U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
FORM 10-Q
 
þQuarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June
For the quarterly period ended September 30, 2009

¨Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ________ to ________ .

Commission file number 1-12711
 

DIGITAL POWER CORPORATION
( Exact name of registrant as specified in its charter )
 
California94-1721931
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization) 
 
41324 Christy Street
Fremont, CA 94538-3158
(Address of principal executive offices)
 
(510) 657-2635
(Registrant’s telephone number)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ    No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨   No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer¨Accelerated filer¨
Non-accelerated filer¨Smaller reporting companyþ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12(b)-2 of the Exchange Act). Yes ¨   No þ
 
At AugustNovember 10, 2009, the registrant had outstanding 6,620,7086,626,468 shares of common stock.

 
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DIGITAL POWER CORPORATION
 
TABLE OF CONTENTS
 
  Page
   
PART I – FINANCIAL INFORMATION3
    
 Item 1.Financial Statements3
    
  Consolidated Balance Sheets as of JuneSeptember 30, 2009 and December 31, 20083
    
  Consolidated Statements of Operations for the sixnine months ended JuneSeptember 30, 2009 and JuneSeptember 30, 2008 and for the three months ended JuneSeptember 30, 2009 and JuneSeptember 30, 20084
    
  Statement of Changes in Shareholders’ Equity for the sixnine months ended JuneSeptember 30, 20095
    
  Consolidated Statements of Cash Flows for the sixnine months ended JuneSeptember 30, 2009 and JuneSeptember 30, 20086
    
  Notes to Interim Consolidated Financial Statements7
    
 Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations1213
 Item 3.Quantitative and Qualitative Disclosures About Market Risk16
 Item 4T.Controls and Procedures16
    
PART II – OTHER INFORMATION
1617
    
 Item 1.Legal Proceedings1617
 Item 1A.Risk Factors1617
 Item 2.Unregistered Sales of Equity Securities and Use of Proceeds22
 Item 3.Defaults Upon Senior Securities22
 Item 4.Submission of Matters to a Vote of Security Holders22
 Item 5.Other Information23
 Item 6.Exhibits23
    
SIGNATURES
23
 
 
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DIGITAL POWER CORPORATION
 
PART I — FINANCIAL INFORMATION

ITEM 1.
ITEM 1. FINANCIAL STATEMENTS
DIGITAL POWER CORPORATION

CONSOLIDATED BALANCE SHEETS
U.S. dollars in thousands (except share and per share data)
  June 30,  December 31, 
  2009  2008 
  Unaudited    
ASSETS      
       
CURRENT ASSETS:      
Cash and cash equivalents $2,196  $2,476 
Restricted cash  87   76 
Trade receivables, net of allowance for doubtful accounts of $ 129 and $ 124 as of June 30, 2009 and December 31, 2008, respectively  1,597   1,901 
Prepaid expenses and other accounts receivable  236   139 
Inventories  1,301   1,494 
         
Total current assets  5,417   6,086 
         
PROPERTY AND EQUIPMENT, NET  219   153 
         
LONG-TERM DEPOSITS  41   41 
         
Total assets $5,677  $6,280 
         
LIABILITIES AND SHAREHOLDERS' EQUITY        
         
CURRENT LIABILITIES:        
Accounts payable $652  $1,069 
Related parties – trade payables  201   957 
Deferred revenues  256   134 
Other current liabilities  542   514 
         
Total current liabilities  1,651   2,674 
         
SHAREHOLDERS' EQUITY:        
Share capital -        
Series A redeemable, convertible Preferred shares, no par value - 500,000 shares authorized, 0 shares issued and outstanding at June 30, 2009 and December 31, 2008  -   - 
Preferred shares, no par value - 1,500,000 shares authorized, 0 shares issued and outstanding at June 30, 2009 and December 31, 2008  -   - 
Common shares, no par value - 30,000,000 shares authorized; 6,620,708 and 6,615,708 shares issued and outstanding at June 30, 2009 and December 31, 2008, respectively  -   - 
Additional paid-in capital  13,999   13,927 
Accumulated deficit  (9,733)  (9,784)
Accumulated other comprehensive loss  (240)  (537)
         
Total shareholders' equity  4,026   3,606 
         
Total liabilities and shareholders' equity $5,677  $6,280 
The accompanying notes are an integral part of the consolidated financial statements.
-3-

DIGITAL POWER CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
U.S. dollars in thousands (except share and per share data)
  
Six months ended
June 30,
  
Three months ended
June 30,
 
  2009  2008  2009  2008 
  Unaudited 
             
Revenues $4,516  $6,516  $2,095  $3,347 
Cost of revenues  2,875   4,833   1,385   2,488 
                 
Gross profit  1,641   1,683   710   859 
                 
Operating expenses:                
Engineering and product development  269   302   133   142 
Selling and marketing  584   460   265   190 
General and administrative  665   880   331   321 
                 
Total operating expenses  1,518   1,642   729   653 
                 
Operating income (loss)  123   41   (19)  206 
Financial income (expense), net  (72)  13   (99)  9 
                 
Income (loss) before income taxes  51   54   (118)  215 
Income taxes  -   -   -   - 
                 
Net income (loss) $51  $54  $(118) $215 
                 
Basic net earnings (loss) per share $0.008  $0.008  $(0.018) $0.032 
                 
Diluted net earnings (loss) per share $0.008  $0.008  $(0.018) $0.031 

The accompanying notes are an integral part of the consolidated financial statements.

-4-

DIGITAL POWER CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
U.S. dollars in thousands, except share data

           Other       
     Additional     accumulated  Total  Total 
  Common shares  paid-in  Accumulated  comprehensive  comprehensive  shareholders' 
  Number  Amount  capital  Deficit  loss  income  equity 
                      
Balance as of January 1, 2009 $6,615,708  $-  $13,927  $(9,784) $(537)    $3,606 
                            
Stock compensation related to options granted to Telkoor's employees and other non- employee consultant  -   -   36   -   -      36 
Stock compensation related to options granted to employees  -   -   31   -   -      31 
Exercise of options granted to employees  5,000       5              5 
Comprehensive income:                           
Net income  -   -   -   51   -  $51   51 
Foreign currency translation adjustments  -   -   -   -   297   297   297 
                             
Total comprehensive income                     $348     
                             
Balance as of June 30, 2009 (unaudited)  6,620,708  $-  $13,999  $(9,733) $(240)     $4,026 
The accompanying notes are an integral part of the consolidated financial statements.

-5-
DIGITAL POWER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. dollars in thousands (except share and per share data)

  
Six months ended
June 30,
 
  2009  2008 
  Unaudited 
Cash flows from operating activities:
      
       
Net income $51  $54 
Adjustments required to reconcile net income to net cash (used in) provided by operating activities:        
Depreciation  64   46 
Stock compensation related to options granted to employees  36   21 
Stock compensation related to options granted to Telkoor's employees  31   38 
Decrease in trade receivables, net  436   62 
(Increase) in prepaid expenses and other accounts receivable  (89)  (33)
Decrease in inventories  252   197 
(Decrease) in accounts payable and related parties trade payables  (1,219)  (429)
Increase in deferred revenues and other current liabilities  96   167 
         
Net cash (used in) provided by operating activities  (342)  123 
         
Cash flows from investing activities:
        
         
Purchase of property and equipment  (37)  (5)
         
Net cash used in investing activities  (37)  (5)
         
Cash flows from financing activities:
        
         
Exercise of employees stock options  5   - 
         
Net cash provided by financing activities  5   - 
         
Effect of exchange rate changes on cash and cash equivalents  94   3 
         
Increase (decrease) in cash and cash equivalents  (280)  121 
Cash and cash equivalents at the beginning of the period  2,476   1,443 
         
Cash and cash equivalents at the end of the period $2,196  $1,564 
         
         
Supplemental disclosure of non-cash activities:
        
         
Reclassification of inventory to fixed assets $74  $- 
         

  September 30,  December 31, 
  2009  2008 
  Unaudited    
       
ASSETS      
       
CURRENT ASSETS:      
Cash and cash equivalents $2,543  $2,476 
Restricted cash  84   76 
Trade receivables, net of allowance for doubtful accounts of $ 127 and $ 124 as of September 30, 2009 and December 31, 2008, respectively  1,373   1,901 
Prepaid expenses and other accounts receivable  218   139 
Inventories  1,059   1,494 
         
Total current assets  5,277   6,086 
         
PROPERTY AND EQUIPMENT, NET  235   153 
         
LONG-TERM DEPOSITS  41   41 
         
Total assets $5,553  $6,280 
         
LIABILITIES AND SHAREHOLDERS' EQUITY        
         
CURRENT LIABILITIES:        
Accounts payable $428  $1,069 
Related parties – trade payables  507   957 
Deferred revenues  277   134 
Other current liabilities  591   514 
         
Total current liabilities  1,803   2,674 
         
SHAREHOLDERS' EQUITY:        
Share capital -        
Series A redeemable, convertible Preferred shares, no par value - 500,000 shares authorized, 0 shares issued and outstanding at September 30, 2009 and December 31, 2008  -   - 
Preferred shares, no par value - 1,500,000 shares authorized, 0 shares issued and outstanding at September 30, 2009 and December 31, 2008  -   - 
Common shares, no par value - 30,000,000 shares authorized; 6,626,468 and 6,615,708 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively  -   - 
Additional paid-in capital  14,010   13,927 
Accumulated deficit  (9,938)  (9,784)
Accumulated other comprehensive loss  (322)  (537)
         
Total shareholders' equity  3,750   3,606 
         
Total liabilities and shareholders' equity $5,553  $6,280 

The accompanying notes are an integral part of the consolidated financial statements.
 
 
-6-3
DIGITAL POWER CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
U.S. dollars in thousands, except per share data
  
Nine months ended
September 30,
  
Three months ended
September 30,
 
  2009  2008  2009  2008 
  Unaudited 
             
Revenues $6,224  $9,341  $1,708  $2,825 
Cost of revenues  4,071   6,594   1,196   1,761 
                 
Gross profit  2,153   2,747   512   1,064 
                 
Operating expenses:                
Engineering and product development  405   460   136   158 
Selling and marketing  834   702   250   242 
General and administrative  1,022   1,243   357   364 
                 
Total operating expenses  2,261   2,405   743   764 
                 
Operating income (loss)  (108)  342   (231)  300 
Financial income (expense), net  (46)  74   26   62 
                 
Income (loss) before income taxes  (154)  416   (205)  362 
Income taxes  -   -   -   - 
                 
Net income (loss) $(154) $416  $(205) $362 
                 
Basic net earnings (loss) per share $(0.023) $0.063  $(0.031) $0.055 
                 
Diluted net earnings (loss) per share $(0.023) $0.062  $(0.031) $0.054 

The accompanying notes are an integral part of the consolidated financial statements.

4
 

DIGITAL POWER CORPORATION
 
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSSTATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
U.S. dollars in thousands, (exceptexcept share and per share data)data
           Other       
     Additional     accumulated  Total  Total 
  
Common shares
  paid-in  Accumulated  comprehensive  comprehensive  shareholders' 
  
Number
  
Amount
  
capital
  
Deficit
  
loss
  
income
  
equity
 
                      
Balance as of January 1, 2009  6,615,708  $-  $13,927  $(9,784) $(537)    $3,606 
                            
Stock compensation related to options granted to Telkoor's employees and other non-employee consultant  -   -   14   -   -      14 
Stock compensation related to options granted to employees  -   -   57   -   -      57 
Exercise of options granted to employees  10,760       12              12 
Comprehensive income:                           
Loss  -   -   -   (154)  -  $(154)  (154)
Foreign currency translation adjustments  -   -   -   -   215   215   215 
                             
Total comprehensive income                     $61     
                             
Balance as of September 30, 2009 (unaudited)  6,626,468  $-  $14,010  $(9,938) $(322)     $3,750 

The accompanying notes are an integral part of the consolidated financial statements.

5
DIGITAL POWER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. dollars in thousands

  
Nine months ended
September 30,
 
  2009  2008 
  Unaudited 
Cash flows from operating activities:
      
       
Net (loss) income $(154) $416 
Adjustments required to reconcile net (loss) income to net cash provided by operating activities:        
Depreciation  56   69 
Stock compensation related to options granted to employees  57   43 
Stock compensation related to options granted to Telkoor's employees and other non-employee consultant  14   41 
Decrease in trade receivables, net  612   618 
Increase in prepaid expenses and other accounts receivable  (73)  (39)
Decrease in inventories  459   14 
Decrease in accounts payable and related parties-trade payables  (1,154)  (463)
Increase in deferred revenues and other current liabilities  183   460 
         
Net cash provided by operating activities  -   1,159 
         
Cash flows from investing activities:
        
         
Purchase of property and equipment  (53)  (64)
         
Net cash used in investing activities  (53)  (64)
         
Cash flows from financing activities:
        
         
Exercise of employee stock options  12   - 
         
Net cash provided by financing activities  12   - 
         
Effect of exchange rate changes on cash and cash equivalents  108   (150)
         
Increase in cash and cash equivalents  67   945 
Cash and cash equivalents at the beginning of the period  2,476   1,443 
         
Cash and cash equivalents at the end of the period $2,543  $2,388 
         
Supplemental disclosure of non-cash activities:
        
         
Reclassification of inventory to fixed assets $74  $- 

The accompanying notes are an integral part of the consolidated financial statements.

6
DIGITAL POWER CORPORATION
 
NOTE 1:-GENERAL

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, sale and distribution of switching power supplies and converters. The Company has two reportable geographic segments - North America (sales through DPC) and Europe (sales through DPL).

NOTE 2:-SIGNIFICANT ACCOUNTING POLICIES

a.
The significant accounting policies applied in the annual financial statements of the Company as of December 31, 2008 are applied consistently in these financial statements. In addition, the following accounting policy is applied:
The accompanying unaudited consolidated financial statements as of June 30, 2009 and for the six months ended June 30, 2009 and 2008 are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim periods. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management's discussion and analysis of the financial condition and results of operations, contained in the Company Annual Report on Form 10-K for the fiscal year ended December 31, 2008. The results of operations for the six months ended June

The accompanying unaudited consolidated financial statements as of September 30, 2009 and for the nine months ended September 30, 2009 and 2008 are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim periods. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management's discussion and analysis of the financial condition and results of operations, contained in the Company Annual Report on Form 10-K for the fiscal year ended December 31, 2008. The results of operations for the nine months ended September 30, 2009 are not necessarily indicative of the results for the entire fiscal year ending December 31, 2009.

b.Accounting for stock-based compensation:

The Company has several stock-based employee compensation plans, which are described more fully in Note 4. The Company accounts for stock based compensation in accordance with Accounting Codification Statement 718-10 (formerly SFAS No. 123 (revised 2004)), “Stock compensation” (“ASC 718-10”).

The Company and its subsidiary apply ASC 718-10 and ASC 505-50 (formerly EITF 96-18), “Equity-Based Payments to Non-Employees” (“ASC 505-50") with respect to options issued to non-employees. ASC 718-10 requires use of an option valuation model to measure the fair value of the options at the grant date.

c.Recently issued accounting pronouncements:
 
b.
Accounting for stock-based compensation:
The Company has several stock-based employee compensation plans, which are described more fully in Note 4. The Company accounts for stock based compensation in accordance with SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)").
The Company and its subsidiary apply SFAS 123(R) and Emerging Issues Task Force No. 96-18, "Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" ("EITF 96-18"), with respect to options issued to non-employees. SFAS 123(R) requires use of an option valuation model to measure the fair value of the options at the grant date.
c.
Recently issued accounting pronouncements:
In May 2009, the FASB issued Statement 165, "Subsequent Events" ("SFAS 165"). SFAS 165 should not result in significant changes in the subsequent events that an entity reports. Rather, SFAS 165 introduces the concept of financial statements being available to be issued. Financial statements are considered available to be issued when they are complete in a form and format that complies with generally accepted accounting principles (GAAP) and all approvals necessary for issuance have been obtained.
In May 2009, the FASB issued ASC 855, “Subsequent Events” (ASC 855) (originally issued as SFAS 165). ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 is effective for interim and annual reporting periods ending after June 15, 2009. The Company evaluated all events or transactions that occurred after September 30, 2009 up through November 13, 2009. During this period no material subsequent events came to its attention.

 
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DIGITAL POWER CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
 
NOTE 3-2:-INVENTORIESSIGNIFICANT ACCOUNTING POLICIES (Cont.)
 
In June 2009, the FASB issued SFAS 168, "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles". SFAS No. 168, which is incorporated in ASC Topic 105, Generally Accepted Accounting Principles, identifies the accounting standard codification (ASC) as the authoritative source of generally accepted accounting principles in the United States. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. We adopted SFAS No. 168 in Q3 2009 and include references to the ASC within our consolidated financial statements. The Company adopted ASC 105 in September 2009, and therefore all references by the Company to authoritative accounting principles recognized by the FASB reflect the codification.
In August 2009, the FASB issued ASU No. 2009-05 "Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value". ASU 2009-05 amends Subtopic 820-10 "Fair Value Measurements and Disclosures - Overall" and provides clarification on the methods to be used in circumstances in which a quoted price in an active market for the identical liability is not available. The provisions of ASU 2009-05 are effective for the third quarter of our fiscal 2009. The adoption of ASU 2009-05 did not have a material impact on the Company’s financial statements.
In September 2009, the FASB reached a consensus on Accounting Standards Update, or ASU, 2009-13, Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements, or ASU 2009-13 and ASU 2009-14, Software (Topic 985) – Certain Revenue Arrangements That Include Software Elements, or ASU 2009-14. ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. ASU 2009-13 eliminates the requirement that all undelivered elements must have either: i) VSOE or ii) third-party evidence (TPE) before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the stand alone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. The residual method of allocating arrangement consideration has been eliminated. ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. These new updates are effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of these ASUs will have on its consolidated financial statements.

8
DIGITAL POWER CORPORATION
NOTE 3:-       INVENTORIES

 June 30,  December 31,  September 30,  December 31, 
 2009  2008  2009  2008 
 Unaudited     Unaudited    
            
Raw materials, parts and supplies $226  $228  $223  $228 
Work in progress 227  308  151  308 
Finished products  848   958   685   958 
                
 $1,301  $1,494  $1,059  $1,494 

NOTE 4:-ACCOUNTING FOR STOCK BASEDSTOCK-BASED COMPENSATION

 a.Stock option plans:

 1.Under the Company's stock option plans, options may be granted to employees, officers, consultants, service providers and directors of the Company or its subsidiary.

 2.As of JuneSeptember 30, 2009, the Company has authorized, by several Incentive Share Option Plans, the grant of options to officers, management, other key employees and others of up to 2,272,000 common shares of the Company.  As of JuneSeptember 30, 2009, options to purchase up to an aggregate of 757,870687,870 common shares of the Company 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 date of grant. Any options that are forfeited or cancelled before expiration become available for future grants.

A summary of the Company's employee share option activity (except options to consultants and service providers) and related information is as follows:

 Six months ended June 30, 2009  Nine months ended September 30, 2009 
 
Amount
of options
  
Weighted
average
exercise
price
  Weighted average remaining contractual term (years)  Aggregate intrinsic value *)  
Amount
of options
  
Weighted
average
exercise
price
  
Weighted
average
remaining
contractual
term (years)
  
Aggregate
intrinsic
value *)
 
Outstanding at the beginning of the period 779,035  $1.02        779,035  $1.02       
Granted 20,000   0.93        90,000   1.60       
Exercised (5,000)  1.05        (10,760)  1.13       
Forfeited (32,000)  1.31        (32,000)  1.31       
Expired  -             -           
Outstanding at the end of the period  762,035  $1.00   5.16  $903   826,275  $1.07   5.57  $414 
                                
Exercisable options at the end of the period  611,535  $1.02   4.17  $715   612,785  $1.02   3.93  $328 

*)Calculation of aggregate intrinsic value is based on the share price of the Company's Common sharecommon shares as of JuneSeptember 30, 2009 ($ 2.181.50 per share).

 
-8-9
 

DIGITAL POWER CORPORATION
 
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 4:-ACCOUNTING FOR STOCK BASEDSTOCK-BASED COMPENSATION (Cont.)

Under the provisions of SFAS 123(R),ASC 718-10, the fair value of each option is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions such as stock price on the date of the grant, exercise price, risk-free interest rate, expected volatility, expected life and expected dividend yield of the option. Expected volatility is based exclusively on historical volatility of the entity's stock as allowed by SFAS 123(R).ASC 718-10. The Company uses historical information with respect to the employee options exercised to estimate the expected term of options granted, representing the period of time that options granted are expected to be outstanding. The risk-free interest rate of period within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

The weighted-average grant-date fair value of options granted during the period of sixnine months ended JuneSeptember 30, 2009 was $ 0.931.24 per shareshare.

As of JuneSeptember 30, 2009, there was $ 125180 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the stock option plans. That cost is expected to be recognized over a period of two years.

b.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 common shares of the Company as retirement benefits to the participants. The Company has not distributed shares since 1998. As of JuneSeptember 30, 2009, the ESOT held 167,504 common shares.

NOTE 5:-NET EARNINGS (LOSS) PER SHARE

The following table sets forth the computation of the basic and diluted net earnings (loss) per share:

1.         Numerator:
  
Six months ended
June 30,
  
Three months ended
June 30,
 
  2009  2008  2009  2008 
  Unaudited 
             
Net income (loss) available to common shareholders $51  $54  $(118) $215 
  
Nine months ended
September 30,
  
Three months ended
September 30,
 
  2009  2008  2009  2008 
  Unaudited 
             
Net income (loss) available to Common shareholders $(154) $416  $(205) $362 

2.         Denominator:
            
Denominator for basic net earnings (loss) per share of weighted average number of common shares 6,616,481  6,615,708  6,616,499  6,615,708  6,618,750  6,615,708  6,621,574  6,615,708 
Effect of dilutive securities:                                
Employee stock options  135,562   150,336   -   169,397   -   96,154   -   42,439 
                                
Denominator for diluted net earnings per common share  6,752,043   6,766,044   6,616,499   6,785,105   6,618,750   6,711,862   6,621,574   6,658,147 

 
-9-10
 

DIGITAL POWER CORPORATION
 
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 6:-SEGMENTS, MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION

The Company has two reportable geographic segments; see Note 1 for a brief description of the Company's business.

The following data presents the revenues, expenditures and other operating data of the Company's geographic operating segments in accordance with Statement of Financial Accounting Standard No.131, "Disclosure About Segments of an Enterprise and Related Information" ("ASC 218-10 (formerly SFAS No. 131")131), “Segment reporting”.

 Six months ended June 30, 2009 (unaudited)  Nine months ended September 30, 2009 (unaudited) 
 DPC  DPL  Eliminations  Total  DPC  DPL  Eliminations  Total 
                        
Revenues $2,127  $2,389  $-  $4,516  $2,673  $3,551  $   $6,224 
Intersegment revenues  151   13   (164)  -   155   23   (178)  - 
                                
Total revenues $2,278  $2,402  $(164) $4,516  $2,828  $3,574  $(178) $6,224 
                                
Depreciation expense $15  $49  $-  $64  $23  $33  $-  $56 
                                
Operating income (loss) $(56) $179  $-  $123  $(286) $178  $-  $(108)
                                
Financial expense, net             $(72)
Financial expenses, net             $(46)
                                
Net income (loss) $(60) $111  $-  $51  $(298) $144  $-  $(154)
                                
Expenditures for segment assets, net as of June 30, 2009 $11  $26  $-  $37 
Expenditures for segment assets, net as of September 30, 2009 $13  $40  $-  $53 
                                
Identifiable assets as of June 30, 2009 $2,294  $3,383  $-  $5,677 
Identifiable assets as of September 30, 2009 $2,237  $3,316  $-  $5,553 

 Six months ended June 30, 2008 (unaudited)  Nine months ended September 30, 2008 (unaudited) 
 DPC  DPL  Eliminations  Total  DPC  DPL  Eliminations  Total 
                        
Revenues $2,406  $4,110  $-  $6,516  $3,947  $5,394  $-  $9,341 
Intersegment revenues  120   -   (120)  -   234   5   (239)  - 
                                
Total revenues $2,526  $4,110  $(120) $6,516  $4,181  $5,399  $(239) $9,341 
                                
Depreciation expense $15  $31  $-  $46  $23  $46  $-  $69 
                                
Operating income (loss) $(272) $313  $-  $41  $(125) $467  $-  $342 
                                
Financial income, net             $13              $74 
                                
Net income (loss) $(256) $310  $-  $54  $(108) $524  $-  $416 
                                
Expenditures for segment assets, net as of June 30, 2008 $-  $31  $-  $31 
Expenditures for segment assets, net as of September 30, 2008 $4  $86  $-  $90 
                                
Identifiable assets as of June 30, 2008 $2,134  $4,023  $-  $6,157 
Identifiable assets as of September 30, 2008 $2,623  $3,879  $-  $6,502 

 
-10-11
 

DIGITAL POWER CORPORATION
 
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 6:-SEGMENTS, MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION (Cont.)

  Three months ended June 30, 2009 (unaudited) 
  DPC  DPL  Eliminations  Total 
             
Revenues $1,019  $1,076  $-  $2,095 
Intersegment revenues  69   6   (75)  - 
                 
Total revenues $1,088  $1,082  $(75) $2,095 
                 
Depreciation expense $7  $31  $-  $38 
                 
Operating income (loss) $(20) $1  $-  $(19)
                 
Financial expense, net             $(99)
                 
Net loss $(31) $(87) $-  $(118)
                 
Expenditures for segment assets as of June 30, 2009 $4  $16  $-  $20 
                 
Identifiable assets as of June 30, 2009 $2,294  $3,383  $-  $5,677 
  Three months ended September 30, 2009 (unaudited) 
  DPC  DPL  Eliminations  Total 
             
Revenues $546  $1,162  $   $1,708 
Intersegment revenues  4   10   (14)  - 
                 
Total revenues $550  $1,172  $(14) $1,708 
                 
Depreciation expense (income) $8  $(14) $-  $(6)
                 
Operating (loss) $(230) $(1) $-  $(231)
                 
Financial income, net             $26 
                 
Net income (loss) $(238) $33  $-  $(205)
                 
Expenditures for segment assets as of September 30, 2009 $2  $14  $-  $16 
                 
Identifiable assets as of September 30, 2009 $2,237  $3,316  $-  $5,553 
 
 Three months ended June 30, 2008 (unaudited)  Three months ended September 30, 2008 (unaudited) 
 DPC  DPL  Eliminations  Total  DPC  DPL  Eliminations  Total 
                        
Revenues $1,257  $2,090  $-  $3,347  $1,536  $1,289  $-  $2,825 
Intersegment revenues  91   -   (91)  -   114   5   (119)  - 
                                
Total revenues $1,348  $2,090  $(91) $3,347  $1,650  $1,294  $(119) $2,825 
                                
Depreciation expense $7  $14  $-  $21  $8  $15  $-  $23 
                                
Operating income $22  $184  $-  $206  $147  $154  $-  $301 
                                
Financial income, net             $9              $61 
                                
Net income $31  $184  $-  $215  $148  $214  $-  $362 
                                
Expenditures for segment assets as of June 30, 2008 $-  $23  $-  $23 
Expenditures for segment assets as of September 30, 2008 $4  $55  $-  $59 
                                
Identifiable assets as of June 30, 2008 $2,134  $4,023  $-  $6,157 
Identifiable assets as of September 30, 2008 $2,623  $3,879  $-  $6,502 
 
 
-11-12
 
 
ITEM 2.MANAGEMENT'SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This quarterly report contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 and the Securities Exchange Act of 1934. All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on our expectations, beliefs, forecasts, intentions and future strategies and are signified by the words "expects," "anticipates," "intends," "believes" or similar language. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified below, under “Part II, Item 1A. Risk Factors” and elsewhere in this report. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. All forward-looking statements included in this quarterly report are based on information available to us on the date of this report and speak only as of the date hereof. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
 
In this quarterly report, the “Company,” “Digital Power,” “we,” “us” and “our” refer to Digital Power Corporation, a California corporation, and our wholly-owned subsidiary, Digital Power Limited.
 
GENERAL

We are a solution-driven organization that designs, develops, manufactures and sells cutting-edge high-grade power system solutions to telecom/datacom, industrial, medical and military/defense industries.  We are highly focused on high-grade and custom product designs for both the commercial and military/defense markets, where customers demand high density, high efficiency and rich features products to meet advance applications.  We provide ruggedized products to meet the harshest and/or military mission critical operating conditions.  We are a California corporation originally formed in 1969, and our common stock trades on the NYSE Amex under the symbol “DPW”. Our corporate headquarters isare located in the heart of the Silicon Valley.
 
We also have a wholly-owned subsidiary, Digital Power Limited ("DPL"), which operates under the brand name of “Gresham Power Electronics” (“Gresham”).  GreshamDPL is located in Salisbury, England, and it designs, manufactures sells and distributessells power products and system solutions mainly for the European marketplace, including power conversion, products for naval and military applications andpower distribution equipment, DC/AC inverters forand Uninterrupted Power Supply (UPS) products. DPL’s defense business has specialists in the telecommunications industry.field of naval applications of power distribution conversion. 

We believe that we are one of the first companies in the power solutions industry to introduce a product strategy based on the premise that products developed with an extremely flexible architecture enable rapid modifications to meet unique customer requirements for non-standard output voltages. The development and implementation of this strategy has resulted in broad acceptance in both the telecom/industrial and medical market segments for our new line of high density and high efficiency power products.segments. Digital Power system solutions set an industry standard as the highest power efficiency products and the highest  power output in package sizes that are smaller than any other commercially available product.
 
We market and sell our products to many diverse market segments, including the telecom, industrial, medical and military/defense industries.  Our products serve a global market, with an emphasis on North America and Europe.  We offer a broad product variety, including a full custom product design and production, unique high-speed switching power front-end, modified-standard and value added products, open-Frame,open-frame, Compact-PCI, ATSC front-ends and power over ethernetEthernet (PoE) product solutions, providing power output from 50 watts to 25,000 watts.
 
In an effort to provide short lead-times, high quality products and competitive pricespricing to support our markets, we have entered into numerous production agreements with numerous manufacturers located in Asia.Asia, primarily China.  These contract manufacturing (CM) agreements allow us to control production costs and ensure that high quality products are deliverable in a timely mattermanner to meet market demand.

 
-12-13
 
 
We intend to remain an innovative leader in the development of cutting-edge custom power solutions and rich features products to meet any customer needs and requirements, rugged power systems to meet harsh and extreme operation environmental requirements, and high performance, high efficiency, high density and modular power systems.   We are focusing today on developing even more high-gradeadvanced custom power system solutions tofor numerous customers in a broadly diversified range of markets and challenging environments. Each product development is based on best of class performance criteria, including unique, advanced feature sets and a special layout to meet each of our customers’ unique operating conditions where efficiency, size and time to market are key to their success.  We intend to release these efforts to production within the next two to threefew quarters and to continue acquiring new product development projects.  Further, we believe that all of these new designs will have a near-term demand, as each of them is a full custom solution for industry leaders. Our customers’ requirements for these new designs are similarly advanced and challenging, as they will serve as the foundation for leading edge products for mobile, medical, telecom and defensediversified industries.   Examples of current custom design projects include a cutting-edge design that will incorporate many advanced features including a universal, dual source, redundant input allowing for the automatic selection of a primary or secondary AC main source.    Further, the operating efficiency will exceedof our products exceeds 90% over much of the intended operating range.power efficiency, which satisfies many of our customers’ objectives to provide “green power” to their customers and to improve products lifetime.  Digital Power will provide this productthese products for the customer’s next generation scalable, content ingest platform for storagedigital video encoders and streaming solutions, for video-on-demandmedical equipment and high-speed data network architecturesother products. We also continue to be used by the broadcast service operators. We are also exploringexplore innovative “green”alternative and renewable power solutions that willto complement our current product lines.
 
RESULTS OF OPERATIONS
 
THREE AND SIXNINE MONTHS ENDED JUNESEPTEMBER 30, 2009, COMPARED TO JUNESEPTEMBER 30, 2008
 
Revenues
 
OurTotal revenues for the Company decreased by 37.4 %39.5% to $2,095,000$1,708,000 for the three months ended JuneSeptember 30, 2009, from $3,347,000$2,825,000 for the three months ended JuneSeptember 30, 2008.  The decrease in revenues is mainly due to a decline in sales of our standard commercial products as a result of the global economic recession. Revenues from our commercialthe military products during this periodof the Company decreased by 44.8%27.1% to $1,310,000$586,000 for the three months ended JuneSeptember 30, 2009, from $2,375,000$804,000 for the three months ended JuneSeptember 30, 2008. RevenueRevenues from salesthe commercial products of our military productsthe Company decreased by 19.2%44.5% to $785,000$1,122,000, from $2,021,000 for the three months ended June 30, 2009, from $972,000 for the three months ended JuneSeptember 30, 2008.
 
Revenues from our U.S. operations decreased by 19.0%64.5% to $1,018,000$546,000 for the three months ended JuneSeptember 30, 2009, from $1,257,000$1,536,000 for the three months ended JuneSeptember 30, 2008. Revenues from our European operations of DPL decreased 48.5%9.9% to $1,077,000$1,162,000 for the three months ended JuneSeptember 30, 2009, from $2,090,000$1,289,000 for the three months ended JuneSeptember 30, 2008. The decrease in our revenues from our U.S. and European operations are mainly attributable to a decline in sales of our standard commercial products as a result of the global economic recession, as discussed above.

-13-
 
For the sixnine months ended JuneSeptember 30, 2009, our revenues decreased by 30.7%33.4% to $4,516,000,$6,224,000, from $6,516,000$9,341,000 for the sixnine months ended JuneSeptember 30, 2008. Revenues from our commercial products decreased by 39.5%40.9% to $2,947,000$4,069,000 for the sixnine months ended JuneSeptember 30, 2009, from $4,868,000$6,889,000 for the sixnine months ended JuneSeptember 30, 2008. Revenues from our military products decreased by 4.8%12.1% to $1,569,000$2,155,000 for the sixnine months ended JuneSeptember 30, 2009, from $1,648,000$2,452,000 for the sixnine months ended JuneSeptember 30, 2008.  The overall decrease in revenues is mainly attributable to the decrease in sales of our commercial products, as discussed above.
 
For the sixnine months ended JuneSeptember 30, 2009, revenues attributed to our U.S. operations decreased by 11.6%32.2% to $2,127,000,$2,673,000 from $2,406,000$3,942,000 for the sixnine months ended JuneSeptember 30, 2008. The decrease in product revenue is mainly attributed to a decrease in sales of our commercial products.  Revenues from our European operations of DPL decreased by 41.9%34.2% to $2,389,000$3,551,000 for the sixnine months ended JuneSeptember 30, 2009, from $4,110,000$5,399,000 for the sixnine months ended JuneSeptember 30, 2008. The decrease in revenues from our U.S. and European operations is mainly attributedattributable to a decrease in sales of our commercial products, as discussed above.
 
Gross Margins
 
Gross margins increaseddecreased to 33.9%30.0% for the three months ended JuneSeptember 30, 2009, compared to 25.7%37.7% for the three months ended JuneSeptember 30, 2008. The decrease in gross margins for the three-month period is mainly attributable to the decrease in revenue partially offset by continued production of our products in Asia. Gross margins for the sixnine months ended JuneSeptember 30, 2009 increased to 36.3%34.6% compared to the gross margins of 25.8%29.4% for the sixnine months ended JuneSeptember 30, 2008. The increase in gross margins for the six and three month periodsnine-month period is mainly attributable to continued production of our products in Asia.

 
14

Engineering and Product Development
 
Engineering and product development expenses were $133,000,$136,000, or 6.4%8.0% of revenues, for the three months ended JuneSeptember 30, 2009, compared to $142,000,$158,000, or 4.2%5.6% of revenues, for the three months ended JuneSeptember 30, 2008. Engineering and product development expenses were $269,000,$405,000, or 6.0%6.5% of revenues, for the sixnine months ended JuneSeptember 30, 2009, compared to $302,000,$460,000, or 4.6%4.9% of revenues, for the sixnine months ended JuneSeptember 30, 2008. This decrease for the three and nine-month periods was primarily due to thea decrease in salary expenses.
 
Selling and Marketing
 
Selling and marketing expenses were $265,000,$250,000, or 12.7%14.6% of revenues, for the three months ended JuneSeptember 30, 2009, compared to $190,000,$242,000, or 5.7%8.6% of revenues, for the three months ended JuneSeptember 30, 2008. Selling and marketing expenses were $834,000, or 13.4% of revenues, for the nine months ended September 30, 2009, compared to $702,000, or 7.5% of revenues, for the nine months ended September 30, 2008. The increase was primarily due to an increase in salary expenses and other marketing expenses. Selling and marketing expenses were $584,000, or 12.9% of revenues, for the six months ended June 30, 2009, compared to $460,000, or 7.1% of revenues, for the six months ended June 30, 2008. The increase was primarily due to an increase in salary expenses and other marketing expenses, as discussed above.
 
General and Administrative
 
General and administrative expenses were $331,000,$357,000, or 15.8%20.9% of revenues, for the three months ended JuneSeptember 30, 2009, compared to $321,000,$364,000, or 9.6%12.9% of revenues, for the three months ended JuneSeptember 30, 2008. The increase in thesuch expenses as a percentage of the expenditure of revenues is due mainly to the decrease in revenues in the three months ended JuneSeptember 30, 2009 compared to the revenues in the three months ended JuneSeptember 30, 2008. General and administrative expenses were $665,000,$1,022,000, or 14.7%16.4% of revenues, for the sixnine months ended JuneSeptember 30, 2009, compared to $880,000,$1,243,000, or 13.5%13.3% of revenues, for the sixnine months ended JuneSeptember 30, 2008. Expenditures decreased in 2009 by $215,000$221,000 mainly due to the accrual of liabilities in relation to the separation agreement with our former President and Chief Executive Officer in the sixnine months ended JuneSeptember 30, 2008.
 
Financial Income (Expense)
 
Financial expenseincome was $99,000$26,000 for the three months ended JuneSeptember 30, 2009, compared to financial income of $9,000$62,000 for the three months ended JuneSeptember 30, 2008. Financial expense was $72,000$46,000 for the sixnine months ended JuneSeptember 30, 2009, compared to financial income of $13,000$74,000 for the sixnine months ended JuneSeptember 30, 2008. From time to time, we enter into forward contracts to hedge certain sales transactions which are denominated in foreign currencies. The change in financial results was due to foreign currency fluctuations during the respective periods and changes in the fair value of forward contracts.

-14-
Net Income (Loss)
 
For the three months ended JuneSeptember 30, 2009, we had a net loss of $118,000$205,000 compared to a net income of $215,000$362,000 for the three months ended JuneSeptember 30, 2008. Loss for the nine months ended September 30, 2009 was $154,000 compared to a net income of $416,000 for the nine months ended September 30, 2008. The loss in the three monthsand nine-month periods ended JuneSeptember 30, 2009 is due primarily to the slowdown in the global economy, which had a significant impact on our revenues. Net income for the six months ended June 30, 2009 was $51,000 compared to a net income of $54,000 for the six months ended June 30, 2008.
 
LIQUIDITY AND CAPITAL RESOURCES
 
On JuneSeptember 30, 2009, we had cash and cash equivalents of $2,196,000$2,543,000 and working capital of $3,766,000.$3,474,000. This compares with cash and cash equivalents of $2,476,000 and working capital of $3,412,000 at December 31, 2008. The decreaseincrease in cash and cash equivalents is due mainly to a decrease in accounts payablestrade receivables and related parties trade payable,inventories, offset by a decrease in accounts payable and related parties trade receivable and a decrease in inventories.payables. The increase in working capital is mainly due to a decrease in accounts payable and related parties trade payables and an increase in cash and cash equivalents, offset partially by a decrease in cash and cash equivalents, a decrease in trade receivable,receivables, a decrease in inventories and an increase in deferred revenues.
 
Cash used inprovided by operating activities totaled $222,000$0 for the sixnine months ended JuneSeptember 30, 2009, compared to cash provided by operating activities of $123,000$1,159,000 for the sixnine months ended JuneSeptember 30, 2008. The net useprovision of cash fromby operating activities was mainly due to a decrease in accounts payable and related parties trade payables, offset by a decrease in trade receivable andreceivables, a decrease in inventories.inventories, a decrease in revenues and a net loss.
 
Net cash used in investing activities was $37,000$53,000 for the sixnine months ended JuneSeptember 30, 2009, compared to net cash used in investing activities of $5,000$64,000 for the sixnine months ended JuneSeptember 30, 2008. The increaseThis decrease is due to a decline in the purchase of property and equipment.

15

If we increase our activities and growth in the United States, we will require a larger facility.  We are reassessing the need on an ongoing basis in order to determine the appropriate time to make such a move in light of the global recession and our results of operations.

The lease for our UK facility expired on September 26, 2009, however we continue to occupy the facility and intend to renew the lease for an additional term.  We are currently in negotiations with the lessor in order to finalize the terms of the new lease.

In the event that the lease is not renewed, we believe that the only potential adverse consequence on our future financial position, results of operations and cash flows would be the disruption of the business while alternative premises were sought and relocation was made, along with the costs associated with such search for new premises and relocation.  However, we believe that such potential adverse consequences are unlikely since we are currently in the process of renewing the lease.

We believe we have adequate resources at this time to continue our operational and promotional efforts to increase sales in the electronic industry market.and support our current operation.  However, if we do not meet those goals,increase our sales, we may have to raise money through debt or equity, which may dilute shareholders’ equity.

-15-
  
CRITICAL ACCOUNTING POLICIES

Revenue Recognition

Revenue from product sales is recognized in accordance with the provisions of Accounting Codification Statement 605-10 (formerly SAB 104), "Revenue Recognition in Financial Statements". We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred (i.e., risk of loss and title have transferred to the customer), the sale price is fixed or determinable and collection is reasonably assured.

We generally use customer purchase orders and contracts to determine the existence of an arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. We assess whether the sales price is fixed or determinable based on the payment terms associated with the transaction and whether the price is subject to refund or adjustment. We assess collectability based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history.
Revenue on shipments to distributors and resellers is recognized on delivery. Generally, the Company does not grant a right of return. However, allowances are provided for stock rotation rights that are granted to distributors in accordance with their respective arrangements.

In our Annual Report on Form 10-K for the year ended December 31, 2008, we identified the critical accounting policies which affect our more significant estimates and assumptions used in preparing our consolidated financial statements.  The basis for developing the estimates and assumptions within our critical accounting policies is based on historical information and known current trends and factors.  The estimates and assumptions are evaluated on an ongoing basis and actual results have been within our expectations.  We have not changed these policies from those previously disclosed in our Annual Report.
 
ITEM 3.
ITEM 3.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Not applicable for a smaller reporting company.
 
ITEM 4T.ITEM 4T.     CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
Our Chief Executive Officer and our Chief Financial Officer, after evaluating our disclosure controls and procedures (as defined in the rules and regulations of the Securities and Exchange Commission under the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of the period covered by this quarterly report, have concluded that, as of such date, our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
 
16

Changes in Internal Control over Financial Reporting

During the period covered by this quarterly report, there were no significant changes in our internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
PART II — OTHER INFORMATION
 
ITEM 1.
ITEM 1.       LEGAL PROCEEDINGS
 
See our disclosures under “Legal Proceedings” in our Annual Report on Form 10-K, filed March 31, 2009. There have been no material developments in those proceedings since that filing.
 
ITEM 1A.
ITEM 1A.    RISK FACTORS
 
The risk factors listed in this section provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Readers should be aware that the occurrence of any of the events described in these risk factors could have a material and adverse effect on our business, results of operations and financial condition. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

Although weWe experienced operating incomeloss during the six month periodthree and nine-month periods ended June 30, 2009 and the year ended December 31, 2008 and we experienced net income for the six month period ended June 30, 2009, we experienced a net loss for the three month period ended JuneSeptember 30, 2009, and have historically experienced net losses, and we may experience net losses in the future.

For the six monthnine-month period ended JuneSeptember 30, 2009, we had an operating incomeloss of $123,000,$108,000, compared to an operating income of $41,000$342,000 for the sixnine month period ended JuneSeptember 30, 2008.  For the year ended December 31, 2008, we had operating income of $391,000.  Although we have actively taken steps to reduce our costs, we experienced a net loss of $118,000$205,000 for the three month period ended JuneSeptember 30, 2009, and we might incur losses in the future until we increase revenues through the sale ofby selling current products, transitioning to production stage of our custom design products and decreaseddecreasing manufacturing costs through a greater use of contract manufacturers in Asia and other strategic locations.

-16-

We depend on Telkoor to design and manufacture many of our products.
 
We depend on Telkoor, our largest shareholder and one of our third party subcontractors, for design and manufacturing capabilities for many of the products whichthat we sell. If Telkoor is unable or unwilling to continue designing or manufacturing our products in required volumes on a timely basis, that could lead to loss of sales and adversely affect our operating results and cash position. We also depend on Telkoor's intellectual property and ability to transfer production to third party manufacturers. Failure to obtain new products in a timely manner or delay in delivery of product to customers will have an adverse effect on our ability to meet our customers’ expectations. In addition, we operate in highly competitive markets where our ability to sell Telkoor’s products could be adversely affected by long lead-times and the high costs of Telkoor’s products. Telkoor’s principal offices, research and development and manufacturing facilities are located in Israel. Political, economic, and military conditions in Israel directly affect Telkoor’s operations.

Our strategic focus on our custom power supply solution competencies and concurrent cost reduction plans may be ineffective or may limit our ability to compete.

As a result of our strategic focus on custom power supply solutions, we will continue to devote significant resources to developing custom products for a large number of customers, where each product represents a uniquely tailored solution for a specific customer’s requirements.  A failure to meet these customer product requirements or a failure to meet production schedules and/or product quality standards may put us at risk with one or more of these customers.  The loss of one or more of our significant custom power supply solution customers could have a material adverse impact on our revenues, business or financial condition.

We have also implemented a series of initiatives designed to increase efficiency and reduce costs.  While we believe that these actions will reduce costs, they may not be sufficient to achieve the required operational efficiencies that will enable us to respond more quickly to changes in the market or result in the improvements in our business that we anticipate. In such event, we may be forced to take additional cost-reducing initiatives, which may negatively impact quarterly earnings and profitability as we account for severance and other related costs. In addition, there is the risk that such measures could have long-term effects on our business by reducing our pool of talent, decreasing or slowing improvements in our products or services, making it more difficult for us to respond to customers, limiting our ability to increase production quickly if and when the demand for our solutions increases and limiting our ability to hire and retain key personnel. These circumstances could cause our earnings to be lower than they otherwise might be.

17

If our new custom products development efforts fail to result in products whichthat meet our customers’ needs, or if our customers fail to accept our new products, our revenues will be adversely affected.

We have recently introduced a new strategy of developing multiple custom product designs. The successful development, introduction and commercial success of this new technology will depend on a number of factors, including our ability to meet customer requirements, our ability to meet all product criteria, successful transition from development stage to production stage, our ability to meet product cost targets generating acceptable margins, timely remediation of product performance issues, if any, identified during testing, product performance at customer locations, differentiation of our product from our competitors’ products, and management of customer expectations concerning product capabilities and life cycles.  If we fail to accomplish all of the above, our business could be materially and adversely affected.

We are dependent upon our ability to attract, retain and motivate our key personnel.

Our success depends on our ability to attract, retain and motivate our key management personnel, including, but not limited to, our CEO and CFO, VP of Finance, sales force, and key engineers, necessary to implement our business plan and to grow our business. Despite the adverse economic conditions at this time, and occurring over the past several years, competition for certain specific technical and management skill sets is intense. If we are unable to identify and hire the personnel that we need to succeed, or if one or more of our present key employees were to cease to be associated with us, our future results could be adversely affected.

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We depend upon a few major customers for a majority of our revenues, and the loss of any of these customers, or the substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income.

We currently depend upon a few major OEMs and other customers for a significant portion of our revenues. Because of the global economic downturn, we have already experienced a reduction of orders by OEMs and a reduction or cancellation of orders, scaling back of certain activities and workforce layoffs by other customers.  The loss of any of these customers, or a substantial reduction in the quantity of products that they purchase from us, would significantly reduce our revenues and net income. Furthermore, diversions in the capital spending of certain of these customers to new network elements have and could continue to lead to their reduced demand for our products, which could, in turn, have a material adverse effect on our business and results of operations. If the financial condition of one or more of our major customers should deteriorate, or if they have difficulty acquiring investment capital due to any of these or other factors, a substantial decrease in our revenues would likely result.

We are dependent on the electronic equipment industry, and accordingly will be affected by the impact on that industry ofby the current economic downturn.

Substantially all of our existing customers are in the electronic equipment industry, and they manufacture products that are subject to rapid technological change, obsolescence, and large fluctuations in demand.  This industry is further characterized by intense competition and volatility.  The OEMs serving this industry 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 current economic downturn has affected the entire supply chain, including us.  Recently, certain segments of the electronic industry 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.

Our reliance on subcontract manufacturers to manufacture certain aspects of our products involves risks, including delays in product shipments and reduced control over product quality.

Since we do not own significant manufacturing facilities, we must rely on, and will continue to rely on, a limited number of subcontract manufacturers to manufacture our power supply products. Our reliance upon such subcontract manufacturers involves several risks, including reduced control over manufacturing costs, delivery times, reliability and quality of components, unfavorable currency exchange fluctuations, and continued inflationary pressures on many of the raw materials used in the manufacturing of our power supply products. If we were to encounter a shortage of key manufacturing components from limited sources of supply, or experience manufacturing delays caused by reduced manufacturing capacity, inability of our subcontract manufacturers to procure raw materials, the loss of key assembly subcontractors, difficulties associated with the transition to our new subcontract manufacturers or other factors, we could experience lost revenues, increased costs, delays in, cancellations or rescheduling of orders or shipments, any of which would materially harm our business.

18

We outsource the development of some of our custom design productsproducts.

 We made an operational decision to outsource some of our custom design products to numerous developer partners. This business structure will remain in place until the custom design volume justifies expanding our in house capabilities. Incomplete product designs that do not fully comply with the customer specification and requirements might affect our ability to transition to a volume production stage of the custom designed product where the revenue goals are dependent on the high volume of custom product production. Furthermore, we rely on the design partners’ ability to provide high quality prototypes of the designed product for our customer approval as a critical stage to approve production.

We face intense industry competition, price erosion and product obsolescence, which, in turn, could reduce our profitability.
 
We operate in an industry that is generally characterized by intense competition. We believe that the principal basisbases of competition in our markets are breadth of product line, quality of products, stability, reliability and reputation of the provider, along with cost. Quantity discounts, price erosion, and rapid product obsolescence due to technological improvements are therefore common in our industry as competitors strive to retain or expand market share. Product obsolescence can lead to increases in unsaleable inventory that may need to be written off and, therefore, could reduce our profitability. Similarly, price erosion can reduce our profitability by decreasing our revenues and our gross margins. In fact, we have seen price erosion over the last several years on most of the products we sell, and we expect additional price erosion in the future.

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Our future results are dependent on our ability to establish, maintain and expand our OEM relationships and our other distribution channels.

We market and sell our products through domestic and international OEM relationships and other distribution channels. Our future results are dependent on our ability to establish, maintain and expand our relationships with OEMs as well as with other marketing and sales distribution channels. If, however, the third parties with whom we have entered into such OEM and other arrangements should fail to meet their contractual obligations, cease doing, or reduce the amount of their, business with us or otherwise fail to meet their own performance objectives, customer demand for our products could be adversely affected, which would have an adverse effect on our revenues.

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We may not be able to procure necessary key components for our products, or we may purchase too much inventory or the wrong inventory.

The power supply industry, and the electronics industry as a whole, can be subject to business cycles. During periods of growth, key components required to build our products may become unavailable in the timeframe required for us to meet our customers’ demands. Our inability to secure sufficient components to build products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of inventory for certain key components. Increased inventory levels can increase the potential risk for excess and obsolescence should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong inventory, we may have to record additional inventory reserves or write-off the inventory, which could have a material adverse effect on our gross margins and on our results of operations.

We depend on sales of our legacy products for a meaningful portion of our revenues, but these products are mature and their sales will continue to decline.

A large portion of our sales have historically been attributable to our legacy products. We expect that these products may continue to account for a meaningful percentage of our revenues for the foreseeable future. However, these sales are declining. Although we are unable to predict future prices for our legacy products, we expect that prices for these products will continue to be subject to significant downward pressure in certain markets for the reasons described above. Accordingly, our ability to maintain or increase revenues will be dependent on our ability to expand our customer base, to increase unit sales volumes of these products and to successfully, develop, introduce and sell new products such as custom design and value added products. We cannot assure you that we will be able to expand our customer base, increase unit sales volumes of existing products or develop, introduce and/or sell new products.

19

Our operating results may vary from quarter to quarter.

Our operating results have in the past been subject to quarter to quarterquarter-to-quarter fluctuations, and we expect that these fluctuations will continue, and may increase in magnitude, in future periods. Demand for our products is driven by many factors, including the availability of funding for our products in customers’ capital budgets. There is a trend for some of our customers to place large orders near the end of a quarter or fiscal year, in part to spend remaining available capital budget funds. Seasonal fluctuations in customer demand for our products driven by budgetary and other reasonsconcerns can create corresponding fluctuations in period-to-period revenues, and we therefore cannot assure you that our results in one period are necessarily indicative of our revenues in any future period. In addition, the number and timing of large individual sales and the ability to obtain acceptances of those sales, where applicable, hashave been difficult for us to predict, and large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or deferral of one or more significant sales in a quarter could harm our operating results. It is possible that, in some quarters, our operating results will be below the expectations of public market analysts or investors. In such events, or in the event adverse conditions prevail, the market price of our common stock may decline significantly.

We are subject to certain governmental regulatory restrictions relating to our international sales.

Some of our products are subject to International Trafficking and Arms Regulation (ITAR) rules, which isare administered by the U.S. Department of State. ITAR controls not only the export, import and trade of certain products specifically designed, modified, configured or adapted for military systems, but also the export of related technical data and defense services as well as foreign production.  Any delays in obtaining the required export, import or trade licenses for products subject to ITAR rules could have a materially adverse effect on our business, financial condition, and/or operating results.  In addition, changes in United States export and import laws that require us to obtain additional export and import licenses or delays in obtaining export or import licenses currently being sought could cause significant shipment delays and, if such delays are too great, could result in the cancellation of orders. Any future restrictions or charges imposed by the United States or any other country on our international sales or foreign subsidiary could have a materially adverse effect on our business, financial condition, and/or operating results. In addition, from time to time, we have entered into contracts with the Israeli Ministry of Defense which were funded with monies subject to, and we therefore were required to comply with the regulations governing, the U.S. Foreign Military Financing program.

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We depend on international operations for a substantial majority of our components and products.

We purchase a substantial majority of our components from foreign manufacturers and have a substantial majority of our commercial products assembled, packaged, and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect on our business, financial condition, and/or operating results.

We depend on international sales for a portion of our revenues.  
 
Sales to customers outside of North America accounted for 54.8%65.0% of net revenues in the first sixnine months of 2009 and for 55.7% of net revenues in the year ended December 31, 2008, and we expect that international sales will continue to represent a material portion of our total revenues. International sales are subject to the risks of international business operations as described above, as well as generally longer payment cycles, greater difficulty collecting accounts receivable, and currency restrictions.  In addition, Gresham,DPL, our wholly-owned foreign subsidiary in the United Kingdom, supports our European and other international customers, distributors, and sales representatives, and therefore is also subject to local regulation.  International sales are also subject to the export laws and regulations of the United States and other countries.

20

If our accounting controls and procedures are circumvented or otherwise fail to achieve their intended purposes, our business could be seriously harmed.
 
We evaluate our disclosure controls and procedures as of the end of each fiscal quarter, and are annually reviewing and evaluating our internal control over financial reporting in order to comply with SEC rules relating to internal control over financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain effective internal control over financial reporting or our management does not timely assess the adequacy of such internal control, we may be subject to regulatory sanctions, and our reputation may decline.

The sale of our products is dependent upon our ability to satisfy the proprietary requirements of our customers.

We depend upon a relatively narrow range of products for the majority of our revenue. Our success in marketing our products is dependent upon their continued acceptance by our customers. In some cases, our customers require that our products meet their own proprietary requirements. If we are unable to satisfy such requirements, or forecast and adapt to changes in such requirements, our business could be materially harmed.

The sale of our products is dependent on our ability to respond to rapid technological change, including evolving industry-wide standards, and may be adversely affected by the development, and acceptance by our customers, of new technologies which may compete with, or reduce the demand for, our products.

Rapid technological change, including evolving industry standards, could render our products obsolete. To the extent our customers adopt such new technology in place of our products, the sales of our products may be adversely affected. Such competition may also increase pricing pressure for our products and adversely affect the revenues from such products.

Our limited ability to protect our proprietary information and technology may adversely affect our ability to compete, and our products could infringe upon the intellectual property rights of others, resulting in claims against us, the results of which could be costly.

Many of our products consist entirely or partly of proprietary technology owned by us. Although we seek to protect our technology through a combination of copyrights, trade secret laws and contractual obligations, these protections may not be sufficient to prevent the wrongful appropriation of our intellectual property, nor will they prevent our competitors from independently developing technologies that are substantially equivalent or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. In order to defend our proprietary rights in the technology utilized in our products from third party infringement, we may be required to institute legal proceedings. If we are unable to successfully assert and defend our proprietary rights in the technology utilized in our products, our future results could be adversely affected.

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Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, we may become subject to legal proceedings and claims for alleged infringement from time to time in the ordinary course of business. Any claims relating to the infringement of third-party proprietary rights, even if not meritorious, could result in costly litigation, divert management’s attention and resources, require us to reengineer or cease sales of our products or require us to enter into royalty or license agreements which are not advantageous to us. In addition, parties making claims may be able to obtain an injunction, which could prevent us from selling our products in the United States or abroad.

If we are unable to satisfy our customers’ specific product quality, certification or network requirements, our business could be disrupted and our financial condition could be harmed.

Our customers demand that our products meet stringent quality, performance and reliability standards. We have, from time to time, experienced problems in satisfying such standards. Defects or failures have occuredoccurred in the past, and may in the future occur, relating to our product quality, performance and reliability. From time to time, our customers also require us to implement specific changes to our products to allow these products to operate within their specific network configurations. If we are unable to remedy these failures or defects or if we cannot effect such required product modifications, we could experience lost revenues, increased costs, including inventory write-offs, warranty expense and costs associated with customer support, delays in, or cancellations or rescheduling of, orders or shipments and product returns or discounts, any of which would harm our business.

21

If we ship products that contain defects, the market acceptance of our products and our reputation will be harmed and our customers could seek to recover their damages from us.

Our products are complex, and despite extensive testing, may contain defects or undetected errors or failures that may become apparent only after our products have been shipped to our customers and installed in their network or after product features or new versions are released. Any such defect, error or failure could result in failure of market acceptance of our products or damage to our reputation or relations with our customers, resulting in substantial costs for both us and our customers as well as the cancellation of orders, warranty costs and product returns. In addition, any defects, errors, misuse of our products or other potential problems within or out of our control that may arise from the use of our products could result in financial or other damages to our customers. Our customers could seek to have us pay for these losses. Although we maintain product liability insurance, it may not be adequate.

Our common stock price is volatile.

Our common stock is listed on the NYSE Amex 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.  The exercise of outstanding options and warrants may adversely affect our stock price and a shareholder’s percentage of ownership.  As of JuneSeptember 30, 2009, we have outstanding options to purchase an aggregate of 762,035826,275 shares of common stock, with a weighted average exercise price of $1.00$1.07 per share, exercisable at prices ranging from $0.48 to $2.375 per share.

ITEM 2.
ITEM 2.       UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None.
 
ITEM 3.
ITEM 3.       DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4.
ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.Our Annual Meeting of Shareholders was held on August 11, 2009.  The following is a listing of the votes cast for or withheld with respect to each nominee for director and a listing of the votes cast for and against, as well as abstentions and broker non-votes with respect to, the ratification of the appointment of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global Limited, as our independent auditors for the fiscal year ending December 31, 2010.

1.           Election of Board of Directors:
  Number of Shares 
  For  Withheld 
         
Ben-Zion Diamant  5,550,599   101,929 
         
Amos Kohn  5,563,326   89,202 
         
Yeheskel Manea  5,547,599   104,929 
         
Israel Levi  5,647,893   4,635 
         
Terry Steinberg  5,648,893   3,635 
 
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2.Ratification of the appointment of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global Limited, as our independent auditors for the fiscal year ending December 31, 2010:
For5,630,183
Against22,345
Abstentions0
Broker Non-Votes0

ITEM 5.OTHER INFORMATION
ITEM 5.      OTHER INFORMATION
 
None.
 
ITEM 6.
ITEM 6.       EXHIBITS
Exhibits

Exhibits
 
31.1 Certification of the CEO under the Sarbanes-Oxley Act.
31.2 31.2 Certification of the CFO under the Sarbanes-Oxley Act.
32 32 Certification of the CEO & CFO under the Sarbanes-Oxley Act.

SIGNATURES
 
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
Dated:  August 14,November 16, 2009

Digital Power Corporation

By:
/s/ Amos Kohn 
 Amos Kohn
 President & Chief Executive Officer
 (Principal Executive Officer)
   
By:/s/ Uri Friedlander 
 Uri Friedlander
 Chief Financial Officer
 (Principal Financial and Accounting Officer)


 
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