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, 1999
[ ] 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
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, 1999, were $15,354,018.
As of March 30, 2000, the aggregate market value of the voting common stock held
by non-affiliates was approximately $9,104,501 based on the closing price of
$3.75 per share.
As of March 30, 2000, the number of shares of common stock outstanding was
2,804,435.
Transitional Small Business Disclosure Format (check one): Yes No x/
<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 Corporation ("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 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.
1999 Activity
Throughout most of 1999, the Company continued to experience softness in
demand for most of its product lines. This resulted in a decrease in revenues
from $18,733,470 in 1998 to $15,354,018 in 1999. The Company instituted several
cost saving measures including headcount reductions, primarily in its production
facilities in Mexico, as well as a 10% salary and wage reduction which affected
all of its employees in the US operations, effective January 1999. During this
same time period, however, the Company recognized the need to update its product
offering and initiated an aggressive new product development campaign. These
efforts have yielded the UPF150 product family which has been released to
production, as well as substantial progress on the development of the Company's
<PAGE>4
recently announced ePower300 and UPF200. These factors produced a loss of
$155,536 in the first quarter and a modest net income of $27,191 for the year.
Digital Power Limited
In 1998, Digital Power acquired the assets of Gresham Power Electronics.
Through its wholly-owned subsidiary, Digital Power Limited, 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 Power'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 to come from the same markets, as internet and intranet
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
<PAGE>5
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. 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, Dot Hill, Motorola,
Stanford Telecommunications, Extreme Networks, Foundry Networks, JDS Uniphase,
Ericsson, British Telecom and Lucent.
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.
<PAGE>6
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 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
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.
<PAGE>7
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.
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.
<PAGE>8
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 1999.
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 20% of its product requirements through
Fortron/Source and expects to increase these production levels due to cost
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.
<PAGE>9
Sales, Marketing and Customers
During 1999, the Company had revenues of $15,354,018 and net income of
$27,191 compared to revenues of $18,733,470 and a net loss of $(570,588) during
fiscal year 1998.
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, 1999 and 1998, distributor sales accounted for 31.6%
and 29.1%, respectively, of the Company's total sales. Over this same period,
one distributor accounted for 11.5% and 13.1%, 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, 1999 and 1998, private label sales accounted for 3.7%
and 8.2%, respectively, of total sales.
The Company's promotional efforts to date have included product data
sheets, feature articles in trade periodicals, and trade shows. The Company's
future promotional activities will likely include space advertising in
industry-specific publications, a full-line product catalog, application notes,
and direct mail to an industry-specific mail list.
The Company's products are warranted to be free of defects for a period
ranging from one to two years from date of shipment. No significant warranty
returns were experienced in either 1999 or 1998. As of December 31, 1999, the
Company's warranty reserve was $212,782.
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
<PAGE>10
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 $952,690 and $1,397,816 for the years ended December 31, 1999 and 1998,
respectively, and represented 6.20% and 7.46% of the Company's total revenues
for the corresponding periods.
Employees
As of December 31, 1999, the Company had approximately 285 full-time
employees, with 210 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
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 20% 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
<PAGE>11
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 1999, the Company lost $6,236 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, 1998,
one OEM accounted for 13% of the Company's total revenues. For the year ended
December 31, 1999, one OEM customer accounted for 11.0% 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, 1999, approximately $940,000 was outstanding.
The credit facility bears interest based upon the lender's prime rate, is due
September 15, 2000, and is secured by all of the Company's assets. Under terms
of the loan agreement, the Company is in compliance with covenants requiring
that the Company be profitable three of four quarters and maintain certain debt
to tangible net worth ratios. Gresham Power also has a credit facility of
$800,000 of which none was outstanding at December 31, 1999.
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
<PAGE>12
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 20% 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
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.
<PAGE>13
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 $6,653 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 $4,583 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. 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 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.
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 litigation, the Company
issued 35,000 shares of its common stock valued at $60,156 and will pay $150,000
in monthly payments, beginning in October 1998.
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
provided Mr. Valencia employment for six months at the hourly rate of $18.50, 40
hours per week. Mr Valencia's term of employment ended 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 is listed and traded on the American Stock
Exchange ("AMEX") under the symbol DPW. Previously, Digital Power had Redeemable
Common Stock Purchase Warrants which were listed and traded on the AMEX under
the symbol DPW+. Under the terms of the Warrants, the Warrants expired on
December 16, 1999. Information regarding the Warrants are for historical purpose
only. The following tables set forth the high and low closing sale prices, as
reported by AMEX, for Digital Power's Common Stock and Warrants for the prior
two fiscal years.
<PAGE>14
Common Stock
Period Low High
Quarter ending December 31, 1999 $1.25 $1.94
Quarter ending September 30, 1999 $1.50 $2.06
Quarter ending June 30, 1999 $1.38 $2.06
Quarter ending March 31, 1999 $1.31 $2.38
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
Redeemable Common Stock Purchase Warrants(1)
Period Low High
Quarter ending December 31, 1999 $ .00 $ .06
Quarter ending September 30, 1999 $ .06 $ .19
Quarter ending June 30, 1999 $ .06 $ .19
Quarter ending March 31, 1999 $ .25 $ .32
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
(1) Under the terms of the Warrants, the Warrants expired on December 16, 2000.
(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.
(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.
<PAGE>15
Item 6. Management's Discussion and Analysis or Plan of Operation.
Overview
The Company designs, develops, manufactures, and markets electronic
power supplies for use in converting electric power into a form suitable for the
operation of electronic circuitry. Revenues are generated from the sale of the
Company's power supplies to OEMs in the computer and other electronic equipment
industries.
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, 1999 and 1998.
Years Ended December 31,
------------------------
1999 1998
---- ----
Revenues 100.00 100.00
Cost of goods sold 73.45 78.89
--------- ---------
Gross margin 26.55 21.11
Selling, general and administrative 18.26 16.73
Research and development 6.20 7.46
--------- ---------
Total operating expense 24.46 24.19
--------- ---------
Operating income 2.09 (3.08)
Net interest expense 1.07 1.14
Translation loss .04 .20
--------- ---------
Income (Loss) before income taxes .98 (4.42)
Provision (Benefit) for income taxes .80 (1.37)
--------- ---------
Net (Loss) Income .18% (3.05)%
========= =========
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>16
Year Ended December 31, 1999, Compared to Year Ended December 31, 1998
Revenues
Revenues for the fiscal year ended December 31, 1999, were $15,354,018,
which represented a decrease of $3,379,452, or approximately 18%, from revenues
of $18,733,470 for the year ended December 31, 1998. This decrease in total
revenues includes a 8% decrease in revenues of $532,424 from Gresham Power with
revenues of $7,002,041 and $6,469,617 for the fiscal years ended December 31,
1998 and 1999. The decrease in revenues was due primarily to a reduction in
sales and marketing efforts and a re-allocation of these resources to new
product development initiatives in the U.S.
Gross Margin
Gross margins were 26.55% for the year ended December 31, 1999, compared
to 21.11% for the fiscal year ended December 31, 1998. This increase in gross
margins can be primarily attributed to aggressive cost containment measures
initiated by the Company including headcount reductions in the U.S. and Mexico,
and a 10% salary and wage reduction which affected all of its U.S. employees.
Selling, General and Administrative
Total selling, general and administrative expenses decreased by $330,628
to $2,803,493 for the year ended December 31, 1999, from $3,134,121 for the
fiscal year ended December 31, 1998, primarily due to reduced U.S. payroll
related expenses and commissionable sales. Gresham Power selling, general and
administrative expenses increased $349,015 from $1,289,006 in 1998 to $1,638,021
for the fiscal year ended December 31, 1999, primarily due to the hiring of a
full time sales manager responsible for the sales and distribution of Digital
Power designs and products in the U.K. and Europe, with related increased
travel, trade show expense and advertising.
Research and Development
Research and development expenses were $952,690 for the year ended
December 31, 1999, as compared to $1,397,816 for the year ended December 31,
1998. Of the $445,126 decrease, $2,390 is attributed to Gresham Power. The other
additional decrease can be primarily attributed to the 1998 settlement of
litigation involving KDK Electronics, with no comparable expense in 1999.
Interest Expense
Net interest expense was $147,408 for the year ended December 31, 1999,
compared to $220,894 for the year ended December 31, 1998. This decrease in
interest expense is primarily due to reduced borrowings on the Company line of
credit which was reduced from $1,590,000 at the end of 1998, to $940,000 at the
end of 1999, paid by cash savings from the 1996 IPO.
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 1999, the
Company experienced a translation loss of $6,236 primarily related to Poder
Digital's operations using Mexican pesos, compared with a translation loss of
$37,771 in 1998.
<PAGE>17
Income (Loss) Before Income Taxes
The Company income before income taxes increased $978,779 to a $150,191
income before income taxes during 1999 from a loss before income taxes of
$(828,588) during 1998. Gresham Power contributed $314,003 income before income
taxes in 1999, and $237,603 income before income taxes in 1998. This increase
was due primarily to the improvement in gross margins which resulted from the
cost containment initiatives, as discussed in the gross margin section.
Income Tax
For the year ended December 31, 1999, the Company had an income tax
expense of $123,000 compared to a tax benefit of $258,000 due to its 1998 net
loss for the year ended December 31, 1998. Gresham Power income tax expense was
$120,983 in 1999 and $120,983 in 1998.
Net Income (Loss)
The Company net income increased $597,779 to a net income of $27,191 in
1999 from a net loss of $(570,588) in 1998. Gresham Power net income was
$171,003 in 1999 compared to net income of $116,620 in 1998.
The Company does not believe that its business is seasonal.
Liquidity And Capital Resources
Through December 31, 1999, the Company funded its operations primarily
through revenues generated from operations, and bank borrowings. As of December
31, 1999, the Company had cash and cash equivalents of $824,708 and working
capital of $5,367,917. This compares with cash and cash equivalents of $867,607
and working capital of $5,001,316 at December 31, 1998. The increase in working
capital for the year ended December 31, 1999, is primarily due to the Company's
income and reduction of debt. Cash provided by operating activities for the
Company totaled $1,728,208 and $10,066 for the year ended December 31, 1999 and
1998 respectively. Cash used in investing activities of $161,896 during 1999
consisted primarily of expenditures for the purchase of production and testing
equipment. During 1998, cash used in investing activities amounted to $3,500,586
primarily from the purchase of the assets of Gresham Power. For the year ended
December 31, 1999, cash used in financing activities included payments of
$1,524,302 on borrowings. During the year ended December 31, 1998, cash provided
by financing activities included proceeds from borrowings of $2,366,846 and
proceeds of $95,350 from the exercise of warrants and stock options, offset by
payments of $300,504 on borrowings.
The Company was 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. The loan was paid during
1999, and bore 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 was paid by the ESOP through contributions made by the Company to the ESOP
in the amount of approximately $8,852 per month. This amount has been a monthly
charge to expense.
<PAGE>18
Year 2000 Compliance
The Year 2000 problem arises when computer programs have been written
having two digits rather than four to define the applicable year. As a result,
date-sensitive software and/or hardware may recognize a date having 00 as the
year 1900 rather than the year 2000. This could result in a system failure or
other disruption of operations and impede normal business activities.
The total cost associated with required modifications to become Year
2000 compliant is not expected to be material to Digital Power's financial
position. The estimated total cost of the Year 2000 project was approximately
$10,000 which was expensed as incurred. In addition, Gresham Power purchased
hardware and software upgrades for approximately $150,000 that were capitalized.
Digital Power completed all phases of its Year 2000 compliance project
and as of March 31, 2000, Digital Power has not encountered any material Year
2000 problems.
Although Digital Power's Year 2000 rollover did not present any material
business disruption, there are some remaining Year 2000 related risks, including
risks due to the fact that the Year 2000 is a leap year. Management believes
that appropriate actions have been taken to address these remaining Year 2000
issues and contingency plans are in place to minimize the financial impact to
Digital Power. Management, however, cannot be certain that Year 2000 issues
affecting customers, suppliers or service provides of Digital Power will not
have a material adverse impact on Digital Power.
Impact of Recently Issued Standards
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities," (FASB133). 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. This statement was amended by
Statement of Financial Accounting Standards No. 137, issued in June 1999, such
that it is effective for the Company's financial statements for the year ending
December 31, 2001. 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.
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-23.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
<PAGE>19
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act of the Registrant.
The bylaws of Digital Power currently sets the number of directors
constituting the entire board to be five (5), each to serve until the next
Annual Meeting and until his successor shall be elected and qualified or until
his earlier death, resignation, or removal. There are no family relationships
between any of the directors and executive officers of Digital Power. The
following table sets forth all the directors and executive officers of Digital
Power and certain information with respect to those persons as of December 31,
1999.
<TABLE>
<CAPTION>
Directors, Executive Officers and Background For the Past
Name Age Five Years
- ---- --- ---------------------------------------------------------
<S> <C> <C>
Robert O. Smith 55 Chief Executive Officer and Director since 1989 and President since
May 1996. From 1980 to 1989 variously served as Vice
President/Group Controller of Power Conversion Group, General
Manager of Compower Division, and President of Boschert
subsidiary, of Computer Products, Inc., manufacturer of power
conversion products and industrial automation systems. Received
B.S. in Business Administration from Ohio University and
completed course work in M.B.A. program at Kent State University.
Chris Schofield 43 Managing Director of Digital Power Limited since January 1998.
Director and General Manager of Gresham Power Group from 1995
to 1998. From 1988 to 1995, Director of United Kingdom
Operations of the Oxford Instruments Group.
Thomas W. O'Neil, Jr. 70 Director since 1991. Certified Public Accountant and Partner since
1991 of Schultze, Wallace and O'Neil, CPAs. Retired as Partner,
from 1955 to 1991, of KPMG Peat Marwick. Director of California
Exposition and State Fair; Director of Regional Credit Association;
Director of Alternative Technology Resources, Inc. Graduate of St.
Mary's College and member of the St. Mary's College Board of
Regents.
<PAGE>20
Directors, Executive Officers and Background For the Past
Name Age Five Years
- ---- --- ---------------------------------------------------------
Scott C. McDonald 46 Director since May 1998. Chief Financial and Administrative
Officer of Conxion Corporation since December 1999. Director of
Castelle Incorporated since April 1999. Director of Octant
Technologies, Inc. since April 1998. From November 1996 to May
1998, director of CIDCO Incorporated, a communications and
information delivery company. From October 1993 to January 1997,
Executive Vice President, Chief Operating and Financial Officer of
CIDCO. From March 1993 to September 1993, President, Chief
Operating and Financial Officer of PSI Integration, Inc. From
February 1989 to February 1993, Chief Financial Officer and Vice
President, Finance of Administration of Integrated System, Inc.
Received B.S. in Accounting from The University of Akron and
M.B.A. from Golden Gate University.
Robert J. Boschert 63 Business consultant for small high-growth technology companies.
Director since 1990 of Hytek Microsystems, Inc. From June 1986
until June 1998, served as consultant to Union Technology. Founder
of Boschert, Inc. Retired as a member of the board of directors in
1984. Received B.S. in Electrical Engineering from University of
Missouri.
Philip G. Swany 50 Mr. Swany joined the Company as its Controller in 1981. In
February 1992, he left the Company to serve as the Controller for
Crystal Graphics, Inc., a 3-D graphics software development
company. In September 1995, Mr. Swany returned to the
Company where he was made Vice President-Finance. In May
1996, he was named Chief Financial Officer and Secretary of the
Company. Mr. Swany received a B.S. degree in Business
Administration - Accounting from Menlo College, and attended
graduate courses in business administration at the University of
Colorado.
</TABLE>
Committees of the Board; Meetings and Attendance
The Board has an Audit Committee and a Compensation Committee. The Audit
Committee currently consists of Messrs. McDonald and O'Neil, and the
Compensation Committee consists of Messrs. Boschert and McDonald. The Board does
not have a Nominating Committee. The primary functions of the Audit Committee
are to review the scope and results of audits by the Company's independent
auditors, the Company's internal accounting controls, the non-audit services
performed by the independent accountants, and the cost of accounting services.
The Compensation Committee administers the Company's 1996 Stock Option Plan and
the Company's 1998 Stock Option Plan upon its adoption and approves
compensation, remuneration, and incentive arrangements for officers and
employees of the Company.
<PAGE>21
The Board met three times during 1999, and the Audit Committee and the
Compensation Committee each met one time during 1999. Each director attended at
least seventy-five percent of the meetings of the Board and of the committees
upon which he served except for Mr. Boschert who attended 66 2/3% of the
meetings and Mr. Schofield who attended 33 1/3% of the meetings.
Compensation of Directors
Non-employee directors receive $10,000 per annum paid quarterly and options
to purchase 10,000 shares of Common Stock.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires Digital
Power's directors, executive officers, and persons who own more than 10% of
Digital Power's outstanding Common Stock to file reports of ownership and
changes in ownership with the SEC. Directors, executive officers, and
shareholders of more the 10% of Digital Power's Common Stock are required by SEC
regulations to furnish Digital Power with copies of the Section 16(a) forms they
file.
Based solely on a review of the copies of such forms furnished to Digital
Power, or written representations that such filings were not required, Digital
Power believes that, during the calendar year 1999, the directors and officers
complied with the Section 16(a) filing requirements.
Item 10. Executive Compensation.
Executive officers are appointed by, and serve at the discretion of, the
Board of Directors. Except for Robert O. Smith, the Company's President and
Chief Executive Officer, the Company has no employment agreements with any of
its executive officers. The following table sets forth the compensation of the
Company's President and Chief Executive Officer during the past three years. No
other officer received annual compensation in excess of $100,000 during the 1999
fiscal year.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Long Term Compensation
Annual Compensation Awards Payouts
----------------------------------- ------------------------------- -------------
Restricted Securities LTIP All Other
Name and Other Annual Stock Underlying Payouts Compensa-
Principal Position Year Salary Compensation ($) Award(s) ($) Options (#) ($) tion
- ---------------------------------------------------------------- ------------------------------- --------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Robert O. Smith 1999 $134,038(1) $0 $0 100,000(2) $0 $0
President and CEO 1998 $141,912(1) $0 $0 100,000(3) $0 $0
1997 $150,000 $0 $0 100,000(4) $0 $0
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Pursuant to Mr. Smith's employment contract, during 1999, Mr. Smith was
entitled to receive $200,000 per annum and during 1998, was entitled to
receive $175,000 per annum. Due to the financial condition of the Company,
Mr. Smith only received $134,038 and $141,912 during 1999 and 1998,
respectively.
(2) Represents options to acquire 100,000 shares of common stock at $1.875 per
share.
<PAGE>22
(3) Pursuant to his employment contract, in January 1998, Mr. Smith received
options to acquire 100,000 shares of Common Stock at $6.69 per share. These
options expire in January 2008. On November 5, 1998, these options were
repriced to an exercise price of $2.31 per share.
(4) Pursuant to his employment contract, in January 1997, Mr. Smith received
options to acquire 100,000 shares of Common Stock at $5.4375 per share.
These options expire in January 2007. On November 5, 1998, these options
were repriced to an exercise price of $2.31 per share
On March 1, 2000, the Company and Mr. Smith entered into an employment
contract effective January 1, 2000. The term of the employment agreement is for
one year subject to annual renewal. Under the terms of Mr. Smith's employment
contract, Mr. Smith shall serve as President and Chief Executive Officer of the
Company and his salary shall be $200,000 per annum and be entitled to bonuses as
determined by the Board. In addition, he shall have the right to receive on the
first business day of each January during the term of his contract options to
acquire 100,000 shares of Common Stock at the lower of market value as of such
date or the average closing price for the first six months of each year of his
contract. Pursuant to Mr. Smith's employment contract, in the event there is a
change in control of the Company, Mr. Smith shall be entitled to receive in one
payment, the sum of six (6) times his annual base salary. If Mr. Smith's
employment agreement is not renewed or he is terminated without cause, Mr. Smith
will be entitled to three times his annual base salary.
The following table sets forth the options granted to Mr. Smith during
the past fiscal year.
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
---------------------------------------------------------------------------------------
% of Total Options
Number of Securities Granted to Exercise or
Underlying Options Employees in Fiscal Base Price Expiration
Name Granted (#) Year ($/Sh) Date
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Robert O. Smith 100,000 54.98% $1.875 January 2009
</TABLE>
The following table sets forth Mr. Smith's fiscal year end option
values. No options were exercised by Mr. Smith during 1999.
<TABLE>
<CAPTION>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Value of
Number of Unexercised In-
Unexercised Options the-Money Options
at FY-End (#) at FY-End ($)(1)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise (#) Value Realized ($) Unexercisable Unexercisable
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Robert O. Smith None None 386,900 Exercisable $81,469 Exercisable
</TABLE>
(1) Market price at December 31, 1999, for a share of common stock was $1.4375.
<PAGE>23
Stock Plans
Employee Stock Purchase Plan. The Company has adopted an Employee Stock
Ownership Plan ("ESOP") in conformity with ERISA requirements. As of December
31, 1999, the ESOP owns, in the aggregate, 167,504 shares of the Company's
Common Stock. In June 1996, the ESOP entered into a $500,000 loan with San Jose
National bank to finance the purchase of shares. The Company guaranteed the
repayment of the loan, and Company contributions to the ESOP were used to pay
off the loan by the end of 1999. All employees of the Company participate in the
ESOP on the basis of level of compensation and length of service. Participation
in the ESOP is subject to vesting over a six-year period. The shares of the
Company's Common Stock owned by the ESOP are voted by the ESOP trustees. Mr.
Smith, President and Chief Executive Officer of the Company, is one of two
trustees of the ESOP.
1998 and 1996 Stock Option Plans
The Company has established the 1998 and 1996 Stock Option Plans (the
"Plans"). The purposes of the Plans are to encourage stock ownership by
employees, officers, and directors of the Company to give them a greater
personal interest in the success of the business and to provide an added
incentive to continue to advance in their employment by or service to the
Company. A total of 753,000 options are authorized to be issued under the Plans,
of which 647,980 options have been issued. The Plans provide for the grant of
either incentive or non-statutory stock options. The exercise price of any
incentive stock option granted under the Plans may not be less than 100% of the
fair market value of the Common Stock of the Company on the date of grant. The
fair market value for which an optionee may be granted incentive stock options
in any calendar year may not exceed $100,000. Shares subject to options under
the Plans may be purchased for cash. Unless otherwise provided by the Board, an
option granted under the Plans is exercisable for ten years. The Plans are
administered by the Compensation Committee which has discretion to determine
optionees, the number of shares to be covered by each option, the exercise
schedule, and other terms of the options. The Plans may be amended, suspended,
or terminated by the Board but no such action may impair rights under a
previously granted option. Each incentive stock option is exercisable, during
the lifetime of the optionee, only so long as the optionee remains employed by
the Company. No option is transferrable by the optionee other than by will or
the laws of descent and distribution.
Other Stock Options
The Company, as of December 31, 1999, has outstanding options to acquire
92,000 shares of Common Stock at $1.80 per share and options to acquire 86,900
shares of Common Stock at $.50 per share. These options were granted to
employees in May 1993 and are now fully vested.
401(k) Plan
The Company has adopted a tax-qualified employee savings and retirement
plan (the "401(k) Plan"), which generally covers all of the Company's full-time
employees. Pursuant to the 401(k) Plan, employees may make voluntary
contributions to the 401(k) Plan up to a maximum of six percent of eligible
compensation. These deferred amounts are contributed to the 401(k) Plan. The
401(k) Plan permits, but does not require, additional matching and Company
contributions on behalf of Plan participants. The Company matches contributions
at the rate of $.25 for each $1.00 contributed. The Company can also make
discretionary contributions. The 401(k) Plan is intended to qualify under
Sections 401(k) and 401(a) of the Internal Revenue Code of 1986, as amended.
Contributions to such a qualified plan are deductible to the Company when made
and neither the contributions nor the income earned on those contributions is
taxable to Plan participants until withdrawn. All 401(k) Plan contributions are
credited to separate accounts maintained in trust.
<PAGE>24
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth, as of March 31, 2000, certain
information with respect to the beneficial ownership of shares of Digital Power
Common Stock by all shareholders known by Digital Power to be the beneficial
owners of more than five percent of the outstanding shares of such Common Stock,
all directors and executive officers of Digital Power individually, and all
directors and all executive officers of Digital Power as a group. As of March
31, 2000, there were 2,804,435 shares of Common Stock outstanding.
No. of Shares
Name Common Stock(1) Percent
- -------------------------------------------------------------------------------
Rhodora Finance Corporation Limited 183,464 6.54%
80 Broad Street
Monrovia, Liberia
Digital Power - ESOP 167,504 5.97%
41920 Christy Street
Fremont, CA 94538
Thomas W. O'Neil, Jr., 75,600(2) 2.65%
Director
Robert O. Smith, 765,904(3) 22.51%
Director and Chief Executive Officer
Chris Schofield, -0- -0-
Managing Director, Digital Power Limited
Philip G. Swany, 49,250(4) 1.73%
Chief Financial Officer
Scott C. McDonald, 10,000(5) *
Director
Robert J. Boschert, 10,000(5) *
Director
All directors and executive officers as a
group (6 persons) 919,754(6) 24.7%
===============================================================================
* Less than one percent.
(1) Except as indicated in the footnotes to this table, the persons named in
the table have sole voting and investment power with respect to all shares
of Common Stock shown as beneficially owned by them, subject to community
property laws where applicable.
(2) Includes 50,000 shares subject to options and warrants exercisable within
60 days.
(3) Includes 598,400 shares subject to options and warrants exercisable within
60 days. Also includes 167,504 owned by the Digital Power ESOP of which Mr.
Smith is a trustee.
(4) Represents 49,250 shares subject to options exercisable within 60 days.
(5) Includes 10,000 shares subject to options and warrants exercisable within
60 days.
(6) Includes 717,650 shares subject to options and warrants and exercisable
within 60 days. Also includes 167,504 shares owned by the Digital Power
ESOP of which Mr. Smith is a trustee and may be deemed a beneficial owner.
<PAGE>25
Item 12. Certain Relationships and Related Transactions.
None.
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)
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(5)
10.10 Promissory Note(5)
10.11 Employment Agreement with Robert O. Smith
21.1 The Company's subsidiaries consist of Poder Digital S.A. de C.V., a
corporation formed under the laws of Mexico, and Digital Power Limited,
a corporation formed under the laws of the United Kingdom.
27.1 Financial Data Schedule
(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.
(5) Previously filed with the Commission with its Form 10-KSB for the year
ended December 31, 1998
(b) Reports on Form 8-K
None.
<PAGE>26
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.
Dated: April 14, 2000 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 14, 2000
Robert O. Smith, Chief Executive Officer
(Principal Executive Officer)
/s/ Philip G. Swany April 14, 2000
Philip G. Swany, Chief Financial Officer
(Principal Accounting and
Financial Officer)
/s/ Robert J. Boschert April 14, 2000
Robert J. Boschert, Director
/s/ Scott C. McDonald April 14, 2000
Scott C. McDonald, Director
April 14, 2000
Thomas W. O'Neil, Jr., Director
/s/ Chris Schofield April 14, 2000
Chris Schofield, Director
<PAGE>F-1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Independent Auditor's Report...............................................F-2
Consolidated Balance Sheet - December 31, 1999.............................F-3
Consolidated Statements of Operations - For the Years
Ended December 31, 1999 and 1998......................................F-4
Consolidated Statement of Stockholders' Equity - For the Years Ended
December 31, 1999 and 1998.............................................F-5
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 1999 and 1998.............................................F-6
Notes to Consolidated Financial Statements.................................F-8
<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, 1999, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended December 31, 1999 and 1998. 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, 1999, and the results of their
operations and their cash flows for the years ended December 31, 1999 and 1998,
in conformity with generally accepted accounting principles.
/s/HEIN + ASSOCIATES LLP
HEIN + ASSOCIATES LLP
Certified Public Accountants
Orange, California
March 15, 2000
<PAGE>F-3
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31,
1999
------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 824,708
Accounts receivable - trade, net of allowance for
doubtful accounts of $210,485 2,813,080
Income tax refund receivable 70,988
Other receivables 99,875
Inventories, net 4,531,261
Prepaid expenses and deposits 61,326
Deferred income taxes 360,136
------------
Total current assets 8,761,374
PROPERTY AND EQUIPMENT, net 1,223,137
EXCESS OF PURCHASE PRICE OVER NET ASSETS ACQUIRED, net of
accumulated amortization of $289,926 1,162,264
DEPOSITS 14,058
------------
TOTAL ASSETS $ 11,160,833
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable $ 940,000
Current portion of capital lease obligations 43,646
Accounts payable 1,196,170
Accrued liabilities 1,213,641
------------
Total current liabilities 3,393,457
CAPITAL LEASE OBLIGATIONS, less current portion 80,825
OTHER LONG-TERM LIABILITIES 25,000
DEFERRED INCOME TAXES 9,344
------------
Total liabilities 3,508,626
COMMITMENTS AND CONTINGENCIES (Notes 7 and 12)
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
Additional paid-in capital 331,310
Accumulated deficit (1,832,337)
Note receivable - stockholder (52,200)
Accumulated other comprehensive income 192,755
------------
Total stockholders' equity 7,652,207
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 11,160,833
============
See accompanying notes to these consolidated financial statements.
<PAGE>F-4
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------
1999 1998
------------ ------------
REVENUES $ 15,354,018 $ 18,733,470
COST OF GOODS SOLD 11,277,170 14,778,103
------------ ------------
Gross margin 4,076,848 3,955,367
------------ ------------
OPERATING EXPENSES:
Research and development 952,690 1,397,816
Marketing and selling 1,159,323 1,561,803
General and administrative 1,644,170 1,572,318
------------ ------------
Total operating expenses 3,756,183 4,531,937
------------ ------------
INCOME (LOSS) FROM OPERATIONS 320,665 (576,570)
------------ ------------
OTHER INCOME (EXPENSE):
Interest income 30,935 16,074
Interest expense (178,343) (236,968)
Translation loss (6,236) (37,771)
Gain (loss) on disposal of assets (16,830) 6,647
------------ ------------
Other income (expense) (170,474) (252,018)
------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES 150,191 (828,588)
PROVISION FOR INCOME TAX (BENEFIT) EXPENSE 123,000 (258,000)
------------ ------------
NET INCOME (LOSS) $ 27,191 $ (570,588)
============ ============
NET INCOME (LOSS) PER COMMON SHARE:
Basic net income (loss) per share $ .01 $ (.21)
============ ============
Diluted net income (loss) per share $ .01 $ (.21)
============ ============
See accompanying notes to these consolidated financial statements.
<PAGE>F-5
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 and 1998
<TABLE>
<CAPTION>
ACCUMULATED
OTHER TOTAL
COMMON STOCK ADDITIONAL NOTE COMPRE- STOCK-
----------------------- PAID-IN ACCUMULATED ESOP RECEIVABLE- HENSIVE HOLDERS'
SHARES AMOUNT CAPITAL DEFICIT SHARES STOCKHOLDER INCOME EQUITY
--------- ----------- --------- ------------ ---------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES, January 1, 1998 2,694,485 $ 8,856,489 $ 233,762 $ (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
settlement 35,000 60,156 - - - - - 60,156
Contribution to ESOP - - - - 140,504 - - 140,504
Compensation recognized
upon issuance of warrants - - 46,032 - - - - 46,032
Comprehensive loss:
Net loss - - - (570,588) - - - -
Income tax benefit arising from
the exercise of employee stock
options - - - - - - 38,366 -
Foreign currency
translation adjustment - - - - - - 36,234 -
Total comprehensive loss - - - - - - (495,988)
--------- ----------- --------- ------------ ---------- ----------- --------- -----------
BALANCES, December 31, 1998 2,771,435 9,012,679 279,110 (1,859,528) (184,919) - 271,428 7,518,770
Contribution to ESOP - - - - 184,919 - - 184,919
Note receivable for common
stock - - 52,200 - - (52,200) - -
Comprehensive income:
Net income - - - 27,191 -
Foreign currency
translation adjustment - - - - - - (78,673) -
Total comprehensive loss - - - - - - - (51,482)
--------- ----------- --------- ------------ ---------- ----------- --------- -----------
BALANCES, December 31, 1999 2,771,435 $ 9,012,679 $ 331,310 $ (1,832,337) $ - $ (52,200) $ 192,755 $ 7,652,207
========= =========== ========= ============ ========== =========== ========= ===========
</TABLE>
See accompanying notes to these consolidated financial statements.
<PAGE>F-6
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------
1999 1998
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 27,191 $ (570,588)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 500,691 423,655
(Gain) loss on disposal of assets 16,830 (6,647)
Deferred income taxes 8,813 (287,927)
Warranty expense (110,000) 140,000
Inventory reserve 30,000 230,000
Contribution to ESOP 184,919 140,504
Bad debt expense 35,547 50,000
Compensation cost recognized upon
issuance of warrants - 46,033
Income tax benefit related to exercise
of stock options - 38,366
Foreign currency translation adjustment 6,236 37,771
Stock issued for legal settlement - 60,156
Changes in operating assets and liabilities:
Accounts receivable 711,411 614,453
Income tax refund receivable 321,658 (392,646)
Other receivables 3,167 173,507
Inventories 303,259 434,597
Prepaid expenses and deposits (6,062) 73,986
Other assets 26,733 (23,531)
Accounts payable (50,685) (1,950,562)
Accrued liabilities (271,457) 743,896
Other long-term liabilities (10,043) 35,043
----------- ------------
Net cash provided by operating activities 1,728,208 10,066
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Gresham Power Electronics - (3,370,293)
Purchase of property and equipment (168,042) (156,707)
Proceeds from sale of assets 6,146 26,414
----------- -----------
Net cash used in investing activities (161,896) (3,500,586)
----------- -----------
(Continued)
<PAGE>F-7
DIGITAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------
1999 1998
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options
and warrants - 95,350
Principal payments on long-term debt (184,919) (140,504)
Principal payments on capital lease
obligations (72,537) (7,310)
Proceeds from notes payable - 2,366,846
Principal payments on notes payable (1,266,846) (160,000)
----------- ------------
Net cash provided by (used in) financing
activities (1,524,302) 2,154,382
----------- ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (84,909) (1,537)
----------- ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (42,899) (1,337,675)
CASH AND CASH EQUIVALENTS, beginning of period 867,607 2,205,282
----------- ------------
CASH AND CASH EQUIVALENTS, end of period $ 824,708 $ 867,607
=========== ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash payments for:
Interest $ 277,935 $ 233,982
=========== ============
Income taxes $ 117,494 $ 289,872
=========== ============
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of equipment through capital leases $ 19,720 $ 166,396
=========== ============
See accompanying notes to these consolidated financial statements.
<PAGE>F-8
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS:
Digital Power Corporation ("DPC"), a California corporation, and its wholly
owned subsidiaries, Poder Digital, S.A. de C.V. ("PD"), located in
Guadalajara, Mexico, and Digital Power Limited ("DPL"), located in the
United Kingdom, are 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 DPC and its wholly owned subsidiaries, PD and DPL. 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 that 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.
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 differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
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. At the same time sales revenue is recognized,
the Company provides a reserve for estimated warranty costs and a reserve
for estimated product returns.
<PAGE>F-9
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Research and Development Costs - Research and development costs are charged
to operations in the period incurred.
Foreign Currency Translation - Gains and losses from the effects of
exchange rate fluctuations on transactions denominated in foreign
currencies are included in the results of operations. 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 a component of accumulated
other comprehensive income, a component of stockholders equity. Because PD
operates in a country with a highly inflationary economy, any translation
adjustment related to PD is included in the results of operations.
Earnings Per Share - Basic earnings per share excludes dilution and is
computed by dividing net 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 ended December 31, 1998 were anti-dilutive and excluded from
the earnings per share computation.
Use of Estimates - The preparation of the Company's consolidated financial
statements in conformity with generally accepted accounting principles
requires the Company's management to make estimates and assumptions that
affect the amounts reported in these consolidated financial statements and
accompanying notes. Actual results could differ from those estimates.
The Company's consolidated 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 as prescribed by
FASB123.
<PAGE>F-10
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 counterparties when they have similar economic
characteristics that would cause their ability to meet contractual
obligations to be similarly affected by changes in economic or other
conditions described below. 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," financial instruments that subject the Company to credit risk
consist of cash balances maintained in excess of federal depository
insurance limits and accounts and notes receivable, which have no
collateral or security. See Note 13 for major customers.
Fair Value of Financial Instruments - The estimated fair values for
financial instruments under FAS 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 fair value of cash is based on its
demand value, which is equal to its carrying value. The fair values of
notes payable are based on borrowing rates that are available to the
Company for loans with similar terms, collateral, and maturity. The
estimated fair values of notes payable approximate their carrying values.
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 "Accounting for Derivative Instruments and Hedging
Activities,"(FASB133). 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. This statement was amended by
Statement of Financial Accounting Standards No. 137, issued in June 1999,
such that it is effective for the Company's financial statements for the
year ending December 31, 2001. 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.
<PAGE>F-11
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVENTORIES:
Inventories consists of the following as of December 31, 1999:
Raw materials $ 4,017,991
Work-in-process 699,490
Finished goods 485,430
-------------
Allowance for obsolescence (671,650)
-------------
$ 4,531,261
=============
4. PROPERTY AND EQUIPMENT:
Property and equipment consist of the following as of December 31, 1999:
Machinery and equipment $ 1,375,563
Office equipment and furniture 838,311
Leasehold improvements 518,586
Transportation equipment 136,655
-------------
Accumulated depreciation and amortization (1,645,978)
-------------
$ 1,223,137
=============
5. ACCRUED LIABILITIES:
Accrued liabilities consist of the following as of December 31, 1999:
Accrued payroll and benefits $ 176,167
Accrued commissions and royalties 78,383
Accrued warranty and product return expense 272,782
Income taxes payable 207,358
Accrued legal and professional fees 168,042
Other 310,909
-------------
$ 1,213,641
=============
<PAGE>F-12
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. NOTES PAYABLE:
DPC has a $3,000,000 line of credit pursuant to a promissory note
agreement. The 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. Borrowing under
this line of credit bears interest based upon an index equal to the
lender's prime rate (totaling 8.50% at December 31, 1999), payable monthly
with outstanding principal due on demand. If no demand is made, the
outstanding principal and unpaid accrued interest is due September 15,
2000. At December 31, 1999, the outstanding principal balance was $940,000.
Under the terms of the agreement, the Company is required to maintain
certain ratios and be in compliance with other covenants. At December 31,
1999, the Company was in compliance with all covenants.
DPL has a $800,000 line of credit pursuant to a loan agreement. Borrowing
under this line of credit bears interest at 2% per annum over the Bank's
Base rate (totaling 10% at December 31, 1999), payable monthly with
outstanding principal due on demand. If no demand is made, the outstanding
principal and accrued interest is due March 31, 2001. The loan is
collateralized by substantially all of the Company's assets. At December
31, 1999, no principal or accrued interest was outstanding. Under the terms
of the agreement, the Company is required to maintain certain ratios and be
in compliance with other covenants. At December 31, 1999, the Company was
in compliance with all covenants.
7. CAPITAL LEASE OBLIGATIONS:
The Company leases certain equipment and vehicles under agreements
classified as capital leases. The cost of assets under capital leases is
$181,484 and accumulated depreciation amounts to $48,701 at December 31,
1999.
The future minimum lease payments are as follows:
YEARS ENDING
DECEMBER 31, AMOUNT
------------- ---------
2000 $ 48,732
2001 43,412
2002 27,792
2003 13,896
---------
Total future minimum lese payments 133,832
Less amount representing interest (9,361)
---------
Present value of net minimum lease payments 124,471
Less Current portion (43,646)
---------
$ 80,825
=========
<PAGE>F-13
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. 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.
9. NOTE RECEIVABLE - STOCKHOLDER:
At December 31, 1999, the Company had a note receivable in the amount of
$52,200 due from a former employee received in consideration for the
exercise of stock options. The note bears interest at 5% and was paid in
full in February 2000.
10. STOCK OPTIONS AND WARRANTS:
Stock Options - 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 compensation committee of 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.
The Company granted 100,000 non-qualified options to purchase the Company's
stock to the president of the Company in each of the years ended December
31, 1998 and 1997, in accordance with his employment agreement. The
exercise prices of $6.6875 and $5.4375 per share in 1998 and 1997,
respectively, were equal to the fair market value on the dates of grant.
Such options vested immediately and expire in 2008 and 2007, respectively.
On November 5, 1998, these options were repriced to $2.3125, which was
equal to the fair market value on that date.
On January 4, 1999, the Company issued 100,000 non-qualified options to
purchase the Company's stock to the president of the Company, in accordance
with his employment agreement. The exercise price of $1.8750 per share was
equal to the fair market value on the date of grant. Such options vested
immediately and expire in 2009.
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 compensation committee of the Board of
Directors will determine the vesting period of the options, if any, and no
options will be exercisable after ten years from the date of grant.
<PAGE>F-14
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 1998, the Company granted 254,000
options to purchase the Company's stock under the 1996 Stock Option Plan to
certain employees. The exercise prices range from $4.00 to $6.1250 per
share, 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 ended December 31, 1998, the Company granted 124,940
options to purchase the Company's stock under the 1998 Stock Option Plan to
certain employees. The exercise price of the options is $6.25 per share,
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 ended December 31, 1999, the Company granted 70,000 options
to purchase the Company's stock under the 1996 Stock Option Plan to certain
employees. The exercise prices range from $1.6875 to $2.00 per share, 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.
During the year ended December 31, 1999, the Company granted 11,900 options
to purchase the Company's stock under the 1998 Stock Option Plan to certain
employees. The exercise prices of the options ranges from $1.5625 to
$1.8750 per share, 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.
During the year ended December 31, 1999 and 1998, the Company granted
non-qualified options under the 1998 plan of 30,000 and 60,000 options,
respectively, to purchase the Company's stock to outside directors. The
exercise prices range from $1.93 to $6.25 per share, which was equal to the
fair value on the date of grant. The options vest after one year.
The following table sets forth activity for all options:
AVERAGE
NUMBER OF EXERCISE PRICE
SHARES PER SHARE
--------- --------------
OUTSTANDING, January 1, 1998 652,900 $ 2.41
Granted 548,940 2.74
Forfeited (100,160) 2.85
Exercised (35,750) 1.80
--------- -------
OUTSTANDING, December 31, 1998 1,065,930 2.19
Granted 211,900 1.90
Forfeited (194,200) 2.42
--------- -------
OUTSTANDING, December 31, 1999 1,083,630 $ 2.09
========= =======
<PAGE>F-15
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1999, options to purchase 40,000 shares, with a weighted
average exercise price of $6.06, were exercisable at prices ranging from
$6.00 to $6.25 per share.
At December 31, 1999, options to purchase 1,043,630 shares were outstanding
with exercise prices ranging from $.50 to $2.31 per share, a weighted
average exercise price of $1.94, and a weighted average remaining
contractual life of 7.17 years. Of the outstanding options, 745,251 options
were excisable at a weighted average exercise price of $1.84 with the
298,379 unvested options become exercisable as follows:
WEIGHTED
NUMBER OF AVERAGE
YEAR ENDING DECEMBER 31, SHARES EXERCISE PRICE
------------------------ --------- --------------
2000 90,283 $ 2.21
2001 85,620 2.22
2002 83,134 2.22
2003 27,978 2.03
2004 11,364 1.93
------- ---------
298,379 $ 2.19
======= =========
If not previously exercised the outstanding options, with a weighted
average contractual life of 7.25 years will expire as follows:
WEIGHTED
NUMBER OF AVERAGE
YEAR ENDING DECEMBER 31, SHARES EXERCISE PRICE
------------------------ --------- --------------
2003 279,150 $ 1.40
2004 - -
2005 - -
2006 192,000 2.07
2007 227,800 2.31
2008 274,680 2.53
2009 110,000 2.34
--------- ---------
1,083,630 $ 2.09
========= =========
Warrants - In January 1998, the Company issued warrants to purchase 30,000
shares of common stock at $7.00 per share granted, to an investor relations
firm for services provided. Compensation expense of $46,032 was recognized
upon issuance of the warrants. The warrants are immediately exercisable and
expire in January 2001.
In March 1997, the Company issued warrants to purchase 15,000 shares of
common stock at $6.75 per share granted, for marketing services provided.
Compensation expense of $35,903 was recognized upon issuance of the
warrants. The warrants are immediately exercisable and expire in March
2000.
<PAGE>F-16
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following represents all activity that took place for warrants issued:
AVERAGE
NUMBER OF EXERCISE PRICE
SHARES PER SHARE
-------- ---------
OUTSTANDING, January 1, 1998 814,290 $ 5.02
Granted 30,000 7.00
Exercised (6,200) 5.00
-------- ---------
OUTSTANDING, December 31, 1998 838,090 5.09
Expired (793,090) 5.11
-------- ---------
OUTSTANDING, December 31, 1999 45,000 $ 6.92
======== =========
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 1999 and 1998, 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:
1999 1998
---------- -------------
Net loss $ (326,681) $ (1,472,924)
========== =============
Net loss per common share:
Basic and diluted $ (.12) $ (.59)
========== =============
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 $.64 and
$2.74 per share for 1999 and 1998, respectively. The following assumptions
were used for grants in 1999 and 1998: average risk-free interest rates of
4.6% and 5.6%, respectively; expected lives of two years, dividend yield of
0%; and expected volatility of 55.0% and 56.8%, respectively.
<PAGE>F-17
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. NET INCOME (LOSS) PER COMMON SHARE:
The following represents the calculation of net income (loss) per common
share:
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------------
1999 1998
----------- -----------
BASIC
Net income (loss) applicable to common
shareholders $ 27,191 $ (570,588)
=========== ===========
Weighted average number of common shares 2,771,435 2,726,631
=========== ===========
Basic earnings (loss) per share $ .01 $ (.21)
=========== ===========
DILUTED
Net income (loss) applicable to common
shareholders $ 27,191 $ (570,588)
=========== ===========
Weighted average number of common shares 2,771,435 2,726,631
Common stock equivalent shares representing
shares issuable upon exercise of stock
options 61,447 -
----------- -----------
Weighted average number of shares used in
calculation of diluted income (loss) per
share 2,832,882 2,726,631
=========== ===========
Diluted earnings (loss) per share $ .01 $ (.21)
=========== ===========
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,
2000 $ 275,446
2001 154,643
2002 134,284
2003 129,242
2004 128,820
Thereafter 611,895
-----------
$ 1,434,330
===========
<PAGE>F-18
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 1999. Changes in the conversion
rate will have an impact on the Company's required minimum payments and its
operating results.
Rent expense was $253,530 and $243,154 for 1999 and 1998, 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
valued at $60,156. The shares were issued upon the close of the agreement.
The $150,000 is due in installments through June 2000. As of December 31,
1999, the Company had paid $118,000 in installments with the remaining
$32,000 being included in accrued liabilities.
EMPLOYMENT AGREEMENT - The Company has an employment contract with its
President/CEO that terminates on December 31, 2000. The contract provides
for an automatic one-year renewal unless terminated by either the Company
or the employee. Under the terms of the employment contract, he shall serve
as president and chief executive officer of the Company for a salary of
$200,000 per annum. 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. Also, pursuant to the employment contract, in the event
there is a change in control of the Company, the employee shall be paid, in
one payment, the sum of six times the annual base salary for the year
preceding the announcement of the change in control. Finally, pursuant to
the employment contract, in the event of termination without cause, the
employee shall receive in one lump sum an amount equal to three times the
employees base salary for the year preceding the termination.
13. MAJOR CUSTOMERS:
The Company frequently sells large quantities of inventory to its
customers. For the year ended December 31, 1999, two customers each
accounted for 11% of the Company's net sales. For the year ended December
31, 1998, two customers accounted for 13% and 10%, respectively, of the
Company's net sales. At December 31, 1999, approximately $417,000 or 15% of
the Company's net accounts receivable were due from two customers.
<PAGE>F-19
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $11,400 and $17,073 for 1999 and 1998, respectively. The Board of
Directors of DPC elected not to make a discretionary contribution to the
Plan for 1999 or 1998.
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 $71,400 and $50,145 to
the plan for the years ended December 31, 1999 and 1998, respectively.
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.
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 bore interest at 8.5% per annum and
required monthly payments of principal and interest of $8,852 through June
2001. 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 was required to contribute amounts to the plan to
sufficiently cover the debt payments. Contributions to the plan in 1999 and
1998 were $184,919 and $165,971, respectively. As of December 31, 1999, the
Company has repaid the loan.
<PAGE>F-20
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. INCOME TAXES:
Income tax expense (benefit) is comprised of the following:
FOR THE YEARS ENDED
DECEMBER 31,
---------------------------
1999 1998
---------- -----------
Current
Federal $ (28,000) $ (32,000)
State 1,000 (60,000)
Foreign 143,000 121,000
---------- -----------
116,000 29,000
---------- -----------
Deferred
Federal 2,000 (234,000)
State 5,000 (53,000)
Foreign - -
---------- -----------
7,000 (287,000)
---------- -----------
$ 123,000 $ (258,000)
========== ===========
The components of the net deferred tax asset and liability recognized as of
December 31, 1999 are as follows:
Current deferred tax assets (liabilities):
Accounts receivable, principally due to allowance
for doubtful accounts $ 84,294
Compensated absences, principally due to accrual
for financial reporting purposes 28,113
Accrued commissions 14,725
Inventory reserve 204,714
Warranty reserve 78,273
Stock rotation liability 24,084
Accrued settlement 12,845
Accrued other 10,404
Book compensation for stock options 79,038
Effect of change in tax accounting method (109,599)
UNICAP 23,896
State taxes 272
-----------
451,059
Valuation allowance (90,923)
----------
Net current deferred tax asset $ 360,136
==========
Long-term deferred tax assets (liabilities):
Net operating loss carryforwards 7,667
Depreciation (17,011)
----------
Net long-term deferred tax liability $ (9,344)
==========
<PAGE>F-21
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
DECEMBER 31,
------------------------
1999 1998
-------- --------
Total expense (benefit) computed by applying
the U.S. statutory rate 34.0% (34.0%)
Permanent differences 2.3 .8
State income taxes 3.8 (13.5)
Tax effect resulting from foreign activities 41.5 7.4
Change in valuation allowance - 10.8
Change in beginning balance of deferred asset - (8.2)
Effect of IRS examination - 5.4
Other - .6
------- --------
81.6% (30.7%)
======= ========
16. ACCUMULATED OTHER COMPREHENSIVE INCOME BALANCES:
Accumulated other comprehensive income consists of the following as of
December 31, 1999:
Total
Compensation Accumulated
related to Other
Foreign Currency exercise of Comprehensive
Translation stock options Income
----------- ------------- -----------
Beginning Balance $ 36,234 $ 235,194 $ 271,428
Current-period change (78,673) - (78,673)
----------- ------------- -----------
$ (42,439) $ 235,194 $ 192,755
=========== ============= ===========
<PAGE>F-22
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. 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 operations are measured
consistent with accounting policies used in these consolidated financial
statements. Segment information is as follows:
<TABLE>
<CAPTION>
1999
----
DPC PD DPL Eliminations Totals
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues $ 8,864,412 $ 19,989 $ 6,469,617 $ $ 15,354,018
============= ============= ============= ============= =============
Intersegment
Revenues $ 221,138 $ 2,150,000 $ - $ (2,371,138) $ -
============= ============= ============= ============= =============
Interest
Income $ 128,106 $ 3,806 $ 12,936 $ (113,913) $ 30,935
============= ============= ============= ============= =============
Interest
Expense $ 130,173 $ 7,098 $ 154,985 $ (113,913) $ 178,343
============= ============= ============= ============= =============
Depreciation
and
Amortization $ 161,489 $ 49,358 $ 289,844 $ - $ 500,691
============= ============= ============= ============= =============
Income Tax
Expense $ (20,000) $ - $ 143,000 $ - $ 123,000
============== ============= ============= ============= =============
Net Income $ (67,139) $ (76,673) $ 171,003 $ - $ 27,191
============== ============== ============= ============= =============
Segment Assets $ 9,251,925 $ 829,095 $ 4,924,991 $ (3,845,178) $ 11,160,833
============= ============= ============= ============= =============
Expenditures
for Segment
Assets $ 42,281 $ 51,687 $ 93,794 $ - $ 187,762
============= ============= ============= ============= =============
</TABLE>
<PAGE>F-23
DIGITAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<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
(Benefit) $ (378,983) $ - $ 120,983 $ - $ (258,000)
============= ============= ============= ============= =============
Net (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>
EMPLOYMENT AGREEMENT
This EMPLOYMENT AGREEMENT (the "Agreement"), effective as of January 1,
2000 (the "Effective Date"), is entered into by and between Digital Power
Corporation, a California corporation (the "Company"), and Robert O. Smith
("Employee").
RECITALS
WHEREAS, the Company and Employee entered into that certain "Employment
Agreement" dated as of October 1, 1996 (the "Original Employment Agreement"),
which Original Employment Agreement had a three-year term commencing on January
1, 1997, and continuing until December 31, 1999, which Original Employment
Agreement has now expired; and
WHEREAS, the Company and Employee now wish to enter into a new
Employment Agreement under the terms and conditions set forth herein;
NOW, THEREFORE, in consideration of the mutual promises and covenants
made herein, the parties hereto AGREE AS FOLLOWS:
ARTICLE I
EMPLOYMENT AND TERM OF EMPLOYMENT
1.1. Employment and Term. The Company hereby employs Employee to render
full-time services to the Company on an exclusive basis (except Employee may
work one day per week from home), upon the terms and conditions set forth below,
from the effective date of this Agreement until the employment relationship is
terminated in accordance with the provisions of this Agreement. This Agreement
shall be for an initial term from the Effective Date until December 31, 2000,
and thereafter for an automatically renewable term of one year from January 1st
to December 31st of each year, unless terminated earlier as provided for herein
(the "Employment Term"). If this Agreement is not renewed by the Company for the
subsequent year pursuant to a written notice from the Company to Employee
delivered prior to December 1st of the applicable year, such non-renewal will be
deemed to be a "Termination without Cause" and Employee shall be entitled to the
amounts set forth in Section 4.3 hereof.
1.2. Acceptance. Employee hereby accepts employment with the Company and
agrees to devote his full-time attention and best efforts exclusively to
rendering the services described below. The Employee shall accept and follow the
direction and authority of the Board of Directors of the Company (the "Board")
in the performance of his duties, and shall comply with all existing and future
regulations applicable to employees of the Company and to the Company's
business.
<PAGE>
ARTICLE II
DUTIES OF EMPLOYEE
2.1. General Duties. Employee shall serve as the President and Chief
Executive Officer of the Company. In his capacity as President and Chief
Executive Officer, Employee shall do and perform all services, acts, or other
things necessary or advisable to manage and conduct the business of the Company,
including, but not limited to, the supervision, direction, and control of the
business and other employees of the Company, subject to the policies and
direction of the Board. Employee shall have all powers, duties, and
responsibilities necessary to carry out his duties, and such other powers and
duties as the Board may prescribe consistent with the Company's articles and
bylaws. Employee may work one day per week from his home.
2.2. Exclusive Services. It is understood and agreed that Employee may
not engage in any other business activity during the term of his employment
hereunder, whether or not for profit or other remuneration, without the prior
written consent of the Company. Further, Employee shall not directly or
indirectly acquire any stock or interest in any corporation, partnership, or
other business entity that competes, directly or indirectly, with the business
of the Company.
2.3. Reporting Obligations. In connection with the performance of his
duties hereunder, unless otherwise instructed by the Company's Board, the
Employee shall report directly to the Board.
2.4. Director. Employee shall also serve as a director of the Company,
and shall be nominated as director each year subject to continued approval of
the stockholders of the Company as required by law.
ARTICLE III
COMPENSATION AND BENEFITS OF EMPLOYEE
3.1. Annual Base Salary. The Company shall pay the Employee salary for
the services to be rendered by him during the term of this Agreement at the rate
of two hundred thousand dollars ($200,000) per annum for the period between
January 1, 2000 to December 31, 2000, with any difference between the annual
base salary and amount actually received by Employee to be temporarily deferred,
subject to this provision and Section 4.3 hereof. Thereafter, the Employee's
annual base salary shall be as determined by the Company's Compensation
Committee, subject to Board approval, on an annual basis, but in no event shall
such annual base salary be less than two hundred thousand dollars ($200,000) per
annum. Such annual base salary shall be payable in periodic installments in
accordance with the terms of the Company's regular payroll practices in effect
from time to time during the term of this Agreement, but in no event less
frequently than once each month. Any amounts voluntarily deferred by Employee
during the term of this Agreement may be paid to Employee from time to time at
such times as the Board and Employee agree the Company is financially able to
make such payments. All deferred compensation shall accrue simple interest at
the rate of six percent (6%) per annum from the date of actual deferment.
<PAGE>
3.2. Bonuses. In addition to the Employee's base salary and other
benefits provided to Employee hereunder, Employee shall be eligible to receive
bonuses based on Company performance and Employee's attainment of objectives
established annually by the Compensation Committee of the Board of Directors.
3.3. Stock Options. Unless this Agreement has been previously
terminated, on the first business day of January of each year during the
Employment Term (including on the Effective Date stated above), Employee shall
be granted immediately vesting stock options to purchase 100,000 shares of the
Company's common stock at an exercise price equal to the lower of (i) the
closing price of the common stock as of the first business day of January, or
(ii) the average closing price of the common stock for the first six months of
the year. The stock options may be subject to (a) the further terms and
conditions set forth in the Company's 1996 Stock Option Plan and 1998 Stock
Option Plan, as they may be amended or updated from time to time or other stock
option plans that may be adopted, and the Stock Option Agreement required to be
executed thereunder, and (b) the Employee's execution of all documents
customarily required by the Company to effect the grant of options.
3.4. Expenses. The Company shall pay or reimburse the Employee for all
reasonable, ordinary, and necessary business expenses actually incurred or paid
by Employee in the performance of Employee's services under this Agreement in
accordance with the expense reimbursement policies of the Company in effect from
time to time during the Employment Term, upon presentation of proper expense
statements or vouchers or such other written supporting documents as the Company
may reasonably require.
3.5. Vacation. Employee shall be entitled to four (4) weeks paid
vacation for each calendar year (prorated for any portion of a year, as
applicable), such vacation to accrue at the rate of thirteen and one-third
(13.33) hours per month. Notwithstanding anything to the contrary in this
Agreement, vacation time shall cease to accrue beyond eight (8) weeks at any
given time during the Employment Term.
3.6. General Employment Benefits. Except where expressly provided for
herein, Employee shall be entitled to participate in, and to receive the
benefits under, any pension, health, life, accident, and disability insurance
plans or programs and any other employee benefit or fringe benefit plans that
the Company makes available generally to its employees, as the same may be in
effect from time to time during the Employment Term.
3.7. Indemnification. Consistent with the terms of the Company's
articles and bylaws, the Company shall indemnify and hold Employee harmless for
any actions taken or decisions made by him in good faith while performing
services in his capacity as President and Chief Executive Officer of the Company
during the Employment Term.
3.8. Annual Physical. Employee shall have the right to an annual
physical examination at the cost of the Company.
<PAGE>
ARTICLE IV
TERMINATION OF EMPLOYMENT
4.1. Termination. This Agreement may be terminated as provided for in
this Article IV, or extended by further written agreement of the parties.
4.2. Termination For Cause. The Company reserves the right to terminate
this Agreement for cause upon: (a) Employee's willful and continued failure to
substantially perform his duties with the Company (other than such failure
resulting from his incapacity due to physical or mental illness) after there is
delivered to Employee by the Board, acting reasonably and in good faith, a
written demand for substantial performance which sets forth in detail the
specific respects in which the Board believes Employee has not performed his
duties, and giving Employee not less than thirty (30) days to correct the
deficiencies specified in the written notice; (b) Employee's willful engagement
in gross misconduct as determined by the Board which is materially and
demonstrably injurious to the Company; or (c) Employee's commission of a felony,
or an act of fraud against the Company or its affiliates. Upon termination for
cause, Employee shall not be entitled to any severance benefits.
4.3. Termination Without Cause. Notwithstanding anything to the contrary
in this Agreement, the Company reserves the right to terminate this Agreement at
any time without cause, subject to the express terms and provisions below.
If Employee is terminated without cause, then on such date (the
"Termination Date"), the Employee-Employer relationship will cease and Employee
will be entitled to receive in one lump-sum: (a) three times (3X) the Employee's
base annual salary for the immediately previous full fiscal year, and (b) any
amounts deferred during the term of this Agreement. Employee, at his sole
discretion, may be entitled to apply any and all such amounts directly to the
exercise price of any stock options then held by him.
If Employee is terminated without cause, then to the extent not already
granted, the remaining options to be granted on the first business day in
January of each year during the Employment Term shall be granted as of the
Termination Date with an exercise price equal to the lowest closing price of a
share of common stock as of (i) the first business day in January; (ii) the
Termination Date; or (iii) the average bid price between the period from the
first business day in January until the Termination Date provided that the
Termination Date is a date less than six (6) months of the Employment Year. Such
option shall have an exercise period of ten (10) years from the Termination
Date.
4.4. Voluntary Termination by Employee. Notwithstanding anything to the
contrary in this Agreement, Employee may terminate this Agreement at any time
upon ninety (90) days written notice to the Company, or upon written notice
delivered prior to December 1st if Employee does not intend to renew this
Agreement for an additional one-year term. If Employee voluntarily terminates
employment, Employee shall not be entitled to any severance benefits, but will
be entitled to receive all deferred compensation and any other benefits required
by law.
<PAGE>5
4.5. Change in Control; Severance. If there is a "change in control" in
the Company during the Employment Term, then this Agreement shall be terminated,
effective as of the date the change in control. For the purposes of this Section
4.5, a "change in control" shall mean an event involving one transaction or a
related series of transactions, in which: (a) the Employer issues securities
equal to fifty percent (50%) or more of the issued and outstanding capital stock
of the Employer to any individual, firm, partnership, or other entity, including
a "group" within the meaning of Section 13 (d)(3) of the Securities Exchange Act
of 1934 ("the Exchange Act"); (b) the Employer is acquired in a merger or other
business combination in which the Employer is not the surviving corporation; or
(c) fifty percent (50%) or more of the Employer's consolidated assets or earning
power are sold or transferred. In the event of a change in control, Employee,
upon the effective date of the change in control, shall be paid, in one payment,
the sum of six (6) times Employee's annual base salary for the fiscal year
preceding the announcement of the change in control. Further, upon a change in
control, any option to be issued to Employee will be treated as if there was
termination without cause under Section 4.3.
4.6. Gross-up Payment. If the Employee becomes subject to the excise tax
imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the
"Code") on "excess parachute payments" as defined in Section 280G of the Code or
the Employee incurs any interest or penalties with respect to such excise tax
(such excise tax, together with any such interest or penalties, being
hereinafter collectively referred to as the "Excise Tax"), the Employer shall be
obligated to promptly pay to the Employee that amount that is necessary to place
the Employee in the same after-tax (taking into account all federal, state,
local, and other taxes) financial position that the Employee would have been in
if he had not incurred any tax liability under Section 4999 of the Code or
otherwise relating to the Excise Tax.
4.7. Disability. If Employee becomes permanently and totally disabled,
this Agreement shall be terminated. Employee shall be deemed permanently and
totally disabled if he is unable to engage in the activities required by this
Agreement by reason of any medically determinable physical or mental impairment
which can be expected to result in death or which has lasted or can be expected
to last for a continuous period of not less than three (3) months. If this
Agreement is terminated due to Disability, Options then held as of the date of
Disability may be exercised by the Optionee or the Employee's personal
representative in whole or in part, at any time within one year after the
Disability. In addition, the Company shall purchase disability insurance in an
amount such that in the event the Employee is disabled in accordance with this
Section 4.7, the insurance proceeds will be equal to the amount that Employee
would have received, net of taxes, under the remaining term of this Employment
Agreement.
4.8. Death. If Employee dies during the term of this Agreement, this
Agreement shall be terminated on the last day of the calendar month of his death
subject to the express terms and provisions below.
Upon the death of Employee, all unexercised options which have been granted
as of the date of death may be exercised by the designated beneficiary, as
provided in Section 6.8 below, the estate, or Employee's personal representative
in whole or in part within one year of the date of death. The Company shall
<PAGE>6
provide Employee with life insurance, at Company's expense, in an amount equal
to one million dollars ($1,000,000).
4.9. Effect of Termination. Except as expressly provided for in this
Agreement, the termination of employment shall not excuse any obligation that
accrued prior to termination, nor shall termination excuse the performance of
any obligation which is required to be performed after termination. Any such
obligation shall survive the termination of employment and this Agreement.
ARTICLE V
COVENANTS AND REPRESENTATIONS OF EMPLOYEE
5.1. Unfair Competition. Employee acknowledges that he will have access
at the highest level to, and the opportunity to acquire knowledge of, the
Company's customer lists, customer needs, business plans, trade secrets, and
other confidential and proprietary information from which the Company may derive
economic or competitive advantage, and that he is entering into the covenants
and representations in this Article V in order to preserve the goodwill and
going concern value of the Company, and to induce the Company to enter into this
Agreement. Employee agrees not to engage in any unfair competition with Company.
In addition during the Employment Term and the term of any consulting agreement,
if applicable, Employee will not work or assist directly or indirectly with a
competitor of Employer.
5.2. Confidential Information. During the Employment Term and at all
times thereafter, the Employee agrees to keep secret and to retain in the
strictest confidence all confidential matters which relate to the Company or its
"affiliate" (as that term is defined in the Exchange Act), which are of a
specific nature to the Company's business and not generic skills or knowledge of
Employer, and which may include, but not necessarily be limited to, customer
lists, client lists, trade secrets, pricing lists, business plans, financial
projections and reports, business strategies, internal operating procedures, and
other confidential business information from which the Company derives an
economic or competitive advantage, or from which the Company might derive such
advantage in its business, whether or not labeled "secret" or "confidential."
5.3. Non-Solicitation of Customers. During the Employment Term, the
Employee will have access to confidential records and data pertaining to the
Company's customers, their needs, and the relationship between the Company and
its customers. Such information is considered secret and is disclosed during the
Employment Term in confidence. Accordingly, during the later of the end of the
Employment Term and one year thereafter or during a consulting agreement, if
applicable, the Employee and any entity controlled by him or with which he is
associated (as the terms "control" and "associate" are defined in the Exchange
Act) shall not, directly or indirectly (i) solicit for a competitive purpose,
interfere with, induce or entice away any person or entity that is or was a
client, customer or agent of the Company or its affiliate (as the term
"affiliate" is defined in the Exchange Act), or (ii) in any manner persuade or
attempt to persuade any such person or entity (A) to discontinue its business
relationship with the Company or its affiliate, or (B) to enter into a business
relationship with any other entity or person the loss of which the Employee
should reasonably anticipate would be detrimental to the Company or its
affiliate in any respect.
<PAGE>
5.4. Non-Solicitation of Employees. The Employee and any entity
controlled by him or with which he is associated (as the terms "control" and
"associate" are defined in the Exchange Act shall not, during later of the end
of the Employment Term and for one (1) year thereafter or end of the consulting
agreement, if applicable, directly or indirectly solicit, interfere with, hire,
offer to hire or induce any person who is or was an officer or employee of the
Company or any affiliate (as the term "affiliate" is defined in the Exchange
Act) (other than secretarial personnel) to discontinue his relationship with the
Company, or affiliate of the Company, in order to accept employment by, or enter
into a business relationship with, any other entity or person. (These acts are
hereinafter referred to as the "prohibited acts of solicitation.") The foregoing
restriction, however, shall not apply to any business with which Employee may
become associated after the Employment Term so long as the prohibited acts of
solicitation taken by such business are not as a result of the active
participation or involvement, direct or indirect, by the Employee.
5.5. Return of Property. Upon termination of employment, and at the
request of the Company otherwise, the Employee agrees to promptly deliver to the
Company all Company or affiliate memoranda, notes, records, reports, manuals,
drawings, designs, computer files in any media, and other documents (including
extracts and copies thereof) relating to the Company or its affiliate, and all
other property of the Company.
5.6. Inventions. All processes, inventions, patents, copyrights,
trademarks, and other intangible rights that may be conceived or developed by
the Employee, either alone or with others, during the Employment Term and
consulting agreement, if applicable, whether or not conceived or developed
during Employee's working hours, and which are related to the Company's
business, shall be the sole property of the Company. Employee shall execute all
documents, including patent applications and assignments, required by the
Company to establish the Company's rights under this provision.
5.7. Representations. The Employee represents and warrants to the
Company that he has full power to enter into this Agreement and perform his
duties hereunder, and that his execution and delivery of this Agreement and the
performance of his duties shall not result in a breach of, or constitute a
default under, any agreement or understanding, whether oral or written,
including, without limitation, any restrictive covenant or confidentiality
agreement, to which he is a party or by which he may be bound.
ARTICLE VI
MISCELLANEOUS PROVISIONS
6.1. Notices. All notices to be given by either party to the other shall
be in writing and may be transmitted by personal delivery, facsimile
transmission, overnight courier or mail, registered or certified, postage
prepaid with return receipt requested; provided, however, that notices of change
of address or telex or facsimile number shall be effective only upon actual
receipt by the other party. Notices shall be delivered at the following
addresses, unless changed as provided for herein.
<PAGE>
To the Employee: Robert O. Smith
5148 Felter Road
San Jose, CA 95132
To the Company: Attention: Secretary
Digital Power Corporation
41920 Christy Street
Fremont, CA 94538-3158
6.2. No Assignment. This Agreement, and the rights and obligations of
the parties, may not be assigned by either party without the prior written
consent of the other party.
6.3. Applicable Law. This Agreement and the relationships of the parties
in connection with the subject matter of this Agreement shall be governed by,
and construed under, the laws of the State of California.
6.4. Entire Agreement. This Agreement supersedes any and all other
agreements or understandings of the parties, either oral or written, with
respect to this employment of Employee by the Company, and contains the complete
and final agreement and understanding of the parties with respect thereto.
Employee acknowledges that no representation, inducements, promises, or
agreements, oral or otherwise, have been made by the Company or any of its
officers, directors, employees or agents, which are not expressed herein, and
that no other agreement shall be valid or binding on the Company.
6.5. Withholding Taxes. All amounts payable under this Agreement,
whether such payment is to be made in cash or other property, including, without
limitation, stock of the Company, may be subject to withholding for Federal,
state, and local income taxes, employment and payroll taxes, and other legally
required withholding taxes and contributions to the extent appropriate in the
determination of the Company, and the Employee agrees to report all such amounts
as ordinary income on his personal income tax returns and for all other
purposes, as called for.
At the election of Employee, Employee shall have the right to sell to
the Company any vested stock options (at the then fair market value of the
common stock less the exercise price) in order to meet any withholding
requirements or pay income taxes on income related to such options.
6.6. Severability. If any provision of this Agreement is held to be
invalid or unenforceable by any judgment of a tribunal of competent
jurisdiction, the remaining provisions and terms of this Agreement shall not be
affected by such judgment, and this Agreement shall be carried out as nearly as
possible according to its original terms and intent and, to the full extent
permitted by law, any provision or restrictions found to be invalid shall be
amended with such modifications as may be necessary to cure such invalidity, and
such restrictions shall apply as so modified, or if such provisions cannot be
amended, they shall be deemed severable from the remaining provisions and the
remaining provisions shall be fully enforceable in accordance with law.
<PAGE>
6.7. Effect of Waiver. The failure of either party to insist on strict
compliance with any provision of this Agreement by the other party shall not be
deemed a waiver of such provision or a relinquishment of any right thereunder,
nor shall it affect the validity of this Agreement nor prevent enforcement of
such provision or any similar provision, at any time.
6.8. Designation of Beneficiary. If the Employee shall die before
receipt of all payments and benefits to which he is entitled under this
Agreement, payment of such amounts or benefits in the manner provided herein
shall be made to such beneficiary as he shall have designated in a writing that
is filed with the Secretary of the Company or, in the absence of such
designation, to his estate or personal representative.
6.9. Arbitration. Any controversy between Employer and Employee
involving the construction or application of any of the terms, provisions, or
conditions of this Agreement shall be submitted to arbitration. Arbitration
shall comply with and be governed by the provisions of the American Arbitration
Association.
6.10. Attorneys Fees. In the event of any litigation arising out of this
Agreement, or the parties' performance as outlined herein, the prevailing party
shall be entitled to an award of costs, including an award of reasonable
attorney's fees.
6.11. Counterparts. This Agreement may be executed in one or more
counterparts, each of which when taken together shall constitute one and the
same instrument.
IN WITNESS WHEREOF, the parties have executed and delivered this
Agreement as of the date first above written.
EMPLOYER
DIGITAL POWER CORPORATION,
A California Corporation
By: ____________________________________
Scott C. McDonald, as Director and Member
of Compensation Committee on behalf of the
Company
By: ____________________________________
Thomas W. O'Neil, Jr., as Director and
Member of Compensation Committee on
behalf of the Company
<PAGE>
EMPLOYEE
By: ____________________________________
Robert O. Smith,
President and Chief Executive Officer
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