UNITED STATES
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,
2004
Commission File Number 1-12711
DIGITAL POWER CORPORATION
(Name of small business issuer in its charter)
California 3679 94-1721931
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(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
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(Address of principal executive offices)
510-657-2635
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(Issuer's Telephone Number)
Securities registered under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
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Common Stock American Stock Exchange
Securities registered under Section 12(g) of the Exchange Act:
Title of Each Class
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None
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act, during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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, 2004, were $8,713,000.
As of March 15, 2005, the aggregate market value of the voting common stock held
by non-affiliates was approximately $3,966,000 based on the closing price of
$1.19 per share.
As of March 15, 2005, the number of shares of common stock outstanding was
6,161,859.
Documents Incorporated by Reference.
The information required by Items 9, 10, 11, 12 and 14 of Part III are
incorporated by reference to the Company's proxy statement, which will be filed
within 120 days of the issuer's year end.
As used in this annual report, the terms "we," "us," "our," the "Company,"
"Digital" or "Digital Power" mean Digital Power Corporation and its subsidiaries
unless otherwise indicated.
With the exception of historical facts stated herein, the following
discussion may contain forward-looking statements regarding events and financial
trends, which may affect Digital Power's future operating results and financial
position. Such statements are subject to risks and uncertainties that could
cause Digital Power'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, the fact that we have experienced losses from our
operations, that the power supply industry, in general, has experienced an
economic down turn and our dependence on our manufacturing subcontractor
primarily in China, 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. Digital Power
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 designs, develops, manufactures, markets, and
sells switching power supplies to industrial, telecommunication, data
communication, medical and military industries. We are a California corporation
originally formed in 1969. Our corporate office, which contains our
administrative, sales, and engineering functions, is located in Fremont,
California. In addition, the Company has a wholly-owned subsidiary, Digital
Power Limited ("DPL"), located in Salisbury, England which designs, manufactures
and sells products for the European market place including power conversion
products for naval and military applications and DC/AC inverters for the
telecommunications industry under the label Gresham Power Electronics.
We primarily sell our switching power supplies to industrial,
telecommunication, data communication, medical and military industries both in
North America and Europe. These industries have experienced pricing pressure
that has adversely affected our operations and financial condition. As a result,
we incurred an operating loss during the year ended December 31, 2004. The
Company has the option of purchasing products from a Mexican subcontractor or
from a Chinese subcontractor at lower prices with longer lead time. For the
products produced in Mexico, we purchase the raw material and ship to our third
party manufacturer who manufactures our products according to our
specifications. Subsequent to the balance sheet date, we have ended our
relationship with the Mexican contract manufacturer.
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 issues of allocation and protection by (i)
converting alternating current (AC) electricity into DC; (ii) by dividing a
single input voltage into distinct and isolated output voltages; and (iii) 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
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converters". "Switching" power supplies are distinguished from "linear" power
supplies by the manner and efficiency with which the power supplies "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.
One of the great advantages of switching power supplies, in addition to the
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.
Our switching power supply products have a high power density making them
smaller than those many of our competitors.
Another advantage of our power supply products is the flexibility of
design. We have designed the 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 us 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". This "flexibility" approach also results in very low non-recurring
engineering (NRE) expenses. Because of reduced NRE expenses, we do not generally
charge our OEM customers for NRE related to tailoring a power supply to a
customer's specific requirements. This gives us an advantage over our
competitors, many of whom do charge their customers for NRE expenses. Our
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 power
supply market.
In addition to the line of proprietary products offered, and in response to
requests from OEMs, we also provide "value-added services". The term
"value-added services" refers to our incorporation of an OEM's selected
electronic components, enclosures, and cable assemblies with our power supply
products to produce a power subassembly that is compatible with the OEM's own
equipment and specifically tailored to meet the OEM's needs. We purchase parts
and components that the OEM itself would otherwise attach to or integrate with
our power supply, and we provide the OEM with that integration and installation
service, thus saving the OEM time and money. We believe that this value-added
service is well-suited to those OEMs who wish to reduce their vendor base and
minimize their investment in manufacturing which leads to increased fixed costs.
Based on the value-added services, the OEMs do not need to build assembly
facilities to manufacture their own power subassemblies and thus are not
required to purchase individual parts from many vendors.
We made progress in penetrating the domestic military sector and, as a
result of our strategic collaboration with Telkoor Power Ltd. ("Telkoor") we
have been an awarded an initial $1.6 million contract to provide sophisticated
mil-spec power supplies for a military avionics application. The majority of
this revenue will be recognized in 2005.
Telkoor Power Ltd.
Telkoor is primarily engaged in developing, marketing and selling power
supplies and power systems for the telecommunication equipment industry and
military. Consistent with our total cost reduction efforts, and taking advantage
of Telkoor's strong engineering team, we have and will continue to utilize
Telkoor to assist us in new product development. Further, during the year ended
December 31, 2004, we made progress in penetrating the United States and
European markets with Telkoor's products. This effort generated sales of
approximately 30.72% of our revenues for 2004. We intend to continue to sell
Telkoor's products in the future to supplement our line of products.
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Digital Power Limited
Digital Power Limited, headquartered in Salisbury, England, designs,
manufactures, and distributes switching power supplies, uninterruptible power
supplies, and power conversion and distribution equipment frequency converters
for the commercial and military markets under the name Gresham Power
Electronics. 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.
Frequency converters manufactured by DPL are used to convert a warship's
generated 60 cycle electricity supply to 400 cycles. This 400 cycle supply is
used to power critical equipment such as the ship's gyro, compass and weapons
systems. DPL also designs and manufactures Transformer Rectifiers for Naval use.
Typically these provide battery supported back-up for critical DC systems such
as machinery and communications. In addition higher power rectifiers are used
for helicopters on naval vessels. DPL and the Gresham Power Electronics products
adds diversity to our product line, provides greater access to the United
Kingdom and European markets and strengthens our engineering and technical
resources. For the year ended December 31, 2004, DPL contributed approximately
56% to our gross revenues.
The Market
Geographically, we primarily serve the North American power electronics
market with individual AC/DC power supplies and DC/DC converters ranging from 50
watts to 800 watts of total output power. DPL serves the United Kingdom and the
European marketplace with AC/DC power supplies, uninterruptible power supplies,
and frequency inverters.
Customers
Our products are sold domestically and in North America through a network
of manufacturers' representatives and distributors. Our customers can generally
be grouped into five broad industries, consisting of the industrial,
telecommunication, data communication, medical and military. We have a current
base of approximately 400 active customers, some of which are sold through our
distributors.
Gresham Power Electronic products are sold primarily in the UK and in
Europe. The Company has been particularly successful in securing an export
market in Spain for its defense products. In the UK, our main customers include
the UK Ministry of Defense, BAE Systems, Bacock Defense and Marshalls plc. In
Mainland Europe, we sell directly to IZAR in Spain and Emerson in Sweden. We
sell power supplies through European distributors with our greatest strength in
Germany and Scandinavia.
Strategy
Our strategy is to be the supplier of choice to OEMs requiring high-quality
power solutions where size, rapid modification, and time-to-market are critical
to business success. Target market segments include the industrial,
telecommunication, data communication, medical and military industries. While
many of these segments would be characterized as computer-related, we do 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.
We intend to continue our sales primarily to existing customers while
simultaneously targeting sales to new customers. We believe that our
"flexibility" concept allows customers a more effective choice between our
products and products offered by other power supply competitors. Our
"flexibility" series is designed around a standardized power platform, but
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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 and higher efficiency. Digital Power's
strategy in responding to this demand has been to offer increasingly smaller
power supply units or packages. 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. Because
custom-designed power supplies are development-intensive and require a great
deal of time to design, develop, and manufacture, typically 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 OEM customers a new choice with Digital Power's "flexibility"
series, we believe we have an advantage over our competitors.
Product Strategy and Products
We have ten 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 2.0 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.
Because 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 because the holes are eliminated and
components can be placed on both sides of the board. Our US100 series is an
example of a product using this manufacturing technology.
Digital Power's "flexibility" concept applies to all of our US, UP/SP, DP
and UPF 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 our primary products.
Four of our product offerings resulting from our strategic relationship
with Telkoor are the eF's series, CPCI`s series , Strong Box serial and custom
products.
The new 1.8KW Strongbox(R) is a single output front end with I2C databus.
It features 3 x 600 watt cassettes. The Strongbox is available in 24V, and 48V
outputs with active power factor correction.
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 power good signal, an isolated V4 output, and UL544
(2nd Ed.) safety approval. All US50 series units are also available in 24VDC, or
48VDC inputs. This optional DC input unit (DP50 series) maintains the same
pin-out, size, and mounting as the US50 series.
The US70 series of power supplies is similar to the US50 series, a compact,
economical, highly efficient, open frame switcher that delivers up to 65 watts
with a 70 watt peak. This unit is offered with one to four outputs, a universal
input rated from 90 to 264 VAC and is only slightly larger than the US50 series.
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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 (2nd Ed.) medical safety approval. The DP70 is
the same as the US70 except the input is 48 volts DC. We also offer 24VDC input
on this series where the model series changes to a 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 was the industry's smallest 100 watt switcher when
originally introduced. 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 and
UL2601-1 (2nd Ed.) medical safety approval. 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 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 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 or 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. 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 UPF150/DP150 series is an open-frame switcher that delivers up to 150
watts of continuous power from one to four outputs. In response to market
condition for more functionality, the UPF 150 has both power factor correction
and a Class B EMI filter as standard features. All UPF150 series units are
available with 24VDC, or 48VDC inputs. This optional DC input unit (DP150)
maintains the same pin-out, size, and mounting as the UPF150 series.
The UPF 300 watts delivers up to 300 watts from one or two outputs and also
includes power factor correction and measures 8" x 4.5" x 2".
Gresham Products
Gresham designs and manufactures a wide range of products for Naval
applications. These include:
Static Frequency Converters - typically converts Ship's supply from 50/60Hz
to 400Hz for gyros and weapons systems. Power range is from 1kVA to 35kVA.
DC Systems - converts main Ship's supply to 24VDC. These systems normally
supported by battery back up provide the vessel's emergency DC supplies for
machinery, communications and other essential services.
Transformer Rectifiers 28V to 400A. Ratings of 10 and 15kVA provide DC
power to enable the ship to start and service helicopters. Gresham's TRUs are in
service with a number of Navies including the Royal Navy and are designated by
Westland Helicopters in support of Super Lynx.
Inverters - 1kVA to 3.6 kVA typically convert DC to 440V 3phase 60 Hz for
communications and emergency services.
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Circuit breaker monitoring and controls - modular system of controls for
main circuit breakers based upon digital circuitry. Modules available include
over current, short circuit, low voltage, over and under frequency and an
indicator module. Many are used in submarine service.
Intelligent switchmode DC/DC power supplies in support of inboard submarine
sonar.
Filter boxes for secure communications.
Navigation and signal panels - for the control and dimming of ship's
external navigation lights.
Gresham also manufactures a range of commercial inverters of its own design
for telecoms applications. Rated at 250VA, 500VA and 1kVA these convert either
24V or 48V DC to AC.
In addition to Digital Power and Telkoor products, Gresham distributes a
wide range of commercial uninterruptible power supplies. Power ratings range
from 500VA to 6kVA in a modular configurable range. The Company also provides
turnkey high power solutions for major business users. Typically configured with
generators for the support of substantial institutional systems, power ratings
can extend to 300kVA
Manufacturing Strategy
Consistent with our product flexibility strategy, we aim to maintain a high
degree of flexibility in our manufacturing strategy through the use of
strategically focused contract manufactures. It is our belief that strategically
focused contract manufacturers will meet our near term cost, delivery and
quality goals while providing synergistic concepts. In addition, we believe
these relationships will eventually give us access to new markets and cross
licensing arrangements that may be beneficial. The competitive nature of the
power supply industry has also placed continual downward pressure on selling
prices. In order to achieve our low cost manufacturing goals with labor
intensive product, we also plan on continually increasing our supply base
through the use of contract manufacturers in the Far East. At present our
principle source in the Far East is Winco Power. Presently, we are in
negotiation with a second contract manufacturer in China. We also subcontract to
a contract manufacturer located in Guadalajara, Mexico on a project to project
basis. Subsequent to the balance sheet date, we have ended our relationship with
the Mexican contract manufacturer and we expect all projects to cease during the
second quarter of 2005.
We have contract manufacturing relationships with Winco Power Technology to
manufacture our products at facilities located in China on a turnkey basis.
Purchases from Winco are made pursuant to purchase orders. For the year ended
December 31, 2004, Digital Power purchased approximately 24% of its power supply
requirements through Winco Power Technology. Our products are meeting the
certification standards according to independent safety agency requirements. We
are in negotiation with a second contract manufacturer in China.
Digital Power Limited Manufacturing
Digital Power Limited operates from a 25,000 sq. ft leased facility located
in Salisbury U.K. The equipment designed and manufactured in Salisbury is
different from the power supplies produced in Mexico and China. Full assembly,
test and quality assurance takes place in house.
Sales and service support staff for the European network of distributors
for Digital Power products are located within the building together with other
functions such as Engineering and Administration.
Sales, Marketing and Customers
Digital Power markets its products through a network of independent
manufacturer's representatives. Each representative organization is responsible
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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 we or the
representative organization may terminate the agreement with 30 day's written
notice.
In certain territories, we have entered into agreements with distributors
who buy and resell our products. For the fiscal years ended December 31, 2004
and 2003, domestic distributor sales accounted for 20.43% and 38.60%,
respectively, of our total sales. Over this same period, one distributor
accounted for 16.85%, and 17.90%, respectively, of total sales. In general, the
agreements with 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 distributor decides to terminate its agreement with
us, we believe that we would be able to continue the sale of our products
through direct sales to the customers of the distributor. Generally, the Company
does not grant a right of return. Revenues subject to certain stock rotation are
deferred until the products are sold to the end customer or until the rotation
rights expire. Certain distributors are allowed, in the sixth month after the
initial stock purchase, to rotate stock that has not been sold for other
products. This may be repeated each sixth month thereafter for 18 months, at no
more than 25% of the distributor's purchase during the previous six months. For
the past three years, stock rotations have not exceeded one percent of total
sales.
Our promotional efforts to date have included product data sheets, trade
shows and Internet Web sites. Our future promotional activities will likely
include space advertising in industry-specific publications, application notes
and enhancements to our existing Web sites.
Our products are warranted to be free of defects for approximately twelve
months from date of shipment. As of December 31, 2004 and 2003, our warranty
reserve was $116,000 and $111,000, respectively.
Competition
The merchant power supply manufacturing industry is highly fragmented and
characterized by intense competition. Our competition includes hundreds of
companies located throughout the world, some of whom have advantages over us in
terms of labor and component costs, and some of who may offer products
comparable in quality to ours. Many of our competitors, including Power One,
Artesyn Technologies, Inc., ASTEC America, Lambda Electronics, and Meanwell
Power Supplies have substantially greater fiscal and marketing resources and
geographic presence than we do. If we are successful in increasing our revenues,
competitors may notice and increase competition for our customers. We also face
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 us if consolidation
trends in the electronics industry continue and some of the OEMs to whom we sell
our products are acquired by larger OEMs. To remain competitive, management
believes that we must continue to compete favorably on the basis of value by
providing reliable manufacturing, offering customer service and design
engineering services, continuously improving quality and reliability levels, and
offering flexible and reliable delivery schedules. We believe we have a
competitive position with our 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 we will continue to
compete successfully in the power supply market.
Engineering and Product Development
Our engineering and product development efforts are primarily directed
toward modification of our standard power supply to provide a broad array of
individual models. Improvements are constantly sought in power density,
modifiability, and efficiency, while we attempt to anticipate changing market
demands for increased functionality, such as PFC and improved EMI filtering.
Historically, the Company has utilized consultants and contract engineering
for the majority of its new product developments, supported by the internal
engineering staff for product engineering. The Company intends to continue this
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strategy for engineering and development. Further, as a result of the strategic
relationship with Telkoor, the Company utilizes Telkoor's engineering team in
Israel to assist it in new product development. If the Company identifies a
potential new product for development, it will cooperate with Telkoor to design
and develop the product.
Employees
As of December 31, 2004, we had 37 employees located in the United States
and the United Kingdom.
Foreign Currency Fluctuations
Gresham Power conducts its financial operation using the United Kingdom
pound sterling. Therefore, we are subject to monetary fluctuations between the
U.S. dollar and United Kingdom pound sterling. For the years ended December 31,
2004 and 2003 we recorded foreign currency translation adjustments of $81,000
and $146,000 respectively.
Raw Materials
The raw materials for power supplies principally consist of electronic
components. These raw materials are available from a variety of sources and we
are not dependent on any one supplier. We generally purchase components based on
orders received or forecast to minimize our risk of unusable inventory. To the
extent necessary we may order materials prior to orders to obtain shorter lead
times and achieve quantity discounts following a risk assessment.
We expect our purchase of raw material to decrease as we move to turnkey
contract manufacturers in the Far East.
Intellectual Property
We rely upon a combination of trade secrets, industry expertise,
confidential procedures and contractual provisions to protect our intellectual
property. We believe that because our products are continually updated and
revised, obtaining patents would be costly and not beneficial.
On July 8, 2004, our trademark, "DP Digital Power - Powering our
technologies," was registered with the United States Patent and Trademark
Office.
ITEM 2. DESCRIPTION OF PROPERTY.
Our headquarters are located in approximately 9,500 square feet of leased
office engineering and development space in Fremont, California. For the year
ended December 31, 2004, we paid $8,550 per month for rent. On October 1, 2005
our rent will increase to $9,025 per month till September 30, 2006. From October
1, 2006 to September 30, 2007, our rent will be $9,500 per month. During 2002,
we issued to the landlord warrants to purchase 10,000 shares of Common Stock at
an exercise price of $1.00 per shares expiring in September 2013.
DPL leases approximately 25,000 square feet for its location in Salisbury,
England. DPL pays rent of approximately $15,000 per month, and the lease expires
on September 26, 2008. We believe that our existing facilities are adequate for
the foreseeable future and have no plans to expand them.
ITEM 3. LEGAL PROCEEDINGS.
On April 2, 2003, a claim was filed against the Company by Tek-Tron
Enterprises Inc. ("Tek-Tron") in state court of Pennsylvania, specifically, the
8
Court of Common Pleas of Bucks County, at Case No. 0302116-24-1. Tek-Tron was
seeking damages of approximately $300,000 for breach of contract and conversion
of parts and infrastructure owned by Tek-Tron located in the Company's former
subsidiary, Poder Digital S.A's, Mexico manufacturing plant. In April 2004, the
Company signed a settlement agreement with Tek-Tron according to which the
Company agreed to pay $90,000 in installments and return certain disputed
inventory for a full release. As of December 31, 2004, the Company paid the full
$90,000. The settlement agreement allows Tek-Tron to seek arbitration limited to
the sum of $50,000 in case the parties do not agree on a resolution regarding
the returned inventory. Tek-Tron has notified the Company it believes that the
disputed inventory contains missing labeling and inspection reports. The Company
continues to work toward reaching a resolution over the returned property for
which the Company' has a maximum liability of $50,000 under the settlement
agreement. The Company's management and its litigation counsel are unable to
assess the outcome of such arbitration proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
(a) Comparative Market Prices
Our common share is listed and traded on the American Stock Exchange
("AMEX") under the symbol DPW. The following tables set forth the high and low
closing sale prices, as reported by AMEX, for our common share for the prior two
fiscal years.
Quarter Ended High Low
------------- ---- ---
12/31/2004 $1.25 $1.23
9/30/2004 0.82 0.76
6/30/2004 1.35 1.20
3/31/2004 1.15 1.10
12/31/2003 $0.85 $0.84
9/30/2003 0.78 0.75
6/30/2003 0.78 0.78
3/31/2003 0.57 0.55
(b) Holders
As of March 15, 2005, there were 6,161,859 shares of our common shares
outstanding, held by approximately 96 registered holders, not including holders
whose shares of common stock are held in street name.
(c) Dividends
We have not declared or paid any cash dividends since our inception and we
do not intend to pay any cash dividends in the foreseeable future. The
declaration of dividends in the future, if any, will be at the discretion of the
Board of Directors and will depend upon our earnings, capital requirements and
financial position.
(d) Recent Sales of Unregistered Securities
In January 2005, the Company entered into a convertible note agreement with
Telkoor, according to which Telkoor loaned a $ 250,000 interest free convertible
9
note to be paid on the tenth business day after the Company announced its
financial results for 2005. The note may be converted into Common stock at a
rate of $ 1.06 per share. Automatic conversion shall occur if the Company meets
its set budget for 2005.
The sale and issuance of the convertible note was made by us in reliance
upon the exemptions from registration provided under Section 4(2) and 4(6) of
the Securities Act of 1933, as amended, and Rule 506 of Regulation D,
promulgated by the SEC under federal securities laws and comparable exemptions
for sales to "accredited" investors under state securities laws. The offers and
sales were made to accredited investors as defined in Rule 501(a) under the
Securities Act, no general solicitation was made by us or any person acting on
our behalf; the securities sold were subject to transfer restrictions, and the
certificates for those shares contained an appropriate legend stating that they
had not been registered under the Securities Act and may not be offered or sold
absent registration or pursuant to an exemption there from.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
General
We are engaged in the business of designing, developing, manufacturing,
marketing and selling switching power supplies to the industrial,
telecommunication, data communication, medical and military industries. Revenues
are generated from sales to distributors, OEMs in North America, Europe and the
United Kingdom.
During the year ended December 31, 2004, the Company's products were
received well in the market place. We have continued our promotional efforts to
increase sales to existing and new customers and continue our strategy to move
the manufacture of our products to the Far East. Until revenues increase to a
sufficient amount to offset our expenses, we anticipate that we will continue to
experience net losses. We believe that our cash will be sufficient to fund those
losses for at least 12 months.
During 2004, the Company issued 511,261 Common shares to Telkoor in
consideration of $ 493,000 net of issuance expenses at the price of the average
closing price of the Company's share of common stock during the twenty trading
days preceding the closing date.
In June 2004, the Company issued 204,918 Common shares to a new investor,
in consideration of $ 250,000 at the price of the average closing price of the
Company's share of common stock during the twenty trading days preceding the
closing date.
Results of Operations
The table below sets forth certain statements of operations data as a
percentage of revenues for the years ended December 31, 2004 and 2003:
Years Ended December 31,
------------------------
2004 2003
---- ----
Revenues 100.00% 100.00%
Cost of Revenues 76.23 72.30
Write-off of excess inventory 2.50 0.63
------ ------
Gross profit 21.27 27.07
Engineering and product development 7.16 7.57
Sales and marketing 15.15 14.93
General and administrative 13.24 19.03
------ ------
10
Total operating expenses 35.55 41.53
------ ------
Operating loss (14.28) (14.46)
Financial income and other expense 0.51 0.34
------ ------
Loss before tax benefit (13.77) (14.12)
Tax benefit 0.28 1.05
------ ------
Net loss (13.49)% (13.07)%
====== ======
The following discussion and analysis should be read in connection with the
consolidated financial statements and the notes thereto and other financial
information included elsewhere in this report. We prepared the financial
statements in accordance with generally accepted accounting principles which
require management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Year Ended December 31, 2004 compared to Year Ended December 31, 2003
Revenues
For the year ended December 31, 2004, revenues increased by 18.24% to
$8,713,000 from $7,369,000 for the year ended December 31, 2003. The increase in
revenue is mainly due to our newer products developed through Telkoor being
received well in the market place.
Revenues from the domestic operation of DPC increased 12.79% to $3,854,000
for the year ended December 31, 2004, from $3,417,000 for the year ended
December 31, 2003. Revenues from the Company's European operations of DPL
increased 22.95% to $4,859,000 for the year ended December 31, 2004, from
$3,952,000 for the year ended December 31, 2003. The increase in revenues for
the year ended December 31, 2004 from December 2003 is due to our products being
received well in the market place.
Gross Margins
Gross margins were 21.27% for the year ended December 31, 2004, compared to
27.07% for the year ended December 31, 2003. The decrease in our gross margins
can be primarily attributed to the shifting in product mix and one time
inventory write-offs in the total amount of $218,000 related mainly to obsolete
raw material and slow moving inventory in DPL.
Engineering and Product Development
Engineering and product development expenses were 7.16% of revenues for the
year ended December 31, 2004, compared to 7.57% for the year ended December 31,
2003. Actual dollar expenditures increased by $66,000 from 2003 to 2004 partly
due to the utilization of subcontractors.
Selling and Marketing
Selling and marketing expenses were 15.15% of revenues for the year ended
December 31, 2004, compared to 14.93% for the year ended December 31, 2003.
11
Actual dollar expenditures increased by $220,000 from 2003 to 2004. The increase
in sales and marketing was primarily due to the hiring of a sales person, travel
and advertising expenses as part of our efforts to increase sales.
General and Administrative
General and administrative expenses were 13.24% of revenues for the year
ended December 31, 2004, compared to 19.03% for the year ended December 31,
2003. The decrease of $248,000 in general and administrative expenses from 2003
to 2004 is mainly due to reductions in the personnel hours spent on
administrative duties. In 2003, general and administrative expenses included
accrued litigation expenses of $102,000.
Financial Income and Other Expenses
Financial income, net of interest expense, was $45,000 for the year ended
December 31, 2004 compared to an income of $25,000 for the year ended December
31, 2003. The increase in the financial income from 2003 to 2004 is from the
Company's United Kingdom's operations of DPL
Loss before Tax benefit
For the year ended December 31, 2004, we had a loss before tax benefit of
$1,200,000 compared to a loss of $1,040,000 for the year ended December 31,
2003. The loss increase is mainly due to one time inventory write-offs in the
total amount of $218,000 related to obsolete raw material and slow moving
inventory in DPL.
Tax Benefit
For the year ended December 31, 2004, the Company recorded a tax benefit of
$25,000 compared to a tax benefit of $77,000 for the year ended December 31,
2003. The tax benefit for the year 2004 and 2003 are from the UK operations.
As of December 31, 2004, the Company had approximately $4,780,000 in
federal net operating loss carryforward for income tax purposes, which can be
carried forward and offset against taxable income for 20 years and expire in
2022 - 2024.
Net Loss and Net Income
Net loss for the year ended December 31, 2004, was $1,175,000 compared to a
net loss of $963,000 for the year ended December 31, 2003. The net loss can be
attributed mainly due to the decrease in gross margins and one time inventory
write-offs in the amount of $218,000. We plan on continually increasing our
supply base through the use of contract manufacturers in the Far East in order
to reduce our cost.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States require management to make
estimates and assumptions that affect the reported assets, liabilities, sales
and expenses in the accompanying financial statements. Critical accounting
policies are those that require the most subjective and complex judgments, often
employing the use of estimates about the effect of matters that are inherently
uncertain. The following are considered our most critical accounting policies
that, under different conditions or using different assumption or estimates,
could show materially different results on our financial condition and results
of operations.
Revenue Recognition
The Company's revenue recognition policy for product revenue is such that
12
revenue is recognized when the risks and rewards of ownership pass, which is
primarily upon delivery of goods to customers (see Note 2h to the Consolidated
Financial Statements).
Inventory Obsolescence Accruals
The Company writes down its inventory for estimated obsolescence or
unmarketable inventory to the estimated net realizable value based upon
assumptions about future demand and market conditions. If actual market
conditions are less favorable than those projected by management, additional
inventory write-downs may be required.
Allowance for Doubtful Accounts
Our accounts receivable are derived from revenue earned from customers
located in the United States and the United Kingdom. We perform ongoing credit
evaluations of our customers' financial condition and currently require no
collateral from our customers. An allowance for doubtful accounts for estimated
losses is maintained in anticipation of the inability or unwillingness of
customers to make required payments. When we become aware that a specific
customer is unable to meet its financial obligations, such as the result of
bankruptcy or deterioration in the customer's operating results or financial
position, we record a specific allowance to reflect the level of credit risk in
the customer's outstanding receivable balance. We are not able to predict
changes in the financial condition of customers, and if the condition or
circumstances of our customers deteriorates, estimates of the recoverability of
trade receivables could be materially affected and we may be required to record
additional allowances. Alternatively, if our estimates are determined to be
greater than the actual amounts necessary, we may reverse a portion of such
allowance in future periods based on actual collection experience.
Other Accrued Liabilities
The Company also maintains other accrued liabilities. These accruals are
based on a variety of factors including past experience and various actuarial
assumptions and, in many cases, require estimates of events not yet reported to
the Company. If future experience differs from these estimates, operating
results in future periods would be impacted.
Liquidity and Capital Resources
On December 31, 2004, we had cash, cash equivalents and restricted cash of
$1,554,000 and working capital of $2,437,000. This compares to cash, cash
equivalents and restricted cash of $1,346,000 and working capital of $2,686,000
at December 31, 2003.
Net cash used in operating activities was $541,000 for the year ended
December 31, 2004, compared to cash used in operating activities of $197,000 for
the year ended December 31, 2003.
Net cash provided by investing activities was $38,000 for the year ended
December 31, 2004, compared to cash provided in investing activities of $262,000
for the year ended December 31, 2003.
Net cash provided by financing activities was $765,000 for the year ended
December 31, 2004, compared to net cash provided by financing activities of
$331,000 for the year ended December 31, 2003.
In January 2005, the Company entered into a convertible note agreement with
Telkoor, according to which Telkoor loaned a $250,000 interest free convertible
note to be paid on the tenth business day after the Company announced its
financial results for 2005. The note may be converted into Common stock at a
rate of $1.06 per share. Automatic conversion shall occur if the Company meets
its set budget for 2005.
Since May 2003, the Company has a line of credit from Silicon Valley Bank
13
("SVB"). The Company can borrow up to $ 1,200,000 at SVB's prime rate plus 1.75%
(totaling 5.25% at December 31, 2004). In order to use the line of credit, the
Company is required to maintain certain ratios and be in compliance with other
covenants. Interest only is payable on a monthly basis. The maturity date of the
line of credit is August 30, 2005. As of December 31, 2004, the Company had not
yet utilized its line of credit.
We do not believe that our sales are seasonal. Further, we do not believe
that inflation at the current and projected rates will have a material adverse
impact on our operations. The Company believes it has adequate resources at this
time to continue its promotional efforts to increase sales in the electronic
industry market. However, if the Company does not meet those goals, it may have
to raise money through debts or equity, which may dilute the shareholder equity.
Management
There is currently a dispute between certain shareholders and managers of
Telkoor, which is subject to litigation in Israel. Two of the members of our
Board of Directors and the two members that comprise the Board of Directors of
Digital Power Limited are involved in this dispute. Although, the Company does
not believe the dispute has seriously effected the day-to-day operations of the
Company, it may however have an adverse impact on certain decision making in the
Company.
RISK FACTORS
In addition to the other information presented in this report, the
following should be considered carefully in evaluating us and our business. This
report contains various forward-looking statements that involve risks and
uncertainties. Our 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.
We experienced an operating loss during the year ended December 31, 2004 and
anticipate that losses will continue in the near future.
For the year ended December 31, 2004, we incurred an operating loss of
$1,245,000. Although we have actively taken steps to reduce our costs, we will
incur losses until we increase revenues through the sale of current products and
decrease manufacturing costs through a greater utilization of Far East contract
manufacturers.
We are dependent on a limited number of customers.
Traditionally, we have relied on a limited number of customers for growth
in sales. It cannot be assured that we will be able to retain current customers
and the loss of any major OEM customer may have an adverse effect on our
revenues.
We are dependant on Telecommunication and other electronic equipment industries.
Substantially all of our existing customers are in the telecommunication
and other electronic equipment industries and they manufacture products that are
subject to rapid technological change, obsolescence and large fluctuations in
demand. These industries are further characterized by intense competition. The
OEMs serving these markets are pressured for increased product performance and
lower product prices. OEMs, in turn, make similar demands on their suppliers,
such as us, for increased product performance and lower prices. The
telecommunication industry is inherently volatile. Recently, certain segments of
the telecommunication and other electronic industries have experienced a
significant softening in product demand. Such lower demand may affect our
customers, in which case the demand for our products may decline and our growth
could be adversely affected.
14
We are dependent on the performance of our subcontract manufacturers.
Since we do not own significant manufacturing facilities, we must rely on
our subcontractors' abilities to purchase components, staff their operation,
maintain high volume and high quality processes and remain financially solvent.
Conditions in Israel may limit our ability to receive and sell products. This
could decrease our revenues.
Telkoor's principal offices, research and development and manufacturing
facilities are located in Israel. Political, economic and military conditions in
Israel directly affect their operations. We could be adversely affected by any
major hostilities involving Israel, the interruption or curtailment of trade
between Israel and its trading partners, a significant increase in inflation, or
a significant downturn in the economic or financial conditions of Israel.
Restrictive laws or policies directed towards Israel or Israeli businesses could
adversely affect us.
We are dependant upon key personnel.
Our performance is substantially dependent on the performance of its
executive officers and key personnel and on our ability to retain and motivate
such personnel. The loss of any of our key personnel could have a material
adverse effect on our business, financial condition and operating results.
We are dependant on suppliers.
We rely on, and will continue to rely on, outside parties to manufacture
parts, components and equipment. We cannot assure you that these suppliers will
be able to meet our needs in a satisfactory and timely manner or that we will be
able to obtain additional suppliers when and if necessary. A significant price
increase, a quality control problem, an interruption in supply or other
difficulties with third party manufacturers could have a material and adverse
effect on our ability to successfully provide our products. Further, the failure
of third parties to deliver the products, components, necessary parts or
equipment on schedule, or the failure of third parties to perform at expected
levels, could delay our delivery of power supply products.
Our products are not protected by patents.
Our products are not subject to any U.S. or foreign patents. We believe
that because our products are continually updated and revised, obtaining patents
would be costly and not beneficial. Therefore, we cannot guarantee that other
competitors or former employees will make use of and develop proprietary
information on which we rely.
Our common stock price is volatile.
Our common stock is listed on the American Stock Exchange and is thinly
traded. In the past, our trading price has fluctuated widely, depending on many
factors that may have little to do with our operations or business prospects.
Further, the exercise of outstanding options and warrants may adversely affect
our stock price and your percentage of ownership. As of December 31, 2004, the
Company has employees options to purchase 1,290,425 shares of common stock, with
a weighted average exercise price of $1.28 exercisable at prices ranging from
$0.48 to $2.375 per share and consultants and service providers options and
warrants to purchase 260,000 shares of common shares, with a weighted average
exercise price of $1.81 exercisable at prices ranging from $0.55 to $3.00 were
outstanding. In January 2005, the Company entered into a convertible note
agreement with Telkoor, according to which Telkoor loaned a $250,000 interest
free convertible note to be paid on the tenth business day after the Company
announced its financial results for 2005. The note may be converted into Common
stock at a rate of $ 1.06 per share. Automatic conversion shall occur if the
Company meets its set budget for 2005. The exercise of these options and
warrants may have an adverse effect on the price of our common share and will
dilute existing shareholder percentage ownership in the Company.
15
Substantial Ownership by Telkoor
As of December 31, 2004, Telkoor owns approximately 43% of the outstanding
shares of Common Stock of the Company. In January 2005, the Company entered into
a convertible note agreement with Telkoor, according to which Telkoor loaned a
$250,000 interest free convertible note to be paid on the tenth business day
after the Company announced its financial results for 2005. The note may be
converted into Common stock at a rate of $1.06 per share. Automatic conversion
shall occur if the Company meets its set budget for 2005. Telkoor ownership
makes it difficult for other shareholders to propose changes or change the Board
of Directors. Currently, certain shareholders and managers of Telkoor are in a
dispute. This dispute may divert limited resources and disrupt our business. See
"management" section above.
We are dependent on Telkoor's new design and transfer of production to third
party manufacturers
We are dependent on Telkoor's intellectual property and its ability to
provide prototypes, pilot production and transfer production to third party
manufacturers in the Far East for cost reductions. Due to concern over
engineering resource limitations and prioritization of those resources, we
cannot be assured that Telkoor will be able to meet our customer's needs. We
also depend on Telkoor's ability to transfer manufacturing satisfactory and
timely to third party manufacturer. Failure to obtain new products or delay in
transferring to third party low cost subcontract manufacturers will have an
adverse effect on our ability to successfully provide our products and be
competitive or profitable in our market place.
Legislative actions, higher insurance cost and potential new accounting
pronouncements are likely to cause our general and administrative expenses to
increase and impact our future financial position and results of operations.
We are working diligently toward evaluating and documenting our internal
control systems in order to allow management to report on, and our independent
auditors to attest to, our internal control over financial reporting, as
required by Section 404 of the Sarbanes-Oxley Act of 2002. Compliance may
require us to retain additional personnel and/or additional outside legal,
accounting and advisory services, which will increase general and administrative
expenses. There can be no assurances that the evaluation required by
Sarbanes-Oxley Section 404 will not result in the identification of significant
control deficiencies or that our auditors will be able to attest to the
effectiveness of our internal control over financial reporting.
Proposed changes in the accounting rules, including legislative and other
proposals to account for employee stock options as a compensation expense among
others, could materially increase the expenses that we report under generally
accepted accounting principles and adversely affect our operating results.
Intellectual Property
While Digital owns the intellectual property rights on its legacy products
(the US, UP and UPF Series), Telkoor designed and developed the newer products
(the CPCI, Strongbox and eF Series) at its expense and owns the intellectual
property rights. Further, all of these new products sold by Digital to date were
manufactured by Telkoor in Israel and shipped to Digital Power at a transfer
price which allowed for some gross margins to be earned by Telkoor This exposes
Digital Power to potentially lower gross margins on these products. Digital and
Telkoor plan to enter into an agreement to manufacture these products in a lower
cost environment to allow for improved gross margins. However, no assurances can
be given that such an agreement will be formalized, which could result in
continued lower margins.
ITEM 7. FINANCIAL STATEMENTS.
The financial statements of the Company, including the notes thereto and
report of the independent auditors thereon, are attached hereto as exhibits as
page numbers F-1 through F-26.
16
DIGITAL POWER CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2004
IN U.S. DOLLARS
INDEX
Page
------------
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheet F-2
Consolidated Statements of Operations F-3
Statements of Changes in Shareholders' Equity F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-6-22
- - - - - - - -
[GRAPHIC OMITTED]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of
DIGITAL POWER CORPORATION
We have audited the accompanying consolidated balance sheet of Digital
Power Corporation ("the Company") and its subsidiary as of December 31, 2004,
and the related consolidated statements of operations, changes in shareholders'
equity and cash flows for each of the two years in the period ended December 31,
2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We are not engaged to
perform an audit of the Company's internal control over finacial reporting. Our
audit included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purposes of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company and its subsidiary as of December 31, 2004, and the consolidated
results of their operations and cash flows for the two years in the period ended
December 31, 2004, in conformity with U.S. generally accepted accounting
principles.
/s/ KOST FORER GABBAY & KASIERER
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
February 10, 2005 A Member of Ernst & Young Global
F-1
DIGITAL POWER CORPORATION
-------------------------
CONSOLIDATED BALANCE SHEET
-------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
December 31,
2004
------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,323
Restricted cash 231
Trade receivables, net of allowance for doubtful accounts of $118 1,690
Prepaid expenses and other receivables 169
Inventories (Note 3) 1,482
------------------
Total current assets 4,895
-----
------------------
LONG-TERM LEASE DEPOSITS 18
------------------
PROPERTY AND EQUIPMENT, NET (Note 4) 250
------------------
Total assets $ 5,163
-----
==================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 984
Related parties - trade payables account (Note 10) 773
Other current liabilities (Note 6) 701
------------------
Total current liabilities 2,458
-----
------------------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 7)
SHAREHOLDERS' EQUITY (Note 8):
Series A redeemable, convertible Preferred shares, no par value: 500,000 shares
authorized, 0 shares issued and outstanding as of December 31, 2004 -
Preferred shares, no par value: 1,500,000 shares authorized, 0 shares issued
and outstanding as of December 31, 2004 -
Common shares, no par value: 10,000,000 shares authorized; 6,161,859 shares
issued and outstanding as of December 31, 2004 11,036
Additional paid-in capital 2,227
Deferred stock compensation (13)
Accumulated deficit (10,620)
Accumulated other comprehensive income 75
------------------
Total shareholders' equity 2,705
-----
------------------
Total liabilities and shareholders' equity $ 5,163
-----
==================
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
Year ended December 31,
--------------------------------
2004 2003
--------------- --------------
Revenues (Note 11) $ 8,713 $ 7,369
Cost of revenues (Note 10) 6,642 5,328
Write-off of excess inventory 218 46
--------------- --------------
Gross profit 1,853 1,995
--------------- --------------
Operating expenses:
Engineering and product development 624 558
Selling and marketing 1,320 1,100
General and administrative 1,154 1,402
--------------- --------------
Total operating expenses 3,098 3,060
-----
--------------- --------------
Operating loss (1,245) (1,065)
Financial income, net 45 25
--------------- --------------
Loss before tax benefit (1,200) (1,040)
Tax benefit (Note 9) 25 77
--------------- --------------
Net loss $ (1,175) $ (963)
=============== ==============
Basic and diluted net loss per share $ (0.20) $ (0.19)
=============== ==============
Weighted average number of shares used in computing basic and diluted
net loss per share 5,915,403 5,185,680
=============== ==============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
DIGITAL POWER CORPORATION
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
-------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
Other
Common shares Add'l Deferred accumulated Total Total
----------------- paid-in stock Accumulated comprehensive comprehensive shareholders'
Number Amount capital compensation deficit income (loss) loss equity
--------- ------- -------- ------------ ----------- ------------- ------------- -------------
Balance as of January 1, 2003 4,510,680 $11,036 $ 837 $ - $ (8,482) $ (152) $ 3,239
Issuance of Common shares, net 900,000 - 600 - - - 600
Comprehensive loss:
Net loss - - - - (963) - $ (963) (963)
Foreign currency translation - - - - - 146 146 146
adjustments -------------
Total comprehensive loss - - - - - - $ (817) -
--------- ------- -------- ------------ ----------- ------------- ============= -------------
Balance as of December 31, 2003 5,410,680 11,036 1,437 - (9,445) (6) 3,022
Issuance of Common shares, net 716,179 - 743 - - - 743
Deferred stock compensation
related to options granted
to an employee - - 25 (25) - - -
Amortization of deferred stock
compensation related to options
granted to an employee - - - 12 - - 12
Exercise of options granted to
employees 35,000 - 22 - - - 22
Comprehensive loss:
Net loss - - - - (1,175) - $ (1,175) (1,175)
Foreign currency translation
adjustments - - - - - 81 81 81
-------------
Total comprehensive loss $ (1,094)
--------- ------- -------- ------------ ------------ ------------ ============= -------------
Balance as of December 31, 2004 6,161,859 $11,036 $ 2,227 $ (13) $ (10,620) $ 75 $ 2,705
========= ======= ======== ============ ============ ============ =============
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
DIGITAL POWER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
---------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands
Year ended December 31,
-------------------------------
2004 2003
--------------- --------------
Cash flows from operating activities:
Net loss $ (1,175) $ (963)
Adjustments required to reconcile net loss to net cash used in
operating activities:
Depreciation 104 131
Amortization of deferred stock compensation related to options
granted to an employee 12 -
Decrease in deferred income taxes, net - 649
Decrease (increase) in trade receivables (16) 437
Decrease (increase) in prepaid expenses and other receivables (29) 2
Decrease (increase) in inventories 259 (179)
Increase (decrease) in accounts payables 642 (316)
Increase (decrease) in other current liabilities (347) 44
Other 9 (2)
--------------- --------------
Net cash used in operating activities (541) (197)
--------------- --------------
Cash flows from investing activities:
Restricted cash 65 304
Purchase of property and equipment (27) (67)
Repayment of long-term loan - 25
--------------- --------------
Net cash provided by investing activities 38 262
--------------- --------------
Cash flows from financing activities:
Payments made on short-term bank credit - (250)
Principal payments of capital lease obligations - (19)
Proceeds from issuance of Common shares, net 743 600
Exercise of options granted to employees 22 -
--------------- --------------
Net cash provided by financing activities 765 331
--------------- --------------
Effect of exchange rate changes on cash and cash equivalents 11 38
--------------- --------------
Increase in cash and cash equivalents 273 434
Cash and cash equivalents at the beginning of the year 1,050 616
--------------- --------------
Cash and cash equivalents at the end of the year $ 1,323 $ 1,050
=============== ==============
Supplemental disclosure of cash flows activities:
Interest paid $ - $ 9
=============== ==============
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 1:- GENERAL
a. Digital Power Corporation ("the Company" or "DPC") was
incorporated in 1969, under the General Corporation Law of
the State of California. The Company has a wholly-owned
subsidiary, Digital Power Limited ("DPL"), located in the
United Kingdom. The Company and its subsidiary are currently
engaged in the design, manufacture and sale of switching
power supplies and converters. The Company has two
reportable geographic segments - North America (sales
through DPC) and Europe (sales through DPL).
b. The Company depends on Telkoor Telecom Ltd. ("Telkoor"), a
major shareholder in the Company, and another major
subcontractor for producing its products. If these
manufacturers were to be unable or unwilling to continue
manufacturing the Company's products in required volumes on
a timely basis, any resulting manufacturing delays could
result in the loss of sales, which could adversely affect
operating results and cash position. The Company also
depends on Telkoor's intellectual property and ability to
transfer production to third party manufacturers. Failure to
obtain new products or delay in transferring to third party
low cost subcontract manufacturers will have an adverse
effect on the ability of the Company to successfully provide
products.
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States ("U.S. GAAP").
a. Use of estimates:
The preparation of the financial statements in conformity
with generally accepted accounting principles requires
management to make estimates and assumptions that affect the
amounts reported in the financial statements and
accompanying notes. Actual results could differ from those
estimates.
b. Financial statements in U.S. dollars:
The financial statements of the foreign subsidiary, whose
functional currency has been determined to be its local
currency, have been translated into U.S. dollars in
accordance with Statement of Financial Accounting Standard
No. 52 "Foreign Currency Translation" ("SFAS No. 52"). All
balance sheet accounts have been translated using the
exchange rates in effect at the balance sheet date.
Statement of operations amounts have been translated using
the average exchange rate for the period. The resulting
translation adjustments are reported as a component of
accumulated other comprehensive income (loss) in
shareholders' equity.
c. Principles of consolidation:
The consolidated financial statements include the accounts
of the Company and its wholly-owned subsidiary. Intercompany
transactions and balances have been eliminated upon
consolidation.
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments
that are readily convertible to cash with original
maturities of three months or less.
F-6
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
e. Restricted cash:
Restricted cash is invested in a deposit, which matures
within less than three months and is used to secure a letter
of credit issued by the Company's bank.
f. Inventories:
Inventories are stated at the lower of cost or market value.
Inventory write-offs are provided to cover risks arising
from slow-moving items or technological obsolescence.
Cost is determined as follows:
Raw materials, parts and supplies - using the "first-in,
first-out" method.
Work-in-progress and finished products - on the basis of
direct manufacturing costs with the addition of indirect
manufacturing costs.
The Company periodically assesses its inventories valuation
in accordance with dead and slow moving items, revenue
forecasts and technological obsolescence. When inventories
on hand exceed the foreseeable demand or become obsolete,
the value of excess inventory, which at the time of the
review was not expected to be sold, is written off.
During 2004 and 2003, the Company recorded inventories
write-offs in a total amount of $ 218 and $ 46,
respectively.
g. Property and equipment:
Property and equipment are stated at cost, net of
accumulated depreciation. Depreciation is calculated by the
straight-line method over the estimated useful lives, at the
following annual rates:
%
--------------------------
Computers, software and
related equipment 20 - 33
Office furniture and equipment 10 - 20
Motor vehicles 20 - 33
Leasehold improvements Over the term of the lease
The long-lived assets of the Company and its subsidiary are
reviewed for impairment in accordance with Statement of
Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"), whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to the
future undiscounted cash flows expected to be generated by
the assets.
During 2003 and 2004, no impairment losses have been
identified.
F-7
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
h. Revenue recognition:
The Company and its subsidiary generate their revenues from
the sale of their products. The Company and its subsidiary
sell their products through direct and indirect sales force.
The sales through an indirect sales force is also considered
as sales to end users.
Revenues from products are recognized in accordance with
Staff Accounting Bulletin No. 104, "Revenue Recognition in
Financial Statements" ("SAB No. 104"), when the following
criteria are met: persuasive evidence of an arrangement
exists, delivery has occurred, the seller's price to the
buyer is fixed or determinable, no further obligation exists
and collectibility is reasonably assured.
Generally, the Company does not grant a right of return.
Revenues subject to certain stock rotation are deferred
until the products are sold to the end customer or until the
rotation rights expire. Certain distributors are allowed, in
the sixth month after the initial stock purchase, to rotate
stock that has not been sold for other products. This may be
repeated each sixth month thereafter for 18 months, at no
more than 25% of the distributor's purchase during the
previous six months.
Service revenues are deferred and recognized on a
straight-line basis over the term of the service agreement.
i. Engineering and product development:
Engineering and product development costs are charged to the
statement of operations as incurred.
j. Income taxes:
The Company and its subsidiary account for income taxes in
accordance with Statement of Financial Accounting Standard
No. 109, "Accounting for Income Taxes" ("SFAS No. 109").
This Statement prescribes the use of the liability method
whereby deferred tax assets and liability account balances
are determined based on differences between financial
reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The
Company and its subsidiary provide a valuation allowance, if
necessary, to reduce deferred tax assets to their estimated
realizable value.
F-8
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
k. Warranty costs:
The Company offers a 12 month warranty period for all of its
products. The Company estimates the costs that may be
incurred under its warranty and records a liability in the
amount of such costs at the time product revenue is
recognized. Factors that affect the Company's warranty
liability include the number of units, historical rates of
warranty claims and cost per claim. The Company periodically
assesses the adequacy of its recorded warranty liabilities
and adjusts the amounts as necessary.
Changes in the Company's warranty allowance during the
period are as follows:
Year ended
December 31,
2004
---------------
Balance at the beginning of the year $ 111
Warranties issued during the year 131
Settlements made during the year (85)
Changes in liability for pre-existing
warranties during the year,
including expirations (41)
---------------
Balance at the end of the year $ 116
===============
l. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles
Board Statement No. 25, "Accounting for Stock Options Issued
to Employees" ("APB No. 25") and FASB Interpretation No. 44,
"Accounting for Certain Transactions Involving Stock
Compensation" ("FIN No. 44") in accounting for its employee
stock option plans. Under APB No. 25, when the exercise
price of an employee stock option is equivalent to or above
the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
The Company adopted the disclosure provisions of Financial
Accounting Standards Board Statement No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure"
("SFAS No. 148"), which amended certain provisions of SFAS
123 to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation,
effective as of the beginning of the prior fiscal year. The
Company continues to apply the provisions of APB No. 25, in
accounting for stock-based compensation.
Pro forma information regarding the Company's net loss and
net loss per share is required by SFAS No. 123 and has been
determined as if the Company had accounted for its employee
stock options under the fair value method prescribed by SFAS
No. 123.
F-9
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
The fair value for options granted in 2004 and 2003 is
amortized over their vesting period and estimated at the
date of grant using a Black-Scholes options pricing model
with the following weighted average assumptions:
2004 2003
------------------- --------------
Dividend yield 0% 0%
Expected volatility 107% - 111% 72%
Risk-free interest 3% - 3.5% 1%
Expected life of up to 5-7 years 4 years
Pro forma information under SFAS No. 123 is as follows:
Year ended December 31,
-------------- - ---------------
2004 2003
-------------- ---------------
Net loss available to Ordinary shares - as reported $ (1,175) $ (963)
Deduct - stock-based employee compensation - intrinsic value 12 -
Add - stock-based employee compensation - fair value (184) 89
-------------- ---------------
Pro forma:
Net loss $ (1,347) $ (1,052)
============== ===============
Net loss per share:
Basic and diluted net loss, as reported $ (0.20) $ (0.19)
============== ===============
Pro forma basic and diluted net loss $ (0.23) $ (0.20)
============== ===============
m. Fair value of financial instruments:
The following methods and assumptions were used by the
Company in estimating its fair value disclosures for
financial instruments:
The carrying amounts of cash and cash equivalents,
restricted cash, trade receivables, accounts payable and
other current liabilities approximate their fair value due
to the short-term maturity of such instruments.
n. Basic and diluted net loss per share:
Basic net loss per share is computed based on the weighted
average number of Common shares outstanding during each
year. Diluted net earnings per share is computed based on
the weighted average number of Common shares outstanding
during each year, plus dilutive potential Common shares
considered outstanding during the year, in accordance with
Statement of Financial Accounting Standard No. 128,
"Earnings per Share" ("SFAS No. 128").
The total number of shares related to the outstanding
options and warrants excluded from the calculations of
diluted net loss per share because these securities are
anti-dilutive was 1,550,425, and 1,232,460 for the years
ended December 31, 2004 and 2003, respectively.
F-10
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
o. Concentrations of credit risks:
Financial instruments that potentially subject the Company
and its subsidiary to concentrations of credit risk consist
principally of cash and cash equivalents, restricted cash
and trade receivables.
Cash and cash equivalents and restricted cash are invested
in banks in the U.S. and in the U.K. Such deposits in the
United States may be in excess of insured limits and are not
insured in other jurisdictions. Management believes that the
financial institutions that hold the Company's and its
subsidiary's investments are financially sound and,
accordingly, minimal credit risk exists with respect to
these investments.
Trade receivables of the Company and its subsidiary are
mainly derived from sales to customers located primarily in
the U.S and in Europe. The Company performs ongoing credit
evaluations of its customers and to date has not experienced
any material losses. An allowance for doubtful accounts is
determined with respect to those amounts that the Company
and its subsidiary have determined to be doubtful of
collection.
The Company and its subsidiary have no off-balance-sheet
concentration of credit risk such as foreign exchange
contracts, option contracts or other foreign hedging
arrangements.
p. Impact of recently issued accounting standards:
In November 2004, the FASB issued Statement of Financial
Accounting Standard No. 151, "Inventory Costs, an Amendment
of ARB No. 43, Chapter 4." ("SAFS No. 151"). SFAS No. 151
amends Accounting Research Bulletin ("ARB") No. 43, Chapter
4, to clarify that abnormal amounts of idle facility
expense, freight handling costs and wasted materials
(spoilage) should be recognized as current-period charges.
In addition, SFAS No. 151 requires that allocation of fixed
production overheads to the costs of conversion be based on
normal capacity of the production facilities. SAFS No. 151
is effective for inventory costs incurred during fiscal
years beginning after June 15, 2005. The Company does not
expect that the adoption of SFAS No. 151 will have a
material effect on its financial position or results of
operations.
In December 2004, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standard No.
123 (revised 2004) ("SFAS No. 123(R)"), "Share-Based
Payment", which is a revision of SFAS No. 123. SFAS No.
123(R) supersedes APB No. 25, and amends FASB Statement No.
95, "Statement of Cash Flows". Generally, the approach in
SFAS No. 123(R) is similar to the approach described in SFAS
No. 123. However, SFAS No. 123(R) requires all share-based
payments to employees, including grants of employee stock
options, to be recognized in the income statement based on
their fair values. Pro forma disclosure is no longer an
alternative.
F-11
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
SFAS No. 123(R) must be adopted no later than the beginning
of the first annual period beginning after December 15,
2005. The Company expects to adopt SFAS No. 123(R) on
January 1, 2006.
SFAS No. 123 (R) permits public companies to adopt its
requirements using one of two methods:
1. A "modified prospective" method in which compensation
is recognized beginning with the effective date (a)
based on the requirements of SFAS No. 123(R) for all
share-based payments granted after the effective date
and (b) based on the requirements of SFAS No. 123 for
all awards granted to employees prior to the effective
date of SFAS No. 123(R) that remain unvested on the
effective date.
2. A "modified retrospective" method which includes the
requirements of the modified prospective method
described above, but also permits entities to restate
based on the amounts previously recognized under SFAS
No. 123 for purposes of pro forma disclosures either (a)
all prior periods presented or (b) prior interim periods
of the year of adoption.
The Company plans to adopt SFAS No. 123(R) using the
modified-prospective method.
As permitted by SFAS No. 123, the Company currently accounts
for share-based payments to employees using APB No. 25's
intrinsic value method and, as such, generally recognizes no
compensation cost for employee stock options. Accordingly,
the adoption of SFAS No. 123 (R)'s fair value method will
have a significant impact on the result of operations,
although it will have no impact on the overall financial
position. The impact of adoption of SFAS No. 123(R) cannot
be predicted at this time because it will depend on levels
of share-based payments granted in the future. However, had
the Company adopted SFAS No. 123(R) in prior periods, the
impact of that Standard would have approximated the impact
of SFAS No. 123 as described in the disclosure of pro forma
net loss and loss per share above in note 2 to our
consolidated financial statements.
NOTE 3:- INVENTORIES
December 31,
2004
----------------
Raw materials, parts and supplies $ 360
Work in progress 388
Finished products 734
----------------
$ 1,482
================
F-12
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 4:- PROPERTY AND EQUIPMENT
December 31,
2004
-----------------
Cost:
Computers, software and related equipment $ 675
Office furniture and equipment 509
Motor vehicles 74
Leasehold improvements 417
-----------------
1,675
-----------------
Accumulated depreciation
Computers, software and related equipment 620
Office furniture and equipment 488
Motor vehicles 74
Leasehold improvements 243
-----------------
1,425
-----------------
Depreciated cost $ 250
=================
NOTE 5:- SHORT-TERM BANK CREDIT
Since May 2003, the Company has a line of credit from
Silicon Valley Bank ("SVB"). The Company can borrow up to $
1,200 at SVB's prime rate plus 1.75% (totaling 5.25% at
December 31, 2004). In order to use the line of credit, the
Company is required to maintain certain ratios and be in
compliance with other covenants. Interest only is payable on
a monthly basis. The maturity date of the line of credit is
August 30, 2005. As of December 31, 2004, the Company had
not yet utilized its line of credit.
If the Company exercises its line of credit, the Company
must in return grant the bank a continuing security interest
in all presently existing and later acquired collateral to
secure all obligations and performance of its duties towards
the bank.
NOTE 6:- OTHER CURRENT LIABILITIES
December 31,
2004
----------------
Accrued payroll and payroll taxes $ 91
Warranty costs 116
Advances from customers 33
Deferred revenues 242
Government authorities 39
Accrued expenses 166
Other 14
----------------
$ 701
F-13
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Lease commitments:
The Company and its subsidiary rent their facilities under
various operating lease agreements, which expire on various
dates, the latest of which is in 2009. Future rental
commitments under non-cancelable leases are as follows:
Year ended
December 31,
-----------------------
2005 $ 304
2006 298
2007 303
2008 189
2009 189
------------------
$ 1,283
==================
Total rent expenses for the years ended December 31, 2004
and 2003, were approximately $298 and $244, respectively.
b. Litigation:
On April 2, 2003, a claim was filed against the Company by
Tek-Tron Enterprises Inc. ("Tek-Tron"). Tek-Tron was seeking
damages of approximately $ 300 for breach of contract and
conversion of parts and infrastructure owned by Tek-Tron
located in the Company's former subsidiary, Poder Digital
S.A.'s Mexico manufacturing plant. In April 2004, the
Company signed a settlement agreement with Tek-Tron,
according to which the Company agreed to pay $90 in
installments and return certain disputed inventory for a
full release. As of December 31, 2004, the Company paid the
$90 in full. The settlement agreement allows Tek-Tron to
seek arbitration limited to the sum of $50, in case the
parties do not agree on a resolution regarding the returned
inventory. Tek-Tron has notified the Company that it
believes that the disputed inventory contains missing
labeling and inspection reports. The Company continues to
work toward reaching a resolution over the returned property
for which the Company has a maximum liability of $50 under
the settlement agreement. The Company's management and its
litigation counsel are unable to assess the outcome of such
arbitration proceeding.
F-14
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 8:- SHAREHOLDERS' EQUITY
a. Preferred shares:
There is one authorized series of Preferred shares in the
amount of 500,000 shares of Series A cumulative redeemable
convertible Preferred shares ("Series A"), and an additional
1,500,000 Preferred shares have been authorized, but the
rights, preferences, privileges and restrictions on these
shares have not been determined. DPC's Board of Directors is
authorized to create a new series of Preferred shares and
fix the number of shares as well as the rights, preferences,
privileges and restrictions granted to or imposed upon any
series of Preferred shares. As of December 31, 2004, there
were no shares issued or outstanding.
b. Common shares:
Common shares confer upon the holders the rights to receive
notice to participate and vote in the general meeting of
shareholders of the Company, to receive dividends, if and
when declared, and to participate in a distribution of
surplus of assets upon liquidation of the Company.
On March 31, 2003, the Company entered into an agreement to
sell 900,000 Common shares to Telkoor, in consideration for
$600, net of issuance expenses.
During 2004, the Company issued 511,261 Common shares to
Telkoor in consideration of $493, net of issuance expenses
at the average closing price of the Company's Common shares
during the twenty trading days preceding the closing date.
In June 2004, the Company issued 204,918 Common shares to a
new investor, in consideration of $250, at the price of the
average closing price of the Company's Common shares during
the twenty trading days preceding the closing date..
c. Share Option Plans:
1. Under the Company's stock option plans ("the plan"),
options may be granted to employees, officers,
consultants, service providers and directors of the
Company or its subsidiary.
2. As of December 31, 2004, the Company has authorized,
by several Incentive Share Option Plans, the grant
of options to officers, management, other key
employees and other of up to 2,272,500 of the
Company's Common shares. As of December 31, 2004, an
aggregate of 522,480 of the Company's options are
still available for future grant.
3. The options granted generally become fully
exercisable after four years and expire no later
than 10 years from the approval date of the option
plan under terms of grant. Any options that are
forfeited or cancelled before expiration become
available for future grants.
F-15
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 8:- SHAREHOLDERS' EQUITY (Cont.)
A summary of the Company's employees share option activity,
(except options to consultants and service providers) and
related information is as follows:
Year ended December 31,
-----------------------------------------------------------------
2004 2003
------------------------------- --------------------------------
Weighted Weighted
Amount average Amount average
of exercise of exercise
options price options price
--------------- --------------- --------------- ----------------
Outstanding at the
beginning of the year 972,460 $ 1.19 1,190,255 $ 1.38
Granted 379,000 $ 1.03 65,000 $ 0.78
Exercised (35,000) $ 0.59 - $ -
Forfeited (26,035) $ 0.62 (282,795) $ 1.88
--------------- ---------------
Outstanding at the end of
the year 1,290,425 $ 1.28 972,460 $ 1.19
=============== =============== =============== ================
Exercisable options at the
end of the year 925,175 $ 1.39 860,460 $ 1.38
=============== =============== =============== ================
In connection with the grant of certain share options to an
employee in 2004, the Company recorded amortization of
deferred share compensation of $25, for the aggregate
differences between the respective exercise price of options
at their date of grant and the fair value of the Common
shares subject to such options. Unamortized deferred stock
compensation is presented as a reduction in shareholders'
equity and is amortized ratably over the vesting period of
the related options.
The options outstanding as of December 31, 2004, have been
classified by exercise price, as follows:
Options Weighted Options Weighted
outstanding average Weighted exercisable average
of as remaining average as of exercise price
Exercise December 31, contractual exercise December 31, of options
price 2004 life price 2004 exercisable
----------------- ---------------- -------------- ------------- --------------- --------------
Years
--------------
$0.48-0.60 40,000 8.11 $ 0.57 25,000 $ 0.55
$0.70-1.05 804,000 8.07 $ 0.86 453,750 $ 0.73
$1.30-1.813 143,535 5.44 $ 1.63 143,535 $ 1.63
$2.31-2.375 302,890 3.17 $ 2.32 302,890 $ 2.32
---------------- -----------------
1,290,425 6.63 $ 1.28 925,175 $ 1.39
================ ============== ================= ================
F-16
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 8:- SHAREHOLDERS' EQUITY (Cont.)
d. Warrants and options issued to service providers and
consultants:
1. The Company's outstanding options to consultants and
service providers as of December 31, 2004, are as
follows:
Options for Exercise
Common price per Options Exercisable
Issuance date shares share exercisable through
-------------------- ---------------- ---------------- ---------------- ----------------
January 2002 100,000 $ 3 100,000 *) -
May 2002 40,000 $ 1 40,000 *) -
August 2002 10,000 $ 1 10,000 *) -
November 2002 10,000 $ 1 10,000 *) -
January 2004 100,000 $ 1.16 100,000 *) -
---------------- ----------------
260,000 260,000
================ ================
*) 10 years from the date of grant.
During 2004, none of the options were exercised.
2. On January 16, 2004, the Board of Directors
cancelled the options to purchase 100,000 Common
shares at $3 per share that were granted on January
1, 2002, and 100,000 Common shares at $3 per share
that were granted on January 1, 2004, which the
Company was obligated to grant under the Termination
and Consulting Agreement with a former CEO. In lieu
thereof, the former CEO was granted options to
purchase 100,000 shares at $1.16 per share.
The Company evaluated the modification according to
SFAS No. 123. Since the fair value of the modified
options were lower than the fair value of the
original options at the date of modification, no
compensation expenses were recorded.
e. Employee Stock Ownership Plan:
The Company has an Employee Stock Ownership Plan ("ESOP")
covering eligible employees. The ESOP provides for the
Employee Stock Ownership Trust ("ESOT") to distribute shares
of the Company's Common shares as retirement benefits to the
participants. The Company did not distribute shares ever
since 1998. As of December 31, 2004, the outstanding Common
shares held by the ESOT are 167,504.
f. Dividends:
In the event that cash dividends are declared in the future,
such dividends will be paid in U.S. dollars. The Company
does not intend to pay cash dividends in the foreseeable
future.
F-17
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 9:- TAXES ON INCOME
a. Taxes on income are comprised of $ 25 and $ 77 of foreign
current taxes for the years ended December 31, 2004 and
2003, respectively.
b. Deferred income taxes:
Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the
amounts used for income tax purposes. Significant components
of the Company's deferred tax liabilities and assets are as
follows:
December 31,
-------------------------------
2004 2003
-------------- --------------
Operating loss carryforward $ 2,171 $ 1,575
Reserves and allowances 739 190
-------------- --------------
Net deferred tax asset before valuation allowance 2,910 1,765
Valuation allowance (2,910) (1,765)
-------------- --------------
Net deferred tax asset $ - $ -
============== ==============
As of December 31, 2004, the Company and its subsidiary
provided a valuation allowance of $2,910 on respect of
deferred tax assets resulting from short-term temporary
differences and depreciation charged in advance of a capital
allowance taken and from carryforward losses. During the
fiscal year 2004, the Company increased the tax valuation by
$ 1,145.
Management currently believes that since the Company and its
subsidiary have a history of losses, it is more likely than
not that the deferred tax assets regarding the remainder of
the loss carryforwards and other temporary differences will
not be realized in the foreseeable future.
c. Net operating losses carryforwards:
As of December 31, 2004, the Company had approximately
$4,780 in federal net operating loss carryforwards for
income tax purposes, which can be carried forward and offset
against taxable income for 20 years and expire in 2022 -
2024.
Utilization of U.S. net operating losses may be subject to
substantial annual limitation, due to the "change in
ownership" provisions of the Internal Revenue Code of 1986
and similar state provisions. The annual limitation may
result in the expiration of net operating losses before
utilization.
d. The main reconciling items between the statutory tax rate of
the Company and the effective tax rate are the
non-recognition of tax benefits resulted from the Company's
accumulated net operating losses carryforward due to the
uncertainty of the realization of such tax benefits.
F-18
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 9:- TAXES ON INCOME (Cont.)
e. Net loss before tax benefit consists of the following:
Year ended December 31,
--------------------------------
2004 2003
-------------- --------------
Domestic (U.S.) $ (436) $ (603)
Foreign (U.K.) (764) (437)
-------------- --------------
$ (1,200) $ (1,040)
============== ==============
NOTE 10:- RELATED PARTY TRANSACTIONS
The results of operations from transactions with Telkoor, a
major shareholder, were as follows:
Year ended December 31,
-----------------------------------
2004 2003
---------------- ---------------
Purchases of products from Telkoor $ 1,942 $ 972
================ ===============
Transactions with Telkoor derive mainly from purchase of
power supplies from Telkoor.
F-19
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 11:- SEGMENTS CUSTOMERS AND GEOGRAPHICAL INFORMATION
a. The Company has two reportable geographic segments, see Note
1a for a brief description of the Company's business. The
data is presented in accordance with Statement of Financial
Accounting Standard No.131, "Disclosure About Segments of an
Enterprise and Related Information ("SFAS No. 131").
The following data presents the revenues expenditures and
other operating data of the Company's geographic operating
segments:
Year ended December 31, 2004
------------------------------------------------------------------------
DPC DPL Eliminations Total
---------------- --------------- --------------- ---------------
Revenues $ 3,854 $ 4,859 $ - $ 8,713
Intersegment revenues 749 - (749) -
---------------- --------------- --------------- ---------------
Total revenues $ 4,603 $ 4,859 $ (749) $ 8,713
================ =============== =============== ===============
Depreciation expense $ 30 $ 74 $ - $ 104
================ =============== =============== ===============
Operating loss $ 655 $ 590 $ - $ 1,245
================ =============== =============== ===============
Financial income, net $ 45
===============
Loss before tax benefit $ 1,200
===============
===============
Tax benefit $ - $ 25 $ - $ 25
================ =============== =============== ===============
Net loss $ 643 $ 532 $ - $ 1,175
================ =============== =============== ===============
Expenditures for segment assets as
of December 31, 2004 $ 16 $ 11 $ - $ 27
================ =============== =============== ===============
Identifiable assets as of
December 31, 2004 $ 1,835 $ 3,328 $ - $ 5,163
================ =============== =============== ===============
F-20
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 11:- SEGMENTS CUSTOMERS AND GEOGRAPHICAL INFORMATION (Cont.)
Year ended December 31, 2003
------------------------------------------------------------------------
DPC DPL Eliminations Total
---------------- --------------- --------------- ---------------
Revenues $ 3,417 $ 3,952 $ - $ 7,369
Intersegment revenues 677 - (677) -
---------------- --------------- --------------- ---------------
Total revenues $ 4,094 $ 3,952 $ (677) $ 7,369
================ =============== =============== ===============
Depreciation expense $ 37 $ 94 $ - $ 131
================ =============== =============== ===============
Operating loss $ (782) $ (283) $ - $ (1,065)
================ =============== =============== ===============
Financial income, net $ 25
===============
Loss before tax benefit $ (1,040)
===============
Tax benefit $ - $ 77 $ - $ 77
================ =============== =============== ===============
Net loss $ (799) $ (164) $ - $ (963)
================ =============== =============== ===============
Expenditures for segment assets as
of December 31, 2003 $ 15 $ 52 $ - $ 67
================ =============== =============== ===============
Identifiable assets as of December
31, 2003 $ 2,054 $ 3,082 $ - $ 5,136
================ =============== =============== ===============
b. Major customers' data as percentage of total sales:
Year ended December 31,
---------------------------------
2004 2003
--------------- ---------------
Customer A 16.89% 17.90%
=============== ===============
Customer B 10.59% -
=============== ===============
c. Total revenues from external customers divided on the basis
of the Company's product lines are as follows:
Year ended December 31,
---------------------------------
2004 2003
--------------- ---------------
Revenues:
Commercial products $ 6,670 $ 5,914
Defense products 2,043 1,455
--------------- ---------------
$ 8,713 $ 7,369
=============== ===============
F-21
DIGITAL POWER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands
NOTE 12:- SUBSEQUENT EVENTS
In January 2005, the Company entered into a convertible note
agreement with Telkoor, according to which Telkoor loaned a
$250 interest free convertible note to be paid on the tenth
business day after the Company announced its financial
results for 2005. The note may be converted into Common
stock at a rate of $1.06 per share. Automatic conversion
shall occur if the Company meets its set budget for 2005.
- - - - - - - - -
F-22
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 8A. CONTROLS AND PROCEDURES.
We carried out an evaluation, under the supervision and with the
participation of the our management, including our Chief Executive Officer and
Chief Financial Officer, about the effectiveness of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures as of the end of the period covered by this
Form 10-KSB are effective in timely alerting them to material information
required to be included in this Form 10-KSB.
ITEM 8B. OTHER INFORMATION.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information called for in Item 9 of Part III is incorporated by
reference from the definitive proxy statement of the Company to be filed with
the Securities and Exchange Commission within 180 days from fiscal year end.
ITEM 10. EXECUTIVE COMPENSATION.
The information called for in Item 10 of Part III is incorporated by
reference from the definitive proxy statement of the Company to be filed with
the Securities and Exchange Commission within 180 days from fiscal year end.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information called for in Item 11 of Part III is incorporated by
reference from the definitive proxy statement of the Company to be filed with
the Securities and Exchange Commission within 180 days from fiscal year end.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for in Item 12 of Part III is incorporated by
reference from the definitive proxy statement of the Company to be filed with
the Securities and Exchange Commission within 180 days from fiscal year end.
17
ITEM 13. EXHIBITS
(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 1996 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 (6)
10.12 Securities Purchase Agreement between the Company and Telkoor Telecom,
Ltd. (now Telkoor Power Ltd.) (7)
10.11 Securities Purchase Agreement between the Company and Telkoor Telecom,
Ltd. (now Telkoor Power Ltd.) (8)
10.12 Employment Letter with David Amitai (9)
10.13 Employment Agreement with Jonathan Wax (9)
10.14 Convertible Note with Telkoor Power Ltd. (10)
21.1 The Company's sole subsidiary is Digital Power Limited, a corporation
formed under the laws of the United Kingdom.
23.1 Consent of Ernst & Young
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act
(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.
(6) Previously filed with the Commission with its Form 10-KSB for the year
ended December 31, 1999.
(7) Previously filed with the Commission with its Form 8-K filed on
November 21, 2001.
(8) Previously filed with the Commission with its Form 8-K filed on January
14, 2004.
(9) Previously filed with the Commission with its Form 10-KSB for the year
ended December 31, 2003.
(10) Previously filed with the Commission with its Form 8-K filed on
February 9, 2005.
18
Item 14. Principal Accounting Fees and Services.
The information called for in Item 14 of Part III is incorporated by
reference from the definitive proxy statement of the Company to be filed with
the Securities and Exchange Commission within 180 days from fiscal year end.
19
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DIGITAL POWER CORPORATION,
a California Corporation
Dated: March 28, 2005 /s/ Jonathan Wax
-------------------------------------
Jonathan Wax,
President and Chief Executive Officer
(Principal 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.
Dated: March 29, 2005 /s/ Ben Zion Diamant
-------------------------------------
Ben Zion Diamant, Chairman
Dated: March 28, 2005 /s/ Jonathan Wax
-------------------------------------
Jonathan Wax, President and
Chief Executive Officer
(Principal Executive Officer)
Dated: March 27, 2005 /s/ David Amitai
-------------------------------------
David Amitai, Director
Dated: March 28, 2005 /s/ Amos Kohn
-------------------------------------
Amos Kohn, Director
Dated: March 28, 2005 /s/ Yeheskel Manea
-------------------------------------
Yeheskel Manea, Director
Dated: March 27, 2005 /s/ Youval Menipaz
-------------------------------------
Youval Menipaz, Director
Dated: March 28, 2005 /s/ Leo Yen
-------------------------------------
Leo Yen, Chief Financial Officer
(Principal Accounting and Financial
Officer)