UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

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

For the quarterly period ended December 31, 2005

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

For the transition period from                      to                     

Commission File Number 000-26698

DATAWAVE SYSTEMS INC.

(Exact name of Registrant as specified in its charter)

Delaware
(State or other Jurisdiction of incorporation or
organization) 98-0186455
(IRS Employer Identification No.)

Wayne Interchange Plaza One
145 Route 46 West, 3^rd Floor
Wayne, NJ 07470
(Address of principal executive offices)

(973) 774-5000

(Issuer’s telephone number)

Securities registered or to be registered pursuant to Section 12(b) of the Act:	(none)
Securities registered or to be registered pursuant to Section 12(g) of the Act:	Common Shares

Indicate by check mark whether the issuer filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  þ  Yes  o  No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  þ  Yes  o  No

As of December 31, 2005 there were 46,826,834 shares of the Company’s common stock issued and outstanding.

Transitional Small Business Disclosure Format (check one).  o  Yes  þ  No

DATAWAVE SYSTEMS INC.

FORM 10-QSB

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
Item 1	Financial Statements	1
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3	Controls and Procedures	24
PART II OTHER INFORMATION
Item 6	Exhibits	25

 - ii -

NOTE REGARDING FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-QSB contains a number of forward-looking statements that reflect management’s current views, beliefs and expectations with respect to our business, strategies, products, revenues, future results and events and financial performance, which include statements relating to, among other things, the ability of our company to continue to successfully compete in the telecommunications and financial products markets. All statements other than statements of historical fact, including future results of operations or financial position, made in this Report on Form 10-QSB are forward looking. In particular, when used in this Report, the words “anticipate,” “believe,” “estimate,” “expect,” “intends,” “forecast,” “plan,” “future,” “strategy” and similar expressions, as they relate to us, are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements and their absence does not mean that the statement is not forward-looking.

While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect our current information and judgment regarding the direction of our business, actual results may vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein. We do not undertake any obligation to revise these forward-looking statements to reflect any future events or circumstances, changes in assumption or other factors. We caution the reader that important factors in some cases have affected and, in the future, could materially affect actual results and cause actual results to differ materially from the results expressed in any such estimates, projections or other “forward-looking statements”.

 - iii -

PART I             FINANCIAL INFORMATION

Item 1 Financial Statements.

DATAWAVE SYSTEMS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
As at December 31, 2005 and March 31,2005
(Expressed in United States dollars, except share amounts)
(Unaudited)

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

See accompanying Notes to the Condensed Consolidated Financial Statements.

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DATAWAVE SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

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

See accompanying Notes to the Condensed Consolidated Financial Statements.

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DATAWAVE SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
As at December 31, 2005 and March 31, 2005
(Expressed in United States dollars, except share amounts)
(Unaudited)

							Accumulated
	Number of				Additional		Other					Total
	Common	Common			Paid-in		Comprehensive		Accumulated			Shareholders’
	Shares	Shares			Capital		Income		Deficit			Equity
Balance, April 1, 2004	43,889,334	$	15,006,743		$	2,725,492	$	277,966	$	(13,829,163	)	$	4,181,038
Net income			—			—		—		622,470			622,470
Foreign currency translation adjustment			—			—		91,842		—			91,842
Comprehensive income													714,312
Balance, December 31, 2004	43,889,334	$	15,006,743		$	2,725,492	$	369,808	$	(13,206,693	)	$	4,895,350
Issuance of shares	2,937,500		235,000			—		—		—			235,000
Reclassification to additional paid-in capital on emigration			(15,194,916	)		15,194,916		—		—			—
Net income			—			—		—		40,977			40,977
Foreign currency translation adjustment			—			—		95,240		—			95,240
Comprehensive income													136,217
Balance, March 31, 2005	46,826,834		46,827			17,920,408		465,048		(13,165,716	)		5,266,567
Net income			—			—		—		828,503			828,503
Foreign currency translation adjustment			—			—		204,395		—			204,395
Comprehensive income													1,032,898
Balance, December 31, 2005	46,826,834	$	46,827		$	17,920,408	$	669,443	$	(12,337,213	)	$	6,299,465

See accompanying Notes to the Condensed Consolidated Financial Statements.

- 3 -

DATAWAVE SYSTEMS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

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

See accompanying Notes to the Condensed Consolidated Financial Statements.

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

1. DESCRIPTION OF BUSINESS

DataWave Systems Inc. (the “Company” or “DataWave”) sells and distributes prepaid products using proprietary systems for activating products at the point-of-sale. DataWave designs, develops, produces, owns and manages a proprietary, intelligent, automated, direct merchandising network (the “DataWave System”). The DataWave System is comprised of point-of-sale-activation (“POSA”) terminals, free-standing “smart” machines (“DTMs”), and cash registers or web-based applications. All of these devices are connected to proprietary server and database systems through wireless, land line wide area networks or host-to-host connectivity, and are capable of dispensing multiple prepaid products and services. In addition, DataWave sells prepaid calling cards and point-of-sale activated prepaid cellular personal identification numbers (“PINs”) on a wholesale basis to certain retail operators and other customers.

2. SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of presentation

These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and pursuant to the rules and regulations of the United States Securities and Exchange Commission for the presentation of interim financial information. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been condensed, or omitted, pursuant to such rules and regulations. These financial statements do not include all disclosures required for annual financial statements and should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included as part of the Company’s 2005 Annual Report on Form 10-KSB. All amounts herein are expressed in United States dollars unless otherwise noted.

In the opinion of management, all adjustments (including reclassifications and normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows at December 31, 2005 and for all periods presented, have been made. Interim results are not necessarily indicative of results for a full year.

(b) Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to, accounting for doubtful accounts, assessing the recoverability of machinery and equipment, intangibles and goodwill, amortization, valuation allowance for deferred income tax assets, accruals for cost of time in excess of amounts billed by service providers, income taxes and contingencies. Actual results could differ from those estimates.

(c) Stock-based compensation

In accordance with SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure the Company provides pro-forma information regarding net income and net income per share for stock-based awards granted or modified after December 31, 1994 as if the awards to employees had been accounted for under the fair value method prescribed by SFAS No. 123, Accounting for Stock Based Compensation.

- 5 -

DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

2. SIGNIFICANT ACCOUNTING POLICIES

(c) Stock-based compensation (continued)

The fair value of the Company’s stock-based awards to employees was estimated using a Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable.

In addition, the Black-Scholes model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock-based awards to employees have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate. In management’s opinion, the models used reflect management’s best estimate of the fair value of its stock-based awards to employees.

The fair value of the Company’s stock-based awards to employees was estimated assuming no expected dividends and using the following weighted-average assumptions:

	Three Months		Three Months
	Ended		Ended
	Dec 31, 2005		Dec 31, 2004
Expected life (years)		—		—
Expected volatility		—		—
Risk-free interest rate		—		—

The weighted-average estimated fair values of employee stock options granted during the three months ending December 31, 2005 and 2004 were $Nil and $Nil per share, respectively.

No options were granted in the three months ended December 31, 2005 and December 31, 2004 but if the computed fair values of previously granted awards had been amortized to expense over the vesting period of the awards as prescribed by SFAS 123, net income and net income per share would have been:

	Three Months			Three Months
	Ended			Ended
	Dec 31, 2005			Dec 31, 2004
Net income — as reported	$	393,765		$	381,495
Add: Stock-based employee compensation expense (recovery) included in reported net income		—			—
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(12,072	)		(1,644	)
Pro-forma net income	$	381,693		$	379,851
Net income per share — as reported
Basic	$	0.01		$	0.01
Diluted	$	0.01		$	0.01
Net income per share — pro-forma
Basic	$	0.01		$	0.01
Diluted	$	0.01		$	0.01

- 6 -

DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

2. SIGNIFICANT ACCOUNTING POLICIES

(c) Stock-based compensation (continued)

The fair value of the Company’s stock-based awards to employees was estimated assuming no expected dividends and using the following weighted-average assumptions:

	Nine Months			Nine Months
	Ended			Ended
	Dec 31, 2005			Dec 31, 2004
Expected life (years)		3.35			—
Expected volatility		136.0	%		—
Risk-free interest rate		4.25	%		—

The weighted-average estimated fair values of employee stock options granted during the nine months ending December 31, 2005 and 2004 were $0.06 and $Nil per share, respectively.

705,000 and nil options were granted in the nine months ended December 31, 2005 and 2004, respectively. If the computed fair values of previously granted awards had been amortized to expense over the vesting period of the awards as prescribed by SFAS 123, net income and net income per share would have been:

	Nine Months			Nine Months
	Ended			Ended
	Dec 31, 2005			Dec 31, 2004
Net income — as reported	$	828,503		$	622,470
Add: Stock-based employee compensation expense (recovery) included in reported net income		—			—
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(47,237	)		(10,019	)
Pro-forma net income	$	781,266		$	612,451
Net income per share — as reported
Basic	$	0.02		$	0.01
Diluted	$	0.01		$	0.01
Net income per share — pro-forma
Basic	$	0.02		$	0.01
Diluted	$	0.01		$	0.01

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

3. BALANCE SHEET DETAILS

(a) Accounts receivable and other

	December 31,			March 31,
	2005			2005
Trade accounts receivable — POSA	$	6,887,826		$	4,499,592
Trade accounts receivable — prepaid long distance		2,150,125			2,638,597
Less allowance for doubtful accounts		(28,450	)		(96,360	)
Other receivables		257,018			324,883
	$	9,266,519		$	7,366,712

(b) Inventories

	December 31,		March 31,
	2005		2005
PINs and cellular time	$	6,942,833	$	3,274,233
Cards and long-distance phone time		496,788		646,139
Parts and supplies		209,531		235,242
	$	7,649,152	$	4,155,614

(c) Machinery and equipment

			December 31, 2005
			Accumulated		Net Book
	Cost		Depreciation		Value
Vending equipment	$	3,816,312	$	3,393,475	$	422,837
POSA equipment		2,450,035		1,748,957		701,078
Computer equipment and software		2,225,522		1,368,786		856,736
Other		551,338		167,523		383,815
	$	9,043,207	$	6,678,741	$	2,364,466

			March 31, 2005
			Accumulated		Net Book
	Cost		Depreciation		Value
Vending equipment	$	3,796,883	$	3,336,090	$	460,793
POSA equipment		1,969,809		1,207,702		762,107
Computer equipment and software		1,921,569		1,102,811		818,758
Other		553,887		141,974		411,913
	$	8,242,148	$	5,788,577	$	2,453,571

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

3. BALANCE SHEET DETAILS (Continued)

(d) Accounts payable and accrued liabilities

	December 31,		March 31,
	2005		2005
Trade accounts payable — PINs and cellular time	$	12,734,661	$	8,663,602
Trade accounts payable — prepaid long distance		3,111,467		3,209,064
Trade accounts payable — other		597,038		500,659
Accrued compensation and benefits		92,285		56,620
Co-op and rebate accruals		804,232		312,993
Long-distance time accruals		587,191		599,098
Other accrued liabilities		2,006,562		1,089,165
State local, GST (net) and other taxes payable		593,834		116,221
	$	20,527,270	$	14,547,422

(e) Equity investment

The Company has an equity investment in Nextwave Card Corp (“NCC”). For the three and nine month period ended December 31, 2005, DataWave recorded equity investment income of $55,608 and $120,070 respectively (2004 — $55,309 and $87,121 respectively).

At December 31, 2005, DataWave’s cumulative share of equity investment income was $159,457 (March 31, 2005 — $39,387).

(f) Convertible promissory note

On December 22, 2005, the Company agreed to file a registration statement for the resale of 7.5 million shares of its common stock underlying the Company’s $600,000 convertible non-interest bearing promissory note in connection with Sigma Opportunity Fund’s purchase of the note. The note, dated February 1, 2005 was originally issued by the Company to Integrated Data Corp. (IDC). Sigma Opportunity Fund purchased the note from Integrated Technologies & Systems Ltd. which had acquired the note from IDC. Following conversion of the note into the Company’s shares, Sigma Opportunity Fund will own approximately 13.8% of the Company’s common stock. As of the date of this report, the note had not been converted to common stock.

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

4. COMMON SHARES

(a)

Net income per share

The following table sets out the computation of basic and diluted net income per common share. Basic income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per share is calculated by dividing net income by the sum of the weighted average number of common shares outstanding and all additional common shares that would have been outstanding if potentially dilutive common shares had been issued during the period. The treasury stock method is used to calculate the dilutive effect of options and warrants.

	Three months ended December 31,
	2005		2004
Numerator:
Net income	$	393,765	$	381,495
Denominator:
Weighted average common shares outstanding		46,826,834		43,889,334
Effect of dilutive securities
Stock Options		2,107,813		—
Convertible promissory note (non-interest bearing)		7,500,000		—
Diluted weighted average common shares outstanding		56,434,647		43,889,334
Basic net income per share	$	0.01	$	0.01
Diluted net income per share	$	0.01	$	0.01

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

4. COMMON SHARES (Continued)

(a) Net income per share (Continued)

	Nine months ended December 31,
	2005		2004
Numerator:
Net income	$	828,503	$	622,470
Denominator:
Weighted average common shares outstanding		46,826,834		43,889,334
Effect of dilutive securities
Stock Options		1,880,857		—
Convertible promissory note (non-interest bearing)		7,500,000		—
Diluted weighted average common shares outstanding		56,207,691		43,889,334
Basic net income per share	$	0.02	$	0.01
Diluted net income per share	$	0.01	$	0.01

For the three and nine month period ended December 31, 2005, securities not included in the diluted net income per share computation were 895,000 options (December 31, 2004 — 872,500).

5. BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES

(a)	Segmented information
	DataWave manufactures and operates prepaid calling card merchandising machines and re-sells long distance telephone time through prepaid and other calling cards distributed through its machines, at retail locations and on a wholesale basis to third parties. DataWave considers its business to consist of one reportable operating segment, therefore these consolidated financial statements have not been segmented.
	DataWave’s revenues are primarily generated from the resale of prepaid long distance and cellular telephone time, principally from the sale of prepaid calling cards and point-of-sale activated PINs. Sales of prepaid calling cards and point-of-sale activated PINs under third party brands where DataWave is not the primary obligor of the related phone service and has no significant continuing obligation with respect to operation of the card subsequent to sale are recognized at the date of sale on a net basis.
	DataWave has total sales, net agency sales, and costs of revenues (exclusive of depreciation and amortization) analyzed by product, as follows:

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

5. BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)

(a) Segmented information (Continued)

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

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

5. BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)

(a) Segmented information (Continued)

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

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DATAWAVE SYSTEMS INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Nine month period ended December 31, 2005 and 2004
(Expressed in United States dollars, except share amounts)
(Unaudited)

5. BUSINESS SEGMENT INFORMATION AND CONCENTRATION OF SALES (Continued)

(b) Concentration of sales and economic dependence

The Company is dependent on a small number of customers for revenues from point-of-sale activation products and future results depend significantly on these strategic relationships.

For the nine months ended December 31, 2005, the top ten customers accounted for 71% of revenues (sales and net agency sales) (2004 — 60%). The Company actively seeks to expand its customer base for point-of-sale activation products to mitigate this risk.

6. RELATED PARTY TRANSACTIONS

On April 23^rd, 2004 DataWave announced that it signed a Letter Agreement with Integrated Data Corp. (“IDC”) whereby IDC would acquire DataWave by merger in which shareholders of DataWave would be issued shares of IDC in exchange for all the issued and outstanding shares of DataWave. During the nine months ended December 31, 2004, the company incurred merger costs of $199,244. The proposed merger was terminated by mutual agreement on November 9, 2004.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this Report. Except for historical information, the following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. See “Note Regarding Forward Looking Statements” above.

Overview

We are an innovator and developer of prepaid and stored-value programs. We pioneered our “DataWave System” that allow for point-of-sale-activation of high value, high shrinkage products, such as cash cards, prepaid phone cards and prepaid wireless time. This proprietary system works equally well over the Internet, or with various card activation devices. Our network systems have been designed to work both with the prepaid platforms of other parties, as well as telecommunication and financial switches. Our systems are scalable and flexible and can be readily modified to offer new premium stored-value products, such as prepaid gift cards and prepaid Internet cards.

Management’s Summary

Revenues for the nine months ended December 31, 2005 were $23,956,000 compared with $16,595,000 for the nine months ended December 31, 2004. The increase of $7,361,000 or 44.4% is primarily due to an increase in revenues from our prepaid long distance business of $5,722,000 or 42.5%, and an increase of $1,159,000 or 89.5% in revenues from our prepaid cellular business.

The margin (total revenues less cost of revenues, exclusive of depreciation and amortization) for the nine months ended December 31, 2005 was $7,951,000, an increase of $1,711,000 over the nine months ended December 31, 2004. The movement is attributable to an increase in the margin earned in prepaid long distance of $140,000, an increase in the prepaid cellular margin of $1,159,000, an increase in margins from other business of $65,000, and an increase in the fees and services margin of $345,000.

Operating costs and expenses, excluding cost of revenues, increased by $1,244,000 to $6,992,000 for the nine months ended December 31, 2005 compared with $5,748,000 for the nine months ended December 31, 2004. The increase is primarily due to increased salary and benefits costs as a result of hiring additional employees and increased investor relations costs. Depreciation expense associated with the investment in POSA terminals and the purchase of the international license, consulting fees, and investor relations costs were also higher for the nine months compared with the same period last year.

Other income of $128,000 for the nine months ended December 31, 2005 (nine months ended December 31, 2004 — $2,000) is primarily interest on deposits and royalties.

We face currency risks associated with fluctuating foreign currency valuations. For the nine months ended December 31, 2005, approximately 64.2% of our sales were denominated in Canadian dollars. A decrease in the value of the Canadian dollar in relation to the U.S. dollar after establishing prices and before our receipt of payment and conversion of such payment to U.S. dollars would have an adverse effect on our operating results. Although the recent strengthening of the Canadian dollars has had a positive impact on our revenue attributable to sales in Canada, it has also negatively impacted our cost of revenues and operating expenses. As of December 31, 2005, we have not entered into foreign currency contracts or other derivatives to mitigate the potential impact of foreign currency fluctuation.

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Selected Financial Operating Data for the Three Month Periods Ended December 31, 2005 and 2004

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

Three Months Ended December 31, 2005 compared to the Three Months Ended December 31, 2004

Revenues

For the quarter ended December 31, 2005, revenues were approximately $8,652,000, an increase of $1,904,000, or 28.2% over the $6,748,000 in revenues for the same period last year. The increase in revenues is reflected by both an increase in the traditional prepaid long distance revenues and by an increase in the POSA business, where activation and dispensing of prepaid cellular PINs is the primary product.

Our ten largest customers accounted for 68% of revenues in the quarter ended December 31, 2005 compared with 60% in the same period last year (two major customers accounted for 19% and 11% of revenues in the quarter ended December 31, 2005 and two major customers accounted for 17% and 10% of revenues in the same period last year). We are actively seeking to expand our customer base for point-of-sale activation of prepaid products to mitigate the risk inherent in such a concentration.

Revenues in Canada and the United States are dependent upon the number of unit placements and locations offering prepaid products. The Company owns and operates POSA terminals, all free-standing machines, over-the-counter units and traditional vending machines.

- 16 -

During the quarter ended December 31, 2005 in Canada we installed 229 POSA terminals, generating an installed base at December 31, 2005 of 4,614 terminals with a further 842 host-to-host locations and distributor operated terminals. During the quarter ended December 2005, daily point-of-sale activations averaged 36,700 compared to the December 2004 daily average of 27,200 activations. We generated transaction fees of $714,000 for the quarter ended December 31, 2005 compared with $442,000 in the same period last year.

Revenues in Canada were $5,352,000 for the quarter ended December 31, 2005 compared with $3,878,000 for the same period last year, an increase of $1,474,000 or 38.0%, which is primarily attributable to an increase in the traditional prepaid long distance revenues, and also an increase in the POSA business.

Gross proceeds for prepaid cellular and prepaid internet products were approximately $40,773,000 for Canada in the quarter ended December 31, 2005 compared with $26,164,000 in the same period last year. We record this revenue on a net agency basis (gross proceeds less payments to suppliers). In the quarter ended December 31, 2005, net agency sales from this business were $961,000 for Canada compared with $495,000 in the same period last year.

Revenues in the United States were $3,297,000 for the quarter ended December 31, 2005 compared with $2,863,000 for the same period last year, an increase of $434,000 or 15.2%, which is attributable to an increase in the traditional prepaid long distance revenues and an increase to transaction fee and service revenues.

Cost of Revenue (exclusive of depreciation and amortization)

Cost of revenue (exclusive of depreciation and amortization) was approximately $5,818,000 or 67.2% of revenues, for the quarter ended December 31, 2005, compared to approximately $4,425,000, or 65.6% of revenues, for the same period last year.

Our cost of revenue consists primarily of payments to carriers who provide long distance telephone time and various services related to the production and shipping of product, supplying and maintaining our network systems, transaction processing costs, site commissions, co-op marketing and volume rebates. In the United States, additional costs are incurred servicing and maintaining our network of free standing machines. The increase in costs of revenue of 31.5% for the quarter ended December 31, 2005 compared to the same period last year is due to the increase in revenues and additional increases in the cost of time.

Margin (total revenues less cost of revenues, exclusive of depreciation and amortization) increased to $2,834,000 in the quarter ended December 31, 2005 compared with $2,323,000 in the same period last year. Margin as a percentage of revenue for the quarter ended December 31, 2005, however, decreased to 32.8% compared with 34.4% for the same period last year. This decrease is primarily attributable to margin as a percentage of revenue on prepaid long distance decreasing from 23.4% in the quarter ended December 31, 2004 to 14.0% in the quarter ended December 31, 2005 due to continued pricing pressure. Prepaid cellular products, which account for 11.5% of total revenues, generate margins as a percentage of gross proceeds of approximately 1% - 3% and are accounted for on a net agency basis. Net agency sales was $994,000 or 35.1% of the total margin in the quarter ended December 31, 2005, compared with $490,000 or 21.1% of the total margin in the same period last year.

Margin on prepaid long distance was $1,057,000 for the quarter ended December 31, 2005 compared with $1,312,000 for the same period last year. Prepaid long distance accounted for 37.3% of margin as a percentage of revenue in the quarter ended December 31, 2005 compared with 56.4% in the same period last year; this reflects the continued shift in our business from traditional prepaid long distance to the new POSA products.

General and Administrative Expenses

General and administrative expenses were $1,126,000 or 13.0% of revenues during the quarter ended December 31, 2005, compared to $773,000 or 11.5% of revenues during the same period last year. The increase in costs in the quarter ended December 31, 2005 of approximately $353,000 over the same period last year includes the following:

• salaries increased by $216,000 as a result of hiring additional staff in operations and finance, including legal counsel;

• accounting, audit and consulting fees increased by $16,000;

• investor relations fees increased by $62,000, as a result of obtaining the services of an investor relations firm;

- 17 -

• occupancy costs including rent and telecommunication increased by $35,000; and

• office expenses increased by $24,000.

Selling and Marketing Expense

Selling and marketing expense decreased by approximately $100,000 or 17.8% during the quarter ended December 31, 2005 over the same period last year. Expenses for the three month period ended December 31, 2005 were approximately $462,000 or 5.3% of revenues, compared with approximately $562,000 or 8.3% of revenues during the same period last year.

Product Development

Product development expenses were approximately $446,000 or 5.2% of revenue for the quarter ended December 31, 2005, compared with approximately $305,000 or 4.5% of revenues during the same period last year. The increase is attributable to hiring additional staff in the last fiscal year.

During the quarter ended December 31, 2005, we continued our rapid expansion of point-of-sale technology to the Canadian marketplace with development of host-to-host connections and introduction of new products.

Depreciation and Amortization

Depreciation and amortization expense increased to $373,000 or 4.3% of revenues for the quarter ended December 31, 2005 from $328,000 or 4.9% of revenues for the same period last year.

Depreciation for machinery and equipment was $270,000 for the quarter ended December 31, 2005, compared with $274,000 for the same period last year. Investment in POSA terminals is being depreciated on a straight line basis over three years. At December 31, 2005 we have installed 4,614 point-of-sale terminals in Canada and support another 842 locations with host-to-host network connections. Depreciation expense of approximately $19,000 was incurred for the equipment acquired under capital lease arrangements.

Amortization of intangible assets was $84,000 for the quarter ended December 31, 2005, compared with $29,000 for the same period last year. Intangible assets are comprised of customer lists acquired in our purchase of AT&T’s Canadian prepaid card operations and an international license, which we purchased from Integrated Data Corp. effective February 2, 2005. The intangible assets are amortized on a straight-line basis over six and five years respectively. The net book value of intangible assets at December 31, 2005 and March 31, 2005 were $963,000 and $1,079,000 respectively. Goodwill is not amortized. We evaluate the carrying value of goodwill for impairment at least annually.

- 18 -

Selected Financial Operating Data for the Nine Month Periods Ended December 31, 2005 and 2004

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

Nine Months Ended December 31, 2005 compared to the Nine Months Ended December 31, 2004

Revenues

For the nine months ended December 31, 2005, revenues were approximately $17,860,000, an increase of $6,722,000, or 60.4% over the $16,595,000 in revenues for the same period last year. The increase in revenues is reflected by both an increase in the traditional prepaid long distance revenues and by an increase in the POSA business, where activation and dispensing of prepaid cellular PINs is the primary product.

Our ten largest customers accounted for 71% of revenues in the nine months ended December 31, 2005 compared with 60% in the same period last year (two major customers accounted for 20% and 11% of revenues in the nine months ended December 31, 2005 and two major customers accounted for 17% and 10% of revenues in the same period last year). We are actively seeking to expand our customer base for point-of-sale activation of prepaid products to mitigate the risk inherent in such a concentration.

Revenues in Canada and the United States are dependent upon the number of unit placements and locations offering prepaid products. The following table lists the number of POSA terminals, free-standing machines (DTMs), over-the-counter units and traditional (or non-networked) machines in which our prepaid products are sold. The Company owns and operates POSA terminals, all free-standing machines, over-the-counter units and traditional vending machines. The following table reflects the growth and change of our business:

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	As at December		As at March
	31, 2005		31, 2005
Canada
POSA terminals (owned)		4,614		3,858
POSA terminals (serviced or host to host)		842		501
United States
DTMs		856		913
Traditional machine units		7		7
Over-the counter units (terminals)		—		—
POSA terminals (owned)		73		27
POSA terminals (serviced or host to host)		150		159
Mexico
POSA terminals (serviced or host to host)		200		200
Total		6,742		5,665

During the nine months ended December 31, 2005 in Canada we installed 756 POSA terminals, generating an installed base at December 31, 2005 of 4,614 terminals with a further 842 host-to-host locations and distributor operated terminals. During the nine months ended December 2005, daily point-of-sale activations averaged 35,300 compared to the nine months ended December 2004 daily average of 26,200 activations. We generated transaction fees of $1,756,000 for the nine months ended December 31, 2005 compared with $1,411,000 in the same period last year.

Revenues in Canada were $15,383,000 for the nine months ended December 31, 2005 compared with $9,951,000 for the same period last year, an increase of $5,432,000 or 54.6%, which is primarily attributable to an increase in the traditional prepaid long distance revenues and also an increase in the POSA business.

Gross proceeds for prepaid cellular and prepaid internet products were approximately $109,507,000 for Canada in the nine months ended December 31, 2005 compared with $66,988,000 in the same period last year. We record this revenue on a net agency basis (gross proceeds less payments to suppliers). In the nine months ended December 31, 2005, net agency sales from this business were $2,377,000 for Canada compared with $1,306,000 in the same period last year.

Revenues in the United States were $8,556,000 for the nine months ended December 31, 2005 compared with $6,599,000 for the same period last year, an increase of $1,957,000 or 29.7%, which is primarily attributable to an increase in the traditional prepaid long distance revenues.

Cost of Revenue (exclusive of depreciation and amortization)

Cost of revenue (exclusive of depreciation and amortization) was approximately $16,005,000 or 66.8% of revenues, for the nine months ended December 31, 2005, compared to approximately $10,355,000 or 64.2% of revenues, for the same period last year.

Our cost of revenue consists primarily of payments to carriers who provide long distance telephone time and various services related to the production and shipping of product, supplying and maintaining our network systems, transaction processing costs, site commissions, co-op marketing and volume rebates. In the United States, additional costs are incurred servicing and maintaining our network of free standing machines. The increase in costs of revenue of 54.6% for the nine months ended December 31, 2005 compared to the same period last year is due to the increase in revenues and additional increases in the cost of time.

Margin (total revenues less cost of revenues, exclusive of depreciation and amortization) increased to $7,951,000 in the nine months ended December 31, 2005 compared with $6,240,000 in the same period last year. Margin as a percentage of revenue for the nine months ended December 31, 2005, however, decreased to 33.2% compared with 37.6% for the same period last year. This decrease is primarily attributable to

- 20 -

margin as a percentage of revenue on prepaid long distance decreasing from 23.7% in the nine months ended December 31, 2004 to 16.0% in the nine months ended December 31, 2005 due to continued pricing pressure. Prepaid cellular products, which account for 10.2% of total revenues, generate margins as a percentage of gross proceeds of approximately 1% - 3% and are accounted for on a net agency basis. Net agency sales was $2,453,000 or 30.9% of the total margin in the nine months ended December 31, 2005, compared with $1,295,000 or 20.7% of the total margin in the same period last year.

Margin on prepaid long distance was $3,536,000 for the nine months ended December 31, 2005 compared with $3,396,000 for the same period last year. Prepaid long distance accounted for 44.4% of margin as a percentage of revenue in the nine months ended December 31, 2005 compared with 54.4% in the same period last year; this reflects the continued shift in our business from traditional prepaid long distance to the new POSA products.

General and Administrative Expenses

General and administrative expenses were $3,129,000 or 13.1% of revenues during the nine months ended December 31, 2005, compared to $2,352,000 or 14.1% of revenues during the same period last year. The increase in costs in the nine months ended December 31, 2005 of approximately $777,000 over the same period last year includes the following:

• salaries increased by $439,000 as a result of hiring additional staff in operations and finance, including legal counsel;

• accounting, audit and consulting fees increased by $82,000;

• investor relations fees increased by $131,000, as a result of obtaining the services of an investor relations firm; and

• occupancy costs including rent and telecommunication increased by $125,000.

Selling and Marketing Expense

Selling and marketing expense increased by approximately $124,000 or 8.9% during the nine months ended December 31, 2005 over the same period last year. Expenses for the nine month period ended December 31, 2005 were approximately $1,513,000 or 6.3% of revenues, compared with approximately $1,389,000 or 8.4% of revenues during the same period last year. The increase is attributable to hiring two additional sales staff for the Canadian and United States businesses, and higher than expected sales incentives payments ($142,000 for the nine months ended December 31, 2005 compared with $46,000 in the same period last year). Selling expenses consist primarily of salaries and the associated employee expenses.

Product Development

Product development expenses were approximately 1,239,000 or 5.2% of revenue for the nine months ended December 31, 2005, compared with approximately $927,000 or 5.6% of revenues during the same period last year. The increase is attributable to hiring additional staff in the last fiscal year.

During the nine months ended December 31, 2005, we continued our rapid expansion of point-of-sale technology to the Canadian marketplace with standalone terminals and development of host-to-host connections for certain customers.

Depreciation and Amortization

Depreciation and amortization expense increased to $1,112,000 or 4.6% of revenues for the nine months ended December 31, 2005 from $881,000 or 5.3% of revenues for the same period last year.

Depreciation for machinery and equipment was $803,000 for the nine months ended December 31, 2005, compared with $719,000 for the same period last year. The increase is the result of our continuing investment in POSA terminals and the supporting network infrastructure. Investment in POSA terminals is being depreciated on a straight line basis over three years. At December 31, 2005 we have installed 4,614 point-of-sale terminals in Canada and support another 842 locations with host-to-host network connections. Depreciation expense of approximately $56,000 was incurred for the equipment acquired under capital lease arrangements.

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Amortization of intangible assets was $253,000 for the nine months ended December 31, 2005, compared with $88,000 for the same period last year. Intangible assets are comprised of customer lists acquired in our purchase of AT&T’s Canadian prepaid card operations and an international license, which we purchased from Integrated Data Corp. effective February 2, 2005. The intangible assets are amortized on a straight-line basis over six and five years respectively. The net book value of intangible assets at December 31, 2005 and March 31, 2005 were $963,000 and $1,079,000 respectively. Goodwill is not amortized. We evaluate the carrying value of goodwill for impairment at least annually.

Liquidity and Capital Resources

Cash and cash equivalents at December 31, 2005 were approximately $6,370,000 compared with $4,561,000 at March 31, 2005. We had a working capital surplus of $2,010,000 at December 31, 2005 compared with $924,000 at March 31, 2005.

Our operating activities provided cash of $2,416,000 during the nine month period ended December 31, 2005 compared with cash provided of $3,717,000 during the same period last year. This movement is primarily due to changes in payments to suppliers. Our operations, development and expansion, are financed from the cash flow generated from our operating activities.

The decrease in our net cash provided by operating activities for the nine month period ended December 31, 2005 is explained below:

• net income for the period was $829,000:

• accounts payable and accrued liabilities increased by $4,544,000, including an increase of $3,093,000 for wireless products (PINs and cellular airtime), and an increase in other accounts payable and accrued liabilities of $1,525,000, offset by a decrease of $74,000 for prepaid long distance products. All wireless accounts payable balances were paid by the end of January 2006;

• accounts receivable increased by $829,000, and prepaid expenses and deposits increased by $138,000;

• inventories increased by $3,233,000, primarily for prepaid cellular PINs products. Inventories of prepaid cellular PINs at December 31, 2005 were $6,942,000; cellular PIN inventory is maintained at approximately ten days sales (ten days sales (gross proceeds of sales) for the same period last year) and the increase is the result of increased sales activity; however, inventories for this quarter turned around in 15 days to provide for increased sales activity during the quarter;

• depreciation, amortization and other operating expense net of equity income for the period was $990,000; and

• deferred revenue increased by $253,000, mainly due to an increase in non-activated PINs.

Our underlying sales arrangements for Canadian prepaid cellular PINs have a significant impact on cash flows. Accounts receivable for cellular product sales are collected within fifteen days; as at January 31, 2006, 92% of accounts receivable for cellular products outstanding at the end of the quarter had been collected. Inventories for cellular products are maintained at levels to support fifteen days sales and are turned over three times a month. We actively manage working capital — inventory, accounts receivable and accounts payable — by quick turnover of inventory, collection terms of accounts receivable and trade terms granted by suppliers, however our cash flows are dependent on our ability to continue managing the business cycle. We believe that cash flows in fiscal 2006 will be sufficient to finance our capital investments, primarily for additional POSA terminals.

We used $628,000 in investing activities for the nine months ended December 31, 2005, primarily for the purchase of terminals used to dispense point-of-sale prepaid cellular PINs in Canada. We used $58,000 in financing activities for the nine months ended December 31, 2005, primarily for the repayment of capital lease obligations.

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Future Capital Needs and Resources

We believe that we currently have sufficient cash resources and working capital to meet our ongoing obligations as they become due. We plan capital expenditure in line with prior years.

We expect to continue using cash flow generated from our operations to further finance the expansion of our wholesale point-of-sale prepaid cellular business in the Canadian and U.S. markets. Typical cash flow terms are net 25 days for the purchase of inventory from suppliers and net 7 to 14 days for collections from customers. Limited credit facilities from vendors may limit our working capital and cash flows to expand the business. As this business expands, we anticipate the need to purchase additional inventory and point-of-sale terminals. A risk to our liquidity is that customers do not pay on-time creating a negative cash flow situation. Furthermore, significant expansion of the wholesale point-of-sale prepaid cellular business in Canada is in part dependent upon expansion of credit limits from vendors to finance the purchase of PINs for inventory.

Our cash flow from operations is impacted by our margin on sales. Pricing competition may reduce margins. Our ability to negotiate supply contracts will impact our margin, net income and operating cash flow.

Additionally, our working capital and capital requirements will depend upon numerous factors, including the level of resources that we devote to the continued development of our network systems and the development of new products and new technology, and the overall structure of potential future strategic alliances and acquisitions of products or other businesses.

Depending on the overall structure of potential future product initiatives, strategic alliances and acquisitions, we may have additional capital requirements related to funding these potential future product initiatives, strategic alliances and acquisitions of products or other businesses. Accordingly, we may seek funding from a combination of sources, including equity or debt financing. No assurances can be given that additional funding will be available or, if available, at terms acceptable to us. If adequate capital is not available, our business can be materially and adversely affected.

Trend Information

The implementation and roll-out of point-of-sale technology in Canada is well established and we continue to increase market share for sale of prepaid products using our technologies. Over the past several fiscal quarters, we have experienced increases in sales of prepaid cellular PINs and revenues from POSA transaction fees, and we currently expect further increases during fiscal 2006. Revenues from our sales arrangements require active management of working capital and terms and conditions of future arrangements may impact the presentation of revenue and related working capital accounts, as well as our margins and operating income. We expect to deploy terminals in Canada during the current fiscal year at a pace similar to last year.

Revenues generated from the bulk sale of prepaid phone cards to retail establishments in Canada are expected to grow slowly and continued pricing pressure in the Canadian marketplace is expected to have an adverse effect on margins.

Revenues generated from the sale of prepaid long distance phone cards through the free-standing machines in the U.S. are static and may decline as usage of mobile phones increases. Revenues generated from the promotional sale of prepaid long distance phone cards increased in the quarter ended December 31, 2005 but may decline in future periods. Cost of time, which is the major component of cost of revenue, is expected to decline somewhat as a result of renegotiating lower rates but continued pricing pressure in the marketplace is anticipated to result in a decline in margins.

Product development costs are expected to continue at similarly high levels due to the continued development of our network systems, the InOneCard.com web site, the development of new products and new customer relationships.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

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Item 3 Controls and Procedures.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our Company’s reports filed under the Exchange Act is accumulated and communicated to management, including our Company’s chairman and chief executive officer as appropriate, to allow timely decisions regarding required disclosure.

Evaluation of disclosure controls and procedures

As required by Rule 13a-15 under the Exchange Act, we have carried out an evaluation of the effectiveness of our Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report, being December 31, 2005. This evaluation was carried out under the supervision and with the participation of our Company’s management, including our Company’s chairman and chief executive officer. Based upon that evaluation, our Company’s chairman and chief executive officer concluded that our Company’s disclosure controls and procedures are effective.

No significant changes in internal controls

There have been no significant changes in our Company’s internal controls over financial reporting that occurred during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II        OTHER INFORMATION

Item 6 Exhibits

INDEX

Exhibit
Number		Description
3.1	(1)	State of Delaware Certificate of Domestication of DataWave Systems Inc.
3.2	(1)	State of Delaware Certificate of Incorporation of DataWave Systems Inc.
3.3	(1)	Bylaws of DataWave Systems Inc.
31.1	**	Certification pursuant to Section 302 of the Sarbanes — Oxley Act of 2002 of Joshua Emanuel
31.2	**	Certification pursuant to Section 302 of the Sarbanes — Oxley Act of 2002 of John Gunn
32.1	**	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 Of The Sarbanes-Oxley Act Of 2002 of Josh Emanuel
32.2	**	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 Of The Sarbanes-Oxley Act Of 2002 of John Gunn

**	Filed herewith
(1)	Previously filed as an exhibit to, and incorporated herein by reference from, the Company’s 8K report filed on March 1, 2004.

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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.

DataWave Systems Inc.
(Registrant)
By	/s/ Joshua Emanuel
Chairman and Chief Executive Officer
Date	February 14, 2006
By	/s/ John Gunn
General Manager, Chief Financial Officer
Date	February 14, 2006

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