NOTE 1:-          GENERAL

NOTE 2:-3.BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements ashave been prepared in accordance with the instructions to Form 10-Q and Regulation S-X and do not include all the information and disclosures required by generally accepted accounting principles in the United States of September 30, 2016America (“GAAP”). The Company has made estimates and forjudgments affecting the threeamounts reported in our consolidated financial statements and nine months ended September 30, 2016 and 2015 arethe accompanying notes. The actual results experienced by the Company may differ materially from our estimates. The consolidated financial information is unaudited and reflectbut reflects all normal adjustments (consisting only of normal recurring adjustments) whichthat are, in the opinion of management, necessary forto provide a fair presentationstatement of the financial position and operating results for the interim periods. The condensedperiods presented. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management's discussion and analysis of the financial condition and results of operations, contained in the Company'sCompany’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015.2016, filed with the Securities and Exchange Commission on April 10, 2017. The resultsconsolidated balance sheet as of operations forDecember 31, 2016 was derived from the Company’s audited 2016 financial statements contained in the above referenced Form 10-K. Results of the three and nine months ended September 30, 2016March 31, 2017, are not necessarily indicative of the results to be expected for the entire fiscalfull year ending December 31, 2016.

The significant accounting policies applied in the annual financial statements of the Company as of December 31, 2015 are      applied consistently in these financial statements.

NOTE 3:-            INVENTORIES

NOTE 4:-           ACCOUNTING FOR STOCK-BASED COMPENSATION

Share Option Plan

DIGITAL POWER CORPORATION AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data

AsPrinciples of September 30, 2016, there was $274 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the share option plans. That cost is expected to be recognized over a period of the next 1.66 years.

NOTE 5:-     INCOME (LOSS) PER SHAREConsolidation

The following table sets forthcondensed consolidated financial statements include the computationaccounts of DPC and its wholly-owned subsidiaries, DPL and DPL Lending. All significant intercompany accounts and transactions have been eliminated in consolidation.

Accounting Estimates

The preparation of financial statements, in conformity with GAAP, requires management to make estimates, judgments and assumptions. The Company's management believes that the estimates, judgments and assumptions used are reasonable based upon information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the basicfinancial statements, and diluted netthe reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. Key estimates include fair value of certain financial instruments, reserve for trade receivables and inventories, carrying amounts of investments, accruals of certain liabilities, and deferred income (loss) per share:taxes and related valuation allowance.

NOTE 6:-         INVESTMENT IN TELKOORInvestments in Debt and EquitySecurities

On June 16, 2011The Company classifies its investments in Avalanche International, Corp (“AVLP”), consisting of shares of common stock and debt securities, in accordance with ASC No. 320,Investment in Debt and Equity Securities (“ASC No. 320”) and ASC No. 325,Investment – Other(“ASC No. 325”). The investment in marketable securities and convertible promissory notes are both classified as “available-for-sale securities” and are carried at fair value, based on quoted market prices. Unrealized gains and losses are reported as a separate component of stockholder’s equity, accumulated other comprehensive loss. When evaluating the Company’s debt and equity investments for other-than-temporary impairment, the Company acquired 1,136,666 sharesreviews factors such as the length of Telkoor, the Company's major shareholder at the time and an Israeli company listed inextent to which fair value has been below cost basis, the Tel Aviv stock exchange (at such time), which represented 8.8%financial condition of the outstanding sharesissuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not that it will be required to sell, the investment before recovery of Telkoor. As a result of this transaction, an existing manufacturing agreement between the Company and Telkoor was updated and extended.

The Company recorded an impairment of its investment in Telkoor of $0 for the nine months ended September 30, 2016 compared to $106,000 for the nine months ended September 30, 2015 and $110,0000 for the year ended December 31, 2015.

On September 22, 2016, the Company sold such shares to Telkoor for $90,000. (see Note 1)

investment’s amortized cost basis. Equity securities that do not have readily determinable fair values (i.e., non-marketable equity securities) and are not required to be accounted for under the equity method are typically carried at cost (i.e., cost method investments), as described in ASC No. 325-20. The Company has classified itsAdditionally, the investment in Telkoor's shares usingdebt securities of AVLP qualifies for application of the cost methodfair value option in accordance with ASC 325-20 "Investments in Other". Paragraphs 320-10-35-17 through 35-35 discuss the methodology for determining impairment and evaluate whether the impairment is other than temporary and therefore should be recognized.No. 825.

NOTE 7:-        SEGMENTS, MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATIONRevenue Recognition

The Company generates revenues from the sale of its products through a direct and indirect sales force.Revenues from products are recognized in accordance with ASC No. 605,Revenue Recognition, when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the seller's price to the buyer is fixed or determinable, no further obligation exists and collectability is reasonably assured.Generally, the Company does not grant a right of return. However, certain distributors are allowed, in the six months after the initial stock purchase, to rotate stock that has not been sold for other products. Revenues subject to stock rotation rights are deferred until the products are sold to the end customer or until the rotation rights expire.Service revenues are deferred and recognized on a straight-line basis over the term of the service agreement. Service revenues are immaterial in proportion to the Company's revenues. 

Warranty

The Company hasoffers a warranty period for all of its products. Warranty periods range from one to two reportable geographic segments (see Note 1 foryears depending on the product. The Company estimates the costs that may be incurred under its warranty and records a brief descriptionliability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company's business).warranty liability include the number of units sold, historical rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary.

As of March 31, 2017 and December 31, 2016, the Company’s accrued warranty liability was $86.

Common Stock Purchase Warrants and Other Derivative Financial Instruments

The following data presents the revenues, expendituresCompany classifies common stock purchase warrants and other operating datafree standing derivative financial instruments as equity if the contracts (i) require physical settlement or net-share settlement or (ii) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies any contracts that (i) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company's geographic operating segmentsCompany), (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (iii) contain reset provisions as either an asset or a liability. The Company assesses classification of its freestanding derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required. The Company determined that certain freestanding derivatives, which principally consist of issuance of warrants to purchase shares of common in connection with convertible notes, units and to employees of the Company, satisfy the criteria for classification as equity instruments as these warrants do not contain cash settlement features or variable settlement provision that cause them to not be indexed to the Company’s own stock.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC 218 "Segment Reporting" ("No. 718,Compensation – Stock Compensation ("ASC 218"No. 718"). Under ASC No. 718, compensation expense related to stock-based payments is recorded over the requisite service period based on the grant date fair value of the awards. Compensation previously recorded for unvested stock options that are forfeited is reversed upon forfeiture. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock.

DIGITAL POWER CORPORATION AND SUBSIDIARY

NOTES TO INTERIMCONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

MARCH 31, 2017

U.S. dollars in thousands, except share and per share data

Major customer data asThe Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of ASC No. 505-50,Equity Based Payments to Non-Employees. Accordingly, the measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a percentagecommitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of total revenues:equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.

Convertible Instruments

The Company accounts for hybrid contracts that feature conversion options in accordance with ASC No. 815,Derivatives and Hedging Activities (“ASC No. 815”). ASC No. 815 requires companies to bifurcate conversion options from their host instruments and account for them as freestanding derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable GAAP with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument.

Conversion options that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuances of equity or equity linked securities at exercise prices more favorable than that featured in the hybrid contract generally result in their bifurcation from the host instrument.

The Company accounts for convertible instruments, when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments, in accordance with ASC No. 470-20,Debt with Conversion and Other Options (“ASCNo.470-20”). Under ASC No. 470-20 the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts for convertible instruments (when the Company has determined that the embedded conversion options should be bifurcated from their host instruments) in accordance with ASC No. 815.

Comprehensive Loss

The Company reports comprehensive loss in accordance with ASC No. 220,Comprehensive Income. This statement establishes standards for the reporting and presentation of comprehensive loss and its components in a full set of general purpose financial statements. Comprehensive loss generally represents all changes in equity during the period except those resulting from investments by, or distributions to, stockholders. The Company determined that its items of other comprehensive loss relate to changes in foreign currency translation adjustments.

Fair value of Financial Instruments

In accordance with ASC No. 820,Fair Value Measurements and Disclosures, fair value is defined as the exit price, or the amount that would be received for the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date.

DIGITAL POWER CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

MARCH 31, 2017

U.S. dollars in thousands, except share and per share data

The guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors that market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-derived valuations. All significant inputs used in our valuations are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities. Level 2 inputs also include quoted prices that were adjusted for security-specific restrictions which are compared to output from internally developed models such as a discounted cash flow models.

Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The carrying amounts of financial instruments carried at cost, including cash and cash equivalents, trade receivables and trade receivable – related party, investments, notes receivable, trade payables and trade payables – related party approximate their fair value due to the short-term maturities of such instruments.

As of March 31, 2017 and December 31, 2016, the fair value of the Company’s investments were $1,653 and $1,036, respectively, and were concentrated in debt and equity securities of AVLP, a related party (See Note 4), which are classified as available-for-sale investments. At March 31, 2017, the Company's investment in AVLP is comprised of convertible promissory notes of $1,561, net of unamortized discount, and marketable equity securities of $92. At December 31, 2016, the Company's investment in AVLP is comprised of convertible promissory notes of $952, net of unamortized discount, and marketable equity securities of $84. For investments in marketable equity securities, the Company took into consideration general market conditions, the duration and extent to which the fair value is below cost, and the Company’s ability and intent to hold the investment for a sufficient period of time to allow for recovery of value in the foreseeable future. As a result of this analysis, the Company has determined that its cost basis in AVLP equitable securities approximates the current fair value.

Consistent with the guidance at ASC No. 835, the Company’s presumption is that the fair value of its convertible promissory notes in AVLP have a present value equivalent to the cash proceeds exchanged. Further, the discount shall be reported in the balance sheet as a direct deduction from the face amount of the convertible promissory notes. Thus, the Company has determined that the amortized cost of its convertible promissory notes approximates fair value and are subject to a periodic impairment review. The interest income, including amortization of the discount arising at acquisition, for the convertible promissory notes are included in earnings. In the future, if the Company does not expect to recover the entire amortized cost basis, the Company shall recognize other-than-temporary impairments in other comprehensive income (loss).

In the first quarter of 2017, the Company purchased at the market shares of common stock of three companies for a total cost of $20. In accordance with ASC No. 320-10, these investments are accounted for pursuant to the fair value method. Based upon the closing market prices of common stock for these three companies at March 31, 2017, and most recently at May 10, 2017, the Company determined that its cost basis in the shares of common stock for these companies approximates the current fair value and has concluded that its investment in marketable securities is not impaired.

DIGITAL POWER CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

MARCH 31, 2017

U.S. dollars in thousands, except share and per share data

The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The following table sets forth the customersCompany’s financial instruments that represented 10%were measured at fair value on a recurring basis by level within the fair value hierarchy:

NOTE 8:-       SUBSEQUENT EVENTScommon stock.

During the period from March 29, 2017 to March 31, 2017, the Company funded $52 in excess of the $1,500 net loan amount required pursuant to the terms of the AVLP Notes. The Company and AVLP have agreed that these additional advances shall feature terms mirroring those of the AVLP Notes, including 12% annual interest and an original issue discount of 5%; however, in addition to these terms, the Company and AVLP are in the process of finalizing additional terms that will be incorporated into a fourth convertible promissory note agreement.

The original issue discount of $78 on the AVLP Notes, inclusive of the original issue discount attributed to the $52 loaned between March 29, 2017 to March 31, 2017, is being amortized as interest income through the maturity date using the interest rate method. During the quarter ended March 31, 2017, the Company recorded $7 of interest income for the discount accretion. As of March 31, 2017 and December 31, 2016, the Company recorded contractual interest receivables attributed to the AVLP Notes of $47 and $13, respectively.

The Company has classified the AVLP Notes as Available-for-Sale securities, subject to the guidance in ASC No. 320. The AVLP Notes qualify for application of the Fair Value Option Subsections of Subtopic 320-10 and 825-10. At March 31, 2017, the closing market price of AVLP’s common Stock was $0.30. Subsequent to quarter-end, the closing market price of AVLP’s common stock was in the range of $0.12 and $ 0.30 and due to the illiquidity and significant volatility of AVLP’s common stock, the Company has determined that its cost basis in AVLP common stock approximates the current fair value.

The Company has concluded that indicators of impairment, including those described in ASC No. 320-10-35-27, do not currently exist for the Company’s investment in debt and equity securities of AVLP.

DIGITAL POWER CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)

MARCH 31, 2017

U.S. dollars in thousands, except share and per share data

5.STOCK-BASED COMPENSATION

Under the Company's 2016 Stock Incentive Plan (the“2016 Plan”) and the 2012 Stock Option Plan, as amended (the“2012 Plan”) (collectively, the“Plans”), options may be granted to employees, officers, consultants, service providers and directors of the Company. The Plans, as amended, provide for the issuance of a maximum of 5,372,630 shares of the Company’s common stock. Options granted under the Plans have an exercise price equal to or greater than the fair value of the underlying common stock at the date of grant and become exercisable based on a vesting schedule determined at the date of grant. Typically, options granted generally become fully vested after four years. Any options that are forfeited or cancelled before expiration become available for future grants. The options expire between 5 and 10 years from the date of grant. Restricted stock awards granted under the Plans are subject to a vesting period determined at the date of grant. As of March 31, 2017, an aggregate of 2,812,630 of the Company's options are still available for future grant.