U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
COMMISSION FILE NUMBER 001-12711
DIGITAL POWER CORPORATION
(Exact name of registrant as specified in its charter)
CALIFORNIA 3679 94-1721931
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code) Identification No.)
41920 Christy Street, Fremont, California 94538-3158; 510-657-2635
(Address and telephone number of principal executive offices)
Securities registered under Section 12(b) of the Exchange Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock American Stock Exchange
Securities registered under Section 12(g) of the Exchange Act:
TITLE OF EACH CLASS
Redeemable Common Stock Purchase Warrants
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 <check-mark> . No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [<check-mark>]
Revenues for the year ended December 31, 1996 were $13,835,008.
As of March 25, 1997, the aggregate market value of the voting common stock
held by non-affiliates was $17,650,907 based on the average bid and ask price
of $8.375 per share.
As of March 25, 1997, the number of shares of common stock outstanding was
2,520,775.
Documents incorporated by reference: Items 9 through 12 of Part III of this
Form 10-KSB are incorporated by reference to Digital's definitive Proxy
Statement for the 1997 annual shareholders' meeting to be filed with the
Commission within 120 days from the end of the year.
Transitional Small Business Disclosure Format (check one): Yes .
No <check-mark> .
Exhibit index is located on page 18.
<PAGE>2
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS REGARDING
EVENTS AND FINANCIAL TRENDS WHICH MAY AFFECT THE COMPANY'S FUTURE OPERATING
RESULTS AND FINANCIAL POSITION. SUCH STATEMENTS ARE SUBJECT TO RISKS AND
UNCERTAINTIES THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS AND FINANCIAL
POSITION TO DIFFER MATERIALLY FROM THOSE ANTICIPATED IN FORWARD-LOOKING
STATEMENTS. THESE FACTORS INCLUDE, BUT ARE NOT LIMITED TO, CUSTOMER
CONCENTRATION, DEPENDENCE ON COMPUTER AND OTHER ELECTRONIC EQUIPMENT
INDUSTRIES, COMPETITION, DEPENDENCE ON GUADALAJARA, MEXICO FACILITY, AND
DEPENDENCE ON KEY PERSONNEL, ALL OF WHICH FACTORS ARE SET FORTH IN MORE DETAIL
IN THE SECTIONS ENTITLED "CERTAIN CONSIDERATIONS" AND "MANAGEMENT'S DISCUSSION
AND ANALYSIS OR PLAN OF OPERATION" HEREIN.
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Digital Power ("Digital Power" or the "Company") designs, develops,
manufactures, and sells 50 watt to 750 watt switching power supplies to
original equipment manufacturers ("OEMs") of computers and other electronic
equipment. Switching power supplies are critical components of all computers
and other electronic equipment. The electronic circuitry in computers and
other electronic equipment requires a steady and isolated supply of direct
current (DC) electrical power. In addition, the various components and
subassemblies within computers and other electronic equipment often require
different voltage levels of electrical power. The power supply products of the
Company satisfy these two requirements by converting the alternating current
(AC) electricity from a primary source, such as a wall outlet, into the direct
current required for the proper functioning of electronic circuits, and by
dividing the single electrical current into as many as four discrete output
voltages.
Electronic systems are sensitive to variations in voltage, and
therefore require protection from the surges and drops in the AC voltage which
commonly occur over electrical lines. The Company's power supply products
monitor and regulate the DC output voltages being delivered to protect the
electronic equipment from harmful surges and drops in voltage levels by
regulating or maintaining the output voltages within a narrow range of values.
In addition, the voltage levels produced by standard power sources must
be significantly lowered in order to allow proper functioning of an electronic
component. For example, internal computer microprocessors, as well as memory
and logic circuitry in telecommunications systems, generally operate on a
voltage level of 5 volts DC or less. However, most electrical outlets produce
at least 115 volts AC. Therefore, the incoming voltage of 115 volts AC must be
both converted to DC and reduced to 5 volts. This is the function performed by
a typical power supply. Those products which accept and convert alternating
current from a primary power source into the direct current required by
electronic systems are generally referred to as "power supplies". Those
products which convert one level of DC voltage into a higher or lower level of
DC voltage as required by a particular electronic device are generally referred
to as "DC/DC converters".
Because the Company's products have a high "power-density" (measured in
watts per cubic inch), the power supply products of the Company are generally
smaller than those of competitors. For example, the Company believes that its
US100 series of power supplies, on a 3"x 5" printed circuit board, is the
smallest 100 watt off-line (AC input) power supply available in the industry.
Furthermore, the Company's power supply products are extremely flexible in
design. This "flexibility" approach allows the Company to modify quickly and
inexpensively its base-design products to satisfy an OEM's specific power
supply needs, thereby enabling the Company to keep to a minimum its expenses
for non-recurring engineering ("NRE") of its base-design products. Because of
this reduced NRE expense related to the "flexibility" line of switching power
supplies, the Company does not charge its customers for its NRE expenses
incurred in tailoring a power supply to a customer's specific requirements.
However, many competitors of the Company do charge their customers for NRE
expenses. As a result of the Company's "flexibility" approach, it has provided
samples of modified power supplies to OEM customers in as quickly as a few
days, an important capability given the increasing emphasis placed by OEMs on
<PAGE>3
"time-to-market". Digital Power's strategic objective is to exploit this
combination of power density, flexibility, and short time-to-market to win an
increasing share of the growing power supply market.
In addition to the line of proprietary products offered, and in response
to requests from OEMs, the Company has recently begun providing "value-added
services" along with its products. The term "value-added services" refers to
the Company's incorporation of an OEM's selected electronic components,
enclosures, and cable assemblies with the Company's power supply products to
produce a power subassembly that is compatible with the OEM's own equipment and
is specifically tailored to meet the OEM's needs. The Company purchases the
parts and components that the OEM itself would otherwise attach to or integrate
with the Company's power supply, and the Company provides the OEM with that
integration and installation service, thus saving the OEM time and money. The
Company believes that this value-added service is well-suited to those OEMs who
wish to reduce their vendor base and minimize their investment in fixed costs
since the OEMs are not required to manufacture their own power subassemblies
and thus are not required to purchase individual parts from many vendors or
build assembly facilities.
Digital Power Corporation, a California corporation, was originally
formed in 1969 through its predecessor, Sideband Associates, Inc. Unless the
context indicates otherwise, references to "Digital Power" or the "Company"
herein includes its majority-owned Mexican subsidiary, Poder Digital S.A. de
C.V.
THE MARKET
The market for power supplies is large, as all electronic systems require
a steady supply of low voltage electrical power. According to Micro-Tech
Consultants of Santa Rosa, California, the worldwide market for electronic
power supplies was estimated to be $15 billion in 1995. The power supply
manufacturing industry is also highly fragmented. Digital Power believes there
are approximately 400 power supply competitors in the world. The electronic
power supply market is typically split into "captive market" and "merchant
market" segments. The captive segment of the market, that portion represented
by OEMs who design and manufacture power supplies for use in their own
products, is estimated by Micro-Tech to account for approximately 50% of the
total market. The remaining 50% of the power supply market is served by
merchant power supply manufacturers such as Digital Power that design and
manufacture power supplies for sale to OEMs.
Growing at an average annual rate of 13%, the merchant market is the
fastest growing segment of the power supply market, as OEMs continue to
outsource their power supply requirements. Micro-Tech forecasts that the
merchant market will experience the greatest rate of growth in the entire power
supply market, increasing from 52.5% of the total market in 1996 to 62.8% of
the total market in 2000. The Company believes that the increase is due, in
part, to the fact that power supplies are becoming an increasingly complex
component to the OEMs, with constantly changing requirements such as power
factor correction (PFC) and filtering specifications to minimize
electromagnetic interference (EMI). This merchant market is itself highly
fragmented according to the power level, technology, packaging, and application
of a particular power supply. One segment of the merchant market involves
industrial and office automation, industrial and portable computing, and
networking applications. This is the market targeted and served by the
Company. The Company believes that its focus on high-efficiency, high-density,
design-flexible power supplies is ideally suited to the rapid growth
opportunities existing in this market segment.
POWER FACTOR CORRECTION. The alternating current electricity delivered
by utility companies over power lines is delivered in smooth waves, known as
harmonic waves, or sine waves. This smooth harmonic wave form of AC
electricity that reaches a power supply is known as "apparent power", and it is
measured in watts (watts equal volts multiplied by amperes). Although the
electricity reaches a switching power supply in a smooth harmonic wave form,
the switching power supply does not draw on the electricity in a smooth
harmonic fashion. Rather, in the process of "rectifying" the alternating
current into direct current form, a switching power supply will draw current
off the AC harmonic wave form in short bursts, each of which is shorter in
duration than the wave frequency. The amount of power drawn off the line by
the switching power supply in these short bursts is known as the "real input
power". The real input power cannot be greater than the apparent power, and in
<PAGE> 4
fact is almost always less than the apparent power. Therefore, a percentage,
or factor, can be arithmetically determined by dividing the real input power by
the apparent power, giving a coefficient known as the "power factor" of the
power supply. Ideally, a switching power supply would have a power factor of
one, where all the apparent power is drawn off by the power supply, resulting
in the real input power equaling the apparent power. In practice, however,
this is not possible. In fact, most switching power supplies without the
special feature known as "power factor correction" have an approximate power
factor of only .60.
The reason why power factor of less than one can be a significant problem
relates to the power that is not drawn off the power line, or the differential
amount between one and the power factor (1 - .60 = .40 in the example given
above). This differential of missing power is reflected back onto the power
line in a harmonically distorted fashion, since the originally smooth harmonic
wave form has now been disrupted by the power that has been drawn off by the
power supply and exhibits a kind of "ripple" in the wave form. The
harmonically distorted wave form circulates as wasted heat energy in the power
line, as well as in wall sockets, electrical wiring in the building, and in
distribution transformers along the power line. This problem of harmonic
distortion and wasted heat energy grows as additional switching power supplies
are connected to and draw power from a power line. A large enough number of
switching power supplies drawing power from a line without power factor
correction will result in: (i) a significant uncompensated loss of electrical
power (in the form of heat) to the electrical utility company; (ii) potential
damage to power lines and transformers caused by excessive heat; and (iii)
"dirty" electrical power for "downstream" consumers of electricity. A low
power factor is generally not a problem for the piece of electronic equipment
itself served by the switching power supply.
In response to these problems, manufacturers of power supplies have
developed certain circuitry within power supplies known as "power factor
correction", or PFC. With PFC, most power supplies can be improved to perform
at a power factor of approximately .99. Historically, PFC has only been
installed in high wattage switching power supplies because of the comparatively
greater amount of harmonic distortion reflected back onto the line by these
power supplies. However, PFC is rapidly becoming critical at all power levels,
not only because it allows equipment designers to power more circuits from a
standard outlet, but also because of regulatory requirements established in the
European Union, such as European Normatives EN61000-3-2 and EN61000-3-3. These
two normative standards, known more fully as "Limits For Harmonic Current
Emissions," and "Limitation Of Voltage Fluctuations And Flicker On Low Voltage
Supply Systems For Equipment With Rated Current <16A [less than 16 amperes],"
respectively, upgrade the former generic standard IEC555.2 and place pressure
on manufacturers of power supplies to develop products with PFC at lower and
lower power levels.
ELECTROMAGNETIC INTERFERENCE (EMI). EMI is universally undesirable
because it potentially interferes with the operation of other electronic
equipment. In the United States, the Federal Communications Commission ("FCC")
has mandated certain EMI limits which cannot be exceeded by OEM equipment. The
European Union (EU) has issued an electromagnetic compatibility (EMC) directive
that applies certain requirements to products sold in Europe beginning January
1, 1996. The EU created these directives to insure conformity with safety and
quality standards and to assess product compliance throughout its jurisdiction.
One of these requirements involves Conformity European ("CE") marking. OEMs
may add the "CE" mark to their equipment if it meets the requirements for
radiated and conducted noise emissions and for noise susceptibility. The power
supply, if part of an OEM system, does not itself need CE certification.
However, since it is one of the major noise generators within an OEM system,
there is a growing demand for the power supply to have the CE mark. A pre-
approved power supply provides added assurance that the OEM will meet the
applicable standards with little trouble.
The power supply market can be further segmented between custom and
standard power supplies. Power supplies designed and manufactured by an OEM
for use in its own equipment are an example of a custom design, as the product
is not intended for resale. However, custom power supplies are also common in
the merchant market, as certain OEMs contract with power supply manufacturers
to design a product that meets the form, fit, and function requirements of
their specific application. Standard "off-the-shelf" power supplies are
intended for sale to many customers whose electronic equipment can operate from
"standard" output voltages, such as 5 volts, 12 volts, or 24 volts DC. A
<PAGE> 5
subset of the standard segment of the market has evolved, commonly known as
"modified", comprising power supply products which have the performance
characteristics of a standard power supply, but need certain, usually minor,
modifications. These modifications may include slight mechanical changes to
the sheet metal chassis, but more typically involve an adjustment to the output
voltages from one of the "standard" output voltages (e.g. 5 volts to 7 volts,
or 15 volts to 18.5 volts).
Digital Power primarily serves the North American power electronics
market with AC/DC power supplies and DC/DC converters ranging from 50 watts to
750 watts of total output power. AC/DC power supplies represent the largest
part of the merchant power electronics market with sales in North America alone
expected to grow from about $4.9 billion in 1996 to $6.7 billion in 2000.
During the same period, DC/DC converter sales in North America are forecasted
to grow from $1.5 billion in 1996 to $2.1 billion in 2000.
CUSTOMERS
Digital Power's products are sold domestically and in Canada through a
network of 13 manufacturers' representatives. Digital Power also has 28
stocking distributors in the United States and Europe. In addition, the
Company has formed strategic relationships with three of its customers to
private label its products. Digital Power's customers can generally be grouped
into three broad industries, consisting of the computer, telecommunication, and
instrument industries. The Company has a current base of over 150 active
customers, including companies such as Ascend Communications, AT&T,
Westinghouse, Telex, Storage Dimensions, Motorola, Retix, Stanford
Telecommunications, and 3Com.
STRATEGY
Digital Power's strategy is to be the supplier of choice to OEMs
requiring a high-quality power solution where size, rapid modification, and
time-to-market are critical to their business success. Target market segments
include telecommunications, networking, switching, mass storage, and industrial
and office automation products. While many of these segments would be
characterized as computer-related, the Company does not participate in the
personal computer (PC) power supply market. The power supply market for PCs is
very competitive with standard power supplies producing low margins.
The Company's strategy is to continue the trend of its sales and profit
growth by making increased sales to existing customers, while simultaneously
targeting sales to new customers. The Company believes that its "flexibility"
concept allows customers a unique choice between its products and products
offered by other power supply competitors. OEMs have typically had to settle
for a standard power supply product with output voltages and other features
predetermined by the manufacturer. Alternatively, if the OEM's product
required a different set of power supply parameters, the OEM was forced to
design this modification in-house, or pay a power supply manufacturer for a
custom product. Since custom-designed power supplies are development-intensive
and require a great deal of time to design, develop, and manufacture, only OEMs
with significant volume requirements can economically justify the expense and
delay associated with their production. Furthermore, since virtually every
power conversion product intended for use in commercial application requires
certain independent safety agency testing, (e.g. by Underwriters Laboratories)
at considerable expense, an additional barrier is presented to the smaller OEM.
By offering the OEM customer a new choice with the Digital Power "flexibility"
series, the Company believes it has gained a competitive advantage. The
Company's "flexibility" series is designed around a standardized power
platform, but allows the customer to specify output voltages tailored to its
exact requirements within specific parameters. Furthermore, OEMs are seeking
power supplies with greater power density (measured in watts per cubic inch).
Digital Power's strategy in responding to this demand has been to offer
increasingly smaller power supply units or packages. For example, the Company
believes that its US100 series of products, mounted on a 3" x 5" printed
circuit board, is the industry's smallest 100 watt off-line (A/C input) power
supply.
<PAGE>6
PRODUCT STRATEGY AND PRODUCTS
Digital Power has eight series of base designs from which thousands of
individual models can be produced. Each series has its own printed circuit
board (PCB) layout that is common to all models within the series regardless of
the number of output voltages (typically one to four) or the rating of the
individual output voltages. A broad range of output ratings, from 3.3 volts to
48 volts, can be produced by simply changing the power transformer construction
and a small number of output components. Designers of electronic systems can
determine their total power requirements only after they have designed the
system's electronic circuitry and selected the components to be used in the
system. Since the designer has a finite amount of space for the system and may
be under competitive pressure to further reduce its size, a burden is placed on
the power supply manufacturer to maximize the power density of the power
supply. A typical power supply consists of a PCB, electronic components, a
power transformer and other electromagnetic components, and a sheet metal
chassis. The larger components are typically installed on the PCB by means of
pin-through-hole assembly where the components are inserted into pre-drilled
holes and soldered to electrical circuits on the PCB. Other components can be
attached to the PCB by surface mount interconnection technology (SMT) which
allows for a reduction in board size since the holes are eliminated and
components can be placed on both sides of the board. The Company's US100
series is an example of a product using this manufacturing technology.
Digital Power's "flexibility" concept applies to all of the Company's US,
UP/SP, and DP product series. A common printed circuit board is shared by each
model in a particular family, resulting in a reduction in parts inventory while
allowing for rapid modifiability into thousands of output combinations. The
following is a description of the Company's products.
The US50 series of power supplies are compact, economical, high
efficiency, open frame switchers that deliver up to 50 watts of continuous or
60 watts of peak power from one to four outputs. The 90-264 VAC universal
input allows them to be used worldwide without jumper selection. Flexibility
options include chassis and cover, power good signal, an isolated V4 output,
and UL544 (medical) safety approval. All US50 series units are also available
in 12VDC, 24VDC, or 48VDC inputs. This optional DC input unit (DP50 series)
maintains the same pin-out, size, and mounting as the US50 series.
The US70 series of power supplies is similar to the US50 series, a
compact, economical, highly efficient, open frame switcher that delivers up to
65 watts with a 70 watt peak. This unit is offered with one to four outputs, a
universal input rated from 90 to 264 VAC, and is only slightly larger than the
US50 series. The US70 series is differentiated from competitive offerings by
virtue of its smaller size, providing up to four outputs while competitors
typically are limited to three outputs. Flexibility options include cover,
power good signal, an isolated V4 output, and UL544 (medical) safety approval.
The DP70 is the same as the US70 except the input is 48 volts DC. The Company
also offers 12 & 24 VDC DC input on this series where the model series changes
to DN&DM. This type of product is ideal for low profile systems with the power
supply measuring 3.2" x 5" x 1.5".
The US100/DP100 is the industry's smallest 100 watt switcher. Measuring
only 5" x 3.3" x 1.5", this series delivers up to 100 watts of continuous or
120 watt peak power from one to four outputs. The 90-264VAC universal input
allows them to be used worldwide. This product is ideal in applications where
OEMs have upgraded their systems, requiring an additional 30-40 watts of output
power but being unable to accommodate a larger unit. The US100 fits in the
same form factor and does not require any tooling or mechanical changes by the
OEM. Flexibility options include a cover and adjustable post regulators on V3
and/or V4 outputs. Fully custom models are also available. All US100 series
units are also available with 12VDC, 24VDC, or 48 VDC inputs. This optional DC
input unit (DP100) maintains the same pin-out, size, and mounting as the US100
series.
The UP300 series are economical, high efficiency, open frame switchers
that deliver up to 300 watts of continuous, 325 watt, peak power from one to
two outputs. The 115/230VAC auto-selectable input allows them to be used
worldwide. On-board EMI filtering is a standard feature. Flexibility options
include a cover, power fail/power good signal, and an isolated 2nd output. The
UP300 is also available as the SP300 series, which is jumper selectable between
<PAGE>7
115 and 230VAC and provides the OEM an even more economical solution. This
product can be used in network switching systems or other electronic systems
where a lot of single output current, such as 5, 12, 24, 48 volt current might
be required.
The US250 series are economical, high efficiency, open frame switchers
that deliver up to 250 watts of continuous or 300 watts of peak power from one
to four outputs. The 115/230VAC auto-selectable input allows them to be used
worldwide. Flexibility options include cover, power fail/power good signal,
enable/inhibit, and an isolated V3 output. All US250 series units are also
available with 12VDC, 24VDC, or 48VDC inputs. This optional DC input unit
(DP250) maintains the same pin-out, size, and mounting as the US250 series.
The US350 series is a fully-featured unit that has active power factor
correction and was designed to be field-configurable by the Company's
international and domestic sales channels. This feature allows the stocking
distributor to lower its inventory costs but still maintain the required stock
to rapidly provide power supplies with the unique combination of output
voltages required by an OEM. This unit delivers 350 watts from one to four
outputs modules and meets the total harmonic distortion spec IEC 555.2. The
US350 has an on-board EMI filter and operates from 90-264 VAC input. This unit
measures 9" x 5" x 2.5" and can operate without any minimum loads and has an
optional internal fan and power fail/power good signal.
The newest product under development by the Company is the US750 series.
The US750 is a fully modular power supply measuring 3" x 10.25" x 5" and
delivers 750 watts from one to four power outputs. This product can be
configured to meet many different applications. It comes with optional N+1
parallelability, hot swapability, frequency synching, power good/power fail,
and remote on/off. The Company anticipates that this product will be available
for sale during the first quarter of 1997.
The Company also produces two products designated as the KD series in a
150 watt and 200 watt product. These designs were acquired in 1987 under a
licensing agreement with KDK Electronics. They are still offered for sale but
are expected to continue to decline as a percentage of Digital Power's
revenues. The licensing agreement with KDK Electronics, as amended, provides
that in the event total historical sales of KD products reaches $20 million,
then KDK Electronics will be granted a stock option to purchase 100,000 shares
of Digital Power's common stock for $3.50 per share with Digital Power paying
the exercise price. Due to changing market conditions, the KD series is
expected to be phased out prior to reaching the $20 million sales level.
Therefore, no common stock is anticipated to be granted to KDK Electronics
under the licensing agreement. In addition, KDK Electronics will be paid a
royalty equal to 5% on the first $20 million total sales of the KD series
products with the royalty decreasing on sales over that amount. KD products
accounted for 14%, and 6% of revenues for the years ended December 31, 1995 and
1996, respectively. Total cumulative sales of KD products were $14,476,274 as
of December 31, 1996.
Digital Power offers its customers various types of value-added services,
which may include the following additions to its standard product offerings:
Electrical (power): Paralleled power supplies for (N+1) redundancy, hot
swapability, output OR'ing diodes, AC input receptacle with fuse, external EMI
filter, on/off switch, cabling and connectors, and battery backup with charger.
Electrical (control and monitoring): AC power fail detect signal, DC
output(s) OK signal, inhibit, output voltage margining, and digital control
interface.
Mechanical: Custom hot-plug chassis for (N+1) redundant operation,
locking handle, cover, and fan.
These services incorporate one of the Company's base products along with
additional enclosures, cable assemblies, and other electronic components to
arrive at a power subassembly. This strategy matches perfectly with those OEMS
<PAGE>8
wishing to reduce their vendor base, as the turnkey sub-assembly allows
customers to eliminate other vendors.
Other than certain fabricated parts such as printed circuit boards and
sheet metal chassis which are readily available from many suppliers, the
Company uses no custom components. Typically, two suppliers are qualified for
every component, with the exception being two line transformers, one
manufactured by Tamura and the second one manufactured by Spitznagel. These
transformers are designed into three of the Company's products, which products
accounted for approximately 7% of the Company's sales in 1996.
MANUFACTURING STRATEGY
Consistent with its product flexibility strategy, the Company aims to
maintain a high degree of flexibility in its manufacturing processes in order
to respond to rapidly changing market conditions. With few exceptions, the
competitive nature of the power supply industry has placed continual downward
pressure on selling prices. In order to achieve low cost manufacturing with a
labor-intensive product, manufacturers have the option of automating much of
the labor out of their product, or producing their product in a low labor cost
environment. Given the high fixed costs of automation and the resistance this
places on making major product changes, Digital Power believes that its
flexible manufacturing strategy is best achieved through a highly variable cost
of operation. In 1986, the Company established a wholly-owned subsidiary in
Guadalajara, Mexico to assemble its products. This manufacturing facility
performs materials management, sub-assembly, final assembly, and test functions
for the majority of the Company's power supply products. Currently, almost all
of the Company's manufacturing, including its value-added services, is done at
a 16,000 square foot facility operated by the Company's wholly-owned
subsidiary, Poder Digital, S.A. de C.V., located in Guadalajara, Mexico. In
addition, Digital Power has entered into an agreement with Fortron/Source Corp.
to manufacture Digital Power's products at a facility located in China on a
turnkey basis. Purchases from Fortron/Source will be made pursuant to purchase
orders and the agreement may be terminated upon 120 days notice. Although the
Company has just recently begun to manufacture its products through
Fortron/Source, the Company believes that it will be able to produce a high
volume of power supplies through Fortron/Source at a cost lower than at its
Guadalajara, Mexico, facility. The Company believes that the facility in China
will complement its manufacturing facility in Guadalajara, Mexico since the
facility in China will allow the Company to produce power supplies with
sufficient lead time at lower costs, while the Guadalajara facility will
continue to manufacture power supplies that need a quick turnaround or
modification.
SALES, MARKETING AND CUSTOMERS
During 1996, the Company increased both its revenues and income before
income taxes, from $10,037,502 and $826,484, respectively, in fiscal year 1995,
to $13,835,008 and $1,822,634, respectively, in fiscal year 1996.
Digital Power markets its products domestically through a network of 13
independent manufacturers' representatives. Each representative organization
is responsible for managing sales in a particular geographic territory.
Generally, the representative has exclusive access to all potential customers
in the assigned territory and is compensated by commissions at 5% of net sales
after the product is shipped, received, and paid for by the customer.
Typically, either the Company or the representative organization may terminate
the agreement with 30 days' written notice.
In certain territories, the Company has entered into agreements with 28
stocking distributors who buy and resell the Company's products. For the
fiscal years ended December 31, 1996 and 1995, distributor sales accounted for
36.4% and 39.7%, respectively, of the Company's total sales. Over this same
period, one distributor accounted for 21.3% and 27%, respectively, of total
sales. In addition, international sales through stocking distributors
accounted for less than 5% of the Company's sales. In general, the agreements
with stocking distributors are subject to annual renewal and may be terminated
upon 90 days' written notice. Although these agreements may be terminated by
either party in the event a stocking distributor decides to terminate its
agreement with the Company, the Company believes that it would be able to
continue the sale of its products through direct sales to the customers of the
<PAGE>9
stocking distributor. Further, and in general, stocking distributors are
eligible to return 25% of their previous six-months' sales for stock rotation.
For the past three years, stock rotations have not exceeded one percent of
total sales.
The Company has also entered into agreements with three private label
customers who buy and resell the Company's products. Under these agreements,
the Company sells its products to the private label company who then resells
the products with its label to its customers. The Company believes that these
private label agreements expand its market by offering the customer a second
source for the Company's products. The private label agreements may be
terminated by either party. Further, the private label agreement requires that
any product subject to a private label be available for 5 years. For the years
ended December 31, 1996 and 1995, private label sales accounted for 10.9% and
10.2%, respectively, of total sales.
The Company's promotional efforts to date have included product data
sheets, feature articles in trade periodicals, and trade shows. The Company's
future promotional activities will likely include space advertising in
industry-specific publications, a full-line product catalog, application notes,
and direct mail to an industry-specific mail list.
The Company's products are warranted to be free of defects for a period
ranging from one to two years from date of shipment. No significant warranty
returns were experienced in either 1996 or 1995. As of December 31, 1996, the
Company's warranty reserve was $135,000.
COMPETITION
The design, manufacture, and sale of power supplies is a highly
competitive industry. The Company's competition includes approximately 400
companies located throughout the world, some of whom have advantages over the
Company in terms of labor and component costs, and some of whom may offer
products comparable in quality to those of the Company. Certain of the
Company's competitors, including Computer Products, Inc., ASTEC America, Zytec
Corporation, and Lambda Electronics, have substantially greater fiscal and
marketing resources and geographic presence than does the Company. The Company
also faces competition from current and prospective customers who may decide to
design and manufacture internally the power supplies needed for their products.
To remain competitive, management believes that the Company must continue to
compete favorably on the basis of value by providing advanced manufacturing
technology, offering superior customer service and design engineering services,
continuously improving quality and reliability levels, and offering flexible
and reliable delivery schedules. The Company believes it has a competitive
position with its targeted customers who need a high-quality, compact product
which can be readily modified to meet the customer's unique requirements.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts are primarily directed
toward the development of new standard power supply platforms which may be
readily modified to provide a broad array of individual models. Improvements
are constantly sought in power density, modifiability, and efficiency, while
the Company attempts to anticipate changing market demands for increased
functionality, such as PFC and improved EMI filtering. Internal research is
supplemented through the utilization of consultants who specialize in various
areas, including component and materials engineering and electromagnetic design
enhancements to improve efficiency, while reducing the cost and size of the
Company's products. Product development is performed at Digital Power's
headquarters in California by three engineers who are supported and assisted by
five technicians. The Company's total expenditures for research and
development were $630,079 and $481,475 for the years ended December 31, 1996
and 1995, respectively, and represented 4.55% and 4.80% of the Company's total
revenues for the corresponding periods.
<PAGE>10
EMPLOYEES
As of December 31, 1996, the Company had approximately 380 full-time
employees, with 330 of these employed at its wholly-owned subsidiary Poder
Digital located in Guadalajara, Mexico. The employees of Digital Power's
Mexican operation are members of a national labor union, as are most employees
of Mexican companies. The Company has not experienced any work stoppages at
either of its facilities and believes its employee relations are good.
GUADALAJARA, MEXICO FACILITY AND FOREIGN CURRENCY FLUCTUATIONS
The Company produces substantially all of its products at its 16,000
square foot facility located in Guadalajara, Mexico. The products are then
delivered to Fremont, California for testing and distribution. The Company
believes that it has a good working relationship with its employees in
Guadalajara, Mexico and has recently signed a five-year contract with the union
representing the employees. In 1996, the Company entered into a "turnkey"
manufacturing contract with a manufacturer located in China to produce its
products in an attempt to reduce its dependence on its Mexican facility. At
this time the purchase of products from the manufacturer located in China is
minimal and requires advance scheduling which affects the Company's ability to
produce products quickly. However, if the Company's revenues grow as
anticipated, the Company intends to manufacture more of its products utilizing
the Chinese manufacturer. In the event that there is an unforeseen disruption
at the Guadalajara production plant or with the Chinese manufacturer, such
disruption may have an adverse effect on the Company's ability to deliver its
products and may adversely affect the Company's financial operations.
Further, the Guadalajara, Mexico facility conducts its financial
operations using the Mexican peso. Therefore, due to financial conditions
beyond the control of the Company, the Company is subject to monetary
fluctuations between the U.S. dollar and Mexican peso. During fiscal 1996, the
Company lost $7,082 as a result of fluctuations in the value of the Mexican
peso against the dollar.
CERTAIN CONSIDERATIONS
In addition to the other information presented in this report, the
following should be considered carefully in evaluating the Company and its
business. This report contains various forward-looking statements that involve
risks and uncertainties. The Company's actual results may differ materially
from the results discussed in the forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
below and elsewhere in this report.
CUSTOMER CONCENTRATION
For the fiscal year ended December 31, 1996, one OEM accounted for 17.9%
of the Company's total revenues, and for the fiscal year ended December 31,
1995, three OEMs accounted for 18% in the aggregate of total revenues. The one
OEM account which accounted for 17.9% of the Company's total revenues for the
fiscal year ended December 31, 1996 substantially contributed to the Company's
increase in revenues for such period. In December 1996, this OEM indicated
that after the second quarter of 1997 it will no longer purchase power supplies
from the Company. The Company anticipates that increased purchases from its
other OEM customers will compensate for the loss of this customer. However, no
assurances can be given that this will occur. The loss of any other major OEM
customers would likely have an adverse effect on the Company's revenues. See
"Management's Discussion and Analysis or Plan of Operation".
DEPENDENCE ON COMPUTER AND OTHER ELECTRONIC EQUIPMENT INDUSTRIES; CUSTOMERS'
PRODUCT OBSOLESCENCE
Substantially all of the Company's existing customers are in the computer
and other electronic equipment industries and produce products which are
<PAGE>11
subject to rapid technological change, obsolescence, and large fluctuations in
product demand. These industries are characterized by intense competition and
a demand on OEMs serving these markets for increased product performance and
lower product prices. Given this industry environment in which they operate,
OEMs make similar demands on their suppliers, such as the Company, for
increased product performance and lower product prices. Thus, in order to be
successful, the Company must properly assess developments in the computer and
other electronic equipment industries and identify product groups and customers
with the potential for continued and future growth. Factors affecting the
computer and other electronic equipment industries, in general, or any of the
Company's major customers or their products, in particular, could have a
material adverse effect on the Company's results of operations. In addition,
the computer industry is inherently volatile. Recently, certain segments of
the computer and other electronic industries have experienced a softening in
demand for their products. Although this has not materially affected the
Company's customers, in the event that it affects all segments of the computer
and other electronic industries, the growth of the Company could be adversely
affected.
DEPENDENCE ON GUADALAJARA, MEXICO FACILITY; FOREIGN CURRENCY FLUCTUATIONS
The Company produces substantially all of its products at its facility
located in Guadalajara, Mexico. The products are then delivered to Fremont,
California for testing and distribution. The Company believes that it has a
good working relationship with its employees in Guadalajara, Mexico and has
recently signed a five-year contract with the union representing the employees.
Recently, the Company has entered into a "turnkey" manufacturing contract with
a manufacturer located in China to produce its products in an attempt to reduce
its dependence on its Mexican facility. At this time the purchase of products
from the manufacturer located in China is minimal and requires advance
scheduling which affects the Company's ability to produce products quickly.
However, if the Company's revenues grow as anticipated, the Company intends to
manufacture more of its products utilizing the Chinese manufacturer. In the
event that there is an unforeseen disruption at the Guadalajara production
plant or with the Chinese manufacturer, such disruption may have an adverse
effect on the Company's ability to deliver its products and may adversely
affect the Company's financial operations.
COMPETITION
The design, manufacture, and sale of power supplies is a highly
competitive industry. The Company's competition includes approximately 400
companies located throughout the world, some of whom have advantages over the
Company in terms of labor and component costs, and some of whom may offer
products comparable in quality to those of the Company. If the Company
continues to be successful in increasing its revenues, other competitors may
notice and increase competition for the Company's customers. The Company also
faces competition from current and prospective customers who may decide to
design and manufacture internally the power supplies needed for their products.
To remain competitive, management believes that the Company must continue to
compete favorably on the basis of value by providing advanced manufacturing
technology, offering superior customer service and design engineering services,
continuously improving quality and reliability levels, and offering flexible
and reliable delivery schedules. There can be no assurance that the Company
will continue to compete successfully in this market.
DEPENDENCE UPON KEY PERSONNEL; NEED TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL
The Company's performance is substantially dependent on the performance
of its executive officers and key personnel, and on its ability to retain and
motivate such personnel. The loss of any of the Company's key personnel,
particularly Robert O. Smith, could have a material adverse effect on the
Company's business, financial condition, and operating results. The Company
has "key person" life insurance policies on Mr. Smith in the aggregate amount
of $2 million. The Company also has an employment agreement with Mr. Smith.
The Company's future success also depends on its continuing ability to
identify, hire, train, and retain other highly-qualified creative, technical,
and managerial personnel. Competition for highly-qualified personnel is
intense. There can be no assurance that the Company will be successful in
<PAGE>12
attracting, assimilating, and retaining such personnel, and the failure to do
so could have a material adverse effect on the Company's business, financial
condition, and operating results. Moreover, in the event of the loss of any
such personnel, there can be no assurance that the Company would be able to
prevent the unauthorized disclosure or use of its proprietary technology,
practices, procedures, or customer lists.
DEPENDENCE ON SUPPLIERS
In order to reduce dependence on any one supplier, the Company attempts
to obtain two suppliers for each component of its products. However, for two
line transformers in three of its products, the Company is dependent on single
suppliers. Currently, these products account for approximately 7% of the
Company's total sales. Although the Company will seek to find other
manufacturers of transformers for these three products, unanticipated shortages
or delays in these parts may have an adverse effect on the Company's results of
operations.
NO PATENTS
The Company's products are not subject to any U.S. or foreign patents.
The Company believes that because its products are being continually updated
and revised, obtaining patents would not be beneficial. Therefore, there can
be no assurance that other competitors or former employees will not obtain the
Company's proprietary information and develop it.
ITEM 2. DESCRIPTION OF PROPERTIES.
The Company's headquarters are located in approximately 9,500 square feet
of leased office, research and development space in Fremont, California. The
Company pays $5,890 per month, subject to adjustment, and the lease expires on
January 31, 2001. The Company's manufacturing facility is located in 16,000
square feet of leased space in Guadalajara, Mexico. The Company pays
approximately $3,500 per month, subject to adjustment, and the lease expires in
February, 2001. The Company believes that its existing facilities are adequate
for the foreseeable future and has no plans to expand them.
ITEM 3. LEGAL PROCEEDINGS.
Neither Digital Power nor its subsidiary was involved in any legal
proceedings, nor is any property of Digital Power the subject of any legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable
<PAGE>13
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(A) COMPARATIVE MARKET PRICES
As of December 16, 1996, Digital Power's common stock and Redeemable
Common Stock Purchase Warrants ("Warrants") were listed and traded on The
NASDAQ SmallCap Market under the symbols "DPWR" and "DPWRW", respectively. On
February 13, 1997, Digital Power's common stock was listed and traded on the
American Stock Exchange ("AMEX") under the symbol "DPW". The following tables
set forth the high and low closing sale prices, as reported by NASDAQ, for
Digital Power's common stock and Warrants for the last quarter of 1996.
COMMON STOCK
PERIOD LOW HIGH
Quarter ending December 31, 1996 $4.00 $6.00
REDEEMABLE COMMON STOCK PURCHASE WARRANTS
PERIOD LOW HIGH
Quarter ending December 31, 1996 $0.125 $2.25
(B) HOLDERS
As of March 25, 1997, there were 2,520,775 shares of Digital Power common
stock outstanding, held by 504 holders of record. As of the same date, there
were 775,000 warrants, with 104 holders of record.
(C) DIVIDENDS
The Company has not declared or paid any cash dividends since its
inception. The Company currently intends to retain future earnings for use in
the operation and expansion of the business. The Company does not intend to
pay any cash dividends in the foreseeable future. The declaration of dividends
in the future will be at the discretion of the Board of Directors and will
depend upon the earnings, capital requirements, and financial position of the
Company.
On May 31, 1996, the Company issued a stock dividend in the form of
Common Stock valued at $1.80 per share on the cumulative accrued but unpaid
dividends on the Series A Preferred Stock. Since such stock dividend, all of
the Series A Preferred Stock has been converted into Common Stock.
<PAGE>14
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
OVERVIEW
The Company designs, develops, manufactures, and markets electronic power
supplies for use in converting electric power into a form suitable for the
operation of electronic circuitry. Revenues are generated from the sale of the
Company's power supplies to OEMs in the computer and other electronic equipment
industries.
RESULTS OF OPERATIONS
The table below sets forth certain statements of operations data as a
percentage of revenues for the years ended December 31, 1996 and 1995.
YEARS ENDED DECEMBER 31
-----------------------
1996 1995
----- -----
Revenues 100% 100%
Cost of goods sold 71.97 74.66
----- -----
Gross margin 28.03 25.34
Selling, general and administrative 9.20 10.30
Engineering and product development 4.55 4.80
----- -----
Total operating expense 13.75 15.10
----- -----
Operating income 14.28 10.24
Net interest expense 1.06 1.16
Translation loss .05 .85
----- -----
Income before income taxes 13.17 8.23
Provision (Benefit) for Income taxes 4.79 (2.76)
---- -----
Net Income 8.38% 10.99%
==== =====
Net Income applicable to common shareholders 8.10% 10.09%
The following discussion and analysis should be read in connection with
the Company's Consolidated Financial Statements and the notes thereto and other
financial information included elsewhere in this report.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES
Revenues for the fiscal year ended December 31, 1996 increased by
$3,797,506 or 37.8%, over the fiscal year ended December 31, 1995. This
increase in revenues was due primarily to substantially increased sales to a
single OEM and, to a lesser extent, to increased sales to the Company's 28
stocking distributors. The majority of this increase, $2,315,553 (61%) was due
to increased sales to OEMs. Distributor sales accounted for $1,002,400 (26.4%)
<PAGE>15
of the increase and the balance of $479,553 (12.6%) was generated by the
Company's private label customers.
As stated above, for the year ended December 31, 1996, one OEM accounted
for 17.9% of the Company's total revenues, and for the year ended December 31,
1995, three OEMs accounted for 18% in the aggregate of total revenues. The one
OEM account which accounted for 17.9% of the Company's total revenues for the
year ended December 31, 1996, substantially contributed to the Company's
increase in revenues for such period. During the latter part of 1996, this OEM
decreased the number of power supplies it purchased from the Company. Further,
this OEM indicated that it will require a higher wattage power supply for its
new products and that the OEM intends to use a power supply manufacturer other
than Digital to manufacture such new higher wattage power supply. Management
believes that this OEM will cease purchasing power supplies from the Company
after the second quarter of 1997. The Company is seeking to design a new
higher wattage power supply to satisfy the needs of this OEM. Further, the
Company believes that increased sales to new and other existing OEM customers
will offset the loss in sales to the OEM. No assurance can be given, however,
that even if the Company is able to design a new higher wattage power supply
that satisfies the needs of the OEM, that it will purchase such power supply
from the Company, or that the Company will be able increase sales of power
supplies to other OEMs to offset the loss in sales.
GROSS MARGINS
Gross margins were 28.03% for the fiscal year ended December 31, 1996
compared to 25.34% for the fiscal year ended December 31, 1995. This
improvement in gross margins can primarily be attributed to greater capacity
utilization as fixed overhead costs declined on a per unit basis.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased by $238,295, from
$1,033,828 for the fiscal year ended December 31, 1995, to $1,272,123 for the
fiscal year ended December 31, 1996. The increase primarily related to one-
time bonuses to certain employees which increased employee compensation
expense. As a percentage of revenues, however, selling, general and
administrative expenses decreased from 10.3% for the year ended December 31,
1995 to 9.2% for the year ended December 31, 1996, since the increase in
revenues during this period was much greater than the increase in selling,
general and administrative expenses.
ENGINEERING AND PRODUCT DEVELOPMENT
Engineering and product development expenses were 4.55% of revenues for
the year ended December 31, 1996, and 4.80% of revenues for the year ended
December 31, 1995. This slight decrease as a percentage of revenues was due to
a greater increase in revenues than the increase in engineering and product
development expenses.
INTEREST EXPENSE
Net interest expense was 1.06% of revenues for the year ended December
31, 1996 and 1.16% of revenues for the year ended December 31, 1995. This
decrease was primarily due to a lower interest rate on the Company's line of
credit and increased interest income with respect to the proceeds of the public
offering. Interest expense relates primarily to the Company's line of credit
and two equipment term loans with San Jose National Bank. The two term loans
in the aggregate principal amount of $170,000, and the line of credit, are
secured by the Company's accounts receivables and the Company's assets.
Proceeds from the two term loans were used to acquire equipment, and proceeds
from the line of credit were used for working capital.
<PAGE>16
TRANSLATION LOSS
The primary currency of the Company's subsidiary, Poder Digital, is the
Mexican peso. During 1996, the Company experienced a translation loss of
$7,082 related to Poder Digital's operations using Mexican pesos, compared with
a translation loss of $85,258 in 1995.
INCOME BEFORE INCOME TAXES
Income before income taxes increased by $996,150, from $826,484 during
1995, to $1,822,634 in 1996. This substantial increase was primarily due to
the increase in revenues from the sale of the Company's power supplies.
INCOME TAX
The Company's income tax expense was 4.79% of revenues for the year ended
December 31, 1996, and -2.76% of revenues for the year ended December 31, 1995
(the Company had a tax benefit in 1995). Through December 31, 1995, the
Company had net operating loss tax carry-forwards (NOLs) which resulted in
minimal federal tax liability for the Company in 1995. During the second
quarter of fiscal 1996, the Company began providing for federal and state tax
liability at an estimated average annual rate of 40%.
NET INCOME
Net income was $1,158,834 in 1996 and $1,103,884 in 1995, an increase of
$54,950, or 5.0%. During the fourth quarter of 1995, the Company recognized a
$277,400 tax benefit due to its prior net operating loss. Excluding the tax
benefit of $277,400, net income for 1995 would have been $826,484. Net income
applicable to common shareholders for the years ended December 31, 1996 and
1995 was $1,120,765 and $1,012,518, respectively. The difference between net
income and net income applicable to common shareholders is due to cumulative
dividends on the Company's Series A Preferred Stock amounting to $91,366 per
year. During 1996, all of the outstanding Series A Preferred Stock was
converted to common stock.
The Company does not believe that its business is seasonal.
LIQUIDITY AND CAPITAL RESOURCES
Through December 31, 1996, the Company funded its operations primarily
through revenues generated from operations, and its $1.5 million line of credit
with San Jose National Bank. As of December 31, 1996 and December 31, 1995,
the Company's working capital was $4,476,555 and $2,211,358, respectively. The
substantial increase in working capital for the year ended December 31, 1996
reflects proceeds from the sale of common stock and Warrants in connection with
the Company's initial public offering completed in December 1996. Proceeds
from the offering, which amounted to $2,276,905, were used to pay off certain
loans and to pay down the Company's line of credit. Payments on the loans and
line of credit during the first part of 1997 totalled $1,483,401. The
remaining proceeds will be used for working capital. On January 6, 1997, the
underwriter in connection with the Company's initial public offering exercised
its overallotment option and purchased an additional 150,000 shares of common
stock and 75,000 warrants, and the Company received an additional $530,156 in
proceeds as a result.
Cash provided by operating activities for the Company totalled $559,016
during fiscal 1996 as compared to cash provided by operating activities of
$319,035 during fiscal 1995. The increase in cash provided by operating
activities was due primarily to the increase in net income. Cash used in
investing activities in each of fiscal 1996 and fiscal 1995 consisted of
expenditures for production and testing equipment of $408,213 and $254,530,
respectively. During fiscal 1995, cash used in investing activities included
the purchase of a temporary investment of $100,000. Expenditures for equipment
were the direct result of increasing business operations. Cash provided by
financing activities consisted of borrowings (including advances under the
<PAGE>17
Company's revolving line of credit) of $12,580,000 and $9,542,788 during fiscal
1996 and fiscal 1995, respectively, net of $12,345,207 and $9,346,200 in note
and line of credit payments during fiscal 1996 and fiscal 1995, respectively.
For the past two fiscal years up until December 1996, the Company had
relied on cash flows from operations supplemented by bank borrowings to finance
working capital and capital improvements. The Company's bank borrowings
consist of a $120,000 promissory note bearing interest at 10% per annum and due
December 8, 1998, a $50,000 promissory note bearing interest at 10.5% per annum
and due May, 1999, and a $1.5 million line of credit bearing interest at prime
plus 1% and due October 15, 1997. Proceeds from the promissory notes were used
to acquire equipment, and the line of credit is used to supplement the
Company's working capital. The promissory notes and line of credit are secured
by substantially all of the Company's assets. The Company does not anticipate
any material capital expenditures during 1997. As of December 31, 1996 and
December 31, 1995, the Company's bank borrowings totalled $1,783,938 and
$1,044,145, respectively.
The Company is a guarantor of a $500,000 term loan granted to the
Company's employee stock ownership plan ("ESOP"). The $500,000 term loan is
included in the total amount of the Company's bank borrowings as of December
31, 1996 stated in the preceding paragraph. The $500,000 is due in June 2001
and bears interest at 10.5% per annum. Proceeds from the loan were used to
acquire the Company's common stock by the ESOP. Principal and interest on the
loan will be paid by the ESOP through contributions made by the Company to the
ESOP in the amount of approximately $10,750 per month. This amount will be a
monthly deduction against revenues through June 2001.
For fiscal year 1997, the Company intends to upgrade its
telecommunications system to improve communication with its Guadalajara
facility. It is anticipated that the system will cost approximately $100,000
and will be paid out of the Company's working capital. No other material
expenditures are anticipated during 1997.
ITEM 7. FINANCIAL STATEMENTS.
The financial statements of the Company, including the notes thereto and
report of the independent auditors thereon, are attached hereto as exhibits
following page number 19.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
In June 1996, the Company decided to retain Hein + Associates LLP as the
Company's independent accountants and dismissed Villanueva, Purcell & Co., the
Company's former accountants. The decision to change independent accountants
was ratified and approved by the Company's Board of Directors in June 1996.
During the relationship between the Company and Villanueva, Purcell & Co.,
there were no disagreements regarding any matters with respect to accounting
principles or practices, financial statement disclosure, or audit scope or
procedure, which disagreements, if not resolved to the satisfaction of the
former accountants, would have caused Villanueva, Purcell & Co. to make
reference to the subject matter of the disagreement in connection with its
report. Prior to retaining Hein + Associates LLP, the Company had not
consulted with Hein + Associates LLP regarding accounting principles.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT OF THE REGISTRANT.
The information required by this item is incorporated by reference to the
Company's definitive Proxy Statement for the annual meeting of stockholders
under the captions "Election of Directors," "Further Information Concerning the
Board of Directors," and "Section 16(a) Information." The Proxy Statement will
be filed within 120 days of the Company's fiscal year end.
<PAGE>18
ITEM 10. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference to the
Company's definitive Proxy Statement for the annual meeting of stockholders
under the caption "Executive Compensation." The Proxy Statement will be filed
within 120 days of the Company's fiscal year end.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference to the
Company's definitive Proxy Statement for the annual meeting of stockholders
under the caption "Principal Stockholders." The Proxy Statement will be filed
within 120 days of the Company's fiscal year end.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference to the
Company's definitive Proxy Statement for the annual meeting of stockholders
under the caption "Certain Relationships and Related Transactions." The Proxy
Statement will be filed within 120 days of the Company's fiscal year end.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS
3.1 Amended and Restated Articles of Incorporation of Digital Power
Corporation*
3.2 Amendment to Articles of Incorporation*
3.3 Bylaws of Digital Power Corporation*
4.1 Specimen Common Stock Certificate**
4.2 Specimen Warrant*
4.3 Representative's Warrant*
10.1 Revolving Credit Facility with San Jose National Bank*
10.2 KDK Contract*
10.3 Agreement with Fortron/Source Corp.*
10.4 Employment Agreement With Robert O. Smith**
10.5 1996 Stock Option Plan*
11.1 Statement Regarding Computation of Per Share Earnings
16.1 Letter on Changes in Certifying Accountants*
21.1 List of Subsidiaries of Issuer*
* Previously filed with Commission on October 16, 1996 to the Company's
Registration Statement on Form SB-2.
** Previously filed with Commission on December 3, 1996 to the Company's
Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2.
(B) REPORTS ON FORM 8-K
Not applicable.
<PAGE>19
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on by the undersigned, thereunto
duly authorized.
DIGITAL POWER CORPORATION,
A CALIFORNIA CORPORATION
ROBERT O. SMITH
Robert O. Smith,
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
SIGNATURES DATE
ROBERT O. SMITH March 31, 1997
Robert O. Smith, Chief Executive Officer
(Principal Executive Officer)
PHILIP G. SWANY March 31, 1997
Philip G. Swany, Chief Financial Officer
(Principal Accounting and
Financial Officer)
EDWARD L. LAMMERDING March 31, 1997
Edward L. Lammerding,
Chairman of the Board
THOMAS W. O'NEIL March 31, 1997
Thomas W. O'Neil, Jr., Director
PHILIP M. LEE March 31, 1997
Philip M. Lee, Director
CLAUDE ADKINS March 31, 1997
Claude Adkins, Director
<PAGE>F-1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Independent Auditor's Report........................................F-2
Consolidated Balance Sheet - December 31, 1996......................F-3
Consolidated Statements of Income - For the Years Ended
December 31, 1996 and 1995........................................F-4
Consolidated Statement of Stockholders' Equity - For the Years
Ended December 31, 1996 and 1995..................................F-5
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 1996 and 1995........................................F-6
Notes to Consolidated Financial Statements..........................F-8
<PAGE>F-2
INDEPENDENT AUDITOR'S REPORT
The Stockholders and Board of Directors
Digital Power Corporation and Subsidiary
Fremont, California
We have audited the accompanying consolidated balance sheet of Digital Power
Corporation and Subsidiary as of December 31, 1996, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the two-year period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Digital Power
Corporation and Subsidiary as of December 31, 1996, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 1996 in conformity with generally accepted accounting
principles.
HEIN + ASSOCIATES LLP
Certified Public Accountants
Orange, California
March 7, 1997
<PAGE>F-3
DIGITAL POWER CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1996
-----------------
ASSETS
CURRENT ASSETS:
Cash $ 2,955,298
Accounts receivable - trade, net of
allowance for doubtful accounts of
$170,000 2,439,523
Other receivables 150,122
Inventory, net 2,832,329
Prepaid expenses and deposits 28,735
Deferred income taxes 53,000
------------
Total current assets 8,459,007
PROPERTY AND EQUIPMENT, net 653,355
DEPOSITS 17,428
------------
TOTAL ASSETS $ 9,129,790
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,347,463
Current portion of capital lease obligations 13,406
Accounts payable 1,420,769
Accrued liabilities 1,200,814
------------
Total current liabilities 3,982,452
LONG-TERM DEBT, less current portion 446,475
OBLIGATIONS UNDER CAPITAL LEASE, less current portion 18,201
------------
Total liabilities 4,447,128
------------
COMMITMENTS AND CONTINGENCIES (Notes 6, 7 and 9) -
STOCKHOLDERS' EQUITY:
Series A cumulative redeemable convertible
preferred stock, no par value, 2,000,000 shares
authorized, no shares issued and outstanding -
Common stock, no par value, 10,000,000 shares
authorized, 2,363,275 shares issued and outstanding 7,766,645
Warrants 66,875
Accumulated deficit (2,689,730)
Unearned employee stock ownership plan shares (461,128)
------------
Total stockholders' equity 4,682,662
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,129,790
============
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>F-4
DIGITAL POWER CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED
DECEMBER 31,
-------------------
1996 1995
------------ ------------
REVENUES $ 13,835,008 $ 10,037,502
COST OF GOODS SOLD 9,956,763 7,494,427
------------ ------------
Gross Margin 3,878,245 2,543,075
------------ ------------
OPERATING EXPENSES:
Engineering and product development 630,079 481,475
Marketing and selling 497,345 452,654
General and administrative 774,778 581,174
------------ ------------
Total operating expenses 1,902,202 1,515,303
------------ ------------
INCOME FROM OPERATIONS 1,976,043 1,027,772
------------ ------------
OTHER INCOME (EXPENSE):
Interest income 13,785 3,116
Interest expense (160,112) (119,146)
Translation loss (7,082) (85,258)
------------ ------------
Other income (expense) (153,409) (201,288)
------------ ------------
INCOME BEFORE INCOME TAXES 1,822,634 826,484
PROVISION (BENEFIT) FOR INCOME TAXES 663,800 (277,400)
------------ ------------
NET INCOME $ 1,158,834 $ 1,103,884
============ ============
NET INCOME APPLICABLE TO COMMON
SHAREHOLDERS $ 1,120,765 $ 1,012,518
============ ============
NET INCOME PER COMMON SHARE:
Primary $ .66 $ 0.80
============ ============
Fully diluted $ .62 $ 0.66
============ ============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING 1,691,136 1,258,858
============ ===========
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>F-5
DIGITAL POWER CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
UNEARNED
EMPLOYEE
PREFERRED STOCK COMMON STOCK STOCK TOTAL
ACCUMULATED OWNERSHIP STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT WARRANTS DEFICIT PLAN EQUITY
------------ ----------- ------------ ----------- ------------ ------------- ---------- ------------
BALANCES, January 1, 1995 415,302 $ 747,569 963,722 $ 4,398,322 $ - $ (4,563,194) $ $ 582,697
Net income - - - - - 1,103,884 - 1,103,884
---------- ----------- ---------- ----------- ---------- ------------ ---------- -----------
BALANCES, December 31, 1995 415,302 747,569 963,722 4,398,322 - (3,459,310) - 1,686,581
Net income - - - - - 1,158,834 - 1,158,834
Dividend on preferred
stock - - 216,229 389,213 - (389,254) - (41)
Conversion of preferred
stock (415,302) (747,569) 415,302 747,569 - - - -
Exercise of stock
options - - 18,022 9,011 - - - 9,011
ESOP loan and shares
purchased - - - - - - (500,000) (500,000)
Contribution to the ESOP - - - - - - 38,872 38,872
Compensation costs recognized
upon issuance of warrants - - - - 12,500 - - 12,500
Sale of common stock and
warrants, net of expenses - - 750,000 2,222,530 54,375 - - 2,276,905
------------ ----------- ------------ ----------- ------------ ------------ ------------ -----------
BALANCES, December 31, 1996 - $ - 2,363,275 $ 7,766,645 $ 66,875 $ (2,689,730) $ (461,128) $ 4,682,662
============ =========== ============ =========== ============= ============= ============ ============
</TABLE>
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>F-6
DIGITAL POWER CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED
DECEMBER 31,
-------------------
1996 1995
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,158,834 $ 1,103,884
------------ ------------
Adjustments to reconcile net
income to net cash provided by
operating activities:
Depreciation and amortization 112,538 70,140
Deferred income taxes 326,856 (374,689)
Warranty expense 75,000 30,000
Inventory reserve (50,000) 195,000
Contribution to ESOP 38,872 -
Bad debt expense 50,000 55,000
Compensation costs recognized
upon issuance of warrants 12,500 -
Foreign currency translation
adjustment 7,082 85,258
Changes in operating assets and
liabilities:
Accounts receivable (873,026) (465,047)
Other receivables (92,264) (39,855)
Inventory (1,225,103) (594,983)
Prepaid expenses (943) (17,879)
Other assets 936 -
Accounts payable 289,183 266,721
Other accrued liabilities 728,551 5,485
------------ ------------
Net adjustments (599,818) (784,849)
------------ ------------
Net cash provided by operating
activities 559,016 319,035
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (408,213) (254,530)
Sale of temporary investment 100,000 -
------------ ------------
Net cash used in investing activities (308,213) (254,530)
------------ ------------
(Continued)
<PAGE>F-7
DIGITAL POWER CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED
DECEMBER 31,
-------------------
1996 1995
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock
and warrants 2,276,905 -
Proceeds from exercise of stock options 9,011 -
Payments of preferred stock dividend (41) -
Proceeds from notes payable 50,000 120,000
Principal payments on notes payable (83,392) (1,276)
Principal payments on capital lease
obligations (12,008) (9,054)
Payment of debenture (5,000) -
Proceeds from line of credit 12,530,000 9,422,788
Principal payments on line of credit (12,256,815) (9,344,924)
------------ ------------
Net cash provided by financing
activities 2,508,660 187,534
------------ -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (7,082) (85,258)
------------ ------------
NET INCREASE IN CASH 2,752,381 166,781
CASH AND CASH EQUIVALENTS, beginning of period 202,917 36,136
------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 2,955,298 $ 202,917
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash payments for:
Interest $ 152,716 $ 121,931
=========== ===========
Income taxes $ 171,214 $ 55,803
=========== ==========
Non-cash investing and financing
transactions:
Property and equipment acquired with
capital lease $ - $ 10,779
=========== ==========
Conversion of preferred stock to
common stock $ 747,569 $ -
=========== ==========
Preferred stock dividend of common
stock $ 389,213 $ -
=========== ==========
Notes payable for unearned employee
stock ownership plan shares $ 500,000 $ -
=========== =========
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>F-8
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS:
Digital Power Corporation ("DPC"), and its wholly owned subsidiary
Poder Digital, S.A. de C.V. ("PD") which is located in Guadalajara,
Mexico, (collectively referred to as the "Company") are engaged in the
design, manufacture and sale of switching power supplies.
2. SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of the Company and its subsidiary. All
significant intercompany accounts and transactions have been
eliminated in consolidation.
STATEMENT OF CASH FLOWS - For purposes of the statements of cash
flows, the Company considers all highly liquid debt instruments
purchased with an original maturity of three months or less to be cash
equivalents.
INVENTORY - Inventory is stated at the lower of cost (first-in, first-
out) or market.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation of equipment and furniture is calculated using the
straight-line method over the estimated useful lives (ranging from 5
to 10 years) of the respective assets. Leasehold improvements are
amortized over the shorter of the estimated useful life or the term of
the lease. The cost of normal maintenance and repairs is charged to
operating expense as incurred. Material expenditures which increase
the life of an asset are capitalized and depreciated over the
estimated remaining useful life of the asset. The cost of fixed
assets sold, or otherwise disposed of, and the related accumulated
depreciation or amortization are removed from the accounts, and any
gains or losses are reflected in current operations.
INCOME TAXES - The Company accounts for income taxes under the
liability method, which requires recognition of deferred tax assets
and liabilities for the expected future tax consequences of events
that have been included in the financial statements or tax returns.
Under this method, deferred tax assets and liabilities are determined
based on the difference between the financial statements and tax basis
of assets and liabilities using enacted tax rates in effect for the
year in which the differences are expected to reverse.
<PAGE>F-9
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
REVENUE RECOGNITION - Sales revenue is recognized when the products
are shipped to customers, including distributors. Customers receive a
one or two year product warranty and sales to distributors are subject
to a right of return. The Company provides a reserve for estimated
warranty costs and a reserve for estimated product returns.
FOREIGN CURRENCY TRANSLATION - Gains and losses from the effects of
exchange rate fluctuations on transactions denominated in foreign
currencies are included in results of operations. Assets and
liabilities of the Company's foreign subsidiary are translated into
U.S. dollars at period-end exchange rates, and their revenues and
expenses are translated at average exchange rates for the period.
NET INCOME PER COMMON SHARE - Net income per common share is
calculated upon net income applicable to common shareholders, which
represents net income adjusted for cumulative preferred dividends
applicable to the period.
The weighted average common shares is based upon actual common stock
and common stock equivalents outstanding. Additionally, common stock
equivalents issued during the prior year at less than the $4.00
initial public offering price have been included for all periods
presented in the computation using the "treasury stock method" and the
public offering price.
Fully diluted net income per common share is computed using the "if
converted" method for preferred stock.
ACCOUNTING ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and the accompanying notes. The
actual results could differ from those estimates.
The Company's financial statements are based upon a number of
significant estimates, including the allowance for doubtful accounts,
technological obsolescence of inventories, the estimated useful lives
selected for property and equipment, realizability of deferred tax
assets, allowance for sales returns, and warranty reserve. Due to the
uncertainties inherent in the estimation process, it is at least
reasonably possible that these estimates will be further revised in
the near term and such revisions could be material.
<PAGE>F-10
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
IMPAIRMENT OF LONG-LIVED ASSETS - In the event that facts and
circumstances indicate that the cost of assets or other assets may be
impaired, an evaluation of recoverability would be performed. If an
evaluation is required, the estimated future undiscounted cash flows
associated with the asset would be compared to the asset's carrying
amount to determine if a write-down to market value or discounted cash
flow value is required.
STOCK-BASED COMPENSATION - In October, 1995, the Financial Accounting
Standards Board issued a new statement titled "Accounting for Stock-
Based Compensation" (FAS 123) which the Company adopted January 1,
1996. FAS 123 encourages, but does not require, companies to
recognize compensation expense for grants of stock, stock options and
other equity instruments to employees based on fair value. Companies
that do not adopt the fair value accounting rules must disclose the
impact of adopting the new method in the notes to the financial
statements. Transactions in equity instruments with non-employees for
goods or services must be accounted for on the fair value method. The
Company has elected not to adopt the fair value accounting prescribed
by FAS 123 for employees, but is subject to the disclosure
requirements prescribed by FAS 123.
CONCENTRATIONS OF CREDIT RISK - Credit Risk represents the accounting
loss that would be recognized at the reporting date if counterparties
failed completely to perform as contracted. Concentrations of credit
risk (whether on or off balance sheet) that arise from financial
instruments exist for groups of customers or groups of counterparties
when they have similar economic characteristics that would cause their
ability to meet contractual obligations to be similarly effected by
changes in economic or other conditions. In accordance with FAS
Statement No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL
INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH
CONCENTRATIONS OF CREDIT RISK, the credit risk amounts shown in Note 10
do not take into account the value of any collateral or security.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The estimated fair values for
financial instruments under FAS Statement No. 107, DISCLOSURES ABOUT
FAIR VALUE OF FINANCIAL INSTRUMENTS, are determined at discrete points
in time based on relevant market information. These estimates involve
uncertainties and cannot be determined with precision. The estimated
fair values of the Company's financial instruments, which includes all
cash, accounts receivables, accounts payable, long-term debt, and
other debt, approximates the carrying value in the consolidated
financial statements at December 31, 1996.
<PAGE>F-11
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
IMPACT OF RECENTLY ISSUED STANDARDS - In February 1997, the Financial
Accounting Standards Board issued a new statement titled "Earnings per
Share" ("FAS 128"). The new statement is effective for both interim
and annual periods ending after December 15, 1997. FAS 128 replaces
the presentation of primary and fully diluted earnings per share with
the presentation of basic and diluted earnings per share. Basic
earnings per share excludes dilution and is calculated by dividing
income available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted earnings per
share reflects the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity. The Company has not
calculated the impact, if any, of adopting FAS 128.
3. INVENTORY:
Inventory consists of the following as of December 31, 1996:
Raw Materials $ 2,110,678
Work-in-process 886,790
Finished goods 184,861
------------
3,182,329
Allowance for obsolescence (350,000)
------------
$ 2,832,329
============
4. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following at December 31, 1996:
Machinery and equipment $ 1,166,915
Office equipment and furniture 392,588
Leasehold improvements 146,520
Transportation equipment 3,168
------------
1,709,191
Accumulated depreciation (1,055,836)
------------
$ 653,355
============
Depreciation and amortization expense for property and equipment
charged to operations for the years ended December 31, 1996 and 1995
was $112,538 and $70,140, respectively.
<PAGE>F-12
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. ACCRUED LIABILITIES:
At December 31, 1996, accrued liabilities consists of the following:
Accrued payroll benefits $ 305,382
Accrued commissions and royalties 88,920
Accrued warranty and product returns expense 335,000
Accrued income taxes 255,281
Other 216,213
------------
$ 1,200,814
============
6. LONG-TERM DEBT:
Long-term debt consists of the following as of December 31, 1996:
Revolving line of credit agreement provides for
borrowings up to 80% of eligible accounts
receivable not to exceed $1,500,000; bears
interest at the bank's prime rate (8.25% at
December 31, 1996) plus one percent. Matures
October 1997. Collateralized by substantially
all assets of DPC. $ 1,197,330
Unsecured note payable, due on demand, interest
at 12%. 10,000
Note payable, due in monthly installments of
$3,881 including interest at 10% through December
1998. Collateralized by substantially all assets
of DPC. 83,986
Note payable, due in monthly installments of
$1,629 including interest at 10.50% through May
1999. Collateralized by substantially all assets
of DPC. 41,494
Employee stock ownership plan loan 461,128
See Note 11 ------------
1,793,938
Less current portion (1,347,463)
------------
$ 446,475
============
<PAGE>F-13
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. LONG-TERM DEBT (CONTINUED):
Aggregate maturities of long-term debt are due as follows:
YEARS ENDING
DECEMBER 31, AMOUNT
------------ ------------
1997 $ 1,347,463
1998 155,580
1999 112,222
2000 115,901
2001 62,772
------------
$ 1,793,938
============
Under the terms of the revolving line of credit agreement the Company
is required to maintain working capital of not less than $800,000, a
debt to worth ratio less than 2.5 to 1, and a minimum tangible net
worth of not less than $1,500,000. As of December 31, 1996, the
Company was in compliance with all terms of the revolving line of
credit agreement.
7. CAPITAL LEASE OBLIGATIONS:
The Company leases certain equipment under agreements classified as
capital leases. The cost of the equipment related to the leases is
$57,147 and accumulated depreciation amounts to $26,387 at December
31, 1996.
Following is a schedule of future minimum lease payments under capital
leases at December 31, 1996:
YEARS ENDING DECEMBER 31, AMOUNT
------------------------- -----------
1997 $ 16,698
1998 14,689
1999 5,282
-----------
Total future minimum lease payments 36,669
Less amount representing interest (5,062)
-----------
Present value of net minimum lease payments 31,607
Less current portion (13,406)
-----------
$ 18,201
===========
<PAGE>F-14
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. STOCKHOLDERS' EQUITY:
COMMON STOCK
In December, 1996, the Company completed a public offering of 750,000
shares of its common stock along with 500,000 warrants, at a public
offering price of $4.00 per share and $.125 per warrant.
As part of the public offering, the underwriter was allocated an
additional 150,000 shares at $4.00 per share and 75,000 warrants at
$.125 per warrant to cover over-allotments, if any. On January 8,
1997, the underwriter exercised and sold these over allotment shares
and warrants for net proceeds of $530,156.
PREFERRED STOCK
The preferred stock has one series authorized, 500,000 shares of
Series A cumulative redeemable convertible preferred stock ("Series
A"), and an additional 1,500,000 shares of preferred stock has been
authorized, but the rights, preferences, privileges and restrictions
on these shares has not been determined. DPC's Board of Directors is
authorized to create new series of preferred stock and fix the number
of shares as well as the rights, preferences, privileges and
restrictions granted to or imposed upon any series of preferred stock.
On May 31, 1996, all of the 415,302 issued and outstanding shares of
Series A Preferred Stock were converted into 415,302 shares of common
stock at the statutory rate of $1.80 per share. Additionally, the
Company declared a dividend on the Series A preferred stock for all
unpaid dividends through the conversion date and issued an aggregate
of 216,229 shares of common stock.
The holders of Series A were entitled to one vote for each share of
common stock into which the Series A could be converted, and vote
together with the common shareholders as a single class. Dividends on
Series A were at an annual rate of $.22 per share and were cumulative
from the date of issuance, and were required to be paid prior to
dividends on common stock.
Shares of Series A were convertible into common stock at any time at
the option of the holder at a rate of one share of common stock for
each share of Series A. The conversion rate was subject to adjustment
under certain circumstances.
In the event of a liquidation, dissolution, or winding up of the
Company, Series A holders were entitled to receive a liquidation
preference of $1.80 per share of Series A plus all dividends in
arrears.
<PAGE>F-15
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS
The Company has issued non-qualified options covering 104,922 shares
exercisable at $.50 per share. Upon issuance, the Company recorded
compensation expense for the difference between the exercise price and
the fair market value of the underlying common stock of $1.80 per
share. Such options expire in 2003. During the year ended December
31, 1996, 18,022 of such options were exercised.
In May, 1993, the Company issued options to purchase 237,500 shares of
its common stock at $1.80 per share. Such options are subject to a
four year vesting plan. The exercise price of $1.80 per share
approximated the fair market value at the date of grant.
In May, 1996, the Company adopted the 1996 Stock Option Plan covering
513,000 shares. Under the plan, the Company can issue either
incentive or non-statutory stock options. The price of the options
granted pursuant to the plan will not be less than 100% of the fair
market value of the shares on the date of grant. The board of
directors will decide the vesting period of the options, if any, and
no option will be exercisable after ten years from the date granted.
Immediately thereafter, the Company issued options to purchase 275,500
shares of its common stock at $1.80 per share. Such options become
100% vested two years after issuance. The exercise price was based
upon a letter from its investment banker as to the fair market value
of such options based upon their terms, conditions and restrictions.
The following table sets forth activity for all options:
EXERCISE PRICE
NUMBER PER SHARE
-------- --------------
OUTSTANDING, January 1, 1995, and
December 31, 1995 342,422 $.50 -$1.80
GRANTED 275,500 1.80
FORFEITED (2,500) 1.80
EXERCISED (18,022) .50
------------ ------------
BALANCE, DECEMBER 31, 1996 597,400 $.50 - $1.80
============ ============
At December 31, 1996 and 1995 options to purchase 265,025 and 223,672
shares, respectively, were exercisable at prices ranging from $.50 to
$1.80 per share. If not previously exercised, these options expire
during the year ended December 31, 2003.
<PAGE>F-16
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. STOCKHOLDERS' EQUITY (CONTINUED):
WARRANTS
On August 19, 1996, the Company issued 200,000 common stock purchase
warrants to certain Company directors and affiliates. Each warrant
entitles the holder to purchase one share of common stock at $5.00 and
expires three years after the effective date of the Company's initial
public offering of securities. The Company recognized $12,500 in
expense for past services rendered for the 100,000 warrants issued to
affiliates.
PROFORMA INFORMATION
As stated in Note 2, the Company has not adopted the fair value
accounting prescribed by FAS 123 for employees. Had compensation cost
for stock options or warrants issued to employees been determined
based on the fair value at grant date for awards in 1996 consistent
with the provisions of FAS 123, the Company's net income and net
income per share would have been reduced to the pro forma amounts
indicated below:
Net Income $ 1,133,473
Net Income per common share:
Primary .65
Fully diluted .61
The fair value of each option or warrant is estimated on the date of
grant using the present value of the exercise price and is pro-rated
based on the percent of time from the grant date to the end of the
vesting period. The weighted average fair value of the options on the
grant date was $1.50 per share. The following assumptions were used
for grants in 1996: risk-free interest rate of 6.17%; expected lives
of three years; dividend yield of 0%; and expected volatility of 0%.
9. COMMITMENTS:
LEASES
The Company leases office space in California, and a manufacturing
facility in Guadalajara, Mexico under operating leases. The total
future minimum lease payments are as follows:
YEARS ENDING
DECEMBER 31, AMOUNT
------------ ----------
1997 $ 105,640
1998 108,880
1999 109,174
2000 112,579
Thereafter 10,378
------------
$ 446,651
============
<PAGE>F-17
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS (CONTINUED):
Lease payments on the manufacturing facility in Mexico are to be made
in Mexican Pesos. The above schedule was prepared using the
conversion rate in effect at December 31, 1996. Changes in the
conversion rate will have an impact on the Company's required minimum
payments and its operating results. Additionally, lease payments on
the facility in Mexico will increase on an annual basis in proportion
to the increase in the minimum wage in the Guadalajara, Mexico area.
Rent expense was $119,106 and $116,699 for 1996 and 1995,
respectively.
ROYALTY AGREEMENT
The Company has a royalty agreement with a third party on various
products, and any derivatives from the base design of these products.
Commitments under this agreement are as follows:
5% of first $20,000,000 in sales of these products
4% of next $25,000,000 in sales of these products
3% of next $33,333,333 in sales of these products
2% of next $50,000,000 in sales of these products
1% of next $100,000,000 in sales of these products
As of December 31, 1996, the Company had sold approximately
$14,476,000 of product subject to this agreement.
If the Company sells an additional $5,524,000 of these products after
December 31, 1996, the Company is required to grant 100,000 shares of
common stock to the third party in the royalty agreement. Due to
changing market demand, the Company's management currently expects to
replace these products with products it is in the process of
designing, and Company's management believes the Company will
therefore not have to grant the 100,000 shares of common stock.
The Company sold approximately $847,000 and $1,453,000 of these
products in 1996 and 1995, respectively, and had royalty expenses of
approximately $42,300 and $72,600 for 1996 and 1995, respectively.
EMPLOYMENT AGREEMENT
The Company has an employment contract with its President/CEO which
terminates on December 31, 1999. Under the terms of the employment
contract, he shall serve as president and chief executive officer of
the Company and his salary shall be $150,000 per annum effective
January 1, 1997, increasing in an amount to be determined by the
employee and the Board such that he shall receive $200,000 per annum
by January 1, 1999. In addition, pursuant to the contract, he shall
have the right to receive on the first day of each January during the
term of his contract options to acquire 100,000 shares of Common Stock
at the lower of market value per share as of such date or the average
per share bid price for the first 6 months beginning from the date of
grant of the option. Finally, pursuant to the employment contract, in
the event there is a change in control of the Company, the employee
shall be granted a five year consulting contract at $200,000 per year.
<PAGE>F-18
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. SIGNIFICANT CONCENTRATIONS OF CREDIT RISK, MAJOR CUSTOMERS AND OTHER
RISKS AND UNCERTAINTIES:
Sales to unaffiliated customers which represent more than 10% of the
Company's net sales for 1996 and 1995 were as follows (customers A & C
are distributors):
CUSTOMER 1996 1995
-------- ---- ----
A 21% 27%
B 18% 8%
C 11% 10%
The Company operates primarily in one industry segment: the
manufacture and sale of switching power supplies. Additionally, most
of the Company's sales are to customers located in California.
Financial instruments that subject the Company to credit risk consist
primarily of accounts receivable. The Company frequently sells large
quantities of inventory to its customers. At December 31, 1996,
approximately $1,823,913 or 67.7 % of the Company's net accounts
receivable were due from five customers.
As of December 31, 1996, the Company maintained cash in banks that was
approximately $2,715,300 in excess of the federally insured limit.
11. EMPLOYEE BENEFIT PLANS:
401(K) PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan (the "Plan") covering
substantially all employees of DPC. Eligible employees may make
voluntary contributions to the Plan, which are matched by the Company
at a rate of $.25 for each $1.00 contributed, up to a maximum of six
percent of eligible compensation. The Company can also make
discretionary contributions. The Company made matching contributions
to the Plan of $11,844 and $9,594 for 1996 and 1995, respectively.
The Board of Directors of DPC elected not to make a discretionary
contribution to the Plan for 1996 or 1995.
EMPLOYEE STOCK OWNERSHIP PLAN
The Company also has an employee stock ownership plan (the "ESOP")
covering substantially all employees of DPC. The Company can make
discretionary contributions of cash or company stock (as defined in
the ESOP plan document) up to deductible limits prescribed by the
Internal Revenue Code. The Board of Directors of DPC elected to make
no contributions to the ESOP for 1995.
<PAGE>F-19
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. EMPLOYEE BENEFIT PLANS (CONTINUED):
Effective June 13, 1996, the ESOP obtained a $500,000 loan guaranteed
by the Company for the purpose of acquiring common stock of Company
from existing stockholders. The loan bears interest at 10.5% per
annum and requires monthly payments of principle and interest of
$10,784 through June 2001. The balance at December 31, 1996 was
$461,128. Immediately upon the funding of the loan, the ESOP
purchased approximately 154,000 shares of the Company's common stock
from existing shareholders. The Company is required to contribute
amounts to the plan to sufficiently cover the debt payments.
Contributions to the plan in 1996 totaled $116,308.
In accordance with the AICPA Statements of Position 93-6 entitled
"Employers Accounting for Employee Stock Ownership Plans", the Company
has recorded the $500,000 loan as debt on its books with a
corresponding charge to stockholder's equity.
12. INCOME TAXES:
Income tax expense is comprised of the following:
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995
---------- ------------
Current
Federal $ 148,225 $ 7,552
State 209,550 73,750
------------ -----------
357,775 81,302
------------ -----------
Deferred
Federal 222,900 (358,702)
State 83,125 -
------------ -----------
306,025 (358,702)
----------- -----------
Income tax expense (benefit) $ 663,800 $ (277,400)
=========== ===========
The component of the net deferred tax asset at December 31, 1996, is
as follows:
State income taxes $ 53,000
---------
Total deferred tax asset $ 53,000
=========
Management believes that, based on earnings through and subsequent to
December 31, 1995, deferred tax assets are more likely than not to be
realized and, therefore, the valuation allowance against deferred tax
assets was reversed as of December 31, 1995.
<PAGE>F-20
DIGITAL POWER CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. INCOME TAXES (CONTINUED):
Total income tax expense differed from the amounts computed by
applying the U.S. federal statutory tax rates to pre-tax income as
follows:
FOR YEARS ENDED
DECEMBER 31,
---------------
1996 1995
----------- -----------
Total expense computed by applying
the U.S. statutory rate $ 619,720 $ 281,005
State income taxes 169,512 73,750
Effect of income taxable in Mexico 26,549 (14,857)
Utilization of net operation loss
carry-forwards (59,034) (258,596)
Effect of valuation allowance - (358,702)
Income tax credits (92,947) -
----------- -----------
$ 663,800 $ (277,400)
=========== ===========
13. SUBSEQUENT EVENTS:
On January 2, 1997, the Company granted 100,000 options to purchase
the Company's stock to the president of the Company, in accordance
with his employment agreement.
On February 4, 1997, the Company granted 27,000 options with an
exercise price of $6.625 per share, to certain employees to purchase
the Company's stock. The options vest over 4 years at 25% per year.
On February 28, 1997, an ex-board member exercised his options to
acquire 7,500 shares of the Company's stock at $1.80 per share.
EXHIBIT 11.1
DIGITAL POWER CORPORATION AND SUBSIDIARY
COMPUTATION OF NET INCOME PER SHARE
FOR THE YEARS ENDED
DECEMBER 31
-------------------
1996 1995
---------- ----------
PRIMARY
Net income $1,158,834 $1,103,884
Less - preferred stock dividends $38,069 $91,366
Net income applicable to common
shareholders $1,120,765 $1,012,518
Weighted average number of common
shares 1,367,843 963,722
Add - common stock equivalent shares
(determined using the treasury stock
method) representing shares issuable
upon exercise of stock options 323,293 295,136
Weighted average number of shares
used in calculation of primary income
per share 1,691,136 1,258,858
Primary net income per common share $0.66 $0.80
FULLY DILUTED
Net income for primary income per share $1,120,765 $1,012,518
Add - preferred stock dividend $38,069 $91,366
Net income used for fully diluted income
per share $1,158,834 $1,103,884
Weighted average number of shares
used in calculation of primary income
per share 1,691,136 1,258,858
Add - weighted average number of
shares issuable upon conversion of
preferred stock 171,810 415,302
Weighted average number of shares
used in calculation of fully diluted
income per share 1,862,946 1,674,160
Fully diluted net income per common
share $0.62 $0.66
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS FROM THE FORM 10-KSB FOR THE YEAR ENDED
DECEMBER 31, 1996, FOR DIGITAL POWER CORPORATION AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,955,298
<SECURITIES> 0
<RECEIVABLES> 2,609,523
<ALLOWANCES> (170,000)
<INVENTORY> 2,832,329
<CURRENT-ASSETS> 8,459,007
<PP&E> 1,709,191
<DEPRECIATION> (1,055,836)
<TOTAL-ASSETS> 9,129,790
<CURRENT-LIABILITIES> 3,982,452
<BONDS> 0
0
0
<COMMON> 7,766,645
<OTHER-SE> (3,083,983)
<TOTAL-LIABILITY-AND-EQUITY> 9,129,790
<SALES> 13,835,008
<TOTAL-REVENUES> 13,835,008
<CGS> (9,956,763)
<TOTAL-COSTS> (9,956,763)
<OTHER-EXPENSES> (1,902,202)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (160,112)
<INCOME-PRETAX> (1,822,634)
<INCOME-TAX> (663,800)
<INCOME-CONTINUING> (1,158,834)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,158,834)
<EPS-PRIMARY> .66
<EPS-DILUTED> .62
</TABLE>
