U.S. SECURITIES AND EXCHANGE COMMISSION
                        WASHINGTON, D.C. 20549
                              FORM 10-KSB

     (Mark One)
      [X]   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
            ACT OF 1934
            For the fiscal year ended December 31, 1996

      [  ]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
            EXCHANGE ACT OF 1934
            For the transition period from _____ to _____

            COMMISSION FILE NUMBER   001-12711

                           DIGITAL POWER CORPORATION
            (Exact name of registrant as specified in its charter)

            CALIFORNIA                       3679                  94-1721931
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization)     Classification Code)      Identification No.)

        41920 Christy Street, Fremont, California 94538-3158; 510-657-2635
            (Address and telephone number of principal executive offices)

Securities registered under Section 12(b) of the Exchange Act:

      TITLE OF EACH CLASS           NAME OF EACH EXCHANGE ON WHICH REGISTERED
         Common Stock                        American Stock Exchange

Securities registered under Section 12(g) of the Exchange Act:

      TITLE OF EACH CLASS
      Redeemable Common Stock Purchase Warrants

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   .  No    .

Indicate by check  mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is  not  contained  herein, and will not be contained, to the
best of registrant's knowledge, in definitive  proxy  or information statements
incorporated by reference in Part III of this Form 10-KSB  or  any amendment to
this Form 10-KSB. []

Revenues for the year ended December 31, 1996 were $13,835,008.

As  of  March  25, 1997, the aggregate market value of the voting common  stock
held by non-affiliates  was  $17,650,907 based on the average bid and ask price
of $8.375 per share.

As of March 25, 1997, the number  of  shares  of  common  stock outstanding was
2,520,775.  

Documents incorporated  by  reference:   Items 9 through 12 of Part III of this
Form  10-KSB  are  incorporated  by reference  to  Digital's  definitive  Proxy
Statement  for the 1997 annual shareholders'  meeting  to  be  filed  with  the
Commission within 120 days from the end of the year.

Transitional  Small  Business  Disclosure  Format  (check  one):   Yes    .  
No  .

Exhibit index is located on page 18.

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      THE  FOLLOWING  DISCUSSION  CONTAINS FORWARD-LOOKING STATEMENTS REGARDING
EVENTS AND FINANCIAL TRENDS WHICH MAY  AFFECT  THE  COMPANY'S  FUTURE OPERATING
RESULTS  AND  FINANCIAL  POSITION.   SUCH STATEMENTS ARE SUBJECT TO  RISKS  AND
UNCERTAINTIES  THAT  COULD CAUSE THE COMPANY'S  ACTUAL  RESULTS  AND  FINANCIAL
POSITION  TO  DIFFER  MATERIALLY  FROM  THOSE  ANTICIPATED  IN  FORWARD-LOOKING
STATEMENTS.   THESE  FACTORS   INCLUDE,   BUT  ARE  NOT  LIMITED  TO,  CUSTOMER
CONCENTRATION,   DEPENDENCE   ON  COMPUTER  AND  OTHER   ELECTRONIC   EQUIPMENT
INDUSTRIES,  COMPETITION,  DEPENDENCE  ON  GUADALAJARA,  MEXICO  FACILITY,  AND
DEPENDENCE ON KEY PERSONNEL,  ALL OF WHICH FACTORS ARE SET FORTH IN MORE DETAIL
IN THE SECTIONS ENTITLED "CERTAIN  CONSIDERATIONS" AND "MANAGEMENT'S DISCUSSION
AND ANALYSIS OR PLAN OF OPERATION" HEREIN.

                                    PART I.

ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

       Digital Power ("Digital Power"  or  the  "Company")  designs,  develops,
manufactures,  and  sells  50  watt  to  750  watt  switching power supplies to
original  equipment manufacturers ("OEMs") of computers  and  other  electronic
equipment.   Switching  power supplies are critical components of all computers
and other electronic equipment.   The  electronic  circuitry  in  computers and
other  electronic  equipment  requires  a steady and isolated supply of  direct
current  (DC)  electrical  power.   In addition,  the  various  components  and
subassemblies within computers and other  electronic  equipment  often  require
different voltage levels of electrical power.  The power supply products of the
Company  satisfy  these  two requirements by converting the alternating current
(AC) electricity from a primary  source, such as a wall outlet, into the direct
current required for the proper functioning  of  electronic  circuits,  and  by
dividing  the  single  electrical  current into as many as four discrete output
voltages.

         Electronic  systems  are  sensitive  to  variations  in  voltage,  and
therefore require protection from the  surges and drops in the AC voltage which
commonly  occur over electrical lines.  The  Company's  power  supply  products
monitor and  regulate  the  DC  output  voltages being delivered to protect the
electronic  equipment  from harmful surges  and  drops  in  voltage  levels  by
regulating or maintaining the output voltages within a narrow range of values.

      In addition, the voltage  levels  produced by standard power sources must
be significantly lowered in order to allow  proper functioning of an electronic
component.  For example, internal computer microprocessors,  as  well as memory
and  logic  circuitry  in  telecommunications systems, generally operate  on  a
voltage level of 5 volts DC  or less.  However, most electrical outlets produce
at least 115 volts AC.  Therefore, the incoming voltage of 115 volts AC must be
both converted to DC and reduced to 5 volts.  This is the function performed by
a typical power supply.  Those  products  which  accept and convert alternating
current  from  a  primary  power  source into the direct  current  required  by
electronic  systems  are generally referred  to  as  "power  supplies".   Those
products which convert  one level of DC voltage into a higher or lower level of
DC voltage as required by a particular electronic device are generally referred
to as "DC/DC converters".

      Because the Company's  products  have a high "power-density" (measured in
watts per cubic inch), the power supply  products  of the Company are generally
smaller than those of competitors.  For example, the  Company believes that its
US100  series  of  power supplies, on a 3"x 5" printed circuit  board,  is  the
smallest 100 watt off-line  (AC  input) power supply available in the industry.
Furthermore, the Company's power supply  products  are  extremely  flexible  in
design.   This  "flexibility" approach allows the Company to modify quickly and
inexpensively its  base-design  products  to  satisfy  an  OEM's specific power
supply  needs, thereby enabling the Company to keep to a minimum  its  expenses
for non-recurring  engineering ("NRE") of its base-design products.  Because of
this reduced NRE expense  related  to the "flexibility" line of switching power
supplies,  the Company does not charge  its  customers  for  its  NRE  expenses
incurred in  tailoring  a  power  supply to a customer's specific requirements.
However, many competitors of the Company  do  charge  their  customers  for NRE
expenses.  As a result of the Company's "flexibility" approach, it has provided
samples  of  modified  power  supplies  to OEM customers in as quickly as a few
days, an important capability given the increasing  emphasis  placed by OEMs on

3

"time-to-market".   Digital  Power's  strategic  objective  is to exploit  this
combination of power density, flexibility, and short time-to-market  to  win an
increasing share of the growing power supply market.

      In  addition to the line of proprietary products offered, and in response
to requests  from  OEMs,  the Company has recently begun providing "value-added
services" along with its products.   The  term "value-added services" refers to
the  Company's  incorporation  of  an  OEM's  selected  electronic  components,
enclosures, and cable assemblies with the Company's  power  supply  products to
produce a power subassembly that is compatible with the OEM's own equipment and
is  specifically  tailored to meet the OEM's needs.  The Company purchases  the
parts and components that the OEM itself would otherwise attach to or integrate
with the Company's  power  supply,  and  the Company provides the OEM with that
integration and installation service, thus  saving the OEM time and money.  The
Company believes that this value-added service is well-suited to those OEMs who
wish to reduce their vendor base and minimize  their  investment in fixed costs
since  the OEMs are not required to manufacture their own  power  subassemblies
and thus  are  not  required  to purchase individual parts from many vendors or
build assembly facilities.

      Digital  Power Corporation,  a  California  corporation,  was  originally
formed in 1969 through  its  predecessor, Sideband Associates, Inc.  Unless the
context indicates otherwise, references  to  "Digital  Power"  or the "Company"
herein  includes its majority-owned Mexican subsidiary, Poder Digital  S.A.  de
C.V.

THE MARKET

      The market for power supplies is large, as all electronic systems require
a steady  supply  of  low  voltage  electrical  power.  According to Micro-Tech
Consultants  of  Santa Rosa, California, the worldwide  market  for  electronic
power supplies was  estimated  to  be  $15  billion  in 1995.  The power supply
manufacturing industry is also highly fragmented.  Digital Power believes there
are approximately 400 power supply competitors in the  world.   The  electronic
power  supply  market  is  typically  split into "captive market" and "merchant
market" segments.  The captive segment  of the market, that portion represented
by  OEMs  who  design and manufacture power  supplies  for  use  in  their  own
products, is estimated  by  Micro-Tech  to account for approximately 50% of the
total  market.   The remaining 50% of the power  supply  market  is  served  by
merchant power supply  manufacturers  such  as  Digital  Power  that design and
manufacture power supplies for sale to OEMs.

      Growing  at  an  average annual rate of 13%, the merchant market  is  the
fastest growing segment  of  the  power  supply  market,  as  OEMs  continue to
outsource  their  power  supply  requirements.   Micro-Tech forecasts that  the
merchant market will experience the greatest rate of growth in the entire power
supply market, increasing from 52.5% of the total  market  in  1996 to 62.8% of
the total market in 2000.  The Company believes that the increase  is  due,  in
part,  to  the  fact  that  power supplies are becoming an increasingly complex
component to the OEMs, with constantly  changing  requirements  such  as  power
factor    correction   (PFC)   and   filtering   specifications   to   minimize
electromagnetic  interference  (EMI).   This  merchant  market is itself highly
fragmented according to the power level, technology, packaging, and application
of  a  particular  power supply.  One segment of the merchant  market  involves
industrial  and office  automation,  industrial  and  portable  computing,  and
networking applications.   This  is  the  market  targeted  and  served  by the
Company.  The Company believes that its focus on high-efficiency, high-density,
design-flexible   power   supplies  is  ideally  suited  to  the  rapid  growth
opportunities existing in this market segment.

      POWER FACTOR CORRECTION.   The  alternating current electricity delivered
by utility companies over power lines is  delivered  in  smooth waves, known as
harmonic  waves,  or  sine  waves.   This  smooth  harmonic  wave  form  of  AC
electricity that reaches a power supply is known as "apparent power", and it is
measured  in  watts  (watts equal volts multiplied by amperes).   Although  the
electricity reaches a  switching  power  supply in a smooth harmonic wave form,
the  switching  power  supply does not draw on  the  electricity  in  a  smooth
harmonic fashion.  Rather,  in  the  process  of  "rectifying"  the alternating
current  into  direct current form, a switching power supply will draw  current
off the AC harmonic  wave  form  in  short  bursts, each of which is shorter in
duration than the wave frequency.  The amount  of  power  drawn off the line by
the switching power supply in these short bursts is known as  the  "real  input
power".  The real input power cannot be greater than the apparent power, and in

 4

fact  is  almost always less than the apparent power.  Therefore, a percentage,
or factor, can be arithmetically determined by dividing the real input power by
the apparent  power,  giving  a  coefficient known as the "power factor" of the
power supply.  Ideally, a switching  power  supply would have a power factor of
one, where all the apparent power is drawn off  by  the power supply, resulting
in  the real input power equaling the apparent power.   In  practice,  however,
this  is  not  possible.   In  fact,  most switching power supplies without the
special feature known as "power factor  correction"  have  an approximate power
factor of only .60.

      The reason why power factor of less than one can be a significant problem
relates to the power that is not drawn off the power line, or  the differential
amount  between  one  and the power factor (1 - .60 = .40 in the example  given
above).  This differential  of  missing  power is reflected back onto the power
line in a harmonically distorted fashion,  since the originally smooth harmonic
wave form has now been disrupted by the power  that  has  been drawn off by the
power  supply  and  exhibits  a  kind  of  "ripple"  in  the  wave  form.   The
harmonically distorted wave form circulates as wasted heat energy in  the power
line,  as  well  as in wall sockets, electrical wiring in the building, and  in
distribution transformers  along  the  power  line.   This  problem of harmonic
distortion and wasted heat energy grows as additional switching  power supplies
are  connected to and draw power from a power line.  A large enough  number  of
switching  power  supplies  drawing  power  from  a  line  without power factor
correction will result in: (i) a significant uncompensated loss  of  electrical
power  (in  the form of heat) to the electrical utility company; (ii) potential
damage to power  lines  and  transformers  caused  by excessive heat; and (iii)
"dirty"  electrical power for "downstream" consumers  of  electricity.   A  low
power factor  is  generally not a problem for the piece of electronic equipment
itself served by the switching power supply.

      In response to  these  problems,  manufacturers  of  power  supplies have
developed  certain  circuitry  within  power  supplies  known  as "power factor
correction", or PFC.  With PFC, most power supplies can be improved  to perform
at  a  power  factor  of  approximately  .99.   Historically, PFC has only been
installed in high wattage switching power supplies because of the comparatively
greater amount of harmonic distortion reflected back  onto  the  line  by these
power supplies.  However, PFC is rapidly becoming critical at all power levels,
not  only  because it allows equipment designers to power more circuits from  a
standard outlet, but also because of regulatory requirements established in the
European Union, such as European Normatives EN61000-3-2 and EN61000-3-3.  These
two normative  standards,  known  more  fully  as  "Limits For Harmonic Current
Emissions," and "Limitation Of Voltage Fluctuations  And Flicker On Low Voltage
Supply Systems For Equipment With Rated Current <16A [less  than  16 amperes],"
respectively,  upgrade the former generic standard IEC555.2 and place  pressure
on manufacturers  of  power  supplies to develop products with PFC at lower and
lower power levels.

      ELECTROMAGNETIC  INTERFERENCE  (EMI).   EMI  is  universally  undesirable
because  it potentially interferes  with  the  operation  of  other  electronic
equipment.  In the United States, the Federal Communications Commission ("FCC")
has mandated certain EMI limits which cannot be exceeded by OEM equipment.  The
European Union (EU) has issued an electromagnetic compatibility (EMC) directive
that applies  certain requirements to products sold in Europe beginning January
1, 1996.  The EU  created these directives to insure conformity with safety and
quality standards and to assess product compliance throughout its jurisdiction.
One of these requirements  involves  Conformity  European ("CE") marking.  OEMs
may  add  the  "CE" mark to their equipment if it meets  the  requirements  for
radiated and conducted noise emissions and for noise susceptibility.  The power
supply, if part  of  an  OEM  system,  does  not  itself need CE certification.
However, since it is one of the major noise generators  within  an  OEM system,
there  is  a growing demand for the power supply to have the CE mark.   A  pre-
approved power  supply  provides  added  assurance  that  the OEM will meet the
applicable standards with little trouble.

      The  power  supply  market  can be further segmented between  custom  and
standard power supplies.  Power supplies  designed  and  manufactured by an OEM
for use in its own equipment are an example of a custom design,  as the product
is not intended for resale.  However, custom power supplies are also  common in
the  merchant  market, as certain OEMs contract with power supply manufacturers
to design a product  that  meets  the  form,  fit, and function requirements of
their  specific  application.   Standard  "off-the-shelf"  power  supplies  are
intended for sale to many customers whose electronic equipment can operate from
"standard" output voltages, such as 5 volts,  12  volts,  or  24  volts  DC.  A

 5

subset  of  the  standard  segment of the market has evolved, commonly known as
"modified",  comprising  power  supply  products  which  have  the  performance
characteristics of a standard  power  supply,  but need certain, usually minor,
modifications.  These modifications may include  slight  mechanical  changes to
the sheet metal chassis, but more typically involve an adjustment to the output
voltages  from one of the "standard" output voltages (e.g. 5 volts to 7  volts,
or 15 volts to 18.5 volts).

      Digital  Power  primarily  serves  the  North  American power electronics
market with AC/DC power supplies and DC/DC converters  ranging from 50 watts to
750  watts of total output power.  AC/DC power supplies represent  the  largest
part of the merchant power electronics market with sales in North America alone
expected  to  grow  from  about  $4.9  billion in 1996 to $6.7 billion in 2000.
During the same period, DC/DC converter  sales  in North America are forecasted
to grow from $1.5 billion in 1996 to $2.1 billion in 2000.

CUSTOMERS

      Digital Power's products are sold domestically  and  in  Canada through a
network  of  13  manufacturers'  representatives.   Digital Power also  has  28
stocking  distributors  in  the  United States and Europe.   In  addition,  the
Company has formed strategic relationships  with  three  of  its  customers  to
private label its products.  Digital Power's customers can generally be grouped
into three broad industries, consisting of the computer, telecommunication, and
instrument  industries.   The  Company  has  a  current base of over 150 active
customers,   including   companies   such   as  Ascend  Communications,   AT&T,
Westinghouse,   Telex,   Storage   Dimensions,   Motorola,    Retix,   Stanford
Telecommunications, and 3Com.

STRATEGY

      Digital  Power's  strategy  is  to  be  the  supplier of choice  to  OEMs
requiring  a high-quality power solution where size,  rapid  modification,  and
time-to-market  are critical to their business success.  Target market segments
include telecommunications, networking, switching, mass storage, and industrial
and  office automation  products.   While  many  of  these  segments  would  be
characterized  as  computer-related,  the  Company  does not participate in the
personal computer (PC) power supply market.  The power supply market for PCs is
very competitive with standard power supplies producing low margins.

      The Company's strategy is to continue the trend  of  its sales and profit
growth  by  making increased sales to existing customers, while  simultaneously
targeting sales  to new customers.  The Company believes that its "flexibility"
concept allows customers  a  unique  choice  between  its products and products
offered by other power supply competitors.  OEMs have typically  had  to settle
for  a  standard  power  supply product with output voltages and other features
predetermined  by  the  manufacturer.   Alternatively,  if  the  OEM's  product
required a different set  of  power  supply  parameters,  the OEM was forced to
design  this  modification in-house, or pay a power supply manufacturer  for  a
custom product.  Since custom-designed power supplies are development-intensive
and require a great deal of time to design, develop, and manufacture, only OEMs
with significant  volume  requirements can economically justify the expense and
delay associated with their  production.   Furthermore,  since  virtually every
power  conversion  product intended for use in commercial application  requires
certain independent  safety agency testing, (e.g. by Underwriters Laboratories)
at considerable expense, an additional barrier is presented to the smaller OEM.
By offering the OEM customer  a new choice with the Digital Power "flexibility"
series,  the Company believes it  has  gained  a  competitive  advantage.   The
Company's   "flexibility"  series  is  designed  around  a  standardized  power
platform, but  allows  the  customer to specify output voltages tailored to its
exact requirements within specific  parameters.   Furthermore, OEMs are seeking
power supplies with greater power density (measured  in  watts per cubic inch).
Digital  Power's  strategy  in  responding  to this demand has  been  to  offer
increasingly smaller power supply units or packages.   For example, the Company
believes  that  its  US100 series of products, mounted on a  3"  x  5"  printed
circuit board, is the  industry's  smallest 100 watt off-line (A/C input) power
supply.

6

PRODUCT STRATEGY AND PRODUCTS

      Digital Power has eight series  of  base  designs from which thousands of
individual models can be produced.  Each series has  its  own  printed  circuit
board (PCB) layout that is common to all models within the series regardless of
the  number  of  output  voltages  (typically one to four) or the rating of the
individual output voltages.  A broad range of output ratings, from 3.3 volts to
48 volts, can be produced by simply changing the power transformer construction
and a small number of output components.   Designers  of electronic systems can
determine  their  total power requirements only after they  have  designed  the
system's electronic  circuitry  and  selected  the components to be used in the
system.  Since the designer has a finite amount of space for the system and may
be under competitive pressure to further reduce its size, a burden is placed on
the  power  supply  manufacturer to maximize the power  density  of  the  power
supply.  A typical power  supply  consists  of  a PCB, electronic components, a
power  transformer  and other electromagnetic components,  and  a  sheet  metal
chassis.  The larger  components are typically installed on the PCB by means of
pin-through-hole assembly  where  the  components are inserted into pre-drilled
holes and soldered to electrical circuits  on the PCB.  Other components can be
attached  to the PCB by surface mount interconnection  technology  (SMT)  which
allows for  a  reduction  in  board  size  since  the  holes are eliminated and
components  can  be  placed  on both sides of the board.  The  Company's  US100
series is an example of a product using this manufacturing technology.

      Digital Power's "flexibility" concept applies to all of the Company's US,
UP/SP, and DP product series.  A common printed circuit board is shared by each
model in a particular family, resulting in a reduction in parts inventory while
allowing for rapid modifiability  into  thousands  of output combinations.  The
following is a description of the Company's products.

      The  US50  series  of  power  supplies  are  compact,   economical,  high
efficiency, open frame switchers that deliver up to 50 watts of  continuous  or
60  watts  of  peak  power  from one to four outputs.  The 90-264 VAC universal
input allows them to be used  worldwide  without jumper selection.  Flexibility
options include chassis and cover, power good  signal,  an  isolated V4 output,
and UL544 (medical) safety approval.  All US50 series units are  also available
in  12VDC,  24VDC, or 48VDC inputs.  This optional DC input unit (DP50  series)
maintains the same pin-out, size, and mounting as the US50 series.

      The US70  series  of  power  supplies  is  similar  to the US50 series, a
compact, economical, highly efficient, open frame switcher  that delivers up to
65 watts with a 70 watt peak.  This unit is offered with one to four outputs, a
universal input rated from 90 to 264 VAC, and is only slightly  larger than the
US50 series.  The US70 series is differentiated from competitive  offerings  by
virtue  of  its  smaller  size,  providing up to four outputs while competitors
typically are limited to three outputs.   Flexibility  options  include  cover,
power  good signal, an isolated V4 output, and UL544 (medical) safety approval.
The DP70  is the same as the US70 except the input is 48 volts DC.  The Company
also offers  12 & 24 VDC DC input on this series where the model series changes
to DN&DM.  This type of product is ideal for low profile systems with the power
supply measuring 3.2" x 5" x 1.5".

      The US100/DP100  is the industry's smallest 100 watt switcher.  Measuring
only 5" x 3.3" x 1.5", this  series  delivers  up to 100 watts of continuous or
120 watt peak power from one to four outputs.  The  90-264VAC  universal  input
allows  them to be used worldwide.  This product is ideal in applications where
OEMs have upgraded their systems, requiring an additional 30-40 watts of output
power but  being  unable  to  accommodate a larger unit.  The US100 fits in the
same form factor and does not require  any tooling or mechanical changes by the
OEM.  Flexibility options include a cover  and adjustable post regulators on V3
and/or V4 outputs.  Fully custom models are  also  available.  All US100 series
units are also available with 12VDC, 24VDC, or 48 VDC inputs.  This optional DC
input unit (DP100) maintains the same pin-out, size,  and mounting as the US100
series.

      The UP300 series are economical, high efficiency,  open  frame  switchers
that  deliver  up to 300 watts of continuous, 325 watt, peak power from one  to
two outputs.  The  115/230VAC  auto-selectable  input  allows  them  to be used
worldwide.  On-board EMI filtering is a standard feature.  Flexibility  options
include a cover, power fail/power good signal, and an isolated 2nd output.  The
UP300 is also available as the SP300 series, which is jumper selectable between

7

115  and  230VAC  and  provides the OEM an even more economical solution.  This
product can be used in network  switching  systems  or other electronic systems
where a lot of single output current, such as 5, 12,  24, 48 volt current might
be required.

      The US250 series are economical, high efficiency,  open  frame  switchers
that deliver up to 250 watts of continuous or 300 watts of peak power from  one
to  four  outputs.  The 115/230VAC auto-selectable input allows them to be used
worldwide.   Flexibility  options  include cover, power fail/power good signal,
enable/inhibit, and an isolated V3 output.   All  US250  series  units are also
available  with  12VDC,  24VDC,  or 48VDC inputs.  This optional DC input  unit
(DP250) maintains the same pin-out, size, and mounting as the US250 series.

      The US350 series is a fully-featured  unit  that  has active power factor
correction  and  was  designed  to  be  field-configurable  by  the   Company's
international  and  domestic  sales channels.  This feature allows the stocking
distributor to lower its inventory  costs but still maintain the required stock
to  rapidly  provide  power supplies with  the  unique  combination  of  output
voltages required by an  OEM.   This  unit  delivers 350 watts from one to four
outputs modules and meets the total harmonic  distortion  spec  IEC 555.2.  The
US350 has an on-board EMI filter and operates from 90-264 VAC input.  This unit
measures 9" x 5" x 2.5" and can operate without any minimum loads  and  has  an
optional internal fan and power fail/power good signal.

      The  newest product under development by the Company is the US750 series.
The US750 is  a  fully  modular  power  supply  measuring  3" x 10.25" x 5" and
delivers  750  watts  from  one  to  four power outputs.  This product  can  be
configured to meet many different applications.   It  comes  with  optional N+1
parallelability,  hot  swapability, frequency synching, power good/power  fail,
and remote on/off.  The Company anticipates that this product will be available
for sale during the first quarter of 1997.

      The Company also produces  two  products designated as the KD series in a
150 watt and 200 watt product.  These designs  were  acquired  in  1987 under a
licensing agreement with KDK Electronics.  They are still offered for  sale but
are  expected  to  continue  to  decline  as  a  percentage  of Digital Power's
revenues.   The licensing agreement with KDK Electronics, as amended,  provides
that in the event  total  historical  sales of KD products reaches $20 million,
then KDK Electronics will be granted a  stock option to purchase 100,000 shares
of Digital Power's common stock for $3.50  per  share with Digital Power paying
the  exercise  price.   Due to changing market conditions,  the  KD  series  is
expected to be phased out  prior  to  reaching  the  $20  million  sales level.
Therefore,  no  common  stock  is  anticipated to be granted to KDK Electronics
under the licensing agreement.  In addition,  KDK  Electronics  will  be paid a
royalty  equal  to  5%  on  the  first $20 million total sales of the KD series
products with the royalty decreasing  on  sales  over that amount.  KD products
accounted for 14%, and 6% of revenues for the years ended December 31, 1995 and
1996, respectively.  Total cumulative sales of KD  products were $14,476,274 as
of December 31, 1996.

      Digital Power offers its customers various types of value-added services,
which may include the following additions to its standard product offerings:

      Electrical (power): Paralleled power supplies  for  (N+1) redundancy, hot
swapability, output OR'ing diodes, AC input receptacle with  fuse, external EMI
filter, on/off switch, cabling and connectors, and battery backup with charger.

      Electrical  (control  and  monitoring): AC power fail detect  signal,  DC
output(s) OK signal, inhibit, output  voltage  margining,  and  digital control
interface.

      Mechanical:  Custom  hot-plug  chassis  for  (N+1)  redundant  operation,
locking handle, cover, and fan.

      These services incorporate one of the Company's base products along  with
additional  enclosures,  cable  assemblies,  and other electronic components to
arrive at a power subassembly.  This strategy matches perfectly with those OEMS

8

wishing  to  reduce  their  vendor  base,  as the turnkey  sub-assembly  allows
customers to eliminate other vendors.

      Other than certain fabricated parts such  as  printed  circuit boards and
sheet  metal  chassis  which  are  readily  available from many suppliers,  the
Company uses no custom components. Typically,  two  suppliers are qualified for
every   component,  with  the  exception  being  two  line  transformers,   one
manufactured  by  Tamura  and  the second one manufactured by Spitznagel. These
transformers are designed into three  of the Company's products, which products
accounted for approximately 7% of the Company's sales in 1996.

MANUFACTURING STRATEGY

      Consistent with its product flexibility  strategy,  the  Company  aims to
maintain  a  high degree of flexibility in its manufacturing processes in order
to respond to  rapidly  changing  market  conditions.  With few exceptions, the
competitive nature of the power supply industry  has  placed continual downward
pressure on selling prices.  In order to achieve low cost  manufacturing with a
labor-intensive  product, manufacturers have the option of automating  much  of
the labor out of their  product, or producing their product in a low labor cost
environment.  Given the high  fixed costs of automation and the resistance this
places  on  making major product  changes,  Digital  Power  believes  that  its
flexible manufacturing strategy is best achieved through a highly variable cost
of operation.   In  1986,  the Company established a wholly-owned subsidiary in
Guadalajara, Mexico to assemble  its  products.   This  manufacturing  facility
performs materials management, sub-assembly, final assembly, and test functions
for the majority of the Company's power supply products.  Currently, almost all
of the Company's manufacturing, including its value-added services, is done  at
a   16,000   square  foot  facility  operated  by  the  Company's  wholly-owned
subsidiary, Poder  Digital,  S.A.  de C.V., located in Guadalajara, Mexico.  In
addition, Digital Power has entered into an agreement with Fortron/Source Corp.
to manufacture Digital Power's products  at  a  facility  located in China on a
turnkey basis.  Purchases from Fortron/Source will be made pursuant to purchase
orders and the agreement may be terminated upon 120 days notice.   Although the
Company   has   just   recently  begun  to  manufacture  its  products  through
Fortron/Source, the Company  believes  that  it  will be able to produce a high
volume of power supplies through Fortron/Source at  a  cost  lower  than at its
Guadalajara, Mexico, facility.  The Company believes that the facility in China
will  complement  its  manufacturing facility in Guadalajara, Mexico since  the
facility  in China will allow  the  Company  to  produce  power  supplies  with
sufficient  lead  time  at  lower  costs,  while  the Guadalajara facility will
continue  to  manufacture  power  supplies  that  need a  quick  turnaround  or
modification.

SALES, MARKETING AND CUSTOMERS

      During 1996, the Company increased both its revenues  and  income  before
income taxes, from $10,037,502 and $826,484, respectively, in fiscal year 1995,
to $13,835,008 and $1,822,634, respectively, in fiscal year 1996.

      Digital  Power markets its products domestically through a network of  13
independent manufacturers'  representatives.   Each representative organization
is  responsible  for  managing  sales  in  a particular  geographic  territory.
Generally, the representative has exclusive  access  to all potential customers
in the assigned territory and is compensated by commissions  at 5% of net sales
after  the  product  is  shipped,  received,  and  paid  for  by  the customer.
Typically, either the Company or the representative organization may  terminate
the agreement with 30 days' written notice.

      In  certain territories, the Company has entered into agreements with  28
stocking distributors  who  buy  and  resell  the  Company's products.  For the
fiscal years ended December 31, 1996 and 1995, distributor  sales accounted for
36.4% and 39.7%, respectively, of the Company's total sales.   Over  this  same
period,  one  distributor  accounted  for 21.3% and 27%, respectively, of total
sales.   In  addition,  international  sales   through   stocking  distributors
accounted for less than 5% of the Company's sales.  In general,  the agreements
with stocking distributors are subject to annual renewal and may be  terminated
upon  90 days' written notice.  Although these agreements may be terminated  by
either  party  in  the  event  a  stocking distributor decides to terminate its
agreement with the Company, the Company  believes  that  it  would  be  able to
continue the sale of its products through direct sales to the customers of  the

9

stocking  distributor.   Further,  and  in  general,  stocking distributors are
eligible to return 25% of their previous six-months' sales  for stock rotation.
For  the  past  three years, stock rotations have not exceeded one  percent  of
total sales.

      The Company  has  also  entered  into agreements with three private label
customers who buy and resell the Company's  products.   Under these agreements,
the Company sells its products to the private label company  who  then  resells
the products with its label to its customers.  The Company believes that  these
private  label  agreements  expand its market by offering the customer a second
source  for  the Company's products.   The  private  label  agreements  may  be
terminated by either party.  Further, the private label agreement requires that
any product subject to a private label be available for 5 years.  For the years
ended December  31,  1996 and 1995, private label sales accounted for 10.9% and
10.2%, respectively, of total sales.

      The Company's promotional  efforts  to  date  have  included product data
sheets, feature articles in trade periodicals, and trade shows.   The Company's
future  promotional  activities  will  likely  include  space  advertising   in
industry-specific publications, a full-line product catalog, application notes,
and direct mail to an industry-specific mail list.

      The  Company's  products are warranted to be free of defects for a period
ranging from one to two  years  from date of shipment.  No significant warranty
returns were experienced in either  1996 or 1995.  As of December 31, 1996, the
Company's warranty reserve was $135,000.

COMPETITION

      The  design,  manufacture,  and  sale  of  power  supplies  is  a  highly
competitive  industry.  The Company's competition  includes  approximately  400
companies located  throughout  the world, some of whom have advantages over the
Company in terms of labor and component  costs,  and  some  of  whom  may offer
products  comparable  in  quality  to  those  of  the  Company.  Certain of the
Company's competitors, including Computer Products, Inc.,  ASTEC America, Zytec
Corporation,  and  Lambda  Electronics, have substantially greater  fiscal  and
marketing resources and geographic presence than does the Company.  The Company
also faces competition from current and prospective customers who may decide to
design and manufacture internally the power supplies needed for their products.
To remain competitive, management  believes  that  the Company must continue to
compete  favorably  on the basis of value by providing  advanced  manufacturing
technology, offering superior customer service and design engineering services,
continuously improving  quality  and  reliability levels, and offering flexible
and reliable delivery schedules.  The Company  believes  it  has  a competitive
position  with its targeted customers who need a high-quality, compact  product
which can be readily modified to meet the customer's unique requirements.

RESEARCH AND DEVELOPMENT

      The Company's  research  and  development  efforts are primarily directed
toward  the development of new standard power supply  platforms  which  may  be
readily modified  to  provide a broad array of individual models.  Improvements
are constantly sought in  power  density,  modifiability, and efficiency, while
the  Company  attempts  to anticipate changing  market  demands  for  increased
functionality, such as PFC  and  improved  EMI filtering.  Internal research is
supplemented through the utilization of consultants  who  specialize in various
areas, including component and materials engineering and electromagnetic design
enhancements to improve efficiency, while reducing the cost  and  size  of  the
Company's  products.   Product  development  is  performed  at  Digital Power's
headquarters in California by three engineers who are supported and assisted by
five   technicians.    The  Company's  total  expenditures  for  research   and
development were $630,079  and  $481,475  for the years ended December 31, 1996
and 1995, respectively, and represented 4.55%  and 4.80% of the Company's total
revenues for the corresponding periods.

10

EMPLOYEES

      As  of  December  31, 1996, the Company had approximately  380  full-time
employees, with 330 of these  employed  at  its  wholly-owned  subsidiary Poder
Digital  located  in  Guadalajara,  Mexico.   The employees of Digital  Power's
Mexican operation are members of a national labor  union, as are most employees
of Mexican companies.  The Company has not experienced  any  work  stoppages at
either of its facilities and believes its employee relations are good.

GUADALAJARA, MEXICO FACILITY AND FOREIGN CURRENCY FLUCTUATIONS

      The  Company  produces  substantially  all of its products at its  16,000
square foot facility located in Guadalajara, Mexico.   The  products  are  then
delivered  to  Fremont,  California  for testing and distribution.  The Company
believes  that  it  has  a  good working relationship  with  its  employees  in
Guadalajara, Mexico and has recently signed a five-year contract with the union
representing the employees.   In  1996,  the  Company  entered into a "turnkey"
manufacturing  contract  with a manufacturer located in China  to  produce  its
products in an attempt to  reduce  its  dependence on its Mexican facility.  At
this time the purchase of products from the  manufacturer  located  in China is
minimal and requires advance scheduling which affects the Company's ability  to
produce   products  quickly.   However,  if  the  Company's  revenues  grow  as
anticipated,  the Company intends to manufacture more of its products utilizing
the Chinese manufacturer.   In the event that there is an unforeseen disruption
at the Guadalajara production  plant  or  with  the  Chinese manufacturer, such
disruption may have an adverse effect on the Company's  ability  to deliver its
products and may adversely affect the Company's financial operations.

      Further,   the   Guadalajara,  Mexico  facility  conducts  its  financial
operations using the Mexican  peso.   Therefore,  due  to  financial conditions
beyond  the  control  of  the  Company,  the  Company  is  subject to  monetary
fluctuations between the U.S. dollar and Mexican peso.  During fiscal 1996, the
Company  lost $7,082 as a result of fluctuations in the value  of  the  Mexican
peso against the dollar.

CERTAIN CONSIDERATIONS

      In addition  to  the  other  information  presented  in  this report, the
following  should  be  considered carefully in evaluating the Company  and  its
business.  This report contains various forward-looking statements that involve
risks and uncertainties.   The  Company's  actual results may differ materially
from  the results discussed in the forward-looking  statements.   Factors  that
might cause  such a difference include, but are not limited to, those discussed
below and elsewhere in this report.

CUSTOMER CONCENTRATION

      For the  fiscal year ended December 31, 1996, one OEM accounted for 17.9%
of the Company's  total  revenues,  and  for the fiscal year ended December 31,
1995, three OEMs accounted for 18% in the aggregate of total revenues.  The one
OEM account which accounted for 17.9% of the  Company's  total revenues for the
fiscal year ended December 31, 1996 substantially contributed  to the Company's
increase  in  revenues  for such period.  In December 1996, this OEM  indicated
that after the second quarter of 1997 it will no longer purchase power supplies
from the Company.  The Company  anticipates  that  increased purchases from its
other OEM customers will compensate for the loss of this customer.  However, no
assurances can be given that this will occur.  The loss  of any other major OEM
customers would likely have an adverse effect on the Company's  revenues.   See
"Management's Discussion and Analysis or Plan of Operation".

DEPENDENCE  ON  COMPUTER  AND OTHER ELECTRONIC EQUIPMENT INDUSTRIES; CUSTOMERS'
PRODUCT OBSOLESCENCE

      Substantially all of the Company's existing customers are in the computer
and  other electronic equipment  industries  and  produce  products  which  are

11

subject  to rapid technological change, obsolescence, and large fluctuations in
product demand.   These industries are characterized by intense competition and
a demand on OEMs serving  these  markets  for increased product performance and
lower product prices.  Given this industry  environment  in which they operate,
OEMs  make  similar  demands  on  their  suppliers,  such as the  Company,  for
increased product performance and lower product prices.   Thus,  in order to be
successful,  the Company must properly assess developments in the computer  and
other electronic equipment industries and identify product groups and customers
with the potential  for  continued  and  future  growth.  Factors affecting the
computer and other electronic equipment industries,  in  general, or any of the
Company's  major  customers  or  their products, in particular,  could  have  a
material adverse effect on the Company's  results  of operations.  In addition,
the computer industry is inherently volatile.  Recently,  certain  segments  of
the  computer  and  other electronic industries have experienced a softening in
demand for their products.   Although  this  has  not  materially  affected the
Company's customers, in the event that it affects all segments of the  computer
and  other  electronic industries, the growth of the Company could be adversely
affected.

DEPENDENCE ON GUADALAJARA, MEXICO FACILITY; FOREIGN CURRENCY FLUCTUATIONS

      The Company  produces  substantially  all of its products at its facility
located in Guadalajara, Mexico.  The products  are  then  delivered to Fremont,
California for testing and distribution.  The Company believes  that  it  has a
good  working  relationship  with  its employees in Guadalajara, Mexico and has
recently signed a five-year contract with the union representing the employees.
Recently, the Company has entered into  a "turnkey" manufacturing contract with
a manufacturer located in China to produce its products in an attempt to reduce
its dependence on its Mexican facility.   At this time the purchase of products
from  the  manufacturer  located  in  China  is minimal  and  requires  advance
scheduling which affects the Company's ability  to  produce  products  quickly.
However, if the Company's revenues grow as anticipated, the Company intends  to
manufacture  more  of  its products utilizing the Chinese manufacturer.  In the
event that there is an unforeseen  disruption  at  the  Guadalajara  production
plant  or  with  the  Chinese manufacturer, such disruption may have an adverse
effect on the Company's  ability  to  deliver  its  products  and may adversely
affect the Company's financial operations.

COMPETITION

      The  design,  manufacture,  and  sale  of  power  supplies  is  a  highly
competitive  industry.   The  Company's competition includes approximately  400
companies located throughout the  world,  some of whom have advantages over the
Company in terms of labor and component costs,  and  some  of  whom  may  offer
products  comparable  in  quality  to  those  of  the  Company.  If the Company
continues  to be successful in increasing its revenues, other  competitors  may
notice and increase  competition for the Company's customers.  The Company also
faces competition from  current  and  prospective  customers  who may decide to
design and manufacture internally the power supplies needed for their products.
To  remain competitive, management believes that the Company must  continue  to
compete  favorably  on  the  basis of value by providing advanced manufacturing
technology, offering superior customer service and design engineering services,
continuously improving quality  and  reliability  levels, and offering flexible
and reliable delivery schedules.  There can be no assurance  that  the  Company
will continue to compete successfully in this market.

DEPENDENCE UPON KEY PERSONNEL; NEED TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL

      The  Company's  performance is substantially dependent on the performance
of its executive officers  and  key personnel, and on its ability to retain and
motivate such personnel.  The loss  of  any  of  the  Company's  key personnel,
particularly  Robert  O.  Smith,  could have a material adverse effect  on  the
Company's business, financial condition,  and  operating  results.  The Company
has "key person" life insurance policies on Mr. Smith in the  aggregate  amount
of $2 million.  The Company also has an employment agreement with Mr. Smith.

      The  Company's  future success also depends on its continuing ability  to
identify, hire, train,  and  retain other highly-qualified creative, technical,
and  managerial  personnel.   Competition  for  highly-qualified  personnel  is
intense.  There can be no assurance  that  the  Company  will  be successful in

12

attracting, assimilating, and retaining such personnel, and the  failure  to do
so  could  have  a material adverse effect on the Company's business, financial
condition, and operating  results.   Moreover,  in the event of the loss of any
such personnel, there can be no assurance that the  Company  would  be  able to
prevent  the  unauthorized  disclosure  or  use  of its proprietary technology,
practices, procedures, or customer lists.

DEPENDENCE ON SUPPLIERS

      In order to reduce dependence on any one supplier,  the  Company attempts
to obtain two suppliers for each component of its products.  However,  for  two
line  transformers in three of its products, the Company is dependent on single
suppliers.   Currently,  these  products  account  for  approximately 7% of the
Company's  total  sales.   Although  the  Company  will  seek  to   find  other
manufacturers of transformers for these three products, unanticipated shortages
or delays in these parts may have an adverse effect on the Company's results of
operations.

NO PATENTS

      The  Company's  products  are not subject to any U.S. or foreign patents.
The Company believes that because  its  products  are being continually updated
and revised, obtaining patents would not be beneficial.   Therefore,  there can
be no assurance that other competitors or former employees will not obtain  the
Company's proprietary information and develop it.

ITEM 2.  DESCRIPTION OF PROPERTIES.

      The Company's headquarters are located in approximately 9,500 square feet
of  leased  office, research and development space in Fremont, California.  The
Company pays  $5,890 per month, subject to adjustment, and the lease expires on
January 31, 2001.   The  Company's  manufacturing facility is located in 16,000
square  feet  of  leased  space  in  Guadalajara,  Mexico.   The  Company  pays
approximately $3,500 per month, subject to adjustment, and the lease expires in
February, 2001.  The Company believes that its existing facilities are adequate
for the foreseeable future and has no plans to expand them.

ITEM 3.  LEGAL PROCEEDINGS.

      Neither  Digital  Power nor its subsidiary  was  involved  in  any  legal
proceedings, nor is any property  of  Digital  Power  the  subject of any legal
proceedings.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

      Not Applicable

13
                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

(A) COMPARATIVE MARKET PRICES

      As  of  December  16, 1996, Digital Power's common stock  and  Redeemable
Common Stock Purchase Warrants  ("Warrants")  were  listed  and  traded  on The
NASDAQ SmallCap Market under the symbols "DPWR" and "DPWRW", respectively.   On
February  13,  1997,  Digital Power's common stock was listed and traded on the
American Stock Exchange  ("AMEX") under the symbol "DPW".  The following tables
set forth the high and low  closing  sale  prices,  as  reported by NASDAQ, for
Digital Power's common stock and Warrants for the last quarter of 1996.

                                 COMMON STOCK

PERIOD                                    LOW         HIGH

Quarter ending December 31, 1996          $4.00       $6.00



                   REDEEMABLE COMMON STOCK PURCHASE WARRANTS

PERIOD                                    LOW         HIGH

Quarter ending December 31, 1996          $0.125      $2.25

(B) HOLDERS

      As of March 25, 1997, there were 2,520,775 shares of Digital Power common
stock outstanding, held by 504 holders of record.  As of  the  same date, there
were 775,000 warrants, with 104 holders of record.

(C) DIVIDENDS

      The  Company  has  not  declared  or  paid  any cash dividends since  its
inception.  The Company currently intends to retain  future earnings for use in
the operation and expansion of the business.  The Company  does  not  intend to
pay any cash dividends in the foreseeable future.  The declaration of dividends
in  the  future  will  be  at the discretion of the Board of Directors and will
depend upon the earnings, capital  requirements,  and financial position of the
Company.

      On  May  31, 1996, the Company issued a stock dividend  in  the  form  of
Common Stock valued  at  $1.80  per  share on the cumulative accrued but unpaid
dividends on the Series A Preferred Stock.   Since  such stock dividend, all of
the Series A Preferred Stock has been converted into Common Stock.

14

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

OVERVIEW

      The Company designs, develops, manufactures, and markets electronic power
supplies  for use in converting electric power into a  form  suitable  for  the
operation of electronic circuitry.  Revenues are generated from the sale of the
Company's power supplies to OEMs in the computer and other electronic equipment
industries.

RESULTS OF OPERATIONS

      The table  below  sets  forth  certain statements of operations data as a
percentage of revenues for the years ended December 31, 1996 and 1995.

                                                  YEARS ENDED DECEMBER 31
                                                  -----------------------

                                                   1996            1995
                                                  -----           -----
Revenues                                           100%            100%
Cost of goods sold                                71.97           74.66
                                                  -----           -----
Gross margin                                      28.03           25.34

Selling, general and administrative                9.20           10.30
Engineering and product development                4.55            4.80
                                                  -----           ----- 
Total operating expense                           13.75           15.10
                                                  -----           -----
Operating income                                  14.28           10.24
Net interest expense                               1.06            1.16
Translation loss                                    .05             .85
                                                  -----           ----- 
Income before income taxes                        13.17            8.23

Provision (Benefit) for Income taxes               4.79           (2.76)
                                                   ----           -----
Net Income                                         8.38%          10.99%
                                                   ====           =====  
Net Income applicable to common shareholders       8.10%          10.09%


      The following discussion and analysis  should  be read in connection with
the Company's Consolidated Financial Statements and the notes thereto and other
financial information included elsewhere in this report.

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

REVENUES

      Revenues  for  the  fiscal  year  ended December 31,  1996  increased  by
$3,797,506  or  37.8%, over the fiscal year  ended  December  31,  1995.   This
increase in revenues  was  due  primarily to substantially increased sales to a
single OEM and, to a lesser extent,  to  increased  sales  to  the Company's 28
stocking distributors.  The majority of this increase, $2,315,553 (61%) was due
to increased sales to OEMs.  Distributor sales accounted for $1,002,400 (26.4%)

15

of  the  increase  and  the  balance of $479,553 (12.6%) was generated  by  the
Company's private label customers.

      As stated above, for the  year ended December 31, 1996, one OEM accounted
for 17.9% of the Company's total  revenues, and for the year ended December 31,
1995, three OEMs accounted for 18% in the aggregate of total revenues.  The one
OEM account which accounted for 17.9%  of  the Company's total revenues for the
year  ended  December  31, 1996, substantially  contributed  to  the  Company's
increase in revenues for such period.  During the latter part of 1996, this OEM
decreased the number of power supplies it purchased from the Company.  Further,
this OEM indicated that  it  will require a higher wattage power supply for its
new products and that the OEM  intends to use a power supply manufacturer other
than Digital to manufacture such  new  higher wattage power supply.  Management
believes that this OEM will cease purchasing  power  supplies  from the Company
after  the  second  quarter  of 1997.  The Company is seeking to design  a  new
higher wattage power supply to  satisfy  the  needs  of this OEM.  Further, the
Company believes that increased sales to new and other  existing  OEM customers
will offset the loss in sales to the OEM.  No assurance can be given,  however,
that  even  if  the Company is able to design a new higher wattage power supply
that satisfies the  needs  of  the OEM, that it will purchase such power supply
from the Company, or that the Company  will  be  able  increase  sales of power
supplies to other OEMs to offset the loss in sales.

GROSS MARGINS

      Gross  margins  were 28.03% for the fiscal year ended December  31,  1996
compared  to  25.34% for  the  fiscal  year  ended  December  31,  1995.   This
improvement in  gross  margins  can primarily be attributed to greater capacity
utilization as fixed overhead costs declined on a per unit basis.

SELLING, GENERAL AND ADMINISTRATIVE

      Selling, general and administrative  expenses increased by $238,295, from
$1,033,828 for the fiscal year ended December  31,  1995, to $1,272,123 for the
fiscal year ended December 31, 1996.  The increase primarily  related  to  one-
time  bonuses  to  certain  employees  which  increased  employee  compensation
expense.    As   a  percentage  of  revenues,  however,  selling,  general  and
administrative expenses  decreased  from  10.3% for the year ended December 31,
1995  to  9.2% for the year ended December 31,  1996,  since  the  increase  in
revenues during  this  period  was  much  greater than the increase in selling,
general and administrative expenses.

ENGINEERING AND PRODUCT DEVELOPMENT

      Engineering and product development expenses  were  4.55% of revenues for
the  year  ended December 31, 1996, and 4.80% of revenues for  the  year  ended
December 31, 1995.  This slight decrease as a percentage of revenues was due to
a greater increase  in  revenues  than  the increase in engineering and product
development expenses.

INTEREST EXPENSE

      Net interest expense was 1.06% of revenues  for  the  year ended December
31,  1996  and  1.16% of revenues for the year ended December 31,  1995.   This
decrease was primarily  due  to  a lower interest rate on the Company's line of
credit and increased interest income with respect to the proceeds of the public
offering.  Interest expense relates  primarily  to the Company's line of credit
and two equipment term loans with San Jose National  Bank.   The two term loans
in  the  aggregate  principal amount of $170,000, and the line of  credit,  are
secured  by  the Company's  accounts  receivables  and  the  Company's  assets.
Proceeds from  the  two term loans were used to acquire equipment, and proceeds
from the line of credit were used for working capital.

16

TRANSLATION LOSS

      The primary currency  of  the Company's subsidiary, Poder Digital, is the
Mexican  peso.  During 1996, the Company  experienced  a  translation  loss  of
$7,082 related to Poder Digital's operations using Mexican pesos, compared with
a translation loss of $85,258 in 1995.

INCOME BEFORE INCOME TAXES

      Income  before  income  taxes increased by $996,150, from $826,484 during
1995, to $1,822,634 in 1996.  This  substantial  increase  was primarily due to
the increase in revenues from the sale of the Company's power supplies.

INCOME TAX

      The Company's income tax expense was 4.79% of revenues for the year ended
December 31, 1996, and  -2.76% of revenues for the year ended December 31, 1995
(the  Company  had  a  tax  benefit in 1995).  Through December 31,  1995,  the
Company had net operating loss  tax  carry-forwards  (NOLs)  which  resulted in
minimal  federal  tax  liability  for  the  Company in 1995.  During the second
quarter of fiscal 1996, the Company began providing  for  federal and state tax
liability at an estimated average annual rate of 40%.

NET INCOME

      Net income was $1,158,834 in 1996 and $1,103,884 in 1995,  an increase of
$54,950,  or 5.0%. During the fourth quarter of 1995, the Company recognized  a
$277,400 tax  benefit  due  to its prior net operating loss.  Excluding the tax
benefit of $277,400, net income  for 1995 would have been $826,484.  Net income
applicable to common shareholders  for  the  years  ended December 31, 1996 and
1995 was $1,120,765 and $1,012,518, respectively.  The  difference  between net
income  and  net  income applicable to common shareholders is due to cumulative
dividends on the Company's  Series  A  Preferred Stock amounting to $91,366 per
year.   During  1996,  all of the outstanding  Series  A  Preferred  Stock  was
converted to common stock.

      The Company does not believe that its business is seasonal.

LIQUIDITY AND CAPITAL RESOURCES

      Through December 31,  1996,  the  Company funded its operations primarily
through revenues generated from operations, and its $1.5 million line of credit
with San Jose National Bank.  As of December  31,  1996  and December 31, 1995,
the Company's working capital was $4,476,555 and $2,211,358, respectively.  The
substantial increase in working capital for the year ended  December  31,  1996
reflects proceeds from the sale of common stock and Warrants in connection with
the  Company's  initial  public  offering completed in December 1996.  Proceeds
from the offering, which amounted  to  $2,276,905, were used to pay off certain
loans and to pay down the Company's line  of credit.  Payments on the loans and
line  of  credit  during  the  first  part of 1997  totalled  $1,483,401.   The
remaining proceeds will be used for working  capital.   On January 6, 1997, the
underwriter in connection with the Company's initial public  offering exercised
its overallotment option and purchased an additional 150,000 shares  of  common
stock  and 75,000 warrants, and the Company received an additional $530,156  in
proceeds as a result.

      Cash  provided  by operating activities for the Company totalled $559,016
during fiscal 1996 as compared  to  cash  provided  by  operating activities of
$319,035  during  fiscal  1995.   The  increase in cash provided  by  operating
activities was due primarily to the increase  in  net  income.   Cash  used  in
investing  activities  in  each  of  fiscal  1996  and fiscal 1995 consisted of
expenditures  for production and testing equipment of  $408,213  and  $254,530,
respectively.   During  fiscal 1995, cash used in investing activities included
the purchase of a temporary investment of $100,000.  Expenditures for equipment
were the direct result of  increasing  business  operations.   Cash provided by
financing  activities  consisted  of borrowings (including advances  under  the

17

Company's revolving line of credit) of $12,580,000 and $9,542,788 during fiscal
1996 and fiscal 1995, respectively,  net  of $12,345,207 and $9,346,200 in note
and line of credit payments during fiscal 1996 and fiscal 1995, respectively.

      For the past two fiscal years up until  December  1996,  the  Company had
relied on cash flows from operations supplemented by bank borrowings to finance
working  capital  and  capital  improvements.   The  Company's  bank borrowings
consist of a $120,000 promissory note bearing interest at 10% per annum and due
December 8, 1998, a $50,000 promissory note bearing interest at 10.5% per annum
and due May, 1999, and a $1.5 million line of credit bearing interest  at prime
plus 1% and due October 15, 1997.  Proceeds from the promissory notes were used
to  acquire  equipment,  and  the  line  of  credit  is  used to supplement the
Company's working capital.  The promissory notes and line of credit are secured
by substantially all of the Company's assets.  The Company  does not anticipate
any  material capital expenditures during 1997.  As of December  31,  1996  and
December  31,  1995,  the  Company's  bank  borrowings  totalled $1,783,938 and
$1,044,145, respectively.

      The  Company  is  a  guarantor  of a $500,000 term loan  granted  to  the
Company's employee stock ownership plan  ("ESOP").   The  $500,000 term loan is
included in the total amount of the Company's bank borrowings  as  of  December
31,  1996 stated in the preceding paragraph.  The $500,000 is due in June  2001
and bears  interest  at  10.5%  per annum.  Proceeds from the loan were used to
acquire the Company's common stock  by the ESOP.  Principal and interest on the
loan will be paid by the ESOP through  contributions made by the Company to the
ESOP in the amount of approximately $10,750  per  month.  This amount will be a
monthly deduction against revenues through June 2001.

      For   fiscal   year   1997,   the   Company   intends  to   upgrade   its
telecommunications  system  to  improve  communication  with   its  Guadalajara
facility.   It is anticipated that the system will cost approximately  $100,000
and will be paid  out  of  the  Company's  working  capital.  No other material
expenditures are anticipated during 1997.

ITEM 7.  FINANCIAL STATEMENTS.

      The financial statements of the Company, including  the notes thereto and
report  of  the independent auditors thereon, are attached hereto  as  exhibits
following page number 19.

ITEM 8.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING AND
FINANCIAL DISCLOSURE.

      In June 1996, the Company decided to retain Hein + Associates  LLP as the
Company's independent accountants and dismissed Villanueva, Purcell &  Co., the
Company's  former  accountants.  The decision to change independent accountants
was ratified and approved  by  the  Company's  Board of Directors in June 1996.
During  the relationship between the Company and  Villanueva,  Purcell  &  Co.,
there were  no  disagreements  regarding any matters with respect to accounting
principles or practices, financial  statement  disclosure,  or  audit  scope or
procedure,  which  disagreements,  if  not  resolved to the satisfaction of the
former  accountants,  would  have caused Villanueva,  Purcell  &  Co.  to  make
reference to the subject matter  of  the  disagreement  in  connection with its
report.   Prior  to  retaining  Hein  +  Associates  LLP, the Company  had  not
consulted with Hein + Associates LLP regarding accounting principles.

                                   PART III

ITEM  9.   DIRECTORS,  EXECUTIVE  OFFICERS,  PROMOTERS  AND   CONTROL  PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT OF THE REGISTRANT.

      The information required by this item is incorporated by reference to the
Company's  definitive  Proxy  Statement for the annual meeting of  stockholders
under the captions "Election of Directors," "Further Information Concerning the
Board of Directors," and "Section 16(a) Information."  The Proxy Statement will
be filed within 120 days of the Company's fiscal year end.

18

ITEM 10.  EXECUTIVE COMPENSATION.

      The information required by this item is incorporated by reference to the
Company's definitive Proxy Statement  for  the  annual  meeting of stockholders
under the caption "Executive Compensation."  The Proxy Statement  will be filed
within 120 days of the Company's fiscal year end.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

      The information required by this item is incorporated by reference to the
Company's  definitive  Proxy  Statement  for the annual meeting of stockholders
under the caption "Principal Stockholders."   The Proxy Statement will be filed
within 120 days of the Company's fiscal year end.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

      The information required by this item is incorporated by reference to the
Company's  definitive Proxy Statement for the annual  meeting  of  stockholders
under the caption  "Certain Relationships and Related Transactions."  The Proxy
Statement will be filed within 120 days of the Company's fiscal year end.

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K.

(A)   EXHIBITS

3.1   Amended and Restated Articles of Incorporation of Digital Power
      Corporation*
3.2   Amendment to Articles of Incorporation*
3.3   Bylaws of Digital Power Corporation*
4.1   Specimen Common Stock Certificate**
4.2   Specimen Warrant*
4.3   Representative's Warrant*
10.1  Revolving Credit Facility with San Jose National Bank*
10.2  KDK Contract*
10.3  Agreement with Fortron/Source Corp.*
10.4  Employment Agreement With Robert O. Smith**
10.5  1996 Stock Option Plan*
11.1  Statement Regarding Computation of Per Share Earnings
16.1  Letter on Changes in Certifying Accountants*
21.1  List of Subsidiaries of Issuer*

*     Previously filed with Commission on October  16,  1996  to  the Company's
      Registration Statement on Form SB-2.
**    Previously  filed  with  Commission  on December 3, 1996 to the Company's
      Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2.


(B)   REPORTS ON FORM 8-K

Not applicable.

19

                                  SIGNATURES

      In  accordance  with  Section  13  or 15(d)  of  the  Exchange  Act,  the
registrant caused this report to be signed  on  by  the  undersigned, thereunto
duly authorized.

                                          DIGITAL POWER CORPORATION,
                                          A CALIFORNIA CORPORATION


                                          ROBERT O. SMITH

                                          Robert O. Smith,
                                          Chief Executive Officer



      In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and  on
the dates indicated.

SIGNATURES                                          DATE


ROBERT O. SMITH                                   March 31, 1997
Robert O. Smith, Chief Executive Officer
(Principal Executive Officer)


PHILIP G. SWANY                                   March 31, 1997
Philip G. Swany, Chief Financial Officer
(Principal Accounting and
Financial Officer)


EDWARD L. LAMMERDING                              March 31, 1997
Edward L. Lammerding,
Chairman of the Board


THOMAS W. O'NEIL                                  March 31, 1997
Thomas W. O'Neil, Jr., Director


PHILIP M. LEE                                     March 31, 1997
Philip M. Lee, Director


CLAUDE ADKINS                                     March 31, 1997
Claude Adkins, Director

F-1

              INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                                                                   PAGE

Independent Auditor's Report........................................F-2

Consolidated Balance Sheet - December 31, 1996......................F-3

Consolidated Statements of Income - For the Years Ended
  December 31, 1996 and 1995........................................F-4

Consolidated Statement of Stockholders' Equity - For the Years
  Ended December 31, 1996 and 1995..................................F-5

Consolidated Statements of Cash Flows - For the Years Ended
  December 31, 1996 and 1995........................................F-6

Notes to Consolidated Financial Statements..........................F-8



F-2

                     INDEPENDENT AUDITOR'S REPORT






The Stockholders and Board of Directors
Digital Power Corporation and Subsidiary
Fremont, California



We  have  audited  the accompanying consolidated balance sheet of Digital Power
Corporation  and  Subsidiary   as   of  December  31,  1996,  and  the  related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the two-year period ended  December  31, 1996.  These financial
statements   are   the   responsibility  of  the  Company's  management.    Our
responsibility  is  to express  an  opinion  on  these  consolidated  financial
statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally  accepted  auditing
standards.  Those standards  require  that  we  plan  and  perform the audit to
obtain reasonable assurance about whether the financial statements  are free of
material misstatement.  An audit includes examining, on a test basis,  evidence
supporting  the amounts and disclosures in the financial statements.  An  audit
also  includes   assessing  the  accounting  principles  used  and  significant
estimates made by  management,  as  well  as  evaluating  the overall financial
statement presentation.  We believe that our audits provide  a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly,  in  all  material  respects,  the financial position of Digital  Power
Corporation and Subsidiary as of December  31,  1996,  and the results of their
operations and their cash flows for each of the years in  the  two-year  period
ended  December  31,  1996  in  conformity  with  generally accepted accounting
principles.






HEIN + ASSOCIATES LLP
Certified Public Accountants



Orange, California
March 7, 1997



F-3

               DIGITAL POWER CORPORATION AND SUBSIDIARY

                      CONSOLIDATED BALANCE SHEET


                                                           DECEMBER 31, 1996
                                                           -----------------
                        ASSETS
CURRENT ASSETS:
  Cash                                                        $  2,955,298
  Accounts receivable - trade, net of 
      allowance for doubtful accounts of 
      $170,000                                                   2,439,523
  Other receivables                                                150,122
  Inventory, net                                                 2,832,329
  Prepaid expenses and deposits                                     28,735
  Deferred income taxes                                             53,000
                                                              ------------
      Total current assets                                       8,459,007

PROPERTY AND EQUIPMENT, net                                        653,355

DEPOSITS                                                            17,428
                                                              ------------
TOTAL ASSETS                                                  $  9,129,790
                                                              ============

               LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
  Current portion of long-term debt                           $  1,347,463
  Current portion of capital lease obligations                      13,406
  Accounts payable                                               1,420,769
  Accrued liabilities                                            1,200,814
                                                              ------------
      Total current liabilities                                  3,982,452

LONG-TERM DEBT, less current portion                               446,475

OBLIGATIONS UNDER CAPITAL LEASE, less current portion               18,201
                                                              ------------
      Total liabilities                                          4,447,128
                                                              ------------
COMMITMENTS AND CONTINGENCIES (Notes 6, 7 and 9)                         -

STOCKHOLDERS' EQUITY:
  Series A cumulative redeemable convertible 
    preferred stock, no par value, 2,000,000 shares 
    authorized, no shares issued and outstanding                         -
  Common stock, no par value, 10,000,000 shares 
    authorized, 2,363,275 shares issued and outstanding          7,766,645
  Warrants                                                          66,875
  Accumulated deficit                                           (2,689,730)
  Unearned employee stock ownership plan shares                   (461,128)
                                                              ------------
      Total stockholders' equity                                 4,682,662
                                                              ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                    $  9,129,790
                                                              ============




SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.

F-4

               DIGITAL POWER CORPORATION AND SUBSIDIARY

                   CONSOLIDATED STATEMENTS OF INCOME


                                                    FOR THE YEARS ENDED
                                                        DECEMBER 31,
                                                    -------------------
                                                1996                    1995
                                           ------------           ------------

REVENUES                                   $ 13,835,008           $ 10,037,502
COST OF GOODS SOLD                            9,956,763              7,494,427
                                           ------------           ------------
  Gross Margin                                3,878,245              2,543,075
                                           ------------           ------------
OPERATING EXPENSES:
  Engineering and product development           630,079                481,475
  Marketing and selling                         497,345                452,654
  General and administrative                    774,778                581,174
                                           ------------           ------------
      Total operating expenses                1,902,202              1,515,303
                                           ------------           ------------
INCOME FROM OPERATIONS                        1,976,043              1,027,772
                                           ------------           ------------

OTHER INCOME (EXPENSE):
  Interest income                                13,785                  3,116
  Interest expense                             (160,112)              (119,146)
  Translation loss                               (7,082)               (85,258)
                                           ------------           ------------
      Other income (expense)                   (153,409)              (201,288)
                                           ------------           ------------
INCOME BEFORE INCOME TAXES                    1,822,634                826,484
PROVISION (BENEFIT) FOR INCOME TAXES            663,800               (277,400)
                                           ------------           ------------
NET INCOME                                 $  1,158,834           $  1,103,884
                                           ============           ============
NET INCOME APPLICABLE TO COMMON 
   SHAREHOLDERS                            $  1,120,765           $  1,012,518
                                           ============           ============
NET INCOME PER COMMON SHARE:
  Primary                                  $        .66           $       0.80
                                           ============           ============
  Fully diluted                            $        .62           $       0.66
                                           ============           ============
WEIGHTED AVERAGE NUMBER OF SHARES 
   OUTSTANDING                                1,691,136              1,258,858
                                           ============            ===========




SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS.


F-5
                         DIGITAL POWER CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY



UNEARNED EMPLOYEE PREFERRED STOCK COMMON STOCK STOCK TOTAL ACCUMULATED OWNERSHIP STOCKHOLDERS' SHARES AMOUNT SHARES AMOUNT WARRANTS DEFICIT PLAN EQUITY ------------ ----------- ------------ ----------- ------------ ------------- ---------- ------------ BALANCES, January 1, 1995 415,302 $ 747,569 963,722 $ 4,398,322 $ - $ (4,563,194) $ $ 582,697 Net income - - - - - 1,103,884 - 1,103,884 ---------- ----------- ---------- ----------- ---------- ------------ ---------- ----------- BALANCES, December 31, 1995 415,302 747,569 963,722 4,398,322 - (3,459,310) - 1,686,581 Net income - - - - - 1,158,834 - 1,158,834 Dividend on preferred stock - - 216,229 389,213 - (389,254) - (41) Conversion of preferred stock (415,302) (747,569) 415,302 747,569 - - - - Exercise of stock options - - 18,022 9,011 - - - 9,011 ESOP loan and shares purchased - - - - - - (500,000) (500,000) Contribution to the ESOP - - - - - - 38,872 38,872 Compensation costs recognized upon issuance of warrants - - - - 12,500 - - 12,500 Sale of common stock and warrants, net of expenses - - 750,000 2,222,530 54,375 - - 2,276,905 ------------ ----------- ------------ ----------- ------------ ------------ ------------ ----------- BALANCES, December 31, 1996 - $ - 2,363,275 $ 7,766,645 $ 66,875 $ (2,689,730) $ (461,128) $ 4,682,662 ============ =========== ============ =========== ============= ============= ============ ============
SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS. F-6 DIGITAL POWER CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, ------------------- 1996 1995 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,158,834 $ 1,103,884 ------------ ------------ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 112,538 70,140 Deferred income taxes 326,856 (374,689) Warranty expense 75,000 30,000 Inventory reserve (50,000) 195,000 Contribution to ESOP 38,872 - Bad debt expense 50,000 55,000 Compensation costs recognized upon issuance of warrants 12,500 - Foreign currency translation adjustment 7,082 85,258 Changes in operating assets and liabilities: Accounts receivable (873,026) (465,047) Other receivables (92,264) (39,855) Inventory (1,225,103) (594,983) Prepaid expenses (943) (17,879) Other assets 936 - Accounts payable 289,183 266,721 Other accrued liabilities 728,551 5,485 ------------ ------------ Net adjustments (599,818) (784,849) ------------ ------------ Net cash provided by operating activities 559,016 319,035 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (408,213) (254,530) Sale of temporary investment 100,000 - ------------ ------------ Net cash used in investing activities (308,213) (254,530) ------------ ------------ (Continued) F-7 DIGITAL POWER CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) FOR THE YEARS ENDED DECEMBER 31, ------------------- 1996 1995 ------------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of common stock and warrants 2,276,905 - Proceeds from exercise of stock options 9,011 - Payments of preferred stock dividend (41) - Proceeds from notes payable 50,000 120,000 Principal payments on notes payable (83,392) (1,276) Principal payments on capital lease obligations (12,008) (9,054) Payment of debenture (5,000) - Proceeds from line of credit 12,530,000 9,422,788 Principal payments on line of credit (12,256,815) (9,344,924) ------------ ------------ Net cash provided by financing activities 2,508,660 187,534 ------------ ----------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (7,082) (85,258) ------------ ------------ NET INCREASE IN CASH 2,752,381 166,781 CASH AND CASH EQUIVALENTS, beginning of period 202,917 36,136 ------------ ------------ CASH AND CASH EQUIVALENTS, end of period $ 2,955,298 $ 202,917 ============ ============ SUPPLEMENTAL CASH FLOW INFORMATION: Cash payments for: Interest $ 152,716 $ 121,931 =========== =========== Income taxes $ 171,214 $ 55,803 =========== ========== Non-cash investing and financing transactions: Property and equipment acquired with capital lease $ - $ 10,779 =========== ========== Conversion of preferred stock to common stock $ 747,569 $ - =========== ========== Preferred stock dividend of common stock $ 389,213 $ - =========== ========== Notes payable for unearned employee stock ownership plan shares $ 500,000 $ - =========== ========= SEE ACCOMPANYING NOTES TO THESE CONSOLIDATED FINANCIAL STATEMENTS. F-8 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF OPERATIONS: Digital Power Corporation ("DPC"), and its wholly owned subsidiary Poder Digital, S.A. de C.V. ("PD") which is located in Guadalajara, Mexico, (collectively referred to as the "Company") are engaged in the design, manufacture and sale of switching power supplies. 2. SIGNIFICANT ACCOUNTING POLICIES: PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation. STATEMENT OF CASH FLOWS - For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. INVENTORY - Inventory is stated at the lower of cost (first-in, first- out) or market. PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. Depreciation of equipment and furniture is calculated using the straight-line method over the estimated useful lives (ranging from 5 to 10 years) of the respective assets. Leasehold improvements are amortized over the shorter of the estimated useful life or the term of the lease. The cost of normal maintenance and repairs is charged to operating expense as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of fixed assets sold, or otherwise disposed of, and the related accumulated depreciation or amortization are removed from the accounts, and any gains or losses are reflected in current operations. INCOME TAXES - The Company accounts for income taxes under the liability method, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. F-9 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): REVENUE RECOGNITION - Sales revenue is recognized when the products are shipped to customers, including distributors. Customers receive a one or two year product warranty and sales to distributors are subject to a right of return. The Company provides a reserve for estimated warranty costs and a reserve for estimated product returns. FOREIGN CURRENCY TRANSLATION - Gains and losses from the effects of exchange rate fluctuations on transactions denominated in foreign currencies are included in results of operations. Assets and liabilities of the Company's foreign subsidiary are translated into U.S. dollars at period-end exchange rates, and their revenues and expenses are translated at average exchange rates for the period. NET INCOME PER COMMON SHARE - Net income per common share is calculated upon net income applicable to common shareholders, which represents net income adjusted for cumulative preferred dividends applicable to the period. The weighted average common shares is based upon actual common stock and common stock equivalents outstanding. Additionally, common stock equivalents issued during the prior year at less than the $4.00 initial public offering price have been included for all periods presented in the computation using the "treasury stock method" and the public offering price. Fully diluted net income per common share is computed using the "if converted" method for preferred stock. ACCOUNTING ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. The actual results could differ from those estimates. The Company's financial statements are based upon a number of significant estimates, including the allowance for doubtful accounts, technological obsolescence of inventories, the estimated useful lives selected for property and equipment, realizability of deferred tax assets, allowance for sales returns, and warranty reserve. Due to the uncertainties inherent in the estimation process, it is at least reasonably possible that these estimates will be further revised in the near term and such revisions could be material. F-10 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): IMPAIRMENT OF LONG-LIVED ASSETS - In the event that facts and circumstances indicate that the cost of assets or other assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to market value or discounted cash flow value is required. STOCK-BASED COMPENSATION - In October, 1995, the Financial Accounting Standards Board issued a new statement titled "Accounting for Stock- Based Compensation" (FAS 123) which the Company adopted January 1, 1996. FAS 123 encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options and other equity instruments to employees based on fair value. Companies that do not adopt the fair value accounting rules must disclose the impact of adopting the new method in the notes to the financial statements. Transactions in equity instruments with non-employees for goods or services must be accounted for on the fair value method. The Company has elected not to adopt the fair value accounting prescribed by FAS 123 for employees, but is subject to the disclosure requirements prescribed by FAS 123. CONCENTRATIONS OF CREDIT RISK - Credit Risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. Concentrations of credit risk (whether on or off balance sheet) that arise from financial instruments exist for groups of customers or groups of counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly effected by changes in economic or other conditions. In accordance with FAS Statement No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK, the credit risk amounts shown in Note 10 do not take into account the value of any collateral or security. FAIR VALUE OF FINANCIAL INSTRUMENTS - The estimated fair values for financial instruments under FAS Statement No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair values of the Company's financial instruments, which includes all cash, accounts receivables, accounts payable, long-term debt, and other debt, approximates the carrying value in the consolidated financial statements at December 31, 1996. F-11 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED): IMPACT OF RECENTLY ISSUED STANDARDS - In February 1997, the Financial Accounting Standards Board issued a new statement titled "Earnings per Share" ("FAS 128"). The new statement is effective for both interim and annual periods ending after December 15, 1997. FAS 128 replaces the presentation of primary and fully diluted earnings per share with the presentation of basic and diluted earnings per share. Basic earnings per share excludes dilution and is calculated by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The Company has not calculated the impact, if any, of adopting FAS 128. 3. INVENTORY: Inventory consists of the following as of December 31, 1996: Raw Materials $ 2,110,678 Work-in-process 886,790 Finished goods 184,861 ------------ 3,182,329 Allowance for obsolescence (350,000) ------------ $ 2,832,329 ============ 4. PROPERTY AND EQUIPMENT: Property and equipment consists of the following at December 31, 1996: Machinery and equipment $ 1,166,915 Office equipment and furniture 392,588 Leasehold improvements 146,520 Transportation equipment 3,168 ------------ 1,709,191 Accumulated depreciation (1,055,836) ------------ $ 653,355 ============ Depreciation and amortization expense for property and equipment charged to operations for the years ended December 31, 1996 and 1995 was $112,538 and $70,140, respectively. F-12 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. ACCRUED LIABILITIES: At December 31, 1996, accrued liabilities consists of the following: Accrued payroll benefits $ 305,382 Accrued commissions and royalties 88,920 Accrued warranty and product returns expense 335,000 Accrued income taxes 255,281 Other 216,213 ------------ $ 1,200,814 ============ 6. LONG-TERM DEBT: Long-term debt consists of the following as of December 31, 1996: Revolving line of credit agreement provides for borrowings up to 80% of eligible accounts receivable not to exceed $1,500,000; bears interest at the bank's prime rate (8.25% at December 31, 1996) plus one percent. Matures October 1997. Collateralized by substantially all assets of DPC. $ 1,197,330 Unsecured note payable, due on demand, interest at 12%. 10,000 Note payable, due in monthly installments of $3,881 including interest at 10% through December 1998. Collateralized by substantially all assets of DPC. 83,986 Note payable, due in monthly installments of $1,629 including interest at 10.50% through May 1999. Collateralized by substantially all assets of DPC. 41,494 Employee stock ownership plan loan 461,128 See Note 11 ------------ 1,793,938 Less current portion (1,347,463) ------------ $ 446,475 ============ F-13 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. LONG-TERM DEBT (CONTINUED): Aggregate maturities of long-term debt are due as follows: YEARS ENDING DECEMBER 31, AMOUNT ------------ ------------ 1997 $ 1,347,463 1998 155,580 1999 112,222 2000 115,901 2001 62,772 ------------ $ 1,793,938 ============ Under the terms of the revolving line of credit agreement the Company is required to maintain working capital of not less than $800,000, a debt to worth ratio less than 2.5 to 1, and a minimum tangible net worth of not less than $1,500,000. As of December 31, 1996, the Company was in compliance with all terms of the revolving line of credit agreement. 7. CAPITAL LEASE OBLIGATIONS: The Company leases certain equipment under agreements classified as capital leases. The cost of the equipment related to the leases is $57,147 and accumulated depreciation amounts to $26,387 at December 31, 1996. Following is a schedule of future minimum lease payments under capital leases at December 31, 1996: YEARS ENDING DECEMBER 31, AMOUNT ------------------------- ----------- 1997 $ 16,698 1998 14,689 1999 5,282 ----------- Total future minimum lease payments 36,669 Less amount representing interest (5,062) ----------- Present value of net minimum lease payments 31,607 Less current portion (13,406) ----------- $ 18,201 =========== F-14 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. STOCKHOLDERS' EQUITY: COMMON STOCK In December, 1996, the Company completed a public offering of 750,000 shares of its common stock along with 500,000 warrants, at a public offering price of $4.00 per share and $.125 per warrant. As part of the public offering, the underwriter was allocated an additional 150,000 shares at $4.00 per share and 75,000 warrants at $.125 per warrant to cover over-allotments, if any. On January 8, 1997, the underwriter exercised and sold these over allotment shares and warrants for net proceeds of $530,156. PREFERRED STOCK The preferred stock has one series authorized, 500,000 shares of Series A cumulative redeemable convertible preferred stock ("Series A"), and an additional 1,500,000 shares of preferred stock has been authorized, but the rights, preferences, privileges and restrictions on these shares has not been determined. DPC's Board of Directors is authorized to create new series of preferred stock and fix the number of shares as well as the rights, preferences, privileges and restrictions granted to or imposed upon any series of preferred stock. On May 31, 1996, all of the 415,302 issued and outstanding shares of Series A Preferred Stock were converted into 415,302 shares of common stock at the statutory rate of $1.80 per share. Additionally, the Company declared a dividend on the Series A preferred stock for all unpaid dividends through the conversion date and issued an aggregate of 216,229 shares of common stock. The holders of Series A were entitled to one vote for each share of common stock into which the Series A could be converted, and vote together with the common shareholders as a single class. Dividends on Series A were at an annual rate of $.22 per share and were cumulative from the date of issuance, and were required to be paid prior to dividends on common stock. Shares of Series A were convertible into common stock at any time at the option of the holder at a rate of one share of common stock for each share of Series A. The conversion rate was subject to adjustment under certain circumstances. In the event of a liquidation, dissolution, or winding up of the Company, Series A holders were entitled to receive a liquidation preference of $1.80 per share of Series A plus all dividends in arrears. F-15 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. STOCKHOLDERS' EQUITY (CONTINUED): STOCK OPTIONS The Company has issued non-qualified options covering 104,922 shares exercisable at $.50 per share. Upon issuance, the Company recorded compensation expense for the difference between the exercise price and the fair market value of the underlying common stock of $1.80 per share. Such options expire in 2003. During the year ended December 31, 1996, 18,022 of such options were exercised. In May, 1993, the Company issued options to purchase 237,500 shares of its common stock at $1.80 per share. Such options are subject to a four year vesting plan. The exercise price of $1.80 per share approximated the fair market value at the date of grant. In May, 1996, the Company adopted the 1996 Stock Option Plan covering 513,000 shares. Under the plan, the Company can issue either incentive or non-statutory stock options. The price of the options granted pursuant to the plan will not be less than 100% of the fair market value of the shares on the date of grant. The board of directors will decide the vesting period of the options, if any, and no option will be exercisable after ten years from the date granted. Immediately thereafter, the Company issued options to purchase 275,500 shares of its common stock at $1.80 per share. Such options become 100% vested two years after issuance. The exercise price was based upon a letter from its investment banker as to the fair market value of such options based upon their terms, conditions and restrictions. The following table sets forth activity for all options: EXERCISE PRICE NUMBER PER SHARE -------- -------------- OUTSTANDING, January 1, 1995, and December 31, 1995 342,422 $.50 -$1.80 GRANTED 275,500 1.80 FORFEITED (2,500) 1.80 EXERCISED (18,022) .50 ------------ ------------ BALANCE, DECEMBER 31, 1996 597,400 $.50 - $1.80 ============ ============ At December 31, 1996 and 1995 options to purchase 265,025 and 223,672 shares, respectively, were exercisable at prices ranging from $.50 to $1.80 per share. If not previously exercised, these options expire during the year ended December 31, 2003. F-16 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. STOCKHOLDERS' EQUITY (CONTINUED): WARRANTS On August 19, 1996, the Company issued 200,000 common stock purchase warrants to certain Company directors and affiliates. Each warrant entitles the holder to purchase one share of common stock at $5.00 and expires three years after the effective date of the Company's initial public offering of securities. The Company recognized $12,500 in expense for past services rendered for the 100,000 warrants issued to affiliates. PROFORMA INFORMATION As stated in Note 2, the Company has not adopted the fair value accounting prescribed by FAS 123 for employees. Had compensation cost for stock options or warrants issued to employees been determined based on the fair value at grant date for awards in 1996 consistent with the provisions of FAS 123, the Company's net income and net income per share would have been reduced to the pro forma amounts indicated below: Net Income $ 1,133,473 Net Income per common share: Primary .65 Fully diluted .61 The fair value of each option or warrant is estimated on the date of grant using the present value of the exercise price and is pro-rated based on the percent of time from the grant date to the end of the vesting period. The weighted average fair value of the options on the grant date was $1.50 per share. The following assumptions were used for grants in 1996: risk-free interest rate of 6.17%; expected lives of three years; dividend yield of 0%; and expected volatility of 0%. 9. COMMITMENTS: LEASES The Company leases office space in California, and a manufacturing facility in Guadalajara, Mexico under operating leases. The total future minimum lease payments are as follows: YEARS ENDING DECEMBER 31, AMOUNT ------------ ---------- 1997 $ 105,640 1998 108,880 1999 109,174 2000 112,579 Thereafter 10,378 ------------ $ 446,651 ============ F-17 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. COMMITMENTS (CONTINUED): Lease payments on the manufacturing facility in Mexico are to be made in Mexican Pesos. The above schedule was prepared using the conversion rate in effect at December 31, 1996. Changes in the conversion rate will have an impact on the Company's required minimum payments and its operating results. Additionally, lease payments on the facility in Mexico will increase on an annual basis in proportion to the increase in the minimum wage in the Guadalajara, Mexico area. Rent expense was $119,106 and $116,699 for 1996 and 1995, respectively. ROYALTY AGREEMENT The Company has a royalty agreement with a third party on various products, and any derivatives from the base design of these products. Commitments under this agreement are as follows: 5% of first $20,000,000 in sales of these products 4% of next $25,000,000 in sales of these products 3% of next $33,333,333 in sales of these products 2% of next $50,000,000 in sales of these products 1% of next $100,000,000 in sales of these products As of December 31, 1996, the Company had sold approximately $14,476,000 of product subject to this agreement. If the Company sells an additional $5,524,000 of these products after December 31, 1996, the Company is required to grant 100,000 shares of common stock to the third party in the royalty agreement. Due to changing market demand, the Company's management currently expects to replace these products with products it is in the process of designing, and Company's management believes the Company will therefore not have to grant the 100,000 shares of common stock. The Company sold approximately $847,000 and $1,453,000 of these products in 1996 and 1995, respectively, and had royalty expenses of approximately $42,300 and $72,600 for 1996 and 1995, respectively. EMPLOYMENT AGREEMENT The Company has an employment contract with its President/CEO which terminates on December 31, 1999. Under the terms of the employment contract, he shall serve as president and chief executive officer of the Company and his salary shall be $150,000 per annum effective January 1, 1997, increasing in an amount to be determined by the employee and the Board such that he shall receive $200,000 per annum by January 1, 1999. In addition, pursuant to the contract, he shall have the right to receive on the first day of each January during the term of his contract options to acquire 100,000 shares of Common Stock at the lower of market value per share as of such date or the average per share bid price for the first 6 months beginning from the date of grant of the option. Finally, pursuant to the employment contract, in the event there is a change in control of the Company, the employee shall be granted a five year consulting contract at $200,000 per year. F-18 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. SIGNIFICANT CONCENTRATIONS OF CREDIT RISK, MAJOR CUSTOMERS AND OTHER RISKS AND UNCERTAINTIES: Sales to unaffiliated customers which represent more than 10% of the Company's net sales for 1996 and 1995 were as follows (customers A & C are distributors): CUSTOMER 1996 1995 -------- ---- ---- A 21% 27% B 18% 8% C 11% 10% The Company operates primarily in one industry segment: the manufacture and sale of switching power supplies. Additionally, most of the Company's sales are to customers located in California. Financial instruments that subject the Company to credit risk consist primarily of accounts receivable. The Company frequently sells large quantities of inventory to its customers. At December 31, 1996, approximately $1,823,913 or 67.7 % of the Company's net accounts receivable were due from five customers. As of December 31, 1996, the Company maintained cash in banks that was approximately $2,715,300 in excess of the federally insured limit. 11. EMPLOYEE BENEFIT PLANS: 401(K) PROFIT SHARING PLAN The Company has a 401(k) profit sharing plan (the "Plan") covering substantially all employees of DPC. Eligible employees may make voluntary contributions to the Plan, which are matched by the Company at a rate of $.25 for each $1.00 contributed, up to a maximum of six percent of eligible compensation. The Company can also make discretionary contributions. The Company made matching contributions to the Plan of $11,844 and $9,594 for 1996 and 1995, respectively. The Board of Directors of DPC elected not to make a discretionary contribution to the Plan for 1996 or 1995. EMPLOYEE STOCK OWNERSHIP PLAN The Company also has an employee stock ownership plan (the "ESOP") covering substantially all employees of DPC. The Company can make discretionary contributions of cash or company stock (as defined in the ESOP plan document) up to deductible limits prescribed by the Internal Revenue Code. The Board of Directors of DPC elected to make no contributions to the ESOP for 1995. F-19 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. EMPLOYEE BENEFIT PLANS (CONTINUED): Effective June 13, 1996, the ESOP obtained a $500,000 loan guaranteed by the Company for the purpose of acquiring common stock of Company from existing stockholders. The loan bears interest at 10.5% per annum and requires monthly payments of principle and interest of $10,784 through June 2001. The balance at December 31, 1996 was $461,128. Immediately upon the funding of the loan, the ESOP purchased approximately 154,000 shares of the Company's common stock from existing shareholders. The Company is required to contribute amounts to the plan to sufficiently cover the debt payments. Contributions to the plan in 1996 totaled $116,308. In accordance with the AICPA Statements of Position 93-6 entitled "Employers Accounting for Employee Stock Ownership Plans", the Company has recorded the $500,000 loan as debt on its books with a corresponding charge to stockholder's equity. 12. INCOME TAXES: Income tax expense is comprised of the following: FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1996 1995 ---------- ------------ Current Federal $ 148,225 $ 7,552 State 209,550 73,750 ------------ ----------- 357,775 81,302 ------------ ----------- Deferred Federal 222,900 (358,702) State 83,125 - ------------ ----------- 306,025 (358,702) ----------- ----------- Income tax expense (benefit) $ 663,800 $ (277,400) =========== =========== The component of the net deferred tax asset at December 31, 1996, is as follows: State income taxes $ 53,000 --------- Total deferred tax asset $ 53,000 ========= Management believes that, based on earnings through and subsequent to December 31, 1995, deferred tax assets are more likely than not to be realized and, therefore, the valuation allowance against deferred tax assets was reversed as of December 31, 1995. F-20 DIGITAL POWER CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. INCOME TAXES (CONTINUED): Total income tax expense differed from the amounts computed by applying the U.S. federal statutory tax rates to pre-tax income as follows: FOR YEARS ENDED DECEMBER 31, --------------- 1996 1995 ----------- ----------- Total expense computed by applying the U.S. statutory rate $ 619,720 $ 281,005 State income taxes 169,512 73,750 Effect of income taxable in Mexico 26,549 (14,857) Utilization of net operation loss carry-forwards (59,034) (258,596) Effect of valuation allowance - (358,702) Income tax credits (92,947) - ----------- ----------- $ 663,800 $ (277,400) =========== =========== 13. SUBSEQUENT EVENTS: On January 2, 1997, the Company granted 100,000 options to purchase the Company's stock to the president of the Company, in accordance with his employment agreement. On February 4, 1997, the Company granted 27,000 options with an exercise price of $6.625 per share, to certain employees to purchase the Company's stock. The options vest over 4 years at 25% per year. On February 28, 1997, an ex-board member exercised his options to acquire 7,500 shares of the Company's stock at $1.80 per share.
                             EXHIBIT 11.1

               DIGITAL POWER CORPORATION AND SUBSIDIARY

                  COMPUTATION OF NET INCOME PER SHARE



                                                      FOR THE YEARS ENDED
                                                           DECEMBER 31
                                                      -------------------
                                                 1996                   1995
                                              ----------            ----------
             PRIMARY

Net income                                    $1,158,834            $1,103,884
Less - preferred stock dividends                 $38,069               $91,366 
Net income applicable to common
  shareholders                                $1,120,765            $1,012,518

Weighted average number of common
  shares                                       1,367,843               963,722
Add - common stock equivalent shares
  (determined using the treasury stock
  method) representing shares issuable
  upon exercise of stock options                 323,293               295,136
Weighted average number of shares
  used in calculation of primary income
  per share                                    1,691,136             1,258,858

Primary net income per common share                $0.66                 $0.80 

               FULLY DILUTED

Net income for primary income per share       $1,120,765            $1,012,518
Add - preferred stock dividend                   $38,069               $91,366
Net income used for fully diluted income
  per share                                   $1,158,834            $1,103,884  

Weighted average number of shares
  used in calculation of primary income
  per share                                    1,691,136             1,258,858
Add - weighted average number of
  shares issuable upon conversion of
  preferred stock                                171,810               415,302
Weighted average number of shares
  used in calculation of fully diluted
  income per share                             1,862,946             1,674,160
Fully diluted net income per common
  share                                            $0.62                 $0.66

 

5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS FROM THE FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 1996, FOR DIGITAL POWER CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS DEC-31-1996 DEC-31-1996 2,955,298 0 2,609,523 (170,000) 2,832,329 8,459,007 1,709,191 (1,055,836) 9,129,790 3,982,452 0 0 0 7,766,645 (3,083,983) 9,129,790 13,835,008 13,835,008 (9,956,763) (9,956,763) (1,902,202) 0 (160,112) (1,822,634) (663,800) (1,158,834) 0 0 0 (1,158,834) .66 .62