12(g) of the Act:

Common Shares(Title of Class)

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 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 whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes _______ No ___X____

Common shares outstanding at
December 31, 2004      43,889,334

---

ii

# DATAWAVE SYSTEMS INC.

# FORM 10-QSB

# TABLE OF CONTENTS

|PART I     FINANCIAL INFORMATION
|--------------------------------
|                                
|Item 1                          
|Item 2                          
|Item 3                          
|Item 4                          
|
|Item 6                          

---

iii

NOTE REGARDING FORWARD
LOOKING STATEMENTS

This quarterly report on Form 10-QSB,
including exhibits hereto, contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements are typically
identified by the words anticipates, believes,
expects, intends, forecasts, plans,
future, strategy, or words of similar meaning. Various factors
could cause actual results to differ materially from those expressed in the
forward-looking statements. The Company assumes no obligations to update these
forward-looking statements to reflect actual results, changes in assumptions, or changes
in other factors, except as required by law.

---

1

# PART I        FINANCIAL
INFORMATION

# Item 1     Financial Statements.

# DATAWAVE SYSTEMS INC. CONSOLIDATED BALANCE
SHEETS (Expressed in United
States dollars and presented in accordance with U.S. GAAP)(Unaudited)

---

|                                                      | December 31
2004 | March 31
2004
|----------------------------------------------------- | ---------------- | -------------
|Assets                                                |                  |              
|Current                                               |                  |              
|Cash and cash equivalents                             |                  |              
|Restricted cash (Note 3 (c))                          |                  |              
|Accounts receivable and other (Note 3 (a))            |                  |              
|Inventories (Note 3 (b))                              |                  |              
|Prepaid expenses and deposits                         |                  |              
|                                                      |                  |              
|Total current assets                                  |                  |              
|Restricted cash (Note 3 (c))                          |                  |              
|Machinery and equipment, net (Note 3 (d))             |                  |              
|Equity investment  (Note 2 (c))                       |                  |              
|Deferred development costs (Note 3 (e))               |                  |              
|Other long term receivables (Note 7)                  |                  |              
|Goodwill (Note 3 (f))                                 |                  |              
|Intangible assets, net (Note 3 (f))                   |                  |              
|                                                      |                  |              
|Total assets                                          |                  |              
|                                                      |                  |              
|Liabilities                                           |                  |              
|Current                                               |                  |              
|Accounts payable and accrued liabilities (Note 3 (g)) |                  |              
|Deferred revenue                                      |                  |              
|Current portion of capital lease obligations (Note 8) |                  |              
|Current portion of deferred inducement (Note 7)       |                  |              
|                                                      |                  |              
|Total current liabilities                             |                  |              
|Capital lease obligations (Note 8)                    |                  |              
|Deferred income taxes (Note 6)                        |                  |              
|Deferred inducement (Note 7)                          |                  |              
|                                                      |                  |              
|Total liabilities                                     |                  |              
|                                                      |                  |              
|Commitments (Note 9)                                  |                  |              
|Shareholders' equity                                  |                  |              
|Common shares                                         |                  |              
|Authorized, 100,000,000 common shares, no par value   |                  |              
|Issued                                                |                  |              
|43,889,334 shares issued and outstanding              |                  |              
|at December 31, 2004 and March 31, 2004 respectively  |                  |              
|Additional paid-in capital                            |                  |              
|Accumulated other comprehensive income                |                  |              
|Accumulated deficit                                   |                  |              
|                                                      |                  |              
|Total shareholders' equity                            |                  |              
|                                                      |                  |              
|Total liabilities and shareholders' equity            |                  |              
|                                                      |                  |              

See accompanying Notes
to the Consolidated Financial Statements.

---

2

# DATAWAVE SYSTEMS INC. CONSOLIDATED
STATEMENTS OF OPERATIONS (Expressed in United
States dollars and presented in accordance with U.S. GAAP)(Unaudited)

---

|                                   | Three months ended December 31, | Nine months ended December 31,
|---------------------------------- | ------------------------------- | ------------------------------
|                                   | 2004                            | 2003                          
|Revenue                            |                                 |                               
|Sales                              |                                 |                               
|Net agency sales (Note 5)          |                                 |                               
|                                   |                                 |                               
|Total revenue                      |                                 |                               
|                                   |                                 |                               
|Operating costs and expenses       |                                 |                               
|Cost of revenues                   |                                 |                               
|General and administrative         |                                 |                               
|Selling and marketing              |                                 |                               
|Product development                |                                 |                               
|Merger costs (Note 11)             |                                 |                               
|Depreciation and amortization      |                                 |                               
|                                   |                                 |                               
|Total operating costs and expenses |                                 |                               
|                                   |                                 |                               
|Operating income                   |                                 |                               
|Other income                       |                                 |                               
|Equity income from investee        |                                 |                               
|Gain on foreign exchange           |                                 |                               
|                                   |                                 |                               
|Income before income taxes         |                                 |                               
|Income taxes (Note 6)              |                                 |                               
|                                   |                                 |                               
|Net income                         |                                 |                               
|                                   |                                 |                               
|Net income per share               |                                 |                               
|Basic and diluted                  |                                 |                               
|                                   |                                 |                               
|Weighted-average number of common  |                                 |                               
|shares - basic and diluted         |                                 |                               
|                                   |                                 |                               

See accompanying Notes
to the Consolidated Financial Statements.

---

3

# DATAWAVE SYSTEMS INC.CONSOLIDATED
STATEMENTS OF SHAREHOLDERS EQUITY (Expressed in United
States dollars and presented in accordance with U.S. GAAP)(Unaudited)

---

|                           | Number of
Common
Shares | Common
Shares | Additional
Paid-in
Capital | Accumulated
Other
Comprehensive
Income | Accumulated
Deficit | Total
Shareholders'
Equity
|-------------------------- | ----------------------- | ------------- | -------------------------- | -------------------------------------- | ------------------- | --------------------------
|Balance, April 1, 2003     |                         |               |                            | 43,889,334                             |                     | $                         
|Net income                 |                         |               |                            |                                        |                     |                           
|Foreign currency           |                         |              
|translation adjustment     |                         |               |                            |                                        |                     |                           
|                           |                         |               |                            |                                        |                     |                           
|Comprehensive income       |                         |               |                            |                                        |                     |                           
|                           |                         |               |                            |                                        |                     |                           
|                           |                         |               |                            |                                        |                     |                           
|Balance, March 31, 2004    |                         |               |                            | 43,889,334                             |                     |                           
|Net income                 |                         |               |                            |                                        |                     |                           
|Foreign currency           |                         |              
|translation adjustment     |                         |               |                            |                                        |                     |                           
|                           |                         |               |                            |                                        |                     |                           
|Comprehensive income       |                         |               |                            |                                        |                     |                           
|                           |                         |               |                            |                                        |                     |                           
|Balance, December 31, 2004 |                         |               |                            | 43,889,334                             |                     | $                         
|                           |                         |               |                            |                                        |                     |                           

See accompanying Notes
to the Consolidated Financial Statements.

---

4

# DATAWAVE SYSTEMS INC.CONSOLIDATED
STATEMENTS OF CASH FLOWS (Expressed in United
States dollars and presented in accordance with U.S. GAAP)(Unaudited)

---

|                                           | Three months ended December 31, | Nine months ended December 31,
|------------------------------------------ | ------------------------------- | ------------------------------
|                                           | 2004                            | 2003                          
|Operating activities                       |                                 |                               
|Net income                                 |                                 |                               
|Adjustments to reconcile net income to net |                                 |                               
|cash provided by operating activities:     |                                 |                               
|Depreciation and amortization              |                                 |                               
|Equity income from investee                |                                 |                               
|Net change in non-cash                     |                                 |                               
|operating assets and liabilities           |                                 |                               
|Accounts receivable and other              |                                 |                               
|Inventories                                |                                 |                               
|Prepaid expenses and deposits              |                                 |                               
|Accounts payable and accrued liabilities   |                                 |                               
|Deferred revenue                           |                                 |                               
|                                           |                                 |                               
|Net cash provided by (used in) operating   |                                 |                               
|activities                                 |                                 |                               
|                                           |                                 |                               
|Investing activity                         |                                 |                               
|Restricted cash                            |                                 |                               
|Equity investment                          |                                 |                               
|Purchase of machinery and equipment        |                                 |                               
|                                           |                                 |                               
|Net cash (used in) investing activity      |                                 |                               
|                                           |                                 |                               
|Financing activity                         |                                 |                               
|Repayment of capital lease obligations     |                                 |                               
|                                           |                                 |                               
|Net cash (used in) financing activity      |                                 |                               
|                                           |                                 |                               
|Increase (decrease) in cash                |                                 |                               
|Cash and cash equivalents, beginning of    |                                 |                               
|period                                     |                                 |                               
|                                           |                                 |                               
|Cash and cash equivalents, end of period   |                                 |                               
|                                           |                                 |                               

See accompanying Notes
to the Consolidated Financial Statements.

---

5

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|1. | DESCRIPTION
OF BUSINESS
|-- | -----------------------

| | DataWave
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 presentation
| | --- | ---------------------

| | These
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 2004 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 December 31, 2004 and for all periods presented, have been
made. Interim results are not necessarily indicative of results for a full year.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Principles
of consolidation
| | --- | ---------------------------

| | The
consolidated financial statements include the accounts of DataWave and its wholly-owned
subsidiaries. Intercompany transactions and balances have been eliminated.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

6

# DATAWAVE SYSTEMS INC.NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTSInformation as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (c) | Equity
investment
| | --- | -----------------

| | In
December 2002, DataWave entered into an agreement to invest in a new corporation called
NextWave Card Corp (NCC) that will develop and provide prepaid stored value
programs.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | DataWave
accounts for this investment under the equity method and records its 50% share of income
or loss as equity income (loss) from investee. For the nine months ended December 31,
2004, DataWave recorded equity income of $87,121 (2003  $Nil).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
December 31, 2004, DataWave has an equity investment of $22,630 (March 31, 2004 $Nil).
| | -----------------------------------------------------------------------------------------

| | (d) | Use
of estimates
| | --- | ----------------

| | The
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, accruals for cost of time in excess of amounts billed by service
providers, income and capital taxes and contingencies. Actual results could differ from
those estimates.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (e) | Foreign
currency translation
| | --- | ----------------------------

| | DataWaves
functional currency is the U.S. dollar since it is the currency of the primary economic
environment in which the Company operates. The accounts of the wholly-owned subsidiary
amounts denominated in foreign currencies are translated into United States dollars using
the current method of foreign currency translation. Under this method, assets and
liabilities are translated at the rate of exchange in effect at the balance sheet date.
Revenues and expenses denominated in foreign currencies are translated at average rates
for the period. Gains and losses on foreign currency transactions are included in
operations for the period in which they occur.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Where
a subsidiarys functional currency is other than the U.S. dollar, translation
adjustments may result from the process of translating that subsidiarys financial
statements into U.S. dollars. These translation adjustments are not included in Net
Income but are reported in Other Comprehensive Income, a separate component of
ShareholdersEquity. Foreign currency exchange rate fluctuations between the U.S.
and Canadian dollars in the period resulted in an increase in Other Comprehensive Income
of $91,842 for the nine months ended December 31, 2004 (in fiscal 2004  $232,121).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

7

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (f) | Cash
and cash equivalents
| | --- | -------------------------

| | Cash
and cash equivalents include cash deposited in DataWaves vending equipment, cash on
hand and highly liquid money market instruments with original terms to maturity of less
than 90 days.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (g) | Restricted
cash
| | --- | ---------------

| | Restricted
cash consists of cash pledges with banks as collateral for letters of credit issued.
| | -----------------------------------------------------------------------------------------------

| | (h) | Inventories
| | --- | -----------

| | Inventories
for cost of time for prepaid long distance and for prepaid cellular airtime are recorded
at the lower of average cost or market value.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | Inventories
for prepaid pre-activated calling cards, related cards, promotional and other supplies
are valued at the lower of average cost or market value. Component parts and supplies
used in the assembly of machines and related work-in-progress are included in machinery
and equipment. Slow moving and obsolete inventory is reviewed regularly and written down
based on managements forecast of use over the next twelve months.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (i) | Revenue
recognition
| | --- | -------------------

| | Revenues
are recognized when the following criteria are met:
| | ------------------------------------------------------------

| |  | persuasive
evidence of an arrangement exists
| | - | --------------------------------------------

| |  | delivery
has occurred or services have been rendered
| | - | ----------------------------------------------------

| |  | the
price is fixed or determinable, and
| | - | ---------------------------------------

| |  | collectibility
is reasonably assured.
| | - | -------------------------------------

| | In
addition, the Company applies the following specific revenue recognition policies:
| | -------------------------------------------------------------------------------------

| | The
Company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, has no significant continuing obligation with respect to services being
rendered subsequent to sale, the price to the consumer is fixed and determinable and
collection is reasonably assured, are recognized at the date of sale to the consumer on a
net basis. The resulting net revenue earned is calculated as the difference between the
gross proceeds received and the cost of the related phone time.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

8

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTSInformation as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (i) | Revenue
recognition (continued)
| | --- | -------------------------------

| | Sales
of Company or custom branded cards where DataWave incurs inventory risk but does not
provide the related telephone time are recognized on the gross basis on the date of sale
to the consumer when title to the card transfers, collectibility of proceeds is
reasonably assured, the full obligation to the phone service provider is fixed and
determinable, and DataWave has no significant continuing obligations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from certain prepaid phone cards where our obligation to the phone service provider is
not fixed or determinable at the date of delivery is deferred and recognized on a gross
basis when services have been rendered to the buyer, phone service is delivered and its
cost determined, as the card is used or expires.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (j) | Product
development costs
| | --- | -------------------------

| | Costs
for the internal development of new software systems and substantial enhancements to
existing software systems to be sold or used in the sale of products are expensed as
incurred until technological feasibility has been established and revenue can be
generated, at which time any additional costs are capitalized. These costs consist of
payments made to third parties and the salaries of employees working on such product
development. Amortization of product development costs commences with commercial
production and is charged as an expense using the straight line method over the life of
the contracts.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Research
costs are charged as an expense in the period in which they are incurred.
| | ----------------------------------------------------------------------------------

---

9

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (k) | Capitalized
internal use software costs
| | --- | ---------------------------------------

| | DataWave
capitalizes the cost of internal-use software which has a useful life in excess of one
year in accordance with Statement of Position (SOP) No. 98-1, Accounting for the Costs
ofComputer Software Developed or Obtained for Internal Use. These costs
consist of payments made to third parties and the salaries of employees working on such
software development. Subsequent additions, modifications or upgrades to internal-use
software are capitalized only to the extent that they allow the software to perform a
task it previously did not perform. Capitalized computer software costs are amortized
using the straight-line method over a period of 3 years.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Software
maintenance and training costs are expensed in the period in which they are incurred.
| | ----------------------------------------------------------------------------------------------

| | (l) | Advertising
costs
| | --- | -----------------

| | Certain
advertising and promotional incentives in which the Company exercises joint-control over
the expenditure, receives an incremental benefit and can ascertain the fair value of
advertising and promotion incurred are included in Cost of revenues.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
majority of the Companys advertising expense relates to its consumer long distance
business. Most of the advertisements are in print media, with expenses recorded as they
are incurred. For the nine months ended December 31, 2004 and 2003, advertising expense
totalled $81,876 and $47,232 respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (m) | Machinery
and equipment
| | --- | -----------------------

| | Machinery
and equipment are recorded at cost less accumulated depreciation. Depreciation is
calculated over the estimated useful lives of machinery and equipment as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                |                                 
|------------------------------- | --------------------------------
|
|Computer equipment and software | 30% declining balance           
|Office equipment                | 20% declining balance           
|Other machinery and equipment   | 30% declining balance           
|Vending, DTM and POSA equipment | 3 years straight-line           
|Leasehold improvements          | from 4 to 10 years straight-line
|                               

| | Parts,
supplies and components are depreciated when they are put in use.
| | ------------------------------------------------------------------------

---

10

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (n) | Impairment
of long-lived assets
| | --- | -------------------------------

| | The
Company reviews annually its long-lived assets, other than goodwill, for impairment
whenever events or changes in circumstances indicate that the carrying value of such
assets may not be recoverable. To determine recoverability, the Company compares the
carrying value of the assets to the estimated future undiscounted cash flows. Measurement
of an impairment loss for long-lived assets held for use is based on the fair value of
the asset. Long-lived assets classified as held for sale are reported at the lower of
carrying value and fair value less estimated selling costs. For assets to be disposed of
other than by sale, an impairment loss is recognized when the carrying value is not
recoverable and exceeds the fair value of the asset.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (o) | Goodwill
and other intangibles assets
| | --- | -------------------------------------

| | SFAS
142 (Goodwill and Other Intangible Assets ) requires that goodwill and intangible
assets with indefinite lives no longer be amortized. Instead, these amounts are subject
to an annual fair-value based impairment assessment and whenever events or changes in
circumstances indicate that the carrying value of such assets may not be recoverable.
Separable intangible assets that are not deemed to have an indefinite life are amortized
over their useful lives.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Other
intangible assets comprised of customer lists is being amortized over 6 years, managements
best estimate of its useful life, following the pattern in which the expected benefits
will be consumed or otherwise used up.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (p) | Financial
instruments
| | --- | ---------------------

| | (i) | Fair
value
| | --- | ----------

| | DataWave
estimates that the carrying values of its cash and cash equivalents, accounts receivable
and other, deposits, restricted cash, and accounts payable and accrued liabilities
approximate fair value at December 31, 2004.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

11

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (p) | Financial
instruments (continued)
| | --- | ---------------------------------

| | (ii) | Credit
risk
| | ---- | -----------

| | Financial
instruments that potentially subject the Company to concentration of credit risk consist
principally of trade accounts receivable, cash and cash equivalents. Concentration of
credit risk with respect to trade accounts receivable is significant due to the high
volume of revenues from a small customer base, primarily in Canada. This concentration of
business increases the Companys risk associated with non-payment by these
customers. The Company manages the risk by regular, ongoing credit evaluations, setting
payment terms at seven days, and may require customers to provide collateral to reduce
risk. DataWave places its cash and cash equivalents with several major financial
institutions of high credit standing. The Company does not believe there is significant
financial risk from non-performance by the holders of the Companys cash and cash
equivalents.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
December 31, 2004, the top ten customers accounted for 62% of accounts receivable (2003
 68%). The Company is also exposed to certain concentration of revenues and
economic dependence (Note 5 (c)).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accounts
receivable also includes amounts due from contractors who collect cash from and service
the Companys DTM and other vending machines. Certain of these contractors are not
bonded resulting in credit risk to the Company.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Write-offs
of accounts receivable balances were not significant in each of the nine month periods
ended December 31, 2004 and December 31, 2003.
| | ------------------------------------------------------------------------------------------------------------------------------------------------

| | (iii) | Foreign
exchange risk
| | ----- | ---------------------

| | DataWave
is exposed to foreign exchange risks due its sales denominated in Canadian dollars.
| | --------------------------------------------------------------------------------------------

| | (q) | Income
taxes
| | --- | ------------

| | DataWave
uses the deferred income tax asset and liability method of accounting for income taxes,
and deferred income assets and liabilities are recorded based on temporary differences
between the carrying amounts of balance sheet items and their corresponding tax bases. In
addition, the future benefit of income tax assets, including unused tax losses, are
recognized, subject to a valuation allowance, to the extent that it is more likely than
not that such losses ultimately will be utilized. The standards also require that the
deferred income tax assets and liabilities be measured using enacted tax rates and laws
that are expected to apply when the tax assets or liabilities are to be either settled or
realized.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

12

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (r) | Earnings
per share
| | --- | ------------------

| | Basic
income per share is calculated by dividing the net income by the weighted average number
of common shares outstanding during the period. Diluted income per share is calculated by
dividing the 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (s) | Stock-based
compensation
| | --- | ------------------------

| | Statement
of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure (SFAS 148), amends the disclosure
requirements of Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123), to require more prominent disclosures in
both annual and interim financial statements regarding the method of accounting for
stock-based employee compensation and the effect of the method used on reported results.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company accounts for stock-based compensation in accordance with the intrinsic value
method prescribed by APB Opinion No. 25 (APB 25), Accounting for
Stock Issued to Employees. Under APB 25, compensation expense is measured as the
amount by which the market price of the underlying stock exceeds the exercise price of
the option on the date of grant; this compensation is amortized over the vesting period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pro
forma information regarding net income and net income per share is required by SFAS 123
for awards granted or modified after December 31, 1994 as if the Company had
accounted for its stock-based awards to employees under the fair value method of SFAS 123.
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:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

13

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|2. | SIGNIFICANT
ACCOUNTING POLICIES (Continued)
|-- | -------------------------------------------

| | (s) | Stock-based
compensation (continued)
| | --- | ------------------------------------

|                        | December 31,
2004 | December 31,
2003
|----------------------- | ----------------- | -----------------
|Expected life (years)   | -                 | 0.3              
|Expected volatility     | -                 | 83%              
|Risk-free interest rate | -                 | 2.6%             

| | The
weighted-average estimated fair values of employee stock options granted during the
period ending December 31, 2004 and 2003 were $Nil and $0.22 per share, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | No
options were granted in the three months ended December 31, 2004 but if the computed fair
values of 2004 and 2003 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 ended
December 31
|-------------------------------------------------- | ------------------------------
|                                                   | 2004                          
|Net income - as reported                           |                               
|Add:  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                              |                               
|                                                   |                               
|Pro forma net income                               |                               
|                                                   |                               
|Net income per share - as reported                 |                               
|Basic and diluted                                  |                               
|                                                   |                               
|Net income per share - pro forma                   |                               
|Basic and diluted                                  |                               
|                                                   |                               

---

14

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

| | (s) | Stock-based
compensation (continued)
| | --- | ------------------------------------

|                                                       | Nine months ended
December 31
|------------------------------------------------------ | -----------------------------
|                                                       | 2004                         
|Net income - as reported                               |                              
|Add:  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                                  |                              
|                                                       |                              
|Pro forma net income                                   |                              
|                                                       |                              
|Net income per share - as reported                     |                              
|Basic and diluted                                      |                              
|                                                       |                              
|Net income per share - pro forma                       |                              
|Basic and diluted                                      |                              
|                                                       |                              

|3. | BALANCE
SHEET DETAILS
|-- | ---------------------

| | (a) | Accounts
receivable and other
| | --- | -----------------------------

|                                     | December 31,
2004 | March 31,
2004
|------------------------------------ | ----------------- | --------------
|Trade accounts receivable - POSA     |                   |               
|Trade accounts receivable - Other    |                   |               
|Less allowance for doubtful accounts |                   |               
|Input tax credits receivable         |                   |               
|Tenant inducements (Note 7)          |                   |               
|Other receivables                    |                   |               
|                                     |                   |               
|                                     |                   |               
|                                     |                   |               

| | (b) | Inventories
| | --- | -----------

|                                   | December 31,
2004 | March 31,
2004
|---------------------------------- | ----------------- | --------------
|Part and supplies                  |                   |               
|Cards and long-distance phone time |                   |               
|PINs and cellular time             |                   |               
|                                   |                   |               
|                                   |                   |               
|                                   |                   |               

---

15

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|3. | BALANCE
SHEET DETAILS (Continued)
|-- | ---------------------------------

| | (c) | Restricted
cash
| | --- | ---------------

| | Restricted
cash consists of two cash deposits pledged with banks for letters of credit issued in the
amount of $24,000 and $16,000. The deposits mature February 28, 2005 and October 18, 2005
and bear interest at 4% and 1.74% per annum respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (d) | Machinery
and equipment
| | --- | -----------------------

|                                | December 31, 2004
|------------------------------- | -----------------
|                                | Cost             
|Computer equipment and Software |                  
|Office equipment                |                  
|Other machinery and equipment   |                  
|Parts, supplies, and components |                  
|Vending machines in assembly    |                  
|Vending equipment               |                  
|POSA equipment                  |                  
|Leasehold improvements          |                  
|                                |                  
|                                |                  
|                                |                  

|                                | March 31, 2004
|------------------------------- | --------------
|                                | Cost          
|Computer equipment and software |               
|Office equipment                |               
|Other machinery and equipment   |               
|Parts, supplies, and components |               
|Vending machines in assembly    |               
|Vending equipment               |               
|POSA equipment                  |               
|Leasehold improvements          |               
|                                |               
|                                |               
|                                |               

| | Vending
machines in assembly includes vending machines being built as new vending machines,
machines being refurbished, parts and supplies used in new and refurbished machines and
as replacement parts for installed vending machines.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the period ended December 31, 2004, the Company capitalized $20,497 of internal use
software costs as computer software (2003  $ Nil).
| | -------------------------------------------------------------------------------------------------------------------------------------------

---

16

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTSInformation as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|3. | BALANCE
SHEET DETAILS (Continued)
|-- | ---------------------------------

| | Machinery
and equipment at December 31, 2004, includes computing equipment and software with a net
book value of $245,446 (March 31, 2004  $316,707) that was acquired under capital
lease (Note 8).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (e) | Deferred
development costs
| | --- | --------------------------

| | During
the period ended December 31, 2004 the Company funded development projects to sell
suppliers products through point-of-sale activation terminals in the Canadian
marketplace and to allow a distributor to sell the Companys products through its
own terminals. Development costs incurred after agreements were signed have been deferred
and will be amortized over the life of the agreements. Net deferred development costs at
December 31, 2004, were $91,013 (March 31, 2004  $49,335).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (f) | Goodwill
and other intangible assets
| | --- | ------------------------------------

| | Intangible
assets comprise goodwill and customer lists acquired in the purchase of AT&Ts
Canadian prepaid card operations. Although DataWave may intend to add customer names and
other information to the list in the future, the expected benefits of the acquired
customer list apply only to the customers on that list at the date of acquisition.
Details of the cost and net book value of goodwill and other intangible assets are as
follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

17

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

| | (f) | Goodwill
and other intangible assets (continued)
| | --- | ------------------------------------------------

|                                    | December 31,
2004 | March 31,
2004
|----------------------------------- | ----------------- | --------------
|Goodwill                            |                   |               
|                                    |                   |               
|Intangible assets                   |                   |               
|Less accumulated amortization       |                   |               
|                                    |                   |               
|Net intangible assets               |                   |               
|                                    |                   |               
|Goodwill and intangible assets, net |                   |               
|                                    |                   |               

| | (g) | Accounts
payable and accrued liabilities
| | --- | ----------------------------------------

|                                                | December 31,
2004 | March 31,
2004
|----------------------------------------------- | ----------------- | --------------
|Trade accounts payable - PINs and cellular time |                   |               
|Trade accounts payable - Other                  |                   |               
|Accrued compensation and benefits               |                   |               
|Co-op and rebate accruals                       |                   |               
|Long-distance time accruals                     |                   |               
|Other accrued liabilities                       |                   |               
|State, local, GST and other taxes payable       |                   |               
|                                                |                   |               
|                                                |                   |               
|                                                |                   |               

|4. | COMMON
SHARES
|-- | -------------

| | (a) | Authorized
| | --- | ----------

| | 100,000,000
common shares without par value
| | -------------------------------------------

---

18

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|4. | COMMON
SHARES (Continued)
|-- | -------------------------

| | (b) | Share
purchase options
| | --- | ----------------------

| | Under
the terms of the Stock Option Plan (the Plan), the Board of Directors may
grant stock options to employees, officers, directors and independent consultants of
DataWave and its subsidiaries for their contributions to DataWave. This includes options
granted prior to the implementation of the Plan which were deemed to be re-granted under
the Plan. Options granted under the Plan are not transferable by an optionee, and each
option is exercisable only by such optionee. The expiry date will be fixed by the Board
of Directors but will be not later than the tenth anniversary of the award date and the
exercise price of each option will be not less than 100% of the fair market value on the
date of grant. In no case will an optionee be granted an option where the number of
shares that may be purchased pursuant to the option exceed, when added to the number of
shares available for purchase pursuant to options previously granted to the optionee
which remain exercisable, 5% of DataWaves issued and outstanding share capital as
of the award date of the option being granted. On plan initiation, approximately
5,370,000 common shares were reserved for issuance under the Plan and as at December 31,
2004, 4,497,500 were available for issuance.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
changes in stock options were as follows:
| | ---------------------------------------------

|                                   | Period
ended
Dec. 31,
2004 | Weighted
Average
Exercise
Price | Year
ended
March 31,
2004 | Weighted
Average
Exercise
Price
|---------------------------------- | -------------------------- | ------------------------------- | ------------------------- | -------------------------------
|Balance outstanding,               |                            |                                 |                           |                                
|beginning of period                |                            |                                 |                           | 4,448,902                      
|Activity during the period:        |                            |                                
|Options granted                    |                            |                                 |                           | --                             
|Options exercised                  |                            |                                 |                           | --                             
|Options cancelled / Expired        |                            |                                 |                           | (3,576,402                     
|Balance outstanding, end of period |                            |                                 |                           | 872,500                        
|                                   |                            |                                 |                           |                                

---

19

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|4. | COMMON
SHARES (Continued)
|-- | -------------------------

| | (b) | Share
purchase options (continued)
| | --- | ----------------------------------

| | As
at December 31, 2004, the following options to acquire common stock were outstanding:
| | ----------------------------------------------------------------------------------------

|Number
of Options | Number of
Exercisable
Options | Exercise
Price | Expiry
Dates
|----------------- | ----------------------------- | -------------- | ------------
|                  | 175,000                       |                |             
|                  | 50,000                        |                |             
|                  | 130,000                       |                |             
|                  | 517,500                       |                |             
|                  |                               |                |             
|                  | 872,500                       |                |             
|                  |                               |                |             

|5. | BUSINESS
SEGMENT INFORMATION
|-- | ----------------------------

| | (a) | Segmented
information
| | --- | ---------------------

| | DataWave
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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

20

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|5. | BUSINESS
SEGMENT INFORMATION (Continued)
|-- | ----------------------------------------

| | (a) | Segmented
information (continued)
| | --- | ---------------------------------

| | DataWave
has total revenues of sales and net agency sales for the three months ended December 31,
2004 and 2003, analyzed by product, as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

|                                     | Prepaid
Long Distance | Prepaid
Cellular | Prepaid
Internet
Products | Fees and
Service | Other | Total
|------------------------------------ | --------------------- | ---------------- | ------------------------- | ---------------- | ----- | -----
|Three months ended December 31, 2004 |                       |                  |                           |                  |       |      
|Canada                               |                       |                  | $                         | 2,807,322        |       | $    
|Mexico                               |                       |                  |                           | --               |       |      
|U.S.                                 |                       |                  |                           | 1,451,587        |       |      
|                                     |                       |                  |                           |                  |       |      
|Sales                                |                       |                  |                           | 4,258,909        |       |      
|                                     |                       |                  |                           |                  |       |      
|Canada                               |                       |                  |                           | --               |       |      
|Mexico                               |                       |                  |                           | --               |       |      
|U.S.                                 |                       |                  |                           | 1,954,187        |       |      
|                                     |                       |                  |                           |                  |       |      
|Gross proceeds received on agency    |                       |                  |                           | 1,954,187        |       |      
|sales                                |                       |                 
|Less payments to suppliers           |                       |                  |                           | (603,987         | )     |      
|                                     |                       |                  |                           |                  |       |      
|Net agency sales                     |                       |                  |                           | 1,350,200        |       |      
|                                     |                       |                  |                           |                  |       |      
|Canada                               |                       |                  |                           | 2,807,322        |       |      
|Mexico                               |                       |                  |                           | --               |       |      
|U.S.                                 |                       |                  |                           | 2,801,787        |       |      
|                                     |                       |                  |                           |                  |       |      
|Total revenue                        |                       |                  |                           | 5,609,109        |       |      
|Cost of revenues                     |                       |                  |                           | 4,297,408        |       |      
|                                     |                       |                  |                           |                  |       |      
|Margin                               |                       |                  | $                         | 1,311,701        |       | $    
|                                     |                       |                  |                           |                  |       |      
|Three months ended December 31, 2003 |                       |                 
|Canada                               |                       |                  | $                         | 1,821,622        |       | $    
|Mexico                               |                       |                  |                           | --               |       |      
|U.S.                                 |                       |                  |                           | 155,652          |       |      
|                                     |                       |                  |                           |                  |       |      
|Sales                                |                       |                  |                           | 1,977,274        |       |      
|                                     |                       |                  |                           |                  |       |      
|Canada                               |                       |                  |                           | --               |       |      
|Mexico                               |                       |                  |                           | --               |       |      
|U.S.                                 |                       |                  |                           | 1,684,968        |       |      
|                                     |                       |                  |                           |                  |       |      
|Gross proceeds received on agency    |                       |                  |                           | 1,684,968        |       |      
|sales                                |                       |                 
|Less payments to suppliers           |                       |                  |                           | (332,752         | )     |      
|                                     |                       |                  |                           |                  |       |      
|Net agency sales                     |                       |                  |                           | 1,352,216        |       |      
|                                     |                       |                  |                           |                  |       |      
|Canada                               |                       |                  |                           | 1,821,622        |       |      
|Mexico                               |                       |                  |                           | --               |       |      
|U.S.                                 |                       |                  |                           | 1,507,868        |       |      
|                                     |                       |                  |                           |                  |       |      
|Total revenue                        |                       |                  |                           | 3,329,490        |       |      
|Cost of revenues                     |                       |                  |                           | 2,407,848        |       |      
|                                     |                       |                  |                           |                  |       |      
|Margin                               |                       |                  | $                         | 921,642          |       | $    
|                                     |                       |                  |                           |                  |       |      

---

21

# DATAWAVE SYSTEMS INC.NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTSInformation as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|5. | BUSINESS
SEGMENT INFORMATION (Continued)
|-- | ----------------------------------------

| | (a) | Segmented
information (continued)
| | --- | ---------------------------------

| | DataWave
has total revenues of sales and net agency sales for the nine months ended December 31,
2004 and 2003, analyzed by product, as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------

|                                    | Prepaid
Long Distance | Prepaid
Cellular | Prepaid
Internet
Products | Fees and
Service | Other | Total
|----------------------------------- | --------------------- | ---------------- | ------------------------- | ---------------- | ----- | -----
|Nine months ended December 31, 2004 |                       |                  |                           |                  |       |      
|Canada                              |                       |                  | $                         | 7,051,253        |       | $    
|Mexico                              |                       |                  |                           | --               |       |      
|U.S.                                |                       |                  |                           | 2,276,427        |       |      
|                                    |                       |                  |                           |                  |       |      
|Sales                               |                       |                  |                           | 9,327,680        |       |      
|                                    |                       |                  |                           |                  |       |      
|Canada                              |                       |                  |                           | --               |       |      
|Mexico                              |                       |                  |                           | --               |       |      
|U.S.                                |                       |                  |                           | 5,021,195        |       |      
|                                    |                       |                  |                           |                  |       |      
|Gross proceeds received on agency   |                       |                  |                           | 5,021,195        |       |      
|sales                               |                       |                 
|Less payments to suppliers          |                       |                  |                           | (870,946         | )     |      
|                                    |                       |                  |                           |                  |       |      
|Net agency sales                    |                       |                  |                           | 4,150,249        |       |      
|                                    |                       |                  |                           |                  |       |      
|Canada                              |                       |                  |                           | 7,051,253        |       |      
|Mexico                              |                       |                  |                           | --               |       |      
|U.S.                                |                       |                  |                           | 6,426,676        |       |      
|                                    |                       |                  |                           |                  |       |      
|Total revenue                       |                       |                  |                           | 13,477,929       |       |      
|Cost of revenues                    |                       |                  |                           | 10,082,291       |       |      
|                                    |                       |                  |                           |                  |       |      
|Margin                              |                       |                  | $                         | 3,395,638        |       | $    
|                                    |                       |                  |                           |                  |       |      
|Nine months ended December 31, 2003 |                       |                 
|Canada                              |                       |                  | $                         | 5,948,484        |       | $    
|Mexico                              |                       |                  |                           | --               |       |      
|U.S.                                |                       |                  |                           | 299,056          |       |      
|                                    |                       |                  |                           |                  |       |      
|Sales                               |                       |                  |                           | 6,247,540        |       |      
|                                    |                       |                  |                           |                  |       |      
|Canada                              |                       |                  |                           | --               |       |      
|Mexico                              |                       |                  |                           | --               |       |      
|U.S.                                |                       |                  |                           | 5,716,228        |       |      
|                                    |                       |                  |                           |                  |       |      
|Gross proceeds received on agency   |                       |                  |                           | 5,716,228        |       |      
|sales                               |                       |                 
|Less payments to suppliers          |                       |                  |                           | (1,208,976       | )     |      
|                                    |                       |                  |                           |                  |       |      
|Net agency sales                    |                       |                  |                           | 4,507,252        |       |      
|                                    |                       |                  |                           |                  |       |      
|Canada                              |                       |                  |                           | 5,948,484        |       |      
|Mexico                              |                       |                  |                           | --               |       |      
|U.S.                                |                       |                  |                           | 4,806,308        |       |      
|                                    |                       |                  |                           |                  |       |      
|Total revenue                       |                       |                  |                           | 10,754,792       |       |      
|Cost of revenues                    |                       |                  |                           | 7,594,348        |       |      
|                                    |                       |                  |                           |                  |       |      
|Margin                              |                       |                  | $                         | 3,160,444        |       | $    
|                                    |                       |                  |                           |                  |       |      

---

22

# DATAWAVE SYSTEMS INC.NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|5. | BUSINESS
SEGMENT INFORMATION (Continued)
|-- | ----------------------------------------

| | (b) | Geographic
information
| | --- | ----------------------

| | DataWave
has long-lived assets and has earned revenue from sales to customers in the following
geographic locations:
| | --------------------------------------------------------------------------------------------------------------------

|              | Three months ended and as at December 31
|------------- | ----------------------------------------
|              | Revenue                                 
|              | 2004                                    
|Canada        |                                         
|Mexico        |                                         
|United States |                                         
|              |                                         
|              |                                         
|              |                                         

|              | Nine months ended and as at December 31
|------------- | ---------------------------------------
|              | Revenue                                
|              | 2004                                   
|Canada        |                                        
|Mexico        |                                        
|United States |                                        
|              |                                        
|              |                                        
|              |                                        

| | Long
lived assets consist of machinery and equipment, equity investment, deferred development
costs, goodwill and other intangible assets.
| | ------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | Concentration
of sales and economic dependence
| | --- | ----------------------------------------------

| | The
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 period ended December 31, 2004, the top ten customers accounted for 60% of revenues
(2003  57%). The Company actively seeks to expand its customer base for
point-of-sale activation products to mitigate this risk.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

23

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|6. | INCOME
TAXES
|-- | ------------

| | The
approximate effects of each type of temporary difference that gives rise to the deferred
tax assets are as follows:
| | -----------------------------------------------------------------------------------------------------------------------

|                                          | December 31,
2004 | March 31,
2004
|----------------------------------------- | ----------------- | --------------
|Deferred income tax assets:               |                   |               
|Operating losses carried forward          |                   |               
|Capital losses carried forward            |                   |               
|Machinery and equipment                   |                   |               
|Intangible assets                         |                   |               
|                                          |                   |               
|Total deferred income tax assets          |                   |               
|                                          |                   |               
|Valuation allowance for income tax assets |                   |               
|                                          |                   |               
|Net deferred income tax assets            |                   |               
|                                          |                   |               

| | As
at December 31, 2004, DataWave and its subsidiaries have accumulated net operating losses
and capital losses which they can apply against future earnings. The portion of the net
operating losses and capital losses carried forward for tax purposes which has not been
recognized in the financial statements amounts to approximately $4.1 million and $1.0
million, respectively. The net operating loss carry forwards commenced expiring in 2003
and the capital loss carry forwards expire in fiscal year 2005.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
December 31, 2004, DataWave has deferred tax liabilities of $276,705 (March 31, 2004
$267,766).
| | --------------------------------------------------------------------------------------------------

|7. | DEFERRED
INDUCEMENT
|-- | -------------------

| | In
January 2004, DataWave entered into a ten year lease for office space in Richmond,
British Columbia, which is being amortized over the ten year term of the lease. At
December 31, 2004, the tenant improvement allowance receivable in the sixth year of the
lease is $110,865. Deferred rent inducements is $333,426 less the current portion of
$28,940 (2003  $Nil).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8. | CAPITAL
LEASE OBLIGATION
|-- | ------------------------

| | The
future minimum lease payments for each fiscal year under the capital lease for equipment
expiring in fiscal year 2007, together with the balance of the obligation under capital
lease are as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                   | 
|---------------------------------- | 
|2005                               | 
|2006                               | 
|                                   | 
|Total minimum lease payments       | 
|Less: amount representing interest | 
|                                   | 
|                                   | 
|Less: current portion              | 
|                                   | 
|Balance of obligation              | 
|                                   | 

---

24

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTSInformation as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|9. | COMMITMENTS
|-- | -----------

| | DataWave
has the following future minimum payments with respect to capital lease obligations and
operating leases for office space, computer and office equipment:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|           | 
|---------- | 
|2005       | 
|2006       | 
|2007       | 
|2008       | 
|2009       | 
|Thereafter | 
|           | 
|           | 
|           | 

| | Rent
expense for the period ended December 31, 2004, was $186,056 (2003  $117,001).
| | ------------------------------------------------------------------------------------

|10. | DIFFERENCES
BETWEEN THE UNITED STATES AND CANADIAN GENERALLY ACCEPTED ACCOUNTING           PRINCIPLES
|--- | -----------------------------------------------------------------------------------------------------

| | These
consolidated financial statements have been prepared in accordance with generally
accepted accounting principles in the United States (U.S. GAAP) which differ in certain
material respects with those in Canada (Canadian GAAP).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | These
consolidated financial statements, as presented in accordance with U.S. GAAP, are
presented in accordance with Canadian GAAP as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------

---

25

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|10. | DIFFERENCES
BETWEEN THE UNITED STATES AND CANADIAN GENERALLY ACCEPTED ACCOUNTING           PRINCIPLES
(Continued)
|--- | -----------------------------------------------------------------------------------------------------------------

| | CONSOLIDATED
BALANCE SHEETS
| | ---------------------------

|                                                    | As at      
|--------------------------------------------------- | -----------
|                                                    | Dec. 31,   
|                                                    | 2004       
|                                                    | (U.S. GAAP)
|Assets                                              |            
|Current                                             |            
|Cash and cash equivalents                           |            
|Restricted cash                                     |            
|Accounts receivable and other                       |            
|Inventories                                         |            
|Prepaid expenses and deposits                       |            
|                                                    |            
|Total current assets                                |            
|Restricted cash                                     |            
|Machinery and equipment, net                        |            
|Equity investment                                   |            
|Deferred development costs                          |            
|Other long term receivables                         |            
|Goodwill                                            |            
|Intangible assets, net                              |            
|                                                    |            
|Total assets                                        |            
|                                                    |            
|Liabilities                                         |            
|Current                                             |            
|Accounts payable and accrued liabilities            |            
|Deferred revenue                                    |            
|Current portion of capital lease obligation         |            
|Current portion of deferred inducement              |            
|                                                    |            
|Total current liabilities                           |            
|Capital lease obligations                           |            
|Deferred income taxes                               |            
|Deferred inducements                                |            
|                                                    |            
|Total liabilities                                   |            
|                                                    |            
|Shareholders' equity                                |            
|Common shares                                       |            
|Authorized: 100,000,000 common shares, no par value |            
|43,889,334 shares issued and outstanding at         |            
|December 31, 2004 and March 31, 2004 respectively   |            
|Additional paid in capital                          |            
|Contributed surplus                                 |            
|Accumulated other comprehensive income              |            
|Accumulated deficit                                 |            
|                                                    |            
|Total shareholders' equity                          |            
|                                                    |            
|Total liabilities and shareholders' equity          |            
|                                                    |            

---

26

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|10. | DIFFERENCES
BETWEEN THE UNITED STATES AND CANADIAN GENERALLY ACCEPTED ACCOUNTING           PRINCIPLES
(Continued)
|--- | -----------------------------------------------------------------------------------------------------------------

| | CONSOLIDATED
STATEMENT OF OPERATIONS
| | ------------------------------------

|                                   | Three months ended December 31, | Nine months ended December 31,
|---------------------------------- | ------------------------------- | ------------------------------
|                                   | 2004                            | 2003                          
|                                   | (U.S.
GAAP)                     | (U.S.
GAAP)                   
|Revenue                            |                                 |                               
|Sales                              |                                 |                               
|Net agency sales                   |                                 |                               
|                                   |                                 |                               
|Total revenue                      |                                 |                               
|                                   |                                 |                               
|Operating costs and expenses       |                                 |                               
|Cost of revenues                   |                                 |                               
|General and administrative         |                                 |                               
|Selling and marketing              |                                 |                               
|Product development                |                                 |                               
|Merger costs                       |                                 |                               
|Depreciation and amortization      |                                 |                               
|                                   |                                 |                               
|Total operating costs and expenses |                                 |                               
|                                   |                                 |                               
|Operating income                   |                                 |                               
|Other income                       |                                 |                               
|Equity income from investee        |                                 |                               
|Gain on foreign exchange           |                                 |                               
|                                   |                                 |                               
|Income before income taxes         |                                 |                               
|Income taxes                       |                                 |                               
|                                   |                                 |                               
|Net income for the period          |                                 |                               
|                                   |                                 |                               
|Net income per share               |                                 |                               
|Basic and diluted                  |                                 |                               

---

27

# DATAWAVE SYSTEMS INC. NOTES TO THE CONSOLIDATED
FINANCIAL STATEMENTSInformation as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|10. | DIFFERENCES
BETWEEN THE UNITED STATES AND CANADIAN GENERALLY ACCEPTED ACCOUNTING           PRINCIPLES
(Continued)
|--- | -----------------------------------------------------------------------------------------------------------------

| | The
following is a reconciliation of the financial position and results of operations of the
Company under U.S. GAAP and Canadian GAAP:
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | Consolidated
Balance Sheets
| | ---------------------------

|                                                  | December 31,
2004 | March 31,
2004
|------------------------------------------------- | ----------------- | --------------
|Total assets, U.S. GAAP                           |                   |               
|Effect of foreign currency translation adjustment |                   |               
|Machinery and equipment                           |                   |               
|Goodwill                                          |                   |               
|Other intangible assets                           |                   |               
|                                                  |                   |               
|Total assets, Canadian GAAP                       |                   |               
|                                                  |                   |               
|Total liabilities, U.S. GAAP and Canadian GAAP    |                   |               
|                                                  |                   |               
|Shareholders' equity, U.S. GAAP                   |                   |               
|Effect of foreign currency translation adjustment |                   |               
|Accumulated deficit                               |                   |               
|Other comprehensive income                        |                   |               
|                                                  |                   |               
|Total shareholders' equity, Canadian GAAP         |                   |               
|                                                  |                   |               

Consolidated Statements of
Operations

|                                         | Three months ended December 31 | Nine months ended December 31
|---------------------------------------- | ------------------------------ | -----------------------------
|                                         | 2004                           | 2003                         
|Net income for the period, U.S. GAAP     |                                |                              
|Effect of foreign currency translation   |                                |                              
|adjustment                               |                                |                              
|Depreciation and amortization            |                                |                              
|                                         |                                |                              
|Net income for the period, Canadian GAAP |                                |                              
|                                         |                                |                              
|Basic and diluted income per share       |                                |                              
|under Canadian GAAP                      |                                |                              

---

28

# DATAWAVE SYSTEMS INC.NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|10. | DIFFERENCES
BETWEEN THE UNITED STATES AND CANADIAN GENERALLY ACCEPTED ACCOUNTING           PRINCIPLES
(Continued)
|--- | -----------------------------------------------------------------------------------------------------------------

| | Consolidated
Statements of Cash Flows
| | -------------------------------------

| | There
are no material differences between Canadian and U.S. GAAP which affect the statements of
cash flows for the current or prior period.
| | -------------------------------------------------------------------------------------------------------------------------------------------

| | (a) | Foreign
currency translation
| | --- | ----------------------------

| | Under
U.S. GAAP foreign subsidiaries which operate in an economic environment where the
principal currency is other than the U.S. dollar are translated into U.S. dollars using
the current rate method. Translation gains and losses that result in changes to
shareholders equity are recorded as other comprehensive income and reported as part
of shareholders equity. Under Canadian GAAP the Company translates its Canadian
subsidiaries into U.S. dollars using the temporal method on the basis that these
subsidiaries are integrated with the U.S. operations. Gains or losses on translation for
items are included in operations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Future
income taxes
| | --- | -------------------

| | Under
U.S. GAAP tax rates applied in the calculation of future income taxes are those rates
that are passed into law. Under Canadian GAAP substantially enacted rates are used. The
Company has determined that there is no material effect on the consolidated financial
statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | Goodwill
and other intangible assets
| | --- | ------------------------------------

| | There
are no material differences between U.S. and Canadian GAAP which affect the recording of
goodwill and other intangible assets except as provided for foreign currency translation
and as recorded in the reconciliation between U.S. and Canadian GAAP.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

28

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|10. | DIFFERENCES
BETWEEN THE UNITED STATES AND CANADIAN GENERALLY ACCEPTED ACCOUNTING           PRINCIPLES
(Continued)
|--- | -----------------------------------------------------------------------------------------------------------------

| | (d) | Stock-based
compensation
| | --- | ------------------------

| | Under
U.S. GAAP the Company accounts for stock-based compensation, as outlined in Note 2 (s),
in accordance with the intrinsic value method where compensation is measured as the
amount by which the market price of the underlying stock exceeds the exercise price of
the option on the date of grant; this compensation is amortized over the vesting period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Effective
April 1, 2003 the Company changed its accounting policy on a prospective basis with
respect to the method of accounting for stock-based compensation. The Company adopted
CICA 3870, Stock-based Compensation and Other Stock-based Payments, and has chosen
to account for all grants of options to employees, non-employees and directors after
April 1, 2003 in accordance with the fair value method of accounting for stock-based
compensation as defined by accounting principles generally accepted in Canada.
Stock-based compensation awards expense is calculated using the Black-Scholes option
pricing model. Previously, the Company used the intrinsic value method for valuing
stock-based compensation awards granted to employees and directors where compensation
expense is recognized for the excess, if any, of the quoted market price of the Companys
common shares over the common share exercise price on the day that options are granted.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | There
are no material differences between U.S. and Canadian GAAP which affect the disclosure of
stock based compensation in Note 2 (s).
| | ---------------------------------------------------------------------------------------------------------------------------------------

---

29

# DATAWAVE SYSTEMS INC. NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS Information as at and for the nine month periods ended December 31, 2004 and 2003 is unaudited
(Expressed in United States Dollars)

---

|11. | OTHER
MATERIAL EVENTS
|--- | ---------------------

| | (a) | Proposed
merger and subsequent termination
| | --- | ------------------------------------------

| | On
April 23rd, 2004 DataWave announced that it signed a Letter Agreement with
Integrated Data Corp. (IDC) whereby IDC will acquire DataWave by merger in
which shareholders of DataWave will be issued shares of IDC in exchange for all the
issued and outstanding shares of DataWave. The proposed merger is subject to a number of
conditions including the approval of DataWave shareholders and regulatory approvals. A
Definitive Agreement was approved and signed on June 2, 2004. On November 9th,
2004, the parties mutually agreed to terminate the proposed merger.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Voluntary
delisting from TSX Venture Exchange
| | --- | ---------------------------------------------

| | On
December 02, 2004 DataWave announced that it was seeking voluntary delisting from the TSX
Venture Exchange. The delisting became effective on December 22, 2004. The Company
continues to trade on the OTC Bulletin Board in the United States (OTCBB: DWVSF).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|12. | SUBSEQUENT
EVENTS
|--- | -----------------

| | (a) | License
buyback
| | --- | ---------------

| | On
January 26th, 2005 DataWave agreed with Integrated Data Corp. (IDC)
to buy back the exclusive international license, granted to DataWave International
Limited in April 1999, for US $865,000.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
purchase price of $865,000 consists of $265,000 cash and $600,000 in the form of a
two-year convertible, interest free promissory note payable to IDC. Within two years
after the execution of the agreement of sale, IDC, at its sole discretion, shall have the
right to convert the note upon demand into DataWave common shares at US$0.08 (8 cents)
per share for a total of 7,500,000 newly issued shares of DataWave common stock. If IDC
does not exercise its right to convert the note to DataWave stock within the 2-year
period, DataWave shall have the option to either repay IDC the original loan amount in
cash (US $600,000), or convert the note into DataWave common shares issued to IDC at US
$0.08 (8 cents) per share for a total of 7,500,000 newly issued shares of DataWave common
stock.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Continuance
into Delaware
| | --- | -------------------------

| | On
January 31, 2005 shareholders approved a special resolution to carry out a continuance of
DataWave from the jurisdiction of the Yukon Territory, Canada, into Delaware, United
States.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

30

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

The following discussion and analysis
of our results of operations and financial position should be read in conjunction with our
consolidated financial statements and the notes thereto included elsewhere in this Report.
Our consolidated financial statements are prepared in accordance with U.S. GAAP. All
references to dollar amounts in this section are in U.S. dollars unless expressly stated
otherwise.

# Overview

We are an innovator and developer of
prepaid and stored-value programs. We pioneered network systems (The DataWave
System) that allow for point-of-sale-activation of high value, high shrinkage
products, such as cash cards, prepaid phone cards and prepaid wireless time. This
proprietary system works equally well over the Internet, or with various card activation
devices. Our network systems have been designed to work both with the prepaid platforms of
other parties, as well as telecommunication and financial switches. Our systems are
scalable and flexible and can be readily modified to offer new premium stored-value
products, such as prepaid gift cards and prepaid Internet cards.

# Managements
Summary

Revenues for the nine months ended
December 31, 2004 were $16,595,017 compared with $13,455,227 for fiscal 2004. Revenues
increased in all business areas. Gross profit at $6,240,361 increased by 13% or $736,448
over the same period last year. Increases in prepaid cellular margins of $138,339, fees
and services margins of $576,209 were the largest increases; margins from prepaid long
distance and other business increased by $21,900. Total gross margin percentage for the
nine months of 37.6% has decreased from 40.9% from the same period last year, the changes
coming from prepaid long distance and prepaid cellular.

Operating costs and expenses,
excluding cost of revenues for the nine months ended December 31, 2004 increased by
$580,839 to $5,747,695 for fiscal 2005 compared with $5,166,856 for fiscal 2004. Merger
costs of $199,244, increased deprecation costs of $242,953 and increases in general,
administrative, selling and marketing expenses of $332,663 were offset by a reduction in
product development costs of $194,021.

Net income for nine months ended
December 31, 2004 of $622,470 was $221,556 or 55% higher than fiscal 2004. Net income
before merger costs was $821,714 or 105% higher than fiscal 2004.

Revenues in Canada and the United
States are substantially dependent upon the number of unit placements and locations
offering prepaid products. The following table lists the number of POSA terminals,
free-standing machines (DTMs), over-the-counter units and traditional (or non-networked)
machines in which our prepaid products are sold. We own and operate POSA terminals, all
free-standing machines, over-the-counter units and traditional vending machines.

|                                          | December 31,
2004 | December 31,
2003
|----------------------------------------- | ----------------- | -----------------
|Canada                                    |                   |                  
|POSA terminals (owned)                    |                   |                  
|POSA terminals (serviced or host to host) |                   |                  
|United States                             |                   |                  
|DTMs                                      |                   |                  
|Traditional machine units                 |                   |                  
|POSA terminals (owned)                    |                   |                  
|POSA terminals (serviced or host to host) |                   |                  
|Mexico                                    |                   |                  
|POSA terminals (serviced or host to host) |                   |                  
|                                          |                   |                  
|Total                                     |                   |                  
|                                          |                   |                  

---

32

# Critical Accounting
Policies and Estimates

The following accounting policies and
estimates are the most important to our financial position and results of operations,
because they require the exercise of significant judgment or the use of estimates.

The preparation of these financial
statements requires us 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. We believe that the estimates we use are reasonable, however actual
results could differ from those estimates.

Our financial statements are prepared
in accordance with accounting principles that are generally accepted in the United States.
Our accounting policies are set out in Note 2 of the accompanying consolidated financial
statements.

# Revenue and cost
recognition

Our revenues are primarily generated
from the resale of prepaid long distance and cellular telephone time. Most of our long
distance and all of our cellular calling cards and virtual vouchers or PINs are activated
at the point-of-sale using our proprietary technologies. We recognize revenues when the
following criteria are met:

 persuasive evidence of an
arrangement exists

 delivery has occurred or
services have been rendered

 the price is fixed
or determinable, and

 collectibility is reasonably
assured.

Our revenue in Canada is primarily
from the sale of prepaid long distance calling cards and PINs and from the activation and
dispensing of prepaid cellular PINs. Prepaid cellular PINs incur inventory risk. Inventory
levels reflect the purchased value of the cost of the PIN and are managed to supply a
level of ten days activations; the resulting accounts payable liability is paid within the
normal terms offered by the supplier (including cash discounts for early payment). Where
DataWave is not the primary obligor or does not incur significant unmitigated inventory or
return risk, revenue is recorded at the date of sale on a net agency basis.

The underlying sales arrangements
entered into by us will impact the presentation of revenues, inventory, accounts
receivable and resulting gross margin and working capital, respectively. Accounts
receivable reflect the wholesale value of the PINs and are almost always collected within
twenty days.

Most of our revenue in the United
States is from the sale of prepaid long distance through our network of vending machines
and is recorded on a net agency basis. Inventory risk (as the liability to the carrier is
incurred at the point-of-sale) is not created. The related U.S. accounts receivable is the
retail value of the product and is typically collected within two weeks of the sale; this
is primarily cash in our vending machines which is collected on a regular basis.

Sales of company or custom branded
cards where we incur significant inventory risk but do not provide the related telephone
time are recognized on the gross basis on the date of sale to the consumer when title to
the card transfers, collectibility of proceeds is reasonably assured, the full obligation
to the phone service provider is fixed and determinable, and we have no significant
continuing obligations.

Cost of revenues for prepaid long
distance phone cards consists primarily of long distance telephone time, standard phone
cards, net of amounts earned on early payments to suppliers and commissions to agents and
site landlords. Direct costs are also associated with the DTM machines including direct
production salaries, parts and accessories and costs to service the machines. Cost of
revenues for transaction fees and services consists of network and communication service
costs, costs of maintaining and supporting point-of-sale activation terminals and third
party processing costs for transactions.

---

33

The presentation of the revenues of
the majority of our business activities on a net agency basis impacts our financial
statements. Where we obtain legal title to PIN and cellular time inventory but are not the
primary obligor or incur significant unmitigated inventory or return risk our recording of
inventory, the related trade payables and net agency revenue from its sale significantly
impacts our financial statements.

# Impairment of long-lived
assets, including goodwill

We review our long-lived assets,
other than goodwill, for impairment whenever events or changes in circumstances indicate
that the carrying value of such assets may not be recoverable. To determine
recoverability, we compare the carrying value of the assets to the estimated future
undiscounted cash flows. Changes in estimates of cash flow may impact our determination of
recoverability. Measurement of an impairment loss for long-lived assets held for use is
based on the fair value of the asset. Long-lived assets classified as held for sale are
reported at the lower of carrying value and fair value less estimated selling costs. For
assets to be disposed of other than by sale, an impairment loss is recognized when the
carrying value is not recoverable and exceeds the fair value of the asset. For goodwill,
an impairment loss will be recorded to the extent that the carrying amount of the goodwill
exceeds its fair value. For each of the three months ended December 31, 2004 and 2003, no
such impairment losses were identified.

# Deferred income taxes

We have significant tax assets
relating to historical operating losses. Based on our assessment of the likelihood of
realization we have recorded a full valuation allowance against such assets and have
recorded no related tax asset. Future conditions that impact our assessment of such
realization may impact the recognition of such assets.

# Selected Financial
Operating Data

|                                   | Three months ended
December 31, | Nine months ended December
31,
|---------------------------------- | ------------------------------- | ------------------------------
|                                   | 2004                            | 2003                          
|Revenue                            |                                 |                               
|Sales                              |                                 |                               
|Net agency sales                   |                                 |                               
|                                   |                                 |                               
|Total revenue                      |                                 |                               
|                                   |                                 |                               
|                                   |                                 |                               
|Operating costs and expenses       |                                 |                               
|Cost of revenues                   |                                 |                               
|General and administrative         |                                 |                               
|Selling and marketing              |                                 |                               
|Product development                |                                 |                               
|Merger costs                       |                                 |                               
|Depreciation and amortization      |                                 |                               
|                                   |                                 |                               
|Total operating costs and expenses |                                 |                               
|                                   |                                 |                               
|Operating income                   |                                 |                               
|Other income                       |                                 |                               
|Equity income from investee        |                                 |                               
|Gain on foreign exchange           |                                 |                               
|                                   |                                 |                               
|Income before income taxes         |                                 |                               
|Income taxes                       |                                 |                               
|                                   |                                 |                               
|Net income                         |                                 |                               
|                                   |                                 |                               

---

34

# Three Months Ended
December 31, 2004 compared to the Three Months Ended December 31, 2003

# Revenues

Revenues were $6,748,487 for the
quarter ended December 31, 2004 compared with $4,572,487 for the quarter ended December
31, 2003. Revenues in the quarter for the core business of prepaid long distance increased
in both Canada and the U.S. compared with same period last year.

Our net revenues in Canada increased
by 43.0% to $3,877,957 for the quarter ended December 31, 2004 compared to $2,712,216 for
the quarter ended December 31, 2003.

Gross proceeds for prepaid cellular
and prepaid internet products were $26,163,929 in the quarter compared with $16,056,915 in
the same period last year. We record this revenue on a net agency basis (gross proceeds
less payments to suppliers). In the quarter net agency sales from this business were
$496,458 compared with $523,514 in the same period last year. This business generated
transaction fees of $574,177 for the quarter compared with $404,145 in the same period
last year.

Revenues in Mexico were $7,730 for
the quarter ended December 31, 2004, compared with $72,912 in the same period last year.
In October 2003, we signed an agreement with Alestra, the company that provides
AT&Ts broadband and added value services in Mexico. Our agents in Mexico confirm
that there has been a significant decrease in this business, primarily in the last
quarter.

Net revenues for the quarter in the
United States, primarily from the retail sale of prepaid calling cards through our network
of intelligent vending machines, were $2,862,800 for the quarter compared with $1,787,359
in the same period last year. Promotional or one time sales of $1,142,523 during the
quarter were the main reason for the increase; free-standing machine revenue increased
slightly.

# Cost of Revenues

Cost of revenues was $4,424,719 or
65.6% of revenues, for the quarter ended December 31, 2004, compared to $2,648,521 or
57.9% of revenues, during the quarter ended December 31, 2003. Our cost of revenues
consists primarily of payments to carriers who provide long distance telephone time and
various services related to supplying and maintaining our network systems, including
transaction processing costs. In the United States, additional costs are incurred for site
commissions and servicing and maintaining our network of free standing machines.

Gross margin increased to $2,323,768
for the quarter ended December 31, 2004 compared with $1,923,966 for the same period last
year. Prepaid cellular and prepaid internet products operate on a margin of less than 2%
(revenue is accounted for on a net agency basis), compared with margins of 23% on prepaid
long distance.

Gross margin on prepaid long distance
was $1,311,701 for the quarter compared with $921,642 in the same period last year;
margins decreased from 27.7% for the quarter last year to 23.3% in the current quarter.

# General and
Administrative

General and administrative expenses
were $773,206 or 11.5% of revenues during the quarter ended December 31, 2004, compared to
$801,460 or 17.5% of revenues during the same period last year. Salary costs increased as
certain costs previously allocated to product development are now included in general and
administrative expense.

Merger costs of $32,229 were incurred
during the quarter. The merger was terminated by mutual agreement on November 9, 2004.

---

35

# Selling and Marketing
Expenses

Selling and marketing expenses were
$562,264 or 8.3% of revenues during the quarter ended December 31, 2004, as compared to
$374,188 or 8.2% of revenues during the quarter ended December 31, 2003. Establishing new
business in the United States required hiring additional staff in our New Jersey office.

Selling expenses consist primarily of
salaries and the associated employee expenses.

# Product Development
Expenses

Product development expenses were
$305,435 or 4.5% of revenues during the quarter ended December 31, 2004, compared to
$374,821 or 8.2% of revenues during the quarter ended December 31, 2003. Reduced salary
costs and the allocation of some resources to general and administrative activities
account for the decrease.

Development costs incurred after
technological feasibility was established for programs associated with specific customers
were deferred and will be amortized over the life of the agreements.

# Depreciation and
Amortization

Depreciation and amortization expense
increased to $328,454 or 4.9% of revenues during the quarter ended December 31, 2004, from
$275,706 or 6.0% of revenues for the quarter ended December 31, 2003. The increase is the
result of our investment in POS terminals and the supporting network infrastructure that
started in November 2002 and is being depreciated on a straight line basis over three
years.

Amortization of intangible assets was
$14,919 for the quarter ended December 31, 2004. Intangible assets comprise goodwill and
customer lists acquired in the purchase of AT&Ts Canadian prepaid card
operations. The customer list is being amortized on a straight-line basis over six years.
We periodically evaluate the recoverability of the carrying value of the intangible assets
(goodwill and customer list) by assessing whether the projected cash flows are sufficient
to recover the unamortized costs of these assets.

# Nine Months Ended
December 31, 2004 compared to the Nine Months Ended December 31, 2003

# Revenues

Revenues were $16,595,017 for the
nine months ended December 31, 2004 compared with $13,455,227 for the nine months ended
December 31, 2003. Revenues in the nine months for the core business of prepaid long
distance increased in both Canada and the U.S. compared with same period last year.

Our net revenues in Canada increased
by 19.9% to $9,951,190 for the nine months ended December 31, 2004 compared to $8,296,516
for the nine months ended December 31, 2003.

Gross proceeds for prepaid cellular
and prepaid internet products were $66,988,068 in the nine months compared with
$41,405,272 in the same period last year. We record this revenue on a net agency basis
(gross proceeds less payments to suppliers). In the nine months net agency sales from this
business were $1,307,838 compared with $1,332,414 in the same period last year. This
business generated transaction fees of $1,592,099 for the nine months compared with
$1,015,618 in the same period last year.

Revenues in Mexico were $44,857 for
the nine months ended December 31, 2004 compared with $72,912 for the same period last
year. In October 2003, we signed an agreement with Alestra, the company that provides
AT&Ts broadband and added value services in Mexico. Sales in the current year
have declined due to lack of competitive products.

Net revenues for the nine months in
the United States, primarily from the retail sale of prepaid calling cards through our
network of intelligent vending machines, were $6,598,970 compared with $5,085,799 in the
same period last year, an increase of 29.8%. Promotional or one time sales of $1,142,523
during the third quarter were the main reason for the increase; free-standing machine
revenue increased slightly during the nine months.

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36

Our ten largest customers accounted
for 60% of revenues in the nine months ended December 31, 2004 compared with 57% for the
same period last year. We are actively seeking to expand our customer base for
point-of-sale activation of prepaid products to mitigate the risk inherent in such a
concentration.

# Cost of Revenues

Cost of revenues was $10,354,656 or
62.4% of revenues, for the nine months ended December 31, 2004, compared to $7,951,314 or
59.1% of revenues, during the nine months ended December 31, 2003. Our cost of revenues
consists primarily of payments to carriers who provide long distance telephone time and
various services related to supplying and maintaining our network systems, including
transaction processing costs. In the United States, additional costs are incurred for site
commissions and servicing and maintaining our network of free standing machines.

Gross margin increased to $6,240,361
for the nine months ended December 31, 2004 compared with $5,503,913 for the same period
last year. Prepaid cellular and prepaid internet products operates on a margin of less
than 2% (revenue is accounted for on a net agency basis), compared with margins of 25% on
prepaid long distance.

Gross margin on prepaid long distance
was $3,395,638 for the nine months compared with $3,160,444 in the same period last year;
margins decreased from 29.3% for the nine months last year to 25.2% in the current nine
month period.

# General and
Administrative

General and administrative expenses
were $2,351,874 or 14.2% of revenues for the nine months ended December 31, 2004, compared
to $2,209,524 or 16.4% of revenues during the same period last year. Salary costs
increased as certain costs previously allocated to product development are now included in
general and administrative expense.

Merger costs for the nine months
ended December 31, 2004 were $199,244 or 1.2% of revenues. Costs consist of legal and
accounting fees, including those associated with obtaining regulatory approval. The merger
was terminated by mutual agreement on November 9, 2004.

# Selling and Marketing
Expenses

Selling and marketing expenses were
$1,388,638 or 8.4% of revenues during the nine months ended December 31, 2004, as compared
to $1,198,325 or 8.9% of revenues during the nine months ended December 31, 2003. The
increase of $190,313 is primarily from hiring additional staff in our New Jersey office
and the costs from establishing new business in The United States.

Selling expenses consist primarily of
salaries and the associated employee expenses.

# Product Development
Expenses

Product development expenses were
$926,836 or 5.6% of revenues during the nine months ended December 31, 2004, compared to
$1,120,857 or 8.3% of revenues during the nine months ended December 31, 2003. Reduced
salary costs and the allocation of some resources to general and administrative activities
account for the decrease.

Development costs incurred after
technological feasibility was established for programs associated with specific customers
were deferred and will be amortized over the life of the agreements. The net amount
deferred at December 31, 2004 is $91,013 (December 31, 2003  $Nil).

# Depreciation and
Amortization

Depreciation and amortization expense
increased to $881,103 or 5.3% of revenues during the nine months ended December 31, 2004,
from $638,150 or 4.7% of revenues for the nine months ended December 31, 2003. The
increase is the result of our investment in POS terminals and the supporting network
infrastructure that started in November 2002 and is being depreciated on a straight line
basis over three years.

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37

Amortization of intangible assets was
$73,398 for the nine months ended December 31, 2004. Intangible assets comprise goodwill
and customer lists acquired in the purchase of AT&Ts Canadian prepaid card
operations. The customer list is being amortized on a straight-line basis over six years.
We periodically evaluate the recoverability of the carrying value of the intangible assets
(goodwill and customer list) by assessing whether the projected cash flows are sufficient
to recover the unamortized costs of these assets.

# Liquidity and Capital
Resources

We have financed our operations,
including development, from cash flow generated from our operating activities during
fiscal 2005 and 2004. We have working capital of $730,242 at December 31, 2004 compared
with $83,320 at March 31, 2004. We use cash to pay trade payables, finance the expansion
of our wholesale Canadian prepaid long distance phone operations into small independent
retail stores; and finance our entrance into wholesale point-of-sale prepaid cellular
sales in the Canadian marketplace.

Cash and cash equivalents at December
31, 2004 were $4,009,010 compared with $852,406 at March 31, 2004.

Our operating activities provided
cash of $3,957,949 during the nine months ended December 31, 2004 compared with $164,890
during the nine months ended December 31, 2003. The increase in operating cash flow is due
to management of receivables and inventory and payments to suppliers. The increase in
operating cash flow for the nine months ended December 31, 2004 is due to:

 accounts payable and accrued
liabilities increased by $6,670,304 including $4,449,272 for wireless products (PINs and
cellular airtime), and

 deferred  revenue  increased by
$652,792,  primarily for sales of prepaid long distance  telephone  time,  and is offset
by;

 accounts receivable  increased by
$1,829,252,  primarily for sales of point-of-sale  dispensed products.  This is due to
the growth in sales of prepaid cellular, and

 inventories increased by
$2,953,506, primarily as a result of the growth in sales of prepaid cellular PINs
products. Inventory levels represent approximately ten days sales.

Our underlying sales arrangements for
Canadian prepaid cellular PINs have a significant impact on cash flows. Accounts
receivable for cellular product sales are paid within twenty days; as at December 31,
2004, all accounts receivable for cellular products outstanding at the end of the year had
been paid. Inventories for cellular products are maintained at levels to support ten days
sales and are turned over three times a month. We actively manage working capital 
inventory, accounts receivable and accounts payable  by quick turnover of inventory,
collection terms of accounts receivable and trade terms granted by suppliers, however our
cash flows are dependent on our ability to continue managing the business cycle. We
believe that cash flows in fiscal 2005 will be sufficient to finance our capital
investments, primarily for additional POSA terminals.

Cash used for investing in capital
expenditures for machinery and equipment was $744,800 in the nine months compared with
$634,690 in the same period last year. Expenditures in the nine months are attributable to
capital expenditures for terminals used to dispense point-of-sale prepaid cellular PINs in
Canada. We have completed installation of more than 1,500 point-of-sale terminals in
Canada during the nine months which brings our total point-of-sale terminals installed in
Canada to approximately 3,800.

Cash used for investing in the
Nextwave joint venture for the nine months was $22,630 compared with $Nil in the same
period last year.

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38

The following table sets forth our
best estimates of material long-term obligations as of December 31, 2004 including
operating lease commitments for office space, computer and office equipment. The table
excludes commitments such as open purchase orders under long term agreements with
customers and suppliers. We have no minimum purchase or supply arrangements in place. We
expect that these commitments will become due in fiscal 2005 and future years. Our
contractual obligations as of December 31, 2004 were:

|Contractual
Obligations   |       | Payments Due by Period |          
|------------------------- | ----- | ---------------------- | ---------
|                          | Total | Less Than
One Year     | 1-3 Years
|Capital Lease Obligations |       |                        | $        
|Operating Leases          |       |                        |          
|                          |       |                        |          
|Total Obligations         |       |                        | $        
|                          |       |                        |          

We agreed to buy back an exclusive
international license from Integrated Data Corp. for $865,000 consisting of $265,000 cash
and $600,000 in the form of a two-year convertible, interest free promissory note payable
to IDC. Within two years IDC, at its sole discretion, shall have the right to convert the
note upon demand into DataWave common shares. If IDC does not exercise its right to
convert the note to DataWave common shares we have the option to either repay IDC the
original loan amount in cash (US $600,000), or convert the note into DataWave common
shares.

# Future Capital Needs and
Resources

While there is no certainty that our
general revenue will be sufficient to cover all of the anticipated expenses, we believe
that we currently have sufficient cash resources and working capital to meet our ongoing
obligations as they become due. In addition to current cash requirements, we have
established NextWave, a joint venture with National Money Mart which will require an
investment of our resources and may require the use of cash, and which is impacted by the
available cash flow from operations.

We expect to continue using cash flow
generated from our operations to further finance the expansion of our wholesale
point-of-sale prepaid cellular business in the Canadian market and possibly the U.S.
market. Typical cash flow terms are net 30 days for the purchase of inventory from
suppliers and net 7 to 14 days for collections from customers. Our limited credit facility
from vendors limits our working capital and cash flows to expand the business. We
negotiated extensions of credit with vendors during the second and third quarters of 2004.
As this business expands, we will need to purchase additional inventory and point-of-sale
terminals. A risk to our liquidity is that customers do not pay on-time creating a
temporary negative cash flow situation. Furthermore, significant expansion of the
wholesale point-of-sale prepaid cellular business in Canada is in part dependent upon
expansion of credit limits from vendors to finance the purchase of PINs for inventory.
Another risk to liquidity is the seasonality of revenues.

Additionally, our working capital and
capital requirements will depend upon numerous factors, including the level of resources
that we devote to the continued development of our network system and the development of
new products and new technology, and the overall structure of potential future strategic
alliances and acquisitions of products or other businesses.

We believe that we currently have
sufficient cash resources and working capital to meet our ongoing obligations as they
become due during the 2005 fiscal year. Depending on the overall structure of potential
future product initiatives, strategic alliances and acquisitions, we may have additional
capital requirements related to funding these potential future product initiatives,
strategic alliances and acquisitions of products or other businesses. Accordingly, we may
seek funding from a combination of sources, including equity and debt financing. No
assurances can be given that additional funding will be available or, if available, at
terms acceptable to us. We have incurred significant merger costs. If adequate capital is
not available, our business can be materially and adversely affected.

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39

A decline in the travel-related
industry, which our U.S. revenues are dependent upon, and general softness in the U.S. and
Canadian economies could continue to pressure our cash levels. Our cash flow from
operations is impacted by our gross margin on sales. Pricing competition may reduce
revenue. Our ability to negotiate supply contracts will impact our gross margin, net
income and operating cash flow.

# Effect of Inflation

In our view, at no time during any of
the last three fiscal years has inflation had a material impact on our sales, earnings or
losses from operations, or net earnings.

# Trend Information

The implementation and roll-out of
point-of-sale technology in Canada is well established and we continue to increase market
share for sale of prepaid products using our technologies. Sales of prepaid cellular PINs
and revenues from POSA transaction fees are expected to increase. Currently our revenues
from our sales arrangements require active management of working capital. Terms and
conditions of future arrangements may impact the presentation of revenue and related
working capital accounts. We expect to deploy terminals in Canada during the current
fiscal year at a pace similar to last year.

Revenues generated from the bulk sale
of prepaid phone cards to retail establishments in Canada are expected to grow slowly and
continued pricing pressure in the Canadian marketplace is expected to have an adverse
effect on margins.

Revenues generated from the sale of
prepaid long distance phone cards through the free-standing machines in the U.S. are
static and may decline. Revenues generated from the promotional sale of prepaid long
distance phone cards continue to decline. Cost of revenues is expected to increase
somewhat as a percent of sales due to higher sales commission costs, transaction
processing costs and other direct expenses; this will be offset by a decline in the cost
of time, which is the major component of cost of revenue, as a result of renegotiating
lower rates.

Product development costs are
expected to continue at similarly high levels due to the continued development of our
network systems, the InOneCard.com web site, and the development of new products.

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40

|Item 3 | Quantitative and Qualitative Disclosures about Market Risk.
|------ | -----------------------------------------------------------

We are exposed to market risk related
to changes in interest and foreign currency exchange rates, each of which could adversely
affect the value of our current assets and liabilities. At December 31, 2004, we had cash
and cash equivalents consisting of cash on hand and highly liquid money market instruments
with original terms to maturity of less than 90 days. If market interest rates were to
increase immediately and uniformly by 10% from its levels at March 31, 2004, the fair
value would decline by an immaterial amount. We do not believe that our results of
operations or cash flows would be affected to any significant degree by a sudden change in
market interest rates relative to our cash and cash equivalents, given our current ability
to hold our money market investments to maturity. We do not have any long-term debt
instruments so we are not subject to market related risks such as interest or foreign
exchange on long-term debt. We do not enter into foreign exchange contracts to manage
exposure to currency rate fluctuations related to its U.S. dollar denominated cash and
money market investments.

With a portion of revenues and
operating expenses denominated in Canadian dollars, a sudden or significant change in
foreign exchange rates could have a material effect on our future operating results or
cash flows. We purchase goods and services in both Canadian and U.S. dollars and earn
revenues in both Canadian and U.S. dollars. Foreign exchange risk is managed by satisfying
foreign denominated expenditures with cash flows or assets denominated in the same
currency.

|Item 4. | Controls and Procedures.
|------- | ------------------------

Disclosure controls and procedures
are controls and other procedures that are designed to ensure that information required to
be disclosed in our Companys reports filed or submitted under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commissions rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in our Companys reports filed under the
Exchange Act is accumulated and communicated to management, including our Companys
chairman and chief executive officer as appropriate, to allow timely decisions regarding
required disclosure.

Evaluation of disclosure
controls and procedures

As required by Rule 13a-15 under the
Exchange Act, we have carried out an evaluation of the effectiveness of our Companys
disclosure controls and procedures as of the end of the period covered by this quarterly
report, being December 31, 2004. This evaluation was carried out under the supervision and
with the participation of our Companys management, including our Companys
chairman and chief executive officer. Based upon that evaluation, our Companys
chairman and chief executive officer concluded that our Companys disclosure controls
and procedures are effective.

No significant changes in
internal controls

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

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41

|PART II | OTHER INFORMATION
|------- | -----------------

|Item 6 | Exhibits
|------ | --------

INDEX

# Exhibit Number
                       Description

|1.1(1) | Certificate
of Continuance, Articles of Continuance, Notice of Address and           Notice of
Directors and Officers (1)
|------ | -------------------------------------------------------------------------------------------------------------------------

|1.2(2) | Bylaws
No. 1 (1)
|------ | ----------------

|2.1(3) | News
release on termination of Agreement and Plan of Merger by and between
          Integrated data Corp. and DataWave Systems Inc.
|------ | ------------------------------------------------------------------------------------------------------------------------------------

|2.1(4) | News
release on the voluntary delisting of DataWave Systems Inc. from TSX           Venture
Exchange.
|------ | -----------------------------------------------------------------------------------------------------

|10.1(5) | Agreement
between Integrated Data Corp. and DataWave Systems Inc. for the sale           and
purchase of an exclusive international license.
|------- | --------------------------------------------------------------------------------------------------------------------------------------------

|21.1 | Subsidiaries
|---- | ------------

| | DataWave
Services (Canada) Inc., incorporated pursuant to the laws of British Columbia DataWave
Systems (U.S.) Inc., incorporated pursuant to the laws of Nevada CXP Canada Inc.
(formerly Phone Line International Inc.,) incorporated pursuant to the laws of Canada
Cardxpress Vending, Inc., incorporated pursuant to the laws of Delaware
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|31.1** | Certification
pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 of Josh Emanuel
|------ | -----------------------------------------------------------------------------------------

|31.2** | Certification
pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 of John Gunn
|------ | --------------------------------------------------------------------------------------

|32.1** | Certification
pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 of Josh Emanuel
|------ | -----------------------------------------------------------------------------------------

|32.2** | Certification
pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 of John Gunn
|------ | --------------------------------------------------------------------------------------

**Filed herewith

(1)    
          Incorporated by reference from our Form 20-F Annual Report, filed on August 31,
          2001.

(2)    
          Incorporated by reference from our Form 20-F Annual Report, filed on August 31,
          2001.

(3)    
          Previously filed as exhibits with the Registrants Form 8-K filed on
          November 10, 2004.

(4)    
          Previously filed as exhibits with the Registrants Form 8-K filed on
          December 07, 2004.

(5)    
          Previously filed as exhibits with the Registrants Form 8-K filed on
          January 26, 2005.

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42

# SIGNATURES

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

| |                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | DataWave Systems Inc.
(Registrant)
By /s/ Josh Emanuel
Chairman and Chief Executive Officer
Date February 14, 2005
By /s/  John Gunn
General Manager, Chief Financial Officer
Date February 14, 2005