##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-QSB
  þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
   o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
 000-26698
 DATAWAVE SYSTEMS INC.
  Delaware
(State or other Jurisdiction of incorporation or
organization)
    
    98-0186455
(IRS Employer Identification No.)
 Wayne Interchange Plaza One
145 Route 46 West, 3rd Floor
Wayne, NJ 07470
 (973) 774-5000
  Securities registered or to be registered pursuant to Section 12(b) of the Act:
    
    (none)Securities registered or to be registered pursuant to Section 12(g) of the Act:
    
    Common Shares
 þ o
 þ o
  o þ




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##### 



DATAWAVE SYSTEMS INC.
 FORM 10-QSB
 TABLE OF CONTENTS
 PART I FINANCIAL INFORMATIONItem 1
    
    Financial Statements
    
    
    1Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3
    
    Controls and Procedures
    
    
    24PART II OTHER INFORMATIONItem 6
    
    Exhibits
    
    
    25




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##### 








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##### 



PART I     
       FINANCIAL INFORMATION
 
 Item 1 Financial Statements.
 DATAWAVE SYSTEMS INC.
 CONDENSED CONSOLIDATED BALANCE SHEETS
As at December 31, 2005 and March 31,2005
(Expressed in United States dollars, except share amounts)
(Unaudited)
 December 31
    
    
    March 312005
    
    
    2005AssetsCurrentCash and cash equivalents
    
    $
    6,370,523
    
    
    $
    4,560,512Accounts receivable and other (Note 3 (a))
    
    
    9,266,519
    
    
    
    7,366,712Inventories (Note 3 (b))
    
    
    7,649,152
    
    
    
    4,155,614Prepaid expenses and deposits
    
    
    491,819
    
    
    
    336,800Total current assets
    
    
    23,778,013
    
    
    
    16,419,638Machinery and equipment, net (Note 3 (c))
    
    
    2,364,466
    
    
    
    2,453,571Equity investment (Note 3(e))
    
    
    159,457
    
    
    
    39,387Goodwill
    
    
    1,882,611
    
    
    
    1,857,985Intangible assets, net
    
    
    962,696
    
    
    
    1,079,843Other assets
    
    
    194,004
    
    
    
    225,575Total assets
    
    $
    29,341,247
    
    
    $
    22,075,999LiabilitiesCurrentAccounts payable and accrued liabilities (Note 3 (d))
    
    $
    20,527,270
    
    
    $
    14,547,422Deferred revenue
    
    
    1,123,991
    
    
    
    839,303Other current liabilities
    
    
    116,854
    
    
    
    109,346Total current liabilities
    
    
    21,768,115
    
    
    
    15,496,071Deferred income taxes
    
    
    321,110
    
    
    
    309,509Deferred inducement
    
    
    352,557
    
    
    
    342,184Convertible promissory note (Note 3 (f))
    
    
    600,000
    
    
    
    600,000Other liabilities
    
    
    
    
    
    
    61,668Total liabilities
    
    
    23,041,782
    
    
    
    16,809,432Shareholders equityCommon sharesAuthorized,
100,000,000 common shares, $0.001 par value
Issued, 46,826,834 shares issued and outstanding at
December 31, 2005 and March 31, 2005
    
    
    46,827
    
    
    
    46,827Additional paid-in capital
    
    
    17,920,408
    
    
    
    17,920,408Accumulated other comprehensive income
    
    
    669,443
    
    
    
    465,048Accumulated deficit
    
    
    (12,337,213
    )
    
    
    (13,165,716
    )Total shareholders equity
    
    
    6,299,465
    
    
    
    5,266,567Total liabilities and shareholders equity
    
    $
    29,341,247
    
    
    $
    22,075,999
 - 1 -




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##### 



DATAWAVE SYSTEMS INC.
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 
 Three months ended December 31,
    
    
    Nine months ended December 31,2005
    
    
    2004
    
    
    2005
    
    
    2004RevenueSales
    
    $
    6,473,285
    
    
    $
    4,903,379
    
    
    $
    17,860,199
    
    
    $
    11,138,480Net agency sales (Note 5)
    
    
    2,178,840
    
    
    
    1,845,108
    
    
    
    6,096,016
    
    
    
    5,456,537Total revenue
    
    
    8,652,125
    
    
    
    6,748,487
    
    
    
    23,956,215
    
    
    
    16,595,017Operating costs and expensesCost of
revenues (exclusive of
depreciation and amortization)
    
    
    5,818,378
    
    
    
    4,424,719
    
    
    
    16,004,943
    
    
    
    10,354,656General and administrative
    
    
    1,126,148
    
    
    
    773,206
    
    
    
    3,128,609
    
    
    
    2,351,874Selling and marketing
    
    
    462,211
    
    
    
    562,264
    
    
    
    1,512,516
    
    
    
    1,388,638Product development
    
    
    445,475
    
    
    
    305,435
    
    
    
    1,239,208
    
    
    
    926,836Depreciation and amortization
    
    
    373,254
    
    
    
    328,454
    
    
    
    1,111,725
    
    
    
    881,103Merger costs (Note 6)
    
    
    
    
    
    
    32,229
    
    
    
    
    
    
    
    199,244Total operating costs and expenses
    
    
    8,225,466
    
    
    
    6,426,307
    
    
    
    22,997,001
    
    
    
    16,102,351Operating income
    
    
    426,659
    
    
    
    322,180
    
    
    
    959,214
    
    
    
    492,666Other income
    
    
    54,390
    
    
    
    (644
    )
    
    
    127,524
    
    
    
    2,250Gain on foreign exchange
    
    
    1,399
    
    
    
    4,650
    
    
    
    11,151
    
    
    
    40,433Income before income taxes
    
    
    482,448
    
    
    
    326,186
    
    
    
    1,097,889
    
    
    
    535,349Income taxes
    
    
    (144,291
    )
    
    
    
    
    
    
    (389,456
    )
    
    
    Equity income from investee (Note
3(e))
    
    
    55,608
    
    
    
    55,309
    
    
    
    120,070
    
    
    
    87,121Net income
    
    $
    393,765
    
    
    $
    381,495
    
    
    $
    828,503
    
    
    $
    622,470Net income per share basic
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.02
    
    
    $
    0.01 diluted
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01Weighted-average number of common
shares basic
    
    
    46,826,834
    
    
    
    43,889,334
    
    
    
    46,826,834
    
    
    
    43,889,334 diluted
    
    
    56,434,647
    
    
    
    43,889,334
    
    
    
    56,207,691
    
    
    
    43,889,334
  - 2 -




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##### 



DATAWAVE SYSTEMS INC.
 CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
As at December 31, 2005 and March 31, 2005
(Expressed in United States dollars, except share amounts)
(Unaudited)
 
 AccumulatedNumber of
    
    
    
    
    
    
    Additional
    
    
    Other
    
    
    
    
    
    
    TotalCommon
    
    
    Common
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Accumulated
    
    
    ShareholdersShares
    
    
    Shares
    
    
    Capital
    
    
    Income
    
    
    Deficit
    
    
    EquityBalance, April 1, 2004
    
    
    43,889,334
    
    
    $
    15,006,743
    
    
    $
    2,725,492
    
    
    $
    277,966
    
    
    $
    (13,829,163
    )
    
    $
    4,181,038Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    622,470
    
    
    
    622,470Foreign currency
translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    91,842
    
    
    
    
    
    
    
    91,842Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    714,312Balance, December 31,
2004
    
    
    43,889,334
    
    
    $
    15,006,743
    
    
    $
    2,725,492
    
    
    $
    369,808
    
    
    $
    (13,206,693
    )
    
    $
    4,895,350Issuance of shares
    
    
    2,937,500
    
    
    
    235,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    235,000Reclassification to
additional paid-in
capital on emigration
    
    
    
    
    
    
    (15,194,916
    )
    
    
    15,194,916
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,977
    
    
    
    40,977Foreign currency
translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    95,240
    
    
    
    
    
    
    
    95,240Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136,217Balance, March 31, 2005
    
    
    46,826,834
    
    
    
    46,827
    
    
    
    17,920,408
    
    
    
    465,048
    
    
    
    (13,165,716
    )
    
    
    5,266,567Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    828,503
    
    
    
    828,503Foreign currency
translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    204,395
    
    
    
    
    
    
    
    204,395Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,032,898Balance,
December 31, 2005
    
    
    46,826,834
    
    
    $
    46,827
    
    
    $
    17,920,408
    
    
    $
    669,443
    
    
    $
    (12,337,213
    )
    
    $
    6,299,465
  - 3 -




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##### 



DATAWAVE SYSTEMS INC.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 
 Nine months ended December 31,2005
    
    
    2004Operating activitiesNet income
    
    $
    828,503
    
    
    $
    622,470Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    1,111,725
    
    
    
    881,103Equity income from investee
    
    
    (120,070
    )
    
    
    (87,121
    )Amortization of lease inducement
    
    
    (2,594
    )
    
    
    17,724Net change in non-cash operating assets and liabilitiesAccounts receivable and other
    
    
    (828,787
    )
    
    
    (1,459,451
    )Inventories
    
    
    (3,233,138
    )
    
    
    (2,556,662
    )Prepaid expenses and deposits
    
    
    (138,232
    )
    
    
    31,690Other long term receivables
    
    
    887
    
    
    
    Accounts payable and accrued liabilities
    
    
    4,544,251
    
    
    
    5,710,480Deferred revenue
    
    
    253,006
    
    
    
    607,126Net cash provided by operating activities
    
    
    2,415,551
    
    
    
    3,767,359Investing activityPurchase of machinery and equipment
    
    
    (627,673
    )
    
    
    (785,523
    )Net cash used in investing activity
    
    
    (627,673
    )
    
    
    (785,523
    )Financing activityRepayment of capital lease obligations
    
    
    (58,350
    )
    
    
    (50,031
    )Net cash used in financing activity
    
    
    (58,350
    )
    
    
    (50,031
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    80,483
    
    
    
    210,799Increase in cash
    
    
    1,810,011
    
    
    
    3,142,604Cash and cash equivalents, beginning of period
    
    
    4,560,512
    
    
    
    906,406Cash and cash equivalents, end of period
    
    $
    6,370,523
    
    
    $
    4,049,010Supplemental disclosures of cash flow information:Cash paid during the period for:Interest
    
    $
    7,873
    
    
    $
    11,204Income taxes
    
    $
    19,076
    
    
    $
    
  - 4 -




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##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 1.
    
    DESCRIPTION OF BUSINESS
  2.
    
    SIGNIFICANT ACCOUNTING POLICIES
 (a)
    
    Basis of presentation
   (b)
    
    Use of estimates
  (c)
    
    Stock-based compensation
 Accounting for Stock-Based Compensation-Transition
and Disclosure Accounting for Stock Based Compensation
 - 5 -




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##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 2.
    
    SIGNIFICANT ACCOUNTING POLICIES
 (c)
    
    Stock-based compensation (continued)
    Three Months
    
    
    Three MonthsEnded
    
    
    EndedDec 31, 2005
    
    
    Dec 31, 2004Expected life (years)
    
    
    
    
    
    
    Expected volatility
    
    
    
    
    
    
    Risk-free interest rate
    
    
    
    
    
    
    
   Three Months
    
    
    Three MonthsEnded
    
    
    EndedDec 31, 2005
    
    
    Dec 31, 2004Net income  as reported
    
    $
    393,765
    
    
    $
    381,495Add: 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
    
    
    (12,072
    )
    
    
    (1,644
    )Pro-forma net income
    
    $
    381,693
    
    
    $
    379,851Net income per share  as reportedBasic
    
    $
    0.01
    
    
    $
    0.01Diluted
    
    $
    0.01
    
    
    $
    0.01Net income per share  pro-formaBasic
    
    $
    0.01
    
    
    $
    0.01Diluted
    
    $
    0.01
    
    
    $
    0.01
 - 6 -




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##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 2.
    
    SIGNIFICANT ACCOUNTING POLICIES
 (c)
    
    Stock-based compensation (continued)
  Nine Months
    
    Nine MonthsEnded
    
    EndedDec 31, 2005
    
    Dec 31, 2004Expected life (years)
    
    
    3.35
    
    
    
    Expected volatility
    
    
    136.0
    %
    
    
    Risk-free interest rate
    
    
    4.25
    %
    
    
    
   Nine Months
    
    
    Nine MonthsEnded
    
    
    EndedDec 31, 2005
    
    
    Dec 31, 2004Net income  as reported
    
    $
    828,503
    
    
    $
    622,470Add: 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
    
    
    (47,237
    )
    
    
    (10,019
    )Pro-forma net income
    
    $
    781,266
    
    
    $
    612,451Net income per share  as reportedBasic
    
    $
    0.02
    
    
    $
    0.01Diluted
    
    $
    0.01
    
    
    $
    0.01Net income per share  pro-formaBasic
    
    $
    0.02
    
    
    $
    0.01Diluted
    
    $
    0.01
    
    
    $
    0.01
 - 7 -




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##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 3.
    
    BALANCE SHEET DETAILS
 (a)
    
    Accounts receivable and other
 December 31,
    
    
    March 31,2005
    
    
    2005Trade accounts receivable  POSA
    
    $
    6,887,826
    
    
    $
    4,499,592Trade accounts receivable  prepaid long distance
    
    
    2,150,125
    
    
    
    2,638,597Less allowance for doubtful accounts
    
    
    (28,450
    )
    
    
    (96,360
    )Other receivables
    
    
    257,018
    
    
    
    324,883$
    9,266,519
    
    
    $
    7,366,712
 (b)
    
    Inventories
 December 31,
    
    
    March 31,2005
    
    
    2005PINs and cellular time
    
    $
    6,942,833
    
    
    $
    3,274,233Cards and long-distance phone time
    
    
    496,788
    
    
    
    646,139Parts and supplies
    
    
    209,531
    
    
    
    235,242$
    7,649,152
    
    
    $
    4,155,614
 (c)
    
    Machinery and equipment
 December 31, 2005Accumulated
    
    Net BookCost
    
    Depreciation
    
    ValueVending equipment
    
    $
    3,816,312
    
    
    $
    3,393,475
    
    
    $
    422,837POSA equipment
    
    
    2,450,035
    
    
    
    1,748,957
    
    
    
    701,078Computer equipment and
software
    
    
    2,225,522
    
    
    
    1,368,786
    
    
    
    856,736Other
    
    
    551,338
    
    
    
    167,523
    
    
    
    383,815$
    9,043,207
    
    
    $
    6,678,741
    
    
    $
    2,364,466
 March 31, 2005Accumulated
    
    Net BookCost
    
    Depreciation
    
    ValueVending equipment
    
    $
    3,796,883
    
    
    $
    3,336,090
    
    
    $
    460,793POSA equipment
    
    
    1,969,809
    
    
    
    1,207,702
    
    
    
    762,107Computer equipment and
software
    
    
    1,921,569
    
    
    
    1,102,811
    
    
    
    818,758Other
    
    
    553,887
    
    
    
    141,974
    
    
    
    411,913$
    8,242,148
    
    
    $
    5,788,577
    
    
    $
    2,453,571
 - 8 -




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##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 3.
    
    BALANCE SHEET DETAILS (Continued)
 (d)
    
    Accounts payable and accrued liabilities
 December 31,
    
    
    March 31,2005
    
    
    2005Trade accounts payable  PINs and cellular
time
    
    $
    12,734,661
    
    
    $
    8,663,602Trade accounts payable  prepaid long distance
    
    
    3,111,467
    
    
    
    3,209,064Trade accounts payable  other
    
    
    597,038
    
    
    
    500,659Accrued compensation and benefits
    
    
    92,285
    
    
    
    56,620Co-op and rebate accruals
    
    
    804,232
    
    
    
    312,993Long-distance time accruals
    
    
    587,191
    
    
    
    599,098Other accrued liabilities
    
    
    2,006,562
    
    
    
    1,089,165State local, GST (net) and other taxes payable
    
    
    593,834
    
    
    
    116,221$
    20,527,270
    
    
    $
    14,547,422
 (e)
    
    Equity investment
   (f)
    
    Convertible promissory note
  - 9 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 4.
    
    COMMON SHARES
 (a)
    
    Net income per shareThe following table sets out the computation of basic and diluted net income per
common share. Basic income per share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
income per share is calculated by dividing net income by the sum of the weighted
average number of common shares outstanding and all additional common shares that
would have been outstanding if potentially dilutive common shares had been issued
during the period. The treasury stock method is used to calculate the dilutive
effect of options and warrants.
 Three months ended December 31,2005
    
    
    2004Numerator:Net income
    
    $
    393,765
    
    
    $
    381,495Denominator:Weighted average common shares outstanding
    
    
    46,826,834
    
    
    
    43,889,334Effect of dilutive securitiesStock Options
    
    
    2,107,813
    
    
    
    Convertible
promissory note
(non-interest
bearing)
    
    
    7,500,000
    
    
    
    Diluted weighted average common shares
outstanding
    
    
    56,434,647
    
    
    
    43,889,334Basic net income per share
    
    $
    0.01
    
    
    $
    0.01Diluted net income per share
    
    $
    0.01
    
    
    $
    0.01
 - 10 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 4.
    
    COMMON SHARES (Continued)
 (a)
    
    Net income per share (Continued)
 Nine months ended December 31,2005
    
    
    2004Numerator:Net income
    
    $
    828,503
    
    
    $
    622,470Denominator:Weighted average common shares outstanding
    
    
    46,826,834
    
    
    
    43,889,334Effect of dilutive securitiesStock Options
    
    
    1,880,857
    
    
    
    Convertible
promissory note
(non-interest
bearing)
    
    
    7,500,000
    
    
    
    Diluted weighted average common shares
outstanding
    
    
    56,207,691
    
    
    
    43,889,334Basic net income per share
    
    $
    0.02
    
    
    $
    0.01Diluted net income per share
    
    $
    0.01
    
    
    $
    0.01
 For the three and nine month period ended December 31, 2005, securities not included
in the diluted net income per share computation were 895,000 options (December 31,
2004  872,500).
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES
 (a)
    
    Segmented informationDataWave manufactures and operates prepaid calling card merchandising machines and
re-sells long distance telephone time through prepaid and other calling cards
distributed through its machines, at retail locations and on a wholesale basis to
third parties. DataWave considers its business to consist of one reportable
operating segment, therefore these consolidated financial statements have not been
segmented.DataWaves revenues are primarily generated from the resale of prepaid long distance
and cellular telephone time, principally from the sale of prepaid calling cards and
point-of-sale activated PINs. Sales of prepaid calling cards and point-of-sale
activated PINs under third party brands where DataWave is not the primary obligor of
the related phone service and has no significant continuing obligation with respect
to operation of the card subsequent to sale are recognized at the date of sale on a
net basis.DataWave has total sales, net agency sales, and costs of revenues (exclusive of
depreciation and amortization) analyzed by product, as follows:
 - 11 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)
 (a)
    
    Segmented information (Continued)
 Prepaid
    
    
    
    
    
    PrepaidLong
    
    Prepaid
    
    Internet
    
    Fees andDistance
    
    Cellular
    
    Products
    
    Service
    
    Other
    
    TotalThree months ended December 31, 2005Canada
    
    $
    3,691,185
    
    
    $
    
    
    
    $
    10,119
    
    
    $
    676,000
    
    
    $
    12,946
    
    
    $
    4,390,250U.S.
    
    
    1,877,881
    
    
    
    
    
    
    
    
    
    
    
    157,132
    
    
    
    44,047
    
    
    
    2,079,060Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,975
    
    
    
    3,975Sales
    
    
    5,569,066
    
    
    
    
    
    
    
    10,119
    
    
    
    833,132
    
    
    
    60,968
    
    
    
    6,473,285Canada
    
    
    
    
    
    
    40,703,756
    
    
    
    69,482
    
    
    
    
    
    
    
    
    
    
    
    40,773,238U.S.
    
    
    2,003,573
    
    
    
    1,219,382
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,222,955Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    2,003,573
    
    
    
    41,923,138
    
    
    
    69,482
    
    
    
    
    
    
    
    
    
    
    
    43,996,193Less payments to
suppliers
    
    
    (824,213
    )
    
    
    (40,929,129
    )
    
    
    (64,011
    )
    
    
    
    
    
    
    
    
    
    
    (41,817,353
    )Net agency sales
    
    
    1,179,360
    
    
    
    994,009
    
    
    
    5,471
    
    
    
    
    
    
    
    
    
    
    
    2,178,840Canada
    
    
    3,691,185
    
    
    
    955,795
    
    
    
    15,590
    
    
    
    676,000
    
    
    
    12,946
    
    
    
    5,351,516U.S.
    
    
    3,057,241
    
    
    
    38,214
    
    
    
    
    
    
    
    157,132
    
    
    
    44,047
    
    
    
    3,296,634Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,975
    
    
    
    3,975Total revenue
    
    
    6,748,426
    
    
    
    994,009
    
    
    
    15,590
    
    
    
    833,132
    
    
    
    60,968
    
    
    
    8,652,125Cost of revenues
    
    
    5,690,673
    
    
    
    
    
    
    
    9,002
    
    
    
    118,703
    
    
    
    
    
    
    
    5,818,378Margin
    
    $
    1,057,753
    
    
    $
    994,009
    
    
    $
    6,588
    
    
    $
    714,429
    
    
    $
    60,968
    
    
    $
    2,833,747Three months ended December 31, 2004Canada
    
    $
    2,807,322
    
    
    $
    
    
    
    $
    1,550
    
    
    $
    574,177
    
    
    $
    
    
    
    $
    3,383,049U.S.
    
    
    1,451,587
    
    
    
    
    
    
    
    
    
    
    
    (6,297
    )
    
    
    67,310
    
    
    
    1,512,600Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,730
    
    
    
    7,730Sales
    
    
    4,258,909
    
    
    
    
    
    
    
    1,550
    
    
    
    567,880
    
    
    
    75,040
    
    
    
    4,903,379Canada
    
    
    
    
    
    
    26,053,523
    
    
    
    110,406
    
    
    
    
    
    
    
    
    
    
    
    26,163,929U.S.
    
    
    1,954,187
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,954,187Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    1,954,187
    
    
    
    26,053,523
    
    
    
    110,406
    
    
    
    
    
    
    
    
    
    
    
    28,118,116Less payments to
suppliers
    
    
    (603,987
    )
    
    
    (25,563,251
    )
    
    
    (105,770
    )
    
    
    
    
    
    
    
    
    
    
    (26,273,008
    )Net agency sales
    
    
    1,350,200
    
    
    
    490,272
    
    
    
    4,636
    
    
    
    
    
    
    
    
    
    
    
    1,845,108Canada
    
    
    2,807,322
    
    
    
    490,272
    
    
    
    6,186
    
    
    
    574,177
    
    
    
    
    
    
    
    3,877,957U.S.
    
    
    2,801,787
    
    
    
    
    
    
    
    
    
    
    
    (6,297
    )
    
    
    67,310
    
    
    
    2,862,800Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,730
    
    
    
    7,730Total revenue
    
    
    5,609,109
    
    
    
    490,272
    
    
    
    6,186
    
    
    
    567,880
    
    
    
    75,040
    
    
    
    6,748,487Cost of revenues
    
    
    4,297,408
    
    
    
    
    
    
    
    1,304
    
    
    
    126,007
    
    
    
    
    
    
    
    4,424,719Margin
    
    $
    1,311,701
    
    
    $
    490,272
    
    
    $
    4,882
    
    
    $
    441,873
    
    
    $
    75,040
    
    
    $
    2,323,768
 - 12 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)
 (a)
    
    Segmented information (Continued)
 Prepaid
    
    
    
    
    
    PrepaidLong
    
    Prepaid
    
    Internet
    
    Fees andDistance
    
    Cellular
    
    Products
    
    Service
    
    Other
    
    TotalNine months ended December 31, 2005Canada
    
    $
    11,103,725
    
    
    $
    
    
    
    $
    17,684
    
    
    $
    1,849,277
    
    
    $
    35,306
    
    
    $
    13,005,992U.S.
    
    
    4,464,982
    
    
    
    
    
    
    
    
    
    
    
    232,296
    
    
    
    140,206
    
    
    
    4,837,484Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,723
    
    
    
    16,723Sales
    
    
    15,568,707
    
    
    
    
    
    
    
    17,684
    
    
    
    2,081,573
    
    
    
    192,235
    
    
    
    17,860,199Canada
    
    
    
    
    
    
    109,327,837
    
    
    
    178,752
    
    
    
    
    
    
    
    
    
    
    
    109,506,589U.S.
    
    
    6,502,679
    
    
    
    2,340,687
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,843,366Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    6,502,679
    
    
    
    111,668,524
    
    
    
    178,752
    
    
    
    
    
    
    
    
    
    
    
    118,349,955Less payments to
suppliers
    
    
    (2,870,969
    )
    
    
    (109,215,251
    )
    
    
    (167,719
    )
    
    
    
    
    
    
    
    
    
    
    (112,253,939
    )Net agency sales
    
    
    3,631,710
    
    
    
    2,453,273
    
    
    
    11,033
    
    
    
    
    
    
    
    
    
    
    
    6,096,016Canada
    
    
    11,103,725
    
    
    
    2,366,172
    
    
    
    28,717
    
    
    
    1,849,277
    
    
    
    35,306
    
    
    
    15,383,197U.S.
    
    
    8,096,692
    
    
    
    87,101
    
    
    
    
    
    
    
    232,296
    
    
    
    140,206
    
    
    
    8,556,295Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,723
    
    
    
    16,723Total revenue
    
    
    19,200,417
    
    
    
    2,453,273
    
    
    
    28,717
    
    
    
    2,081,573
    
    
    
    192,235
    
    
    
    23,956,215Cost of revenues
    
    
    15,664,472
    
    
    
    
    
    
    
    15,362
    
    
    
    325,109
    
    
    
    
    
    
    
    16,004,943Margin
    
    $
    3,535,945
    
    
    $
    2,453,273
    
    
    $
    13,355
    
    
    $
    1,756,464
    
    
    $
    192,235
    
    
    $
    7,951,272Nine months ended December 31, 2004Canada
    
    $
    7,051,253
    
    
    $
    
    
    
    $
    1,550
    
    
    $
    1,592,099
    
    
    $
    
    
    
    $
    8,644,902U.S.
    
    
    2,276,427
    
    
    
    
    
    
    
    
    
    
    
    89,872
    
    
    
    82,422
    
    
    
    2,448,721Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,857
    
    
    
    44,857Sales
    
    
    9,327,680
    
    
    
    
    
    
    
    1,550
    
    
    
    1,681,971
    
    
    
    127,279
    
    
    
    11,138,480Canada
    
    
    
    
    
    
    66,737,211
    
    
    
    250,857
    
    
    
    
    
    
    
    
    
    
    
    66,988,068U.S.
    
    
    5,021,195
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,021,195Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross proceeds
received on agency
sales
    
    
    5,021,195
    
    
    
    66,737,211
    
    
    
    250,857
    
    
    
    
    
    
    
    
    
    
    
    72,009,263Less payments to
suppliers
    
    
    (870,946
    )
    
    
    (65,442,507
    )
    
    
    (239,273
    )
    
    
    
    
    
    
    
    
    
    
    (66,552,726
    )Net agency sales
    
    
    4,150,249
    
    
    
    1,294,704
    
    
    
    11,584
    
    
    
    
    
    
    
    
    
    
    
    5,456,537Canada
    
    
    7,051,253
    
    
    
    1,294,704
    
    
    
    13,134
    
    
    
    1,592,099
    
    
    
    
    
    
    
    9,951,190U.S.
    
    
    6,426,676
    
    
    
    
    
    
    
    
    
    
    
    89,872
    
    
    
    82,422
    
    
    
    6,598,970Mexico
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,857
    
    
    
    44,857Total revenue
    
    
    13,477,929
    
    
    
    1,294,704
    
    
    
    13,134
    
    
    
    1,681,971
    
    
    
    127,279
    
    
    
    16,595,017Cost of revenues
    
    
    10,082,291
    
    
    
    
    
    
    
    1,304
    
    
    
    271,061
    
    
    
    
    
    
    
    10,354,656Margin
    
    $
    3,395,638
    
    
    $
    1,294,704
    
    
    $
    11,830
    
    
    $
    1,410,910
    
    
    $
    127,279
    
    
    $
    6,240,361
 - 13 -




---



##### 



DATAWAVE SYSTEMS INC.
 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)
 5.
    
    BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)
 (b)
    
    Concentration of sales and economic dependence
   6.
    
    RELATED PARTY TRANSACTIONS
 rd
 - 14 -




---



##### 



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 You should read the following discussion and analysis in conjunction with our consolidated
financial statements and related notes included elsewhere in this Report. Except for historical
information, the following discussion contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. See Note Regarding Forward Looking Statements
above.
 Overview
  Managements Summary
      - 15 -




---



##### 



Selected Financial Operating Data for the Three Month Periods Ended December 31, 2005 and 2004
 Three months Ended December 312005
    
    
    2004
    
    
    2005
    
    
    2004$000
    
    
    $000
    
    
    Percentage of RevenueRevenueSales
    
    $
    6,473
    
    
    $
    4,903
    
    
    
    74.8
    %
    
    
    72.7
    %Net agency sales
    
    
    2,179
    
    
    
    1,845
    
    
    
    25.2
    %
    
    
    27.3
    %Total revenue
    
    
    8,652
    
    
    
    6,748
    
    
    
    100.0
    %
    
    
    100.0
    %Operating costs and expensesCost of revenues (exclusive
of depreciation and
amortization)
    
    
    5,818
    
    
    
    4,425
    
    
    
    67.2
    %
    
    
    65.6
    %General and administrative
    
    
    1,126
    
    
    
    773
    
    
    
    13.0
    %
    
    
    11.5
    %Selling and marketing
    
    
    462
    
    
    
    562
    
    
    
    5.3
    %
    
    
    8.3
    %Product development
    
    
    446
    
    
    
    306
    
    
    
    5.2
    %
    
    
    4.5
    %Merger costs
    
    
    
    
    
    
    32
    
    
    
    0.0
    %
    
    
    0.5
    %Depreciation and amortization
    
    
    373
    
    
    
    328
    
    
    
    4.3
    %
    
    
    4.9
    %Total operating costs and expenses
    
    
    8,225
    
    
    
    6,426
    
    
    
    95.0
    %
    
    
    95.3
    %Operating income
    
    
    427
    
    
    
    322
    
    
    
    5.0
    %
    
    
    4.7
    %Other income (loss)
    
    
    54
    
    
    
    (1
    )
    
    
    0.6
    %
    
    
    0.0
    %Foreign exchange (loss)
    
    
    1
    
    
    
    5
    
    
    
    0.0
    %
    
    
    0.1
    %Income before income taxes
    
    
    482
    
    
    
    326
    
    
    
    5.6
    %
    
    
    4.8
    %Income taxes
    
    
    (144
    )
    
    
    
    
    
    
    (1.6
    %)
    
    
    0.0
    %Equity gain (loss) from investee
    
    
    56
    
    
    
    55
    
    
    
    0.6
    %
    
    
    0.8
    %Net income
    
    $
    394
    
    
    $
    381
    
    
    
    4.6
    %
    
    
    5.6
    %
 Three Months Ended December 31, 2005 compared to the Three Months Ended December 31, 2004
 Revenues
    - 16 -




---



##### 



Cost of Revenue (exclusive of depreciation and amortization)
     General and Administrative Expenses
  
    
    salaries increased by $216,000 as a result of hiring additional staff in operations
and finance, including legal counsel;
    
    accounting, audit and consulting fees increased by $16,000;
    
    investor relations fees increased by $62,000, as a result of obtaining the services
of an investor relations firm;
 - 17 -




---



##### 




    
    occupancy costs including rent and telecommunication increased by $35,000; and
    
    office expenses increased by $24,000.
 Selling and Marketing Expense
  Product Development
   Depreciation and Amortization
    - 18 -




---



##### 



Selected Financial Operating Data for the Nine Month Periods Ended December 31, 2005 and 2004
 Nine months Ended December 312005
    
    
    2004
    
    
    2005
    
    
    2004$000
    
    
    $000
    
    
    Percentage of RevenueRevenueSales
    
    $
    17,860
    
    
    $
    11,138
    
    
    
    74.6
    %
    
    
    67.1
    %Net agency sales
    
    
    6,096
    
    
    
    5,457
    
    
    
    25.4
    %
    
    
    32.9
    %Total revenue
    
    
    23,956
    
    
    
    16,595
    
    
    
    100.0
    %
    
    
    100.0
    %Operating costs and expensesCost of revenues (exclusive
of depreciation and
amortization)
    
    
    16,005
    
    
    
    10,355
    
    
    
    66.8
    %
    
    
    62.4
    %General and administrative
    
    
    3,129
    
    
    
    2,351
    
    
    
    13.1
    %
    
    
    14.1
    %Selling and marketing
    
    
    1,512
    
    
    
    1,389
    
    
    
    6.3
    %
    
    
    8.4
    %Product development
    
    
    1,239
    
    
    
    927
    
    
    
    5.1
    %
    
    
    5.6
    %Merger costs
    
    
    
    
    
    
    199
    
    
    
    0.0
    %
    
    
    1.2
    %Depreciation and amortization
    
    
    1,112
    
    
    
    881
    
    
    
    4.6
    %
    
    
    5.3
    %Total operating costs and expenses
    
    
    22,997
    
    
    
    16,102
    
    
    
    95.9
    %
    
    
    97.0
    %Operating income
    
    
    959
    
    
    
    493
    
    
    
    4.1
    %
    
    
    3.0
    %Other income (loss)
    
    
    128
    
    
    
    2
    
    
    
    0.5
    %
    
    
    0.0
    %Foreign exchange (loss)
    
    
    11
    
    
    
    40
    
    
    
    0.0
    %
    
    
    0.2
    %Income before income taxes
    
    
    1,098
    
    
    
    535
    
    
    
    4.6
    %
    
    
    3.2
    %Income taxes
    
    
    (389
    )
    
    
    
    
    
    
    (1.6
    %)
    
    
    0.0
    %Equity gain (loss) from investee
    
    
    120
    
    
    
    87
    
    
    
    0.5
    %
    
    
    0.5
    %Net income
    
    $
    829
    
    
    $
    622
    
    
    
    3.5
    %
    
    
    3.7
    %
 Nine Months Ended December 31, 2005 compared to the Nine Months Ended December 31, 2004
 Revenues
    - 19 -




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##### 



As at December
    
    As at March31, 2005
    
    31, 2005CanadaPOSA terminals (owned)
    
    
    4,614
    
    
    
    3,858POSA terminals (serviced or host to host)
    
    
    842
    
    
    
    501United StatesDTMs
    
    
    856
    
    
    
    913Traditional machine units
    
    
    7
    
    
    
    7Over-the counter units (terminals)
    
    
    
    
    
    
    POSA terminals (owned)
    
    
    73
    
    
    
    27POSA terminals (serviced or host to host)
    
    
    150
    
    
    
    159MexicoPOSA terminals (serviced or host to host)
    
    
    200
    
    
    
    200Total
    
    
    6,742
    
    
    
    5,665
     Cost of Revenue (exclusive of depreciation and amortization)
    - 20 -




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##### 



General and Administrative Expenses
  
    
    salaries increased by $439,000 as a result of hiring additional staff in operations
and finance, including legal counsel;
    
    accounting, audit and consulting fees increased by $82,000;
    
    investor relations fees increased by $131,000, as a result of obtaining the services
of an investor relations firm; and
    
    occupancy costs including rent and telecommunication increased by $125,000.
 Selling and Marketing Expense
  Product Development
   Depreciation and Amortization
   - 21 -




---



##### 



Liquidity and Capital Resources
    
    
    net income for the period was $829,000:
    
    accounts payable and accrued liabilities increased by $4,544,000, including an
increase of $3,093,000 for wireless products (PINs and cellular airtime), and an
increase in other accounts payable and accrued liabilities of $1,525,000, offset by a
decrease of $74,000 for prepaid long distance products. All wireless accounts payable
balances were paid by the end of January 2006;
    
    accounts receivable increased by $829,000, and prepaid expenses and deposits
increased by $138,000;
    
    inventories increased by $3,233,000, primarily for prepaid cellular PINs products.
Inventories of prepaid cellular PINs at December 31, 2005 were $6,942,000; cellular PIN
inventory is maintained at approximately ten days sales (ten days sales (gross proceeds
of sales) for the same period last year) and the increase is the result of increased
sales activity; however, inventories for this quarter turned around in 15 days to
provide for increased sales activity during the quarter;
    
    depreciation, amortization and other operating expense net of equity income for the
period was $990,000; and
    
    deferred revenue increased by $253,000, mainly due to an increase in non-activated
PINs.
   - 22 -




---



##### 



Future Capital Needs and Resources
      Trend Information
     Off-Balance Sheet Arrangements
  - 23 -




---



##### 



Item 3 Controls and Procedures.
  Evaluation of disclosure controls and procedures
  No significant changes in internal controls
  - 24 -




---



##### 



PART II        OTHER INFORMATION
 
 Item 6 Exhibits
  ExhibitNumber
    
    
    
    
    
    Description3.1
    
    
    (1)
    
    
    State of Delaware Certificate of Domestication of DataWave Systems Inc.3.2
    
    
    (1)
    
    
    State of Delaware Certificate of Incorporation of DataWave Systems Inc.3.3
    
    
    (1)
    
    
    Bylaws of DataWave Systems Inc.31.1
    
    
    **
    
    
    Certification pursuant to
Section 302 of the Sarbanes  Oxley Act of 2002 of Joshua Emanuel31.2
    
    
    **
    
    
    Certification pursuant to
Section 302 of the Sarbanes  Oxley Act of 2002 of John Gunn32.1
    
    
    **
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
Of The Sarbanes-Oxley Act Of 2002 of Josh Emanuel32.2
    
    
    **
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
Of The Sarbanes-Oxley Act Of 2002 of John Gunn
 **
    
    Filed herewith(1)
    
    Previously filed as an exhibit to, and incorporated herein by reference from, the Companys
8K report filed on March 1, 2004.
 
 - 25 -




---



##### 



SIGNATURES
  DataWave Systems Inc.(Registrant)By
    
    /s/ Joshua EmanuelChairman and Chief Executive OfficerDate
    
    February 14, 2006By
    
    /s/ John GunnGeneral Manager, Chief Financial OfficerDate
    
    February 14, 2006
 - 26 -