Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2010


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 as Specified in Its Charter)


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

5675 HUDSON INDUSTRIAL PARK, HUDSON, OHIO (Address of Principal Executive Offices)		44236 (Zip Code)

(800) 553-1170
(Registrant’s Telephone Number, Including Area Code)

(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 Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES þ NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:


Large Accelerated filer o		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller Reporting Company þ

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES o NO þ

The number of shares of common stock, no par value, outstanding as of November 5, 2010 was 109,414,896.

CAUTIONARY STATEMENT RELATED TO FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements as defined within Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, relating to revenue, revenue composition, market conditions, demand and pricing trends, future expense levels, competition in our industry, trends in average selling prices and gross margins, product and infrastructure development, market demand and acceptance, the timing of and demand for next generation products, customer relationships, employee relations, and the level of expected future capital and research and development expenditures. Such forward-looking statements are based on the beliefs of, estimates made by, and information currently available to DPAC Technologies Corp.’s (“DPAC” or the “Company”) management and are subject to certain risks, uncertainties and assumptions. Any other statements contained herein (including without limitation statements to the effect that DPAC or management “estimates,” “expects,” “anticipates,” “plans,” “believes,” “projects,” “continues,” “may,” “will,” “could,” or “would” or statements concerning “potential” or “opportunity” or variations thereof or comparable terminology or the negative thereof) that are not statements of historical fact are also forward-looking statements. The actual results of DPAC may vary materially from those expected or anticipated in these forward-looking statements. The realization of such forward-looking statements may be impacted by certain important unanticipated factors, including those discussed under Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Because of these and other factors that may affect DPAC’s operating results, past performance should not be considered as an indicator of future performance, and investors should not use historical results to anticipate results or trends in future periods. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers should carefully review the risk factors described in this and other documents that DPAC files from time to time with the Securities and Exchange Commission, including subsequent Current Reports on Form 8-K, Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K.

HOW TO OBTAIN DPAC’S SEC FILINGS

All reports filed by DPAC with the SEC are available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials filed by the Company with the SEC at the SEC’s public reference room located at 100 F Street, N.E., Washington, DC 20549

PART I — FINANCIAL INFORMATION

ITEM 1. Financial Statements.

DPAC Technologies Corp.
Condensed Consolidated Balance Sheets


	September 30,			December 31,
	2010			2009
	(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	28,731		$	17,532
Accounts receivable, net		1,158,666			1,124,598
Inventories		941,177			1,076,739
Prepaid expenses and other current assets		102,076			73,914

Total current assets		2,230,650			2,292,783

PROPERTY, Net		662,413			745,756

FINANCING COSTS, Net		79,979			101,911
GOODWILL AND OTHER NON-AMORTIZING INTANGIBLE ASSETS		6,405,503			6,405,503
OTHER INTANGIBLE ASSETS, Net		250,169			621,684
OTHER ASSETS		16,216			18,817


TOTAL	$	9,644,930		$	10,186,454


LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Revolving credit facility	$	1,500,000		$	1,425,243
Short term note		8,818			—
Current portion of long-term debt		320,000			230,000
Accounts payable		1,117,453			1,513,568
Put warrant liability		129,000			100,300
Other accrued liabilities		515,517			367,144

Total current liabilities		3,590,788			3,636,255

LONG-TERM LIABILITIES:
Ohio Development loan, less current portion		1,994,668			2,106,724
Subordinated debt, less current portion		1,170,216			1,160,649

Total long-term liabilities		3,164,884			3,267,373

STOCKHOLDERS’ EQUITY:
Convertible, voting, cumulative, 9% series A preferred stock, $100 stated value; 30,000 shares authorized; 30,000 shares issued and outstanding at September 30, 2010 and December 31, 2009		2,499,203			2,499,203
Common stock, no par value; 500,000,000 shares authorized, 109,414,896 shares outstanding at September 30, 2010 and December 31, 2009		5,736,798			5,687,232
Preferred stock dividends distributable in common stock; 26,628,549 and 3,571,429 common shares issuable at September 30, 2010 and December 31, 2009, respectively		352,500			50,000
Accumulated deficit		(5,699,243	)		(4,953,609	)

Total stockholders’ equity		2,889,258			3,282,826


TOTAL	$	9,644,930		$	10,186,454

See accompanying notes to consolidated financial statements.

DPAC Technologies Corp.
Condensed Consolidated Statements of Operations
(Unaudited)


	For the quarter ended:						For the nine months ended:
	September 30,			September 30,			September 30,			September 30,
	2010			2009			2010			2009

NET SALES	$	1,877,487		$	1,425,770		$	5,630,995		$	5,135,724

COST OF GOODS SOLD		1,119,227			869,320			3,180,780			3,040,134


GROSS PROFIT		758,260			556,450			2,450,215			2,095,590

OPERATING EXPENSES
Sales and marketing		189,819			182,276			554,761			673,686
Research and development		178,729			178,432			560,699			599,036
General and administrative		254,924			260,022			847,034			957,692
Amortization of intangible assets		136,087			132,088			400,261			377,098
Restructuring costs		—			12,097			—			12,097

Total operating expenses		759,559			764,915			2,362,755			2,619,609


INCOME (LOSS) FROM OPERATIONS		(1,299	)		(208,465	)		87,460			(524,019	)

OTHER EXPENSE:
Interest expense		153,495			146,126			466,894			431,933
Fair value adjustment for put warrant liability		64,500			29,000			28,700			29,000

Total other expenses		217,995			175,126			495,594			460,933


LOSS BEFORE INCOME TAXES		(219,294	)		(383,591	)		(408,134	)		(984,952	)

INCOME TAX PROVISION		—			—			—			—


NET LOSS	$	(219,294	)	$	(383,591	)	$	(408,134	)	$	(984,952	)

PREFERRED STOCK DIVIDENDS		112,500			47,813			337,500			143,439


NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	(331,794	)	$	(431,404	)	$	(745,634	)	$	(1,128,391	)


NET LOSS PER SHARE:
Net Loss — Basic and diluted	$	0.00		$	0.00		$	0.00		$	(0.01	)


WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic and diluted		109,415,000			105,856,000			109,415,000			103,167,000

See accompanying notes to consolidated financial statements.

DPAC Technologies Corp.
Condensed Consolidated Statements of Cash Flows
(Unaudited)


	For the nine months ended
	September 30,			September 30,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(408,134	)	$	(984,952	)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		510,732			442,378
Loss on the sale of assets		—			483
Provision for bad debts		—			1,000
Write off of bad debts		—			(24,673	)
Provision for obsolete inventory		36,000			36,000
Accretion of discount and success fees on debt		22,511			43,789
Amortization of deferred financing costs		34,987			35,609
Adjustment to put warrant liability		28,700			29,000
Non-cash compensation expense		49,566			100,306

Changes in operating assets and liabilities:
Accounts receivable		(34,068	)		202,868
Inventories		99,562			25,454
Prepaid expenses and other assets		(25,561	)		(45,580	)
Accounts payable		(396,115	)		235,854
Accrued restructuring charges		—			(42,366	)
Other accrued liabilities		130,873			(96,114	)


Net cash provided by (used in) operating activities		49,053			(40,944	)


CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions		(55,874	)		(61,430	)
Net cash from sale of assets		—			150,000


Net cash provided by (used in) investing activities:		(55,874	)		88,570


CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowing under revolving credit facility		74,757			40,243
Net borrowing under short term notes		8,818			15,011
Repayments on Ohio Development loan		—			(93,751	)
Repayment of Subordinated Debt		(35,000	)		—
Financing costs incurred		(13,055	)		(9,900	)
Principal payments on capital lease obligations		—			(3,252	)
Preferred stock dividends paid in cash		(17,500	)		—


Net cash provided by (used in) financing activities		18,020			(51,649	)


NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		11,199			(4,023	)

CASH & CASH EQUIVALENTS, BEGINNING OF PERIOD		17,532			9,157


CASH & CASH EQUIVALENTS, END OF PERIOD	$	28,731		$	5,134


SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	371,321		$	358,634


NON-CASH INVESTING AND FINANCING ACTIVITIES
Preferred stock dividends paid in common stock	$	302,500		$	143,439

Issuance of preferred stock for acquisition of SocketSerial assets	$	—		$	450,000

See accompanying notes to consolidated financial statements.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 — Summary of Significant Accounting Policies

Nature of Operations

DPAC Technologies Corp., (“DPAC”) through its wholly owned subsidiary, Quatech Inc., (“Quatech”) designs and sells device connectivity and device networking solutions for a broad market. Quatech sells its products through a global network of distributors, system integrators, value added resellers, and original equipment manufacturers (“OEM”). Quatech designs communication and data acquisition products for personal computer based systems. The Company sells to customers in both domestic and foreign markets.

Going Concern

The Company’s financial statements have been prepared on a going concern basis. Certain conditions exist that raise substantial doubt about the Company’s ability to continue as a going concern. These conditions include recent operating losses, declines in working capital balances and the inherent risk in extending or refinancing our bank line of credit, which matures on December 15, 2010. Our ability to continue as a going concern is dependent upon our ability to maintain positive cash flows from operations and to raise additional financing. Management believes that it has taken the necessary steps to achieve and maintain positive cash flows from operations, including the acquisition of a product line and reduction and management of the Company’s operating costs. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As such, they do not include adjustments relating to the recoverability of recorded asset amounts and classification of recorded assets and liabilities that might result from the outcome of this uncertainty.

Liquidity

At September 30, 2010, the Company had a cash balance of $29,000 and a deficit in working capital of $1,360,000. This compares to a cash balance of $18,000 and a deficit in working capital of $1,343,000 at December 31, 2009. Although the Company has reported net losses in recent periods, a significant portion of our operating expenses are non-cash. During the first nine months of 2010, the Company reported a net loss of $408,000, which included the following non-cash operating expenses: depreciation and amortization of $511,000, non-cash compensation for stock options of $50,000, and non-cash interest expense of $57,000. For the year ended December 31, 2009, the Company reported a net loss of $1,133,000, which included the following non-cash operating expenses: depreciation and amortization of $595,000, non-cash compensation expense for stock options of $119,000, and non-cash interest expense of $108,000.

The Company has taken the following actions to reduce expenses and increase capital: In the third quarter of 2008, the Company reduced its cash operating expenses to align its cost structure with then current economic conditions and a downturn in the Company’s revenue levels, resulting in annualized operating cost savings of approximately $600,000. During the first quarter of 2009, the Company entered into an agreement with one of its contract manufacturers to sell certain equipment and inventory, lease a portion of its facility to the manufacturer, and further engage the manufacturer to produce more of the Company’s products (see Note 11 for more information). This transaction provided $150,000 in cash and has improved the operating efficiency of the Company. In the third quarter of 2009, the Company implemented additional cost reduction measures by reducing headcount and implementing a salary reduction program for all employees resulting in annual operating costs reductions of approximately $400,000. On September 30, 2009, the Company acquired the SocketSerial product line in a non cash transaction for the Company (see Note 2 for more information). Margins generated from revenues of this product line have helped enable the Company to achieve a cash flow break even from operations. During the third quarter of 2010, the Company entered into a Third Amendment to Credit Agreement extending the maturity date of its Bank revolving credit facility to December 15, 2010.

Going forward, the Company is dependent on financing its operations through the use of its bank line of credit and the contribution from future revenues. Management believes that the actions it has taken will help enable the Company to generate positive cash flows from operations. Additionally, the Company experienced an increase in the rate of new orders during the first nine months of 2010, resulting in a 30% and 10% increase in net sales for, respectively, the three and nine months ended September 30, 2010, when compared to the comparable prior year periods, and a 122% increase in the size of its backlog of firm orders from $540,000 at December 31, 2009 to $1.2 million at the beginning of the fourth quarter of 2010. However, a further downturn in our revenue levels can severely impact the availability under our line of credit and limit our ability to meet our obligations on a timely basis and finance our operations as needed. The Company was fully drawn on its line of credit at September 30, 2010. The Company may find it necessary to raise additional capital to fund its operations, however, there can be no assurance that additional capital will be available on acceptable terms, if at all, if and when it may be needed.

Interim financial Statements

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Article 8-03 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 complete financial statements. In the opinion of management, all material adjustments (consisting of normal recurring adjustments) necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

All intercompany transactions and balances have been eliminated in consolidation.

Some historical amounts have been reclassified to be consistent with the current financial presentation.

For further information, refer to the audited financial statements and footnotes thereto of DPAC for the year ended December 31, 2009 which were filed on Form 10-K on April 15, 2010.

Use of Estimates

In accordance with accounting principles generally accepted in the United States, management utilizes estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates and assumptions relate to recording net revenue, collectibility of accounts receivable, useful lives and impairment of tangible and intangible assets, accruals, income taxes, inventory realization, stock-based compensation expense and other factors. Management believes it has exercised reasonable judgment in deriving these estimates. Consequently, a change in conditions could affect these estimates.

Fair Value Measurements

In September 2006, the FASB issued ASC No. 820, Fair Value Measurements (“ASC 820,” and previously referred to as Statement No. 157). The accounting pronouncement establishes a three-level hierarchy which prioritizes the inputs used in measuring fair value. In general, fair value determined by Level 1 inputs utilize quoted prices in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs are unobservable data points for the asset or liability, and includes situations in which there is little, if any, market activity for the asset or liability.

The following table represents our financial assets and liabilities measured at fair value on a recurring basis and the basis for that measurement:

Fair Value Measurement at September 30, 2010 Using:

Significant

Quoted Prices in

Other

Significant

Total

Active Markets

Observable

Unobservable

Fair Value

for Identical Assets

Inputs

Measurement

(Level 1)

(Level 2)

(Level 3)

Put Warrant Liability

129,000

—

129,000

—

The Company values the put warrant liability by calculating the difference between the Company’s closing stock price at the end of a reporting period and the exercise price per share multiplied by the number of warrants granted. The Company has classified the fair value of the warrants as a liability and changes in the fair value of the warrants are recognized in the earnings of the Company. The Company recognized a loss of $64,500 and $28,700 for the three and nine month periods ended September 30, 2010, respectively, and a loss of $29,000 for both the comparable periods in 2009, related to the change in value of the put warrant liability. In addition, the actual settlement amount of the put warrant liability could differ materially from the value determined based on the Company’s stock price. There was no change in the valuation technique used by the Company since the last reporting period.

The Subordinated Debt Agreement, which funded on January 31, 2008, provides for a formula driven success fee equal to 7.0 times the trailing twelve months EBITDA minus indebtedness plus cash, times 5.5%, to be paid at maturity or a triggering event. The success fee is being accounted for as a separate contingent component of the note and will be revalued at each reporting period. The success fee is calculated at the end of each reporting period based on the trailing twelve months EBITDA, with the resultant amount multiplied times the percentage of the loan period remaining at each measurement date. As such, the liability is trued up at each reporting period based on the time elapsed, with the remaining unamortized portion of the success fee accreted monthly as additional interest expense over the remaining term of the loan. Based on the results of the above calculation, the Company recorded no liability for the success fee as of September 30, 2010. There was no change in the valuation technique used by the Company since the last reporting period.

New Accounting Pronouncements

In January 2009, the Securities and Exchange Commission (“SEC”) issued Release No. 33-9002, “Interactive Data to Improve Financial Reporting.” The final rule requires companies to provide their financial statements and financial statement schedules to the SEC and on their corporate websites in interactive data format using the eXtensible Business Reporting Language (“XBRL”). The rule was adopted by the SEC to improve the ability of financial statement users to access and analyze financial data. The SEC adopted a phase-in schedule indicating when registrants must furnish interactive data. Under this schedule, the Company will be required to submit filings with financial statement information using XBRL commencing with its June 30, 2011 quarterly report on Form 10-Q. The Company is currently evaluating the impact of XBRL reporting on its financial reporting process.

In October 2009, the FASB amended revenue recognition guidance for arrangements with multiple deliverables. The guidance eliminates the residual method of revenue recognition and allows the use of management’s best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence (“VSOE”), vendor objective evidence (“VOE”) or third-party evidence (“TPE”) is unavailable. This guidance should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. Full retrospective application of the guidance is optional. The Company is currently evaluating the impact of adopting this guidance on its financial statements.

In July 2010, FASB issued an amendment to Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This Update requires an entity to provide a greater level of disaggregated information about the credit quality of its financing receivables and its allowance for credit losses, excluding short-term trade accounts receivable. In addition, the amendments in this Update require an entity to disclose credit quality indicators, past due information, and modifications of its financing receivables. These improvements will help financial statement users assess an entity’s credit risk exposures and its allowance for credit losses. The amendment is effective for interim and annual periods ending on or after December 15, 2010. The Company does not expect adoption of this guidance to have a significant effect on current or future earnings or results of operations.

NOTE 2 — Product Line Acquisition

On September 30, 2009, in a non-cash transaction for the Company, the Company acquired from Socket Mobile, Inc. (“Socket”) the SocketSerial product line and all assets of Socket which pertain to Socket’s serial card business (the “Business”), including the tangible personal property and assets of Socket related to the Business; rights to any contract, purchase order, license or other agreement to the ownership, manufacture and distribution of the assets; certain rights to the intellectual property and proprietary rights related to or useful in connection with the Business and customer lists; the SocketSerial brand name and the SocketSerial website. The products in the SocketSerial product line consist of a CompactFlash serial card, a PC serial card, a PC dual serial card, and a PC quad serial card, all with fixed and removable cable models. Also included are a USB to Serial Adapter, USB to Ethernet Adapter and a license to sell the Cordless Serial Adapter. Quatech intends to continue to manufacture and distribute the SocketSerial product line and assumed existing customer support responsibilities. The transaction was completed with the assistance of Development Capital Ventures, LP (“DCV”), the Company’s majority shareholder. DCV initially purchased the Assets from Socket and immediately transferred the Assets to the Company in exchange for 8,750 shares of the Company’s Series A Preferred Stock.

The Assets were acquired for a purchase price of $500,000, of which $450,000 was payable at closing, and a contingent $50,000 payment would be payable upon the attainment by Quatech of $250,000 in quarterly sales revenue from the sale of SocketSerial products in any quarter through the quarter ending December 31, 2010. The Company has not achieved $250,000 in SocketSerial revenue in any quarter through September 30, 2010. The purchase price was allocated as follows:


Equipment	$	10,000
Developed software		390,000
Customer list		50,000

Total	$	450,000

The acquired Assets were placed into service effective December 31, 2009 and began being depreciated in January 2010 under their respective lives, estimated to be 5 years, on a straight line basis.

NOTE 3 — Inventories

Inventories consist of the following:


	September 30,			December 31,
	2010			2009
Raw materials and sub-assemblies	$	659,599		$	547,816
Finished goods		580,763			811,600
Less: reserve for excess and obsolete inventories		(299,185	)		(282,677	)

Total net inventories	$	941,177		$	1,076,739

Purchases of finished assemblies and components from two major vendors represented 35% and 33% of the total inventory purchased in the nine months ended September 30, 2010, and two vendors accounted for 45% and 21% for the nine month period ended September 30, 2009. The Company has arrangements with these vendors to purchase product based on purchase orders periodically issued by the Company.

NOTE 4 — Property

Property consists of the following:


	September 30,			December 31,
	2010			2009
Leasehold improvements	$	103,714		$	103,714
Machinery and equipment		371,123			328,197
Computer software and equipment		624,410			611,462
Office funiture and equipment		79,602			79,602
Internally developed software		191,657			191,657
Developed embedded software		390,000			390,000

		1,760,506			1,704,632
Less: accumulated depreciation and amortization		(1,098,093	)		(958,876	)

Net property	$	662,413		$	745,756

NOTE 5 — Debt

At September 30, 2010 and December 31, 2009, outstanding debt is comprised of the following:


	September 30,			December 31,
	2010			2009

Revolving credit facility	$	1,500,000		$	1,425,243


Long term debt:
Ohio Development Loan:
Principal balance	$	1,933,278		$	1,933,279
Accrued participation fee		186,390			173,445


		2,119,668			2,106,724
Less: current portion		(125,000	)		—


Net long-term portion		1,994,668			2,106,724


Subordinated debt:
Principal balance	$	1,395,000		$	1,430,000
Accrued success fee		—			—
Less: Unamortized discount for stock warrants		(29,784	)		(39,351	)


		1,365,216			1,390,649
Less: current portion		(195,000	)		(230,000	)


Net long-term portion	$	1,170,216		$	1,160,649


Total Current Portion of Long-term Debt	$	320,000		$	230,000


Total Net Long-term Debt	$	3,164,884		$	3,267,373

Revolving Credit Facility

The Company has a revolving line of credit with a Bank providing for a maximum $1,500,000 working capital line of credit. At September 30, 2010, the facility had a floating interest rate at the Bank’s Revolver LIBOR Rate (0.25%), plus 8.5%. Interest is payable monthly on the last day of each month, until maturity. On September 20, 2010, the Company entered into a Third Amendment to Credit Agreement, effective as of July 30, 2010, extending the maturity date to December 15, 2010 and under which the Company paid to the Bank half of the previously agreed upon extension fee of $25,000 with the balance due at maturity. Additionally, the Company paid to the Bank $5,000 in fees. The Bank waived certain events of default occurring under the Credit Agreement, including covenant non-compliance. All other terms and conditions of the Credit Agreement remain unchanged by the Amendment. Availability under the line of credit is formula driven based on applicable balances of the Company’s accounts receivable and inventories. Based on the formula, at September 30, 2010 the Company had availability to draw up to the maximum of the line of $1,500,000, on which the Company was fully drawn. As previously reported, previous covenant defaults were waived by the Bank in an agreement dated March 30, 2010. The Credit Facility is secured by substantially all of the assets of the Company.

Short Term Note

The short term note is with a financial institution and was funded for $39,700 to finance insurance premiums. The note bears interest at 10.85% per annum and calls for 9 monthly payments of $4,609, beginning in April 2010.

Ohio Development Loan

On January 27, 2006 Quatech entered into a Loan Agreement with the Director of Development of the State of Ohio pursuant to which Quatech borrowed $2,267,000 for certain eligible project financing. The State of Ohio debt accrues interest at the rate of 9.0% per year. Payments of interest only were due and payable monthly from March 2006 through February 2007. Thereafter, Quatech was obligated to make 48 consecutive monthly principal payments of $10,417 plus interest with the then balance due on February 1, 2011. In November 2009, the Company and the Director of Development of the State of Ohio came to an agreement to modify the repayment schedule and extend the maturity date. Per the new agreement, the Company was obligated to make only monthly interest payments from November 2009 through September 2010. Thereafter, Quatech is obligated to make monthly principal payments of $10,417 plus interest through January 2013, with the remaining balance due January 31, 2013. In October 2010, the Company began making both interest and principal payments per the amended agreement. At maturity, Quatech must also pay the State of Ohio a participation fee equal to the lesser of 10% of the maximum principal amount borrowed or $250,000. The State of Ohio debt is secured by all the assets of Quatech which security interest is subordinated to the interest of the Bank. The participation fee is being accrued as additional interest each month over the term of the loan.

Subordinated Debt

On January 31, 2008, the Company entered into a Senior Subordinated Note and Warrant Purchase Agreement (“Agreement”) with Canal Mezzanine Partners, L.P. (“Canal”), for $1,200,000. The subordinated note has a stated annual interest rate of 13% and a five year maturity date. Interest only payments are payable monthly during the first five years of the note with all principal due and payable on the fifth anniversary of the note. The Agreement also provides for a formula driven success fee based on a multiple of the trailing twelve months EBITDA, to be paid at maturity or a triggering event, and for issuance of warrants entitling Canal to purchase 3% of the Company’s fully diluted shares at time of exercise at a nominal purchase price.

In October 2008, the Company entered into an Amendment to the Agreement securing additional Senior Subordinated Debt financing from Canal of $250,000, which was originally due and payable on February 15, 2009. In March 2010, the Company agreed to make monthly principal payments of $20,000 plus interest through March 31, 2010 and beginning April 1, 2010, monthly principal payments of $25,000 plus interest until the additional financing loan is paid in full. The Company, because of cash constraints, has not been able to meet the terms of the repayment agreement and is currently in the process of renegotiating the terms with Canal. The agreement also increases the interest on the additional financing from 13% to 16% per annum.

The warrants associated with the Canal debt have a 10 year life and are exercisable at any time. The subordinated note has been discounted by the fair value of the detachable warrants, with a corresponding contribution to capital. The discount, calculated to be $63,800 at time of issuance, is amortized as additional interest expense and accretes the note to face value at maturity. The Company determined the fair value of the warrant by using the Black-Scholes pricing model and calculating 3% of fully diluted shares at time of issuance, including a potential 50 million common shares for the conversion of the outstanding Series A preferred stock, which equated to approximately 4.9 million shares and using the closing stock price on the date of the transaction of $0.014 per share.

The success fee is defined as equal to 7.0 times the trailing twelve months EBITDA minus indebtedness plus cash, times 5.5%, to be paid at maturity or a triggering event. The success fee is being accounted for as a separate contingent component of the note and will be revalued at each reporting period. The success fee is calculated at the end of each reporting period based on the trailing twelve months EBITDA, with the resultant amount multiplied times the percentage of the loan period remaining at each measurement date. As such, the liability is trued up at each reporting period based on the time elapsed, with the remaining unamortized portion of the success fee accreted monthly as additional interest expense over the remaining term of the loan. In connection with the Amendment for additional financing, Canal is entitled to increase the multiplier in the success fee, as described above, from 5.5% to 6.0%.

Put Warrant Liability

In connection with the Subordinated Loan Agreement between the Company and the HillStreet Fund, entered into on February 28, 2006 and which was paid in full on January 31, 2008, the Company issued 5,443,457, and per certain default provisions is obligated to issue 1,006,000 additional, 10-year warrants (“Put Warrants”) at an exercise price of $0.00001 per share. The warrants expire on February 28, 2016. The Put Warrants continue to remain outstanding and can be “put” to the Company at any time based on criteria set forth in the warrant agreement at a price equal to the greatest of (i) the fair market value as established by a capital transaction or public offering; (ii) six times the Company’s EBITDA for the trailing 12 month period; and (iii) an appraised value. The Company has determined to value the put warrant liability by calculating the difference between the Company’s closing stock price at the end of a reporting period and the exercise price per share multiplied by the number of warrants granted. The Company has classified the fair value of the warrants as a liability and changes in the fair value of the warrants are recognized in the earnings of the Company. The Company recognized a loss of $64,500 and $28,700 for the three and nine month periods ended September 30, 2010, respectively, and a loss of $29,000 for both the comparable periods in 2009, related to the change in value of the put warrant liability. The actual settlement amount of the put warrant liability could differ materially from the value determined based on the Company’s stock price.

The aggregate amounts of combined long term debt, exclusive of the put warrant liability and the unamortized discount for stock warrants, maturing as of September 30th in future years is $320,000 in 2011, $125,000 in 2012, and $3,039,884 in 2013.

NOTE 6 — Concentration of Customers

One customer accounted for 12% and no single customer accounted for more than 10% of net sales for the three and nine months ended September 30, 2010, and two customers accounted for 15% and 10% of net sales for the three months ended September 30, 2009, respectively. No single customer accounted for more than 10% of accounts receivable at September 30, 2010, and accounts receivable from one customer accounted for 16% of net accounts receivable at September 30, 2009. The Company has and will have customers ranging from large OEM’s to startup operations. Any inability to collect receivables from any such customers could have a material adverse effect on the Company’s financial position and liquidity.

NOTE 7 — Net Income (Loss) Per Share

The Company computes net income (loss) per share by dividing the net income (loss) by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities by including other common stock equivalents, such as stock options and warrants, in the weighted-average number of shares outstanding for a period. Common stock equivalents are excluded from the calculation in loss periods, as the effect is anti-dilutive.

The tables below set forth the reconciliation of the denominator of the income (loss) per share calculations:


	Three-months ended
	September 30,
	2010		2009
Shares used in computing basic net income per share		109,415,000		105,856,000
Dilutive effect of stock options and warrants(1)(3)		—		—

Shares used in computing diluted net income per share		109,415,000		108,856,000


	Nine-months ended
	September 30,
	2010		2009
Shares used in computing basic net income per share		109,415,000		103,167,000
Dilutive effect of stock options and warrants(2)(3)		—		—

Shares used in computing diluted net income per share		109,415,000		103,167,000


(1)		Potential common shares of 8,503,000 and 8,076,000 for the exercise of stock options and warrants have been excluded from diluted weighted average common shares for the three month periods ended September 30, 2010 and 2009, respectively, as the effect would be anti-dilutive.

(2)		Potential common shares of 8,502,000 and 8,089,000 for the exercise of stock options and warrants have been excluded from diluted weighted average common shares for the nine month periods ended September 30, 2010 and 2009, respectively, as the effect would be anti-dilutive.

(3)		Also excluded from both the September 30, 2010 and 2009 computations are the potential of approximately 71 million common shares that would be issued upon the conversion of the total number of shares of Preferred Stock outstanding, at the option of the preferred shareholders. Additionally excluded from both the September 30, 2010 and 2009 computations are 26.6 million and 2.2 million, respectively, common shares issuable in payment of accrued stock dividends on Preferred Stock.

The number of shares of common stock, no par value, outstanding at November 5, 2010 was 109,414,896.

At September 30, 2010 the Company had outstanding 30,000 shares of convertible, voting, cumulative, Series A preferred stock. Through December 31, 2009, dividends accrued and were payable quarterly in arrears at the annual rate of 9% of the Original Issue Price of $100 per share, either in cash or common stock, at the decision of the Company. Effective January 1, 2010, dividends accrue and are payable quarterly in arrears at the annual rate of 15% given that the Company is not listed for trading on the American Stock Exchange, a NASDAQ Stock Market or the New York Stock Exchange. For purposes of valuing the common stock payable to holders of Series A Preferred in lieu of cash with respect to such quarterly dividends, the value shall be deemed to be the average of the closing bid or sale prices (whichever is applicable) over the 10 day period ending the day prior to the dividend payment date. At September 30, 2010, the Company has accrued dividends distributable in common stock of $352,500, which equates to approximately 26,629,000 common shares issuable, and $17,500 of accrued dividends payable in cash.

Series A preferred stock can, at the option of the holder, be converted into fully paid shares of common stock. The number of shares of common stock into which shares of Series A preferred may be converted shall be obtained by multiplying the number of shares of Series A preferred to be converted by the Original Issue Price of $100 and dividing the result by the product of $0.034 (the “Reference Price”) times 1.25, which equates to approximately 71 million common shares should the total number of outstanding preferred shares be converted. After December 31, 2009, the Company can redeem the Series A preferred shares at a price per share equal to the Original Issue Price. The holders of preferred stock have preference in the event of liquidation or dissolution of the Company over the holders of common stock.

NOTE 8 — Stock Options

Stock-Based Compensation

The Company recognizes compensation expense, using a fair-value based method, for costs related to all share-based payments including stock options and stock issued under our employee stock plans. The Company estimates the fair value of share-based payment awards on the date of grant using a Black-Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service periods in our consolidated statements of operations.

Under the terms of the Company’s 1996 Stock Option Plan, (the “Plan”), qualified and nonqualified options to purchase shares of the Company’s common stock are available for issuance to employees, officers, directors, and consultants. As amended on February 23, 2006, the Plan authorized 15,000,000 option shares with an annual increase to the total number of option shares available in the plan equal to 4% of the total number of common shares outstanding each year until the end of the option plan. On February 23, 2006, the termination date for the plan was extended to January 11, 2011. At September 30, 2010, approximately 17,944,000 shares were available for future grants under the Plan.

Options issued under this Plan are granted with exercise prices equal to the closing stock price on the date of grant and generally vest immediately for options granted to directors and at a rate of 25% per year for options granted to employees, and expire within 10 years from the date of grant or 90 days after termination of employment.

During the nine-month periods ended September 30, 2010 and 2009, the Company recognized compensation expense for stock options of $49,566 and $100,306 respectively. The expense is included in the consolidated statement of operations as general and administrative expense. Total unamortized compensation expense related to non-vested stock option awards at September 30, 2010 was $65,000, which is expected to be recognized over a weighted-average period of 0.85 years. The Company’s calculations were made using the Black-Scholes option-pricing model, with the following weighted average assumptions:


	For the Nine
	Months Ended September 30,
	2010 (1)		2009
Expected life		N/A		6.5 Years
Volatility		N/A		297	%
Interest rate		N/A		2.0	%
Dividend yield		N/A		None


(1)		No options were granted during the nine months ended September 30, 2010.

Expected volatilities are based on historical volatility of the Company’s stock. The Company used historical experience with exercise and post employment termination behavior to determine the options’ expected lives. The expected life represents the period of time that options granted are expected to be outstanding. The risk-free rate is based on the U.S. Treasury rate with a maturity date corresponding to the options’ expected life. The dividend yield is based upon the historical dividend yield.

The following table summarizes stock option activity under DPAC’s 1996 Stock Option Plans for the nine months ended September 30, 2010:


				Weighted-
				Average		Weighted-Average		Aggregate
	Number of			Exercise		Remaining		Intrinsic
	Shares			Price		Contractual Life		Value
Outstanding — December 31, 2009		14,550,936		$	0.42
Granted		—			—
Exercised		—			—
Canceled		(1,430,833	)	$	2.30

Outstanding —September 30, 2010		13,120,103		$	0.22		5.4 Years	$	1,500

Exercisable — September 30, 2010		11,082,603		$	0.25		5.0 Years	$	1,500

NOTE 9 — 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. The Company’s Chief Executive Officer reviews financial information and makes operational decisions based upon the Company as a whole. Therefore, the Company reports as a single segment.

The Company had export sales of 32% and 29% of net sales for the three and nine months ended September 30, 2010 and 22% and 20% of net sales for the three and nine months ended September 30, 2009, respectively. Export sales were primarily to Canada, Brazil, Singapore, and Western European countries. Foreign sales are made in U.S. dollars. All long-lived assets are located in the United States.

NOTE 10 — Income Taxes

The Company recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax bases of assets and liabilities. 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. DPAC regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. To the extent that recovery is not believed to be more likely than not, a valuation allowance is established. The Company has established a valuation allowance associated with its net deferred tax assets.

The valuation allowance was calculated by using an assessment of both negative and positive evidence when measuring the need for a valuation allowance. Evidence evaluated by management included operating results during the most recent three-year period and future projections, with more weight given to historical results than expectations of future profitability, which are inherently uncertain. The Company’s net losses in recent periods represented sufficient negative evidence to require a full valuation allowance against its net deferred tax assets. This valuation allowance will be evaluated periodically and could be reversed partially or totally if business results have sufficiently improved to support realization of deferred tax assets.

NOTE 11 — Sale of Manufacturing Capability

The Company entered into an Equipment Purchase Agreement (the “Agreement”) that was consummated in the first quarter of 2009 with one of its contract manufacturers (“Manufacturer”) and sold certain of its manufacturing capability (consisting of manufacturing equipment, fixtures, tools, shelving and tables) for a sale price of $74,000. The Manufacturer also assumed the obligations of Quatech under a certain capital lease with a remaining balance of approximately $21,000 at December 31, 2008. Also pursuant to the Agreement, Quatech sold certain inventory valued at a sum of $150,000. Quatech and Manufacturer have agreed that Manufacturer will purchase additional active inventory from Quatech as required. Also pursuant to the Agreement, the Company sublet to Manufacturer 4,911 square feet of space at the Company’s manufacturing facility located in Hudson, OH. Additionally, the Company has agreed to utilize Manufacturer as its manufacturer of all products and parts for existing products of the Company (other than under the Company’s Airborne wireless product line) for a period of 24 months under terms and conditions to be determined by the parties. A negligible loss was recorded with regard to the transaction as the assets were sold at the Company’s approximate net carrying value of the assets.

NOTE 12 — Commitments and Contingencies

Legal Proceedings

We are subject to various legal proceedings and threatened legal proceedings from time to time as part of our business. We are not currently party to any legal proceedings nor are we aware of any threatened legal proceedings, the adverse outcome of which, individually or in the aggregate, we believe would have a material adverse effect on our business, financial condition and results of operations. However, any potential litigation, regardless of its merits, could result in substantial costs to us and divert management’s attention from our operations. Such diversions could have an adverse impact on our business, results of operations and financial condition.

Other Contingent Contractual Obligations

Over time, the Company has made and continues to make certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include: indemnities to past, present and future directors, officers, employees and other agents pursuant to the Company’s Articles, Bylaws, resolutions, agreements or otherwise; indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease; indemnities to vendors and service providers pertaining to claims based on the negligence or willful misconduct of the Company; and indemnities pursuant to contracts involving protection of selling security holders against claims by third parties arising from any alleged inaccuracy of information in registration statements filed by the Company with the SEC or involving indemnification of the other parties to contracts from any damages arising from misrepresentations made by the Company. The Company may also issue a guarantee in the form of a standby letter of credit as security for contingent liabilities under certain customer contracts. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees may not provide for any limitation of the future payments that the Company could potentially be obligated to make. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying balance sheets.

The Company’s severance agreements with the current CEO and CFO provide for compensation equivalent to one year of compensation and six months of compensation, respectively, should either individual be terminated for any reason other than cause.

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Please refer to the Cautionary Statement Related to Forward-Looking Statements set forth on page 2 of this Report, which is incorporated herein by reference. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed financial statements and notes to those statements included elsewhere in this Report.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction/Business Overview

DPAC, through its wholly owned subsidiary, Quatech, designs and sells device connectivity and device networking solutions for a broad market. Quatech sells its products through a global network of distributors, system integrators, value added resellers, and original equipment manufacturers (“OEM”).

In October 2009, Quatech acquired the SocketSerial product line from Socket Mobile. The products in the SocketSerial product line consist of a CompactFlash serial card, a PC serial card, a PC dual serial card, and a PC quad serial card, all with fixed and removable cable models. Also included are a USB to Serial Adapter, USB to Ethernet Adapter and a license to sell the Cordless Serial Adapter. In addition, Quatech has added several of the North American and International distribution partners that had historically sold the SocketSerial products to its list of distribution partners for both its device and networking connectivity product lines.

Quatech products can be categorized into two broad product lines:

Our Device Connectivity products include:

•

Multi-port serial boards that add ports to desktop computers to allow for the connection of multiple peripherals with standard interfaces. These products are used in a variety of industries including banking, transportation management, kiosks, satellite communications, and retail point of sale.

•

Mobile products that add ports for laptop and handheld computers. These products include multi-port serial adapters, parallel port adapters, and Bluetooth products.

•

USB to Serial products that add standard serial ports to any computing environment through a USB port. These products address the need to add connectivity through a solution that is external to the computer. These products are used in several markets including retail point of sale and kiosks.

Our Device Networking products include:

•

Serial device server products that connect peripherals to a local area network through a standard TCP/IP interface. This product line was introduced in 2003 and was extended in 2004 through the introduction of product models that connect to the local area network through a wireless 802.11 interface.

•

Industrial rated, embedded wireless modules that enable OEM customers to add standard 802.11 connectivity capabilities to their products. These modules address the needs of a number of industries including transportation, telematics, warehouse and logistic, and point of sale.

Risks

Period-to-period comparisons of our financial results are not necessarily meaningful and should not be relied upon as indications of future performance. It is likely that from time to time our operating results will be below the expectations of some investors and not above the expectations of enough investors. In such events, the market price of our common stock would be adversely affected, in some proportion, and perhaps disproportionately. We ourselves have difficulties forecasting, and there are numerous risks and uncertainties concerning the timing of our customers’ initiating their production orders and the amounts of such orders, fluctuating market demand for and declines in the selling prices of similar products, decreases or increases in the costs of the components, uncertain market acceptance, our competitors, delays, or other problems with new products, software, manufacturing inefficiencies, cost overruns, fixed overhead costs, competition from new wireless products using 802.11 with newer technology, and challenges managing production from overseas suppliers, among other factors, each of which will make it more difficult for us to meet expectations.

Other primary factors that may in the future affect our results of operations include our efforts to reduce our operating expenses and our fixed overhead. Our costs in any particular period could include higher costs associated with stock-based compensation and / or higher costs associated with adjusting the liability for warrants to their fair value through earnings at each reporting period.

These risks should be read in connection with the detailed risks associated with DPAC and Quatech set forth under the caption “Risk Factors” contained in the Registrant’s Annual Report on Form 10-K filed with the SEC on April 15, 2010.

Results of Operations and Financial Condition

Three Months Ended September 30, 2010 and 2009

The following table sets forth certain Condensed Consolidated Statement of Operations data in total dollars, as a percentage of net revenues and as a percentage change from the same period in the prior year. This information should be read in conjunction with the Consolidated Financial Statements included elsewhere in this Form 10-Q.


	For the Three Months Ended:
	September 30, 2010						September 30, 2009						Change
	Results			% of Sales			Results			% of Sales			Dollars			%

NET SALES	$	1,877,487			100	%	$	1,425,770			100	%	$	451,717			32	%
COST OF GOODS SOLD		1,119,227			60			869,320			61			249,907			29

GROSS PROFIT		758,260			40			556,450			39			201,810			36
OPERATING EXPENSES
Sales and marketing		189,819			10			182,276			13			7,543			4
Research and development		178,729			10			178,432			13			297			—
General and administrative		254,924			14			260,022			18			(5,098	)		(2	)
Amortization of intangible assets		136,087			7			132,088			9			3,999			3
Restructuring costs		—			—			12,097			1			(12,097	)		(100	)

Total operating expenses		759,559			41			764,915			54			(5,356	)		(1	)

LOSS FROM OPERATIONS		(1,299	)		(1	)		(208,465	)		(15	)		207,166			(99	)

OTHER EXPENSE:
Interest expense		153,495			8			146,126			10			7,369			5
Fair value adjustment for warrant liability		64,500			3			29,000			2			35,500			122

Total other expenses		217,995			11			175,126			12			42,869			24

LOSS BEFORE INCOME TAXES		(219,294	)		(12	)		(383,591	)		(27	)		164,297			(43	)
INCOME TAX PROVISION		—			—			—			—			—			—

NET LOSS	$	(219,294	)		(12	)%	$	(383,591	)		(27	)%	$	164,297			(43	)%

PREFERRED STOCK DIVIDENDS		112,500			6			47,813			3			64,687			135

NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	(331,794	)		(18	)%	$	(431,404	)		(30	)%	$	99,610			(23	)%

Net Sales. Net sales of $1.9 million for the quarter ended September 30, 2010 increased by $452,000 or 32% as compared to the prior year comparable period net sales. Net sales related to the Company’s Device Connectivity products increased by $238,000, or 30%, and net sales related to the Company’s Device Networking products, including the Airborne wireless product line, increased by $214,000, or 31% from the prior year period.

Gross Profit. Gross profit in absolute dollars increased by $202,000 or 36% as a result of the increase in net sales. Gross profit as a percentage of net sales increased to 40% from 39% due primarily to lower variable costs (direct material) as a percentage of net sales.

Sales and Marketing Expenses. Sales and marketing expenses for the quarter ended September 30, 2010 of $190,000 increased by $8,000 or 4% from the prior year third quarter, due to an increase in salary and benefits costs.

Research and Development Expenses. Research and development expenses of $179,000 for the third quarter of 2010 was flat compared to the third quarter of 2009. The Company will continue to invest in research and development to expand and develop new wireless products. See “Forward-Looking Statements.”

General and Administrative Expenses. General and administrative expenses of $255,000 incurred for the third quarter of 2010 decreased by $5,000 or 2% from the prior year period.

Amortization of Intangible Assets. $122,000 of amortization expense is related to the amortization of purchased intangible assets acquired in the Merger on February 28, 2006 being amortized over 5 years, and the balance of $14,000 in the current year period for the amortization of capitalized developed software and customer lists being amortized over 5 years.

Interest Expense. The Company incurred interest and financing costs of $153,000 during the third quarter of 2010, as compared to $146,000 for the same period in the prior year. The increase is due to higher average effective interest rates. The following non-cash charges are included in interest expense for the third quarter of 2010: accretion of success fees of $4,000, amortization of deferred financing costs of $12,000, and amortization of the discount for warrants of $3,000. The following non-cash charges are included in interest expense for the third quarter of 2009: accretion of success fees of $11,000, amortization of deferred financing costs of $14,000, and amortization of the discount for warrants of $3,000.

Fair Value Adjustment of Put Warrant Liability. The Company adjusts the liability for the HillStreet Fund put warrant to its fair value, through earnings, at the end of each reporting period. During the third quarter of 2010, the company recorded a loss of $65,000 compared to a loss of $29,000 for the third quarter of 2009.

Income Taxes. The Company has recorded a full valuation allowance against the Company’s related deferred tax assets. Recent net operating losses represent sufficiently negative evidence to require a continued valuation allowance against the net deferred tax assets. This valuation allowance will be evaluated periodically and could be reversed partially or totally if business results have sufficiently improved to support realization of our deferred tax assets.

Nine Months Ended September 30, 2010 and 2009


	For the Nine Months Ended:
	September 30, 2010						September 30, 2009						Change
	Results			% of Sales			Results			% of Sales			Dollars			%

NET SALES	$	5,630,995			100	%	$	5,135,724			100	%	$	495,271			10	%
COST OF GOODS SOLD		3,180,780			56			3,040,134			59			140,646			5

GROSS PROFIT		2,450,215			44			2,095,590			41			354,625			17
OPERATING EXPENSES
Sales and marketing		554,761			10			673,686			13			(118,925	)		(18	)
Research and development		560,699			10			599,036			12			(38,337	)		(6	)
General and administrative		847,034			15			957,692			19			(110,658	)		(12	)
Amortization of intangible assets		400,261			7			377,098			7			23,163			6
Restructuring costs		—			—			12,097			—			(12,097	)		(100	)

Total operating expenses		2,362,755			42			2,619,609			51			(256,854	)		(10	)

INCOME (LOSS) FROM OPERATIONS		87,460			2			(524,019	)		(10	)		611,479			(117	)

OTHER EXPENSE:
Interest expense		466,894			8			431,933			8			34,961			8
Fair value adjustment for warrant liability		28,700			1			29,000			1			(300	)		(1	)

Total other expenses		495,594			9			460,933			9			34,661			8

LOSS BEFORE INCOME TAXES		(408,134	)		(7	)		(984,952	)		(19	)		576,818			(59	)
INCOME TAX PROVISION		—			—			—			—			—			—

NET LOSS	$	(408,134	)		(7	)%	$	(984,952	)		(19	)%	$	576,818			(59	)%

PREFERRED STOCK DIVIDENDS		337,500			6			143,439			3			194,061			135

NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	(745,634	)		(13	)%	$	(1,128,391	)		(22	)%	$	382,757			(34	)%

Net Sales. Net sales of $5.6 million for the nine months ended September 30, 2010 increased by $495,000 or 10% as compared to net sales for the comparable prior year period. Net sales related to the Company’s Device Connectivity products decreased $126,000, or 4% from the nine months ended September 30, 2009, and net sales related to the Company’s Device Networking products, including the Airborne wireless product line, increased by $621,000, or 31% from the prior year period.

Gross Profit. Gross profit increased by $355,000, or 17%, for the nine month period as a result of the increase in revenues. Gross profit as a percentage of net sales increased to 44% from 41% due primarily to lower variable costs (direct material) as a percentage of net sales and lower fixed costs. During the first quarter of 2009, the Company sold certain of its manufacturing capability to one of its contract manufacturing vendors and ceased internal manufacturing its products. The Company purchases completed assemblies from contract manufacturers.

Sales and Marketing Expenses. Sales and marketing expenses for the nine months ended September 30, 2010 of $555,000 decreased by $119,000 or 18% from the prior year period. The decrease is due to a decrease in salary and related expenses.

Research and Development Expenses. Research and development expenses of $561,000 for the first nine months of 2010 decreased by $38,000 or 6% as compared to the same period of 2009 primarily due to lower salary and consulting costs of $76,000, higher R&D expenses of $7,000, partially offset by $29,000 of incurred expenses in 2009 being capitalized for developed software. The Company will continue to invest in research and development to expand and develop new wireless products. See “Forward-Looking Statements.”

General and Administrative Expenses. General and administrative expenses incurred for the nine months ended September 30, 2010 of $847,000 decreased by $111,000 or 12% from the prior year period. The decrease was due primarily to lower salary costs and lower non-cash compensation expense related to stock options.

Amortization of Intangible Assets. $368,000 of amortization expense is related to the amortization of purchased intangible assets acquired in the Merger on February 28, 2006 being amortized over 5 years, with the balance of $32,000 in the current year period related to the amortization of capitalized developed software and customer lists, being amortized over 5 years.

Interest Expense. The Company incurred interest and financing costs of $467,000 during the first nine months of 2010 as compared to $432,000 incurred in the prior year period. The increase is due to higher effective interest rates. The following non-cash charges are included in interest expense during the first nine months of 2010: accretion of success fees of $13,000, amortization of deferred financing costs of $35,000, and amortization of the discount for warrants of $10,000. The following non-cash charges are included in interest expense during the first nine months of 2009: accretion of success fees of $34,000, amortization of deferred financing costs of $36,000, and amortization of the discount for warrants of $10,000.

Fair Value Adjustment of Put Warrant Liability. For the nine months ended September 30, 2010 and 2009, the company recorded a loss of $29,000 related to the adjustment of the put warrant. The Company adjusts the warrant to its fair value through earnings at the end of each reporting period.

Preferred Stock Dividends. The Company has outstanding 30,000 shares of convertible, cumulative, 9% Series A preferred stock, $100 stated value. Effective January 1, 2010, the dividend rate increased to 15% per annum. On September 30, 2009, the Company issued 8,750 shares of Series A preferred stock in conjunction with the SocketSerial asset purchase.

Liquidity and Capital Resources

The Company has taken the following actions to reduce expenses and increase capital: In the third quarter of 2008, the Company took actions to reduce its cash operating expenses to align its cost structure with then current economic conditions and a downturn in the Company’s revenue levels, resulting in annualized operating cost savings of approximately $600,000. During the first quarter of 2009, the Company entered into an agreement with one of its contract manufacturers to sell certain equipment and inventory, lease a portion of its facility to the manufacturer, and further engage the manufacturer to produce more of the Company’s products (see Note 11 for more information). This transaction provided $150,000 in cash and has improved the operating efficiency of the Company. In the third quarter of 2009, the Company implemented additional cost reduction measures by reducing headcount and implementing a salary reduction program for all employees resulting in annual operating costs reductions of approximately $400,000. On September 30, 2009, the Company acquired the SocketSerial product line in a non cash transaction for the Company (see Note 2 for more information). Margins generated from revenues of this product line have helped enable the Company to achieve a cash flow break even from operations.

Going forward, the Company is dependent on financing its operations through the use of its bank line of credit and the contribution from future revenues. Management believes that the actions it has taken will help enable the Company to generate positive cash flows from operations. Additionally, the Company experienced an increase in the rate of new orders during the first nine months of 2010, resulting in a 30% and 10% increase in net sales for, respectively, the three and nine months ended September 30, 2010, when compared to the comparable prior year periods, and a 122% increase in the size of its backlog of firm orders from $540,000 at December 31, 2009 to $1.2 million at the beginning of the fourth quarter of 2010. However, a further downturn in our revenue levels can severely impact the availability under our line of credit and limit our ability to meet our obligations on a timely basis and finance our operations as needed. The Company may find it necessary to raise additional capital to fund its operations, however, there can be no assurance that additional capital will be available on acceptable terms, if at all, if and when it may be needed.

The Company has a revolving line of credit with a Bank providing for a maximum $1,500,000 working capital line of credit. The facility bears a floating interest rate at the Bank’s Revolver LIBOR Rate (.25% at September 30, 2010) plus 8.5%. Availability under the line of credit is formula driven based on applicable balances of the Company’s accounts receivable and inventories. Based on the formula calculation, the Company had availability to draw up to the maximum line amount of $1,500,000, of which the Company was fully drawn at September 30, 2010. The Credit Facility is secured by substantially all the assets of the Company and is scheduled to mature on December 15, 2010.

The actual amount and timing of working capital and capital expenditures that we may incur in future periods may vary significantly and will depend upon many factors, including the amount and timing of the receipt of revenues from operations, any potential acquisitions or divestitures, an increase in manufacturing capabilities, the reduction of liabilities, the timing and extent of the introduction of new products and services and growth in personnel and operations. If needed, there can be no assurance that additional financing will be available on terms favorable to the Company, if at all. If internally generated funds are inadequate, we may scale back expenditures or seek other financing, which might include sales of equity securities that could dilute existing shareholders. See “Cautionary Statements.”

Net cash provided by operating activities for the nine months ended September 30, 2010 was $49,000 as compared to net cash used of $41,000 in the first nine months of 2009. The net loss of $408,000 incurred in the first nine months of 2010 was offset by non-cash items, including depreciation and amortization, non-cash compensation expense, accretion of success fees and amortization of deferred financing costs, totaling $682,000. Cash was used to pay down accounts payable by $396,000, and fund increases in accounts receivable of $34,000. A decrease in inventories of $100,000 and an increase in other accrued liabilities of $131,000 contributed to cash.

Net cash used in investing activities for the nine months ended September 30, 2010 consisted of property additions of $56,000 as compared to $89,000 provided in the nine months ended September 30, 2009, which consisted of net cash received from the sale of assets of $150,000, partially offset by property additions of $61,000.

Net cash provided by financing activities for the nine months ended September 30, 2010 was $18,000 as compared to $52,000 used during the first nine months of 2009. Cash provided in the current year period consisted of net borrowing of $75,000 under the bank line of credit and $9,000 net borrowing in short term notes to finance insurance premiums, partially offset by $35,000 in repayments of subordinated debt, dividends of $18,000 and financing costs incurred of $13,000.

The Company operates at leased premises in Hudson, Ohio, which are adequate for the Company’s needs for the near term.

The Company does not expect to acquire more than $50,000 in capital equipment during the remainder of the fiscal year.

Off Balance Sheet Arrangements

Our off-balance sheet arrangements consist primarily of conventional operating leases, purchase commitments and other commitments arising in the normal course of business, as further discussed below under “Contractual Obligations and Commercial Commitments.” As of September 30,2010, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Contractual Obligations and Commercial Commitments

Purchase Commitments with Contract Manufacturers. We generally issue purchase orders to our contract manufacturers with delivery dates from four to eight weeks from the purchase order date, and longer when lead times dictate. In addition, we regularly provide such contract manufacturers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. We are committed to accept delivery of materials pursuant to our purchase orders subject to various contract provisions which may in certain limited circumstances allow us to delay receipt of such orders or cancel orders beyond certain agreed lead times. Such cancellations, if any, may or may not result in cancellation costs payable by us. Cancellation without contractual permission to do so would result in additional potential losses, damages and costs. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our actual requirements at the time of delivery, and we have previously recognized charges and expenses related to such excess material. If we are unable to adequately manage our commitments to contract manufacturers and adjust such commitments for changes in demand, we may incur additional costs and expenses, including without limitation inventory expenses related to excess and obsolete inventory. Such costs and expenses could have a material adverse effect on our business, financial condition and results of operations.

Other Purchase Commitments. We also incur various purchase obligations with other vendors and suppliers for the purchase of inventory, as well as other goods and services, in the normal course of business. These obligations are generally evidenced by purchase orders with delivery dates from four to six weeks from the purchase order date, and in certain cases, supply agreements that contain the terms and conditions associated with these purchase arrangements. Because of macro conditions impacting the entire electronics industry, lead times for certain components of the Company’s products have extended to beyond twenty weeks. We are committed to accept delivery of such materials pursuant to such purchase orders subject to various contract provisions which allow us to delay receipt of such orders or cancel orders beyond certain agreed lead times. Such cancellations may or may not result in cancellation costs payable by us. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. If we are not able to adequately manage our supply chain and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, financial condition and results of operations.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America and the Company’s discussion and analysis of its financial condition and results of operations requires the Company’s management to make judgments, assumptions, and estimates that affect the amounts reported in its financial statements and accompanying notes. Note 1 of the notes to DPAC’s audited financial statements, filed on Form 10-K, describes the significant accounting policies and methods used in the preparation of the Company’s financial statements. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates.

Management believes the Company’s critical accounting policies are those related to revenue recognition, allowance for doubtful accounts, warranty reserves, inventory valuation, valuation of long-lived assets including capitalized developed software, acquired intangibles, goodwill and trademarks, accrual of income tax liability estimates, accounting for our put warrant liability, and accounting for stock-based compensation. Management believes these policies to be critical because they are both important to the portrayal of the Company’s financial condition and results of operations, and they require management to make judgments and estimates about matters that are inherently uncertain.

We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable and there are no post-delivery obligations other than warranty. In those instances where customers have right of return, which typically would be for initial stocking orders for distributors, revenue is deferred until confirmation has been received from the customer indicating that the product has shipped and completed the sales cycle. Some distributors have annual stock rotation or return provisions which are typically limited to 5% of the previous twelve months of shipments. In these situations, we reserve the appropriate percentage against shipments throughout the period as deferred revenue. We do not typically have any post delivery obligations other than warranty. The Company also offers marketing incentives to certain customers. These incentives are incurred based on the level of expenses the customers incur and are charged to operations as expenses in the same period. Development revenue is recognized when services are performed and was not material for any of the periods presented.

We establish an allowance for doubtful accounts and a warranty reserve based on historical experience and believe the collection of revenues, net of these reserves, is reasonably assured.

The allowance for doubtful accounts is an estimate for potential non-collection of accounts receivable based on historical experience and known circumstances regarding collectibility of customer accounts. Accounts will be written off as uncollectible if the company determines the amount cannot be collected. The Company typically has not experienced a non-collection of accounts receivable materially affecting its financial position or results of operations. If the financial condition of the Company’s customers were to deteriorate causing an impairment of their ability to make payments, additional provisions for bad debts may be required in future periods.

The Company records a warranty reserve as a charge against earnings based on historical warranty claims and estimated costs. If actual returns are not consistent with the historical data used to calculate these estimates, additional warranty reserves could be required.

Inventories consist principally of raw materials, sub-assemblies and finished goods, which are stated at the lower of average cost or market. The Company records an inventory reserve as a charge against earnings for potential slow-moving or obsolete inventory. The reserve is evaluated quarterly utilizing both historical movement over a three year period as compared to quantities on-hand and qualitative factors related to the age of product lines. Significant changes in market conditions, including potential changes in technology, in the future may require additional inventory reserves.

We capitalize certain internally developed software costs after a product becomes technologically feasible and before its general release to customers. Significant judgment is required in determining when a product becomes “technologically feasible.” Capitalized development costs are then amortized over the product’s estimated life beginning upon general release of the product. Periodically, we compare a product’s unamortized capitalized cost to the product’s net realizable value. To the extent unamortized capitalized cost exceeds net realizable value based on the product’s estimated future gross revenues (reduced by the estimated future costs of completing and selling the product) the excess is written off. This analysis requires us to estimate future gross revenues associated with certain products and the future costs of completing and selling certain products. Changes in these estimates could result in write-offs of capitalized software costs. As of September 30, 2010, $191,657 of software development costs were capitalized with accumulated amortization of $47,914. The assets are being amortized on a straight line basis over their estimated life of 5 years.

Goodwill is subject to an impairment assessment at least annually which may result in a charge to operations if the fair value of the reporting unit in which the goodwill is reported declines. The Company tests goodwill and trademarks on at least an annual basis at the end of the fourth quarter, and more often if circumstances should dictate, for impairment. Other intangible assets are amortized over their estimated useful lives. The determination of related estimated useful lives of other intangible assets and whether goodwill and trademarks are impaired involves judgments based upon long-term projections of future performance. The Company operates in a single business segment as a single business unit and annually reviews the recoverability of the carrying value of goodwill using the methodology prescribed in FASB guidance. Recoverability of goodwill is determined by comparing the fair value of the entire Company to the accounting value of the underlying net assets. Based on the results of the most recently completed analysis, the Company’s goodwill and trademarks were not impaired as of December 31, 2009. No event has occurred as of or since the period ended December 31, 2009 that would give management an indication that an impairment charge was necessary that would adversely affect the Company’s financial position or results of operations.

Deferred tax assets and liabilities are recorded in accordance with FASB guidance. The Company records an estimated income tax liability to recognize the amount of income taxes payable or refundable for the current year and deferred income tax liabilities and assets for the future tax consequences of events that have been recognized in the Company’s financial statements or income tax returns. Judgment is required in estimating the future income tax consequences of events that have been recognized in the Company’s financial statements or the income tax returns. The Company estimates and provides an allowance for deferred tax assets based on estimated realization of the asset utilizing information related to historical taxable income and projected taxable income.

The Company values the put warrant liability by calculating the difference between the Company’s closing stock price at the end of a reporting period and the exercise price per share multiplied by the number of warrants granted. In accordance with FASB guidance, the Company has classified the fair value of the put warrants as a liability and changes in the fair value of the warrants are recognized in the earnings of the Company. Changes in our stock price can have a material impact to the put warrant valuation and, therefore, to our financial statements. Additionally, the actual settlement amount of the put warrant liability could differ materially from the value determined based on the Company’s stock price.

The Company amortizes deferred debt issuance costs using the effective interest method.

Item 4 — Controls and Procedures.

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, 2010, the end of the period covered by this report, as required by Exchange Act Rule 13a-15(b). The Company’s disclosure controls were designed to provide reasonable assurance that information required to be disclosed in reports filed or furnished under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, the Company’s disclosure controls have been designed to provide reasonable assurance of achieving the controls’ stated goals. Based on the foregoing evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level. There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1 — Legal Proceedings.

We are or could be subject to various legal proceedings and threatened legal proceedings from time to time as part of the conduct of our business. We believe we are not currently party to any material legal proceedings nor are we aware of any threatened material legal proceedings, the adverse outcome of which, individually or in the aggregate, would have a material adverse effect on our business, financial condition and results of operations. However, any potential litigation, regardless of its merits, could result in substantial costs to us and divert management’s attention from our operations. Such costs and diversions could have a material adverse impact on our business, results of operations and financial condition.

Item 6 — Exhibits.


Exhibit No.		Description

	10.1	Third Amendment to Credit Agreement, by and among DPAC Technologies Corp., QuaTech, Inc. and Fifth Third Bank, dated as of July 30, 2010 (incorporated herein by reference to Exhibit 10.1 to the registrant’s current report on Form 8-K filed September 22, 2010).

	31.1	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a).

	32.1	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	DPAC TECHNOLOGIES CORP. (Registrant)
Date: November 15, 2010	By:	/s/ STEVEN D. RUNKEL
		Steven D. Runkel,
		Chief Executive Officer

Date: November 15, 2010	By:	/s/ STEPHEN J. VUKADINOVICH
		Stephen J. Vukadinovich,
		Chief Financial Officer

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents



PART I—FINANCIAL INFORMATION

Item 1. Financial Statements			4

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			16

Item 4 — Controls and Procedures			25

PART II—OTHER INFORMATION

Item 1 — Legal Proceedings			26

Item 6 — Exhibits			26

SIGNATURES			27

EXHIBIT INDEX			28

Exhibit 31.1
Exhibit 32.1