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, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from _____ to _____
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
Redeemable Common Stock Purchase Warrants American Stock Exchange
Securities registered under Section 12(g) of the Exchange Act:
Title of Each Class
-------------------
None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934,
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark 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. [ ]
Revenues for the year ended December 31, 1998, were $18,733,470.
As of February 26, 1999, the aggregate market value of the voting common stock
held by non-affiliates was approximately $4,617,495 based on the average bid and
ask price of $1.81 per share.
As of February 26, 1999, the number of shares of common stock outstanding was
2,771,435.
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 1999 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 [X]
Exhibit index is located on page 21.
<PAGE>2
With the exception of historical facts stated herein, the following
discussion may contain 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 such forward-looking statements. Factors that could
cause actual results to differ materially include, in addition to other factors
identified in this report, a high degree of customer concentration, the loss of
a key customer, dependence on the computer and electronic equipment industries,
competition in the power supply industry, 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. Readers of this report are
cautioned not to put undue reliance on "forward looking" statements which are,
by their nature, uncertain as reliable indicators of future performance. The
Company disclaims any intent or obligation to publicly update these "forward
looking" statements, whether as a result of new information, future events, or
otherwise.
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 and DC/DC
converters to original equipment manufacturers (OEMs) of computers and other
electronic equipment. Power supplies are critical components of electronic
equipment that supply, convert, distribute, and regulate electrical power. The
various subsystems within electronic equipment require a steady supply of direct
current (DC) electrical power, usually at different voltage levels from the
other subsystems within the equipment. In addition, the electronic components
and subsystems require protection from the harmful surges and drops in
electrical power that commonly occur over power lines. Power supplies satisfy
these requirements by converting alternating current (AC) electricity into DC by
dividing a single input voltage into distinct and isolated output voltages, and
by regulating and maintaining such output voltages within a narrow range of
values.
Products which convert AC from a primary power source into DC are
generally referred to as "power supplies." Products which convert one level of
DC voltage into a higher or lower level of DC voltage are generally referred to
as "DC/DC converters." "Switching" power supplies are distinguished from
"linear" power supplies by the manner and efficiency with which the power supply
"steps down" voltage levels. A linear power supply converts an unregulated DC
voltage to a lower regulated voltage by "throwing away" the difference between
the two voltages as heat. Consequently, the linear power supply is inherently
inefficient-typically only 45% efficient for a 5V output regulator. By contrast,
a switching power supply converts an unregulated DC voltage to a lower regulated
voltage by storing the difference in a magnetic field. When the magnetic field
grows to a pre-determined level, the unregulated DC is switched off and the
output power is provided by the energy stored in the magnetic field. When the
field is sufficiently depleted, the unregulated DC is switched on again to
deliver power to the output while the excess voltage is again stored in the
magnetic field. As a result, the switching power supply is more
efficient-typically 75% efficient for a 5V output regulator.
<PAGE>3
One of the great advantages of switching power supplies, in addition to
their high efficiency, is their high power density, or power-to-volume ratio.
This density is the result of the reduction in the size of the various
components. Because the Company's switching power supply products have a high
power density, they are generally smaller than those of competitors. For
example, to the Company's knowledge 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.
Another advantage of the Company's power supply products is their
extreme flexibility of design. The Company has purposely designed its base model
power supply products so that they can be quickly and inexpensively modified and
adapted to the specific power supply needs of any OEM. This "flexibility"
approach has allowed the Company to provide samples of modified power supplies
to OEM customers in only a few days after initial consultation, an important
capability given the emphasis placed by OEMs on "time to market." In addition,
this "flexibility" approach results in very low non-recurring engineering (NRE)
expenses. Because of its reduced NRE expenses, the Company does not charge its
OEM customers for NRE related to tailoring a power supply to a customer's
specific requirements. This gives the Company a distinct advantage over its
competitors, many of whom do charge their customers for NRE expenses. The
Company's marketing strategy is to exploit this combination of high power
density, design 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 also provides "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 is a California corporation originally formed
in 1969 through a predecessor. Unless the context indicates otherwise, any
reference to "Digital Power" or the "Company" herein includes its majority-owned
Mexican subsidiary, Poder Digital S.A. de C.V. and its United Kingdom
subsidiary, Digital Power Limited, dba Gresham Power Electronics. Further,
unless otherwise indicated, reference to dollars in this Annual Report shall
mean United States dollars.
1998 Activity
At the end of calendar year 1997, the Company was informed by its then
largest customer that it would cease making purchases of power supplies from the
Company. That customer accounted for approximately 24.4% of the Company's total
sales during 1997. Further, during calendar year 1998, there was a softness in
the overall market for power supplies. As a result during 1998, the Company
experienced a substantial decrease in revenues of approximately $7 million from
its United States operations. The decrease in revenues, however, was offset by
revenues acquired through the acquisition of certain assets of Gresham Power
Electronics in January 1998 discussed below. The Company is conducting business
<PAGE>4
in Europe through its wholly-owned subsidiary Digital Power Limited, dba Gresham
Power Electronics ("Gresham Power"). In addition, the Company had certain
adverse adjustments to its cost of goods sold due to obsolescence and price
erosion of the Company's inventory. Finally, during 1998, the Company increased
its research and development expenditures to develop new products. Due to all of
these factors, the Company incurred a net loss of $570,588 during 1998.
Gresham Power
Pursuant to an Asset Sale Agreement (the "Agreement"), on January 22,
1998, Digital Power acquired the assets of Gresham Power Electronics from
Gresham Lion Technology Limited, an English corporation ("Gresham Lion"). The
consideration paid for the acquisition was $2.7 million, which amount is subject
to adjustment depending upon the net asset value (accounts receivables, fixed
assets and inventory less liabilities) ("NAV") as of the closing date.
Specifically, pursuant to the Agreement, the acquisition amount shall be
increased by $1.6284 for each United Kingdom pound that Gresham Power's NAV
exceeds UK(pound)1,100,000 as of the closing date, and shall be reduced by
$1.6284 for each United Kingdom pound that the NAV is less than
UK(pound)1,100,000 as of the closing date. In addition to the foregoing, if the
NAV as of March 31, 1998, equals or exceeds UK(pound)1,606,000, Gresham Lion
shall be paid an additional $300,000 subject to a reduction of $1.6284 for every
United Kingdom pound NAV is less than UK(pound)1,606,000. Further, Digital Power
shall pay Gresham Lion an additional $1.15 for every United Kingdom pound of
earnings before interest and taxes which exceeds UK(pound)250,000, up to a
maximum additional payment of $300,000. As a result of primarily Gresham Power's
NAV as of the closing date, and, to a lesser extent, Gresham Power achieving
certain earnings, Digital Power paid an additional $371,978 in the aggregate to
Gresham Lion.
Headquartered in Salisbury, England, Gresham Power designs,
manufactures, and distributes switching power supplies, uninterruptible power
supplies, and frequency converters for the commercial and military markets.
Uninterruptible power supplies (UPS) are devices that are inserted between a
primary power source and the primary power input of the electronic equipment to
be protected for the purpose of eliminating the effects of transient anomalies
or temporary outages. A UPS consists of an inverter that is powered by a battery
that is kept trickle-charged by rectified AC from an incoming power line. In the
event of a power interruption, the battery takes over without the loss of even a
fraction of a cycle in the AC output of the UPS. The battery also provides
protection against transients. A frequency converter is an electronic unit for
speed control of a phase induction motor. The frequency converter controls the
motor speed by converting the frequency and voltage of the power main's supply
from fixed to variable values. This is the most efficient means of varying the
fixed speed of an induction motor, since other methods involve great power
losses or great investments. The acquisition of Gresham Power will diversify the
Company's product line, provide greater access to the United Kingdom and
European markets, and strengthen Digital's engineering and technical resources.
The Market
Since all electronic equipment requires power supplies, the overall
market for power supplies is very large. The growth of the power supply industry
has paralleled that of the general electronics industry. Since 1994, growth has
escalated at an even faster pace, fueled by the demand for networking
communications equipment and computing equipment and its peripherals. Future
growth is expected tocome from the same markets, as internet and intranet
<PAGE>5
networking and cellular and digital telephones continue to become popular around
the world.
The electronic power supply market is typically split into "captive" 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. The remaining power supply market is served by merchant power
supply manufacturers, such as Digital Power, that design and manufacture power
supplies for sale to OEMs.
The Company believes that the merchant market is the fastest growing
segment of the power supply market, as OEMs continue to outsource their power
supply requirements. The Company believes that this increase is due, in part, to
the fact that power supplies are becoming an increasingly complex component in
the eyes of OEMs, with constantly changing requirements such as power factor
correction (PFC) and filtering specifications to minimize electromagnetic
interference (EMI).
The power supply market can also be divided between "custom" and
"standard" power supplies. Custom power supplies are those that are customized
in design and manufactured with a specific application in mind, whereas standard
power supplies are sold off-the-shelf to customers whose electronic equipment
can operate from standard output voltages such as 5, 12, or 24 volts. Power
supplies in the captive market that are 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 that
OEM's specific application. A subset of the standard segment of the market has
evolved, commonly known as "modified standard" segment, comprising power supply
products that have the performance characteristics of a standard power supply,
but require certain, usually minor, modifications. These modifications typically
involve an adjustment to one of the standard output voltages, such as from 5
volts to 7 volts, or from 15 volts to 18.5 volts.
The power supply industry is highly fragmented. There are approximately
300 domestic merchant power supply competitors in the United States, with over
200 that generate less than $5 million in revenues. No one manufacturer holds
more than five percent of the total market. The merchant market segment is also
highly fragmented according to the power level, technology, packaging, or
application of a merchant's particular power supply. Most merchant manufacturers
concentrate on niche markets, whether power ranges or industry segments.
With no industry standards for power supplies, it is very difficult to
design out an existing power supply component which prevents large companies
from quickly gaining market share. The key to being a profitable manufacturer is
to have long-term expertise in power electronics and to be able to provide
products needed by customers. The Company has targeted and serves the industrial
and office automation, industrial and portable computing, and networking
applications niches of the merchant market. 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.
Geographically, 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.
<PAGE>6
Gresham Power serves the United Kingdom marketplace with AC/DC power supplies,
uninterruptible power supplies, and frequency inverters. Both commercial and
government (Ministry of Defense) markets are served by Gresham Power.
Customers
Digital Power's products are sold domestically and in Canada through a
network of 14 manufacturers' representatives. Digital Power also has 23 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, Telex, Storage Dimensions,
Motorola, Stanford Telecommunications, Extreme Network, Ericsson and British
Telecom.
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 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 because of the low margins arising out of the high
volume and extremely competitive nature of that market.
The Company intends to continue its sales primarily to existing
customers while simultaneously targeting sales primarily 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 applications requires certain independent safety agency testing at
considerable expense, such as by Underwriters Laboratories, 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
an advantage over its competitors. 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. Digital Power's strategy in responding to this demand has been to offer
increasingly smaller power supply units or packages.
Product Strategy and Products
Digital Power has nine 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
<PAGE>7
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 consists of compact, economical, high
efficiency, open frame switchers that deliver up to 50 watts of continuous
power, 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 & 24VDC 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 power,
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 customized 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.
<PAGE>8
The UP300 series consists of economical, high efficiency, open frame
switchers that deliver up to 300 watts of continuous, or 325 watts of 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 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, or 48 volt current might be required.
The US250 series consists of economical, high efficiency, open frame
switchers that deliver up to 250 watts of continuous power, 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 full-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 output 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". It can operate without any minimum loads and has an optional internal
fan and power fail/power good signal.
The newest product developed by the Company is the UPF 150 series. The
UPF 150 is an open- frame switcher that delivers up to 150watts of continuous
power from one to four outputs. The UPF 150 is endowed with power factor
correction and a Class B EMI filter, making the series particularly well-suited
for those customers selling into the international market place.
The Company also produces two products designated as the KD series in a
150 watt and 200 watt product. These designs were licensed in 1987, and amended
in 1990, 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 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. Further, in the event total historical
sales of KD products reach $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.
In connection with litigation involving KDK Electronics and the
Company, on September 3, 1998, the Company entered into a Technology Transfer
Agreement with KDK Electronics. Under the terms of the Technology Transfer
Agreement, the Company acquired from KDK Electronics the technology and right to
sell in the future products that may be derived under the 1987 licensing
agreement, as amended, between KDK Electronics and the Company. For the
acquisition of the technology and future sales rights and settlement of
<PAGE>9
litigation, the Company issued 35,000 shares of its common stock and will pay
$150,000 in $7,000 monthly payments, beginning in October 1998. "See Item 3.
Legal Proceedings."
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 with those OEMS 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 one line transformer manufactured by
Spitznagel. This transformer is designed into one of the Company's products,
which accounted for less than 10% of the Company's total sales in 1998.
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. The Company is
manufacturing approximately 15% of its product requirements through
Fortron/Source and expects to increase these production levels due to cost
<PAGE>10
advantages achieved through Chinese procurement. The Company believes that the
facility in China complements its manufacturing facility in Guadalajara, Mexico
since the facility in China allows 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 1998, the Company had revenues of $18,733,470 and a net loss of
$570,588 compared to revenues of $18,884,259 and net income of $1,400,790 during
fiscal year 1997.
Digital Power markets its products through a network of thirteen
domestic and one Canadian 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 23
stocking distributors who buy and resell the Company's products. For the fiscal
years ended December 31, 1998 and 1997, distributor sales accounted for 26.07%
and 44.3%, respectively, of the Company's total sales. Over this same period,
one distributor accounted for 13% and 24.9%, 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 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 five years. For the
years ended December 31, 1998 and 1997, private label sales accounted for 8.0%
and 13.9%, 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.
<PAGE>11
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 1998 or 1997. As of December 31, 1998, the
Company's warranty reserve was $305,000.
Competition
The merchant power supply manufacturing industry is highly fragmented
and characterized by intense competition. The Company's competition includes
over 500 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 Artesyn Technologies, Inc. (now merged with
Zytec Corporation), ASTEC America, and Lambda Electronics, have substantially
greater fiscal and marketing resources and geographic presence than does the
Company. If the Company continues to be successful in increasing its revenues,
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. Furthermore, certain larger OEMs tend to contract only with larger
power supply manufacturers. This factor could become more problematic to the
Company if consolidation trends in the electronics industry continue and some of
the OEMs to whom the Company sells its products are acquired by larger OEMs. 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. However, there
can be no assurance that the Company will continue to compete successfully in
the power supply market.
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 $1,397,816 and $866,787 for the years ended December 31, 1998 and 1997,
respectively, and represented 7.46% and 4.59% of the Company's total revenues
for the corresponding periods.
Employees
As of December 31, 1998, the Company had approximately 340 full-time
employees, with 255 of these employed at its wholly-owned subsidiary Poder
Digital located in Guadalajara, Mexico, and 50 employed by Gresham Power. The
employees of Digital Power's Mexican operation are members of a national labor
<PAGE>12
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 1997, 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 accounts
for approximately 15% of revenues 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 and Gresham Power conducts its financial
operation using the United Kingdom pound. Therefore, due to financial conditions
beyond the control of the Company, the Company is subject to monetary
fluctuations between the U.S. dollar, Mexican peso, and United Kingdom pound.
During fiscal 1998, the Company lost $37,771 as a result of currency
fluctuations.
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
Traditionally, the Company has relied on a limited number of customers
for growth and increase in sales. For the fiscal year ended December 31, 1997,
one OEM accounted for 24.9% of the Company's total revenues which subsequently
ceased purchases during the fourth quarter of 1997. See "Management's Discussion
and Analysis or Plan of Operation." For the year ended December 31, 1998, one
OEM customer accounted for 13% of the Company's total revenue. The loss of any
major OEM customers may have an adverse effect on the Company's revenues.
$3 Million Credit Facility
The Company has entered into a $3 million credit facility with San Jose
National Bank. As of December 31, 1998, approximately $1.6 million was
outstanding. The credit facility bears interest based upon the lender's prime
<PAGE>13
rate, is due June 15, 1999, and is secured by all of the Company's assets. Under
terms of the loan agreement, the Company is in technical default requiring that
the Company be profitable on a quarterly basis and maintain certain debt to
tangible net worth ratios. The Company has obtained a wavier of the covenants
from the bank. However, in the event the Company continues to be unprofitable,
no assurance can be given that the bank will continue to waive the covenants or
renew the Company's loan.
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 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 signed a
five-year contract with the union representing the employees. The Company has
also 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 accounts for approximately 15% of revenues and requires advance
scheduling which affects the Company's ability to produce products quickly.
However, the Company may 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.
Dependence Upon Key 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, Chief Executive Officer, 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
<PAGE>14
the aggregate amount of $2 million. The Company also has an employment agreement
with Mr. Smith.
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 one
line transformer in its product, the Company is dependent on a single supplier.
Currently, this product accounts for less than 10% of the Company's total sales.
Although the Company will seek to find other manufacturers of transformers for
this product, 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. Gresham Power leases approximately 25,000 square feet for its
location in Salisbury, England. Gresham Power pays rent of approximately
(pound)17,500 per quarter, and the lease will expire September 26, 2009. Gresham
Power is currently negotiating to enter into a new lease with the landlord. The
Company believes that its existing facilities are adequate for the foreseeable
future and has no plans to expand them.
Item 3. Legal Proceedings.
On April 20, 1998, the Company was served with a complaint in the
Superior Court of California in and for the County of Santa Clara (Case No.
CV773108) by KDK Electronics, Inc. In its complaint, KDK Electronics alleged
breach of contract, misappropriation of trade secrets, fraud, and negligent
misrepresentation in connection with, among other things, the Company's alleged
failure to pay KDK Electronics royalties on sales of products that were
allegedly derived from KDK Electronic's designs, and for failure to issue
100,000 shares of the Company's Common Stock based on revenues from those
products. KDK Electronic's complaint seeks economic damages of approximately
$300,000, punitive and exemplary damages, injunctive relief, attorneys' fees and
costs.
In connection with litigation involving KDK Electronics and the
Company, on September 3, 1998, the Company entered into a Technology Transfer
Agreement with KDK Electronics. Under the terms of the Technology Transfer
Agreement, the Company acquired from KDK Electronics the technology and right to
sell in the future products that may be derived under the 1987 licensing
agreement, as amended, between KDK Electronics and the Company. For the
<PAGE>15
acquisition of the technology and future sales rights and settlement of
litigation, the Company issued 35,000 shares of its common stock and will pay
$150,000 in $7,000 monthly payments, beginning in October 1998. Further, under
the terms of the settlement agreement, each party bore its own expenses.
On March 17, 1998, a lawsuit was filed by Ignacio Valencia against the
Company in the Superior Court of Santa Clara County (No. CV772665) alleging
deceit and breach of contract. In the complaint, Mr. Valencia alleged that in
1986, Mr. Valencia moved his family to Guadalajara, Mexico on reliance that he
would become president of Poder Digital S.A. de C.V. ("Poder"), the Company's
wholly-owned subsidiary and would receive forty percent of the profits of Poder.
Mr. Valencia claimed lost wages of $52,000 and lost stock options of $350,000
and punitive damages.
On February 12, 1999, the Company settled the lawsuit with Mr. Valencia.
Under the terms of the settlement, the Company paid Mr. Valencia $16,110 and
will provide Mr. Valencia employment for six months at the hourly rate of
$18.50, 40 hours per week. Mr Valencia's term of employment will end on August
13, 1999. In connection with the settlement, Mr. Valencia dismissed his claim
with prejudice.
Item 4. Submission of Matters to a Vote of Security Holders.
None
PART II
Item 5. Market for Common Equity and related Stockholder Matters.
(a) Comparative Market Prices
Digital Power's Common Stock and Redeemable Common Stock Purchase
Warrants are listed and traded on the American Stock Exchange ("AMEX") under the
symbols DPW and DPW+, respectively. Prior to being listed and traded on AMEX,
Digital Power's Common Stock and Redeemable Common Stock Purchase Warrants were
traded on the NASDAQ SmallCap Market. The following tables set forth the high
and low closing sale prices, as reported by AMEX and/or NASDAQ SmallCap Market,
for Digital Power's Common Stock and Warrants for the prior two fiscal years.
Common Stock
Period Low High
- ------ --- ----
Quarter ending December 31, 1998 $1.38 $2.94
Quarter ending September 30, 1998 $1.63 $5.44
Quarter ending June 30, 1998 $4.25 $6.69
Quarter ending March 31, 1998 $5.75 $7.00
<PAGE>16
Common Stock
Period Low High
- ------ --- ----
Quarter ending December 31, 1997 $6.25 $9.75
Quarter ending September 30, 1997 $9.63 $11.38
Quarter ending June 30, 1997 $7.50 $10.25
Quarter ending March 31, 1997 $5.25 $8.50
Redeemable Common Stock Purchase Warrants
Period Low High
- ------ --- ----
Quarter ending December 31, 1998 $ .13 $ .63
Quarter ending September 30, 1998 $ .25 $ .94
Quarter ending June 30, 1998 $ .75 $2.19
Quarter ending March 31, 1998 $1.00 $2.25
Quarter ending December 31, 1997 $1.69 $4.63
Quarter ending September 30, 1997 $4.50 $6.13
Quarter ending June 30, 1997 $2.88 $5.00
Quarter ending March 31, 1997 $1.50 $3.75
(b) Holders
As of December 31, 1999, there were 2,771,435 shares of Digital Power
common stock outstanding, held by approximately 124 holders of record, not
including shareholders whose shares are held in street name. As of the same
date, there were 838,090 warrants outstanding, with approximately 68 holders of
record, not including warrantholders whose warrants are held in street name.
(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.
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
<PAGE>17
Company's power supplies to OEMs in the computer and other electronic equipment
industries.
In January 1998, the Company acquired certain assets of Gresham Power.
Similar to Digital Power, Gresham Power designs, manufactures and distributes
switching power supplies, uninterruptible power supplies and frequency
converters for the commercial and military markets. As a result of the
acquisition of Gresham Power, the Company's Consolidated Balance Sheet,
Consolidated Statements of Income, Consolidated Statement of Stockholders'
Equity and Consolidated Statements of Cash Flows for the year ended December 31,
1998, include the financial statements of Gresham Power from January 22, 1998,
the date of acquisition.
Results of Operations
The table below sets forth certain statements of operations data as a
percentage of revenues for the years ended December 31, 1998 and 1997.
Years Ended December 31
-----------------------
1998 1997
---- ----
Revenues 100% 100%
Cost of goods sold 78.89 73.90
----- -----
Gross margin 21.11 26.10
Selling, general and administrative 16.73 8.44
Engineering and product development 7.46 4.59
----- -----
Total operating expense 24.19 13.03
----- -----
Operating income (3.08) 13.07
Net interest expense 1.14 .11
Translation loss .20 .11
----- -----
Income (Loss) before income taxes (4.42) 12.85
Provision (Benefit) for income taxes (1.37) 5.43
----- -----
Net (Loss) Income (3.05%) 7.42%
====== =====
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.
<PAGE>18
Year Ended December 31, 1998, Compared to Year Ended December 31, 1997
Revenues
Revenues for the fiscal year ended December 31, 1998, were $18,733,470
which represented a decrease of $150,789, or approximately 1%, from revenues of
$18,884,259 for the year ended December 31, 1997. The decrease in revenues was
due primarily to the loss of the Company's largest customer which accounted for
approximately 24.4% of the Company's revenues during 1997. This decrease in
total revenues was offset by an increase in revenues of $7,002,041 from Gresham
Power which was acquired in January 1998.
Gross Margins
Gross margins were 21.11% for the year ended December 31, 1998 compared
to 26.10% for the fiscal year ended December 31, 1997. This decrease in gross
margins can be primarily attributed to an increase in cost of goods sold due to
price erosion of inventory, the write off certain slow moving inventory, and the
increase in warranty reserves.
Selling, General and Administrative
Selling, general and administrative expenses increased by $1,540,446
to $3,134,211 for the year ended December 31, 1998, from $1,593,765 for the
fiscal year ended December 31, 1997. Of the increase, $1,289,006 is attributed
to Gresham Power. The other additional increase is primarily related to an
increase in provision of bad debts and for professional fees.
Engineering and Product Development
Engineering and product development expenses were $1,397,816 for the
year ended December 31, 1998, as compared to $866,787 for the year ended
December 31, 1997. Of the increase, $280,514 is attributed to Gresham Power. The
other additional increase can be attributed to expenses related to the
development of the UPF 150 and another new product and to the settlement of
litigation involving KDK Electronics.
Interest Expense
Net interest expense was $220,894 for the year ended December 31, 1998,
compared to $21,542 for the year ended December 31, 1997. This increase in
interest expense is primarily due to increased borrowings of approximately
$1,700,000 to acquire Gresham Power in January 1998.
Translation Loss
The primary currency of the Company's subsidiary, Poder Digital, is the
Mexican peso and for Gresham Power, the United Kingdom pound. During 1998, the
Company experienced a translation loss of $37,771 primarily related to Poder
Digital's operations using Mexican pesos, compared with a translation loss of
$19,846 in 1997.
<PAGE>19
(Loss) Income Before Income Taxes
The Company incurred a loss of ($828,588) before income taxes during
1998 compared to income before income taxes of $2,426,790 in 1997. This
substantial decrease, as discussed above was due to the loss of the Company's
largest customer during the end of 1997, softness in the power supply market,
and erosion of the Company's gross margin, and increased research and
developments expenses.
Income Tax
For the year ended December 31, 1998, the Company had an income tax
benefit of $258,000 due to its 1998 net loss compared to tax expense of
$1,026,000 for the year ended December 31, 1997.
Net (Loss) Income
Net loss was ($570,588) in 1998 compared to net income of $1,400,790 in
1997.
The Company does not believe that its business is seasonal.
Liquidity and Capital Resources
Through December 31, 1998, the Company funded its operations primarily
through revenues generated from operations, and bank borrowings. As of December
31, 1998, the Company had cash and cash equivalents of $867,607 and working
capital of $5,001,316. This compares with cash and cash equivalents of
$2,205,299 and working capital of $7,050,144 at December 31, 1997. The decrease
in working capital for the year ended December 31, 1998, is primarily due to the
Company's loss and borrowings to acquire Gresham Power. Cash provided by (used
in) operating activities for the Company totaled $10,066 and $(80,252) for the
year ended December 31, 1998 and 1997, respectively. Cash used in investing
activities of $3,500,586 during 1998 consisted of primarily expenditures for the
purchase of the assets of Gresham Power. During 1997, cash used in investing
activities amounted to $388,825 from the purchase of production and testing
equipment. For the year ended December 31, 1998, cash flow from financing
activities included proceeds from borrowings of $2,366,846 offset by proceeds of
$95,350 from the exercise of warrants and stock options and payments of $300,505
on borrowings. During the year ended December 31, 1997, the Company's line of
credit and bank loans, other than the ESOP, were paid in full.
The Company is a guarantor of a $500,000 term loan granted to the
Company's employee stock ownership plan ("ESOP"). The balance outstanding of
$184,919 related to this term loan is included in the total amount of the
Company's bank borrowings as of December 31, 1998, stated in the preceding
paragraph. The loan is due in June 2001, and bears interest at 8.5% 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
$8,852 per month. This amount will be a monthly charge to expense.
Impact of the Year 2000 Issue. The Year 2000 Issue is the result of
computer programs being written using two digits rather than four to define the
applicable year. Any of the Company's, or its suppliers' and customers' computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in system failures or
<PAGE>20
miscalculations causing disruptions of operations including, among other things,
a temporary inability to process transactions, send invoices, or engage in
similar normal business activities.
The Company upgraded its software at a cost of less than $10,000 and has
been informed by its suppliers that such software is Year 2000 compliant. The
software from these suppliers is used in major areas of the Company's operations
such as for financial, sales, warehousing and administrative purposes. The
Company has no internally generated software. The Company believes that all of
its hardware is Year 2000 compliant. In connection with the acquisition of
Gresham Power, the Company has determined that Gresham Power's existing software
will not be Year 2000 compliant, and has acquired new hardware and software to
address the Year 2000 issue at a cost of approximately $150,000 to make Gresham
Power Year 2000 compliant. The Company anticipates that Gresham Power will
complete the installation of hardware and software during the first part of
1999. Other than Gresham Power, and after reasonable investigation, the Company
has not yet identified any other Year 2000 problem but will continue to monitor
the issue. However, there can be no assurances that the Year 2000 problem will
not occur with respect to the Company's computer systems.
The Company and its subsidiaries intend, but have not yet, initiated
formal communications with significant suppliers and large customers to
determine the extent to which those third parties' failure to remedy their own
Year 2000 Issues would materially effect the Company and its subsidiaries. In
the event that the Company receives indications from its suppliers and large
customers that the Year 2000 Issue may materially effect their ability to
conduct business, the Company will seek contingency plans such as finding other
vendors that are Year 2000 compliant or increase its inventory of supplies or
parts in an attempt to ensure smooth operations until such vendor can remedy the
problem.
Impact of Recently Issued Standards
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 (FASB133), "Accounting for Derivative
Instruments and Hedging Activities." This statement is effective for fiscal
years beginning after June 15, 1999. Earlier application is encouraged; however,
the Company does not anticipate adopting FASB133 until the fiscal year beginning
January 1, 2000. FASB133 requires that an entity recognize all derivatives as
assets or liabilities in the statement of financial position and measure those
instruments at fair value. The Company does not believe the adoption of FASB133
will have a material impact on assets, liabilities or equity. The Company has
not yet determined the impact of FASB133 on the income statement or the impact
on comprehensive income.
FASB132, "Employers' Disclosures About Pensions and Other Postretirement
Benefits" and FASB134, "Accounting for Mortgage-Backed Securities Retained After
the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise" were issued in 1998 and are not expected to impact the Company's
future financial statement disclosures, results of operations and financial
position.
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 as
page numbers F-1 through F-26.
<PAGE>21
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
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.
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(1)
3.2 Amendment to Articles of Incorporation(1)
3.3 Bylaws of Digital Power Corporation(1)
4.1 Specimen Common Stock Certificate(2)
4.2 Specimen Warrant(1)
4.3 Representative's Warrant(1)
10.1 Revolving Credit Facility with San Jose National Bank(1)
10.2 KDK Contract(1)
<PAGE>22
10.3 Agreement with Fortron/Source Corp.(1)
10.4 Employment Agreement With Robert O. Smith(2)
10.5 1997 Stock Option Plan(1)
10.6 Gresham Power Asset Purchase Agreement(3)
10.7 1998 Stock Option Plan
10.8 Technology Transfer Agreement with KDK Electronics(4)
10.9 Loan Commitment and Letter Agreement
10.10 Promissory Note
21.1 List of Subsidiaries of Issuer
(1) Previously filed with the Commission on October 16, 1996, to the
Company's Registration Statement on Form SB-2.
(2) Previously filed with the Commission on December 3, 1996, to the
Company's Pre-Effective Amendment No. 1 to Registration Statement on
Form SB-2.
(3) Previously filed with the Commission on February 2, 1998, to the Company's
Form 8-K.
(4) Previously filed with the Commission with its Form 10-QSB for the quarter
ended September 30, 1998.
(b) Reports on Form 8-K
None.
<PAGE>23
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
DIGITAL POWER CORPORATION,
a California Corporation
/s/ 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
/s/ Robert O. Smith April 12, 1999
- ----------------------------------------
Robert O. Smith, Chief Executive Officer
(Principal Executive Officer)
/s/ Philip G. Swany April 12, 1999
- ----------------------------------------
Philip G. Swany, Chief Financial Officer
(Principal Accounting and
Financial Officer)
/s/ Robert J. Boschert April 12, 1999
- ----------------------------------------
Robert J. Boschert, Director
/s/ Scott C. McDonald April 10, 1999
- ----------------------------------------
Scott C. McDonald, Director
- ---------------------------------------- April __, 1999
Thomas W. O'Neil, Jr., Director
/s/ Chris Schofield April 12, 1999
- ----------------------------------------
Chris Schofield, Director
<PAGE>F-1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Independent Auditor's Report...............................................F-2
Consolidated Balance Sheet - December 31, 1998.............................F-3
Consolidated Statements of Operations - For the Years Ended
December 31, 1998 and 1997.............................................F-4
Consolidated Statements of Comprehensive Income (Loss) -
For the Years Ended December 31, 1998 and 1997.........................F-5
Consolidated Statement of Stockholders' Equity - For the Years Ended
December 31, 1998 and 1997.............................................F-6
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 1998 and 1997.............................................F-7
Notes to Consolidated Financial Statements.................................F-9
<PAGE>F-2
INDEPENDENT AUDITOR'S REPORT
To the Stockholders and Board of Directors
Digital Power Corporation and Subsidiaries
Fremont, California
We have audited the accompanying consolidated balance sheet of Digital Power
Corporation and Subsidiaries as of December 31, 1998, and the related
consolidated statements of operations, comprehensive income (loss),
stockholders' equity, and cash flows for the years ended December 31, 1998 and
1997. 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 Subsidiaries as of December 31, 1998, and the results of their
operations and their cash flows for the years ended December 31, 1998 and 1997,
in conformity with generally accepted accounting principles.
/s/HEIN + ASSOCIATES LLP
HEIN + ASSOCIATES LLP
Certified Public Accountants
Orange, California
March 12, 1999
<PAGE>F-3
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31,
1998
-------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 867,607
Accounts receivable - trade, net of
allowance for doubtful accounts of $292,000 3,560,038
Income tax refund receivable 392,646
Other receivables 103,042
Inventories, net 4,864,520
Prepaid expenses and deposits 55,264
Deferred income taxes 385,605
-------------
Total current assets 10,228,722
PROPERTY AND EQUIPMENT, net 1,402,233
EXCESS OF PURCHASE PRICE OVER NET ASSETS
ACQUIRED, net of amortization of $133,117 1,319,073
DEPOSITS 40,791
-------------
TOTAL ASSETS $ 12,990,819
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable $ 2,206,846
Current portion of long-term debt 115,476
Current portion of capital lease obligations 63,131
Accounts payable 1,246,855
Accrued liabilities 1,595,098
-------------
Total current liabilities 5,227,406
LONG-TERM DEBT, less current portion 69,443
CAPITAL LEASE OBLIGATIONS, less current portion 114,156
OTHER LONG-TERM LIABILITIES 35,043
DEFERRED INCOME TAXES 26,000
-------------
Total liabilities 5,472,048
-------------
COMMITMENTS AND CONTINGENCIES (Notes 7, 9, 12, 13, and 14) -
STOCKHOLDERS' EQUITY:
Preferred stock issuable in series, no par value,
2,000,000 shares authorized, no shares issued and
outstanding. -
Common stock, no par value, 10,000,000 shares authorized,
2,771,435 shares issued and outstanding 9,012,679
Warrants 60,776
Additional paid-in capital 218,335
Accumulated deficit (1,859,528)
Unearned employee stock ownership plan shares (184,919)
Accumulated other comprehensive income 271,428
-------------
Total stockholders' equity 7,518,771
-------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,990,819
=============
See accompanying notes to these consolidated financial statements.
<PAGE>F-4
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
REVENUES $ 18,733,470 $ 18,884,259
COST OF GOODS SOLD 14,778,103 13,955,529
--------------- ----------------
Gross margin 3,955,367 4,928,730
--------------- ----------------
OPERATING EXPENSES:
Engineering and product development 1,397,816 866,787
Marketing and selling 1,561,803 665,235
General and administrative 1,572,318 928,530
--------------- ----------------
Total operating expenses 4,531,937 2,460,552
--------------- ----------------
INCOME (LOSS) FROM OPERATIONS (576,570) 2,468,178
--------------- ----------------
OTHER INCOME (EXPENSE):
Interest income 16,074 47,415
Interest expense (236,968) (68,957)
Translation loss (37,771) (19,846)
Gain on disposal of assets 6,647 -
--------------- ----------------
Other income (expense) (252,018) (41,388)
--------------- ----------------
INCOME (LOSS) BEFORE INCOME TAXES (828,588) 2,426,790
INCOME TAX (BENEFIT) PROVISION (258,000) 1,026,000
--------------- ----------------
NET INCOME (LOSS) $ (570,588) $ 1,400,790
=============== ================
NET INCOME (LOSS) PER COMMON SHARE:
Basic $ (.21) $ .54
=============== ================
Diluted $ (.21) $ .41
=============== ================
</TABLE>
See accompanying notes to these consolidated financial statements.
<PAGE>
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 1998 and 1997
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
NET INCOME (LOSS) $ (570,588) $ 1,400,790
OTHER COMPREHENSIVE INCOME ITEMS, before tax
Foreign currency translation adjustments 36,234 -
Additional compensation expense for
income tax purposes related to the
exercise of stock options 79,869 397,506
--------------- ----------------
COMPREHENSIVE INCOME (LOSS), before tax (454,485) 1,798,296
INCOME TAX EXPENSE RELATED TO ITEMS OF
COMPREHENSIVE INCOME (41,503) (200,678)
--------------- ----------------
COMPREHENSIVE INCOME (LOSS), net of tax $ (495,988) $ 1,597,618
=============== ================
</TABLE>
See accompanying notes to these consolidated financial statements.
<PAGE>F-6
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 and 1997
<TABLE>
<CAPTION>
ACCUMULATED TOTAL
COMMON STOCK OTHER STOCK-
---------------------- PAID-IN ACCUMULATED ESOP COMPREHENSIVE HOLDERS'
SHARES AMOUNT WARRANTS CAPITAL DEFICIT SHARES INCOME EQUITY
--------- ----------- --------- ---------- ------------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES, January 1, 1997 2,363,275 $ 7,630,246 $ 66,875 $ 136,399 $ (2,689,730) $ (461,128) $ - $4,682,662
Sale of common stock and
warrants, net of expenses 150,000 484,122 8,256 - - - - 492,378
Exercise of stock options 55,500 99,900 - - - - - 99,900
Exercise of warrants 125,710 642,221 (13,671) - - - - 628,550
Contribution to the ESOP - - - - - 135,705 - 135,705
Compensation recognized upon
issuance of warrants - - - 35,903 - - - 35,903
Income tax benefit arising from
the exercise of employee - - - - - - 196,828 196,828
stock options
Net income - - - - 1,400,790 - - 1,400,790
--------- ----------- --------- ---------- ------------ ---------- -------- ----------
BALANCES, December 31, 1997 2,694,485 8,856,489 61,460 172,302 (1,288,940) (325,423) 196,828 7,672,716
Exercise of stock options 35,750 64,350 - - - - - 64,350
Exercise of warrants 6,200 31,684 (684) - - - - 31,000
Stock issued for legal 35,000 60,156 - - - - - 60,156
settlement
Contribution to the ESOP - - - - - 140,504 - 140,504
Compensation recognized upon
issuance of warrants - - - 46,033 - - - 46,033
Income tax benefit arising from
the exercise of employee - - - - - - 38,366 38,366
stock options
Foreign currency translation
adjustment - - - - - - 36,234 36,234
Net loss - - - - (570,588) - - (570,588)
--------- ----------- --------- ---------- ------------ ---------- -------- ----------
BALANCES, December 31, 1998 2,771,435 $ 9,012,679 $ 60,776 $ 218,335 $ (1,859,528) $ (184,919) $271,428 $7,518,771
========= =========== ========= ========== ============ ========== ======== ==========
</TABLE>
<PAGE>F-7
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (570,588) $ 1,400,790
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 423,655 174,047
Gain on disposal of assets (6,647) (18,678)
Deferred income taxes (287,927) -
Warranty expense 140,000 30,000
Inventory reserve 230,000 (100,000)
Contribution to ESOP 140,504 135,705
Bad debt expense 50,000 65,000
Compensation cost recognized upon
issuance of warrants 46,033 35,903
Income tax 38,366 196,828
Foreign currency translation adjustment 37,771 19,846
Stock issued for legal settlement 60,156 -
Changes in operating assets and liabilities:
Accounts receivable 614,453 (601,480)
Income tax refund receivable (392,646) -
Other receivables 173,507 (43,310)
Inventories 434,597 (1,036,860)
Prepaid expenses 73,986 (100,515)
Other assets (23,531) 168
Accounts payable (1,950,562) 281,916
Accrued liabilities 743,896 (519,612)
Other long-term liabilities 35,043 -
--------------- ----------------
Net cash provided by (used in)
operating activities 10,066 (80,252)
--------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Gresham Power Electronics (3,370,293) -
Purchase of property and equipment (156,707) (388,825)
Proceeds from sale of assets 26,414 -
--------------- ----------------
Net cash used in investing activities (3,500,586) (388,825)
--------------- ----------------
</TABLE>
(continued)
<PAGE>F-8
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock and warrants $ - $ 492,378
Proceeds from exercise of stock options and warrants 95,350 728,450
Principal payments on long-term debt (140,504) (271,185)
Principal payments on capital lease obligations (7,310) (13,406)
Proceeds from notes payable 2,366,846 1,990,964
Principal payments on notes payable (160,000) (3,188,294)
--------------- ----------------
Net cash provided by (used in) financing activities 2,154,382 (261,093)
--------------- ----------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (1,537) (19,846)
--------------- ----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,337,675) (750,016)
CASH AND CASH EQUIVALENTS, beginning of period 2,205,282 2,955,298
--------------- ----------------
CASH AND CASH EQUIVALENTS, end of period $ 867,607 $ 2,205,282
=============== ================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash payments for:
Interest $ 233,982 $ 74,874
=============== ================
Income taxes $ 289,872 $ 1,017,402
=============== ================
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of equipment through capital leases $ 166,396 $ -
=============== ================
</TABLE>
See accompanying notes to these consolidated financial statements.
<PAGE>F-9
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS:
Digital Power Corporation ("DPC"), and one of its wholly owned subsidiaries
Poder Digital, S.A. de C.V. ("PD"), which is located in Guadalajara, Mexico, are
engaged in the design, manufacture and sale of switching power supplies.
On January 26, 1998, DPC acquired the assets and assumed certain liabilities of
Gresham Power Electronics, a division of Gresham Lion Technology Ltd., a
European corporation, through a newly-formed subsidiary Digital Power Limited
("DPL"). (See Note 3.) DPL is also engaged in the design, manufacture, and sale
of switching power supplies.
DPC, PD, and DPL are collectively referred to as the "Company".
2. SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Statements 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.
Inventories - Inventories are 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 their estimated useful
life or the term of the lease. The cost of normal maintenance and repairs is
charged to operations 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 resulting gains or losses are reflected in current operations.
Excess of Purchase Price Over Net Assets Acquired - Excess of purchase price
over net assets acquired ("Goodwill") represents the purchase price in excess of
the fair value of the net assets of the acquired business and is being amortized
using the straight-line method over its estimated useful life of ten years. The
carrying value is evaluated at least annually. The Company considers current
facts and circumstances, including expected future operating income and cash
flows to determine whether it is probable that impairment has occurred.
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-10
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 certain sales to distributors are subject to a limited
right of return. The Company provides a reserve for estimated warranty costs and
a reserve for estimated product returns.
Foreign Currency Translation - Assets and liabilities of the Company's foreign
subsidiaries are translated into U.S. dollars at year-end exchange rates. Income
and expense items are translated at average exchange rates prevailing during the
year. The resulting translation adjustment for DPL is recorded as accumulated
other comprehensive income, a component of stockholders equity. Because PD
operates in a country with a highly inflationary economy, any translation
adjustment is included in the results of operations.
Earnings Per Share - Basic earnings per share excludes dilution and is computed
by dividing income (loss) 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. Common stock equivalents for the year ending December 31, 1998 were
anti-dilutive and excluded in the earnings per share computation.
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 and goodwill, 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.
Impairment of Long-Lived Assets - In the event that facts and circumstances
indicate that the cost of long-lived 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 - The Company has elected to follow Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
(APB25) and related interpretations in accounting for its employee stock
options. In accordance with FASB Statement No. 123 "Accounting For Stock-Based
Compensation" (FASB123), the Company will disclose the impact of adopting the
fair value accounting of employee stock options. Transactions in equity
instruments with non-employees for goods or services have been accounted for
using the fair value method prescribed by FASB123.
<PAGE>F-11
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 FASB
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 13, 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 FASB 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 following methods and assumptions were used in estimating the indicated fair
values of the Company's financial instruments:
Cash and cash equivalents: The carrying amount approximates fair
value because of the short maturity of those instruments.
Long-term and other debt: The fair value of the Company's debt is
estimated based on current rates offered to the Company for similar
debt and approximates carrying value.
Comprehensive Income - The Company has adopted the Financial Accounting
Standards Board Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (FASB130). FASB130 defines comprehensive income as all
changes in stockholders' equity exclusive of transactions with owners, such as
capital investments. Comprehensive income includes net income or loss and
changes in certain assets and liabilities that are reported directly in equity,
such as, translation adjustments on investments in foreign subsidiaries,
difference in the recognition of compensation expense for books versus tax for
employee stock options, and certain changes in minimum pension liabilities.
Impact of Recently Issued Standards - In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 133
(FASB133), "Accounting for Derivative Instruments and Hedging Activities". This
statement is effective for fiscal years beginning after June 15, 1999. Earlier
application is encouraged; however, the Company does not anticipate adopting
FASB133 until the fiscal year beginning January 1, 2000. FASB133 requires that
an entity recognize all derivatives as assets or liabilities in the statement of
financial position and measure those instruments at fair value. The Company does
not believe the adoption of FASB133 will have a material impact on assets,
liabilities or equity. The Company has not yet determined the impact of FASB133
on the income statement or the impact on comprehensive income.
FASB132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits" and FASB134, "Accounting for Mortgage-Backed Securities Retained after
the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise" were issued in 1998 and are not expected to impact the Company's
future financial statement disclosures, results of operations and financial
position.
<PAGE>
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reclassifications - Certain reclassifications have been made to the prior year's
consolidated financial statements to conform with the current presentation. Such
reclassifications had no effect on net income (loss).
3. ACQUISITION:
In January 1998, the Company entered into an agreement to acquire certain assets
and assume certain liabilities of Gresham Power Electronics, a division of
Gresham Lion Technology Ltd., a European Corporation. The total purchase price
including acquisition costs was $3,370,293 with $1,452,190 being allocated to
excess of purchase price over net assets acquired.
Gresham Power Electronics had no material activity for 1998 prior to the
acquisition, therefore the statements presented for the year ended December 31,
1998 resemble those that would be shown in a pro forma. The following presents
unaudited pro forma information as if the acquisitions described above occurred
on January 1, 1997:
FOR THE YEAR ENDED
DECEMBER 31, 1997
------------------
Revenue $ 21,895,259
================
Operating income (loss) $ 2,530,178
================
Net income (loss) $ 1,393,790
================
Basic income per common share $ .54
================
Diluted income per common share $ .41
================
4. INVENTORY:
Inventory consists of the following as of December 31, 1998:
Raw materials $ 4,448,871
Work-in-process 829,967
Finished goods 232,182
----------------
5,511,020
Allowance for obsolescence (646,500)
----------------
$ 4,864,520
================
<PAGE>F-13
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. PROPERTY AND EQUIPMENT:
Property and equipment consist of the following as of December 31, 1998:
Machinery and equipment $ 1,338,278
Office equipment and furniture 752,934
Leasehold improvements 500,341
Transportation equipment 117,093
----------------
2,708,646
Accumulated depreciation and amortization (1,306,413)
----------------
$ 1,402,233
================
6. ACCRUED LIABILITIES:
Accrued liabilities consist of the following as of December 31, 1998:
Accrued payroll and benefits $ 430,314
Accrued commissions and royalties 243,894
Accrued warranty and product return expense 383,291
Income taxes payable 163,884
Other 373,715
----------------
$ 1,595,098
================
7. NOTES PAYABLE:
Notes payable consist of the following at December 31, 1998:
Revolving line of credit agreement with a
financial institution. Interest payable monthly
at the bank's prime rate, 7.75% at December 31, 1998. $ 1,590,000
Advances under factoring agreement 616,846
-------------
$ 2,206,846
=============
The revolving line of credit agreement provides for borrowings up to 80% of
eligible accounts receivable, plus 20% of inventory or $500,000, whichever is
less, not to exceed a total of $3,000,000. Under the terms of the agreement, the
Company is required to maintain certain ratios and be in compliance with other
covenants. At December 31, 1998, the Company was not in compliance with certain
covenants. Subsequent to December 31, 1998, the Company received a waiver from
the financial institution with regards to those items.
In February 1998, DPL entered into an agreement to factor its accounts
receivable at a discount of 0.195% plus interest at the rate of 2% above Lloyds
Bank Base Rate per annum (8.25% at December 31, 1998). The factor may maintain a
reserve of 25% of the outstanding balance on accounts factored. As of December
31, 1998, the face amount of accounts factored was $822,461.
<PAGE>F-14
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. LONG-TERM DEBT:
As of December 31, 1998, long-term debt consisted of an Employee Stock Ownership
Plan loan, for which the current portion equaled $115,476 and the long-term
portion equaled $69,443. See Note 14 for details.
Aggregate maturities of long-term debt are due as follows:
YEARS ENDING
DECEMBER 31, AMOUNT
------------ ------
1999 $ 115,476
2000 69,443
-----------
$ 184,919
===========
9. CAPITAL LEASE OBLIGATIONS:
The Company leases certain equipment and vehicles under agreements classified as
capital leases. The cost of these assets related to the leases is $224,557 and
accumulated depreciation amounts to $86,662 at December 31, 1998.
The future minimum lease payments are as follows:
YEARS ENDING
DECEMBER 31, AMOUNT
------------ ------
1999 $ 68,327
2000 46,631
2001 34,785
2002 26,798
2003 13,398
-----------
Total future minimum lese payments 189,939
Less amount representing interest (12,652)
-----------
Present value of net minimum lease payments 177,287
Less Current portion (63,131)
-----------
$ 114,156
===========
10. 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 the over allotment shares and warrants for net proceeds of $492,378.
<PAGE>F-15
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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. At
December 31, 1998, 86,900 of such options were outstanding.
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. During the years ended December 31, 1998 and 1997, 12,500 and
55,500, respectively, of such options were exercised. 167,000 of these options
are outstanding at December 31, 1998. During the year ended December 31, 1997,
2,500 of such options were forfeited.
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 their terms, conditions and
restrictions. During the years ended December 31, 1998 and 1997, 1,000 and
19,000 of such options were forfeited. During the year ended December 31, 1998,
23,250 of such options were exercised.
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. The exercise price of $5.4375 per share was equal to the
fair market value on the date of grant. These options were repriced in November
1998 to the fair market value of $2.3125.
On February 4, 1997, the Company granted 28,000 options with an exercise price
of $6.625 per share, which was equal to the fair market value on the date of
grant, to certain employees to purchase the Company's stock. The options vest
over 5 years. The options were repriced in November 1998 to the fair market
value of $2.3125. During the years ended December 31, 1998 and 1997, 4,000 and
8,000, respectively, of such options were forfeited.
<PAGE>F-16
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On November 4, 1997, the Company granted 10,000 options with an exercise price
of $7.125 per share, which was equal to the fair market value on the date of
grant, to an employee, to purchase the Company's stock. The options vest over 4
years at 25% per year. During the year ended December 31, 1998, all 10,000 of
the options were forfeited.
On January 2, 1998, the Company granted 100,000 options to purchase the
Company's stock to the president of the Company, in accordance with his
employment agreement. The exercise price of $6.6875 per share was equal to the
fair market value on the date of grant. On November 5, 1998, these options were
repriced to $2.3125, which was equal to the fair market value on that date.
On January 12, 1998, the Company granted 229,000 options to purchase the
Company's stock under the 1996 Stock Option Plan to certain employees. The
exercise price was $6.1250, which was equal to the fair market value on the date
of grant. The options vest over 5 years at 25% per year starting in the second
year. On November 5, 1998, the options were repriced to the current fair market
value of $2.3125 per share. During the year, 76,400 options were forfeited.
During the year ended December 31, 1998, the Company granted 60,000 options to
purchase the Company's stock to it's three outside directors. The exercise price
ranged from $6.00 to $6.25 per share, which was equal to the fair value on the
date of grant. The options vest after one year.
In February 1998, the Company adopted the 1998 Stock Option Plan covering
240,000 shares. Under the plan, the Company can issue either incentive or
non-qualified stock options. The exercise 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 grant date. The vesting period of the options will be determined by the
compensation committee of the Board of Directors, if any, and no options will be
exercisable after ten years from the date of grant. Immediately thereafter, the
Company granted 124,940 options to purchase the Company's stock to the employees
of DPL at an exercise price of $6.25. The options vest over 5 years at 25% per
year starting in the second year. On November 5, 1998, the options were repriced
to the current fair market value of $2.3125 per share. As of December 31, 1998,
7,760 options had been forfeited.
In July 1998, the Company granted 25,000 options to purchase stock to an
employee under the 1998 Stock Option Plan. The exercise price was $4.00 per
share, which equaled the market price on the date of grant. The options vest
over 5 years at 25% per year starting in the second year. On November 5, 1998,
the options were repriced to the current fair market value of $2.3125 per share.
<PAGE>F-17
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth activity for all options:
AVERAGE
EXERCISE PRICE
NUMBER PER SHARE
----------- --------------
OUTSTANDING, January 1, 1997 597,400 $ .50 - $1.80
Granted 138,000 5.80
Forfeited (27,000) 3.23
Exercised (55,500) 1.80
----------- -------------
BALANCE, December 31, 1997 652,900 2.41
Granted 538,940 2.74
Forfeited (99,160) 2.79
Exercised (35,750) 1.80
----------- -------------
BALANCE, December 31, 1998 1,056,930 $ 2.19
=========== =============
At December 31, 1998 options to purchase 690,150 shares, were exercisable at
prices ranging from $.50 to $1.80 per share. The remaining 366,780 shares
become exercisable as follows:
WEIGHTED
NUMBER OF AVERAGE
YEAR ENDING DECEMBER 31, SHARES EXERCISE PRICE
------------------------ --------- --------------
1999 60,000 $ 6.13
2000 77,695 2.31
2001 77,695 2.31
2002 77,695 2.31
2003 73,695 2.31
-------- --------
366,780 $ 2.94
======== ========
If not previously exercised the outstanding options will expire as follows:
WEIGHTED
NUMBER OF AVERAGE
YEAR ENDING DECEMBER 31, SHARES EXERCISE PRICE
------------------------ --------- --------------
2003 253,900 $ 1.36
2004 - -
2005 - -
2006 232,250 1.80
2007 116,000 2.31
2008 454,780 2.82
---------- --------
1,056,930 $ 2.19
========== ========
<PAGE>F-18
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
WARRANTS
The following represents all activity that took place with regards to warrants
issued:
AVERAGE
EXERCISE PRICE
NUMBER PER SHARE
-------- --------------
OUTSTANDING, January 1, 1997 850,000 $ 4.99
Sold 75,000 5.00
Granted 15,000 6.75
Exercised (125,710) 5.00
--------- ------------
BALANCE, December 31, 1997 814,290 5.02
Granted 30,000 7.00
Exercised (6,200) 5.00
--------- ------------
BALANCE, December 31, 1998 838,090 $ 5.09
========= ============
Compensation cost related to the warrants granted for outside services amounted
to $46,033 and $35,903 for the years ended December 31, 1998 and 1997,
respectively. The warrants expire three years after the grant date.
PROFORMA INFORMATION
As stated in Note 2, the Company has not adopted the fair value accounting
prescribed by FASB123 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 1998 and 1997, consistent with the provisions of FASB123, the
Company's net income (loss) and net income (loss) per share would have been
reduced to the proforma amounts indicated below:
1998 1997
-------------- ----------------
Net income (loss) $ (1,472,924) $ 1,159,540
============== ================
Net income (loss) per common share:
Basic $ (.59) $ .45
============== ================
Diluted $ (.59) $ .34
============== ================
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 $2.74 and $5.80 per share for
1998 and 1997, respectively. The following assumptions were used for grants in
1998 and 1997: average risk-free interest rates of 5.6% and 5.8%, respectively;
expected lives of five years and two years, respectively; dividend yield of 0%;
and expected volatility of 69.3% and 56.8%, respectively.
<PAGE>F-19
11. NET INCOME (LOSS) PER COMMON SHARE:
The following represents the calculation of net income (loss) per common share:
FOR THE YEARS ENDED
1998 1997
----------------- -------------
BASIC
Net income (loss) $ (570,588) $ 1,400,790
Less - preferred stock dividends - -
-------------- -------------
Net income (loss) applicable to common
shareholders $ (570,588) $ 1,400,790
=============== =============
Weighted average number of common shares 2,726,631 2,577,889
============== =============
Basic earnings (loss) per share $ (.21) $ .54
============== =============
DILUTED
Net income (loss) available to common
shareholders $ (570,588) $ 1,400,790
Preferred stock dividend - -
------------- -------------
Net income (loss) available to common
shareholders plus assumed conversion $ (570,588) $ 1,400,790
============= =============
Weighted average number of common shares 2,726,631 2,577,889
Common stock equivalent shares representing
shares issuable upon exercise of stock
options - 487,237
Common stock equivalent shares representing
shares issuable upon exercise of warrants - 355,252
------------- -------------
Weighted average number of shares used in
calculation of diluted income (loss)
per share 2,726,631 3,420,378
============= =============
Diluted earnings (loss) per share $ (.21) $ .41
============= =============
<PAGE>F-20
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. COMMITMENTS:
LEASES
The Company leases its office space in California, a manufacturing facility in
Guadalajara, Mexico, and the facility and certain equipment in the UK under
operating leases. The total future minimum lease payments are as follows:
YEARS ENDING DECEMBER 31,
- -------------------------
1999 $ 249,964
2000 243,602
2001 137,316
2002 121,724
2003 116,270
Thereafter 667,063
------------
$ 1,535,939
============
Lease payments on the manufacturing facility in Mexico are to be made in Mexican
Pesos. Lease payments on the facility and equipment in the UK are to be made in
GB pound-sterling. The above schedule was prepared using the conversion rate in
effect at December 31, 1998. Changes in the conversion rate will have an impact
on the Company's required minimum payments and its operating results.
Rent expense was $243,154 and $117,341 for 1998 and 1997, respectively.
ROYALTY AGREEMENT
The Company had a royalty agreement with a third party on various products, and
any derivatives from the base design of these products.
In April 1998, the third party filed a lawsuit against the Company related to
this agreement. This lawsuit was settled in September 1998. In exchange for the
release of all future obligations under the royalty agreement, the Company
agreed to pay $150,000 and issue 35,000 shares of common stock. The shares were
issued upon the close of the agreement. The $150,000 is due in installments
through June 2000. As of December 31, 1998, the Company had paid $34,000 in
installments, the remaining $116,000 is included in accrued liabilities.
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 business 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 six months beginning from the date of grant of this 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-13
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. SIGNIFICANT CONCENTRATIONS OF CREDIT RISK, MAJOR CUSTOMERS AND OTHER RISKS
AND UNCERTAINTIES:
Sales to unaffiliated customers of the Company's DPC segment represented more
than 10% of the Company's net sales for 1998 and 1997 and were as follows
(customers A & D are distributors):
CUSTOMER 1998 1997
-------- ---- ----
A 13% 25%
B 8% 14%
C - 24%
D 10% 5%
The Company operates primarily in one industry: the manufacture and sale of
switching power supplies. 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, 1998,
approximately $2,171,560 or 56% of the Company's net accounts receivable were
due from ten customers.
As of December 31, 1998, the Company maintained cash in banks that was
approximately $666,208 in excess of the federally insured limit.
14. 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 $17,073 and $19,625 for 1998 and 1997,
respectively. The Board of Directors of DPC elected not to make a discretionary
contribution to the Plan for 1998 or 1997.
The Company's subsidiary DPL, has a group personal pension plan covering
substantially all of its employees. Eligible employees may make voluntary
contributions to the plan. The Company will contribute 7% of the employees basic
annual salary to the plan. Contributions are charged to operations as incurred.
The Company made contributions totaling $50,145 to the plan for the year ended
December 31, 1998.
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.
<PAGE>F-22
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective June 13, 1996, the ESOP obtained a $500,000 loan guaranteed by the
Company for the purpose of acquiring common stock of the Company from existing
stockholders. The loan bears interest at 8.5% per annum and requires monthly
payments of principal and interest of $8,852 through June 2001. The balance at
December 31, 1998 was $184,919. 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 1998 and
1997 were $165,971 and $179,416, respectively.
In accordance with the AICPA Statements of Position 93-6 entitled "Employers
Accounting for Employee Stock Ownership Plans", the Company has recorded the
loan as debt on its books with a corresponding charge to stockholders' equity.
15. INCOME TAXES:
Income tax expense (benefit) is comprised of the following:
FOR THE YEARS ENDED
------------------------------------
1998 1997
--------------- --------------
Current
Federal $ (32,135) $ 808,978
State (59,543) 235,700
Foreign 121,000 -
--------------- --------------
29,322 1,044,678
--------------- --------------
Deferred
Federal (233,865) (15,135)
State (53,457) (3,543)
Foreign - -
--------------- --------------
(287,322) (18,678)
--------------- --------------
$ (258,000) $ 1,026,000
=============== ==============
<PAGE>F-23
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the net deferred tax asset and liability recognized as of
December 31, 1998 are as follows:
Current deferred tax assets (liabilities):
Accounts receivable, principally due to
allowance for doubtful accounts 114,393
Compensated absences, principally due to
accrual for financial reporting purposes 36,049
Accrued commissions 22,520
Inventory reserve 192,662
Warranty reserve 122,421
Stock rotation liability 24,083
Accrued settlement 60,749
Accrued other 31,458
Book compensation for stock options 79,034
Effect of change in account method (219,186)
UNICAP 23,895
State taxes (11,550)
------------
476,528
Valuation allowance (90,923)
------------
Net current deferred tax asset $ 385,605
============
Long-term deferred tax assets (liabilities):
Net operating loss carryforwards $ 6,002
Depreciation (32,002)
------------
Net long-term deferred tax liability $ (26,000)
============
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 THE YEARS ENDED
-------------------------
1998 1997
---------- ---------
Total expense (benefit) computed by applying
the U.S. statutory rate (34.0%) 34.0%
Permanent differences .8 .2
State income taxes (13.5) 8.0
Tax effect resulting from foreign activities 7.4 (.4)
Change in valuation allowance 10.8 -
Change in beginning balance of deferred asset (8.2) -
Effect of IRS examination 5.4 -
Other .6 .5
---------- --------
(30.7%) 42.3%
========== ========
<PAGE>F-24
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. ACCUMULATED OTHER COMPREHENSIVE INCOME BALANCES:
Accumulated other comprehensive income consists of the following as of December
31, 1998:
Compensation Accumulated
related to Other
Foreign Currency exercise of Comprehensive
Items stock option Income
--------- -------------- --------------
Beginning Balance $ - $ 196,828 $ 196,828
Current-period change 36,234 38,366 74,600
--------- -------------- --------------
$ 36,234 $ 235,194 $ 271,428
========= ============== ==============
17. FOURTH QUARTER ADJUSTMENTS AND TRANSACTIONS:
During the fourth quarter of 1998, the Company recognized certain expenses as
follows:
Additional allowance for inventory obsolescence $ 260,000
Additional allowance for doubtful accounts 85,000
Additional accrual for warranty expense 140,000
Additional accruals for litigation settlements 222,166
Accruals for severance payments 51,746
------------
Total $ 758,912
============
<PAGE>F-25
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. SEGMENT REPORTING:
The Company has identified its segments based upon its geographic operations.
These segments are represented by each of the Company's individual legal
entities: DPC, PD and DPL. Segment information is as follows:
<TABLE>
<CAPTION>
1998
----
DPC PD DPL Eliminations Totals
------------ ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 11,681,979 $ 49,450 $ 7,002,041 $ - $ 18,733,470
============ ============ =========== ============ ============
Intersegment
Revenues $ 94,223 $ 2,541,720 $ - $ (2,635,943) $ -
============ ============ =========== ============ ============
Interest
Income $ 114,686 $ - $ - $ (98,612) $ 16,074
============ ============ =========== ============ ============
Interest
Expense $ 163,344 $ 3,867 $ 168,369 $ (98,612) $ 236,968
============ ============ =========== ============ ============
Depreciation
and
Amortization $ 164,548 $ 26,780 $ 232,327 $ - $ 423,655
============ ============ =========== ============ ============
Income Tax
Expense
(Benefit) $ (378,983) $ - $ 120,983 $ - $ (258,000)
============ ============ =========== ============ ============
Net Income
(loss) $ (634,896) $ (52,312) $ 116,620 $ - $ (570,588)
============ ============ =========== ============ ============
Segment
Assets $ 10,999,046 $ 602,425 $ 5,501,699 $ (4,112,351) $ 12,990,819
============ ============ =========== ============ ============
Expenditures
for Segment
Assets $ 34,182 $ 76,185 $ 212,736 $ - $ 323,103
============ ============ =========== ============ ============
</TABLE>
<PAGE>F-26
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1997
----
DPC PD DPL Eliminations Totals
------------ ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues $ 18,846,381 $ 37,878 $ - $ - $ 18,884,259
============ ============ ============ ============ ============
Intersegment
Revenues $ - $ 2,891,664 $ - $ (2,891,664) $ -
============ ============ ============ ============ ============
Interest
Income $ 47,415 $ - $ - $ - $ 47,415
============ ============ ============ ============ ============
Interest
Expense $ 61,892 $ 7,065 $ - $ - $ 68,957
============ ============ ============ ============ ============
Depreciation
and
Amortization $ 145,237 $ 28,810 $ - $ - $ 174,047
============ ============ ============ ============ ============
Income Tax
Expense $ 1,026,000 $ - $ - $ - $ 1,026,000
============ ============ ============ ============ ============
Net Income $ 1,373,473 $ 27,317 $ - $ - $ 1,400,790
============ ============ ============ ============ ============
Segment
Assets $ 10,363,939 $ 551,466 $ - $ (452,951) $ 10,462,454
============ ============ ============ ============ ============
Expenditures
for Segment
Assets $ 274,075 $ 114,750 $ - $ - $ 388,825
============ ============ ============ ============ ============
</TABLE>
Exhibit 10.7
DIGITAL POWER CORPORATION
1998 STOCK OPTION PLAN
1. PURPOSE; DEFINITIONS.
1.1 Purpose. The purpose of the Plan is to attract, retain, and motivate
officers, employees, consultants, and directors of the Company by giving them
the opportunity to acquire Stock ownership in the Company.
1.2 Definitions. For purposes of the Plan, the following terms shall
have the following meanings:
1.2.1 "Administrator" shall mean the Compensation Committee
referred to in Section 4 in its capacity as administrator
of the Plan in accordance with Section 4.
1.2.2 "Board" shall mean the Board of Directors of the Company.
1.2.3 "Code" shall mean the Internal Revenue Code of 1986, as
amended from time to time.
1.2.4 "Company" shall mean Digital Power Corporation, a
California corporation, or its subsidiary.
1.2.5 "Director" shall mean a member of the Board.
1.2.6 "Effective Date" shall have the meaning set forth in
Section 2.
1.2.7 "Eligible Person" shall mean, in the case of the grant of
an Incentive Stock Option, all employees of the Company,
and in the case of a Non-qualified Stock Option, any
director (including a director who is also a member of the
Compensation Committee), officer, or employee of or
consultant to the Company.
1.2.8 "Fair Market Value" shall mean the value established by
the Administrator for purposes of granting Options under
the Plan.
1.2.9 "Grant Date" shall mean the date of grant of any Option.
1.2.10 "Incentive Stock Option" shall mean an Option within the
meaning of Section 422 of the Code, the award of which
contains such provisions as are necessary to comply with
that section.
<PAGE>
1.2.11 "Non-qualified Stock Option" shall mean an Option which is
designated a Nonqualified Stock Option.
1.2.12 "Option" shall mean an option to purchase Common Stock
under this Plan. An Option shall be designated by the
Committee as either an Incentive Stock Option or a
Non-qualified Stock Option.
1.2.13 "Option Agreement" shall mean the written option agreement
with respect to an Option.
1.2.14 "Optionee" shall mean the holder of an Option.
1.2.15 "Plan" shall mean this Digital Power Corporation 1998
Stock Option Plan, as amended from time to time.
1.2.16 "Stock" shall mean the Common Stock, no par value, of the
Company, and any successor entity.
1.2.17 "Vesting Date" shall mean the date on which an Option
becomes wholly or partially exercisable, as determined by
the Administrator in its sole discretion.
2. EFFECTIVE DATE; TERM OF PLAN.
The Effective Date of this Plan shall be upon shareholder approval of
this Plan pursuant to California Corporations Code ss.600, which shall occur
within 12 months of the date of Board approval. This Plan, but not Options
already granted, shall terminate automatically ten (10) years after its adoption
by the Board, unless terminated earlier by the Board under Section 13. No
Options shall be granted after termination of this Plan but all Options granted
prior to termination shall remain in effect in accordance with their terms.
3. NUMBER AND SOURCE OF SHARES OF STOCK SUBJECT TO THE PLAN.
Subject to the provisions of Section 8, the total number of shares of
Stock with respect to which Options may be granted under this Plan is 240,000
shares of Stock. The shares of Stock covered by any canceled, expired, or
terminated Option or the unexercised portion thereof shall become available
again for grant under this Plan. The shares of Stock to be issued hereunder upon
exercise of an Option may consist of authorized and unissued shares or treasury
shares.
4. ADMINISTRATION OF THE PLAN.
This Plan shall be administered by the Compensation Committee which
shall consist of at least two (2) members of the Board. The "Administrator"
shall mean the "Compensation Committee" referred to in this Section 4 in its
capacity as administrator of the Plan in accordance with this Section 4. The
Administrator may delegate nondiscretionary administrative duties to such
employees of the Company as it deems proper. A majority of the members of the
Compensation Committee shall be non-employee directors within the meaning of
Rule 16b-3(b)(3)(i) of the Securities Exchange Act of 1934.
<PAGE>
Subject to the express provisions of this Plan, the Administrator shall
have the authority to construe and interpret this Plan and any agreements
defining the rights and obligations of the Company and Optionees under this
Plan; to further define the terms used in this Plan; to prescribe, amend, and
rescind rules and regulations relating to the administration of this Plan; to
determine the duration and purposes of leaves of absence which may be granted to
Optionees without constituting a termination of their employment for purposes of
this Plan; and to make all other determinations necessary or advisable for the
administration of this Plan.
Any decision or action of the Administrator in connection with this Plan
or Options granted or shares of Stock purchased under this Plan shall be final
and binding. The Administrator shall not be liable for any division, action, or
omission respecting this Plan, or any Options granted or shares of Stock sold
under this Plan. The Board at any time may abolish the Compensation Committee
and revest in the Board the administration of the Plan.
To the extent permitted by applicable law in effect from time to time,
no member of the Compensation Committee or the Board of Directors shall be
liable for any action or omission of any other member of the Compensation
Committee or the Board of Directors nor for any act or omission on the member's
own part, excepting only the member's own willful misconduct or gross
negligence, arising out of or related to the Plan. The Company shall pay
expenses incurred by, and satisfy a judgment or fine rendered or levied against,
a present or former director or member of the Compensation Committee or Board in
any action against such person (whether or not the Company is joined as a party
defendant) to impose liability or a penalty on such person for an act alleged to
have been committed by such person while a director or member of the
Compensation Committee or Board arising with respect to the Plan or
administration thereof, or out of membership on the Compensation Committee or
Board, or by the Company, or all or any combination of the preceding; provided,
the director or Compensation Committee member was acting in good faith, within
what such director or Compensation Committee member reasonably believed to have
been within the scope of his or her employment or authority, and for a purpose
which he or she reasonably believed to be in the best interests of the Company
or its shareholders. Payments authorized hereunder include amounts paid and
expenses incurred in settling any such action or threatened action. The
provisions of this section shall apply to the estate, executor, administrator,
heirs, legatees, or devisees of a director or Compensation Committee member, and
the term "person" as used in this section shall include the estate, executor,
administrator, heirs, legatees, or devisees of such person.
5. GRANT OF OPTIONS; TERMS AND CONDITIONS OF GRANT.
5.1 Grant Of Options. One or more Options may be granted to any Eligible
Person. Subject to the express provisions of the Plan, the Administrator shall
determine from the Eligible Persons those individuals to whom Options under the
Plan may be granted. Each Option so granted shall be designated by the
Administrator as either a Non-qualified Stock Option or an Incentive Stock
Option.
Subject to the express provisions of this Plan, the Administrator shall
specify the Grant Date, the number of shares of Stock covered by the Option, the
exercise price, and the terms and conditions for exercise of the Options. If the
Administrator fails to specify the Grant Date, the Grant Date shall be the date
of the action taken by the Administrator to grant the Option. As soon as
practicable after the Grant Date, the Company shall provide the Optionee with a
written Option Agreement in the form approved by the Administrator, which sets
<PAGE>
out the Grant Date, the number of shares of Stock covered by the Option, the
exercise price, and the terms and conditions for exercise of the Option.
The Administrator may, in its absolute discretion, grant Options under
this Plan to an Eligible Person at any time and from time to time before the
expiration of ten (10) years from the Effective Date.
5.2 General Terms And Conditions. Except as otherwise provided herein,
the Options shall be subject to the following terms and conditions and such
other terms and conditions not inconsistent with this Plan as the Administrator
may impose.
5.3 Exercise Of Option. In order to exercise all or any portion of any
Option granted under this Plan, an Optionee must remain as an officer, employee,
consultant, or director of the Company, until the Vesting Date. The Option shall
be exercisable on or after each Vesting Date in accordance with the terms set
forth in the Option Agreement.
5.4 Option Term. Each Option and all rights or obligations thereunder
shall expire on such date as shall be determined by the Administrator, but not
later than ten (10) years after the grant of the Option (five (5) years in the
case of an Incentive Stock Option when the Optionee owns more than 10% of the
total combined voting power of all classes of Stock of the Company), and shall
be subject to earlier termination as hereinafter provided.
5.5 Exercise Price. The Exercise Price of any Option shall be determined
by the Administrator, but in the case of Incentive Stock Options shall not be
less than 100% (110% in the case of an Optionee who owns more than 10% of the
total combined voting power of all classes of stock of the Company) of the Fair
Market Value of the Stock on the date the Incentive Stock Option is granted, and
100% of the Fair Market Value of the Stock on the date the Non-qualified Stock
Option is granted.
5.6 Method Of Exercise. To the extent the right to purchase shares of
Stock has accrued, Options may be exercised, in whole or in part, from time to
time in accordance with their terms by written notice from the Optionee to the
Company stating the number of shares of Stock with respect to which the Option
is being exercised, and accompanied by payment in full of the exercise price.
Payment may be made in cash or check.
5.7 Restrictions On Stock; Option Agreement. At the time it grants
Options under this Plan, the Company may retain, for itself or others, rights to
repurchase the shares of Stock acquired under the Option, or impose other
restrictions on such shares. The terms and conditions of any such rights or
other restrictions shall be set forth in the Option Agreement evidencing the
Option. No Option shall be exercisable until after execution of the Option
Agreement by the Company and the Optionee.
5.8 Non-Assignability Of Option Rights. No Option shall be transferable
other than by will or by the laws of descent and distribution. During the
lifetime of an Optionee, only the Optionee may exercise an Option.
<PAGE>
5.9 Exercise After Certain Events.
5.9.1 Termination as an employee, director, or consultant. If for
any reason other than permanent and total disability or death (as defined below)
an Optionee ceases to be employed by or to be a consultant or director of the
Company, Options held at the date of such termination (to the extent then
exercisable) may be exercised, in whole or in part, at any time within three (3)
months after the date of such termination or such lesser period specified in the
Option Agreement (but in no event after the earlier of (i) the expiration date
of the Option as set forth in the Option Agreement, and (ii) ten years from the
Grant Date).
If an Optionee granted an Incentive Stock Option terminates
employment but continues as a consultant, advisor, or in a similar capacity to
the Company, Optionee need not exercise the Option within three months of
termination of employment but shall be entitled to exercise within three months
of termination of services to the Company (one (1) year in the event of
permanent disability or death). However, if Optionee does not exercise within
three (3) months of termination of employment, the Option will not qualify as an
Incentive Stock Option.
5.9.2 Permanent disability and death. If an Optionee becomes
permanently and totally disabled (within the meaning of section 22(e)(3) of the
Code), or dies while employed by the Company, or while acting as an officer,
consultant, or director of the Company,(or, if the Optionee dies within the
period that the Option remains exercisable after termination of employment or
affiliation), Options then held (to the extent then exercisable) may be
exercised by the Optionee, the Optionee's personal representative, or by the
person to whom the Option is transferred by will or the laws of descent and
distribution, in whole or in part, at any time within one (1) year after the
disability or death or any lesser period specified in the Option Agreement (but
in no event after the earlier of (i) the expiration date of the Option as set
forth in the Option Agreement, and (ii) ten (10) years from the Grant Date).
5.10 Compliance With Securities Laws. The Company shall not be obligated
to issue any shares of Stock upon exercise of an Option unless such shares are
at that time effectively registered or exempt from registration under the
federal securities laws and the offer and sale of the shares of Stock are
otherwise in compliance with all applicable securities laws. Upon exercising all
or any portion of an Option, an Optionee may be required to furnish
representations or undertakings deemed appropriate by the Company to enable the
offer and sale of the shares of Stock or subsequent transfers of any interest in
such shares to comply with applicable securities laws. Evidences of ownership of
shares of Stock acquired upon exercise of Options shall bear any legend required
by, or useful for purposes of compliance with, applicable securities laws, this
Plan, or the Option Agreement evidencing the Option.
6. LIMITATIONS ON GRANT OF INCENTIVE STOCK OPTIONS.
6.1 One Hundred Thousand Dollars Rule. The aggregate Fair Market Value
(determined as of the Grant Date) of the Stock for which Incentive Stock Options
may first become exercisable by any Optionee during any calendar year under this
Plan, together with that of Stock subject to Incentive Stock Options first
exercisable (other than as a result of acceleration pursuant to Section 9) by
such Optionee under any other plan of the Company, shall not exceed $100,000.
<PAGE>
6.2 Option Agreements. There shall be imposed in the Option Agreement
relating to Incentive Stock Options such terms and conditions as are required in
order that the Option be an "incentive stock option" as that term is defined in
section 422 of the Code.
6.3 Ten Percent Rule. No Incentive Stock Option may be granted to any
person who, at the time the Incentive Stock Option is granted, owns shares of
outstanding Stock possessing more than 10% of the total combined voting power of
all classes of Stock of the Company, unless the exercise price of such Option is
at least 110% of the Fair Market Value of the Stock (determined as of the Grant
Date) subject to the Option, and such Option by its terms is not exercisable
after the expiration of five (5) years from the Grant Date.
6.4 Non-Employees. No Incentive Stock Option may be granted to any
person who is not an employee of the Company.
7. PAYMENT OF TAXES.
Upon the disposition by an Optionee or other person of shares of an
Option prior to satisfaction of the holding period requirements of Section 422
of the Code, or upon the exercise of a Non-qualified Stock Option, the Company
shall have the right to require such Optionee or such other person to pay by
cash, or check payable to the Company, the amount of any taxes which the Company
may be required to withhold with respect to such transactions. Any such payment
must be made promptly when the amount of such obligation becomes determinable.
The Administrator may, in lieu of such cash payment, withhold that number of
shares sufficient to satisfy such withholding.
8. ADJUSTMENT FOR CHANGES IN CAPITALIZATION.
The existence of outstanding Options shall not affect the Company's
right to effect adjustments, recapitalizations, reorganizations, or other
changes in its or any other corporation's capital structure or business, any
merger or consolidation, any issuance of bonds, debentures, preferred or prior
preference stock ahead of or affecting the Stock, the dissolution or liquidation
of the Company's or any other corporation's assets or business, or any other
corporate act, whether similar to the events described above or otherwise.
Subject to Section 9, if the outstanding shares of the Stock are increased or
decreased in number or changed into or exchanged for a different number or kind
of securities of the Company or any other corporation by reason of a
recapitalization, reclassification, stock split, combination of shares, stock
dividend, or other event, an appropriate adjustment of the number and kind of
securities with respect to which Options may be granted under this Plan, the
number and kind of securities as to which outstanding Options may be exercised,
and the exercise price at which outstanding Options may be exercised, will be
made.
9. DISSOLUTION, LIQUIDATION, OR MERGER.
9.1 Company Not The Survivor. In the event of a dissolution or
liquidation of the Company, a merger, consolidation, combination, or
reorganization in which the Company is not the surviving corporation, or a sale
of substantially all of the assets of the Company, any outstanding Option shall
become fully vested immediately upon the Company's public announcement of any
one of the foregoing. The Board of Directors shall determine, in its sole and
absolute discretion, when the Company shall be deemed to survive for purposes
<PAGE>
of this paragraph. If the Optionee does not exercise the entire Option within
ninety (90) days, the Administrator, in its sole and absolute discretion, may,
with respect to the unexercised portion of the Option:
9.1.1 cancel the Option upon payment to the Optionee of an amount
equal to the difference between the closing price of the Stock underlying the
Option quoted the day before such liquidation, dissolution, merger,
consolidation, combination, or reorganization, and the exercise price of the
Option; or
9.1.2 assign the Option and all rights and obligations under it
to the successor entity, with all such rights and obligations being assumed by
the successor entity.
9.2 Company Is The Survivor. In the event of a merger, consolidation,
combination, or reorganization in which the Company is the surviving
corporation, the Board of Directors shall determine the appropriate adjustment
of the number and kind of securities with respect to which outstanding Options
may be exercised, and the exercise price at which outstanding Options may be
exercised. The Board of Directors shall determine, in its sole and absolute
discretion, when the Company shall be deemed to survive for purposes of this
Plan.
10. CHANGE OF CONTROL.
If there is a "change of control" in the Company, all outstanding
Options shall fully vest immediately upon the Company's public announcement of
such a change. A "change of control" shall mean an event involving one
transaction or a related series of transactions, in which (i) the Company issues
securities equal to 25% or more of the Company's issued and outstanding voting
securities, determined as a single class, to any individual, firm, partnership,
limited liability company, or other entity, including a "group" within the
meaning of SEC Exchange Act Rule 13d-3, (ii) the Company issues voting
securities equal to 25% or more of the issued and outstanding voting stock of
the Company in connection with a merger, consolidation, or other business
combination, (iii) the Company is acquired in a merger or other business
combination transaction in which the Company is not the surviving company, or
(iv) all or substantially all of the Company's assets are sold or transferred.
See Section 9 with respect to Options vesting upon the occurrence of either of
the events described in (iii) or (iv) of this Section 10 and the result upon the
non-exercise of the Options.
11. SUSPENSION AND TERMINATION.
In the event the Board or the Administrator reasonably believes an
Optionee has committed an act of misconduct, including, but not limited to,
those specified below, the Administrator may suspend the Optionee's right to
exercise any Option granted hereunder pending final determination by the Board
or the Administrator. If the Board or Administrator determines that an Optionee
has committed an act of misconduct, including, without limitation, an act of
embezzlement, fraud, breach of fiduciary duty, or deliberate disregard of the
Company rules, or if an Optionee makes an unauthorized disclosure of any Company
trade secret or confidential information, engages in any conduct constituting
unfair competition, induces any Company customer to breach a contract with the
Company, or induces any principal for whom the Company acts as agent to
terminate such agency relationship, neither the Optionee nor his estate shall
<PAGE>
be entitled to exercise any Option hereunder. The determination of the Board or
the Administrator shall be final and conclusive.
12. NO RIGHTS AS SHAREHOLDER OR TO CONTINUED EMPLOYMENT.
An Optionee shall have no rights as a shareholder with respect to any
shares of Stock covered by an Option. An Optionee shall have no right to vote
any shares of Stock, or to receive distributions of dividends or any assets or
proceeds from the sale of Company assets upon liquidation until such Optionee
has effectively exercised the Option and fully paid for such shares of Stock.
Subject to Sections 8 and 9, no adjustment shall be made for dividends or other
rights for which the record date is prior to the date title to the shares of
Stock has been acquired by the Optionee. The grant of an Option shall in no way
be construed so as to confer on any Optionee the rights to continued employment
by the Company.
13. TERMINATION; AMENDMENT.
The Board may amend, suspend, or terminate this Plan at any time and for
any reason, but no amendment, suspension, or termination shall be made which
would impair the right of any person under any outstanding Options without such
person's consent not unreasonably withheld. Further, any amendment which
materially increases the benefits accruing to participants under this Plan shall
be subject to the approval of the Company's shareholders.
14. GOVERNING LAW.
This Plan and the rights of all persons under this Plan shall be
construed in accordance with and under applicable provisions of the laws of the
State of California.
Exhibit 10.9
San Jose National Bank
One North Market Street
San Jose, California 95113
Phone: (408) 947-7562
Fax: (408) 947-0362
e-mail: [email protected]
June 11, 1998
Mr. Robert Smith, CEO
Digital Power Corporation
41920 Christy Street
Fremont, CA 94538
LOAN COMMITMENT AND LETTER AGREEMENT
Dear Mr. Smith:
We are pleased to confirm to you the following Credit Facility subject to the
terms and conditions set forth below:
I. PARTIES
Lender: San Jose National Bank ("Bank")
One North Market Street
San Jose, CA 95113
Borrower: Digital Power Corporation ("Borrower")
41920 Christy Street
Fremont, CA 94538
II. CREDIT FACILITY
Type: Standard (Borrowing Base) line of credit having an inventory
subfeature.
Term: Maturity of June 15, 1999. Advances at Borrowers request,
subject to availability as determined by the Borrowing Base
Certificate.
Amount: $3,000,000 (Three Million Dollars).
Collateral: Broadform UCC-1 filing on all business assets with a priority
filing in accounts receivable.
Payments: Monthly interest only payments. Principal at maturity.
Rate & Fee: Bank's Prime Rate, floating. $500 documentation fee.
Guarantor: None.
<PAGE>
Digital Power Corporation
Commitment Letter dated June 11, 1998
page 2 of 3
III. CONDITIONS
1) Satisfactory execution of all Bank documents.
2) In consideration of the rate charged and the credit extended, Borrower will
maintain its primary commercial banking relationship with Bank.
3) Borrower to maintain general insurance coverage naming Bank as loss payee.
4) Borrower to provide quarterly, internally prepared financial statements
within 45 days of quarters end. Financial statements are to show the
consolidated and separate results of Digital Power and Gresham Power (next
due August 15, 1998).
5) To provide a CPA audited financial statement within 120 days of each fiscal
year end (next due April 30, 1999).
6) To provide monthly A/R & A/P and inventory breakdown report accompanied by
a Bank provided Borrowing Base Certificate within 20 days of month end
(next due by July 20, 1998).
7) Advances under the line of credit are subject to a 80% advance rate on
eligible receivables. Ineligible receivables include those receivables
which are over 60 days delinquent, those which have concentrations in
excess of 15% (Foresight will be allowed a 25% concentration), those which
have 25% or more over 90 days delinquent, intercompany, foreign, contra,
employee and government accounts.
8) The advance rate on inventory will be $500,000 or 20% of total inventory,
whichever is less; borrower to maintain U.S. inventory in the minimum
amount of $500,000.
9) An annual accounts receivable audit will be required with the next due in
April 1999. All audits are to be deemed satisfactory to the bank. In lieu
of future audits, borrower can allow its outside CPA to provide work papers
verifying A/R and Inventory audit results.
10) Financial covenants consist of the following and will be calculated using
the consolidated financial statement figures:
a) Quarterly profitability.
b) Maintain a maximum debt to tangible net worth ratio of 1.50 to 1.
Currently .98 to 1.
c) Maintain a tangible net worth of $6,250,000. Currently $7,051,000.
11) Borrower will not seel, hypothecate or encumber its interest in Gresham
Power Electronics without Bank's prior approval.
<PAGE>
Digital Power Corporation
Commitment Letter dated June 11, 1998
page 3 of 3
Upon any default by Borrower under any of the terms or conditions of this
agreement, or under the events of default listed in said note, or if a default
occurs in any other loan or obligation to San Jose National Bank by you or in
any other credit obligation by Borrower, these loans and/or lines of credit
shall, at the option of the Bank, immediately terminate and Bank may declare all
sums of principal and interest remaining unpaid on loans made and note issued
under these line of credit and loans immediately due and payable without notice.
Your acknowledgment of this letter shall constitute acceptance of the foregoing
terms and conditions. Unless accepted, this commitment shall expire on June 30,
1998.
We appreciate the opportunity to make this commitment to you and look forward to
a long and mutually beneficially relationship.
Sincerely,
By: /s/ Tim Johnson
----------------------------------
Tim Johnson
Vice President
Acknowledged and agreed to:
DIGITAL POWER CORPORATION
By: /s/ Robert Smith
----------------------------------
Robert Smith
President & CEO
Exhibit 10.10
PROMISSORY NOTE
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Principal Loan Date Maturity Loan No. Call Collateral Account Officer Initials
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$3,000,000.00 06-15-1998 06-15-1999 1071513796R 50/74 UCC 1071513796R TAJ
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
References in the shaded area are for Lender's use only and do not limit the
applicability of this document to any particular loan or item
<TABLE>
<CAPTION>
<S> <C>
Borrower: DIGITAL POWER CORPORATION (TIN: 94-1721931) Lender: SAN JOSE NATIONAL BANK
41920 CHRISTY STREET P. O. BOX 1957 JOHN ST., SUITE 710
FREMONT, CA 94538 ONE NORTH MARKET STREET
SAN JOSE, CA 95113
</TABLE>
<TABLE>
<S> <C> <C> <C>
Principal Amount: $3,000,000.00 Initial Rate: 8.500% Date of Note: June 15, 1998
</TABLE>
PROMISE TO PAY. DIGITAL POWER CORPORATION ("Borrower") promises to pay to SAN
JOSE NATIONAL BANK ("Lender"), or order, in lawful money of the United States of
America, the principal amount of Three Million & 00/100 Dollars ($3,000,000.00)
or so much as may be outstanding, together with interest on the unpaid
outstanding principal balance of each advance. Interest shall be calculated from
the date of each advance until repayment of each advance.
PAYMENT. Borrower will pay this loan on demand, or if no demand is made, in one
payment of all outstanding principal plus all accrued unpaid interest on June
15, 1999. In addition, Borrower will pay regular monthly payments of accrued
unpaid interest beginning July 15, 1998, and all subsequent interest payments
are due on the same day of each month after that. The annual interest rate for
this Note is computed on a 365/360 basis; that is, by applying the ratio of the
annual interest rate over a year of 360 days, multiplied by the outstanding
principal balance, multiplied by the actual number of days the principal balance
is outstanding. Borrower will pay Lender at Lender's address shown above or at
such other place as Lender may designate in writing. Unless otherwise agreed or
required by applicable law, payments will be applied first to accrued unpaid
interest, then to principal, and any remaining amount to any unpaid collection
costs and late charges.
VARIABLE INTEREST RATE. The interest rate on this Note is subject to change from
time to time based on changes in the index which is Lender's Prime Rate (the
"Index"). This is the rate Lender charges, or would charge, on 90-day unsecured
loans to the most creditworthy corporate customers. This rate may or may not be
the lowest rate available from Lender at any given time. Lender will tell
Borrower the current Index rate upon Borrower's request. Borrower understands
that Lender may make loans based on other rates as well. The interest rate
change will not occur more often than each DAY. The Index currently is 8.500%.
The interest rate to be applied to the unpaid principal balance of this Note
will be at a rate equal to the Index, resulting in an initial rate of 8.500%.
NOTICE: Under no circumstances will the interest rate on this Note be more than
the maximum rate allowed by applicable law.
PREPAYMENT; MINIMUM INTEREST CHARGE. Borrower agrees that all loan fees and
other prepaid finance charges are earned fully as of the date of the loan and
will not be subject to refund upon early payment (whether voluntary or as a
result of default), except as otherwise required by law. In any event, even upon
full prepayment of this Note, Borrower understands that Lender is entitled to a
minimum interest charge of $100.00. Other than Borrower's obligation to pay any
minimum interest charge, Borrower may pay without penalty all or a portion of
the amount owed earlier than it is due. Early payments will not, unless agreed
to by Lender in writing, relieve Borrower of Borrower's obligation to continue
to make payments of accrued unpaid interest. Rather, they will reduce the
principal balance due.
LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged
5.000% of the regularly scheduled payment or $25.00, whichever is greater.
DEFAULT. Borrower will be in default if any of the following happens: (a)
Borrower fails to make any payment when due. (b) Borrower breaks any promise
Borrower has made to Lender, or Borrower fails to comply with or to perform when
due any other term, obligation, covenant, or condition contained in this Note or
any agreement related to this Note, or in any other agreement or loan Borrower
has with Lender. (c) Any representation or statement made or furnished to Lender
by Borrower or on Borrower's behalf is false or misleading in any material
respect either now or at the time made or furnished. (d) Borrower becomes
insolvent, a receiver is appointed for any part of Borrower's property, Borrower
makes an assignment for the benefit of creditors, or any proceeding is commenced
either by Borrower or against Borrower under any bankruptcy or insolvency laws.
(e) Any creditor tries to take any of Borrower's property on or in which Lender
has a lien or security interest. This includes a garnishment of any of
Borrower's accounts with Lender. (f) Any guarantor dies or any of the other
events described in this default section occurs with respect to any guarantor of
this Note. (g) A material adverse change occurs in Borrower's financial
condition, or Lender believes the prospect of payment or performance of the
indebtedness is impaired.
If any default, other than a default in payment, is curable and if Borrower has
not been given a notice of a breach of the same provision of this Note within
the preceding twelve (12) months, it may be cured (and no event of default will
have occurred) if Borrower, after receiving written notice from Lender demanding
cure of such default: (a) cures the default within fifteen (15) days; or (b) if
the cure requires more than fifteen (15) days, immediately initiates steps which
Lender deems in Lender's sole discretion to be sufficient to cure the default
and thereafter continues and completes all reasonable and necessary steps
sufficient to produce compliance as soon as reasonably practical.
<PAGE>
LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal
balance on this Note and all accrued unpaid interest immediately due, without
notice, and then Borrower will pay that amount. Upon Borrower's failure to pay
all amounts declared due pursuant to this section, including failure to pay upon
final maturity, Lender, at its option, may also , if permitted under applicable
law, do one or both of the following: (a) increase the variable interest rate on
this Note to 5.000 percentage points over the Index, and (b) add any unpaid
accrued interest to principal and such sum will bear interest therefrom until
paid at the rate provided in this Note (including any increased rate). Lender
may hire or pay someone else to help collect this Note if Borrower does not pay.
Borrower also will pay Lender that amount. This includes, subject to any limits
under applicable law, Lender's attorneys' fees and Lender's legal expenses
whether or not there is a lawsuit, including attorneys' fees and legal expenses
for bankruptcy proceedings (including efforts to modify or vacate any automatic
stay or injunction), appeals, and any anticipated post-judgment collection
services. Borrower also will pay any court costs, in addition to all other sums
provided by law. This Note has been delivered to Lender and accepted by Lender
in the State of California. If there is a lawsuit, Borrower agrees upon Lender's
request to submit to the jurisdiction of the courts of SANTA CLARA County, the
State of California. Lender and Borrower hereby waive the right to any jury
trial in any action, proceeding, or counterclaim brought by either Lender or
Borrower against the other. This Note shall be governed by and construed in
accordance with the laws of the State of California.
DISHONORED ITEM FEE. Borrower will pay a fee to Lender of $15.00 if Borrower
makes a payment on Borrower's loan and the check or preauthorized charge with
which Borrower pays is later dishonored.
RIGHT OF SETOFF. Borrower grants to Lender a contractual security interest in,
and hereby assigns, conveys, delivers, pledges, and transfers to Lender all
Borrower's right, title and interest in and to, Borrower's accounts with Lender
(whether checking, savings, or some other account), including without limitation
all accounts held jointly with someone else and all accounts Borrower may open
in the future, excluding however all IRA and Keogh accounts, and all trust
accounts for which the grant of a security interest would be prohibited by law.
Borrower authorizes Lender, to the extent permitted by applicable law, to charge
or setoff all sums owing on this Note against any and all such accounts.
COLLATERAL. This Note is secured by a SECURITY AGREEMENT DATED JANUARY 20, 1998
AND A UCC FILING DATED APRIL 28, 1994, RECORDED AS INSTRUMENT #94106664 ON MAY
27, 1994, WITH THE SECRETARY OF STATE IN SACRAMENTO.
LINE OF CREDIT. This Note evidences a revolving line of credit. Advances under
this Note may be requested orally by Borrower or by an authorized person. Lender
may, but need not, require that all oral requests be confirmed in writing. All
communications, instructions, or directions by telephone or otherwise to Lender
are to be directed to Lender's office shown above. The following party or
parties are authorized to request advances under the line of credit until Lender
receives from Borrower at Lender's address shown above written notice of
revocation of their authority: ROBERT SMITH, PRESIDENT; PHILIP G. SWANY,
SECRETARY; and JOSEPHINE JACKEWICZ, CONTROLLER. Borrower agrees to be liable for
all sums either: (a) advanced in accordance with the instructions of an
authorized person or (b) credited to any of Borrower's accounts with Lender. The
unpaid principal balance owing on this Note at any time may be evidenced by
endorsements on this Note or by Lender's internal records, including daily
computer printouts. Lender will have no obligation to advance funds under this
Note if: (a) Borrower or any guarantor is in default under the terms of this
Note or any agreement that Borrower or any guarantor has with Lender, including
any agreement made in connection with the signing of this Note; (b) Borrower or
any guarantor ceases doing business or is insolvent; (c) any guarantor seeks,
claims or otherwise attempts to limit, modify or revoke such guarantor's
guarantee of this Note or any other loan with Lender; or (d) Borrower has
applied funds provided pursuant to this Note for purposes other than those
authorized by Lender.
LETTER AGREEMENT. THIS NOTE IS SUBJECT TO, AND SHALL BE GOVERNED BY, ALL THE
TERMS AND CONDITIONS OF THE LETTER AGREEMENT DATED JUNE 11, 1996, BETWEEN THE
BORROWER(S) AND SAN JOSE NATIONAL BANK, WHICH LETTER AGREEMENT IS INCORPORATED
HEREIN BY REFERENCE.
GENERAL PROVISIONS. This Note is payable on demand. The inclusion of specific
default provisions or rights of Lender shall not preclude Lender's right to
declare payment of this Note on its demand. Lender may delay or forgo enforcing
any of its rights or remedies under this Note without losing them. Borrower and
any other person who signs, guarantees or endorses this Note, to the extent
allowed by law, waive any applicable statute of limitations, presentment, demand
for payment, protest and notice of dishonor. Upon any change in the terms of
this Note, and unless otherwise expressly stated in writing, no party who signs
this Note, whether as maker, guarantor, accommodation maker or endorser, shall
be released from liability. All such parties agree that Lender may renew or
extend (repeatedly and for any length of time) this loan, or release any party
or guarantor or collateral; or impair, fail to realize upon or perfect Lender's
security interest in the collateral; and take any other action deemed necessary
by Lender without the consent of or notice to anyone. All such parties also
agree that Lender may modify this loan without the consent of or notice to
anyone other than the party with whom the modification is made.
PRIOR TO SIGNING THIS NOTE, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF
THIS NOTE, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS. BORROWER AGREES TO
THE TERMS OF THE NOTE AND ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THE NOTE.
BORROWER:
DIGITAL POWER CORPORATION
By: /s/ Robert Smith By: /s/ Philip G Swany
------------------------- ---------------------------
ROBERT SMITH, PRESIDENT PHILIP G. SWANY, SECRETARY
Exhibit 21.1
SUBSIDIARIES OF DIGITAL POWER CORPORATION
Poder Digital S. A. de C.V., a Mexican corporation
Digital Power Limited, a United Kingdom corporation
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM
10-KSB FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998, 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-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 867,607
<SECURITIES> 0
<RECEIVABLES> 3,852,038
<ALLOWANCES> (292,000)
<INVENTORY> 4,864,520
<CURRENT-ASSETS> 10,228,722
<PP&E> 2,708,646
<DEPRECIATION> (1,306,413)
<TOTAL-ASSETS> 12,990,819
<CURRENT-LIABILITIES> 5,227,406
<BONDS> 0
0
0
<COMMON> 9,012,679
<OTHER-SE> (1,493,908)
<TOTAL-LIABILITY-AND-EQUITY> 12,990,819
<SALES> 18,733,470
<TOTAL-REVENUES> 18,733,470
<CGS> 14,778,103
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<INTEREST-EXPENSE> (236,968)
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<INCOME-TAX> (258,000)
<INCOME-CONTINUING> (570,588)
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<EXTRAORDINARY> 0
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<NET-INCOME> (570,588)
<EPS-PRIMARY> (.21)
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</TABLE>
