Form 10-Q for period ended November 30, 2005

10-Q 1 d10q.htm FORM 10-Q FOR PERIOD ENDED NOVEMBER 30, 2005 Form 10-Q for period ended November 30, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended November 30, 2005

¨	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 Office)		(Zip Code)

(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 x NO ¨

Indicate by Check Mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

Indicate by Check Mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of common stock, no par value, outstanding as of November 30, 2005 was 23,744,931.

PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

DPAC Technologies Corp.

Condensed Balance Sheets


	November 30, 2005			February 28, 2005
	(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	500,646		$	2,693,938
Accounts receivable, net		423,815			252,465
Inventories		26,296			146,800
Prepaid expenses and other current assets		75,373			279,255
Current assets of discontinued operations		—			164,134

Total current assets		1,026,130			3,536,592

PROPERTY, net		170,474			230,305

TECHNOLOGY LICENSE AGREEMENT		—			332,506
DEPOSITS		41,501			31,501

TOTAL	$	1,238,105		$	4,130,904

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
CURRENT LIABILITIES:
Note payable	$	500,000		$	147,641
Accounts payable		295,230			398,946
Accrued compensation		37,119			172,607
Accrued restructuring costs—current		183,715			627,415
Other accrued liabilities		149,794			175,998
Current liabilities of discontinued operations		245,849			467,952

Total current liabilities		1,411,707			1,990,559

ACCRUED RESTRUCTURING COSTS, Less current portion		419,987			257,707
NON-CURRENT LIABILITIES OF DISCONTINUED OPERATIONS		326,648			443,425

COMMITMENTS AND CONTINGENCIES (Note 15)

STOCKHOLDERS’ EQUITY (DEFICIT):
Common stock		27,361,086			27,361,086
Additional paid-in capital		2,701,701			2,701,701
Accumulated deficit		(30,983,024	)		(28,623,574	)

Net stockholders’ equity (deficit)		(920,237	)		1,439,213

TOTAL	$	1,238,105		$	4,130,904

See accompanying notes to condensed financial statements.

DPAC Technologies Corp.

Condensed Statements of Operations

(Unaudited)


	For the quarter ended:						For the nine months ended:
	November 30, 2005			November 30, 2004			November 30, 2005			November 30, 2004
NET SALES	$	378,047		$	333,955		$	1,181,925		$	957,323

COST OF SALES		270,737			221,129			874,188			780,286

GROSS PROFIT		107,310			112,826			307,737			177,037

COSTS AND EXPENSES:
Sales and marketing		—			530,346			593,140			1,504,029
Research and development		17,674			388,349			493,615			1,086,167
General and administrative		581,211			643,404			2,109,367			2,065,227
Write-off of amount due under technology license		—			—			282,506			—
Restructuring charges		—			—			—			573,215

Total costs and expenses		598,885			1,562,099			3,478,628			5,228,638

LOSS FROM CONTINUING OPERATIONS		(491,575	)		(1,449,273	)		(3,170,891	)		(5,051,601	)

OTHER INCOME (EXPENSE):
Interest income		2,509			9,985			14,076			25,277
Interest expense		(15,167	)		—			(19,667	)		—

LOSS FROM CONTINUING OPERATIONS
BEFORE INCOME TAX PROVISION		(504,233	)		(1,439,288	)		(3,176,482	)		(5,026,324	)

INCOME TAX PROVISION		—			—			—			—

NET LOSS FROM CONTINUING OPERATIONS	$	(504,233	)	$	(1,439,288	)	$	(3,176,482	)	$	(5,026,324	)

DISCONTINUED OPERATIONS, Net		330,004			508,030			817,032			1,641

NET LOSS	$	(174,229	)	$	(931,258	)	$	(2,359,450	)	$	(5,024,683	)

NET GAIN (LOSS) PER SHARE:
Continuing Operations—Basic and diluted	$	(0.02	)	$	(0.06	)	$	(0.13	)	$	(0.22	)

Discontinued Operations—Basic and diluted	$	0.01		$	0.02		$	0.03		$	0.00

Net Loss—Basic and diluted	$	(0.01	)	$	(0.04	)	$	(0.10	)	$	(0.22	)

WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic and diluted		23,745,000			23,732,000			23,745,000			23,180,000

See accompanying notes to condensed financial statements.

DPAC Technologies Corp.

Condensed Statements of Cash Flows

(Unaudited)


	For the nine months ended
	November 30, 2005			November 30, 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations	$	(3,176,482	)	$	(5,026,324	)

Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depreciation and amortization		92,719			124,673
Compensation expense associated with stock options		—			24,198
Provision for bad debts		(200	)		21,000
Provision for obsolete inventory		(10,000	)		50,000
Write-off of amount due from technology license		282,506			—

Changes in operating assets and liabilities:
Accounts receivable		(171,150	)		(137,982	)
Inventories		130,504			(220,202	)
Other assets		193,882			177,208
Accounts payable		(103,716	)		(9,250	)
Accrued compensation		(135,488	)		(46,083	)
Accrued restructuring charges		(281,420	)		146,841
Other accrued liabilities		(26,204	)		175,167

Net cash used in operating activities		(3,205,049	)		(4,720,754	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions		(32,888	)		(135,217	)
Technology license agreement		50,000			81,083

Net cash provided by (used in) investing activities:		17,112			(54,134	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short term debt		(147,641	)		—
Proceeds from issuance of convertible debt		500,000			—
Proceeds from issuance of common stock		—			1,783,900
Note receivable		—			(48,589	)

Net cash provided by financing activities		352,359			1,735,311

NET CASH PROVIDED BY DISCONTINUED OPERATIONS		642,286			2,563,429

NET DECREASE IN CASH AND CASH EQUIVALENTS		(2,193,292	)		(476,148	)

CASH & CASH EQUIVALENTS, BEGINNING OF PERIOD		2,693,938			4,477,396

CASH & CASH EQUIVALENTS, END OF PERIOD	$	500,646		$	4,001,248

SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	31,187		$	21,977

On May 6, 2004, the Company sold its industrial, defense, and aerospace product line for $333,000 in cash. Included in the sale was net inventory of $148,000 and property with a net book value of $136,000.

One June 14, 2004, the Company sold its commercial memory stacking patents and patent applications and related excess inventory for $670,092 in cash.

See accompanying notes to condensed financial statements.

CAUTIONARY STATEMENT RELATED TO FORWARD-LOOKING STATEMENTS

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

HOW TO OBTAIN DPAC TECHNOLOGIES SEC FILINGS

All reports filed by DPAC Technologies with the SEC are available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials filed by the Company with the SEC at the SEC’s public reference room located at 100 F Street St., N.E., Washington, D.C. 20549. DPAC also provides copies of its Forms 8-K, 10-K, 10-Q, Proxy and Annual Report at no charge to investors upon request and makes electronic copies of its most recently filed reports available through its website at www.dpactech.com as soon as reasonably practicable after filing such material with the SEC.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1—Liquidity

The Company has incurred losses from continuing operations during the first nine months of fiscal year 2006 and for each of the last three fiscal years. At November 30, 2005, the Company had cash and cash equivalents of $501,000, negative working capital of $386,000 and a current ratio of 0.7 to 1. This compares to a cash balance of $2.7 million, working capital of $1.5 million and a current ratio of 1.8 to 1 at February 28, 2005.

On August 5, 2005 the Company entered into a license agreement with Development Capital Ventures LP (“DCV”) that resulted in QuaTech obtaining the exclusive world-wide right, subject to shareholder approval, to sell, manufacture and distribute the Airborne^™ products in exchange for royalties on products sold. As a result of the License, DPAC’s on-going business operations consists primarily of the collection of royalties under the QuaTech License. If our shareholders do not approve the exclusive License with DCV and QuaTech, QuaTech will have the option to continue the licensing arrangement on a non-exclusive basis and DPAC would have the ability to license the Airborne^™ technology to other potential licensees. If the Merger with QuaTech is terminated for any reason, QuaTech has the option, subject to DPAC shareholder approval, to purchase an exclusive Airborne^™ product license for the agreed fair market value of the technology of $2.4 million.

Management expects the Company will continue to consume cash for the foreseeable future. The rate at which cash will be consumed is primarily dependent on the amount of revenues realized from royalties during each period. On March 3, 2006, subject to extension at the Company’s election, the Company will be required to repay $500,000 to DCV under a secured, convertible bridge loan agreement entered into on August 5, 2005, unless the Company completes the merger with QuaTech before that date, which would result in conversion of the note into DPAC common stock. The Company may not have sufficient cash available to repay the DCV loan. Based on the Company’s current cash flow requirements, management believes that our positive cash position will not be adequate to continue to maintain liquidity throughout the ensuing fiscal year. This raises substantial doubt about the Company’s ability to continue as a going concern. The Company will seek to close the merger with QuaTech and continue to seek additional equity or financing in order to meet its obligations, as they are due. There can be no assurance that additional financing would be available if and when needed on terms favorable to the Company.

NOTE 2—General Background

Agreement with QuaTech, Inc.

On April 26, 2005, we announced that DPAC has entered into a definitive agreement with QuaTech, Inc. (“QuaTech”) that sets forth the terms of a proposed acquisition by us of QuaTech, Inc. through a triangular stock-for-stock merger (the “Merger Agreement” or the “Merger”). On August 5, 2005, we amended the definitive agreement with QuaTech and simultaneously entered into a technology licensing agreement (the “License Agreement”) and a $500,000 convertible loan agreement (the “Bridge Loan”) with QuaTech’s largest shareholder, DCV. On October 20, 2005 we announced that we had entered into a second amendment of the Merger Agreement and the first amendment to the license agreement. The second amendment of the Merger Agreement modifies certain of the conditions to close the transaction, and extends the date for completion of the transaction to March 31, 2006. The first amendment to the license agreement provides an option to QuaTech to prepay all exclusive license fees for a one time cash payment of $2.4 million. DPAC has filed an S-4 registration statement and proxy materials to seek shareholder approval of the Merger with QuaTech. For accounting purposes, the transaction will be considered a reverse-acquisition of us by QuaTech, Inc. Following the transaction, QuaTech would be a wholly-owned subsidiary of DPAC. Under the amended Merger Agreement, QuaTech’s shareholders and stakeholders would receive DPAC shares in an amount calculated to result in QuaTech’s shareholders owning approximately 70% of the outstanding shares of DPAC after the completion of

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

the merger. In addition, DCV will convert the Bridge Loan to DPAC common stock upon the completion of the merger. This will result in DCV owning approximately 54% of DPAC’s outstanding common stock at the completion of the merger, and all QuaTech shareholders, including DCV, will own approximately 76% of the DPAC shares outstanding following the completion of the merger.

QuaTech, a privately-held company, is an industry leader in device networking and connectivity solutions. Through design, manufacturing and support, QuaTech maintains high standards of reliability and performance. Customers include original equipment manufacturers (“OEMs”), value-added resellers (“VARs”) and System Integrators, as well as end-users in many industries, including banking, retail/POS, access control, building automation and security, and energy management. QuaTech is a leading supplier of data connectivity products to financial institutions, serving five of the top ten U.S. banks. Founded in 1983 and headquartered in Hudson, Ohio, QuaTech sells and supports its solutions both direct and through a global network of resellers and distributors.

The consummation of the merger, as contemplated by the definitive agreement, is subject to various conditions, including the approval of DPAC shareholders and QuaTech shareholders, as well as satisfaction of certain other requirements and the absence of material adverse changes in conditions. Another major condition is that QuaTech completes the closing of certain additional financing to complete the transactions as envisioned. There are no assurances possible, and none are intended, that the transaction will be completed at all or on the terms described. The transaction is and shall continue to be subject to numerous conditions and contingencies until the transaction is completed. Also, there can be no assurance that such transaction, if completed, will succeed in achieving our goals.

DPAC Technologies Corp. will provide further detailed information to its shareholders in a definitive proxy statement to solicit their vote for the transaction.

The Merger transaction’s costs and diversion of management attention have and could continue to negatively impact results.

The Merger transaction would involve a change of control, in that voting control of DPAC would be given to shareholders of QuaTech, and DCV would own more than 50% of DPAC common stock. The principal former shareholder of QuaTech would be able to elect a majority of DPAC’s Board of Directors.

Description of Business

DPAC Technologies Corp. (formerly Dense-Pac Microsystems, Inc.) (“DPAC” or the “Company” or “we” or “our”) is a provider of wireless connectivity products for industrial, transportation, medical and other commercial applications. The Airborne^™ wireless Local Area Network (“LAN”) Node Module was introduced in September 2003. The product is designed to enable OEM equipment designers to incorporate 802.11 wireless LAN connectivity into their device, instrument or equipment through the inclusion of the Company’s Wireless LAN Node Module in their system design. The Company also sells Airborne^™ Direct plug-and-play wireless products that add 802.11 wireless connectivity to legacy instruments and equipment that have a pre-existing serial or Ethernet data port. On August 5, 2005 we entered into a license agreement with DCV which resulted in QuaTech obtaining the exclusive world-wide right, subject to shareholder approval, to sell, manufacture and distribute the Airborne^™ products in exchange for royalties on products sold. As a result of the License, DPAC’s on-going business operations consist exclusively of the collection of royalties under the QuaTech License. If our shareholders do not approve the License with DCV and QuaTech, QuaTech will continue the licensing arrangement on a non-exclusive basis and DPAC would have the ability to license the Airborne^™ technology to

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

other potential licensees. If the Merger with QuaTech is terminated for any reason, QuaTech has the option, subject to DPAC shareholder approval, to purchase an exclusive Airborne^™ product license for the agreed fair market value of $2.4 million.

Airborne^™ products are used in medical monitoring and diagnostic equipment, heavy construction vehicles, forklifts, printers, point of sale devices, machine tools and other instruments and devices that seek to communicate data wirelessly with a local area network. The products are sold to both OEMs, who incorporate the products into their proprietary systems, and directly to individual operators for deployment into their existing networks.

DPAC Technologies Corp. was incorporated in California in September 1983, originally under the name Dense-Pac Microsystems, Inc., and changed its name to DPAC Technologies Corp. in August 2001. Our web site is at www.DPACtech.com. The information on our web site is not part of this report.

During fiscal year 2005, the Company sold its Industrial, Defense and Aerospace (“IDA”) product line and ceased the sale and production of memory stacking services to providers of high-density memory boards for the personal computer, server and telecommunications markets. These product lines had comprised the majority of the Company’s historical revenues. We now treat the results of operations and any remaining assets for these product lines as discontinued operations in our financial statements.

Except where otherwise noted, the financial information contained herein represents our continuing operations and excludes the discontinued IDA and memory stacking products.

NOTE 3—Basis of Presentation

The accompanying unaudited interim Condensed Financial Statements of DPAC as of November 30, 2005 and for the three and nine months ended November 30, 2005 and 2004, reflect all adjustments (consisting of normal recurring accruals and a restructuring charge), which, in the opinion of DPAC 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 complete-year financial statements. DPAC^®, DPAC Technologies^® and Airborne^™ 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, 2005. Operating results for the three and nine months ended November 30, 2005 are not necessarily indicative of the results that may be expected for the full year ending February 28, 2006.

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

NASDAQ SmallCap Listing

In August 2004, DPAC (ticker: DPAC) elected to apply and was approved for listing of its common stock on the Nasdaq SmallCap Market, transferring from the Nasdaq National Market listing after its shareholders’ equity balance decreased to less than the $10 million level required for continued listing on the National Market. On August 3, 2005, DPAC was de-listed from the Nasdaq SmallCap Market as a result of continuing deficiencies

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

in maintaining the minimum $1 per share stock price and minimum net worth requirements for continued listing. DPAC common stock now trades on the Over-the Counter Bulletin Board (“OTCBB”) under the symbol DPAC.OB.

Stock Based Compensation

The Company has elected, pursuant to Statement of Financial Accounting Standards 123 (“SFAS 123”), 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. We only record compensation expense for stock-based awards granted with an exercise price below the market price 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.

As prescribed in SFAS 123, the Company’s calculations are based on a single-option valuation approach and forfeitures are recognized as they occur. If compensation costs for the Company’s stock option plans were to have been determined based on the estimated fair value at the grant dates for awards under those plans consistent with the fair value method of SFAS 123 utilizing the Black-Scholes option-pricing model, the Company’s net loss from continuing operations and basic and diluted earnings loss per share for the three and nine months ended November 30, 2005 and 2004 would have approximated the pro forma amounts indicated below:


	For the Three Months Ended: November 30,						For the Nine Months Ended: November 30,
	2005			2004			2005			2004
Loss from continuing operations:
As reported	$	(504,233	)	$	(1,439,288	)	$	(3,176,482	)	$	(5,026,324	)

Add: Stock-based compensation expense included in reported net income, net of related tax effects		—			7,984			—			24,198
Deduct: Total stock-based compensation determined under fair value based method for all awards, net of related tax effects		(67,047	)		(85,347	)		(218,146	)		(451,763	)

Pro forma net loss from continuing operations	$	(571,280	)	$	(1,516,651	)	$	(3,394,628	)	$	(5,453,889	)

Net (loss) income per share as reported:
Basic and diluted	$	(0.02	)	$	(0.06	)	$	(0.13	)	$	(0.22	)
Pro forma net (loss) income per share:
Basic and diluted	$	(0.02	)	$	(0.06	)	$	(0.14	)	$	(0.24	)

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

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


	For the Three Months Ended: November 30,				For the Nine Months Ended: November 30,
	2005		2004		2005		2004
Expected life in months	33		35		33		35
Volatility	93	%	98	%	93	%	98	%
Interest rate	2.8	%	3.2	%	2.8	%	3.2	%
Dividends	None		None		None		None

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R). Under the provisions of SFAS 123R, companies are required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award, usually the vesting period. On April 14, 2005, the Securities and Exchange Commission approved a delay to the effective date of SFAS 123R. Under the new SEC rule, SFAS 123R is effective for annual periods that begin after June 15, 2005. SFAS 123R applies to all awards granted, modified, repurchased or cancelled by the Company after February 28, 2006 and to unvested options at the date of adoption.

NOTE 4—Discontinued Operations

As a result of the significant decline in the demand for the Company’s legacy stacking products experienced during fiscal year 2004 and continuing into fiscal year 2005, the Company implemented a number of restructuring initiatives to focus future endeavors of the Company on the Airborne^™ product line.

On June 14, 2004, DPAC sold all of its memory stacking patent and patent applications and related excess inventory associated with our legacy commercial product line for $670,000 in cash. Under the agreement, DPAC accepted agreed upon orders for LP Stacks^™ subject to material and capacity availability through July 30, 2004 and all orders were shipped no later than August 6, 2004. In conjunction with the sale, the Company’s memory stacking product line was discontinued. This product line accounted for $16.3 million (or 83%) of the Company’s net sales during fiscal year 2004 and $3.9 million (or 56%) of the Company’s net sales during fiscal year 2005. Accordingly, the Company completed the planned shut down of its in-house manufacturing, disposed of all related manufacturing equipment and vacated the portion of its leased facility utilized for manufacturing purposes during the third quarter of fiscal year 2005. The product lines are classified as discontinued operations beginning in the second fiscal quarter of 2005.

On May 6, 2004, DPAC reached an agreement with a third party to sell DPAC’s industrial, defense and aerospace (“IDA”) memory product line. The agreement transferred all of our relevant licensed rights to the specified technology and product line, and certain inventory and assets for $333,000 in cash and contingent future consideration based on the revenues of the product lines. The entire IDA product line, including royalty revenues, accounted for $3.16 million (or 16%) of the Company’s net sales during fiscal year 2004 and $1.7 million (or 24%) of the Company’s net sales during fiscal year 2005. In conjunction with the sale of the memory stacking product line as well as the shut down of the Company’s manufacturing process, the Company determined that, after completing shipments of existing IDA orders, it would no longer have continuing significant involvement with the IDA product line. The product line was categorized as discontinued during the second quarter of fiscal year 2005. The company’s right to receive royalties under this license agreement was paid in full as of October 31, 2005 and no future royalties from the sale of IDA products will be received.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” both the IDA and memory stacking product lines are classified as discontinued operations beginning in the second quarter of fiscal 2005, and the related financial results are reported separately as discontinued operations for all periods presented. Certain financial information regarding these product lines included in discontinued operations is set forth below:


	Three-months ended November 30,				Nine-months ended November 30,
	2005		2004		2005			2004
	(unaudited)				(unaudited)
Revenue	$	333,173	$	868,959	$	729,891		$	5,310,725
Gain (loss) from discontinued operations		330,004		508,030		714,132			440,381
Gain on the sale of assets		—		—					720,692
Restructuring charges		—		—		(102,900	)		1,159,432

Net gain (loss) from discontinued operations, net of tax effect	$	330,004	$	508,030	$	817,032		$	1,641


	November 30, 2005		February 28, 2005
	(unaudited)
Accounts receivable, net	$	—	$	164,134

Total assets	$	—	$	164,134

Current portion of capital leases	$	101,958	$	109,800
Accounts payable and accrued expenses		15,000		20,087
Deferred revenue		—		—
Accrued restructuring costs—current		128,891		338,065

Total current liabilities		245,849		467,952
Accrued restructuring costs—long term		262,063		303,447
Capital leases, net of current portion		64,585		139,978

Total Liabilities	$	572,497	$	911,377

During the quarter ended August 31, 2004, the Company recorded a reserve for vacated excess facilities of $295,000. During the quarter ended May 31, 2005, the Company was able to sub lease the vacated premises, which had previously been considered to be highly unlikely. The Company therefore recorded a reduction to the reserve in the amount of $102,900, reflecting the estimated value of future lease receipts. This resulted in a credit of $102,900 to restructuring charges for discontinued operations for the quarter ended May 31, 2005. During the quarter ended August 31, 2005, the Company renegotiated the payment terms on the accrued severance resulting in a reduced monthly payment amount and an extension of the time period the accrued severance charges are payable over to the period ending January 31, 2009. No other restructuring charges were recorded in the quarter ended November 30, 2005.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

A summary of the activity that affected the Company’s accrued restructuring costs for discontinued operations during the nine months ended November 30, 2005 is as follows:


	Employee Severance			Facilities			Total
Balance at 2/28/05	$	394,096		$	247,416		$	641,512
Amounts expensed		—			—			—
Net present value of future rent income					(102,900	)		(102,900	)
Amounts paid		(51,796	)		(24,745	)		(76,541	)

Balance at 5/31/05	$	342,300		$	119,771		$	462,071
Amounts expensed		—			—			—
Amounts paid		(27,550	)		(14,196	)		(41,746	)

Balance at 8/31/05	$	314,750		$	105,575		$	420,325
Amounts expensed		—			—			—
Amounts paid		(22,351	)		(7,020	)		(29,371	)

Balance at 11/30/05	$	292,399		$	98,555		$	390,954

All of the charges reflected in the above table are included in the gain or loss from discontinued operations in the accompanying financial statements. No additional impairment or restructuring charges are anticipated beyond those incurred in the quarter ended November 30, 2005. Refer to Note 13 for a summary of restructuring charges affecting continuing operations.

NOTE 5—Inventories

Net inventories consist of the following:


	November 30, 2005		February 28, 2005
Parts and components	$	5,800	$	89,500
Work-in-process		4,600		31,400
Finished goods		15,900		25,900

Total inventories	$	26,300	$	146,800

Inventories are net of an allowance for excess and obsolete inventory of $25,000 at November 30, 2005 and $35,000 at February 28, 2005. The inventory balance at November 30, 2005 is either consigned to or will be sold to QuaTech, therefore the utilization of the inventory is dependent upon QuaTech sales of the Airborne product line.

NOTE 6—Concentration of Customers

During the three and nine months ended November 30, 2005, sales to QuaTech accounted for 93% and 38% of net sales, including royalty revenues. Accounts receivable from QuaTech accounted for 75% of net accounts receivable at November 30, 2005.

NOTE 7—Note Payable

At November 30, 2005, the Company had a $500,000 convertible note payable to Development Capital Ventures LP (DCV), QuaTech’s largest shareholder, with an annual interest rate of 12%, payable monthly, principal balance due and payable on February 3, 2006. On January 5, 2005 the Company extended the maturity date of the note such that the principal balance is currently due and payable on March 3, 2006. The Company has

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

the option, at the Company’s election, to further extend the maturity date of the note to April 4, 2006 upon payment of a $3,000 extension fee. The loan is secured by all the assets of DPAC. If the merger with QuaTech is consummated prior to March 3, 2006, subject to extension at the Company’s election to April 4, 2006, then, simultaneously with the effective date of the merger, the outstanding balance of the note shall be converted into 3,289,473 shares of the Company’s common stock. In addition, as a conversion incentive upon the completion of the merger, the Company will issue to DCV an additional 1,644,736 shares of the Company’s common stock.

The Company’s bank credit facility expired in June 2005.

NOTE 8—Stock Options

The following table summarizes stock option activity under DPAC’s 1985 and 1996 Stock Option Plans for the nine months ended November 30, 2005:


		Number of Shares		Price per Share		Number of Options Exercisable
Balance—February 28, 2005		5,400,945		$	0.35 - $7.56	3,539,865

	Granted	—			—
	Exercised	—			—
	Canceled	(797,950	)		0.35 - 7.00

Balance—November 30, 2005		4,602,995		$	0.35 - $7.56	3,887,148

At November 30, 2005, a total of 3,806,222 shares were available for future grants under all of the Company’s stock option plans.

NOTE 9—Net Loss Per Share

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

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


	Three-months ended November 30,
	2005	2004
Shares used in computing basic net loss per share	23,745,000	23,732,000
Dilutive effect of stock options⁽¹⁾and warrants⁽²⁾	—	—

Shares used in computing diluted net loss per share	23,745,000	23,732,000


	Nine-months ended November 30,
	2005	2004
Shares used in computing basic net loss per share	23,745,000	23,180,000
Dilutive effect of stock options⁽¹⁾and warrants⁽²⁾	—	—

Shares used in computing diluted net loss per share	23,745,000	23,180,000

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(1)	Potential common shares of 106,000 and 356,000 have been excluded from diluted weighted average common shares for the three and nine month periods ended November 30, 2004, as the effect would be anti-dilutive.

(2)

Excluded from the diluted weighted average common shares for the three and nine month periods ended November 30, 2005 and 2004, are 2,514,410 warrants issued in conjunction with the private placement of common stock in the first quarter of fiscal year 2005. These options were excluded because the exercise prices of these options were greater than the average market price of our common stock for the referenced periods.

(3)	Excluded from the diluted weighted average common shares for the three and nine month periods ended November 30, 2005 and 2004 are 3.9 million common shares issuable with the conversion of the DCV note upon the completion of the QuaTech merger.

The number of shares of common stock, no par value, outstanding at November 30, 2005 was 23,744,931.

NOTE 10—Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company’s chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s chief executive officer reviews financial information and makes operational decisions based upon the Company as a whole. Therefore, the Company reports as a single segment.

The Company had no export sales for the three months ended November 30, 2005 and 16% of net sales were export sales (primarily to New Zealand and Western European countries) for the nine months ended November 30, 2005. Foreign sales are made in U.S. dollars. All long-lived assets are located in the United States.

NOTE 11—Income Taxes

The Company recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax bases of assets and liabilities. The Company exercises significant judgment relating to the projection of future taxable income to determine the recoverability of any tax assets recorded on the balance sheet. DPAC regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. To the extent that recovery is not believed to be more likely than not, a valuation allowance is established. During the fiscal year ended February 28, 2005 and for the nine months ended November 30, 2005, the Company established a full valuation allowance associated with its net deferred tax assets.

The valuation allowance was calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”), which requires an assessment of both negative and positive evidence when measuring the need for a valuation allowance. Evidence evaluated by management included operating results during the most recent three-year period and future projections, with more weight given to historical results than expectations of future profitability, which are inherently uncertain. The Company’s net losses in recent periods represented sufficient negative evidence to require a full valuation allowance against its net deferred tax assets under SFAS 109. This valuation allowance will be evaluated periodically and could be reversed partially or totally if business results shall have sufficiently improved to support realization of our deferred tax assets.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

NOTE 12—Private Placement of Common Stock

On May 6, 2004, the Company completed a private placement of approximately 2.5 million shares of common stock and warrants for net proceeds of approximately $1.8 million. In conjunction with the sale of stock, the Company issued warrants to purchase additional common stock. The Series A warrants expire in five years and are exercisable for approximately 1.24 million additional shares of common stock to the investors at $1.24 per share. Of these Series A Warrants, 968,836 are called “Restricted” as they were not exercisable until November 5, 2004. The remaining Series A warrants were immediately exercisable. The Series B warrants expired on May 30, 2005 (320 days after July 14, 2004) and were immediately exercisable for approximately 1.03 million additional shares of common stock to the investors at $.97 per share. The placement agent has received warrants to purchase approximately 238,000 shares of common stock at $1.07 per share that became exercisable on November 5, 2004, and that will expire on November 4, 2009. The warrants are callable by DPAC under certain conditions. [describe past and future pricing adjustments]

The Company valued the warrants using the Black-Scholes option-pricing model with the following assumptions:

(a) expected life equal to the contract life of each warrant,

(b) 100% volatility and 3.7% risk-free interest rate for the Series A and placement agent warrants, and

This calculation resulted in the following valuations: $0.7 million for the Series A warrants, $240,000 for the Series B warrants, and $140,000 for the placement agent warrants. The value ascribed to the warrants has been treated as a reduction to common stock issued in the private placement.

NOTE 13—Restructuring Costs

As a result of the significant decline in the demand for the Company’s stacking products, the Company implemented a number of restructuring initiatives during fiscal year 2004 and 2005 to focus future endeavors of the Company on the Airborne^™ product line and to transition to an outsourced manufacturing model.

During the fiscal year ended February 28, 2005, the Company recorded net restructuring charges affecting continuing operations of $665,000, which are comprised of severance charges as the result of a reduction in workforce of ten individuals, including the Company’s prior CFO. During the quarter ended August 31, 2005, the Company renegotiated the payment terms on the accrued severance resulting in a reduced monthly payment amount and an extension of the time period the accrued severance charges are payable over to the period ending April 30, 2009. No restructuring charges were recorded for continuing operations in the nine months ended November 30, 2005.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

A summary of the activity that affected the Company’s accrued restructuring costs of continuing operations during the nine months ended November 30, 2005 is as follows:


	Employee Severance
Balance at 2/28/05	$	885,122
Amounts expensed		—
Amounts paid		(166,325	)

Balance 5/31/05		718,797
Amounts expensed		—
Amounts paid		(68,077	)

Balance 8/31/05		650,720
Amounts expensed		—
Amounts paid		(47,018	)

Balance 11/30/05	$	603,702

All of the charges reflected in the above table are included in restructuring charges of continuing operations in the accompanying financial statements. Refer to Note 4 for a summary of the restructuring charges affecting discontinued operations.

NOTE 14—QuaTech Merger

On April 26, 2005, DPAC announced that we had entered into a definitive agreement with QuaTech, Inc. that sets forth the terms of a proposed merger on a stock-for-stock basis. A copy of the agreement is included in the Company’s Form 8-K/A as filed with the SEC on April 27, 2005. On August 5, 2005 DPAC announced an amendment to the definitive agreement and simultaneously entered into a Bridge Loan agreement and License agreement with DCV, QuaTech’s largest shareholder. On October 20, 2005 DPAC announced a second amendment to the definitive agreement and a first amendment to the License Agreement. QuaTech, a privately-held company, is an industry leader in device networking and connectivity solutions. Following the Merger transaction, QuaTech would be a wholly-owned subsidiary of DPAC. Under the agreements, QuaTech’s shareholders and stakeholders would receive DPAC shares in an amount equal to approximately 70% of the shares deemed to be outstanding at the completion of the Merger. DCV would receive an additional approximately 5% of the post-Merger shares outstanding from the conversion of its Bridge Loan. On January 5, 2006, DCV and DPAC amended the Bridge Loan. The Amendment amends the Bridge Loan by extending the Maturity Date from February 3, 2006 to March 3, 2006. In return, the Registrant shall pay a $1,500 extension fee to DCV. The Amendment also grants the Registrant the option, at the Registrant’s election, to pay an additional $3,000 extension fee to DCV to further extend the Maturity Date to April 4, 2006.

The consummation of the merger, as contemplated by the definitive agreement, is subject to various conditions, including the approval of DPAC shareholders and QuaTech shareholders, as well as satisfaction of certain other requirements and the absence of material adverse conditions. DPAC has filed a Form S-4 Registration Statement with the SEC describing the Merger and License transactions, as well as other proposals to be submitted to shareholders for approval. Shareholders of record as of January 4, 2006 will be entitled to vote on the merger and other proposals at a shareholders meeting to be held on February 23, 2006 at 10:00 AM at DPAC’s offices in Garden Grove, California.

DPAC TECHNOLOGIES CORP.

NOTES TO CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

NOTE 15—Commitments and Contingencies

Legal Proceedings

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

Other Contingent Contractual Obligations

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

The Company also has a severance agreement with the current CEO that provides for compensation equivalent to one year of salary should the CEO be terminated for any reason other than cause.

The Company has had limited warranty-related experience with our Airborne^™ products.

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

FORWARD-LOOKING STATEMENTS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed financial statements and notes to those statements included elsewhere in this Report. This Report and the following discussion contain forward-looking statements that involve risks and uncertainties. Forward-looking statements include statements of our beliefs, plans, objectives, expectations, anticipated results and intentions. Our actual results could differ materially from those discussed in our forward-looking statements. Every statement that is not entirely historic in this Report is considered to be forward-looking statement. Numerous important factors, risks and uncertainties affect our operations and could cause actual results to differ materially from those expressed or implied by these or any other forward-looking statements made by us or on our behalf. Factors that could cause or contribute to such differences include those discussed in the Company’s Annual Report on Form 10-K for the year ended February 28, 2005 as filed with the Securities and Exchange Commission on June 15, 2005, as well as those discussed in this Item or elsewhere herein. We undertake no obligation to publicly release the result of any revisions to our forward-looking statements that may be required to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Operating Losses

The Company has experienced losses from operations for the past fifteen quarters. Even if our expectations for net sales for future periods are met, we continue to expect losses from operations for several future quarters. Our longer-term potential for profitability depends upon successful product introductions by present and future customers for Airborne^™ products and the receipt of the resulting royalties under our license agreement with DCV and QuaTech. QuaTech must secure a sufficient number of OEM customers whose products generate a sufficient sales volume for Airborne^™ products before we can reach the revenues from royalties necessary for profitability. This is due to the level of selling, general and administrative expenses we are incurring.

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

Successful implementation of the Airborne^™ wireless products and new product lines will require, among other things, best-in-class designs, exceptional customer service and patience. Also timing of revenue may be affected by the length of time it may take our licensee’s end customers to design our Airborne^™ product into their product lines and to introduce their products. In addition, our revenues are ultimately limited by the success of our customers’ products in relation to their competition.

Other primary factors that may in the future affect our results of operations include our efforts to reduce our operating expenses and our fixed overhead. Our costs in any particular period could include higher costs associated with stock-based compensation.

Accordingly, for these reasons among many others, there can be no assurance that we will become profitable in any future period.

Our operating results were materially reduced from historic levels by our sale on May 6, 2004 of the industrial, defense and aerospace product line as well as the sale on June 6, 2004 of the LP memory stacking business. These two legacy product lines accounted for approximately $19.5 million (99%) of the fiscal year 2004 net sales, prior to restatement for discontinued operations. After we sold these product lines in fiscal year 2004, we began reporting operating results from these product lines as discontinued operations. These discontinued operations are excluded from our operating results.

Fluctuations in Operating Results

The primary factors that may in the future create material fluctuations in our results of operations include the following: timing and amount of shipments, changes in the mix of products sold, any inability to procure required components, whether new customer orders are for immediate or deferred delivery, the sizes and timing of investments in new technologies or product lines, a partial or complete loss of any principal customer, any addition of a significant new customer, a reduction in orders or delays in orders from a customer, excess product inventory accumulation by a customer, and other factors.

During the prior two years, DPAC divested itself of its historical product lines and primary sources of revenues and committed its future and resources to developing and selling wireless technology. During fiscal year 2005, we focused on restructuring DPAC to lower our operating cost structure while ensuring that we maintained our operating flexibility to support future growth in the industry. We licensed our Airborne wireless technology to QuaTech on August 5, 2005 to further reduce our operating costs. Since that time, our revenues depend on royalties received from QuaTech’s sales of those products while our operating cost structure consists primarily of administrative expenses.

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 future performance.

Due to the foregoing factors, it is likely that in some future period our operating results and financial condition will be below the expectations of public market or investors generally. In such event, the market price of our common stock or other securities could be materially and adversely affected.

The following discussion and analysis focuses primarily on the results of operations and financial condition of our continuing operations and separately discusses changes due to discontinued operations.

Three Months Ended November 30, 2005 and 2004

Net Sales. Net sales for the quarter ended November 30, 2005 of $378,000 consisted of $264,000 of product shipments, $26,000 of revenues derived from development contracts, and $88,000 of royalty income from the QuaTech license agreement. The product shipments during the current year period consisted mainly of inventory items sold to QuaTech at or near costs. This compares to total net sales of $334,000 for the same period in the prior fiscal year, which consisted of $315,000 of Airborne^™ wireless products and $19,000 of revenues related to development contracts.

On August 5, 2005 the Company entered into a license agreement with DCV that resulted in QuaTech obtaining the exclusive worldwide right, subject to shareholder approval, to sell, manufacture and distribute the Airborne^™ products in exchange for royalties on products sold. As a result of the License, DPAC’s on-going business operations consist primarily of the collection of royalties under the QuaTech License. A previously issued license granted to Twilight Technologies, Inc for certain Industrial, Defense and Aerospace products is included in discontinued operations. The Twilight Technologies license terminated during the third quarter of 2005.

If our shareholders do not approve the exclusive License with DCV and QuaTech, QuaTech will continue the licensing arrangement on a non-exclusive basis and DPAC would have the ability to license the Airborne^™ technology to other potential licensees. If the Merger with QuaTech is terminated for any reason, QuaTech has the option, subject to DPAC shareholder approval, to purchase an exclusive Airborne^™ product license for a one-time cash payment of $2.4 million, which the parties have determined is the fair market value of the technology.

Gross Profit. Gross profit for the quarter ended November 30, 2005 was $107,000 as compared to $113,000 in the same period in the prior fiscal year. Gross profit as a percentage of sales was 28% for the third quarter of fiscal year 2006 as compared to 34% for the same period in the prior fiscal year. The decrease in gross profit in both absolute dollars and as a percentage of sales is directly related to the change in the product mix and nature of the revenues. Gross margin on product sales to QuaTech are very small or break-even. See “Forward-Looking Statements.”

Costs and expenses

The following table presents a breakdown of our operating expenses by functional category:


	Three Months Ended:
	November 30, 2005		November 30, 2004
OPERATING EXPENSES:
Sales and marketing	$	—	$	530,346
Research and development		17,674		388,349
General and administration		581,211		643,404

Total operating expenses	$	598,885	$	1,562,099

Selling and Marketing Expenses. No Selling and marketing expenses were incurred in the third quarter of fiscal year 2006 as compared to $530,000 incurred in the third quarter of the prior fiscal year. All sales and marketing efforts and associated costs were transferred to QuaTech effective August 5, 2005 with the signing of the License agreement. Sales and marketing expenses had consisted primarily of salaries and commissions, travel expenses, web page development and advertising, trade show expenses, print advertising and public relations expenses.

Research and Development. Research and development expenses consist primarily of ongoing design and development expenses for new wireless products. Research and development expenses for the quarter ended November 30, 2005 were $18,000 as compared to $388,000 in the second quarter of the prior fiscal year. The Company transferred substantially all research and development activity and associated costs to QuaTech effective August 5, 2005, with the signing of the License agreement and does not expect to incur additional research and development costs in future periods.

General and Administrative Expenses. General and administrative expenses in the third quarter of fiscal year 2006 decreased by $62,000 or 10% to $581,000 from $643,000 in the third quarter of the prior fiscal year. The decrease was primarily due to a decrease in salaries and benefits of $207,000 and decreases in professional services of $129,000, including legal and accounting services. These decreases were partially offset by acquisition costs incurred of $235,000 and by increases in facility related expenses of $43,000, including rent expense. Facility costs are now exclusively included in general and administrative expenses whereas in prior periods they were allocated to the various operating departments, including sales and marketing and research and development. The Company will incur ongoing general and administrative expenses.

Interest. For the three months ended November 30, 2005, interest income was $2,500 as compared to interest income of $10,000 for the same period in the prior fiscal year, due to lower cash balances. Interest expense of $15,000 for the current period is related to the convertible note.

Income Taxes. No income tax benefit or provision has been provided during the quarters ended November 30, 2005 and 2004. Net operating losses represent sufficiently negative evidence to require a continued valuation allowance against the net deferred tax assets. This valuation allowance will be evaluated periodically and could be reversed partially or totally if business results have sufficiently improved to support realization of our deferred tax assets.

Discontinued Operations. The gain from discontinued operations for the third quarter ended November 30, 2005 was $330,000 as compared to $508,000 for the same period in the prior fiscal year. The gain in the current fiscal period resulted from royalty revenues on the IDA product line of $333,000, whereas the prior year quarter gain resulted from revenues of $869,000, including royalty revenues of $144,000. The company’s right to receive royalties under license agreement for the IDA product line was paid in full as of October 31, 2005 and no future royalties will be received.

Nine Months Ended November 30, 2005 and 2004

Net Sales. Through August 5, 2005, our sales were derived primarily from the shipment Airborne^™ wireless products and engineering development contracts. Product shipments consisted of sales of evaluation kits, prototype units, and pre-production and limited production quantities of the Company’s Airborne^™ wireless product line. Net sales after August 5, 2005 were derived primarily from the collection of royalty payments from the QuaTech license agreement. Net sales for the nine months ended November 30, 2005 of $1.2 million consisted of $938,000 of product shipments, $144,000 of revenues derived from development contracts, and $100,000 of royalty income from the QuaTech license agreement. This compares to total net sales of $957,000 for the same period in the prior fiscal year, which consisted of $784,000 of Airborne^™ wireless products and $173,000 of revenues related to development contracts. Revenues from development contracts are not expected to be a significant element of our future revenue base.

Gross Profit. Gross profit for the nine months ended November 30, 2005 was $308,000 as compared to $177,000 in the same period in the prior fiscal year. Gross profit as a percentage of sales was 26% for the current nine-month period as compared to 18% for the same period in the prior fiscal year. The increase in gross profit in both absolute dollars and as a percentage of sales is directly related to the increased sales volume as well as to the product mix and nature of the revenues. Gross margin on product shipments to QuaTech are very small or break-even. See “Forward-Looking Statements.”

Costs and expenses

The following table presents a breakdown of our operating expenses by functional category:


	Nine Months Ended:
	November 30, 2005		November 30, 2004
OPERATING EXPENSES:
Sales and marketing	$	593,140	$	1,504,029
Research and development		493,615		1,086,167
General and administration		2,109,367		2,065,227
Write-off of amount due under technology license		282,506		—
Restructuring charges		—		573,215

Total operating expenses	$	2,879,743	$	5,228,638

Selling and Marketing Expenses. Sales and marketing expenses consist primarily of salaries and commissions, travel expenses, web page development and advertising, trade show expenses, print advertising and public relations expenses. Selling and marketing expenses for the first nine months of fiscal year 2006 of $593,000 decreased by $911,000 or 61% from $1.5 million for the same period of the prior fiscal year. The decrease is due to the transfer of all sales and marketing efforts and associated costs to QuaTech effective August 5, 2005 with the signing of the license agreement. No sales and marketing expenses were incurred during the three months ended November 30, 2005. In addition, the Company generally incurred a lower level of spending on sales and marketing efforts during the six month period ended August 31, 2005 as compared to the same period in fiscal year 2005, when the Company incurred a higher level of spending on sales and marketing efforts related to launching the Airborne^™ wireless product line.

Research and Development. Research and development expenses consist primarily of ongoing design and development expenses for new wireless products. Research and development expenses for the nine months ended November 30, 2005 were $494,000 as compared to $1.1 million in the comparable period of the prior fiscal year. The Company transferred substantially all research and development activity and associated costs to QuaTech effective August 5, 2005, with the signing of the license agreement, and does not anticipate incurring additional research and development costs on an on-going basis.

General and Administrative Expenses. General and administrative expenses of $2,109,000 for the first nine months of fiscal year 2006 increased by $44,000 or 2% from $2,065,000 for the comparable period of the prior fiscal year. The increase is primarily due to the expensing of acquisition costs incurred of $595,000, of which there were no similar costs in the prior year period. These costs were partially offset by a decrease in salaries and benefits of $419,000 and a decrease in professional services of $158,000. The Company will incur on-going general and administrative expenses.

Write-off of Amounts Due Under Technology License. During the quarter ended August 31, 2005, the Company wrote-off the balance of the DigiVision technology license of $283,000, due to the uncertainty of the realization and collectibility of amounts due under the license agreement.

Restructuring Charges. No restructuring charges were incurred during the first nine months of fiscal year 2006 as compared to $573,000 of restructuring charges incurred during the same prior fiscal year period. The prior year period charges consisted of severance charges for ten individuals, including the Company’s CFO.

Interest. Interest income was $14,000 for the nine months ended November 30, 2005, as compared to interest income of $25,000 for the same period in the prior fiscal year, due to lower cash balances. Interest expense of $19,700 for the current period is related to the convertible note.

Income Taxes. No income tax benefit or provision has been provided during the nine-month periods ended November 30, 2005 and 2004. Net operating losses represent sufficiently negative evidence to require a continued valuation allowance against the net deferred tax assets. This valuation allowance will be evaluated periodically and could be reversed partially or totally if business results have sufficiently improved to support realization of our deferred tax assets.

Discontinued Operations. The gain from discontinued operations for the nine months ended November 30, 2005 was $817,000 as compared to $1,600 for the same period in the prior fiscal year. The gain in the current fiscal period resulted from revenues of $730,000, consisting primarily of royalty revenues on the IDA product line, and a reduction in the amount of a previously recorded impairment charge for vacated facilities of $103,000. The prior year gain resulted from revenues of $5.3 million and included impairment and restructuring charges of $1.2 million and a gain on the sale of assets of $721,000. The company’s right to receive royalties under license agreement for the IDA product line was paid in full as of October 31, 2005 and no future royalties will be received.

LIQUIDITY AND CAPITAL RESOURCES

At November 30, 2005 we had a cash balance of $501,000 and negative working capital of $386,000. The current ratio (current assets to current liabilities) was 0.7 to 1.0. This compares to a cash balance of $2.7 million, working capital of $1.5 million and a current ratio of 1.8 to 1.0 at February 28, 2005. In the first six months of fiscal year 2006 we consumed cash at a rate of approximately $100,000 per week. We consummated the license agreement with QuaTech to reduce the use of cash and extend the amount of time the Company has to complete the merger. Our usage of cash was reduced to approximately $100,000 per month during the three months ended November 30, 2005 as a result of the license. Under the terms of a bridge loan granted on August 5, 2005 by DCV, the largest shareholder of QuaTech, the Company will owe $500,000 to DCV on March 3, 2006, subject to extension to April 4, 2006 at DPAC’s election and upon payment of a $3,000 extension fee, unless the merger with QuaTech has been completed, at which time the loan automatically converts into 4,934,209 shares of DPAC common stock. Based on our expected use of cash and projected future royalty revenues, if we do not complete the merger with QuaTech we would likely not have sufficient cash to repay the loan at its maturity and we would need additional capital in order to continue operations.

Based on our projected cash consumption rate, management believes that the Company’s cash balance of $501,000 at November 30, 2005 and cash from operations will not be sufficient to finance our operations through fiscal year 2006. Management intends to address the Company’s need for additional capital through or in connection with the proposed transaction with QuaTech, Inc. As described in our Form S-4 filed with the SEC, the Company signed a definitive agreement to acquire QuaTech, Inc. for stock. DPAC and QuaTech are actively engaged in securing the necessary financing to effect and close the transaction. Neither we nor QuaTech has a binding agreement for the funding which is required for us to complete the transaction with QuaTech. We can provide no assurance that we or QuaTech will be able to obtain any necessary financing on satisfactory terms, or at all, and consequently we can provide no assurance we will be able to close the transaction with QuaTech or continue operations.

The Company’s primary source of operating capital for the nine months ended November 30, 2005 was our cash balances, the collection of royalties and accounts receivable and proceeds from a secured convertible term note (the Bridge Loan) of $500,000 provided by DCV, the largest shareholder of QuaTech.

Net cash used in operating activities for the nine months ended November 30, 2005 of $3.2 million consisted primarily of the net loss from continuing operations of $3.2 million. Net cash used in operating activities for the nine months ended November 30, 2004 of approximately $4.7 million consisted primarily of the net loss from continuing operations of $5.0 million partially offset by increases to accrued restructuring chares of $146,000 and other accrued liabilities of $175,000.

The Company’s discontinued operations provided cash of $642,000 and $2.6 million for the nine-month periods ended November 30, 2005 and 2004, respectively. The cash generated in the current fiscal year nine-month period resulted from the operating income partially offset by payments of accrued restructuring charges and capital leases. The cash generated in the nine months ended November 30, 2004 resulted primarily from collections of accounts receivable and reductions in inventory, partially offset by the payments of accrued restructuring charges. Proceeds from the sale of the IDA product line and commercial memory stacking patents in May and June 2004 contributed $1.0 million in cash in that prior-year period.

Net cash provided by investing activities of $17,000 for the nine months ended November 30, 2005 consisted of cash receipts of $50,000 from the technology license agreement and was partially offset by equipment purchases of $32,000. Net cash used in investing activities for the nine months ended November 30, 2004 of $54,000 consisted of $135,000 of equipment purchases and was partially offset by cash receipts of $81,000 from the technology license agreement.

Net cash provided by financing activities for the nine months ended November 30, 2005 of $352,000 consisted of proceeds from a convertible term note of $500,000, offset by principal payments of short term debt of $148,000. Net cash provided by financing activities for the nine months ended November 30, 2004 consisted primarily of net proceeds of $1.8 million from a private placement of common stock and warrants to purchase common stock.

As of November 30, 2005, our future commitments under capital leases through fiscal year 2008 were $202,000. Our commitments due in the fiscal quarter ending February 28, 2006 under capital leases are $28,000.

DPAC operates at leased premises in Southern California, which are adequate for the Company’s needs for the near term.

As of December 31, 2005, we were in compliance with the covenants, terms and conditions of our leases and debt instruments.

Management estimates that the Company, at least pending completion of its transaction with QuaTech, Inc., could continue to consume cash at the rate of about $100,000 per month. If QuaTech does not raise the additional financing required to complete the merger transaction, or if the merger transaction is not completed for any other reason, by February 28, 2006, the Company will not have sufficient resources to continue to operate. Also the Company will not have sufficient cash to repay the DCV $500,000 loan that becomes due on March 3, 2006, subject to April 4, 2006 at DPAC’s election and upon payment of a $3,000 extension fee. In order to pay the loan when due and continue operations, we would need additional equity financing or debt financing as a means to continue in business. Management believes that, if QuaTech does raise the additional financing required to complete the merger transaction and if the merger is completed, the consolidated entitles shall have sufficient cash resources to operate for the following 12 months.

There can be no assurance that additional financing would be available if and when needed on terms favorable to the Company; and any future sale of our equity securities could dilute or subordinate the ownership interest of existing shareholders. Although the rate at which cash will be consumed is dependent on the amount of revenues realized during each period and on the amount of costs, management believes that our positive cash position will not be adequate to continue to maintain liquidity past February 28, 2006.

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 licensing revenues, and any potential divestitures of assets. There can be no assurance that additional financing will be available when needed on terms favorable to the Company, if at all. If the merger with QuaTech is not completed the Company will need other financing, which might include sales of equity securities that could dilute existing shareholders, or a sale of some of our assets, which may adversely affect our shareholders.

OFF BALANCE SHEET ARRANGEMENTS

Our off-balance sheet arrangements consist primarily of conventional operating leases, purchase commitments and other commitments arising in the normal course of business, as further discussed below under “Contractual Obligations and Commercial Commitments.” As of November 30, 2005, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Contractual Obligations and Commercial Commitments

We incur and have incurred various contractual obligations and commercial commitments in our normal course of business. Such obligations and commitments consist primarily of the following:

Short-Term Debt

At November 30, 2005, we had $500,000 of short-term debt, with an annual interest rate of 12%, payable monthly, principal due February 3, 2006. On January 5, 2006, the Company extended the maturity date of this short-term debt such that the principal is currently due March 3, 2006. The Company has the option, at the Company’s election, to further extend the maturity date to April 4, 2006 upon payment of a $3,000 extension fee.

Capital Lease Obligations

We have various capital lease obligations in connection with equipment purchases. Our current outstanding capital lease obligations of $174,000 relate to manufacturing and test equipment and are included as part of short-term or long-term debt of discontinued operations, as appropriate, within our balance sheet.

Operating Lease Obligations

We have an operating lease for our facilities with future minimum payments of $416,000 as of November 30, 2005. The obligations accrue at the rate of approximately $24,000 per month.

Purchase Commitments with Contract Manufacturers

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

Other Purchase Commitments

We also incur various purchase obligations with other vendors and suppliers for the purchase of inventory, as well as other goods and services, in the normal course of business. These obligations are generally evidenced by purchase orders with delivery dates from four to six weeks from the purchase order date, and in certain cases,

supply agreements that contain the terms and conditions associated with these purchase arrangements. We are committed to accept delivery of such materials pursuant to such purchase orders subject to various contract provisions which allow us to delay receipt of such orders or cancel orders beyond certain agreed lead times. Such cancellations may or may not result in cancellation costs payable by us. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. If we are not able to adequately manage our supply chain and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, financial condition and results of operations.

Severance Agreement Commitments

The Company is party to severance agreements with former employees and is obligated to continue payments on these agreements, with the latest obligation being due in April 2009. The balance due from these arrangements at November 30, 2005 is $276,000 in short-term obligations and $620,000 in long-term obligations. The severance agreements arose from the termination of the previous officers of DPAC during fiscal years 2005 and 2004 as highlighted below:

Severance of CEO—On December 18, 2003, the Company accepted the resignation of its CEO. Pursuant to an employment agreement, the former CEO is entitled to salary and benefits totaling approximately $1,100,000 through June 2006. The Company recorded a charge in the fourth quarter of fiscal year 2004 associated with the severance benefits. Approximately $186,000 of the charge related to the acceleration of stock options. The remaining benefits, after renegotiating the payment terms on July 15, 2005, are being paid ratably through April 2009.

Severance of COO and CFO—The Company also owes termination benefits pursuant to the employment agreements of the two other former officers of the Company who left the Company during fiscal 2005. The Company recorded charges totaling $995,000 during fiscal 2005 related to these two former officers. The benefits payable under the employment agreements are, after renegotiating the payment terms on July 15, 2005, being paid ratably through January 2009.

Tabular Disclosure of Contractual Obligations

As of November 30, 2005, expected future cash obligations, related to contractual agreements were as follows:


	Total		Less than 1 Year		1 to 3 Years		3 to 5 Years
Capital Lease Obligations	$	174,000	$	110,000	$	64,000		—
Operating Lease Obligations	$	416,000	$	293,000	$	123,000		—
Purchase Obligations	$	128,000	$	128,000		—		—
Severance Agreements	$	897,000	$	276,000	$	570,000	$	51,000

Total	$	1,615,000	$	807,000	$	757,000	$	51,000

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 condensed 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 under the section entitled “Critical Accounting Polices and Estimates” on pages 22 through 24 of our Annual Report on Form 10-K for the fiscal year ended February 28, 2005. Management believes that as of November 30, 2005, 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. Also our debt instruments, consisting principally of capital lease agreements, were based on fixed interest rates; and therefore 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.

ITEM 4. Controls and Procedures.

Evaluation of disclosure 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 partial 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 November 30, 2005, 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.

Changes in internal control over financial reporting. There has been no change in the Company’s internal control 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 control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1—Legal Proceedings

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

ITEM 1-A.—Risk Factors

RISK FACTORS

Please read and consider all of the factors mentioned in the following pages. We describe these factors because they could be very material to the Company’s results. All of the beliefs and oral statements that we or our directors, officers or agents have made, make herein, or may hereafter make about the Company’s present or future prospects are hereby qualified in their entirety by the additional statement that each of these beliefs and statements is subject to material changes over time or at any time on account of numerous risks and uncertainties, including but not limited to each of these risks and uncertainties:

Potential Future Insufficiency of Capital and Financial Resources

We require additional financing to meet our ongoing obligations plans through to the end of the fiscal year ending February 28, 2006. If the Company does not complete the intended merger with QuaTech, DPAC will owe $500,000 to DCV on March 3, 2006, subject to extension at DPAC’s election to April 4, 2005, under a loan arrangement entered into on August 5, 2005. If the merger with QuaTech is completed, the $500,000 loan will be automatically converted into 4,934,209 shares of DPAC common stock. Despite intending to obtain financing when needed, it may be unavailable when our liquid resources are at an end. Once we obtain financing, terms of the financing itself could have material adverse effects on the market price of the common stock. Problems that we could encounter because of insufficient capital are numerous, but include a default on the $500,000 loan as well as additional costs and expenses. Some additional costs might be associated with complying with or defending legal actions by or for creditors, or paying fees, charges or costs of creditors. Other costs may include relative inefficiencies or loss of productivity, which may be reflected in the financial results. We could lose lenders, suppliers, vendors, key employees and service providers due to concerns about the Company’s liquidity. Many costs and fees could become higher as the Company loses liquidity, and this could accelerate the Company’s cash consumption rate. The combined effect of these problems could lead the Company to have to cease operations and/or make arrangements with creditors which could materially adversely affect the value of the Company’s common stock.

Pending Agreement and Plan of Reorganization

Our plans for future financing and growth center on a transaction with QuaTech, Inc. We are committed to the transaction, subject to certain conditions, pursuant to a binding written agreement. The closing of the transaction is conditioned upon QuaTech being able to raise additional financing. Although no assurance exists that we will complete the acquisition, we are continuing to incur substantial costs to attempt to complete the transaction, including but not limited to transaction costs. Should the transaction be terminated, there are additional expenses and costs that we would also incur, including the requirement to repay $500,000 to DCV on March 3, 2006, subject to extension at DPAC’s election to April 4, 2005. We have filed a registration statement on Form S-4 in connection with the QuaTech, Inc. transaction and will combine that registration statement with our proxy statement for our annual shareholders’ meeting, which will among other things be held to consider

whether to approve the transaction and the License, which involves approving the issuance of shares of our authorized and unissued common stock for all the shares of QuaTech, Inc. and approving more shares, if necessary, for additional financing as described in the proxy statement.

Product Development and Technological Change

Our future revenues will come primarily from royalties derived from QuaTech’s sale of Airborne^™ products into the wireless industry, which is characterized by rapid technological change. As a result, wireless products may have a product life of not more than one to three years. Our industry is highly competitive with respect to timely product innovation, performance, time to market, and other characteristics necessary to succeed in the industry. Our products are subject to price erosion and sometimes charges for obsolescence because competitors are continuously introducing technologies with equal or greater capacity as compared with the technology we employ.

Any success we hope to have in the long-term will depend on QuaTech’s ability to keep up with technological advances and to meet customers’ demands by developing new wireless products and product enhancements continually. We or QuaTech might incur additional operating costs connected with the development, manufacture and introduction of DPAC’s products. We hope to improve our financial condition by completing the merger with QuaTech and by QuaTech raising additional capital in the future.

There can be no assurance that we will be successful in completing the merger with QuaTech. We presently do not have adequate financial or technical resources for as much product development and promotion as will be needed to sustain us in the long-term.

Uncertainty of Market Acceptance or Profitability of New Products

The introduction of new products, such as our product for the wireless marketplace, requires the expenditure of an unknown amount of funds for research and development, tooling, software development, 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. 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 royalties received from QuaTech from the sale and distribution 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 electronics and components 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 and contractors for wireless and semiconductor devices used in our products, and we have no long-term supply contracts with any of them.

Due to the cyclical nature of these industries and competitive conditions, we, our licensees or our sub-contractors, 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 and therefore delay receiving royalties which would have a material adverse effect on our business, financial condition and results of operations.

Credit Risks and Dependence on Major Customers

We will be dependent on the receipt of royalties from QuaTech. Our inability to collect receivables from them could have a material adverse effect on our business, financial condition, and results of operations.

Intellectual Property Rights

The successful sale of Airborne^™ products may be dependent on our proprietary know-how, technology and patent rights. We have applied for a patent in the wireless area. There can be no assurance that our patent application will be approved, that any issued patent 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 wireless 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.

Competition

There are companies that offer or are in the process of developing similar types of wireless products, including Lantronix, Digi-International and others. We could also experience competition from established and emerging network companies. There can be no assurance that our products will be competitive with existing or future products, or that QuaTech or any other potential licensee 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 whom 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, if any, is excluded or inadequate.

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 wireless, 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 wireless, computer, telecommunications, networking or other industries utilizing our products.

Our suppliers, contract manufacturers or customers could become competitors.

Many of the customers for wireless products internally design and/or manufacture their own wireless communications network products. These customers also continuously evaluate whether to manufacture their own wireless communications network products or utilize contract manufacturers to produce their own internal designs. Certain of the customers and prospective customers regularly produce or design wireless communications network products in an attempt to replace products supplied by us or our licensee. We believe that this practice will continue. In the event that our customers manufacture or design their own wireless communications network products, such customers could reduce or eliminate their purchases of our products, which would result in reduced revenues and would adversely impact our results of operations and liquidity. Wireless infrastructure equipment manufacturers with internal manufacturing capabilities, including many of our customers, could also sell wireless communications network products externally to other manufacturers, thereby competing directly with us. In addition, our suppliers or contract manufacturers may decide to produce competing products directly for our customers and, effectively, compete against us. If, for any reason, our customers produce their wireless communications network products internally, increase the percentage of their internal production, require us to participate in joint venture manufacturing with them, engage our suppliers or contract manufacturers to manufacture competing products, or otherwise compete directly against us, our revenues would decrease, which would adversely impact our results of operations.

International Sales

In fiscal year 2005, approximately 15% of our sales were export sales, primarily to Canada and Western Europe as compared to 12% in fiscal year 2004 and none for 2003. Foreign sales are made in U.S. dollars. The increase was primarily due to the wireless product being available for sale and new customers overseas. 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, our competitors may have the ability to manufacture competitive products in Asia or otherwise at lower cost than our licensee would incur to have them manufactured.

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. Some of our licensee’s customers’ purchase orders and agreements are governed by foreign laws, which may differ significantly from United States laws. Therefore, they may be limited in their 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 Business Combinations or Acquisitions

We are pursuing a strategy of acquiring additional companies or businesses. We are in the process of one transaction. We may pursue selective acquisitions to complement our internal growth. If the present transaction closes, we will issue stock that would dilute our shareholders’ percentage ownership, incur substantial debt, assume contingent liabilities, and use other company assets available at the time of acquisition. If and when we make any future combinations or acquisitions, we could do so again. We have limited experience in acquiring other businesses, product lines and technologies. In addition, the attention of our management team may be diverted from our core business if we undertake an acquisition. Potential acquisitions also involve numerous risks, including, among others:

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Problems assimilating the purchased operations, technologies or products;

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Costs associated with the acquisition;

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Adverse effects on existing business relationships with suppliers and customers;

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Sudden market changes;

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Risks associated with entering markets in which we have no or limited prior experience;

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Potential loss of key employees of purchased organizations; and

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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 Wireless and Electronics Industries

The wireless and the electronics industries are highly cyclical and are 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 the producing 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 these industries could result in increased demand for, and possible shortages of, components used 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

Our inventory balances on our balance sheet represent products held for sale to QuaTech in anticipation of future demand and in the event that demand does not materialize, or in the event a customer cancels outstanding

orders, we would not be able to convert that inventory to cash. In addition, while we may not be contractually obligated to accept returned products, and have typically not done so in the past, 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.

Neither we nor QuaTech have long-term volume commitments from our customers that are not subject to cancellation by the customer. Sales of our products were made through individual purchase orders and, in certain cases, were made under master agreements governing the terms and conditions of the relationships. These purchase orders and master agreements are now being serviced by QuaTech under our licensing agreement. 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 QuaTech to continue to experience similar cancellations and fluctuations in the future that could result in fluctuations in our royalty revenues.

Additional Capital Funding to Impair Value of Investment

We need to raise additional capital. Our potential means to raise capital potentially include public or private equity offerings or debt financings. Our present financial condition mandates that we obtain additional financing for the sake of continuing operations after February 28, 2006. We need to complete the merger with QuaTech or raise additional capital to continue to operate. The completion of the merger with QuaTech requires, among other things, that QuaTech would raise additional financing of approximately $3 million. We do not know whether additional financing will be available when needed, or will be available on terms favorable to us. If we or QuaTech cannot raise needed funds on acceptable terms, we would not be able to complete our transaction with QuaTech, Inc. and shall not be able to continue developing or enhancing our products, taking advantage of future opportunities or responding 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. To the extent we raise additional capital by issuing debt, we would incur additional interest expenses that would reduce earnings and cash flow per share of the Company. Also, any plans to borrow money and repay that debt later are usually subject to numerous risks. In the event the debt is not repaid as and when due, additional costs and debt would be incurred to satisfy and refinance the obligation, and the debt therefore could grow. If a company’s debt coverage costs are excessive, its equity can lose value for reasons including a decline in creditworthiness.

Geographic Concentration of Operation

Our wireless product line is manufactured overseas in Taiwan, with some contract manufacturing conducted in the United States. Due to the geographic concentration of our contract manufacturing, a disruption of the 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 sub-contractors operations and consequently harm our business, financial condition and results of operations.

Compliance with Environmental Laws and Regulations

We are subject to a variety of environmental laws and regulations governing, among other things, air emissions, waste water discharge, waste storage, treatment and disposal, and remediation of releases of hazardous materials. Our failure to comply with present and future requirements could harm our ability to continue manufacturing our products. Such requirements could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. The imposition of additional or more stringent environmental requirements, the results of future testing at our facilities, or a determination that we are potentially responsible for remediation at other sites where problems are not presently known to us, could result in expenses in excess of amounts currently estimated to be required for such matters.

Key Personnel

The Company’s licensee 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 its licensee’s 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’s licensee 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 or its licensee 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 and Market Overhang

Existing shareholders may suffer with each adverse change in the market price of our common stock. The market price of our common stock will be affected by a variety of factors in the future. Most obviously, our shares may suffer adversely if and when our future operating results are below the expectations of investors. The stock market in general, and the market for shares of technology companies in particular, experiences extreme price fluctuations. Our common stock market price is made more volatile because of the relatively low volume of trading in our common stock. When trading is sporadic, significant price movement can be caused by a relatively small number of shares.

Another factor that may affect our common stock price will be the number of our outstanding shares and, at times, the number and prices of warrants that could be exercised. We have reserved a total of 1,480,292 shares for issuance upon exercise of outstanding, unexpired warrants. Holders of our warrants hold registration rights that are intended to make the warrant shares immediately available for public sale upon exercise, and warrants may be exercised at any time until their expiration. It is foreseeable that when a warrant has an intrinsic value, which is usually called being “in-the-money,” the holder may desire to exercise the warrant and immediately sell the stock. If our common stock trades at prices higher than a warrant’s exercise price, the shares can be sold at a profit. At such times, sales of large numbers of shares received upon exercises of warrants might materially and adversely affect the market price of our common stock.

An additional factor that independently affects the common stock is a potential future adjustment to certain outstanding warrants that, until such provision expires by its own terms on May 5, 2009 will be adjusted to that lower exercise price if we sell stock; however, the number of shares purchasable with the warrant is constant. For example, there are presently 730,794 shares purchasable at $1.235 each under those warrants; but if we were to sell shares of common stock (except in certain instances defined as excluded issuances) at, for instance, $0.40 each, the warrants would become warrants to purchase 730,794 shares at $0.40 each. The adjustments can reduce the warrants’ exercise price but not increase it.

Other Contingent Contractual Obligations

The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying balance sheets. However, 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 all directors and officers pertaining to claims on account of acting as a director or officer. In the event that the Company has, or is claimed to have, any indemnification obligation related to current or former directors or officers, the costs and expenses could be material to the Company and the amount of cost and expense of such an obligation would not necessarily be limited whatsoever. Other indemnities are made to various lessors in connection with facility leases for certain claims arising from such

facility or lease; other indemnities are made to vendors and service providers pertaining to claims based on the negligence or willful misconduct of the Company; and other indemnities involve the accuracy of representations and warranties in certain contracts and are made in favor of the other contractual party. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential for future payments the Company could be obligated to make. 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, which would customarily be for a limited amount. Product warranty costs are not significant.

ITEM 2—Unregistered Sales of Equity Securities and Use of Proceeds

On April 26, 2005, we entered into an agreement and plan of reorganization with QuaTech, Inc. that restricts us from paying any cash dividends on our common stock.

ITEM 3—Defaults Upon Senior Securities

None

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

None

ITEM 5—Other Information

None

ITEM 6—Exhibits


2.4.3		Second Amendment dated October 20, 2005 to Agreement and Plan of Reorganization, which is incorporated by reference to Exhibit 2.4.3 to the Registrant’s Current Report on Form 8-K/A as filed November 22, 2005.

2.4.4		Third Amendment dated December 12, 2005 to Agreement and Plan of Reorganization, which is incorporated by reference to Exhibit 2.4.4 to the Registrant’s Current Report on Form 8-K/A as filed December 13, 2005.

2.5.1		First Amendment dated October 20, 2005 to License Agreement dated August 5, 2005, which is incorporated by reference to Exhibit 2.5.1 to the Registrant’s Current Report on Form 8-K/A as filed November 22, 2005.

2.7		Certificate of Merger, which is incorporated by reference to Exhibit 2.7 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

10.3.1		Proposed 2006 Amendment to 1996 Stock Option Plan, which is incorporated by reference to Exhibit 10.3.1 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed January , 2006.*

10.20		Form of Employment Agreement for Steven D. Runkel, which is incorporated by reference to Exhibit 10.20 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.*

10.25.1		Amendment to Convertible Term Note dated January 5, 2006, which is incorporated by reference to Exhibit 10.25.1 to the Registrant’s Current Report on Form 8-K/A as filed on January 6, 2006.



10.29		Agreement between the Registrant and B. Riley & Co., Inc. dated August 10, 2004, which is incorporated by reference to Exhibit 10.29 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

10.29.1		Amendment, dated January 5, 2005, to the Agreement between the Registrant and B. Riley & Co., Inc. dated August 10, 2004, which is incorporated by reference to Exhibit 10.29.1 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

10.29.2		Amendment Two, dated March 24, 2005, to the Agreement between the Registrant and B. Riley & Co., Inc. dated August 10, 2004, which is incorporated by reference to Exhibit 10.29.2 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

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.

*	Management Compensatory Plan or Arrangement.

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)

Date January 15, 2006	By:	/s/ CREIGHTON K. EARLY
Date January 15, 2006		Creighton K. Early, Chief Executive Officer

Date January 15, 2006	By:	/s/ STEPHEN J. VUKADINOVICH
Date January 15, 2006		Stephen J. Vukadinovich, Chief Financial Officer

EXHIBIT INDEX


Exhibit No.		Description
2.4.3		Second Amendment dated October 20, 2005 to Agreement and Plan of Reorganization, which is incorporated by reference to Exhibit 2.4.3 to the Registrant’s Current Report on Form 8-K/A as filed November 22, 2005.

2.4.4		Third Amendment dated December 12, 2005 to Agreement and Plan of Reorganization, which is incorporated by reference to Exhibit 2.4.4 to the Registrant’s Current Report on Form 8-K/A as filed December 13, 2005.

2.5.1		First Amendment dated October 20, 2005 to License Agreement dated August 5, 2005, which is incorporated by reference to Exhibit 2.5.1 to the Registrant’s Current Report on Form 8-K/A as filed November 22, 2005.

2.7		Certificate of Merger, which is incorporated by reference to Exhibit 2.7 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

10.3.1		Proposed 2005 Amendment to 1996 Stock Option Plan, which is incorporated by reference to Exhibit 10.3.1 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.*

10.20		Form of Employment Agreement for Steven D. Runkel, which is incorporated by reference to Exhibit 10.20 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.*

10.25.1		Amendment to Convertible Term Note dated January 5, 2006, which is incorporated by reference to Exhibit 10.25.1 to the Registrant’s Current Report on Form 8-K/A as filed on January 6, 2006.

10.29		Agreement between the Registrant and B. Riley & Co., Inc. dated August 10, 2004, which is incorporated by reference to Exhibit 10.29 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

10.29.1		Amendment, dated January 5, 2005, to the Agreement between the Registrant and B. Riley & Co., Inc. dated August 10, 2004, which is incorporated by reference to Exhibit 10.29.1 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

10.29.2		Amendment Two, dated March 24, 2005, to the Agreement between the Registrant and B. Riley & Co., Inc. dated August 10, 2004, which is incorporated by reference to Exhibit 10.29.2 to the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-129532) as filed November 7, 2005.

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.