-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LK+hwHioDriy/dQXMklE0IK7D6bg+AKuYfV0jo/t1034TA9Z0Nv57Zw92BkFM934 ACDo8lLzuy2CrucPEAhntA== 0000912057-02-038503.txt : 20021015 0000912057-02-038503.hdr.sgml : 20021014 20021011193422 ACCESSION NUMBER: 0000912057-02-038503 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020831 FILED AS OF DATE: 20021015 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DPAC TECHNOLOGIES CORP CENTRAL INDEX KEY: 0000784770 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 330033759 STATE OF INCORPORATION: CA FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-14843 FILM NUMBER: 02788063 BUSINESS ADDRESS: STREET 1: 7321 LINCOLN WAY CITY: GARDEN GROVE STATE: CA ZIP: 92641 BUSINESS PHONE: 7148980007 MAIL ADDRESS: STREET 1: 7321 LINCOLN WAY CITY: GARDEN GROVE STATE: CA ZIP: 92641 FORMER COMPANY: FORMER CONFORMED NAME: DENSE PAC MICROSYSTEMS INC DATE OF NAME CHANGE: 19920703 10-Q 1 a2091039z10-q.htm FORM 10-Q
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2002

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-14843

DPAC TECHNOLOGIES CORP.
(Exact Name of Registrant Issuer as Specified in Its Charter)

CALIFORNIA		33-0033759
(State or other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

7321 LINCOLN WAY
GARDEN GROVE, CALIFORNIA 92841
(Address of Principal Executive Offices) (Zip)

(714) 898-0007
(Registrant's Telephone Number, Including Area Code)

Not Applicable
(Former Name, Former Address and Former Fiscal Year
If Changed Since Last Report)

Indicate by Check Mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý NO o

APPLICABLE ONLY TO CORPORATE REGISTRANTS

The number of shares of common stock, no par value, outstanding as of August 31, 2002 was 21,049,029.

PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

DPAC Technologies Corp.

Condensed Balance Sheets

			August 31, 2002			February 28, 2002
			(unaudited)
ASSETS
Current Assets:
	Cash and cash equivalents		$	9,029,322		$	6,258,836
	Accounts receivable, net			2,407,739			3,673,779
	Inventories, net			1,008,142			1,172,384
	Deferred income taxes			91,822			—
	Prepaid expenses and other current assets			479,708			505,221

		Total current assets		13,016,733			11,610,220
Property, net				4,163,028			4,580,929
Goodwill				4,528,721			4,782,921
Deferred income taxes				4,267,893			—
Other assets				349,754			367,283

			$	26,326,129		$	21,341,353

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion of capital lease obligations		$	426,206		$	472,577
	Accounts payable			556,585			943,930
	Accrued compensation			769,004			1,013,707
	Other accrued liabilities			394,473			298,913
	Deferred revenue			—			15,000

		Total current liabilities		2,146,268			2,744,127
Capital lease obligations, less current portion				199,908			421,176
Commitments and contingenticies (Note 8)
Stockholders' equity
	Common stock			24,949,444			24,868,200
	Additional paid in capital			2,665,253			—
	Accumulated deficit			(3,634,744	)		(6,692,150	)

		Total stockholders' equity		23,979,953			18,176,050

			$	26,326,129		$	21,341,353

See accompanying notes to condensed financial statements.

DPAC Technologies Corp.

Condensed Statements of Operations

(Unaudited)

			For the quarter ended:						For the six months ended:
			August 31, 2002			August 31, 2001			August 31, 2002			August 31, 2001
NET SALES			$	10,882,890		$	8,201,071		$	22,819,740		$	15,654,462
COST OF SALES				7,964,483			5,685,700			17,075,385			10,924,767

GROSS PROFIT				2,918,407			2,515,371			5,744,355			4,729,695
COSTS AND EXPENSES:
	Selling, general and administrative			1,673,902			1,387,332			3,252,703			2,915,987
	Research and development			447,988			473,603			904,184			891,455
	Amortization of goodwill			—			194,485			—			387,939

		Total costs and expenses		2,121,890			2,055,420			4,156,887			4,195,381
INCOME FROM OPERATIONS				796,517			459,951			1,587,468			534,314

OTHER INCOME:
	Interest income			33,478			40,717			68,754			108,406
	Interest expense			(20,719	)		(39,301	)		(43,692	)		(70,663	)

		Total other income		12,759			1,416			25,062			37,743
INCOME BEFORE INCOME TAX BENEFIT				809,276			461,367			1,612,530			572,057
INCOME TAX BENEFIT				1,444,876			—			1,444,876			—

NET INCOME			$	2,254,152		$	461,367		$	3,057,406		$	572,057

NET INCOME PER SHARE:
	Basic		$	0.11		$	0.02		$	0.15		$	0.03

	Diluted		$	0.11		$	0.02		$	0.14		$	0.03

WEIGHTED AVERAGE SHARES OUTSTANDING:
	Basic			21,044,000			20,956,000			21,030,000			20,950,000

	Diluted			21,305,000			21,338,000			21,464,000			21,176,000

See accompanying notes to condensed financial statements.

DPAC Technologies Corp.

Condensed Statements of Cash Flows

(Unaudited)

		For the six months ended
		August 31, 2002			August 31, 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net income	$	3,057,406		$	572,057
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
	Depreciation and amortization		708,175			1,101,406
	Deferred income taxes		(1,440,262	)		—
Changes in operating assets and liabilities:
	Accounts receivable		1,266,040			280,342
	Inventories		164,242			857,789
	Other assets		43,042			(274,435	)
	Accounts payable		(387,345	)		(499,706	)
	Accrued compensation		(244,703	)		(32,056	)
	Other accrued liabilities		95,560			(328,263	)
	Deferred revenue		(15,000	)		(348,365	)

Net cash provided by operations:			3,247,155			1,328,769

CASH FLOWS FROM INVESTING ACTIVITIES:
	Property additions		(290,274	)		(283,338	)
	Payment of acquisition related income tax obligation		—			(1,545,649	)

Net cash used in investing activities:			(290,274	)		(1,828,987	)

CASH FLOWS FROM FINANCING ACTIVITIES:
	Principal payments on other long-term debt		(267,639	)		(256,093	)
	Proceeds from issuance of common stock		81,244			66,590

Net cash used in financing activities			(186,395	)		(189,503	)
NET INCREASE (DECREASE) IN CASH			2,770,486			(689,721	)
CASH & CASH EQUIVALENTS, BEGINNING OF PERIOD			6,258,836			5,346,525

CASH & CASH EQUIVALENTS, END OF PERIOD		$	9,029,322		$	4,656,804

SUPPLEMENTAL CASH FLOW INFORMATION:
	Interest paid	$	43,692		$	70,663

	Income taxes paid	$	27,000		$	1,545,000

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
	Acquisition of property under capital leases	$	—		$	177,980

	Reversal of valuation allowance to paid in capital	$	2,665,253		$	—

See accompanying notes to condensed financial statements.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1—General Background

DPAC Technologies Corp. (formerly Dense-Pac Microsystems, Inc.) ("we," "us," "DPAC" or the "Company") is a technology company that provides patented component packaging technology to create high-density, space-saving surface mount electronic components. High-density design and manufacturing allows customers to meet their electronic system performance and time-to-market objectives for maximum system integration. Our products are used in applications such as network servers, computer storage devices, guidance systems, medical instrumentation and communication electronics. The Company also provides outsourced engineering design services to aid customers in creating cost-saving circuit designs as well as contract manufacturing of prototype designs and medium volume production runs of circuit boards. We were formed as a California corporation on September 7, 1983. On August 10, 2001, Dense-Pac Microsystems, Inc. stockholders voted in favor of changing the Company name to DPAC Technologies Corp.

NOTE 2—Basis of Presentation

The accompanying unaudited interim Condensed Financial Statements of DPAC as of August 31, 2002 and for the three and six months ended August 31, 2002 and 2001, reflect all adjustments (consisting of normal recurring accruals) which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for completed-year financial statements.

These financial statements should be read in conjunction with the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended February 28, 2002. Operating results for the three and six months ended August 31, 2002 are not necessarily indicative of the results that may be expected for the full year ending February 28, 2003.

NOTE 3—Recent Accounting Pronouncements

On March 1, 2002 the Company adopted the provisions of Statement of Financial Accounting Standards, ("SFAS No. 142"), "Goodwill and Other Intangible Assets". SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. Goodwill and intangible assets that have indefinite useful lives are not amortized into results of operations, but instead are evaluated at least annually for impairment and written down when the recorded value exceeds the estimated fair value. As a result, the Company has ceased amortization of goodwill. The effect of the change in accounting during the three and six month periods ended August 31, 2002 was

to increase net income by $194,000, or $0.01 per basic and diluted share, and by $388,000, or $0.02 per basic and diluted share, respectively.

		For the three months ended August 31,				For the six months ended August 31,
		2002		2001		2002		2001
Net income as reported		$	2,254,152	$	461,367	$	3,057,406	$	572,057
Add back amortization of goodwill			—		194,485		—		387,939

Adjusted net income		$	2,254,152	$	655,852	$	3,057,406	$	959,996

Net income per share, basic
	As reported	$	0.11	$	0.02	$	0.15	$	0.03
	Amortization of goodwill		—		0.01		—		0.02

	Adjusted net income per share	$	0.11	$	0.03	$	0.15	$	0.05

Net income per share, diluted
	As reported	$	0.11	$	0.02	$	0.14	$	0.03
	Amortization of goodwill		—		0.01		—		0.02

	Adjusted net income per share	$	0.11	$	0.03	$	0.14	$	0.05

Also in August 2001, the FASB issued Statement of Financial Accounting Standard No. 144 ("SFAS No. 144"), Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. This new statement also supersedes certain aspects of Accounting Principles Board ("APB") 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, with regard to reporting the effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations in the period incurred (rather than as of the measurement date as presently required by APB 30). In addition, more dispositions may qualify for discontinued operations treatment. The provisions of this statement are required to be applied for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company has adopted SFAS No. 144 effective March 1, 2002, and such adoption did not have a material impact on the Company's financial statements.

NOTE 4—Stock Options

The following table summarizes stock option activity under DPAC's 1985 and 1996 Stock Option Plans for the six months ended August 31, 2002:

		Number of Shares		Exercise Price Per Share		Number of Options Exercisable
Balance, February 28, 2002		2,579,520		$	.94 - 7.56	1,210,628

	Granted	447,700		$	3.10 - 3.50
	Exercised	(63,000	)	$	1.00 - 2.56
	Canceled	(31,250	)	$	1.00 - 6.00

Balance, August 31, 2002		2,932,970		$	.94 - 7.56	1,607,629

At August 31, 2002, a total of 3,024,515 shares were available for grant under all of the Company's stock option plans.

NOTE 5—Earnings Per Share

The Company computes net income per share in accordance with SFAS No. 128, Earnings Per Share. Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities by including other common stock equivalents, such as stock options, in the weighted average number of shares outstanding, if dilutive.

The table below sets forth the reconciliation of the denominator of the earnings per share calculations:

	Three months ended August 31,
	2002	2001
Shares used in computing basic net income per share	21,044,000	20,956,000
Dilutive effect of stock options	261,000	382,000

Shares used in computing diluted net income per share	21,305,000	21,338,000
	Six months ended August 31,
	2002	2001
Shares used in computing basic net income per share	21,030,000	20,950,000
Dilutive effect of stock options	434,000	226,000

Shares used in computing diluted net income per share	21,464,000	21,176,000

NOTE 6—SEGMENT INFORMATION

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company's chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance.

Subsequent to the acquisition of Productivity Enhancement Products, Inc. ("PEP") in fiscal 2001, the Company began reporting results under three operating segments, the "Advanced Packaging Group", the "System Design Group" and the "Value Added Manufacturing Group" based on the structure of the two companies and the operating reports reviewed and used by the Company's CEO at that time. As the Company integrated PEP during fiscal 2002, the personnel, facilities, accounting systems, and overhead structures were combined with DPAC. The initially identified operating segments also began to combine and share resources, including facilities, management, and sales, production, and development personnel. As a result, the Company has discontinued the preparation of separate financial information for the three segments and Company's CEO is now reviewing financial information and making operational decisions based upon the Company as a whole. Due to these changes, the Company combined the previously reported three operating segments into single operating segment as of November 30, 2001 and expects to continue with such reporting structure in future periods.

The Company had export sales (primarily to Western European customers) accounting for approximately 29% and 3% of net sales for the three months ended August 31, 2002 and 2001, and 22% and 3% for the six months ended August 31, 2002 and 2001, respectively.

NOTE 7—INCOME TAXES

In the quarter ended August 31, 2002, the Company reversed a valuation allowance on its deferred tax assets totaling $4,359,715. Based on the nature of the underlying deferred tax assets, the reversal of the valuation allowance resulted in an increase to additional paid-in capital of $2,665,253, a reduction

of Goodwill in the amount of $254,200, and a net income tax benefit of $1,444,876. This reversal is the result of the Company's recent sustained history of operating profitability and the determination by management that the future realization of the net deferred tax assets was judged to be more likely than not. The Company exercises significant judgment relating to the projection of future taxable income to determine the recoverability of any tax assets recorded on the balance sheet. If judgments regarding recoverability of deferred tax assets are not accurate, the Company could be required to record additional reserves against deferred tax assets in future periods.

NOTE 8—COMMITMENTS AND CONTINGENTICIES

Legal Proceedings

Use of the name DPAC below also includes a reference to the name Dense-Pac Microsystems, Inc., the company's corporate name until changed in fiscal year 2001.

On September 23, 1998, DPAC was served with a complaint from SimpleTech (formerly Simple Technology, Inc.), filed in U.S. District Court for the Central District of California, Santa Ana Division, alleging that DPAC's stacking technology infringed on a SimpleTech stacking patent. On October 23, 1998, DPAC filed a counterclaim in the same action for patent infringement against SimpleTech alleging that SimpleTech was infringing upon DPAC's earlier issued patent.

On April 11, 2000, DPAC filed suit, in Superior Court for the State of California, Orange County, against SimpleTech and its Chief Operating Officer. The complaint alleged trade secret misappropriation, unfair competition and intentional and negligent interference with prospective business advantages. DPAC dismissed the suit without prejudice on February 28, 2001.

On February 8, 2001, the U.S. District Court for the Central District of California ruled that SimpleTech did not infringe DPAC's patent. On March 29, 2001, the U.S. District Court for the Central District of California ruled that DPAC did not infringe on the SimpleTech patent and entered a final judgment of no liability. As part of the ruling DPAC was awarded court costs. On April 17, 2001, SimpleTech's appeal was docketed in the U.S. Court of Appeals for the Federal Circuit.

On March 5, 2002 the U.S. Court of Appeals heard the appeal. A decision on the appeal was reached on March 6, 2002, confirming the lower court's ruling that DPAC did not infringe on the SimpleTech patent and awarded DPAC court costs.

On February 21, 2001, DPAC was served with a new complaint from SimpleTech, filed in U.S. District Court for the Central District of California, for an undetermined amount, alleging that DPAC's stacking technology infringes on SimpleTech's reissued stacking patent. DPAC intends to vigorously defend itself against these charges. The ultimate outcome or any resulting potential loss is not presently determinable.

On June 7, 2002, SimpleTech petitioned the U.S. Supreme Court for review of the U.S. Court of Appeals affirmance.

On September 9, 2002, the lawsuit filed on February 21, 2001 was dismissed without prejudice by joint stipulation of SimpleTech and DPAC. The lawsuit filed on September 23, 1998 is currently set for review with the U.S. Supreme Court.

ITEM 2—Management's Discussion and Analysis of Financial Condition and Results of Operations.

FORWARD-LOOKING STATEMENTS

Included in the Notes to Financial Statements, this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Report are statements that do not present historical information. These are forward-looking statements, which reflect the Company's current expectations. Although the Company believes that its expectations are based on reasonable assumptions, there can be no assurance that the Company's financial goals or expectations will be realized. Numerous factors may affect the Company's actual results and may cause results to differ materially from those expressed in forward-looking statements made by or on behalf of the Company. Our web site is at www.DPACtech.com. The information on our website is not part of this report.

Some of these factors include risks and uncertainties in regard to demand for and acceptance of new and existing products, technological advances and product obsolescence, availability of semiconductor devices at reasonable prices, competitive factors, costs and risks concerning litigation, the ability to protect proprietary intellectual property, limited experience in acquisitions, business interruptions due to acts of terrorism or natural disasters, the availability of capital to finance growth, and changes in gross margin as a result of changes in product mix toward commercial memory stacking where the Company purchases and sells the memory. These and other factors which could cause actual results to differ materially from those in the forward-looking statements are discussed in greater detail in the Company's Annual Report on Form 10-K for the year ended February 28, 2002 as filed with the SEC on May 28, 2002, under the headings "Risk Factors" and "Cautionary Statements." Such Cautionary Statements are incorporated herein by this reference. Investors are cautioned against ascribing undue weight to any forward-looking statements herein or elsewhere. Additional cautionary statements are set forth below.

Concentration of Customers

DPAC's customer base is largely comprised of DRAM manufacturers, memory module manufacturers, and related businesses. These businesses are subject to volatility and the cyclical nature of the DRAM marketplace. There is risk of a significant impact to DPAC's revenues if one of our major customers was to be acquired, merge, consolidate, or close. There is no guarantee that current business relationships will prevail in the event of one of the above occurrences. Also, during the three and six months ended August 31, 2002, sales to two major customers accounted for 30% and 29%, and 23% and 37%, respectively, of net sales. Accounts receivable from these two customers accounted for 25% of total net accounts receivable at August 31, 2002. During the three and six months ended August 31, 2001, sales to two major customers accounted for 35% and 24%, and 37% and 22%, respectively, of net sales. Accounts receivable from these two customers accounted for 50% of total net accounts receivable at August 31, 2001. Any reduction in purchases by such customers could have a material adverse effect on our results of operations.

Plans for Acquisition

While we have no agreements or negotiations currently underway, we intend to pursue selective acquisitions to complement our internal growth. However, we are unable to predict whether or when any prospective acquisition candidate will become available or the likelihood that any acquisition will be completed. If we make any future acquisitions, we could issue stock that would dilute our shareholders' percentage ownership, incur substantial debt or assume contingent liabilities. We have limited experience in acquiring other businesses, product lines and technologies. In addition, the attention of our small management team may be diverted from our core business if we undertake an acquisition. An inability to overcome problems encountered in connection with such acquisitions also could divert

the attention of management, utilize scarce corporate resources and harm our business. Potential acquisitions also involve numerous risks, including, among others:

•: Problems assimilating the purchased operations, technologies or products;
•: Costs associated with the acquisition;
•: Adverse effects on existing business relationships with suppliers and customers;
•: Risks associated with entering markets in which we have no or limited prior experience;
•: Potential loss of key employees of purchased organizations; and
•: Potential litigation arising from the acquired company's operations before the acquisition.

Visability of Marketplace

DPAC's visability into the marketplace is limited due to increasing consolidation within the semiconductor market. This consolidation has resulted in turmoil and uncertainty as to some future developments of technology. As a result, the risks are high that:

•: The semiconductor companies attempt or are successful in bringing stacking in-house, using not only pre-packaged parts, but also "die" level stacking;
•: Competitors introduce other stacking methodology;
•: Module manufacturers and semiconductor packaging companies develop in-house stacking services;
•: DRAM pricing create a volatile marketplace reducing the demand for stacking; and
•: The transition to new technology, such as fBGA packaging could eliminate the need for stacking.

As a result, any of the above could have a negative effect on the financial performance of DPAC, potentially reducing revenues and/or placing future quarters into losses.

RESULTS OF OPERATIONS

Three Months Ended August 31, 2002 and 2001

Net Sales. Net sales for the quarter ended August 31, 2002 increased by $2.7 million or 33% to $10.9 million from $8.2 million for the quarter ended August 31, 2001. The increase in net sales was primarily due to a change in product mix toward a greater percentage of commercial stacking revenue that contained purchased memory. Stacking revenues containing purchased memory, or "memory stacking", involves DPAC purchasing memory chips, stacking them, and then selling the stacked product to the customer. In these cases where the costs of memory chips are included in the sales price of products, the Company will purchase material for the commercial order concurrently with finalizing the sales price thereof, in order to avoid any price volatility in the components. Revenues from memory stacking may vary significantly from period to period based not only on quantities shipped but also on the current market price of purchased memory. The balance of commercial stacking revenues is from "service stacking", where customers provide us with consigned memory chips and we configure and stack the memory to customer specifications. As there is no memory chip component cost to service stacking, revenues per unit are significantly lower than revenues per unit of memory stacking sales. Of total revenue in the second quarter of fiscal year 2003, approximately 70% was related to memory stacking and 13% to service stacking, as compared with 41% and 39%, respectively, in the second quarter of fiscal year 2002. The remaining sales are primarily related to the industrial, defense and aerospace sectors. The quantity of total commercial stacks shipped during the second quarter of fiscal

year 2003 remained flat from the comparable period of the previous fiscal year. See "Forward-Looking Statements."

Gross Profit. Gross profit in the second quarter of fiscal 2003 increased by $403,000 or 16% from the comparable prior period. The increase in gross profit in absolute dollars is attributable to the increase in revenue offset by lower prices for stacking services. Gross profit as a percentage of sales decreased to 27% for the quarter ended August 31, 2002, as compared to 31% for the quarter ended August 31, 2001. The decrease in the gross margin percentage can primarily be attributed to the increased percentage of revenues from memory stacking, which has a lower gross margin than revenues derived from service stacking, due to low margins on the memory component of the sales price.

The Company believes that it has been able to define a niche for products that use a unique proprietary stacking technology and has been marketing these products to a defined market. During the second quarter of fiscal year 2003, the Company continued its offering of commercial products and focused on those products that relate to the Company's proprietary packaging technology. Additionally, the Company has numerous products that have been designed into industrial, defense and aerospace applications. DPAC is beginning to see some impact on its business due to the continued turmoil in the semiconductor industry and it is unknown at this time whether or not there will be a change in demand for these proprietary products. See "Forward-Looking Statements."

Selling, General and Administrative. Selling, general and administrative expenses increased in the second quarter of fiscal year 2003 by $287,000 or 21% from the second quarter of the prior fiscal year. As a percentage of net sales, selling, general and administrative expenses decreased to 15% of net sales for the quarter ended August 31, 2002 as compared to 17% for the same period in the prior fiscal year. The increase in absolute dollars in selling, general and administrative expenses is mainly attributed to increased levels of expense associated with compensation, legal fees, investor relations, and recruitment fees.

Research and Development. Research and development costs decreased by $26,000 or 5% for the quarter ended August 31, 2002 from the second quarter of the prior fiscal year. For the quarter ended August 31, 2002, research and development expense represented 4% of net sales as compared to 6% of net sales from the same quarter in the previous fiscal year. The amount in absolute dollars spent on research and development has remained relatively constant year over year. The continued investment in research and development is primarily due to continued efforts to allocate resources to the development and production of unique new technologies. The Company is continuing to invest in research and development for new products in the advanced technology marketplace. See "Forward-Looking Statements."

Interest. For the three months ended August 31, 2002, interest income decreased by $7,000 from the same period last year. This change primarily relates to the impact that declining interest rates have on the amount we are able to earn on our cash balances. Interest expense decreased by $19,000 for the same period due to the decline in the amount of our debt balances, which are at fixed interest rates.

Income Taxes. During the quarter ended August 31, 2002, the Company recorded a net income tax benefit of $1,444,876 which reflects the reversal of a previously recorded valuation allowance against deferred income tax assets. This reversal is the result of the Company's recent sustained history of operating profitability and the prospects of the realization of the deferred tax benefits. The Company exercises judgment relating to projected future taxable income to determine the recoverability of any tax assets recorded on the balance sheet. If judgments regarding recoverability of deferred tax assets are not accurate, the Company could be required to record additional income tax expense in future periods. The effective income tax rate for the quarter ended August 31, 2001 was zero. The Company expects to record an income tax provision in future periods at approximately the statutory tax rates.

Six Months Ended August 31, 2002 and 2001

Net Sales. Net sales for the six months ended August 31, 2002 of $22.8 million increased by $7.2 million or 46% from $15.7 million for the six months ended August 31, 2001. The increase in net sales was primarily due to a change in product mix toward a greater percentage of commercial stacking revenue that contained purchased memory, or memory stacking. Of total revenue in the first half of fiscal year 2003, approximately 70% related to memory stacking and 14% to service stacking, as compared with 42% and 31%, respectively, in the first half of fiscal year 2002. Additionally, the total quantity of stacks shipped during the first half of fiscal year 2003 increased by 34% over the same period in the previous fiscal year. This increase in units shipped was partially offset from a revenue perspective by a decrease in pricing for stacking services.

Gross Profit. Gross profit for the six months ended August 31, 2002 increased by $1.0 million or 21% from the same period in the previous fiscal year. The increase in gross profit is attributable to the increase in stacks shipped and partially offset by lower prices for stacking services. Gross profit as a percentage of sales decreased to 25% for the six months ended August 31, 2002, as compared to 30% for the same period in the prior fiscal year. The decrease in the gross margin percentage can primarily be attributed to the increased percentage of revenues from memory stacking, which has a lower gross margin than revenues derived from service stacking, due to low margins on the memory component on the sales price.

Selling, General and Administrative. Selling, general and administrative expenses increased by $337,000 or 12% for the six months ended August 31, 2002 as compared to the same period in the prior fiscal year. As a percentage of net sales, selling, general and administrative expenses decreased to 14% of net sales for the period ended August 31, 2002 as compared to 19% for the same period in the prior fiscal year. The increase in absolute dollars in selling, general and administrative expenses is primarily attributed to incurred acquisition search costs of $180,000, and increased levels of compensation expense, recruitment fees, insurance premiums, and investor relations. These increases were partially offset by lower legal fees and savings realized with the consolidation of facilities, completed in fiscal year 2002.

Research and Development. For the six months ended August 31, 2002, research and development, in terms of absolute dollars, remained almost constant as compared to the same period in the previous fiscal year. For the first half of fiscal year 2003, research and development expense represented 4% of net sales as compared to 6% of net sales for the same period in the previous fiscal year. The continued investment in research and development is primarily due to continued efforts to allocate resources to the development and production of unique new technologies. The Company is continuing to invest in research and development for new products in the advanced technology marketplace. See "Forward-Looking Statements."

Interest. For the six months ended August 31, 2002, interest income decreased by $40,000 from the same period last year. This change primarily relates to the impact that declining interest rates have on the amount we are able to earn on our cash balances. Interest expense decreased by $27,000 for the same period due to the decline in the amount of our debt balances, which are at fixed interest rates.

Income Taxes. During the six months ended August 31, 2002, the Company recorded a net income tax benefit of $1,444,876 which reflects the reversal of a previously recorded valuation allowance against deferred income tax assets. This reversal is the result of the Company's recent sustained history of operating profitability and the prospects of the realization of the deferred tax benefits. The Company exercises judgment relating to projected future taxable income to determine the recoverability of any tax assets recorded on the balance sheet. If judgments regarding recoverability of deferred tax assets are not accurate, the Company could be required to record additional income tax expense in future periods. The effective income tax rate for the six months ended August 31, 2001 was

zero. The Company expects to record an income tax provision in future periods at approximately the statutory tax rates.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary source of liquidity for the six months ended August 31, 2002 and August 31, 2001 was from cash provided by operations. The Company believes that our working capital position, including cash and cash equivalents, and the expected cash flow from operations will be sufficient to meet the Company's operating cash needs for the next twelve months. Additionally, the Company has available at August 31, 2002 a credit facility for three million dollars from a financial institution, which we can utilize if the need should arise for additional working capital to support operations. The credit facility contains certain financial covenants, including minimum tangible net worth requirements. The Company was in compliance with all covenants at August 31, 2002. See "Forward-Looking Statements."

Net cash provided by operating activities was approximately $3,247,000 during the six months ended August 31, 2002 and substantially consisted of net income, non-cash depreciation expense, and a decrease in accounts receivable, partially offset by an increase in deferred income taxes. For the six months ended August 31, 2001, net cash provided by operating activities was approximately $1,329,000 and consisted primarily of net income and non-cash depreciation and amortization expense.

The Company purchased for cash approximately $290,000 and $283,000 in new equipment during the six months ended August 31, 2002 and 2001, respectively. The Company expects that it may incur additional lease debt with the acquisition of additional equipment during the next nine months. The Company expects that it will not acquire more than one million dollars in additional equipment for the remainder of the fiscal year. See "Forward-Looking Statements." The Company also paid a $1.5 million tax liability assumed in the Productivity Enhancement Products acquisition during the first quarter ended May 31, 2001.

Net cash used in financing activities was approximately $186,000 and $190,000 for the six months ended August 31, 2002 and 2001, respectively, and principally relates to debt repayments offset by proceeds from the issuance of common stock.

New Accounting Pronouncements

See Note 3 to financial statements in Item 1.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

The Company invests excess cash in money market funds. Money market funds do not have maturity dates and do not present a material market risk. For the three-month period covered by this Report, interest expense was not sensitive to any changes in the general level of U.S. interest rates because our debt instruments, consisting principally of capital lease agreements, were based on fixed interest rates.

PART II—OTHER INFORMATION

Item 1—Legal Proceedings

Use of the name DPAC below also includes a reference to the name Dense-Pac Microsystems, Inc., the company's corporate name until changed in fiscal year 2001.

On June 7, 2002, SimpleTech petitioned the U.S. Supreme Court for review of the U.S. Court of Appeals affirmance.

Item 2—Changes in Securities

None

Item 3—Defaults Upon Senior Securities

None

Item 4—Controls and Procedures

During the quarter ended August 31, 2002, we evaluated our disclosure controls and procedures and believe that they are effective in the timely recording, processing, summarizing and reporting material financial and non-financial information in our filings.

During the quarter ended August 31, 2002, we did not make any significant changes in, nor take any corrective actions regarding, our internal controls or other factors that could significantly affect

these controls. We review our internal controls for effectiveness on an ongoing basis, including routine reviews during this period. We plan to continue our review process, including both internal and external audit examinations, as part of our evaluation of our disclosure controls and internal controls.

Item 5—Submission of Matters to a Vote of Security Holders

None

Item 6—Exhibits and Reports on Form 8-K

(a)	Exhibits
	99.1	Cautionary Statements are incorporated herein by reference to pages 19 through 25, inclusive, of the Registrant's Form 10-K filed May 28, 2002 with the Securities and Exchange Commission.
	99.2	Certification of Chief Executive Officer and Chief Financial Officer.
	99.3	Silicon Valley Bank Loan Agreement
(b)	Reports on Form 8-K—No reports on Form 8-K were filed during the six months of fiscal year 2003 covered by this Form 10-Q.

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.

	DPAC TECHNOLOGIES CORP. (Registrant)
October 14, 2002	By:	/s/ TED BRUCE
Date		Ted Bruce, Chief Executive Officer
October 14, 2002	By:	/s/ WILLIAM M. STOWELL
Date		William M. Stowell, Chief Financial Officer

CERTIFICATIONS

I, Ted Bruce, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of DPAC Technologies Corp.;

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: October 14, 2002
/s/ TED BRUCE Ted Bruce Chief Executive Officer

I, William M. Stowell, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of DPAC Technologies Corp.;

2.

3.

4.

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: October 14, 2002
/s/ WILLIAM M. STOWELL William M. Stowell Chief Financial Officer

EXHIBIT INDEX

Exh. No.		Description
99.1		Cautionary Statements
99.2		Certification of Chief Executive Officer and Chief Financial Officer
99.3		Silicon Valley Bank Loan Agreement

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PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

DPAC Technologies Corp. Condensed Balance Sheets
DPAC Technologies Corp. Condensed Statements of Operations (Unaudited)
DPAC Technologies Corp. Condensed Statements of Cash Flows (Unaudited)
DPAC TECHNOLOGIES CORP. NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

ITEM 2—Management's Discussion and Analysis of Financial Condition and Results of Operations.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

PART II—OTHER INFORMATION

Item 1—Legal Proceedings

Item 2—Changes in Securities

Item 3—Defaults Upon Senior Securities

Item 4—Controls and Procedures

Item 5—Submission of Matters to a Vote of Security Holders

Item 6—Exhibits and Reports on Form 8-K

SIGNATURES
CERTIFICATIONS
EXHIBIT INDEX
EX-99.1 3 a2091039zex-99_1.htm EXHIBIT 99.1
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EXHIBIT 99.1

Cautionary Statements

Statements in this Prospectus which are not historical facts, including all statements about the Company's business strategy or expectations, or information about new and existing products and technologies or market characteristics and conditions, are forward-looking statements that involve risks and uncertainties. These include, but are not limited to, the factors described below which could cause actual results to differ from those contemplated by the forward-looking statements.

Product Development and Technological Change

The semiconductor and memory module industries are characterized by rapid technological change and are highly competitive with respect to timely product innovation. The Company's memory products are subject to obsolescence or price erosion because semiconductor manufacturers are continuously introducing chips with the same or greater memory density as the Company's custom modules. As a result, memory products typically have a product life of not more than three to five years.

The Company's future success depends on its ability to develop new products and product enhancements to keep up with technological advances and to meet customer needs. Any failure by the Company to anticipate or respond adequately to technological developments and customer requirements, or any significant delays in product development or introduction, could have a material adverse effect on the Company's financial condition and results of operations.

There can be no assurance that the Company will be successful in its product development or marketing efforts, or that the Company will have adequate financial or technical resources for future product development and promotion.

Uncertainty of Market Acceptance or Profitability of New Products

The introduction of new products will require the expenditure of funds for research and development, tooling, manufacturing processes, inventory and marketing. In order to achieve high volume production, the Company will need to make substantial investments in inventory and capital equipment or, as currently contemplated, the Company will need to out-source production to third parties. The Company has limited marketing capabilities and resources and is dependent upon internal sales and marketing personnel and a network of independent sales representatives for the marketing and sale of its products. There can be no assurance that our products will achieve or maintain market acceptance, result in increased revenues, or be profitable.

Parts Shortages and Over-Supplies and Dependence on Suppliers

The semiconductor industry is characterized by periodic shortages or over-supplies of parts which have in the past and may in the future negatively affect the Company's operations. The Company is dependent on a limited number of suppliers for semiconductor devices used in its products, and it has no long-term supply contracts with any of them.

Due to the cyclical nature of the semiconductor industry and competitive conditions, the Company may experience difficulties in meeting its supply requirements in the future. Any inability to obtain adequate deliveries of parts, either due to the loss of a supplier or industry-wide shortages, could delay shipments of the Company's products, increase its cost of goods sold and have a material adverse effect on its business, financial condition and results of operations. For example, the Company was not able to market its second-generation Dense-Stack product when it lost its source of SRAM die.

Concentration of Credit Risk

The Company grants credit to customers included in the military, aerospace, and a variety of commercial industries. Credit is extended based on an evaluation of the customer's financial condition

and collateral is not required. Estimated credit losses are provided for in the financial statements. During the year ended February 28, 2002, sales to three major customers accounted for 23%, 22% and 11% of net sales. Accounts receivable from these three customers accounted for 46% of total accounts receivable at February 28, 2002. During the year ended February 28, 2001, 45% of net sales were to one major customer. Accounts receivable from this customer accounted for 44% of total net accounts receivable at February 28, 2001. During the year ended February 29, 2000, sales to three major customers accounted for 29%, 12% and 11% of net sales. Accounts receivable from these three customers accounted for 38% of total net accounts receivable at February 29, 2000. A decision by a significant customer to substantially decrease or delay purchases from the Company or the Company's inability to collect receivables from these customers could have a material adverse effect on the Company's business, financial condition, and results of operations.

Dependence on Defense-Related Business

The Company has historically derived a portion of its revenues from defense-related contracts. As a result, the Company's business has been impacted by reductions in the federal defense budget and will continue to be subject to risks affecting the defense industry, including changes in governmental appropriations and changes in national defense policies and priorities. The Company has sought to reduce its dependence on defense-related business by developing products with commercial applications, although such products generally have lower margins than defense-related products.

Intellectual Property Rights

The Company's ability to compete effectively is dependent on its proprietary know-how, technology and patent rights. The Company holds U.S. patents on certain aspects of its 3-D stacking technology and has applied for additional patents. There can be no assurance that the Company's patent applications will be approved, that any issued patents will afford the Company's products any competitive advantage or will not be challenged or circumvented by third parties, or that patents issued to others will not adversely affect the sales, development or commercialization of the Company's present or future products.

Management of Growth

Successful expansion of the Company's operations will depend on, among other things, the ability to obtain new customers, to attract and retain skilled management and other personnel, to secure adequate sources of supply on commercially reasonable terms and to successfully manage growth. To manage growth effectively, the Company will have to continue to implement and improve its operational, financial and management information systems, procedures and controls. As the Company expands, it may from time to time experience constraints that will adversely affect its ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely affect the Company's financial condition and results of operations.

Competition

There are memory companies which offer or are in the process of developing three-dimensional products, including Irvine Sensors, Staktek, Samsung and others. Some of such companies have greater financial, manufacturing and marketing capabilities than the Company. The Company could also experience competition from established and emerging computer memory companies. There can be no assurance that the Company's products will be competitive with existing or future products, or that the Company will be able to establish or maintain a profitable price structure for its products.

Product Liability

In the course of its business, the Company may be subject to claims for product liability for which its insurance coverage is excluded or inadequate.

Variability of Gross Margin

Gross profit as a percentage of sales was 33% for fiscal year ended February 28, 2002 as compared to 28% for the fiscal year ended February 28, 2001, and 34% for the fiscal year ended February 29, 2000. Any change in the gross margins can typically be attributed to the type of products that the Company was selling during the year as well as the royalty income generated during the periods. As the Company markets its products both to military and aerospace, and commercial customers, the product mix that each category of the customers orders may be different and result in changes in the gross margin. Due to the various configuration and applications of the Company's product, prices range from less than $5 for commercial custom modules to over two thousand dollars for high-end military specification custom modules.

The Company expects that its net sales and gross margin may vary significantly based on these and other factors, including the mix of products sold and the manufacturing services provided, the channels through which the Company's products are sold, changes in product selling prices and component costs, the level of manufacturing efficiencies achieved and pricing by competitors. The selling prices of the Company's products may decline depending upon the price changes of DRAM, SRAM and Flash semiconductors, which would have a material adverse effect on the Company's net sales and could have a material adverse effect on the Company's business, financial condition and results of operation. Accordingly, the Company's ability to maintain or increase net sales will be highly dependent upon its ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in selling prices. Declining product selling prices may also materially and adversely affect the Company's gross margin unless the Company is able to reduce its cost per unit to offset declines in product selling prices. There can be no assurance that the Company will be able to increase unit sales volumes, introduce and sell new products or reduce its cost per unit. The Company also expects that its business may experience significant seasonality to the extent it sells a material portion of its products in Europe and to the extent its exposure to the personal computer market remains significant.

Decline of Demand for Product Due to Downturn of Related Industries

The Company may experience substantial period-to-period fluctuations in operating results due to factors affecting the semiconductor, computer, telecommunications and networking industries. From time to time, each of these industries has experienced downturns, often in connection with, or in anticipation of, declines in general economic conditions. A decline or significant shortfall in growth in any one of these industries could have a material adverse impact on the demand for the Company's products and therefore a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company's net sales and results of operations will not be materially and adversely affected in the future due to changes in demand from individual customers or cyclical changes in the semiconductor, computer, telecommunications, networking or other industries utilizing the Company's products.

Fluctuations in Operating Results

The Company's results of operations and gross margin have been subject to fluctuations from period to period. The primary factors that have affected and may in the future affect the Company's results of operations include adverse changes in the mix of products sold, the inability to procure required components, and the partial or complete loss of a principal customer or the reduction in

orders from a customer due to, among other things, excess product inventory accumulation by such customer. Other factors that have affected and may in the future affect the Company's results of operations include fluctuating market demand for and declines in the selling prices of the Company's products, decreases or increases in the costs of the components of the Company's products, market acceptance of new products and enhanced versions of the Company's products, the Company's competitors selling products that compete with the Company's products at lower prices or on better terms than the Company's products, delays in the introduction of new products and enhancements to existing products, manufacturing inefficiencies associated with the start up of new product introductions, and the Company's semiconductor customers manufacturing memory custom modules, internally or with other third parties, outside of the United States due to concerns about United States antidumping investigations and laws.

The Company's operating results may also be affected by the timing of new product announcements and releases by the Company or its competitors, the timing of significant orders, the ability to produce products in volume, delays, cancellations or rescheduling of orders due to customer financial difficulties or other events, inventory obsolescence, including the reduction in value of the Company's inventories due to price declines, unexpected product returns, the timing of expenditures in anticipation of increased sales, cyclicality in the Company's targeted markets, and expenses associated with acquisitions. In particular, declines in DRAM, SRAM and Flash semiconductor prices could affect the valuation of the Company's inventory which could result in adverse changes in the Company's business, financial condition and results of operations.

Sales of the Company's individual products and product lines toward the end of a product's life cycle are typically characterized by steep declines in sales, pricing and gross margin, the precise timing of which may be difficult to predict. The Company has experienced and could continue to experience unexpected reductions in sales of products as customers anticipate new product purchases. In addition, to the extent that the Company manufactures products in anticipation of future demand that does not materialize, or in the event a customer cancels outstanding orders during a period of either declining product selling prices or decreasing demand, the Company could experience an unanticipated decrease in sales of products. These factors could give rise to charges for obsolete or excess inventory, returns of products by distributors, or substantial price protection charges or discounts. In the past, the Company has had to write-down and write-off excess or obsolete inventory. To the extent that the Company is unsuccessful in managing product transitions, its business, financial condition and results of operations could be materially and adversely affected.

The need for continued significant expenditures for capital equipment purchases, research and development and ongoing customer service and support, among other factors, will make it difficult for the Company to reduce its operating expenses in any particular period if the Company's expectations for net sales for that period are not met. Accordingly, there can be no assurance that the Company will be able to continue to be profitable. The Company believes that period-to-period comparisons of the Company's financial results are not necessarily meaningful and should not be relied upon as indications of future performance. Due to the foregoing factors, it is likely that in some future period the Company's operating results will be below the expectations of public market analysts or investors. In such event, the market price of the Company's securities would be materially and adversely affected.

International Sales

In fiscal year 2002, approximately 12% of the Company's sales were export sales, primarily to Western Europe as compared to 4% in fiscal 2001 and 5% in fiscal year 2000. Foreign sales are made in U.S. dollars. The increase was primarily due to the addition of a significant new international customer in fiscal year 2002. International sales may be subject to certain risks, including changes in regulatory requirements, tariffs and other barriers, timing and availability of export licenses, political and economic instability, difficulties in accounts receivable collections, natural disasters, difficulties in

staffing and managing foreign subsidiary and branch operations, difficulties in managing distributors, difficulties in obtaining governmental approvals for telecommunications and other products, foreign currency exchange fluctuations, the burden of complying with a wide variety of complex foreign laws and treaties, potentially adverse tax consequences and uncertainties relative to regional, political and economic circumstances. Moreover and as a result of currency changes and other factors, certain of the Company's competitors may have the ability to manufacture competitive products in Asia at lower costs than the Company.

The Company is also subject to the risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. The Company cannot predict whether quotas, duties, taxes or other charges or restrictions upon the importation or exportation of the Company's products will be implemented by the United States or other countries. Because sales of the Company's products have been denominated to date in United States dollars, increases in the value of the United States dollar could increase the price of the Company's products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country. Future international activity may result in increased foreign currency denominated sales. Gains and losses on the conversion to United States dollars of accounts receivable, accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in the Company's results of operations. Some of the Company's customer's purchase orders and agreements are governed by foreign laws, which may differ significantly from United States laws. Therefore, the Company may be limited in its ability to enforce its rights under such agreements and to collect damages, if awarded. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business, financial condition and results of operations.

Limited Experience in Acquisition

We may pursue selective acquisitions to complement our internal growth. If we make any future acquisitions, we could issue stock that would dilute our shareholders' percentage ownership, incur substantial debt or assume contingent liabilities. We have limited experience in acquiring other businesses, product lines and technologies. In addition, the attention of our small management team may be diverted from our core business if we undertake an acquisition. Potential acquisitions also involve numerous risks, including, among others:

•: Problems assimilating the purchased operations, technologies or products;
•: Costs associated with the acquisition;
•: Adverse effects on existing business relationships with suppliers and customers;
•: Risks associated with entering markets in which we have no or limited prior experience;
•: Potential loss of key employees of purchased organizations; and
•: Potential litigation arising from the acquired company's operations before the acquisition.

Our inability to overcome problems encountered in connection with such acquisitions could divert the attention of management, utilize scarce corporate resources and harm our business. In addition, we are unable to predict whether or when any prospective acquisition candidate will become available or the likelihood that any acquisition will be completed.

Cyclical Nature of Semiconductor Industry

The semiconductor industry, including the memory markets in which we compete, is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and

demand. The industry has experienced significant downturns, often connected with, or in anticipation of, maturing product cycles of both semiconductor companies' and their customers' products and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturns could have a material adverse effect on our business and operating results. Furthermore, any upturn in the semiconductor industry could result in increased demand for, and possible shortages of, components we use to manufacture and assemble our ICs. Such shortages could have a material adverse effect on our business and operating results.

Product Returns And Order Cancellation

To the extent we manufacture products in anticipation of future demand that does not materialize, or in the event a customer cancels outstanding orders, we could experience an unanticipated increase in our inventory. In addition, while we may not be contractually obligated to accept returned products, we may determine that it is in our best interest to accept returns in order to maintain good relations with our customers. Product returns would increase our inventory and reduce our revenues. We have had to write-down inventory in the past for reasons such as obsolescence, excess quantities and declines in market value below our costs.

We have no long-term volume commitments from our customers except those subject to cancellation by the customer. Sales of our products are made through individual purchase orders and, in certain cases, are made under master agreements governing the terms and conditions of the relationships. Customers may change, cancel or delay orders with limited or no penalties. We have experienced cancellations of orders and fluctuations in order levels from period-to-period and we expect to continue to experience similar cancellations and fluctuations in the future which could result in fluctuations in our revenues.

Additional Capital Funding to Impair Value of Investment

If we expand more rapidly than currently anticipated or if our working capital needs exceed our current expectations, we may need to raise additional capital through public or private equity offerings or debt financings. Our future capital requirements depend on many factors including our research, development, sales and marketing activities. We do not know whether additional financing will be available when needed, or will be available on terms favorable to us. If we cannot raise needed funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. To the extent we raise additional capital by issuing equity securities, our shareholders may experience substantial dilution and the new equity securities may have greater rights, preferences or privileges than our existing common stock.

Geographic Concentration of Operation

All of our manufacturing operations are located in our facility in Garden Grove, California. Due to this geographic concentration, a disruption of our manufacturing operations, resulting from sustained process abnormalities, human error, government intervention or natural disasters such as earthquakes, fires or floods could cause us to cease or limit our manufacturing operations and consequently harm our business, financial condition and results of operations.

Compliance with Environmental Laws and Regulations

We are subject to a variety of environmental laws and regulations governing, among other things, air emissions, waste water discharge, waste storage, treatment and disposal, and remediation of releases of hazardous materials. Our failure to comply with present and future requirements could harm our

ability to continue manufacturing our products. Such requirements could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. The imposition of additional or more stringent environmental requirements, the results of future testing at our facilities, or a determination that we are potentially responsible for remediation at other sites where problems are not presently known to us, could result in expenses in excess of amounts currently estimated to be required for such matters.

Stock Price Volatility

The stock market in general, and the market for shares of technology companies in particular, has experienced extreme price fluctuations. These price fluctuations are often unrelated to the operating performance of the affected companies. Many technology companies, including the Company, have experienced dramatic volatility in the market prices of their common stock. If our future operating results are below the expectations of stock market analysts and investors, our stock price may decline. We cannot be certain that the market price of our common stock will remain stable in the future. Our stock price may undergo fluctuations that are material, adverse and unrelated to our performance.

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Cautionary Statements
EX-99.2 4 a2091039zex-99_2.htm EXHIBIT 99.2
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EXHIBIT 99.2

Periodic Report Certification
Of the Chief Executive Officer and Chief Financial Officer

I, Ted Bruce, Chief Executive Officer of DPAC Technologies Corp. (the "Company"), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge the Quarterly Report of DPAC Technologies Corp. on Form 10-Q for the quarterly period ended August 31, 2002, as filed with the Securities and Exchange Commission fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ TED BRUCE Ted Bruce Chief Executive Officer
October 14, 2002

I, William M. Stowell, Chief Financial Officer of DPAC Technologies Corp. (the "Company"), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge the Quarterly Report of DPAC Technologies Corp. on Form 10-Q for the quarterly period ended August 31, 2002, as filed with the Securities and Exchange Commission fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ WILLIAM M. STOWELL William M. Stowell Chief Financial Officer
October 14, 2002

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Periodic Report Certification Of the Chief Executive Officer and Chief Financial Officer
EX-99.3 5 a2091039zex-99_3.htm EXHIBIT 99.3
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Exhibit 99.3

This LOAN AND SECURITY AGREEMENT dated August 30, 2002 between SILICON VALLEY BANK ("Bank"), whose address is 3003 Tasman Drive, Santa Clara, California 95054 and DPAC TECHNOLOGIES CORP. ("Borrower"), whose address is 7321 Lincoln Way, Garden Grove, California 92841, provides the terms on which Bank will lend to Borrower and Borrower will repay Bank. The parties agree as follows:

1. ACCOUNTING AND OTHER TERMS

Accounting terms not determined in this Agreement will be construed following GAAP. Calculations and determinations must be made following GAAP. The term "financial statements" includes the notes and schedules. The terms "including" and "includes" always mean "including (or includes) without limitation," in this or any Loan Document.

2. LOAN AND TERMS OF PAYMENT

2.1 Promise to Pay.

Borrower promises to pay Bank the unpaid principal amount of all Credit Extensions and interest on the unpaid principal amount of the Credit Extensions.

2.1.1 Revolving Advances.

(a-1) At such time that the aggregate utilization amount with respect to advances hereunder ("Revolving Advances") is less than or equal to $1,000,000 (including any outstanding Letters of Credit and Revolving Advances arising from the Cash Management Services, and including the effect of the amount of any then requested Revolving Advance), the following shall apply: Bank will make Revolving Advances hereunder in an amount not to exceed the Committed Revolving Line minus the sum of (A) the amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) and (B) all amounts utilized for Cash Management Services. Amounts borrowed under this Section may be repaid and reborrowed during the term of this Agreement.

(a-2) At such time that the aggregate utilization amount with respect to Revolving Advances hereunder, exceeds $1,000,000 (including any outstanding Letters of Credit and Revolving Advances arising from the Cash Management Services, and including the effect of the amount of any then requested Revolving Advance), the following shall apply with respect to all Revolving Advances (whether below or above the $1,000,000 level): Bank will make Revolving Advances not exceeding: (i) the lesser of the Committed Revolving Line or the Borrowing Base; minus (ii) the sum of (A) the amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) and (B) all amounts utilized for Cash Management Services. Amounts borrowed under this Section may be repaid and reborrowed during the term of this Agreement. Revolving Advances that are made subject to the terms and provisions of this clause (a-2) are also referred to herein as the "Borrowing Base Advances."

(b) To obtain a Revolving Advance, Borrower must notify Bank by facsimile or telephone by 12:00 p.m. Pacific time on the Business Day the Revolving Advance is proposed to be made. Borrower must promptly confirm the notification by delivering to Bank the Payment/Advance Form, in the form attached hereto as Exhibit B. Bank will credit Revolving Advances to Borrower's deposit account. Bank may make Revolving Advances under this Agreement based on instructions from a Responsible Officer or his or her designee or without instructions if any such Revolving Advances are necessary to meet Obligations which have become due. Bank may rely on any telephonic notice given by a person whom Bank believes is a Responsible Officer or such Person's designee, and Borrower hereby indemnifies Bank for any loss Bank suffers due to any such reliance, other than that arising from the gross negligence or willful misconduct of Bank. Further, prior to the making of the first Borrowing Base Advance, Borrower shall comply with the Collateral audit and other applicable requirements set forth in Section 6.2 hereof.

(c) The Bank's undertaking to extend credit accommodations under the Committed Revolving Line terminates on the Revolving Maturity Date, when all Revolving Advances and related Obligations are immediately due and payable.

2.1.2 Letters of Credit Sublimit.

At such times that the provisions of 2.1.1(a-1) are in effect the following shall apply: Bank will issue or have issued letters of credit for Borrower's account (individually referred as a "Letter of Credit" and collectively referred to herein as the "Letters of Credit") not exceeding (i) the Committed Revolving Line, minus (ii) the outstanding principal balance of the Revolving Advances and minus (iii) the Cash Management Sublimit; however, the face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) may not exceed $500,000. Each Letter of Credit will have an expiry date of no later than 180 days after the Revolving Maturity Date, but Borrower's reimbursement obligation will be secured by cash on terms acceptable to Bank at any time after the Revolving Maturity Date if the term of this Agreement is not extended by Bank. Borrower agrees to execute any further documentation in connection with the Letters of Credit as Bank may reasonably request.

At such times that the provisions of 2.1.1(a-2) are in effect the following shall apply: Bank will issue or have issued letters of credit for Borrower's account (individually referred as a "Letter of Credit" and collectively referred to herein as the "Letters of Credit") not exceeding (i) the lesser of the Committed Revolving Line or the Borrowing Base, minus (ii) the outstanding principal balance of the Revolving Advances and minus (iii) the Cash Management Sublimit; however, the face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) may not exceed $500,000. Each Letter of Credit will have an expiry date of no later than 180 days after the Revolving Maturity Date, but Borrower's reimbursement obligation will be secured by cash on terms acceptable to Bank at any time after the Revolving Maturity Date if the term of this Agreement is not extended by Bank. Borrower agrees to execute any further documentation in connection with the Letters of Credit as Bank may reasonably request.

2.1.3 Cash Management Services Sublimit.

Borrower may use up to $500,000 for Bank's Cash Management Services (the "Cash Management Services Sublimit") for Bank's cash management services, which may include merchant services, business credit card, and check cashing services identified in various cash management services agreements related to such services (the "Cash Management Services"). The aggregate amounts utilized under the Cash Management Services Sublimit will at all times reduce the amount otherwise available to be borrowed under the Committed Revolving Line and new Cash Management Services may be extended only if the amount of such proposed new extension of such services would otherwise be available for the making of an Advance in such amount in accordance with the terms and provisions hereof. Any amounts Bank pays on behalf of Borrower or any amounts that are not paid by Borrower for any Cash Management Services will be treated as Revolving Advances under the Committed Revolving Line and will accrue interest at the rate for Revolving Advances.

2.2 Overadvances.

If Borrower's Obligations under Section 2.1 exceed the applicable lending limitations set forth therein, Borrower must immediately pay Bank the excess.

2.3 Interest Rate, Payments.

(a) Interest Rate. (i) Revolving Advances accrue interest on the outstanding principal balance at a per annum rate equal to the Prime Rate. After an Event of Default, Obligations accrue interest at five (5) percentage points above the rate effective immediately before the Event of Default. The interest

rate increases or decreases when the Prime Rate changes. Interest is computed on a 360 day year for the actual number of days elapsed.

(b) Payments. Interest due on the Committed Revolving Line is payable on the 25^th day of each month. Bank may debit any of Borrower's deposit accounts for principal and interest payments owing or any amounts Borrower owes Bank (Bank will promptly notify Borrower when it debits Borrower's accounts and these debits are not set-offs). Borrower may, however, provide written notice to Bank that it would like to switch from such a payment procedure to a written billing notification, and Bank agrees to implement such a change within a reasonable period of time after receipt of Borrower written request therefor. Payments received after 12:00 noon Pacific time are considered received at the opening of business on the next Business Day. When a payment is due on a day that is not a Business Day, the payment is due the next Business Day and additional fees or interest accrue.

2.4 Fees.

(a) Facility Fee. Borrower shall pay to Bank a fee of $12,500 concurrently herewith, which shall be in addition to interest and to all other amounts payable hereunder and which shall not be refundable. Bank acknowledges that it has received a deposit of $10,000 to be applied to the foregoing.

(b) Bank Expenses. Borrower shall pay to the Bank all Bank Expenses (including reasonable attorneys' fees and expenses) incurred through and after the Closing Date when due.

3. CONDITIONS OF LOANS

3.1 Conditions Precedent to Initial Credit Extension.

Bank's obligation to make the initial Credit Extension is subject to the condition precedent that it receive the agreements, documents and fees it requires relating to the transactions contemplated under this Agreement and all other Loan Documents.

3.2 Conditions Precedent to all Credit Extensions.

Bank's obligations to make each Credit Extension, including the initial Credit Extension, is subject to the following:

(a) timely receipt of any Payment/Advance Form; and

(b) the representations and warranties in Section 5 must be materially true on the date of the Payment/Advance Form and on the effective date of each Credit Extension and no Event of Default may have occurred and be continuing, or result from the Credit Extension. Each Credit Extension is Borrower's representation and warranty on that date that the representations and warranties of Section 5 are true, as the date made and as of the date such representations and warranties are deemed made.

4. CREATION OF SECURITY INTEREST

4.1 Grant of Security Interest.

Borrower grants Bank a continuing security interest in all presently existing and later acquired Collateral to secure all Obligations and performance of each of Borrower's duties under the Loan Documents. Except for Permitted Liens, any security interest will be a first priority security interest in the Collateral. Bank may place a "hold" on any deposit account pledged as Collateral. If this Agreement is terminated, Bank's lien and security interest in the Collateral will continue until Borrower fully satisfies its Obligations.

5. REPRESENTATIONS AND WARRANTIES

Borrower represents and warrants as follows:

5.1 Due Organization and Authorization.

Each of Borrower and each Subsidiary is duly existing and in good standing in its state of formation and qualified and licensed to do business in, and in good standing in, any state in which the conduct of its business or its ownership of property requires that it be qualified, except where the failure to do so could not reasonably be expected to cause a Material Adverse Change.

The execution, delivery and performance of the Loan Documents have been duly authorized, and do not conflict with Borrower's formation documents, nor constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement to which or by which it is bound in which the default could reasonably be expected to cause a Material Adverse Change.

5.2 Collateral.

Borrower has good title to the Collateral, free of Liens except Permitted Liens. The Accounts are bona fide, existing obligations, and the service or property has been performed or delivered to the account debtor or its agent for immediate shipment to, and unconditional acceptance by, the account debtor (other than with respect to warranties given by Borrower consistent with past practices and given in the ordinary course of Borrower's business). Borrower has no notice of any actual or imminent Insolvency Proceeding of any account debtor whose accounts are an Eligible Account in any Borrowing Base Certificate. All Inventory is in all material respects of good and marketable quality, free from material defects, other than for items of Inventory that are obsolete that are not material in value. Borrower is the owner or valid licensee of the Intellectual Property, except for non-exclusive licenses granted to its customers in the ordinary course of business. Each Patent is valid and enforceable and no part of the Intellectual Property has been judged invalid or unenforceable, in whole or in part, and no claim has been made that any part of the Intellectual Property violates the rights of any third party, except to the extent such claim could not reasonably be expected to cause a Material Adverse Change.

5.3 Litigation.

Except as shown in the Schedule, there are no actions or proceedings pending or, to the knowledge of Borrower's Responsible Officers, threatened by or against Borrower or any Subsidiary in which a likely adverse decision could reasonably be expected to cause a Material Adverse Change, other than for the existing patent infringement litigation with respect to Simpletech, as disclosed to Bank prior to the date hereof.

5.4 No Material Adverse Change in Financial Statements.

All consolidated financial statements for Borrower, and any Subsidiary, delivered to Bank fairly present in all material respects Borrower's consolidated financial condition and Borrower's consolidated results of operations. There has not been any material deterioration in Borrower's consolidated financial condition since the date of the most recent financial statements submitted to Bank.

5.5 Solvency.

The fair salable value of Borrower's assets (including goodwill minus disposition costs) exceeds the fair value of its liabilities; the Borrower is not left with unreasonably small capital after the transactions in this Agreement; and Borrower is able to pay its debts (including trade debts) as they mature.

5.6 Regulatory Compliance.

Borrower is not an "investment company" or a company "controlled" by an "investment company" under the Investment Company Act. Borrower is not engaged as one of its important activities in extending credit for margin stock (under Regulations T and U of the Federal Reserve Board of Governors). Borrower has complied in all material respects with the Federal Fair Labor Standards Act. Borrower has not violated any laws, ordinances or rules, the violation of which could reasonably be expected to cause a Material Adverse Change. None of Borrower's or any Subsidiary's properties or assets has been used by Borrower or any Subsidiary or, to the best of Borrower's knowledge, by previous Persons, in disposing, producing, storing, treating, or transporting any hazardous substance other than legally. Borrower and each Subsidiary has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes, except those being contested in good faith with adequate reserves under GAAP. Borrower and each Subsidiary has obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all government authorities that are necessary to continue its business as currently conducted, except where the failure to do so could not reasonably be expected to cause a Material Adverse Change.

5.7 Subsidiaries.

Borrower does not own any stock, partnership interest or other equity securities except for Permitted Investments.

5.8 Full Disclosure.

No written representation, warranty or other statement of Borrower in any certificate or written statement given to Bank (taken together with all such written certificates and written statements to Bank) contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained in the certificates or statements not misleading, with it being recognized by Bank that the projections and forecasts provided by Borrower in good faith and based upon reasonable assumptions are not viewed as facts and that actual results during the period or periods covered by such projections and forecasts may differ from the projected and forecasted results.

6. AFFIRMATIVE COVENANTS

Borrower will do all of the following for so long as Bank has an obligation to lend, or there are outstanding Obligations:

6.1 Government Compliance.

Borrower will maintain its legal existence and good standing and the legal existence and good standing of all Subsidiaries' in the applicable jurisdiction of formation and maintain qualification in each applicable jurisdiction in which the failure to so qualify or maintain such legal existence would reasonably be expected to cause a material adverse effect on Borrower's business or operations. Borrower will comply, and have each Subsidiary comply, with all laws, ordinances and regulations to which such party is subject to the extent that noncompliance therewith could have a material adverse effect on Borrower's business or operations or could reasonably be expected to cause a Material Adverse Change.

6.2 Financial Statements, Reports, Certificates.

(a) Borrower will deliver to Bank: (i) as soon as available, but no later than 30 days after the last day of each month, a company prepared consolidated balance sheet and income statement covering Borrower's consolidated operations during the period certified by a Responsible Officer and in a form acceptable to Bank; (ii) within 5 days of filing, copies of all statements, reports and notices made

available to Borrower's security holders or to any holders of Subordinated Debt and all reports and related financial statements on Form 10-K and 10-Q and 8-K filed with the Securities and Exchange Commission; (iii) a prompt report of any legal actions pending or threatened against Borrower or any Subsidiary that could result in damages or costs to Borrower or any Subsidiary of $100,000 or more; (iv) budgets, sales projections, operating plans or other financial information Bank reasonably requests; and (v) prompt notice of any material change in the composition of the Intellectual Property. It is agreed that Bank shall maintain confidential all non-public financial information delivered to Bank above in accordance with the confidentiality standards set forth in Section 12.8 hereof.

(b) (i) Within 20 days after the last day of each month when any Borrowing Base Advances are outstanding; or (ii) otherwise, immediately prior to the making of any Borrowing Base Advance, Borrower will deliver to Bank a Borrowing Base Certificate signed by a Responsible Officer in the form of Exhibit C, with aged listings of accounts receivable and accounts payable.

(c) Within 30 days after the last day of each month, Borrower will deliver to Bank with the monthly financial statements a Compliance Certificate signed by a Responsible Officer in the form of Exhibit D.

(d) Bank has the right to audit Borrower's Accounts and other Collateral (with results determined to be acceptable to Bank in accordance with the good faith business judgment of Bank) at Borrower's expense, but the audits will be conducted no more often than once every 12 months unless an Event of Default has occurred and is continuing, provided that, in any event, such an audit (with results determined to be acceptable to Bank in accordance with the good faith business judgment of Bank) shall be conducted upon the earlier to occur of (i) the Borrower's request for Revolving Advances under Section 2.1.1(a-1) of this Agreement when first made; or (ii) the date that is six (6) months from the date hereof; and, in any event, any such first audit shall be promptly initiated and completed (with results satisfactory to Bank) prior to the making of any Revolving Advances under Section 2.1.1(a-2).

6.3 Inventory; Returns.

Borrower will keep all Inventory in good and marketable condition, free from material defects. Returns and allowances between Borrower and its account debtors will follow Borrower's customary practices as they exist at execution of this Agreement. Borrower must promptly notify Bank of all returns, recoveries, disputes and claims by its account debtors that involve more than $50,000.

6.4 Taxes.

Borrower will make, and cause each Subsidiary to make, timely payment of all material federal, state, and local taxes or assessments (other than taxes and assessments which Borrower is contesting in good faith, with adequate reserves maintained in accordance with GAAP) and will deliver to Bank, on demand, appropriate certificates attesting to the payment.

6.5 Insurance.

Borrower will keep its business and the Collateral insured for risks and in amounts standard for Borrower's industry, and as Bank may reasonably request. Insurance policies will be in a form, with companies, and in amounts that are satisfactory to Bank in Bank's reasonable discretion. All property policies will have a lender's loss payable endorsement showing Bank as an additional loss payee and all liability policies will show the Bank as an additional insured and provide that the insurer must give Bank at least 20 days notice before canceling its policy. At Bank's request, Borrower will deliver certified copies of policies and evidence of all premium payments. Proceeds payable under any policy will, at Bank's option, be payable to Bank on account of the Obligations.

6.6 Primary Accounts.

Borrower will maintain its primary banking and investment account relationships with Bank, which relationships shall include Borrower maintaining deposit and investment account balances in accounts at or through Bank representing at least 85% of all such account balances of Borrower at any and all financial institutions.

6.7 Financial Covenant.

Borrower will maintain at all times and tested as of the last day of each month a ratio of (A) Quick Assets to (B) Current Liabilities plus any other Obligations of Borrower owing to Bank to the extent they are not otherwise categorized as Current Liabilities of Borrower, of at least 1.25 to 1.00.

6.8 Further Assurances.

Borrower will execute any further instruments and take further action as Bank reasonably requests to perfect or continue Bank's security interest in the Collateral or to effect the purposes of this Agreement.

7. NEGATIVE COVENANTS

Borrower will not do any of the following without Bank's prior written consent, which will not be unreasonably withheld, for so long as Bank has an obligation to lend or there are any outstanding Obligations:

7.1 Dispositions.

Convey, sell, lease, transfer or otherwise dispose of (collectively "Transfer"), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, except for Transfers (i) of Inventory in the ordinary course of business; (ii) of non-exclusive licenses and similar arrangements for the use of the property of Borrower or its Subsidiaries in the ordinary course of business; or (iii) of worn-out or obsolete Equipment; (iv) other Transfers which in the aggregate do not exceed $50,000 in any fiscal year; (v) use cash of Borrower in the ordinary course of business for ordinary course business operating expenses, all in accordance with past business practices of Borrower; or the (vi) the making of Permitted Investments.

7.2 Changes in Business, Ownership, Management or Business Locations.

Engage in or permit any of its Subsidiaries to engage in any business other than the businesses currently engaged in by Borrower or reasonably related thereto or have a material change in its senior executive management or have a material change in its ownership of greater than 25% (other than by the sale of Borrower's equity securities in a public offering or otherwise resulting from ordinary course publicly-traded market transfers). Borrower will not, without at least 30 days prior written notice, relocate its chief executive office or add any new offices or business locations in which Borrower maintains or stores over $50,000 in Borrower's assets or property.

7.3 Mergers or Acquisitions.

Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with any other Person, or acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person, except where: (i) no Default or Event of Default has occurred and is continuing or would result from such action during the term of this Agreement; (ii) such transaction would not result in a decrease of more than 25% of Tangible Net Worth; and (iii) upon the acquisition of any other Person as otherwise permitted pursuant to the terms of this Section, such Person become

an obligor (whether as a primary or third surety of the Obligations, as determined by Bank) relating to the Obligations hereunder, as the Bank may determine, and shall execute such agreements, documents and instruments as are reasonably necessary or appropriate, as the Bank may determine, in order to evidence such debt obligations and to establish a first priority security interest in the personal property assets of such Person in favor of Bank, subject to Permitted Liens. A Subsidiary may merge or consolidate into another Subsidiary or into Borrower as long as no Default or Event of Default is occurring prior thereto or arises thereafter.

7.4 Indebtedness.

Create, incur, assume, or be liable for any Indebtedness, or permit any Subsidiary to do so, other than Permitted Indebtedness.

7.5 Encumbrance.

Create, incur, or allow any Lien on any of its property, or assign or convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries to do so, except for Permitted Liens, or permit the first priority lien status of Bank regarding the Collateral to change, subject only to Permitted Liens as may be applicable.

7.6 Distributions; Investments.

Directly or indirectly acquire or own any Person, or make any Investment in any Person, other than Permitted Investments, or permit any of its Subsidiaries to do so. Pay any dividends or make any distribution or payment or redeem, retire or purchase any capital stock.

7.7 Transactions with Affiliates.

Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for transactions that are in the ordinary course of Borrower's business, upon fair and reasonable terms that are no less favorable to Borrower than would be obtained in an arm's length transaction with a nonaffiliated Person.

7.8 Subordinated Debt.

Make or permit any payment on any Subordinated Debt, except under the terms of the Subordinated Debt, or amend any provision in any document relating to the Subordinated Debt without Bank's prior written consent.

7.9 Compliance.

Become an "investment company" or a company controlled by an "investment company," under the Investment Company Act of 1940 or undertake as one of its important activities extending credit to purchase or carry margin stock, or use the proceeds of any Credit Extension for that purpose; fail to meet the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the Federal Fair Labor Standards Act or violate any other law or regulation, if the violation could reasonably be expected to have a material adverse effect on Borrower's business or operations or would reasonably be expected to cause a Material Adverse Change, or permit any of its Subsidiaries to do so.

8. EVENTS OF DEFAULT

Any one of the following is an Event of Default:

8.1 Payment Default.

If Borrower fails to pay any of the Obligations within 3 Business Days after their due date. During such additional 3 day period the failure to cure such payment default is not an Event of Default hereunder (but no Credit Extension will be made during the cure period);

8.2 Covenant Default.

If Borrower does not perform any obligation in Section 6 or violates any covenant in Section 7; or

If Borrower does not perform or observe any other material term, condition or covenant in this Agreement, any Loan Documents, or in any agreement between Borrower and Bank and as to any default under a term, condition or covenant that can be cured, has not cured the default within 10 days after it occurs, or if the default cannot be cured within 10 days or cannot be cured after Borrower's attempts within 10 day period, and the default may be cured within a reasonable time, then Borrower has an additional period (of not more than 30 days) to attempt to cure the default. During the additional time, the failure to cure the default is not an Event of Default (but no Credit Extensions will be made during the cure period);

8.3 Material Adverse Change.

If there (i) occurs a material adverse change in the business, operations, or condition (financial or otherwise) of the Borrower, or (ii) is a material impairment of the prospect of repayment of any portion of the Obligations or (iii) is a material impairment of the value or priority of Bank's security interests in the Collateral (any of the foregoing is referred to herein as a "Material Adverse Change").

8.4 Attachment.

If any material portion of Borrower's assets is attached, seized, levied on, or comes into possession of a trustee or receiver and the attachment, seizure or levy is not removed in 10 days, or if Borrower is enjoined, restrained, or prevented by court order from conducting a material part of its business or if a judgment or other claim becomes a Lien on a material portion of Borrower's assets, or if a notice of lien, levy, or assessment is filed against any of Borrower's assets by any government agency and not paid within 10 days after Borrower receives notice. These are not Events of Default if stayed or if a bond is posted pending contest by Borrower (but no Credit Extensions will be made during the cure period);

8.5 Insolvency.

If Borrower becomes insolvent or if Borrower begins an Insolvency Proceeding or an Insolvency Proceeding is begun against Borrower and not dismissed or stayed within 30 days (but no Credit Extensions will be made before any Insolvency Proceeding is dismissed);

8.6 Other Agreements.

If there is a default in any agreement between Borrower and a third party that gives the third party the right to accelerate any Indebtedness exceeding $100,000 or that could cause a Material Adverse Change;

8.7 Judgments.

If a money judgment(s) in the aggregate of at least $100,000 is rendered against Borrower and is unsatisfied and unstayed for 10 days (but no Credit Extensions will be made before the judgment is stayed or satisfied);

8.8 Misrepresentations.

If Borrower or any Person acting for Borrower makes any material misrepresentation or material misstatement now or later in any warranty or representation in this Agreement or in any writing delivered to Bank or to induce Bank to enter this Agreement or any Loan Document; or

8.9 Guaranty.

Any guaranty of any Obligations ceases for any reason to be in full force or any Guarantor does not perform any obligation under any guaranty of the Obligations, or any material misrepresentation or material misstatement is made or is deemed made now or later in any warranty or representation in any guaranty of the Obligations or in any certificate delivered to Bank in connection with the guaranty, or any circumstance described in Sections 8.4, 8.5 or 8.7 occurs to any Guarantor.

9. BANK'S RIGHTS AND REMEDIES

9.1 Rights and Remedies.

When an Event of Default occurs and continues Bank may, without notice or demand, do any or all of the following:

(a) Declare all Obligations immediately due and payable (but if an Event of Default described in Section 8.5 occurs all Obligations are immediately due and payable without any action by Bank);

(b) Stop advancing money or extending credit for Borrower's benefit under this Agreement or under any other agreement between Borrower and Bank;

(c) Settle or adjust disputes and claims directly with account debtors for amounts, on terms and in any order that Bank considers advisable;

(d) Make any payments and do any acts it considers necessary or reasonable to protect its security interest in the Collateral. Borrower will assemble the Collateral if Bank requires and make it available as Bank designates. Bank may enter the premises, in accordance with law, where the Collateral is located, take and maintain possession of any part of the Collateral, and pay, purchase, contest, or compromise any Lien which appears to be prior or superior to its security interest and pay all expenses incurred and Bank may further occupy any of Borrower's premises, without charge, in connection with the exercise of any of Bank's rights or remedies regarding the Collateral;

(e) Apply to the Obligations any (i) balances and deposits of Borrower it holds, or (ii) any amount held by Bank owing to or for the credit or the account of Borrower;

(f) Ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell the Collateral. Bank is granted a non-exclusive, royalty-free license or other right to use (and with respect to items licensed by Borrower, to the extent the underlying license agreement so permits or Borrower otherwise undertakes to arrange, which Borrower hereby covenants to so undertake for the benefit of Bank), without charge, Borrower's labels, Patents, Copyrights, Mask Works, rights of use of any name, trade secrets, trade names, Trademarks, service marks, and advertising matter, or any similar property as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and, in connection with Bank's exercise of its rights under this Section, Borrower's rights under all licenses and all franchise agreements inure to Bank's benefit; and

(g) Dispose of the Collateral according to the Code.

9.2 Power of Attorney.

Effective only when an Event of Default occurs and continues, Borrower irrevocably appoints Bank as its lawful attorney to: (i) endorse Borrower's name on any checks or other forms of payment or security; (ii) sign Borrower's name on any invoice or bill of lading for any Account or drafts against account debtors, (iii) make, settle, and adjust all claims under Borrower's insurance policies; (iv) settle and adjust disputes and claims about the Accounts directly with account debtors, for amounts and on terms Bank determines reasonable; and (v) transfer the Collateral into the name of Bank or a third party as the Code permits. Bank may exercise the power of attorney to sign Borrower's name on any documents necessary to perfect or continue the perfection of any security interest regardless of whether an Event of Default has occurred. Bank's appointment as Borrower's attorney in fact, and all of Bank's rights and powers, coupled with an interest, are irrevocable until all Obligations have been fully repaid and performed and Bank's obligation to provide Credit Extensions terminates.

9.3 Accounts Collection.

When an Event of Default occurs and continues, Bank may notify any Person owing Borrower money of Bank's security interest in the funds and verify the amount of the Account. Borrower must collect all payments in trust for Bank and, if requested by Bank, immediately deliver the payments to Bank in the form received from the account debtor, with proper endorsements for deposit.

9.4 Bank Expenses.

If Borrower fails to pay any amount or furnish any required proof of payment to third persons relating to Section 6.5 hereof Bank may make all or part of the payment or obtain insurance policies required in Section 6.5 hereof and take any action under the policies Bank deems prudent. Any amounts paid by Bank are Bank Expenses and immediately due and payable, bearing interest at the then applicable rate and secured by the Collateral. No payments by Bank are deemed an agreement to make similar payments in the future or Bank's waiver of any Event of Default.

9.5 Bank's Liability for Collateral.

If Bank complies with reasonable banking practices and the Code, it is not liable for: (a) the safekeeping of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution in the value of the Collateral; or (d) any act or default of any carrier, warehouseman, bailee, or other person. Borrower bears all risk of loss, damage or destruction of the Collateral.

9.6 Remedies Cumulative.

Bank's rights and remedies under this Agreement, the Loan Documents, and all other agreements are cumulative. Bank has all rights and remedies provided under the Code, by law, or in equity. Bank's exercise of one right or remedy is not an election, and Bank's waiver of any Event of Default is not a continuing waiver. Bank's delay is not a waiver, election, or acquiescence. No waiver is effective unless signed by Bank and then is only effective for the specific instance and purpose for which it was given.

9.7 Demand Waiver.

Borrower waives demand, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees held by Bank on which Borrower is liable.

10. NOTICES

All notices or demands by any party about this Agreement or any other related agreement must be in writing and be personally delivered or sent by an overnight delivery service, by certified mail, postage prepaid, return receipt requested, or by telefacsimile to the addresses set forth at the beginning of this Agreement. A party may change its notice address by giving the other party written notice.

11. CHOICE OF LAW, VENUE AND JURY TRIAL WAIVER

California law governs the Loan Documents without regard to principles of conflicts of law. Borrower and Bank each submit to the exclusive jurisdiction of the State and Federal courts in Orange County, California.

BORROWER AND BANK EACH WAIVE THEIR RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL.

12. GENERAL PROVISIONS

12.1 Successors and Assigns.

This Agreement binds and is for the benefit of the successors and permitted assigns of each party. Borrower may not assign this Agreement or any rights under it without Bank's prior written consent which may be granted or withheld in Bank's discretion. Bank has the right, without the consent of or notice to Borrower, to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank's obligations, rights and benefits under this Agreement.

12.2 Indemnification.

Borrower will, except for losses caused by Bank's gross negligence or willful misconduct, indemnify, defend and hold harmless Bank and its officers, employees, and agents against: (a) all obligations, demands, claims, and liabilities asserted by any other party in connection with the transactions contemplated by the Loan Documents; and (b) all losses or Bank Expenses incurred, or paid by Bank from, following, or consequential to transactions between Bank and Borrower (including reasonable attorneys fees and expenses).

12.3 Time of Essence.

Time is of the essence for the performance of all obligations in this Agreement.

12.4 Severability of Provision.

Each provision of this Agreement is severable from every other provision in determining the enforceability of any provision.

12.5 Amendments in Writing, Integration.

All amendments to this Agreement must be in writing and signed by Borrower and Bank. This Agreement represents the entire agreement about this subject matter, and supersedes prior negotiations or agreements. All prior agreements, understandings, representations, warranties, and negotiations between the parties about the subject matter of this Agreement merge into this Agreement and the Loan Documents.

12.6 Counterparts.

This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, are an original, and all taken together, constitute one Agreement.

12.7 Survival.

All covenants, representations and warranties made in this Agreement continue in full force while any Obligations remain outstanding. The obligations of Borrower in Section 12.2 to indemnify Bank will survive until all statutes of limitations for actions that may be brought against Bank have run.

12.8 Confidentiality.

In handling any confidential information, Bank will exercise the same degree of care that it exercises for its own proprietary information and as a reasonable person under the applicable circumstances, but disclosure of information may be made (i) to Bank's subsidiaries or affiliates in connection with their business with Borrower, (ii) to prospective transferees or purchasers of any interest in the loans; provided, however, Bank shall use reasonable efforts in obtaining agreement by such prospective transferee or purchasers of the terms of this provision and otherwise conduct itself reasonably in order to maintain the confidential nature of any such information in accordance with any securities laws and regulations applicable to Bank, provided, further, any actual purchaser of this Agreement shall by such purchase be bound by this provision, (iii) as required by law, regulation, subpoena, or other order, (iv) as required in connection with Bank's examination or audit and (v) as Bank considers appropriate exercising remedies under this Agreement. Confidential information does not include information that either: (a) is in the public domain or in Bank's possession when disclosed to Bank, or becomes part of the public domain after disclosure to Bank; or (b) is disclosed to Bank by a third party, if Bank does not know that the third party is prohibited from disclosing the information. Bank will undertake reasonable efforts to notify Borrower of any material disclosure of any confidential information.

12.9 Attorneys' Fees, Costs and Expenses.

In any action or proceeding between Borrower and Bank arising out of the Loan Documents, the prevailing party will be entitled to recover its reasonable attorneys' fees and other reasonable costs and expenses incurred, in addition to any other relief to which it may be entitled.

13. DEFINITIONS

13.1 Definitions.

In this Agreement:

"Accounts" are all existing and later arising accounts, contract rights, and other obligations owed Borrower in connection with its sale or lease of goods (including licensing software and other technology) or provision of services, all credit insurance, guaranties, other security and all merchandise returned or reclaimed by Borrower and Borrower's Books relating to any of the foregoing.

"Affiliate" of a Person is a Person that owns or controls directly or indirectly the Person, any Person that controls or is controlled by or is under common control with the Person, and each of that Person's senior executive officers, directors, partners and, for any Person that is a limited liability company, that Person's managers and members.

"Bank Expenses" are all audit fees and expenses and reasonable costs and expenses (including reasonable attorneys' fees and expenses) for preparing, negotiating, administering, defending and enforcing the Loan Documents (including appeals or Insolvency Proceedings).

"Borrower's Books" are all Borrower's books and records including ledgers, records regarding Borrower's assets or liabilities, the Collateral, business operations or financial condition and all computer programs or discs or any equipment containing the information.

"Borrowing Base" is 80% of Eligible Accounts as determined by Bank from Borrower's most recent Borrowing Base Certificate; provided, however, that Bank may lower the percentage of the Borrowing Base after performing an audit of Borrower's Collateral.

"Borrowing Base Advances" has the meaning ascribed to such term in Section 2.1.1 hereof.

"Business Day" is any day that is not a Saturday, Sunday or a day on which the Bank is closed.

"Closing Date" is the date of this Agreement.

"Code" is the California Uniform Commercial Code, as in effect from to time, as amended or otherwise modified.

"Collateral" is the property described on Exhibit A.

"Committed Revolving Line" is an aggregate amount of advance availability hereunder of up to $3,000,000.

"Contingent Obligation" is, for any Person, any direct or indirect liability, contingent or not, of that Person for (i) any indebtedness, lease, dividend, letter of credit or other obligation of another such as an obligation directly or indirectly guaranteed, endorsed, co-made, discounted or sold with recourse by that Person, or for which that Person is directly or indirectly liable; (ii) any obligations for undrawn letters of credit for the account of that Person; and (iii) all obligations from any interest rate, currency or commodity swap agreement, interest rate cap or collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; but "Contingent Obligation" does not include endorsements in the ordinary course of business. The amount of a Contingent Obligation is the stated or determined amount of the primary obligation for which the Contingent Obligation is made or, if not determinable, the maximum reasonably anticipated liability for it determined by the Person in good faith; but the amount may not exceed the maximum of the obligations under the guarantee or other support arrangement.

"Copyrights" are all copyright rights, applications or registrations and like protections in each work or authorship or derivative work, whether published or not (whether or not it is a trade secret) now or later existing, created, acquired or held.

"Credit Extension" is each Revolving Advance and each other extension of credit by Bank for Borrower's benefit.

"Current Assets" are amounts that under GAAP should be included on that date as current assets on Borrower's consolidated balance sheet.

"Current Liabilities" are the aggregate amount of Borrower's Total Liabilities which mature within one (1) year.

"Default" shall mean any event or occurrence which with the passing of time or the giving of notice or both would become an Event of Default hereunder.

"Eligible Accounts" are Accounts in the ordinary course of Borrower's business that meet all Borrower's representations and warranties in Section 5; but Bank may change eligibility standards by giving Borrower notice. Unless Bank agrees otherwise in writing, Eligible Accounts will not include:

(a) Accounts that the account debtor has not paid within 90 days of invoice date;

(b) Accounts for an account debtor, 50% or more of whose Accounts have not been paid within 90 days of invoice date;

(d) Accounts for an account debtor, including Affiliates, whose total obligations to Borrower exceed 25% of all Accounts, for the amounts that exceed that percentage, unless the Bank approves in writing;

(e) Accounts for which the account debtor does not have its principal place of business in the United States;

(f) Accounts for which the account debtor is a federal, state or local government entity or any department, agency, or instrumentality;

(g) Accounts for which Borrower owes the account debtor, but only up to the amount owed (sometimes called "contra" accounts, accounts payable, customer deposits or credit accounts);

(h) Accounts for demonstration or promotional equipment, or in which goods are consigned, sales guaranteed, sale or return, sale on approval, bill and hold, or other terms if account debtor's payment may be conditional;

(i) Accounts for which the account debtor is Borrower's Affiliate, officer, employee, or agent;

(j) Accounts in which the account debtor disputes liability or makes any claim and Bank believes there may be a basis for dispute (but only up to the disputed or claimed amount), or if the Account Debtor is subject to an Insolvency Proceeding, or becomes insolvent, or goes out of business; and

(k) Accounts for which Bank reasonably determines collection to be doubtful.

"Equipment" is all present and future machinery, equipment, tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments in which Borrower has any interest.

"GAAP" is generally accepted accounting principles, consistently applied.

"Guarantor" is any present or future guarantor of the Obligations.

"Indebtedness" is (a) indebtedness for borrowed money or the deferred price of property or services, such as reimbursement and other obligations for surety bonds and letters of credit, (b) obligations evidenced by notes, bonds, debentures or similar instruments, (c) capital lease obligations and (d) Contingent Obligations.

"Insolvency Proceeding" are proceedings by or against any Person under the United States Bankruptcy Code, or any other bankruptcy or insolvency law, including assignments for the benefit of creditors, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief.

"Intellectual Property" is:

(a) Copyrights, Trademarks, Patents, and Mask Works including amendments, renewals, extensions, and all licenses or other rights to use and all license fees and royalties from the use;

(b) Any trade secrets and any intellectual property rights in computer software and computer software products now or later existing, created, acquired or held;

(d) Any claims for damages (past, present or future) for infringement of any of the rights above, with the right, but not the obligation, to sue and collect damages for use or infringement of the intellectual property rights above; and

(e) All proceeds and products of the foregoing, including all insurance, indemnity or warranty payments.

"Inventory" is present and future inventory in which Borrower has any interest, including merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products intended for sale or lease or to be furnished under a contract of service, of every kind and description now or later owned by or in the custody or possession, actual or constructive, of Borrower, including inventory temporarily out of its custody or possession or in transit and including returns on any accounts or other proceeds (including insurance proceeds) from the sale or disposition of any of the foregoing and any documents of title.

"Investment" is any beneficial ownership of (including stock, partnership interest or other securities) any Person, or any loan, advance or capital contribution to any Person.

"Letter of Credit" is defined in Section 2.1.2 hereof.

"Lien" is a mortgage, lien, deed of trust, charge, pledge, security interest or other encumbrance.

"Loan Documents" are, collectively, this Agreement, any note, or notes or guaranties or third party suretyship obligations in favor of Bank executed by Borrower or other Persons, as applicable, and any other present or future agreement between Borrower and/or for the benefit of Bank in connection with this Agreement, all as amended, extended or restated.

"Mask Works" are all mask works or similar rights available for the protection of semiconductor chips, now owned or later acquired.

"Material Adverse Change" is defined in Section 8.3 hereof.

"Obligations" are debts, principal, interest, Bank Expenses and other amounts Borrower owes Bank now or later, including cash management services, letters of credit and foreign exchange contracts, if any and including interest accruing after Insolvency Proceedings begin and debts, liabilities, or obligations of Borrower assigned to Bank.

"Patents" are patents, patent applications and like protections, including improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same.

"Permitted Indebtedness" is:

(a) Borrower's indebtedness to Bank under this Agreement or any other Loan Document;

(b) Indebtedness existing on the Closing Date and shown on the Schedule;

(d) Indebtedness to trade creditors incurred in the ordinary course of business; and

(e) Indebtedness secured by Permitted Liens.

"Permitted Investments" are:

(a) Investments shown on the Schedule and existing on the Closing Date;

(b) (i) marketable direct obligations issued or unconditionally guaranteed by the United States or its agency or any State maturing within 1 year from its acquisition, (ii) commercial paper maturing no more than 1 year after its creation and having the highest rating from either Standard & Poor's

Corporation or Moody's Investors Service, Inc., and (iii) Bank's certificates of deposit issued maturing no more than 1 year after issue;

(c) Investments relating to third party entities in an aggregate amount of no more than $100,000 in any fiscal year, provided that no such new Investment may be made while any Default or Event of Default is then occurring and continuing; and

(d) Investments by Borrower with respect to the repurchase of its shares in a company buyback program as approved by the Board of Directors in an aggregate amount not to exceed $500,000, provided that Borrower may not effect any such Investment while any Default or Event of Default is then occurring and continuing.

"Permitted Liens" are:

(a) Liens existing on the Closing Date and shown on the Schedule or arising under this Agreement or other Loan Documents;

(b) Liens for taxes, fees, assessments or other government charges or levies, either not delinquent or being contested in good faith and for which Borrower maintains adequate reserves on its Books, if they have no priority over any of Bank's security interests;

(c) Purchase money Liens or liens arising in connection with leases with respect to in each case (i) Equipment acquired or held by Borrower or its Subsidiaries incurred for financing the acquisition of the Equipment, or (ii) existing on equipment when acquired, if the Lien is confined to the property and improvements and the proceeds of the equipment;

(d) Non-exclusive licenses and non-exclusive sublicenses granted in the ordinary course of Borrower's business;

(e) Leases or subleases entered into in the ordinary course of Borrower's business, including in connection with Borrower's leased premises or leased property; and

(f) Liens incurred in the extension, renewal or refinancing of the indebtedness secured by Liens described in (a) through (c), but any extension, renewal or replacement Lien must be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness may not increase.

"Person" is any individual, sole proprietorship, partnership, limited liability company, joint venture, company association, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or government agency.

"Prime Rate" is Bank's most recently announced "prime rate," even if it is not Bank's lowest rate.

"Quick Assets" is, on any date, the Borrower's consolidated, unrestricted cash, cash equivalents and net trade accounts receivable.

"Responsible Officer" is each of the Chief Executive Officer, the President, the Chief Financial Officer and the Controller of Borrower.

"Revolving Advance" or "Revolving Advances" is a loan advance (or advances) under the Committed Revolving Line and as defined in Section 2.1.1 hereof.

"Revolving Maturity Date" is August 30, 2004.

"Schedule" is any attached schedule of exceptions.

"Subordinated Debt" is debt incurred by Borrower subordinated to Borrower's indebtedness owed to Bank and which is reflected in a written agreement in a manner and form acceptable to Bank and approved by Bank in writing.

"Subsidiary" is for any Person, or any other business entity of which more than 50% of the voting stock or other equity interests is owned or controlled, directly or indirectly, by the Person or one or more Affiliates of the Person.

"Tangible Net Worth" is, on any date, the consolidated total assets of Borrower and its Subsidiaries minus, without duplication, (i) any amounts attributable to (a) goodwill, (b) intangible items such as unamortized debt discount and expense, Patents, trade and service marks and names, Copyrights and research and development expenses except prepaid expenses, and (c) reserves not already deducted from assets, and (ii) Total Liabilities.

"Total Liabilities" is on any day, obligations that should, under GAAP, be classified as liabilities on Borrower's consolidated balance sheet, including all Indebtedness, and current portion Subordinated Debt allowed to be paid, but excluding all other Subordinated Debt.

"Trademarks" are trademark and servicemark rights, registered or not, applications to register and registrations and like protections, and the entire goodwill of the business of Assignor connected with the trademarks.

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized representatives as of the date first above written.

		BORROWER:
		DPAC TECHNOLOGIES CORP.
		By:	/s/ WILLIAM M. STOWELL
		Title:	Chief Financial Officer
		BANK:
		SILICON VALLEY BANK
		By:	/s/ GARY REAGAN
		Title:	Vice President

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Exhibit 99.3

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