0001104659-03-022734.txt : 20031014 0001104659-03-022734.hdr.sgml : 20031014 20031014160918 ACCESSION NUMBER: 0001104659-03-022734 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20030831 FILED AS OF DATE: 20031014 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: 03939794 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 a03-4034_110q.htm 10-Q

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, 2003

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		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 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 ý NO o

Indicate by Check Mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)

YES o NO ý

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of common stock, no par value, outstanding as of September 19, 2003 was 21,031,664.

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

DPAC Technologies Corp.
Condensed Balance Sheets
(Unaudited)

	August 31, 2003			February 28, 2003

ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	7,152,463		$	8,197,144
Accounts receivable, net	1,056,739			2,599,732
Inventories, net	964,488			980,592
Prepaid expenses and other current assets	470,348			569,331
Deferred income taxes	209,776			209,776
Total current assets	9,853,814			12,556,575

PROPERTY, net	4,167,465			3,863,118
DEFERRED INCOME TAXES	5,794,208			4,554,208
GOODWILL	4,528,721			4,528,721
OTHER ASSETS	576,186			250,183

TOTAL	$	24,920,394		$	25,752,805

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of capital lease obligations	$	197,893		$	286,236
Accounts payable	1,328,692			1,043,913
Accrued compensation	476,737			492,630
Other accrued liabilities	1,166,306			433,781
Total current liabilities	3,169,628			2,256,560

CAPITAL LEASE OBLIGATIONS, less current portion	337,667			98,829

COMMITMENTS AND CONTINGENCIES (Note 9)

STOCKHOLDERS’ EQUITY:
Common stock	24,969,498			24,929,987
Additional paid-in capital	2,701,701			2,701,701
Accumulated deficit	(6,258,100		)	(4,234,272		)
Net stockholders’ equity	21,413,099			23,397,416

TOTAL	$	24,920,394		$	25,752,805

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, 2003			August 31, 2002			August 31, 2003			August 31, 2002

NET SALES	$	4,400,432		$	10,882,890		$	9,563,095		$	22,819,740

COST OF SALES	4,027,984			7,964,483			8,000,858			17,075,385

GROSS PROFIT	372,448			2,918,407			1,562,237			5,744,355

COSTS AND EXPENSES:
Selling, general and administrative	1,388,688			1,673,902			2,564,624			3,252,703
Research and development	749,159			447,988			1,525,439			904,184
Reserve for litigation	—			—			750,000			—
Total costs and expenses	2,137,847			2,121,890			4,840,063			4,156,887

INCOME (LOSS) FROM OPERATIONS	(1,765,399		)	796,517			(3,277,826		)	1,587,468

OTHER INCOME:
Interest income	12,954			33,478			30,493			68,754
Interest expense	(7,817		)	(20,719		)	(16,495		)	(43,692		)
Total other income	5,137			12,759			13,998			25,062

INCOME (LOSS) BEFORE INCOME TAX BENEFIT	(1,760,262		)	809,276			(3,263,828		)	1,612,530

INCOME TAX BENEFIT	669,000			1,444,876			1,240,000			1,444,876

NET INCOME (LOSS)	$	(1,091,262	)	$	2,254,152		$	(2,023,828	)	$	3,057,406

NET INCOME (LOSS) PER SHARE:
Basic	$	(0.05	)	$	0.11		$	(0.10	)	$	0.15
Diluted	$	(0.05	)	$	0.11		$	(0.10	)	$	0.14

WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic	21,010,000			21,044,000			20,999,000			21,030,000
Diluted	21,010,000			21,305,000			20,999,000			21,464,000

See accompanying notes to condensed financial statements.

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

	For the six months ended
	August 31, 2003			August 31, 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(2,023,828	)	$	3,057,406

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	719,393			708,175
Deferred income taxes	(1,240,000		)	(1,440,262		)
Compensation expense associated with stock options	15,761			—

Changes in operating assets and liabilities:
Accounts receivable	1,542,993			1,266,040
Inventories	16,104			164,242
Other assets	147,980			43,042
Accounts payable	284,779			(387,345		)
Accrued compensation	(15,893		)	(244,703		)
Other accrued liabilities	732,525			95,560
Deferred revenue	—			(15,000		)

Net cash provided by operations:	179,814			3,247,155

CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions	(637,779		)	(290,274		)
Acquired license agreement	(375,000		)	—

Net cash used in investing activities:	(1,012,779		)	(290,274		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations	(235,466		)	(267,639		)
Proceeds from issuance of common stock	23,750			81,244

Net cash used in financing activities	(211,716		)	(186,395		)

NET INCREASE (DECREASE) IN CASH	(1,044,681		)	2,770,486

CASH & CASH EQUIVALENTS, BEGINNING OF PERIOD	8,197,144			6,258,836

CASH & CASH EQUIVALENTS, END OF PERIOD	$	7,152,463		$	9,029,322

SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	16,495		$	43,692
Income taxes paid	$	—		$	27,000

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of property under capital leases	$	385,961		$	—
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 memory and wireless products. High-density design and manufacturing allows our 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. Additionally, the Company announced that it had entered the wireless marketplace with plans for a new product line. The entry into the wireless market may combine DPAC’s expertise in high-density packaging with the need of the marketplace for wireless products. The initial product for entry into this marketplace has been designed, developed and is currently available, although no significant revenues have been recognized to date. 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, our 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, 2003 and for the three and six months ended August 31, 2003 and 2002, 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. DPAC® and DPAC Technologies® are registered trademarks of DPAC Technologies Corp.

These unaudited 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 fiscal year ended February 28, 2003. Operating results for the three and six months ended August 31, 2003 are not necessarily indicative of the results that may be expected for the full year ending February 29, 2004.

NOTE 3 –New Accounting Pronouncements

In August 2002, The Financial Accounting Standards Board (FASB) issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that costs associated with exit or disposal activities be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. The Company must apply SFAS 146 prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 had no significant impact on the Company’s financial position or results of operations.

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others (“FIN 45”). FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation

undertaken in issuing the guarantee. The Company adopted the disclosure provisions of FIN 45 during the fourth quarter of fiscal 2003 and the recognition provisions of FIN 45 effective January 1, 2003. Such adoption did not have a material impact on our financial statements.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation - - Transition and Disclosure (“SFAS 148”). SFAS 148 amends Statement No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), to provide alternative methods for voluntary transition to the fair value method of accounting for stock-based employee compensation prescribed by SFAS 123. SFAS 148 also requires disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income (loss) and earnings (loss) per share in annual and interim financials statements. The Company adopted the disclosure provisions of SFAS 148 effective February 28, 2003 and has included the additional required disclosures below under “Stock-Based Compensation.” Such adoption did not impact our results of operations and financial position since we have not adopted the fair value method. However, should we be required to adopt the fair value method in the future, such adoption could have a material impact on our results of operations and financial position.

In January 2003, FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”). In general, a variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company adopted the provisions of FIN 46 effective March 1, 2003 and such adoption did not have a material impact on its financial statements since the Company currently has no variable interest entities.

In May 2003, the FASB issued Statement of Financial Accounting Standards, Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity (“SFAS 150”), which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the provisions of SFAS 150, effective June 1, 2003, and such adoption did not have a material impact on its financial condition.

Stock Based Compensation

Pursuant to SFAS 123, the Company has elected to continue using the intrinsic value method of accounting for stock-based awards granted to employees and directors in accordance with Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations in accounting for its stock option and purchase plans. As a result, we only record compensation expense for stock-based awards granted with an exercise price below the market value of the Company’s stock at the date of grant.

SFAS 123, Accounting for Stock-Based Compensation, as amended by SFAS 148, requires the disclosure of pro forma net income and earnings per share. Under SFAS 123, and as amended by SFAS 148, the fair value of stock-based awards to employees is calculated through the use of option-pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock

option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.

The Company’s calculations were made using the Black-Scholes option-pricing model, with the following weighted-average assumptions:

	For the three months ended August 31,				For the six months ended August 31,
	2003		2002		2003		2002
Assumptions
Expected life - months	39		39		39		39
Stock volatility	103	%	106	%	103	%	106	%
Rick-free interest rate	4	%	5	%	4	%	5	%
Dividends during the expected term	None		None		None		None

The Company’s calculations are based on a single-option valuation approach and forfeitures are recognized as they occur. If the fair values of the awards had been amortized to expense over the vesting period of the awards, the Company’s results would have been as follows:

	For the three months ended August 31,						For the six months ended August 31,
	2003			2002			2003			2002
Net income:
As reported	$	(1,091,262	)	$	2,254,152		$	(2,023,828	)	$	3,057,406
Add: Stock-based compensation expense included in reported net income, net of related tax effects	9,004			—			9,772			—
Deduct: Total stock-based compensation determinded under fair value based method for all awards, net of related tax effects	(239,644		)	(264,120		)	(467,332		)	(519,560		)
Pro forma net income	$	(1,321,902	)	$	1,990,032		$	(2,481,388	)	$	2,537,846

Net income per share as reported:
Basic	$	-0.05		$	0.11		$	-0.10		$	0.15
Diluted	$	-0.05		$	0.11		$	-0.10		$	0.14
Pro forma net income per share:
Basic	$	-0.06		$	0.09		$	-0.12		$	0.12
Diluted	$	-0.06		$	0.09		$	-0.12		$	0.12

NOTE 4 - Concentration of Customers

accounted for 53%, 12% and 14%, and 23%, 23% and 30%, respectively, of net sales. Accounts receivable from these three customers accounted for 53% of total net accounts receivable at August 31, 2003. 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 50% of total net accounts receivable at August 31, 2002. Any reduction in purchases by, or inability to collect receivables from, such customers could have a material adverse effect on the Company.

NOTE 5 - 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, 2003:

	Number of Shares		Exercise Price Per Share	Number of Options Exercisable
Balance, February 28, 2003	2,970,770		$ 0.94 – 7.56	1,767,504

Granted	1,285,000		$ 0.94 - 1.40
Exercised	(23,750	)	$ 1.00 - 1.00
Cancelled	(99,800	)	$ 0.99 - 6.00
Balance, August 31, 2003	4,132,220		$ 0.94 - 7.56	2,333,554

At August 31, 2003, a total of 2,825,532 shares were available for future grants under all of the Company’s stock option plans.

NOTE 6 – Net Income (Loss) Per Share

The Company computes net income (loss) 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,
	2003	2002
Shares used in computing basic net income (loss) per share	20,010,000	21,044,000
Dilutive effect of stock options (1)	—	261,000
Shares used in computing diluted net income (loss) per share	20,010,000	21,305,000

	Six months ended August 31,
	2003	2002
Shares used in computing basic net income (loss) per share	20,999,000	21,030,000
Dilutive effect of stock options (1)	—	434,000
Shares used in computing diluted net income (loss) per share	20,999,000	21,464,000

(1) Potential common shares of 188,000 and 174,000 have been excluded from diluted weighted average common shares for the three-month and six month periods ended August 31, 2003, as the effect would be anti-dilutive.

NOTE 7 – 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. As the Company’s CEO reviews financial information and makes operational decisions based upon the Company as a whole, the Company reports as a single segment.

The Company had export sales (primarily to Western European customers) accounting for approximately 9% and 17% of net sales for the three and six months ended August 31, 2003 and 29% and 22% for the three and six months ended August 31, 2002, respectively.

NOTE 8 – 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. 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. 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 $254,000, and a net income tax benefit of $1,444,876. This reversal was the result of the Company’s 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 at August 31, 2002. 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. Subsequent to the reversal of the valuation allowance in fiscal year 2003, the Company experienced an unexpected decrease in operating results that continued through the first six months of fiscal year 2004. If the Company continues to operate at a loss or is unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, the Company could be required to record a valuation allowance against all or a significant portion of its deferred tax assets which could substantially increase reported net loss and effective tax rate for such period.

NOTE 9 – Commitments and Contingencies

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 August 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.

On June 7, 2002, SimpleTech petitioned the U.S. Supreme Court for review of the U.S. Court of Appeals affirmance. On October 7, 2002, the U.S. Supreme Court vacated the September 23, 1998 lawsuit and sent the case back to the U.S. Court of Appeals for the Federal Circuit for further consideration. On March 6, 2003, the U.S. Court of Appeals vacated the September 23, 1998 lawsuit and sent the case back to the U.S. District Court for further consideration. On May 19, 2003, the U.S. District Court set a briefing schedule for the Company’s motion for summary judgment of no infringement under the doctrine of equivalents. According to this schedule, a hearing on the motion will be held August 25, 2003. The Court also set a pretrial conference for October 20, 2003, and a trial date of January 13, 2004. Costs of defense of this lawsuit could be substantial, and the ultimate outcome of the lawsuit, or any resulting potential loss is not presently determinable.

The Company entered into settlement discussions with SimpleTech during the quarter ended, May 31, 2003. Although the parties did not reach an agreement, the Company recorded a reserve of $750,000 in the quarter ended May 31, 2003, as a result of the discussions.

On September 17, 2003, the United States District Court for the Central District of California granted judgment in favor of DPAC on SimpleTech’s claim of infringement of a certain DPAC patent. On October 10, 2003 SimpleTech filed a notice of appeal with the U.S. Court of Appeals for the Federal Court.

Other Contingent Contractual Obligations

During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include: 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 involving the accuracy of representations and warranties in certain contracts. 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 maximum potential for future payments the Company could be obligated to make. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying balance sheets. Product warranty costs are not significant.

ITEM 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.

FORWARD-LOOKING STATEMENTS

Included in the Notes to Condensed 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.

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, 2003 as filed with the Securities and Exchange Commission on May 28, 2003, 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 were 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. During the three and six months ended August 31, 2003, sales to three major customers accounted for 53%, 12% and 14%, and 23%, 23% and 30%, respectively, of net sales. Accounts receivable from these three customers accounted for 53% of total net accounts receivable at August 31, 2003. 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 50% of total net accounts receivable at August 31, 2002. Any reduction in purchases by, or inability to collect receivables from, such customers could have a material adverse effect on our results of operations.

Plans for Diversification

We intend to pursue diversification strategies that will expand our plans for internal growth. The Company’s plan for diversification includes, but is not limited to, entering into partnerships, joint ventures, acquisitions, marketing and production agreements. We are unable to predict whether or when any prospective acquisition candidate will be identified 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.

Visibility of Marketplace

DPAC’s visibility into the marketplace is limited due to factors including the 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:

• Semiconductor companies may attempt or may be successful in bringing stacking in-house, using not only pre-packaged parts, but also “die” level stacking;

• Competitors may introduce other stacking methodologies;

• Module manufacturers and semiconductor packaging companies may develop in-house stacking services;

• DRAM pricing may create a volatile marketplace and reduce 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 material negative effect on the financial performance of DPAC, potentially reducing revenues and results of operations.

RESULTS OF OPERATIONS

Three Months Ended August 31, 2003 and 2002

Net Sales. Net sales for the quarter ended August 31, 2003 of $4.4 million decreased by $6.5 million or 60% from $10.9 million for the quarter ended August 31, 2002. This decrease in net sales is primarily due to a 40% decrease in the total quantity of commercial stacks shipped and a significant decrease in the average selling price of both memory and service stacking.

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 purchases 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 2004, approximately 68% was related to memory stacking and 16% to service stacking, as compared with 70% and 13% respectively, in the second quarter of fiscal year 2003. The remaining 16% and 17% of sales in the second quarter of fiscal years 2004 and 2003, respectively, were primarily related to other products sold to the industrial, defense and aerospace sectors.

DPAC has seen an impact on its business due to competitive products and technologies, and the continued consolidation in the semiconductor industry. It is unknown at this time whether or not there will be additional changes in demand for the Company’s proprietary products. Additionally, semiconductor companies are performing stacking in-house, which impacted demand for the Company’s products. See “Forward-Looking Statements,” including the discussion under “Visibility of Marketplace.”

Gross Profit. Gross profit in the second quarter of fiscal year 2004 decreased by $2.5 million or 87% to $0.4 million from $2.9 million in the comparable prior-year period. Gross profit as a percentage of sales declined to 9% for the quarter ended August 31, 2003, as compared to 27% for the quarter ended August 31, 2002. The decrease in gross profit in absolute dollars is directly attributable to the decrease in revenues. The decrease in the gross margin percentage can primarily be attributed to lower revenues available to absorb fixed manufacturing costs as well as decreased average selling prices.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased in the second quarter of fiscal year 2004 by $0.3 million or 17% to $1.4 million from $1.7 million in the second quarter of the prior fiscal year. As a percentage of net sales, selling, general and administrative expenses increased to 32% of net sales for the quarter ended August 31, 2003 as compared to 15% for the same period in the prior fiscal year. The decrease in absolute dollars in selling, general and administrative expenses is primarily attributed to decreased levels of compensation expense (decrease in head cost and executive compensation) and investor relations expenses, which activities were brought in-house. The increase as a percentage of revenue is due to decreased revenues.

Research and Development. Research and development expenses for the quarter ended August 31, 2003 of $0.7 million increased by $0.3 million or 67% from the second quarter of the prior fiscal year. For the quarter ended August 31, 2003 research and development expense represented 17% of net sales as compared to 4% of net sales from the same quarter in the previous fiscal year. The increase in absolute dollars spent on research and development is the result of the Company’s efforts to expand into the wireless marketplace and develop new stacking technologies. The increase as a percentage of revenues is primarily due to decreased revenue levels. The Company is continuing to invest in research and development for new products. See “Forward-Looking Statements.”

Interest. For the three months ended August 31, 2003, interest income decreased by $21,000 from the same period last year due primarily to the impact of declining interest rates on the amount we are able to earn on our cash balances. Interest expense decreased by $13,000 for the same period due to the decline in the average amount of our debt balances, which are at fixed interest rates.

Income Taxes. During the quarter ended August 31, 2003, the Company recorded a net income tax benefit at the rate of 38% or $0.7 million. During the quarter ended August 31, 2002, the Company recorded a net income tax benefit of $1.4 million, which reflects the reversal of a previously recorded valuation allowance against deferred income tax assets.

unexpected decrease in operating results that continued through the first six months of fiscal year 2004. If the Company continues to operate at a loss or is unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, the Company could be required to record a valuation allowance against all or a significant portion of its deferred tax assets which could substantially increase reported net loss and effective tax rate for such period.

Six Months Ended August 31, 2003 and 2002

Net Sales. Net sales for the six months ended August 31, 2003 decreased by $13.2 million or 58% to $9.6 from $22.8 million for the six months ended August 31, 2002. This decrease in net sales is primarily due a 43% decrease in the quantity of memory stacks shipped and a 27% decrease in the quantity of service stacks shipped for the first half for fiscal year 2004 as compared to the same period in the prior fiscal year, coupled with a significant decrease in the average selling price of both memory stacking and service stacking during this same period.

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 purchases 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 first six months of fiscal year 2004, approximately 58% was related to memory stacking and 26% to service stacking, as compared with 70% and 14%, respectively, in the first six months of fiscal year 2003. The remaining 16% of sales in both the first six months of fiscal years 2003 and 2002 were primarily related to other products sold to the industrial, defense and aerospace sectors.

DPAC has seen an impact on its business due to competitive products and technologies, and the continued turmoil in the semiconductor industry, and it is unknown at this time whether or not there will be additional declines in demand for these proprietary products. See “Forward-Looking Statements,” including the discussion under “Visibility of Marketplace.”

Gross Profit. Gross profit for the six months ended August 31, 2003 of $1.6 million decreased by $4.2 million or 73% from $5.7 million for the same period in the previous fiscal year. Gross profit as a percentage of sales declined to 16% for the six months ended August 31, 2003, as compared to 25% for the six months ended August 31, 2002. The decrease in gross profit in absolute dollars is directly attributable to the decrease in revenues. The decrease in the gross margin percentage can primarily be attributed to lower revenues available to absorb fixed manufacturing costs as well as decreased average selling prices.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased 21% to $2.6 million for the six months ended August 31, 2003 from $3.3 million for the same period in fiscal year 2003. . As a percentage of net sales, selling, general and administrative expenses increased to 27% of net sales for the six months ended August 31, 2003 as compared to 14% for the same period in the prior fiscal year. The decrease in absolute dollars in selling, general and administrative expenses is primarily attributed to decreased levels of expense for compensation, investor relations, and incurred acquisition search costs. The increase as a percentage of revenue is due to decreased revenues.

Research and Development. For the six months ended August 31, 2003, research and development, in terms of absolute dollars increased by 69% to $1.5 million from $0.9 million for the

same period in the previous fiscal year. For the first half of fiscal year 2003, research and development expense represented 16% of net sales as compared to 4% of net sales for the same period in the previous fiscal year. The increased investment in research and development is primarily due to efforts to allocate more resources to the development and production of unique new technologies primarily for the wireless marketplace and continued investment in stacking technologies. The Company is continuing to invest in research and development for new products in the advanced technology marketplace. See “Forward-Looking Statements.”

Reserve for Litigation. During the quarter ended May 31, 2003, DPAC entered into settlement discussions for its outstanding patent litigation. The Company recorded a reserve of $750,000 because of these discussions. There were no similar charges in the prior year. (See discussion in Note 9 – Commitments and Contingencies).

Interest. For the six months ended August 31, 2003, interest income decreased by $38,000 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 as well as a decrease in our average cash balances. Interest expense decreased by $27,000 for the same period due to the decline in the amount of our average debt balances outstanding, which are at fixed interest rates.

Income Taxes. For the six months ended August 31, 2003, the Company recorded a net income tax benefit at the rate of 38% or $1.2 million. During the quarter ended August 31, 2002, the Company recorded a net income tax benefit of $1.4 million which reflects the reversal of a previously recorded valuation allowance against deferred income tax assets.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s primary source of liquidity for the six months ended August 31, 2003 and August 31, 2002 was from our cash balances and cash provided by operations. Net cash provided by operating activities during the six months ended August 31, 2003 of approximately $0.2 million was provided by non-cash depreciation and amortization expense, collections of accounts receivable, an increase in accrued expenses, and substantially offset by the net loss and an increase in deferred tax assets. For the six-months ended August 31, 2002 net cash provided by operating activities was approximately $3.2

million and consisted primarily of net income and non-cash depreciation and amortization expense and a reduction in accounts receivable, associated with favorable collections.

The Company purchased for cash approximately $0.6 million and $0.3 million in new equipment during the six months ended August 31, 2003 and 2002, respectively. Additionally, the Company paid $0.4 million for marketing and manufacturing rights for an advanced imaging product and acquired $0.4 million of new equipment under capital leases during the six months ended August 31, 2003. The Company expects that it may incur additional debt with the acquisition of additional equipment during the next 12 months. The Company expects that it will not acquire more than $1 million in additional equipment for the remainder of the fiscal year. See “Forward-Looking Statements.”

Net cash used in financing activities was approximately $0.2 million and $0.2 million for the six months ended August 31, 2003 and 2002, respectively, and principally relates to payments on capital leases partially offset by proceeds from the issuance of common stock associated with stock options exercised.

As of August 31, 2003, our future commitments under capital leases and term debt through fiscal year 2006 were $596,000.

The Company has available a bank credit facility providing for borrowings of up to 80% of eligible accounts receivable, as defined, not to exceed $3.0 million. Additionally, during the quarter ended August 31, 2003 the agreement was amended whereby the Company may borrow, through February 28, 2004, up to an additional $4.0 million on a term loan, payable over 48 months with equal principal payments plus interest. The credit facility bears interest at the bank’s prime rate plus 0.5% (4.5% at August 31, 2003), expires in November 2004, and is collateralized by the assets of the Company. The agreement requires the Company to maintain certain financial covenants that the Company was in compliance with at August 31, 2003. Such covenants also restrict the Company’s ability to pay dividends on its common stock. No amounts were outstanding under the agreements at August 31, 2003.

Management believes that our positive cash position, together with working capital, cash from operations, and the current credit facility, should be adequate to continue to implement management’s business plan and to meet our cash needs for at least the next twelve months. 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 numerous factors, including the amount and timing of the receipt of revenues from operations, any potential acquisitions, an increase in manufacturing capabilities, the timing and extent of the introduction of new products and services and growth in personnel and operations. There can be no assurance that additional financing will be available when needed 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 the discussion regarding “Cautionary Statements” under “Forward-Looking Statements” above.

As of August 31, 2003, expected future cash payments, related to contractual obligations were as follows:

Contractual Obligations	Total		Less than 1 Year		1 to 3 Years
Capital Lease Obligations	$	596,000	$	226,000	$	370,000
Operating Lease Obligations	$	208,000	$	200,000	$	8,000
Purchase Obligations	$	1,158,000	$	1,158,000	—
Total	$	1,962,000	$	1,584,000	$	378,000

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any material off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our results of operations or financial condition.

NEW ACCOUNTING PRONOUCEMENTS

See Note 3 to financial statements in Item 1. Note 3 is incorporated herein by this reference.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Among the significant estimates affecting our consolidated financial statements are those relating to allowances for doubtful accounts, inventories, goodwill, deferred taxes, stock based compensation and revenue recognition. We regularly evaluate our estimates and assumptions based upon historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent actual results differ from those estimates, our future results of operations may be affected. Detailed information on these critical accounting policies is included on pages 14 thru 16 of our Annual Report on Form 10-K for the fiscal year ended February 28, 2003. Management believes that as of August 31, 2003, there has been no material change to this information.

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 United States interest rates because our debt instruments, consisting principally of capital lease agreements, were based on fixed interest rates.

ITEM 4. Controls and Procedures.

The Company maintains disclosure controls and procedures that are designed to ensure that the information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of August 31, 2003, the end of the quarter covered by this report, 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 required by Sec Rule 13a – 15(b). Based on the foregoing, 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 has been no change in the Company’s internal controls over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II - OTHER INFORMATION

ITEM 1 - Legal Proceedings

The Company is engaged in a lawsuit with SimpleTech (formerly Simple Technology, Inc.) in connection with its lawsuit alleging that the Company’s stacking technology infringed on a SimpleTech Stacking patent. Costs of defense of this lawsuit could be substantial, and the ultimate outcome of the lawsuit or any resulting potential loss is not presently determinable.

ITEM 2 - Changes in Securities and Use of Proceeds

None

ITEM 3 - Defaults Upon Senior Securities

None

ITEM 4 - Submission of Matters to a Vote of Security Holders

None

ITEM 5 - Other Information

Previously reported

ITEM 6 - Exhibits and Reports on Form 8-K

(a) Exhibits

10.6 Loan and Security Agreement between Silicon Valley Bank and DPAC Technologies Corp. dated August 30, 2002. (1)

10.6.1 Amendment to Loan and Security Agreement between Silicon Valley Bank and DPAC Technologies Corp. dated June 25, 2003.

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.

99.1 Cautionary Statements are incorporated herein by reference to pages 21 through 29, inclusive, of the Registrant’s Form 10-K filed May 28, 2003 with the Securities and Exchange Commission.

(1) Filed on October 15, 2002 as Exhibit 99.3 to DPAC Technologies Corp.’s quarterly report on Form 10-Q for the quarter ended August 31, 2002, and incorporated herein by reference.

(b) Reports on Form 8-K - We filed a Report on Form 8-K on June 30, 2003, filing under Items 7 and 9, the news release related to our earnings for the quarter ended May 31, 2003 and the accompanying Condensed Consolidated Balance Sheet Information (Unaudited) and Condensed Statement of Income (Unaudited).

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, 2003	By:	/s/ TED BRUCE
Date		Ted Bruce, Chief Executive Officer


October 14, 2003	By:	/s/ WILLIAM M. STOWELL
Date		William M. Stowell, Chief Financial Officer

EXHIBIT INDEX

Exh. No.		Description

10.6		Loan and Security Agreement between Silicon Valley Bank and DPAC Technologies Corp. dated August 30, 2002. (1)

10.6.1		Amendment to Loan and Security Agreement between Silicon Valley Bank and DPAC Technologies Corp. dated June 25, 2003.

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.

99.1		Cautionary Statements

(1) Filed on October 15, 2002 as Exhibit 99.3 to DPAC Technologies Corp.’s quarterly report on Form 10-Q for the quarter ended August 31, 2002, and incorporated herein by reference.

EX-10.6.1 3 a03-4034_1ex10d6d1.htm EX-10.6.1

EXHIBIT 10.6.1

Silicon Valley Bank

Amendment to Loan and Security Agreement

Borrower: DPAC Technologies Corp.

Dated: June 25, 2003

THIS AMENDMENT TO LOAN AND SECURITY AGREEMENT (“Amendment”) is entered into between SILICON VALLEY BANK (“Bank”) and the borrower named above (the “Borrower”).

Reference is made to the Loan and Security Agreement between them dated August 30, 2002, as amended from time to time (the “Loan Agreement”). Capitalized terms used but not defined in this Amendment, shall have the meanings set forth in the Loan Agreement.

Borrower and Bank desire to modify the terms of the Loan Agreement and the parties agree to do so as follows:

1. New Section 2.1.4. A new section is hereby added to the Loan Agreement to follow immediately after Section 2.1.3, which new section shall be entitled “2.1.4. Term Loan Advances”, and which shall read as follows:

“2.1.4. Term Loan Advances.

“(a) Through February 28, 2004, Bank will make advances (individually referred to herein as an “Term Loan Advance” and collectively as the “Term Loan Advances”) in an aggregate amount not to exceed Four Million Dollars ($4,000,000).

(b) Interest accrues from the date of the making of each Term Loan Advance at the applicable interest rates as set forth in Section 2.3(a) hereof and is payable as set forth therein beginning on the first possible interest payment date following the making of such Term Loan Advance. Borrower shall repay the aggregate amount of the Term Loan Advances to Bank in forty-eight (48) equal monthly installments of principal beginning on March 1, 2004 and continuing on the first day of each of the succeeding forty-seven (47) months thereafter (such final installment payment date for the Term Loan Advances is referred to herein as the “ Term Loan Maturity Date”), with the understanding that on the Term Loan Maturity Date all Term Loan Advances and all related Obligations shall be repaid in full. Term Loan Advances when repaid may not be reborrowed.

(c) To obtain a Term Loan Advance, Borrower must notify Bank (the notice is irrevocable) by facsimile no later than 12:00 p.m. Pacific time one Business Day before the day on which the Term Loan Advance is to be made. The notice in the form of Exhibit B (Payment/Advance Form) must be signed by a Responsible Officer or designee. The proceeds of each Term Loan Advances shall be used for general corporate purposes.

2. Revised Section 2.3(a) and Section 2.3(b). Subsections (a) and (b) of Section 2.3 are hereby amended and restated to read, respectively, as follows:

(a) Interest Rate. (i) Revolving Advances accrue interest on the outstanding principal balance at a per annum rate equal to the Prime Rate; and (ii) Term Loan Advances accrue interest on the outstanding principal balance at a per annum rate equal to the Prime Rate plus the Applicable Margin (as defined below). 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.

As used herein the term “Applicable Margin” shall mean and refer to one-half of one percentage point (.50%), provided if a Term Loan Advance in the amount of $4,000,000 is made concurrently with the execution and delivery of the Amendment to Loan and Security Agreement dated June 25, 2003 by and between Borrower and Bank, then the Applicable Margin shall be one-quarter of one percentage point (.25%), provided, further, if a Term Loan Advance of $4,000,000 is not so made but a Term Loan Advance of at least $2,000,000 is made concurrently therewith, then the Applicable Margin shall be three-eighths of one percentage point (.375%).

(b) Payments. Interest due on the Committed Revolving Line is payable on the 25^th day of each month. Interest due on the Term Loan Advances is payable on the 1st 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. ”

3. Revised Section 6.7. Section 6.7 of the Loan Agreement is hereby amended to read as follows:

“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 1.50 to 1.00.”

4. Revised Definitions. It is hereby agreed that the defined term of “Credit Extension” shall also include, without limitation, all Term Loan Advances, and that the defined term “Obligations” shall include all indebtedness and other obligations arising in connection with the Term Loan Advances.

5. New Definitions. Section 13 of the Loan Agreement is hereby amended by adding the defined terms of “ Term Loan Advance(s)” and “ Term Loan Maturity Date” thereto and inserting such definitions in their appropriate alphabetical order in such Section:

“ ‘Term Loan Advance(s)’ shall have the meaning set forth in Section 2.1.4 hereof.

‘Term Loan Maturity Date’ shall have the meaning set forth in Section 2.1.2A hereof.

6. Fee. Borrower shall pay to Bank a facility fee in connection herewith in the amount of $15,000 , which shall be in addition to interest and to all other amounts payable under the Loan Agreement, and which shall not be refundable, provided, however, such fee shall be eliminated entirely if a Term Loan Advance in the amount of $4,000,000 is made concurrently herewith, provided, further, if a Term Loan Advance of $4,000,000 is not made but a Term Loan Advance of at least $2,000,000 is made, then no fee shall be payable but, instead, the Borrower agrees to pay the Unused Line Fee (as defined below) during the term of the Agreement.

Borrower hereby agrees to pay to Bank the Unused Line Fee for term of the Loan Agreement, if such fee is applicable based on the above provision. As used herein the term “Unused Line Fee” shall be an amount equal to 0.375% per annum multiplied by the difference between $4,000,000 and the average daily principal balance of the Term Loan Advances outstanding during any, quarter prior to the later to occur of the Term Loan Maturity Date or the date when any Term Loan Advances remain outstanding (the “Final Payment Date”), which unused line fee shall be computed and paid quarterly, in arrears, on the first day of the following quarter, or otherwise payable on

the Final Payment Date (if such date is not the first day of a quarter) on a pro rata basis for such period then ending.

7. Conditions to Effectiveness. The following shall be conditions precedent to the effectiveness of this Agreement:

7.1 Executed Counterparts; Certified Resolutions. Borrower shall deliver to Bank fully executed and authorized counterparts of this Amendment together with certified corporate resolutions relating hereto that authorize the execution and delivery of this Amendment and the incurring of the obligations referenced herein;

7.2 Payment of Fee. Borrower shall pay to Bank the fee referred to in Section 6 above, if applicable.

8. Representations True. Borrower represents and warrants to Bank that all representations and warranties in the Loan Agreement, as amended hereby, are true and correct.

9. General Provisions. The amendments and modifications set forth in this Agreement shall be deemed effective as of the date hereof when all conditions to effectiveness have been satisfied, as Bank has determined. This Amendment, the Loan Agreement, any prior written amendments to the Loan Agreement signed by Bank and the Borrower, and the other written documents and agreements between Bank and the Borrower set forth in full all of the representations and agreements of the parties with respect to the subject matter hereof and supersede all prior discussions, representations, agreements and understandings between the parties with respect to the subject hereof. Except as herein expressly amended, all of the terms and provisions of the Loan Agreement, and all other documents and agreements between Bank and the Borrower shall continue in full force and effect and the same are hereby ratified and confirmed. This Agreement may be executed in any number of counterparts, which when taken together shall constitute one and the same agreement.

IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written.

	Borrower:					Bank:

	DPAC TECHNOLOGIES CORP.					SILICON VALLEY BANK


	By					By

	Title					Title

EX-31.1 4 a03-4034_1ex31d1.htm EX-31.1

EXHIBIT 31.1

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 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 14, 2003

/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.;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 14, 2003

/s/ WILLIAM M. STOWELL
William M. Stowell
Chief Financial Officer

EX-32.1 5 a03-4034_1ex32d1.htm EX-32.1

EXHIBIT 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.

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, 2003, 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, 2003

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, 2003, 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, 2003

EX-99.1 6 a03-4034_1ex99d1.htm EX-99.1

EXHIBIT 99.1

Cautionary Statements

Statements in this Report that are not historical facts, including all statements about our 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.

Disclosure About Terrorist Risk

We did not experience any direct impact from the September 11, 2001 terrorist attacks on the United States other than minor delays in certain material shipments due to disruptions in the air transportation system. These delays did not have a material impact on us. We are unable to estimate or predict what future impact these events will have on us, our customers, our suppliers and the market demand for our products. Any production delays or shutdowns, reduction in demand or loss of customers due to terrorist attacks could have a negative impact on our results of operations and future sales.

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. Our memory and future wireless products are subject to obsolescence or price erosion because semiconductor manufacturers are continuously introducing chips with the same or greater memory density as our custom modules. As a result, memory products typically have a product life of not more than three to five years.

Our future success depends on our ability to develop new products and product enhancements to keep up with technological advances and to meet customer needs. Any failure by us 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 our financial condition and results of operations. Additionally, the Company could incur new operating costs with the introduction of new products.

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

Uncertainty of Market Acceptance or Profitability of New Products

The introduction of new products, such as our announced product plans for the wireless marketplace, will require the expenditure of an unknown amount of funds for research and development, tooling, manufacturing processes, inventory and marketing. In order to successfully develop products, we will need to successfully anticipate market needs and may need to overcome rapid technological change and competition. In order to achieve high volume production, we will need to make substantial investments in inventory and capital equipment or, as currently contemplated, we will need to out-source production to third parties or enter into licensing arrangements. We are inexperienced in the wireless industry, and our plans in that industry are unproven. We have limited marketing capabilities and resources and are dependent upon internal sales and marketing personnel and a network of independent sales representatives for the marketing and sale of our 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 that have in the past and may in the future negatively affect our operations. We are dependent on a limited number of suppliers for semiconductor devices used in our products, and we have no long-term supply contracts with any of them.

Due to the cyclical nature of the semiconductor industry and competitive conditions, we may experience difficulties in meeting our 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 our products, increase our cost of goods sold and have a material adverse effect on our business, financial condition and results of operations.

Concentration of Credit Risk

We grant 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. A decision by a significant customer to substantially decrease or delay purchases from us or our inability to collect receivables from any of these customers could have a material adverse effect on our business, financial condition, and results of operations.

Dependence on Defense-Related Business

We have historically derived a portion of our revenues from defense-related contracts. As a result, our business may be 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. We have reduced, and attempt to continue to reduce, our dependence on defense-related business by developing products with commercial applications, although such products generally have lower margins than defense-related products, and this adversely affects our results of operations and cash flows.

Intellectual Property Rights

Our ability to compete effectively is dependent on our proprietary know-how, technology and patent rights. We hold U.S. patents on certain aspects of our three-dimensional stacking technology and have applied for additional patents. There can be no assurance that our patent applications will be approved, that any issued patents will afford our products any competitive advantage or that any of our products 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 our present or future products.

We are involved from time to time in claims and litigation over intellectual property rights, which may adversely affect our ability to manufacture and sell our products.

The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights. We believe that it may be necessary, from time to time, to initiate litigation against one or more third parties to preserve our intellectual property rights. In addition, from time to time, we have received, and may continue to receive in the future, notices that claim we have infringed upon, misappropriated or misused other parties’ proprietary rights, which claims could result in litigation. Such litigation would likely result in significant expense to us and divert the efforts of our technical and management personnel. In the event of an adverse result in such litigation, we could be required to pay substantial damages, cease the manufacture, use and sale of certain products, expend significant resources to develop non-infringing technology, discontinue the use of certain processes or obtain licenses to use the infringed technology. Such a license may not be available on commercially reasonable terms, if at all. Our failure to obtain a license or our failure to obtain a license on

commercially reasonable terms could cause us to incur substantial costs and suspend manufacturing products using the infringed technology. If we obtain a license, we would likely be required to make royalty payments for sales under the license. Such payments would increase our costs of revenues and reduce our gross profit. In addition, any litigation, whether as plaintiff or as defendant, would likely result in significant expense to us and divert the efforts of our technical and management personnel, whether or not such litigation is ultimately determined in our favor. In addition, the results of any litigation are inherently uncertain.

Management of Growth or Diversification

Successful expansion or diversification of the Company’s operations will depend on 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 new product introductions. To manage growth or diversification effectively, we will have to continue to implement and improve our operational, financial and management information systems, procedures and controls. As we expand or diversify, we may from time to time experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion. Failure to manage growth or diversification effectively could adversely affect our financial condition and results of operations.

Competition

There are memory companies that offer or are in the process of developing three-dimensional products, including ChipPac, Amcor, Staktek, Samsung, Infineon, Elpedida and others. Some of such companies have greater financial, manufacturing and marketing capabilities than we have. We could also experience competition from established and emerging computer memory companies. There can be no assurance that our products will be competitive with existing or future products, or that we will be able to establish or maintain a profitable price structure for our products.

We expect to face competition from existing competitors and new and emerging companies that may enter our existing or future markets with similar or alternative products, which may be less costly or provide additional features. In addition, some of our significant suppliers are also our competitors, many of who have the ability to manufacture competitive products at lower costs as a result of their higher levels of integration. We also face competition from current and prospective customers that evaluate our capabilities against the merits of manufacturing products internally. Competition may arise due to the development of cooperative relationships among our current and potential competitors or third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors will emerge and rapidly acquire significant market share.

We expect our competitors will continue to improve the performance of their current products, reduce their prices and introduce new products that may offer greater performance and improved pricing, any of which could cause a decline in sales or loss of market acceptance of our products. In addition, our competitors may develop enhancements to or future generations of competitive products that may render our technology or products obsolete or uncompetitive.

Product Liability

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

Variability of Gross Margin

Any change in the gross margins can typically be attributed to the type of products, and the amount of purchased memory included in sales during the year as well as the amount of royalty income generated during the periods. As we market our 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 our product, prices could range from less than $5 for commercial custom modules to over a thousand dollars for high-end military specification custom modules.

We expect that our 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 our 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 our products may decline depending upon the price changes of DRAM, SRAM and Flash semiconductors, which would have a material adverse effect on our net sales and could, have a material adverse effect on our business, financial condition and results of operation. Accordingly, our ability to maintain or increase net sales will be highly dependent upon our 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 our gross margin unless we are able to reduce our cost per unit to offset declines in product selling prices. There can be no assurance that we will be able to increase unit sales volumes, introduce and sell new products or reduce our cost per unit. We also expect that our business may experience significant seasonality to the extent it sells a material portion of our products in Europe (due to vacation cycles) and to the extent, our exposure to the personal computer market remains significant.

Our average sales prices have historically declined, and we anticipate that the average sales prices for our products will continue to decline and could negatively impact our gross profit margins.

Semiconductor companies and OEM’s are placing increasing price pressure on module manufactures, which in turn, has resulted in downward pricing pressure on our products with certain competitors aggressively reducing prices in an effort to increase market share. Fierce competition among third-party suppliers has also increased, at the same time the major semiconductor companies, who are supplying their own stacking solutions with the goal to sell semiconductors, can result in little-to-no-value for the service providers of stacking. To offset declining average sales prices, we must reduce manufacturing costs and ultimately develop new products with lower costs or higher average sales prices. If we cannot achieve such cost reductions or product improvements, our gross margins will decline.

Decline of Demand for Product Due to Downturn of Related Industries

We 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 or a technology shift, could have a material adverse impact on the demand for our products, and therefore, a material adverse effect on our business, financial condition and results of operations. There can be no assurance that our 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 our products.

Fluctuations in Operating Results

Our 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 our results of operations; include, adverse changes in the mix of products sold, the inability to procure required components, the size of investments in new technologies or product lines, 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 our results of operations include fluctuating market demand for and declines in the selling prices of our

products, decreases or increases in the costs of the components of our products, market acceptance of new products and enhanced versions of our products, our competitors’ selling products that compete with our products at lower prices or on better terms than we sell our products, delays in our the introduction of new products and in our making enhancements to existing products, manufacturing inefficiencies associated with the start up of new product introductions, or our 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.

Our operating results may also be affected by the timing of new product announcements and releases by us or our 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 our inventories due to price declines, unexpected product returns, the timing of expenditures in anticipation of increased sales, cyclicality in our targeted markets, and expenses associated with acquisitions. In particular, declines in DRAM, SRAM and Flash semiconductor prices could affect the valuation of our inventory, the pricing of services, which could result in adverse changes in our business, financial condition and results of operations. Many of these same conditions apply to the products being developed for the wireless market.

Sales of our 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. We have experienced and could continue to experience unexpected reductions in sales of products as customers anticipate new product purchases. In addition, to the extent that we manufacture 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, we 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, we have had to write-down and write-off excess or obsolete inventory. To the extent that we are unsuccessful in managing product transitions, our business, financial condition and results of operations could be materially and adversely affected.

From time to time, our customers may purchase products from us in large quantities over a short period of time, which may cause demand for our products to change rapidly. Due to these and other uncertainties associated with semiconductor infrastructure deployments and OEMs’ purchasing strategies, we may experience significant fluctuations in demand from our customers. Such fluctuations could cause a significant increase in demand that could exceed our production capacity and could negatively impact our ability to meet customers’ demands as well as potentially impact product quality. Alternatively, such fluctuations could cause a significant reduction in revenues, which could have a material adverse effect on our business, results of operations and financial condition. We cannot guarantee that a major customer will not reduce, delay or eliminate purchases from us, which could have a material adverse effect on our business, results of operations and financial condition.

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 us to reduce our operating expenses in any particular period if our expectations for net sales for that period are not met or our investment objective for future revenues streams need to continue for potential success. Accordingly, there can be no assurance that we will be able to be profitable in any future period. We believe that period-to-period comparisons of our financial results are not necessarily meaningful and should not be relied upon as indications of good future performance. Due to the foregoing factors, it is likely that in some future period our operating results will be below the expectations of public market analysts or investors. In such event, the market price of our Common Stock or other securities would be materially and adversely affected.

International Sales

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 our competitors may have the ability to manufacture competitive products in Asia at lower costs than we can manufacture them.

We are also subject to the risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether the United States or other countries will implement quotas, duties, taxes or other charges or restrictions upon the importation or exportation of our products. Because sales of our products have been denominated to date in United States dollars, increases in the value of the United States dollar could increase the price of our 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 our results of operations. Some of our customer’s purchase orders and agreements are governed by foreign laws, which may differ significantly from United States laws. Therefore, we may be limited in our ability to enforce any rights under such agreements and to collect damages, if awarded. These factors could have a material adverse effect on our 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, assume contingent liabilities, or use other company assets available at the time of acquisition. 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;

• Sudden market changes;

• 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 products. 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 that 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

A majority 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. Additionally, as the company lease period expires the Company may be required to move to new locations, which may present risks associated with such a move.

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.

Key Personnel

The Company may fail to attract or retain the qualified technical sales, marketing and managerial personnel required to operate its business successfully.

DPAC’s future success depends, in part, upon ability to attract and retain highly qualified technical, sales, marketing and managerial personnel. Personnel with the necessary expertise are scarce and competition for personnel with proper skills is intense. Also, attrition in personnel can result from, among other things, changes related to acquisitions, as well as retirement or disability. The Company may not be able to retain existing key technical, sales, marketing and managerial employees or be successful in attracting, assimilating or retaining other highly qualified technical, sales, marketing and managerial personnel in the future. If the Company is unable to retain existing key employees or is unsuccessful in attracting new highly qualified employees, business, financial condition and results of operations of DPAC could be materially and adversely affected.

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 us, 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.