Business context and reporting period
Digital Power Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017; amounts are in U.S. dollars, thousands, except per-share data. The filing identifies the registrant as Digital Power Corporation, not Hyperscale Data, Inc. The business included power-conversion products, U.K. operations, commercial lending, and newly acquired defense electronics and power distribution businesses.
- In June, the company acquired 56.4% of Microphase, a maker of RF and microwave components for defense, aerospace, and telecommunications. In September, it acquired all of Power-Plus, an industrial power-products distributor.
- The company reported two geographic segments: North America and Europe. Acquisition results are consolidated only from each acquisition date.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $3,220 | $1,826 | $6,670 | $5,603 |
| Gross profit | $1,096 | $703 | $2,534 | $2,077 |
| Gross margin | 34.0% | 38.5% | 38.0% | 37.1% |
| Operating loss | $(1,318) | $(83) | $(3,549) | $(272) |
| Net loss | $(2,071) | $(38) | $(4,916) | $(165) |
| Loss attributable to Digital Power | $(1,967) | $(38) | $(4,700) | $(165) |
| Loss per common share | $(0.15) | $(0.01) | $(0.46) | $(0.02) |
- For the nine months, operating cash flow was $(1,577), investing cash flow $(4,384), and financing cash flow $5,194. Cash declined by $682 to $314 from $996 at year-end 2016.
- At September 30, current assets were $5,667 and current liabilities $9,841, a working-capital deficit of $4,174. Total assets were $18,260; total liabilities $10,798; and total equity $7,462.
- Balance-sheet debt and financing obligations included $1,475 of advances on future receipts, $310 under a revolving credit facility, $2,268 of notes payable, $406 of related-party notes payable, $465 of convertible notes, and $166 of related-party convertible notes, as reported in the respective balance-sheet categories.
- Stock-based compensation was $1,269 for the nine months. Net interest expense was $1,367, including substantial non-cash debt-discount amortization.
Material changes versus the prior comparable period
- Q3 revenue rose 76%, primarily due to Microphase and Power-Plus. Excluding those acquisitions, Q3 revenue was $1,656, down $170 year over year. Nine-month revenue rose 19%, but excluding acquisition revenue, the company reported $4,883, down $720 from the comparable 2016 period.
- Acquired businesses contributed $1,564 of Q3 revenue and $1,787 for the nine months. Management attributed the nine-month decline in legacy business mainly to weaker European sales; U.S. legacy revenue was approximately flat.
- Q3 gross margin fell to 34.0%, while the nine-month margin increased to 38.0%. Management cited lower European sales and slightly lower acquired-business margins for the quarterly decline.
- Operating expenses and interest expense rose sharply. Nine-month general and administrative expense increased to $4,240 from $1,115, reflecting stock compensation, legal and audit fees, investor-relations and consulting costs, and added infrastructure. The company recorded $1,269 of non-cash debt-discount amortization for the nine months.
Outlook, risks, contingencies, and unusual items
- Going concern: Management expects continued losses and says additional capital is needed. The filing states that substantial doubt exists about the company’s ability to continue as a going concern; the financial statements contain no adjustments for a potential failure to continue operations.
- Customer contract: Management cited a three-year, $50 million MTIX purchase order to manufacture, install, and service an MLSE plasma-laser system. The company recognized only $109 of revenue from it through September 30 and said performance and related cash generation would extend over several years; timing and realization remain uncertain.
- Financing and dilution: The company relied on equity, convertible debt, notes, and high-cost advances on future receipts. Those advances provided $1,772 for an obligation to remit $2,585. The filing also describes subsequent financings after quarter-end. Potential common-stock equivalents were 20.9 million at September 30; the company later disclosed that unrestricted potential conversions could exceed its authorized common shares.
- Related-party exposure: At September 30, investments in related-party AVLP were $3,782, principally convertible notes. The company had also established a credit facility of up to $5,000 for AVLP, subject to available funds. Significant relationships and transactions involve Philou, AVLP, and company directors or officers.
- Credit facility issue: Microphase received a notice of default from its lender, principally involving the change of control and borrowings exceeding the borrowing base. A July forbearance agreement accelerated repayment of certain borrowings; approximately $65 subject to acceleration remained outstanding at September 30.
- Controls and reporting: Management reported ineffective disclosure controls and material weaknesses, citing insufficient accounting resources, inadequate segregation of duties, and untimely communication of information to financial-reporting personnel. The filing notes that the June 2017 quarterly report had been restated and amended in November 2017.
- Other items: A Microphase former noteholder had initiated litigation to collect a balance; the disclosed principal and accrued interest were $162. The filing’s Legal Proceedings item itself states “None.” Subsequent events included additional future-receipts financing and convertible debentures.
Important facts for investors to verify
- Whether the company can secure enough capital to fund operations and meet near-term debt and future-receipts repayment obligations.
- Actual revenue, margins, cash receipts, and contract milestones under the $50 million MTIX purchase order, given the limited revenue recognized to date.
- The terms, repayment burden, and dilution effects of subsequent financings, warrants, convertible securities, and related-party transactions.
- Progress resolving the Microphase credit-facility defaults, the disclosed litigation, and the material weaknesses in financial reporting controls.
- The recoverability and valuation of the AVLP-related investment and loans, including the effect of related-party connections and funding commitments.