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|   | **Annual    report under Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     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|   |   For the fiscal year ended December        31, 2002   **Transition    report under Section 13 or 15(d) of the Securities Exchange Act of 1934**   For the transition period from ____________        to ____________   Commission File Number:  000-31805 **Power Efficiency Corporation**(Name of Small    Business Issuer in its Charter)   **Delaware** **22-3337365**(State or Other    Jurisdiction of Incorporation or Organization) (I.R.S. Employer    Identification No.)   **4220    Varsity Drive, Suite E**  **Ann    Arbor, Michigan** **48108**(Address of    Principal Executive Offices) (Zip Code)   **(734)    975-9111**(Issuer’s    Telephone Number, Including Area Code)   Securities    Registered under Section 12(g) of the Exchange Act:   **Common    Stock, $.001 Par Value**(Title of Class) Check whether the registrant: (1) filed all reports required to be  filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or  for such shorter period that the registrant was required to file such reports),  and (2) has been subject to such filing requirements for the past 90 days.  Yes     No   . Check if there is no disclosure of delinquent filers in response to  Item 405 of Regulation S-B contained in this form, and no disclosure will be  contained, to the best of registrant’s knowledge, in definitive proxy or  information statements incorporated by reference in Part III of this Form  10-KSB or any amendment to this Form 10-KSB.   The issuer’s revenues for the  year ended December 31, 2002, were $538,819. As of March 21, 2003, the aggregate market value of the Common Stock  held by non-affiliates of the issuer was approximately $6,851,645. This amount  is based on the average of the bid and asked price of $1.04 per share for the registrant’s stock as  of such date. On March 21, 2003 there were 6,580,620  shares of the registrant’s Common Stock outstanding. The Registrant has incorporated into Part III  of Form 10-K by reference portions of its Proxy Statement for its 2003 Annual  Meeting of Shareholders. Transitional Small Business Disclosure Format (check one):  Yes    No  .  **FORWARD-LOOKING  STATEMENTS** This report and the documents incorporated into this report contain  forward-looking statements within the meaning of the Private Securities  Litigation Reform Act of 1995 (the “PSLRA”), including, but not limited to,  statements relating to the Registrant’s business objectives and strategy. Such  forward-looking statements are based on current expectations, management  beliefs, certain assumptions made by the Registrant’s management, and estimates  and projections about the Registrant’s industry. Words such as “anticipates,”  “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “forecasts,”  “is likely,” “predicts,” “projects,” “judgment,” variations of such words and  similar expressions are intended to identify such forward-looking statements.  These statements are not guarantees of future performanceand are subject to  certain risks, uncertainties and assumptions that are difficult to predict with  respect to timing, extent, likelihood and degree of occurrence. Therefore,  actual results and outcomes may differ materially from those expressed,  forecasted, or contemplated by any such forward-looking statements. The PSLRA  does not apply to initial public offerings. Factors that could cause actual events or results to differ materially  include, but are not limited to, the following: continued market acceptance of  the Registrant’s line of *Power Commander*® products; the  Registrant’s ability to expand and/or modify its line of *Power Commander*® products on  an ongoing basis; general demand for the Registrant’s products, intense  competition from other developers, manufacturers and/or marketers of energy  reduction and/or power saving products; the Registrant’s negative net tangible  book value; delays or errors in the Registrant’s ability to meet customer  demand and deliver *Power Commander*® products on a timely  basis; the Registrant’s lack of working capital; the Registrant’s need to  relocate and/or upgrade its facilities; changes in laws and regulations  affecting the Registrant and/or its products; the impact of technological  advances and issues;the outcomes of pending and future litigation and  contingencies; trends in energy use and consumer behavior; changes in the local  and national economies; local and global uncertainties created by the terrorist  acts of September 11 and the current war against terrorism; and other risks  inherent in and associated with doing business in an engineering and technology  intensive industry. See “Management’s Discussion and Analysis or Plan of Operation.”  Given these uncertainties, investors are cautioned not to place undue reliance  on any such forward-looking statements. Unless required by law, the Registrant undertakes no obligation to  update publicly any forward-looking statements, whether as a result of new  information, future events or otherwise. However, readers should carefully  review the risk factors set forth in other reports or documents that the  Registrant files from time to time with the Securities and Exchange Commission  (the “SEC”), particularly Annual Reports on Form 10-KSB, Quarterly Reports on  Form 10-QSB and any Current Reports on Form 8-K. 2 **GLOSSARY  OF TERMS**** **Set forth below are technical terms used in the discussion in this  document and explanations of the meanings of those terms. Alternating Current (AC) A type of electrical current, the direction of which    is reversed at regular intervals or cycles; in the U.S. the standard is 120    reversals or 60 cycles per second; typically abbreviated as AC.   Ampere (amp) A unit of measure for an electrical current; the    amount of current that flows in a circuit; abbreviated as amp.   Apparent Power (KVA) The product of volts times amperes in an electric    current.   Audit (Energy) The process of determining energy consumption, by    various techniques, of a building or facility.   Current (Electrical) The flow of electrical energy (electricity) in a    conductor, measured in amperes.   Cycle In an alternating current, the current goes from    zero potential (or voltage) to a maximum in one direction, back to zero, and    then to a maximum potential (or voltage) in the other direction. The number    of complete cycles per second determines the current frequency; in the U.S.    the standard for alternating current is 60 cycles.   Efficiency Efficiency is the ratio of work (or energy) output    to work (or energy) input, and cannot exceed 100 percent.   Energy The capability of doing work.   Hertz A measure of the number of cycles or wavelengths of    electrical energy per second; U.S. electricity supply has a standard    frequency of 60 hertz.   Horsepower (HP) A unit for measuring the power of motors or the rate    of doing work. One horsepower equals 33,000 foot-pounds of work per minute or    746 watts.   Induction The production of an electric current in a conductor    by the variation of a magnetic field in its vicinity.   Induction Motor The simplest and most rugged electric motor, it    consists of a wound starter and a rotor assembly. The AC induction motor is    so named because the electric current flowing in its secondary member (the    rotor) is induced by the alternating current flowing in its primary member    (starter). The power supply is connected only to the starter. The combined    electromagnetic efforts of the two currents produce the force to create    rotation. 3 Inrush Current The current that flows at the instant of connection    of a motor to the power source. Usually expressed as a multiple of motor    full-load current.   Kilowatt (kW) A standard unit of electrical power equal to one    thousand watts.   Load The demand on an energy producing system. The energy    consumption or requirement of a piece or group of equipment.   Losses (Energy) A general term applied to the energy that is    converted to a form that cannot be effectively used (lost) during the    operation of an energy producing, conducting, or consuming system.   Motor A machine supplied with external energy that is    converted into force and/or motion.   Motor Speed The number of revolutions that the motor turns in a    given time period (i.e. revolutions per minute, or rpm).   Power The rate at which work is done, typically measured    in Watts or horsepower.   Power Factor The ratio of watts to volt-amperes of an AC electric    circuit.   Soft-start Soft-start is the regulation of the supply voltage    from an initial low value to full voltage during the starting process.   Staring Torque The torque produced by a motor at rest when power is    applied. For an AC machine, this is the locked-rotor torque.   Three-phase Current Alternating current in which three separate pulses    are present, identical in frequency and voltage, but separated 120 degrees in    phase.   Torque (Motor) The rotating force provided by a motor. The units of    torque may be expressed as pound-foot, pound-inch (English system), or    newton-meter (metric system).   Torque (Starting) This torque is what is available to initially get    the load moving and begin its acceleration.   Total Harmonic Distortion The measure of closeness in shape between a waveform    and its fundamental component.   Transformer An electromagnetic device that changes the voltage    of alternating current electricity; it consists of an induction coil having a    primary and secondary winding and a closed iron core.   Voltage The amount of electromotive force, measured in    volts, that exists between two points. 4 Watt The amount of power required maintaining a current    of one ampere at a pressure of one volt when the two are in phase with each    other. One horsepower is equal to 746 watts.   Wattmeter A device for measuring power consumption. **PART I** **Item    1.****Description    of Business**  (a)Business Development **Formation** Power Efficiency Corporation (the “Registrant” or the “Company”) was  incorporated in Delaware on October 19, 1994. From inception through 1997, the  Registrant was a development stage entity that sought to become engaged in the  design, development, marketing and sale of proprietary solid state electrical  components designed to effectively reduce energy consumption in alternating  current induction motors. Alternating current induction motors are commonly  found in industrial and commercial facilities throughout the world.  **2000 Acquisition/Private Placement.** On August 7, 2000, the Registrant executed an Asset Purchase Agreement  (the “Asset Agreement”) with Performance Control, L.L.C., a Michigan limited  liability company and formerly the largest distributor of the Registrant’s  products (“Percon”). Percon was formed on February 15, 1996. Pursuant to the  terms and conditions of the Asset Agreement, the Registrant acquired Percon’s  (i) contracts; (ii) inventory; (iii) state and municipal permits, certificates,  registrations, licenses and authorizations; (iv) intellectual property,  including the name “Performance Control”; (v) goodwill; (vi) accounts  receivable; (vii) prepaid expenses; (viii) furniture, fixtures and equipment;  (ix) customer lists; and (x) Internet web site located at  www.performancecontrol.com (collectively the “Assets”) in consideration for an  aggregate of 1,112,245 newly issued shares of the Registrant’s Common Stock,  $.001 parvalue per share. The Registrant also assumed $438,888 of Percon’s  liabilities. The closing of the Registrant’s purchase of the Percon assets was  conditioned upon the sale of a minimum of 12 units in the Registrant’s May 16,  2000 private offering of a minimum of 12 ($300,000) units and a maximum of 40  ($1,000,000) units pursuant to the provisions of Rule 506 of Regulation D under  the Securities Act of 1933, as amended (the “Securities Act”). Each unit  consisted of 25,000 shares of the Registrant’s Common Stock, $.001 par value  per share, offered at $1.00 per share; and a five-year warrant to purchase  25,000 additional shares of the Registrant’s Common Stock at an exercise price  of $3.00 per share during the first year, $4.00 per share during the second  year and $5.00 per share thereafter. As part of the transaction with Percon,  the parties entered into a stockholders’ agreement providing the parties with  certain rights and obligations.  This  agreement was subsequently amended in 2002when Summit Energy Ventures, LLC  purchased securities from the Registrant in a private placement.  For a description of the Summit transaction  and of the provisions in the stockholders’ agreement, see Part II, Item 5, “Recent Sales of Unregistered Securities.” 5  (b)Business of the    Registrant **The Registrant’s Principal Products** In 1995, the Registrant commenced the sale of the *Power Commander*®, its  principal and proprietary product that reduces energy consumption in  alternating current induction motors in industrial applications. In addition,  the *Power  Commander*® extends motor life, minimizes maintenance, results in  cooler running, reduces stress and strain on the motor, and reduces stress and  strain on accompanying electrical and mechanical systems. Technology and  circuitry included in the Registrant’s *Power Commander*® is the subject of a  United States Patent granted in 1998. The Registrant offers the *Power  Commander*® in two versions, each of which is a distinctly different  product having different applications. These two products are:  •the Three-Phase *Power Commander*® used in industrial and    commercial applications; and    •the Single-Phase *Power Commander*® is also used in    industrial and commercial applications and is currently in research and    development for use in consumer applications such as home appliances and the    like. The Registrant’s motor starter product is designed to soft start a  motor, save energy, and protect and conserve the motor. It also has the  capacity to act as a remote-switching device. The Registrant offers the *Power Commander*® in a Three-Phase version  and a Single-Phase version. The Registrant’s marketing efforts have been  initially focused on the Three-Phase *Power Commander®.* Both versions of the *Power  Commander*® reduce energy consumption on electrical equipment by  electronically sensing and controlling the amount of energy the motor consumes.  A motor with a *Power Commander*® installed only uses the energy it needs to  perform its work task, thereby increasing its efficiency. The result is a  reduction of energy consumption of up to 15% to 35% in those applications,  which do not always run at peak load levels. The Registrant’s management believes that the *Power Commander*® line offers  certain advantages over competing products for the following reasons:  •The *Power Commander*® is the result of field    and laboratory engineering refinements undertaken since 1994. These    refinements enable the *Power Commander*® to offer a control    system which measures and monitors key motor operating conditions and adapts    motor operating parameters during rapid changes in motor load, all without    excessive vibration, synchronization problems or other material adverse    effects to the motor or surrounding electrical and mechanical systems.    •Energy savings and motor efficiencies were verified    through tests of the *Power Commander*® performed by three    independent laboratories. Oak Ridge National Laboratory tested the *Power    Commander*® and concluded that “significant energy savings due to    lower electrical power demand can clearly be obtained in medium-sized and    especially large-sized motor applications where the motor is frequently    operating with no load.” Oak Ridge’s conclusions were based on tests that    examined energy savings, motor temperature, and soft start impact.    •Another independent laboratory at Oregon State    University determined that the *Power Commander*® converted electrical    energy into mechanical energy at a more efficient rate than a motor without    the unit. The test compared energy consumption and torque on a 15HP motor    with and without the unit installed. 6  •Finally, Medsker Electric, Inc., an independent    electric motor repair and test laboratory, performed a series of inrush    current and energy savings tests on the *Power Commander*®. The tests compared the    Registrant’s product to the products of three competitors. In its    conclusions, Medsker stated that the Registrant’s *Power Commander*®    “exhibited twice the energy savings of the next nearest competitor.” In    addition, Medsker concluded that the *Power Commander*® “exhibited the best    soft-start performance, reducing the motor inrush current by 71%.” Finally,    Medsker concluded that the *Power Commander*® “was the simplest to    install and test, and was the best performer in terms of energy savings and    inrush current reduction.”    •In addition to the tests performed by independent    laboratories, the *Power Commander*® was subjected to a    performance case study by one of the Registrant’s customers, Otis Elevator    Company. In the Otis Elevator case study, the *Power Commander*® resulted    in reduced energy consumption and lower operating temperatures. The case    study examined the effects and energy savings obtained with a *Power Commander*®    installed on a 10 horsepower AC induction motor operating a single width,    single level escalator.* ****Three-Phase Power Commander®*** The initial market for the Three-Phase *Power Commander*® is the  elevator and escalator industry, although the Registrant is marketing this  product to other industries such as the plastics manufacturing, petroleum and  automotive industries. Domestic sales in the elevator and escalator market were  $6.5 billion in 2000. Based upon trade journals (e.g. Elevator World Source  Book 2001-2002), there are approximately 699,725 elevators and 36,400  escalators currently in operation in North America alone. Additionally,  approximately 24,725 new elevators and 1,400 new escalators, respectively, are  installed annually in the domestic market. Each existing installation is a  potential candidate for the retrofit of the Three-Phase *Power Commander*®. Various other markets such as conveyor systems, machine tools, mining  equipment, crude oil pumps, weaving machines, etc., are believed to be viable  target markets for the Three-Phase *Power Commander*® and the Registrant is  seeking to build an Original Equipment Manufacturer (“OEM”) and distributor  base to address these markets.* ****Single-Phase Power Commander®*** Like the Registrant’s Three-Phase *Power Commander®* described above, the  Registrant’s Single-Phase *Power Commander®* reduces energy  consumption in electrical equipment by sensing and controlling the amount of  energy the motor consumes. Most motors commonly used in-home appliances and  other consumer goods are Single-Phase motors. Since the Single-Phase *Power Commander*® is usable in a broad  variety of contexts and can be installed when the motor is assembled with  little effort and expense, it is a product suitable for installation at the OEM  level or large volume sales and installation. Consequently, the Registrant’s  marketing plan for the Single-Phase *Power Commander*® is to identify the major  OEMs that can best utilize the Single-Phase *Power Commander*®.* *7 ***Registrant’s Motor Starter Product*** The Registrant’s motor starter product is designed to soft start a  motor, which saves energy and protects the motor, and has the capacity to act  as a remote-switching device. The Registrant had hoped to release this product  in fiscal 2002 but the product is still under development. The expected release  date of this product is uncertain at this time. **Marketing and Sales** The Registrant’s marketing efforts for the *Power Commander*® have been  concentrated in several industries in which the Registrant’s principal  stockholders have significant experience. These areas include the elevator and  escalator industry; national electrical supply houses; large real estate  property management companies; the oilfield supply industry; and to a lesser  extent, public transportation systems. From inception through December 31,  2002, a total of 4,471 of the Registrant’s motor controllers were sold to more  than 120 customers located throughout the United States and Asia under the  following brands: *Performance Controller*TM, *Power Commander*®, Energy Master, Current  Control, and Ecostart. Customer industry profiles include retail outlets,  public transportation, hotels, manufacturers and federal government facilities.  This unit total includes sales made by Percon’s OEMs and distributorsprior to  selling its assets to the Registrant. As the Registrant’s operations are scaled up and revenues from the sale  of the *Power  Commander*® grow, the Registrant intends to simultaneously (i) market  the *Power  Commander*® through OEMs to other compatible industries such as  conveyor and line production systems, machine tools and other industrial  applications, and (ii) develop and market its motor starter product line.  The Registrant is a party to one material contract for the sale of *Power Commander*®  products, with two other contracts pending renewal. The first contract is a  letter agreement and open master purchase order with Otis Elevator Company, the  world leader in elevator sales, for the sale of Power Commander® brand devices  containing a safety circuit exclusive to Otis.   The master purchase order was executed on May 13, 2002 for purchases up  to $100,000, and the Letter Agreement commenced June 1, 2002 and will expire  December 31, 2004. Pending renewal is an annual contract with KONE, Inc., a major  escalator and elevator manufacturer and service provider. The contract was  executed on December 1, 1998, and was renewed on August 21, 2001, extending the  contract until December 1, 2002. It is a requirements contract and covers the  sale of motor controllers manufactured under the brand name Ecostart. The  Ecostart brand name is exclusive to KONE and contains a safety circuit designed  specially for KONE. The Registrant hopes to negotiate and execute a new  agreement with this customer in the near future.  Also pending renewal is an annual contract with Schindler Elevator  Corporation (which acquired Millar Elevator Corporation).  The contract was executed on August 17,  2000, whereby Schindler agreed to purchase Performance ControllerSM  motor controllers under the brand name “Current Control.” The contract was  renewed on October 5, 2001, extending the contract until September 1, 2002. The  Registrant hopes to negotiate and execute a new agreement with this customer in  the near future. **Manufacturing** The Registrant has an arrangement with a leading manufacturer in the  electronics industry, Q.C. Corporation d/b/a System Controls. System Controls  manufactures units for the Registrant on an as-needed basis. Under the  arrangement, the Registrant issues a purchase order to System Controls that  outlines, among other things, the number of units to be manufactured and the  price per unit. System Controls is under no obligation to accept the order and  the Registrant is under no obligation to use System Controls for its  manufacturing needs. Management believes the arrangement between the Registrant  and  8 System Controls has been mutually beneficial to both and expects that  the relationship will continue. System Controls’ production capacity is  approximately 1,000 units per month.  Additionally, the Registrant is actively seeking to enter into  agreements with additional manufacturers. The Registrant leases space in Ann  Arbor, Michigan, where it performs activities such as component assembly,  quality assurance, quality control and packaging.  The Registrant has completed the pre-production testing of compact, low  cost electronic modules designed to replace other more costly components used  in the manufacture of certain *Power Commander*® models and eliminate  several labor-intensive assembly steps. Total per unit cost savings (component  cost savings and labor cost savings) are estimated to be approximately 30% of  the production cost by current methods. Product cost-reduction efforts are, and will remain, an objective of  the Registrant. One key element of the program includes an aggressive  manufacturing and engineering effort to reduce production cycle times as well  as material and processing costs. A second element of the program is to  out-source production operations. The Registrant outsources the assembly of  printed circuit boards to qualified suppliers with automated assembly and test  equipment, which reduces costs and ensures quality. As the product volumes  increase, the Registrant expects to recognize favorable purchasing economies,  increased labor efficiencies and improved overhead absorption. In addition, the  Registrant is continuing to evaluate additional domestic, Canadian and offshore  sources of contract manufacturing in order to reduce production costs further. **Competition** The principal competitive factors in the Registrant’s markets include  innovative product design, product quality, product performance, utility rebate  acceptance, established customer relationships, name recognition, distribution  and price. The Registrant competes against a number of companies, many of which  have longer operating histories, established markets and far greater financial,  advertising, research and development, manufacturing, marketing, personnel and  other resources than the Registrant currently has or may reasonably be expected  to have in the foreseeable future. This competition may have an adverse effect  on the ability of the Registrant to commence and expand its operations or  operate in a profitable manner.* ****Three-Phase Competition*.** Although the  Registrant has not conducted any formal market study, the Registrant believes  its Three-Phase *Power Commander*® has the following competitive advantages:  •The *Power Commander*® is the only device    management is aware of that combines soft start features with energy savings    features in a single integrated unit that achieves energy savings levels of    up to 15% to 35%;    •The *Power Commander*® analog circuitry is    proprietary and protected by a patent; and    •Energy saving motor controllers claimed to be    competitive with the *Power Commander*® (i.e., Fairford, Power    Boss and Power Planner) utilize technologies inferior to the Registrant’s    technology because (i) their products achieve lower levels of energy savings    in comparable applications compared to the *Power Commander*® (see Part    I, Item 1 “Description of Business,” for a description of the independent    tests performed on the Registrant’s products); and (ii) their digital design    produces extensive harmonic distortion. 9 ***Single-Phase Competition****.*  There  have been several companies that have, with different technologies, attempted  to exploit this market due to the enormous opportunity in single-phase motor  applications. These products include “Green Plug” (voltage clamping), “Power Planner”  (digital microchip) and “Econelectric” (power factor control).* ****High Efficiency Motors****.*  Insofar as high efficiency motor replacement  is concerned, management believes that the energy savings gain attributable to  high efficiency motors is materially lower than that of the *Power  Commander®.* In addition, the in-rush amperage needed to start an  energy efficient motor is many times higher than that needed to start a  conventional motor. This factor is made worse because the purchase of a new  motor does not provide a soft starting capability without the purchase of a  separate soft start device.* ****Motor Starter Competition.*** The Registrant believes that expected  competition in the motor starter market will be more intense than that for the *Power  Commander*® because:  •The potential market for the Registrant’s motor    starter product is much larger than that for motor controllers in general and    the *Power    Commander*® in particular;    •Competitors in the motor starter field are more    numerous and generally much larger compared to competitors in the motor    controller field; and    •The motor starter is a staple product type and is    currently being sold by nearly all companies in the electrical component    business. However, Management believes it has a competitive  advantage in this market because the *Power Commander*® is the only device  management is aware of that combines soft start features with energy  savings features in a single integrated unit that achieves energy savings  levels of up to 15% to 35%. **Source of Supply and Availability of  Raw Materials** The *Power  Commander*® motor controller and the Registrant’s motor starter  product have both been designed to use standard, off-the-shelf, easily acquired  components. Such components are basic items that are readily available  worldwide at competitive prices. They come in standard and miniature versions  and offer the Registrant large latitude in product design. Both the *Power  Commander*® motor controller and the motor starter use a combination  of components. Although the Registrant believes that most of the key components  required for the production of its products are currently available in  sufficient production quantities from multiple sources, there can be no  assurance that they will remain so readily available. **Customers** The Registrant currently does business with approximately 30 customers.  Of this number, four, including Otis Elevator Company (Division of United  Technologies), KONE, Inc., Schindler Elevator, and ThyssenKrupp Elevator,  presently account for approximately 76% of the Registrant’s gross revenues. In  light of the Registrant’s intentions to focus its business on OEMs in the  elevator, oil field pump and manufacturing industries, the Registrant may be  deemed to be and continue to be dependent upon a small number of customers.  Accordingly, the loss of one or more of these customers is likely to have a  material adverse effect upon the Registrant’s business. 10 **Patents and Proprietary Rights** The Registrant currently relies on a combination of trade secrets,  non-disclosure agreements and a patent to establish and protect its proprietary  rights in its products. There can be no assurance that these mechanisms will  provide the Registrant with any competitive advantages. Furthermore, there can  be no assurance that others will not independently develop similar  technologies, or duplicate or “reverse engineer” the proprietary aspects of the  Registrant’s technology. The Registrant has one U.S. patent issued with respect to its products.  The “Balanced and Synchronized Phase Detector for an AC Induction Motor  Controller,” No. 5,821,726, was issued on October 13, 1998 and expires in 2017.  This patent covers improvements to the technology under the NASA License  Agreement (described below), which were developed by the Registrant. Management  believes this patent protects the Registrant’s intellectual property position  beyond the expiration of the NASA License Agreement because:  •the circuitry covered by the Registrant’s patent    more effectively reduces the motor vibration; and    •the circuitry eliminates most of the balance and    synchronization problems that are created by other energy saving motor    controllers, including those that would eventually use the licensed NASA    technology upon the expiration of the underlying NASA patents. The Registrant has additional proprietary technology being assessed for  patent filing.* ****NASA License Agreement*** The Registrant had been the exclusive United States licensee of certain  Power Factor Controller Technology owned by the United States of America, as  represented by NASA. This license agreement covered the USA and its territories  and possessions and did not require the Registrant to pay royalties to NASA in  connection with the Registrant’s sale of products employing technology  utilizing the licensed patents. The Registrant’s rights under the license  agreement were non-transferable and were not to be sublicensed without NASA’s  consent. The license agreement terminated on December 16, 2002 with the  expiration of all of the licensed patents. The Registrant believes that its products and other proprietary rights  do not infringe any proprietary rights known to be possessed by third parties.  There can be no assurance, however, that third parties will not assert  infringement claims in the future, the defense costs of which could be  substantial. The Registrant has obtained U.S. Trademark registration of the *Power  Commander*® mark.  **Government Regulation** The Registrant is not required to be certified by any government  agencies. However, the Registrant’s products are manufactured to comply with  specific Underwriters’ Laboratory codes that meet national safety standards.  Presently, the Registrant’s products comply with UL 508 Industrial Control  Equipment and the Registrant has also received certification meeting CSA  (Canadian Standards Association) CSA-B44.1-96/ASME-17.5-1996 Elevator and  Escalator Electrical Equipment. The Department of Commerce does not require the  Registrant’s technology to be certified for export. The Registrant’s industrial  code is 421610 and the SIC code is 5063. 11 **Deregulation of Electrical Energy** Sales of the Registrant’s product are not dependant on continued  deregulation of the electrical energy market as the Registrant’s product can be  sold in regulated and deregulated markets.    **Research and Development** The Registrant intends to continue its research and development effort  to introduce new products based on the *Power Commander*® solid-state technology.  Towards this end, the Registrant spent $271,634 and $242,243 in fiscal years  2002 and 2001, respectively, on research and development activities, virtually  none of which was borne by customers. A major focus of the Registrant’s  foreseeable research and development activities will be on consumer  applications for the single-phase unit. The Registrant intends to limit its  research and development activities on secondary products for Three-Phase  industrial and commercial AC induction motors. Two of these products are (i) a  soft starting motor starter (without energy saving features) to compete with  existing transformer and other electro-mechanical type motor starters; and (ii)  a high voltage energy saving motor controller for motors ranging in sizes from  2000 to 6000 volts. **Effect of Environmental Regulations** The Registrant is not aware of any federal, state, or local provisions  regulating the discharge of materials into the environment or otherwise  relating to the protection of the environment with which compliance by the  Registrant has had, or is expected to have, a material effect upon the capital  expenditures, earnings, or competitive position of the Registrant. **Employees** At the date of this document, the Registrant employs 12 people on a  full time basis. Of this number, one person is engaged in executive management  and finance, one in operations management, three in sales and marketing, two in  research and development, one in legal counsel, three in engineering and  production, and one in clerical and reception. At such time as business  conditions dictate, the Registrant expects to hire additional personnel for,  among other things, increased production, marketing and sales. The Registrant  has no collective bargaining agreements and considers its relationship with its  employees to be good. The Registrant utilizes consultants in the areas of  electrical and mechanical engineering, manufacturing engineering, and financing  and strategy on an ongoing basis. 12 **RISK FACTORS*** ****Limited Capitalization*** As of the date of this document, the Registrant continues to have limited  working capital and will be dependent upon additional financing to meet its  capital needs. There can be no assurance that any additional financing will be  available on acceptable terms, if at all. The Registrant needs additional  capital to expand its operations and fully implement its business plan.* ****Limited Operating History, Manufacturing and Distribution  Arrangements*** To date, and principally attributable to a lack of working capital, the  Registrant’s operations have been limited in scale. Although the Registrant has  an arrangement with an automated production facility, has established  relationships with suppliers, and received contracts for its products, the  Registrant may experience difficulties in production scale-up, inventory  management, product distribution and obtaining and maintaining working capital  until such time as the Registrant’s operations have been scaled-up to normal  commercial levels. There can be no assurance that the Registrant will operate  profitably. * ****Registrant’s License From NASA Has Expired*** The basic technology upon which the Registrant’s products are based is  derived from a patent license agreement by and between the Registrant and NASA,  which expired on December 16, 2002.  The  license expired upon expiration of NASA’s underlying patents, at which time  anyone, including the Registrant, became free to use the underlying NASA  technology. The Registrant has also made certain improvements to the basic  technology covered by the NASA license, which may place the Registrant in a competitively  superior position. No assurance can be given, however, that others will not  seek to improve the basic technology in a manner similar to that of the  Registrant.* ****Arbitration with Former CEO*** The Registrant is involved with certain claims and counterclaims  related to arbitration with its former CEO. The claim was filed by the former  CEO on October 10, 2002 and is being administrated by the East Providence,  Rhode Island office of the American Arbitration Association. The former CEO is  claiming the Registrant owes him, and is seeking to recover, approximately  $528,659. The amount of his claim is comprised of (i) $116,039 for unpaid  salary and expenses, and (ii) $412,620 for a payment owed to him in the case of  a change of control of the Registrant. The Registrant has recorded $102,401 at  December 31, 2002, related to the unpaid salary and expenses but has not  accrued an amount related to the other claims. The Registrant is currently  defending these claims.   * ****Supplier Dependence*** Although the Registrant believes that most of the key components  required for the production of its products are currently available in  sufficient production quantities from multiple sources, there can be no  assurance that they will remain so readily available. It is possible that other  components required in the future may necessitate custom fabrication in  accordance with specifications developed or to be developed by the Registrant.  Also, in the event that the Registrant, or its contract manufacturer, as  applicable, is unable to develop or acquire components in a timely fashion, the  Registrant’s ability to achieve production yields, revenues and net income  would be adversely affected.* *13 ***Sales and Marketing Risks*** The Registrant’s products are currently distributed primarily through  OEMs. The Registrant’s future growth and profitability will depend upon the  successful development of business relationships with additional OEMs and upon  their ability to penetrate the market with the Registrant’s products.* ****Competition; Rapid Technological Change*** The Registrant competes against a number of companies, many of which  have longer operating histories, established markets and far greater financial,  advertising, research and development, manufacturing, marketing, personnel and  other resources than the Registrant currently has or may reasonably be expected  to have in the foreseeable future. This competition may have an adverse effect  on the ability of the Registrant to expand its operations or operate  profitability. The motor control industry is highly competitive and  characterized by rapid technological change. The Registrant’s future  performance will depend in large part upon its ability to become and remain  competitive and to develop, manufacture and market acceptable products in these  markets. Competitive pressures may necessitate price reductions, which can  adversely affect revenues and profits. If the Registrant is not competitive in  its ongoing research and development efforts, itsproducts may become obsolete,  or be priced above competitive levels. Although management believes that, based  upon their performance and price, the Registrant’s products are attractive to  customers; there can be no assurance that competitors will not introduce  comparable or technologically superior products, which are priced more  favorably than the Registrant’s products.* ****Retail Price of Electrical Energy*** A customer’s decision to purchase the *Power Commander*® is  primarily driven by the payback on the investment resulting from the increased  energy savings. Although management believes that current retail energy prices  support an attractive return on investment for the Registrant’s products, there  can be no assurances that future retail pricing of electrical energy will  remain at such levels.* ****No Cash Dividends on Common Stock*** The Registrant has not paid or declared any dividends on its Common  Stock and does not anticipate paying or declaring any cash dividends on its  Common Stock in the foreseeable future.* ****Possible Resales under Rule 144*** Of the 6,580,620 shares of the Registrants Common Stock outstanding on  March 21, 2003, 3,222,502 shares are freely trading in the market place (the  “Free Trading Shares”). The Free Trading Shares are comprised mostly of shares  that were originally issued to officers, directors and 10% shareholders (the  “Affiliates”) of the Registrant, which shares were, over time, resold pursuant  to Rule 144, as set forth below. The remaining 3,358,118 shares of the Registrant’s Common Stock  outstanding are restricted securities as defined in Rule 144 under the  Securities Act and under certain circumstances may be resold without  registration pursuant to Rule 144. Approximately 7,500 shares of the restricted  securities are held by non-Affiliates. In addition, the Registrant has approximately 949,000 Common Stock  purchase warrants outstanding and has approximately 3,433,640 Common Stock  options outstanding. Neither the granting of options nor the issuance of  warrants have been registered under the Securities Act, but may, under certain  circumstances, be available for public sale in the open market pursuant to Rule  144, subject to certain limitations. 14 In general, under Rule 144, a person (or persons whose shares are  aggregated) who has satisfied a one-year holding period may, under certain  circumstances, sell within any three-month period a number of securities which  does not exceed the greater of 1% of the then outstanding shares of Common  Stock or the average weekly trading volume of the class during the four  calendar weeks prior to such sale. Rule 144 also permits, under certain  circumstances, the sale of securities, without any limitation, by a person who  is not an Affiliate, as such term is defined in Rule 144(a)(1), of the  Registrant and who has satisfied a two-year holding period. Any substantial sale of the Registrant’s  Common Stock pursuant to Rule 144 may have an adverse effect on the market  price of the Registrant’s shares.* ****Common Stock Price Volatility. *** Since 1996, the Company’s Common Stock has  traded in OTCBB under the symbol “PREF”.   There can be no assurance that a regular market for the Company’s Common  Stock will be sustained.  The OTCBB  offers less trading liquidity than NASDAQ.   Quotes for securities traded on the OTCBB are not as widely available in  newspapers as are those for NASDAQ.   Therefore, this lack of readily available price information may impair  the ability of holders of Common Stock to resell their securities.  The trading prices of the Common Stock could  be subject to wide fluctuations in response to quarterly variations in the  Company’s operating results, announcements by the Company or others,  developments affecting the Company, or other events or factors.  In addition, the stock market has  experienced extreme price and volume fluctuations in recent years.  These fluctuations have had a substantial  effect on themarket price for many companies, often unrelated to the operating  performance of such companies, and may adversely affect the market price for  the Company’s Common Stock.* ****Potential Effect of Penny Stock Rules on Liquidity of Shares*** If the Registrant’s securities are not listed on The Nasdaq Stock  Market or certain other national securities exchanges and the price thereof is  below $5.00, then subsequent purchases of such securities will be subject to  the requirements of the penny stock rules absent the availability of another  exemption. The SEC has adopted rules that regulate broker-dealer practices in  connection with transactions in “penny stocks.” Penny stocks generally are  equity securities with a price of less than $5.00 (other than securities  registered on certain national securities exchanges or quoted on The Nasdaq  Stock Market). The penny stock rules require a broker-dealer to deliver a  standardized risk disclosure document required by the SEC, to provide the  customer with current bid and offer quotations for the penny stock, the  compensation of the broker-dealer and its salesperson in the transaction,  monthly account statements showing the market valueof each penny stock held in  the customer’s account, to make a special written determination that the penny  stock is a suitable investment for the purchaser and receive the purchaser’s  written agreement to the transaction. The Registrant is currently subject to  the penny stock rules and, therefore, these disclosure requirements may have  the effect of reducing the level of trading activity in the Registrant’s Common  Stock.* ****Limitation on Directors’ Liabilities under Delaware Law*** Pursuant to the Registrant’s Certificate of Incorporation and under  Delaware law, directors of the Registrant are not liable to the Registrant or  its stockholders for monetary damages for breach of fiduciary duty, except for  liability in connection with a breach of the duty of loyalty, for acts or  omissions not in good faith or which involve intentional misconduct or a  knowing violation of law, for dividend payments or stock repurchases illegal  under Delaware law or any transaction in which a director has derived an improper personal benefit. 15 ***Outstanding Options and Warrants *** The Company has reserved 500,000 shares of  its Common Stock for issuance upon exercise of stock options or similar awards  which may be granted pursuant to the Company’s 1994 Stock Option Plan  (hereinafter the “1994 Plan”), of which options to purchase an aggregate of  463,640 shares have been issued.   Furthermore, the Company has reserved 4,000,000 shares of its Common  Stock for issuance upon exercise of stock options or similar awards which may  be granted pursuant to the Company’s 2000 Stock Option and Restricted Stock  Plan (hereinafter the “2000 Plan”), of which options to purchase an aggregate  of 2,970,000 shares have been issued.   The outstanding options have a weighted average exercise price of $2.00  per share.  In addition to the Summit warrant  described below, the Company has issued warrants exercisable for 949,000 shares  of Common Stock to financial consultants, investors and other businesspartners, having a weighted average exercise price of $2.76 per share and  expiring on various dates from August 7, 2003 to June 11, 2007.   In connection with the Summit financing  described below, Summit received a stock purchase warrant to purchase such  number of additional shares of Series A-2 Convertible Preferred Stock or Common  Stock of the Registrant enabling Summit to acquire a 51% fully diluted equity  stake in the Registrant.  By the terms  of the warrant, the number of shares issuable upon exercise of the warrant will  adjust with the number of shares of the Company outstanding and issuable pursuant  to options and warrants. The exercise price of the warrant is a function of the  Company’s earnings.  As such, it is  possible that the warrant will have an exercise price of zero and will  therefore entitle Summit to the additional shares at no cost.  Exercise of these options and warrants and  options and warrants issued by the Registrant in the future will reduce the  percentage of Common Stock held by the public stockholders.  Furthermore, the terms on which the Company  could obtain additional capital during the life of the options and warrants may  be adversely affected, and it should be expected that the holders of the  options and warrants would exercise them at a time when the Company would be  able to obtain equity capital on terms more favorable than those provided for  by such options and warrants.  * ****Issuance of Preferred Stock with  Anti-Dilution Provisions and Superior Liquidation Preference***** ** In 2002, the Registrant issued 2,346,233 shares of Series A-1  Convertible Preferred Stock to Summit Energy Ventures for a purchase price of  $2,500,000. The Series A Preferred Stock provides the holders of the Series A  Preferred Stock with protection against dilution. In the event that the  Registrant issues shares at a price less than the price Summit paid for the  Series A Preferred Stock, the conversion rights of the Series A Preferred Stock  will be adjusted so that the Series A Preferred Stock can convert into such  number of shares that Summit would have received had it bought Common Stock at  such lower price. Currently, the conversion rights of the Series A-1  Convertible Preferred Stock entitle the holder of the Series A-1 to receive two  shares of Common Stock for each share of Series A-1. In the event of a  Liquidation Event (as defined in the Certificate of Designation of the Series A  Convertible Preferred Stock which includes a winding up ofthe Registrant, a  sale of substantially all of the Registrant’s assets, and certain mergers and consolidations) the  holders of the Series A Convertible Preferred Stock are entitled to two times  the price paid by Summit for such stock.   Thereafter, the remaining corporate assets would be distributed among  the holders of Common Stock and Series A Preferred Stock on a pro rata basis.  The existence of the Series A Preferred Stock’s anti-dilution provisions may  reduce the percentage of Common Stock held by the public stockholders.  Furthermore, the terms on which the Registrant could obtain additional capital  may be adversely affected by the Series A Preferred Stock’s anti-dilution  provisions and superior liquidation preference.* *16 ***Dilution of Ownership by Exercise of Summit  Warrant*** In connection with the Summit financing  described above, Summit also received a stock purchase warrant which is  exercisable after January 1, 2004 and prior to June 14, 2012, to purchase such  number of additional shares of Series A-2 Convertible Preferred Stock, $.001  par value per share, or Common Stock, $.001 par value per share, of the  Registrant that would result in Summit owning 51% of the Registrant’s fully  diluted equity. By the terms of the warrant, the number of shares issuable upon  exercise of the warrant will adjust with the number of shares of the Registrant  outstanding and the number of shares issuable pursuant to options and warrants.  The exercise price of the warrant is a function of the Registrant’s  earnings.  As such, it is possible that  the warrant will have an exercise price of zero and will therefore entitle  Summit to the additional shares at no cost. The existence of the warrant issued  to Sumit will likelyreduce the percentage of equity held by the public  stockholders. Furthermore, the terms on which the Registrant could obtain  additional capital may be adversely affected by the existence of such warrant  and, in particular, the anti-dilution provisions of such warrant.* ****Authorization and Discretionary Issuance of Preferred Stock*** The Registrant’s Certificate of Incorporation authorizes the issuance  of “blank check” preferred stock with such designations, rights and preferences  as may be determined from time to time by the Board of Directors. Accordingly,  the Registrant’s Board of Directors is empowered, without stockholder approval,  to issue preferred stock with dividends, liquidation, conversion, voting or  other rights that could adversely affect the relative voting power or other  rights of the holders of the Registrant’s Common Stock. In the event of  issuance, the preferred stock could be used, under certain circumstances, as a  method of discouraging, delaying or preventing a change in control of the  Registrant, which could have the effect of discouraging bids for the Registrant  and thereby prevent stockholders from receiving the maximum value for their  shares. Although the Registrant has no present intention to issue any shares of  its preferredstock, there can be no assurance that the Registrant will not do  so in the future. * ****Product Liability Risk*** The Registrant may be subject to potential product liability claims  that could, in the absence of sufficient insurance coverage, have a material  adverse impact on the Registrant. Presently, the Registrant has general  liability coverage that includes product liability up to two million dollars.  Any large product liability suits occurring early in the Registrant’s growth  may significantly and adversely affect the Registrant’s ability to expand the  market for its *Power Commander*® line of products. * ****No Key Man Insurance*** The Registrant presently has no key man life insurance policies. As  soon as practicable following the commencement of profitable operations (of  which there can be no assurance), the Registrant intends to purchase key man  life insurance on the lives of its two principal executive officers, Raymond J.  Skiptunis and Nicholas Anderson. Upon purchase of such insurance, the Registrant  intends to pay the premiums and be the sole beneficiary. The lack of such  insurance may have a material adverse effect upon the Registrant’s business.* ****Line of Credit*** At the present time, the Registrant does not have a bank line of  credit.  * ****Potential Violation of Section 5 of the Securities Act*.** In its original Form 10-SB, filed on October 20, 2000, the Registrant  inadvertently filed its Private Placement Memorandum as an Exhibit. This may  constitute general solicitation under Rule 502(c) of Regulation D and the  Registrant may be in violation of Section 5 of the Securities Act of 1933 and  be  17 unable to avail itself of the exemption found in Rule 506 of Regulation  D as to that offering. The Registrant believes it can establish pre-existing connections  with all purchasers under the Private Placement Memorandum. If proceedings  based on this inadvertent filing were commenced against the Registrant,  purchasers under the Private Placement Memorandum, possibly together with other  purchasers of the Registrant’s securities, may make a claim for rescission of  their investments, which if successful may exceed $725,000. Such claims would  be subject to any applicable defenses that the Registrant might assert,  including statute of limitations. The last sales under the Private Placement  Memorandum were made in March 2001. Therefore, the Registrant believes that the  statute of limitations for such claims under the Securities Act has expired. **Item 2.****Description of Property** The Registrant leases office, warehouse and research facilities at  three locations. The Registrant leases approximately 5,745 square feet of  office and warehouse space located at 4220 Varsity Drive, Suite E, Ann Arbor,  Michigan 48108. The Registrant’s lease was due to expire on February 16, 2001  but the Registrant extended the lease until May 31, 2003.  The base rent is $5,026.88 per month.  The Registrant leases approximately 5,000  square feet of office and research space located at 40 Nassau Terminal Road,  New Hyde Park, New York 11040.  The base  rent is currently $4,652.08 per month with annual increases of 1.5%. The lease  expires on June 30, 2004. The Registrant shares office space located at 75-153  Merle Drive, Suite B, Palm Desert, California 92211 with a major investor in  the Registrant, Summit Energy Ventures, LLC. Commencing January 2003, the  Registrant pays $2,124.63 per month and the lease is on a month-to-monthbasis. **Item 3.****Legal Proceedings** The Registrant is involved with certain claims and counterclaims  related to arbitration with its former CEO. The claim was filed by the former  CEO on October 10, 2002 and is being administrated by the East Providence,  Rhode Island office of the American Arbitration Association. The former CEO is  claiming the Registrant owes him, and is seeking to recover, approximately  $528,659. The amount of his claim is comprised of (i) $116,039 for unpaid  salary and expenses, and (ii) $412,620 for a payment owed to him in the case of  a change of control of the Registrant. The Registrant has recorded $102,401 at  December 31, 2002, related to the unpaid salary and expenses but has not  accrued an amount related to the other claims. The Registrant is currently  defending these claims. 18 **PART II**** ****Item 5.****Market    for Common Equity and Related Stockholder Matters**** ****Market for  Common Stock** The Registrant’s Common Stock is thinly  traded on the National Association of Securities Dealers’ Over the Counter  Bulletin Board (“OTCBB”) under the symbol “PREF”. The following table sets forth the high and  low bid information for quarterly periods in the two twelve month periods ended  December 31, 2002 and December 31, 2001, as reported by the National Quotation  Bureau:  **Twelve months Ended December 31, 2002** **High** **Low** October 1, 2002 —    December 31, 2002 $1.90 $0.55 July 1, 2002 — September 30, 2002  3.20  1.45 April 1, 2002 — June 30, 2002  3.25  1.60 January 1, 2002 — March 31, 2002  3.80  2.90  **Twelve months Ended December 31, 2001** **High** **Low** October 1, 2001 —    December 31, 2001 $3.51 $2.90 July 1, 2001 — September 30, 2001  5.40  3.25 April 1, 2001 — June 30, 2001  8.20  2.65 January 1, 2001 — March 31, 2001  4.45  2.10  As of March 21, 2003, there were 51  shareholders of record of the Registrant’s Common Stock. The Registrant has not paid dividends on its  Common Stock since its incorporation on October 19, 1994. The Registrant does  not expect to pay cash dividends on its Common Stock in the foreseeable future.  The Registrant intends to invest funds otherwise available for dividends, if  any, on improving the Registrant’s capital assets.  **Recent  Sales of Unregistered Securities** On June 14, 2002, the Registrant sold  2,346,233 shares of Series A-1 Convertible Preferred Stock, $.001 par value per  share, for $2,500,000, pursuant to the provisions of Rule 506 of Regulation D  under the Securities Act of 1933, as amended (the “Securities Act”). The sale  was made to Summit Energy Ventures, LLC, a private equity firm specializing in  energy related technologies.  Summit is  an affiliate of Commonwealth Energy Corporation, a diversified energy provider  and service company based in Tustin, California. The sale resulted in Summit  owning a 28% fully diluted stake in the Registrant.  Summit also received a stock purchase warrant  which is exercisable after January 1, 2004 and prior to June 14, 2012, to  purchase such number of additional shares of Series A-2 Convertible Preferred  Stock, $.001 par value per share, or Common Stock, $.001 par value per share,  of the Registrant that would result in Summit owning 51% of the Registrant’s  fully diluted equity. By the terms of the warrant, the number of shares  issuable upon exercise of the warrant will adjust with the number of shares of  the Registrant outstanding and the number of shares issuable pursuant to  options and warrants. The exercise 19 price of the warrant is a function of the  Registrant’s earnings.  As such, it is  possible that the warrant will have an exercise price of zero and will  therefore entitle Summit to the additional shares at no cost. The Series A Preferred Stock provides the holders of the Series A  Preferred Stock with protection against dilution. In the event that the  Registrant issues shares at a price less than the price Summit paid for the  Series A Preferred Stock, the conversion rights of the Series A Preferred Stock  will be adjusted so that the Series A Preferred Stock can convert into such  number of common shares that Summit would have received had it bought Common  Stock at such lower price. Currently, the conversion rights of the Series A-1  Convertible Preferred Stock entitle the holder of the Series A-1 to receive two  shares of Common Stock for each share of Series A-1.  The Registrant and Summit also entered into a Registration Rights  Agreement entitling Summit, subject to the terms and conditions of the  Registration Rights Agreement, to demand that he Registrant file a registration  statement covering all of the Registrant’s securities owned by Summit. **Amended  Stockholders’ Agreement** As part of the transaction with Percon, the  Registrant, Nicholas Anderson and Anthony Caputo, the Registrant’s two  principal stockholders, and Percon, Philip Elkus and Stephen L. Shulman,  Percon’s two principal members, entered into a Stockholders’ Agreement  dated August 7, 2000. The Stockholders’ Agreement established two groups of stockholders: Messrs. Anderson and  Caputo, on the one hand (the “Founders”), and Percon and Messrs. Elkus and  Shulman, on the other hand (the “Percon Group”). As part of the Summit financing, the Stock  Holders’ Agreement was amended and Summit became a party to the agreement (the  “Amended Stockholders’ Agreement”).  The  governance provisions of the Amended Stockholders’ Agreement provides that the  Registrant’s Board of Directors (the “Board”) be expanded from five (5) members  to eight (8) members; three (3) who are nominated by the Founders; two (2) who  are nominated by the Percon Group; and three (3) who are nominated by  Summit.  The Registrant’s by-laws were  amended to accurately reflect the governance provisions of the Amended  Stockholders’ Agreement. In addition, the Amended Stockholders’  Agreement contains certain provisions that affect the ability of the parties to  the Stockholders’ Agreement (the “Stockholders”) to transfer their shares.* ****Right of First Refusal*****.** If  at any time a party to the Amended Stockholders’ Agreement desires to sell  their shares (the “Offered Shares”) (other than (i) a resale under rule 144 of  the Securities Act of 1933, as amended (the “Securities Act”) or (ii) pursuant  to a registered public offering under the Securities Act or (iii) a transfer to  permitted affiliates or family members, as set forth in the Amended  Stockholders’ Agreement), the selling Stockholder must first offer to the other  Stockholders the right to purchase the Offered Shares upon terms and conditions  similar to the ones the selling Stockholder was initially proposing to sell the  Offered Shares to the third party purchaser.   In the event the Stockholders fail to exercise this right, then the  selling Stockholder can sell the Offered Shares subject to the “Co-Sale” Rights  and “Tag-Along” Rights set forthbelow.* ****“Co-Sale” Rights*****.**  If  any of the parties to the Stockholders’ Agreement (other than Summit) intends  to sell or transfer their shares and the other Stockholders have not fully  exercised their Right of First Refusal, set forth above, then Summit shall have  the right to participate in such sale and sell a pro rata share of their stock  to the third party purchaser.* ****“Tag Along” Rights*****.**  If  Summit intends to sell or otherwise transfer such number of shares that will  result in the party receiving such shares beneficially owning on a fully  diluted basis a greater number of shares of stock than any other Stockholder  group to the Amended Stockholders’ Agreement, then the other Stockholder groups  shall have the right to participate in such sale and sell a pro rata share of  their stock to the purchasing party. 20 ***Preemptive Rights*****.**  The  Amended Stockholders’ Agreement also provides the Stockholders with certain  preemptive rights entitling the Stockholders the option to purchase a pro rata  share of the securities to be issued by the Registrant in certain private  financings. The Amended Stockholders’ Agreement shall  terminate upon (i) the Registrant closing a firmly underwritten public offering  by the Registrant pursuant to a registration statement filed and declared  effective under the Securities Act covering the offer and sale of Common Stock  for the account of the Registrant yielding net proceeds of at least $15,000,000  to the Registrant at a price per share of Common Stock that yields a total  enterprise value of the Registrant of not less than $50,000,000; (ii)  bankruptcy receivership or dissolution of the Registrant; (iii) the voluntary  agreement of all parties bound by the terms of the Agreement; (iv) the  acquisition of all the shares of stock by one party; (v) the full and complete  exercise of all the rights under the Warrant by Summit (or its assignee)  pursuant to its terms; or (vi) on June 14, 2007. **Item 6.****Management’s    Discussion and Analysis or Plan of Operation**** ****OVERVIEW** The Registrant generates revenues from a  single business segment: the design, development, marketing and sale of  proprietary solid state electrical components designed to reduce energy  consumption in alternating current induction motors. The Registrant began generating revenues from sales of its patented *Power  Commander*® line of motor controllers in late 1995. As of December  31, 2002, the Registrant had total stockholders’ equity of $1,908,706 primarily  due to the Registrant’s sale of 2,346,233 shares of Series A-1 Convertible  Preferred stock to Summit Energy Ventures, LLC in June 2002, which resulted in  Summit owning a 28% fully diluted stake in the Registrant. In addition, in  August 2000, the Registrant purchased the assets of Percon, formerly the  largest distributor of the Registrant’s products. The transaction was accounted  for as a purchase and the Registrant’s Statements of Operations includes  Percon’s results of operations since the date of acquisition. The consolidation  of the operations of both entities allowed the Registrant to integrate the  administrative, sales, marketing and manufacturing operations of Percon. Percon  had developedsales contacts with major OEM’s in the elevator/escalator industry  and transferred those agreements to the Registrant as part of the Asset  Agreement.  **RESULTS OF OPERATIONS: FISCAL YEAR  2002 COMPARED TO FISCAL YEAR 2001**** ****REVENUES** Revenues for the twelve months ended December 31, 2002, were $538,819  compared to $633,563 for the twelve months ended December 31, 2001, a decrease  of $94,744, or 15%. The decrease in revenues was principally attributable to  organizational issues including funding problems and management issues. **COST OF  REVENUES** Cost of revenues for the twelve months ended December 31, 2002,  decreased to $379,684 from $428,463 a $48,779 or an 11% decline as compared to  the twelve months ended December 31, 2001. The decrease in cost of revenues was  primarily attributed to the decrease in revenues and an overall reduction in  the cost of materials from the Registrant’s suppliers. 21 **OPERATING  EXPENSES** **Research  and Development Expenses** Research and development expenses were $271,634 for the twelve months  ended December 31, 2002, as compared to $242,243, representing a $29,391 or a  12%, increase compared to the same period ended December 31, 2001.  The development of the low cost, low  horsepower Platform A product family, the single-phase controller, and the fast-reaction  integrator board increased research and development costs. **Selling,  General and Administrative Expenses** Selling, general and administrative expenses were $1,844,117 for the  twelve months ended December 31, 2002, an increase of $542,579 or 42% as  compared to the twelve months ended December 31, 2001. The increase in selling,  general and administrative expenses was due primarily to the recognition of  compensation expense and an increase in consulting and professional fees.   **Financial Condition, Liquidity, and  Capital Resources: For the Year Ended December 31, 2002**** **Since inception, the Registrant has financed its operations primarily  through the sale of its equity securities and using bank borrowings. As of  December 31, 2002, the Registrant has received a total of approximately  $4,757,261 from public and private offerings of its equity securities and  received approximately $445,386 under a bank line of credit which was repaid  during 2002. As of December 31, 2002, the Registrant had cash and cash  equivalents of $257,708. Cash used for operating activities for the twelve months ended December  31, 2002 was $1,690,250 which primarily consisted of: a net loss of $2,354,775;  less depreciation and amortization of $132,216, additional paid in capital  related to issuance of stock options of $312,741, Common stock issued for  services of $167,500, and interest accrued on stockholders, officers and former  officers’ loans of $28,174; increases in accounts receivable of $76,118;  decreases in inventory of $105,522; and increases in prepaid expenses of $9,628.  In addition, operating activities reflected a $90,369 decrease in accounts  payable and accrued expenses and an increase in accrued salaries and payroll  taxes of $94,487.  Net cash used for  operating activities in fiscal year 2001 was $1,107,265 which primarily  consisted of: a net loss of $1,863,802; less depreciation and amortization of  $281,587 and additional paid-in capital related to issuance of stock optionsof  $47,300; write-off of deferred financing costs of $38,502; debt restructuring  costs of $130,000; decreases in accounts receivable of $103,048; increases in  inventory of $83,091; and increases in prepaid expenses and deposits of $9,057.  In addition, operating activities reflected a $216,426 increase in accounts  payable and accrued expenses and an increase in accrued salaries and payroll  taxes of $31,822.  Cash used in  investing activities for fiscal year 2002 was $7,214, compared to $51,981 in  fiscal year 2001.  The amounts for both  years consisted of the purchase of fixed assets.  Net cash provided by financing activities for fiscal year 2002  was $1,919,927, which primarily consisted of proceeds from the issuance of  equity securities of $2,380,000, net of costs, and net repayments to  stockholders and officers of $14,687.   Repayments on a line of credit of $445,386 offset the amounts included  above.  During fiscal year 2001, net  cash provided from financingactivities was $1,185,999, which primarily  consisted of proceeds from the issuance of equity securities of $613,000,  advances on a line of credit of $167,499 and loans from stockholders and  officers of $405,500. The Registrant expects to experience growth in its operating expenses,  particularly in research and development and selling, general and  administrative expenses, for the foreseeable future in order to execute its  business strategy. As a result, the Registrant anticipates that operating  expenses will constitute a material use of any cash resources. Since capital resources are insufficient to satisfy the Registrant’s  liquidity requirements, management intends to sell additional equity or debt  securities or obtain debt financing.   The Registrant is currently in the process of negotiating a $1,000,000  debt facility with Summit Energy Ventures, LLC.  The Board of Directors has approved the terms of the proposed  financing but the Registrant is currently waiting for 22 Summit’s investment committee to approve the financing.  According to the terms of the proposed  financing, the outstanding balance would accrue interest at a rate of 15 percent  and would be convertible into Series A Preferred Stock at a price per share of  $0.183 if, after seven (7) days notice by Summit, the outstanding balance is  not paid off.  The Registrant is also  currently meeting with many different potential equity investors and believes  it can raise additional funds through private placements of equity. **Cash Requirements and Need for  Additional Funds**** **The Registrant anticipates a substantial need for cash to fund its  working capital requirements for the next twelve months. In accordance with the  Registrant’s prepared expansion plan, it is the opinion of management that  approximately $1.3 million will be required to cover operating expenses,  including, but not limited to, marketing, sales and operations during the next twelve  months. **Recent Accounting Pronouncements**** **See “Note 2 – Summary of Significant Accounting Policies” of the  Financial Statements for an explanation of recent accounting pronouncements. 23  **Item    7.****Financial    Statements**** ****POWER EFFICIENCY CORPORATION** **DECEMBER  31, 2002 AND 2001**** ****INDEX**   **Page**  Independent Auditors’ ReportF-1  Financial Statements:    Balance SheetF-2    Statements of OperationsF-3    Statements of Changes in Stockholders’ EquityF-4    Statements of Cash FlowsF-5   Notes to Financial StatementsF-6-F-19  **INDEPENDENT  AUDITORS’ REPORT** Board of Directors and StockholdersPower Efficiency CorporationAnn Arbor, Michigan We have audited the accompanying balance sheet of Power Efficiency  Corporation, (a Delaware corporation) (the “Company”) as of December 31, 2002,  and the related statements of operations, changes in stockholders’ equity, and  cash flows for each of the years ended December 31, 2002 and 2001.  These financial statements are the  responsibility of the Company’s management.   Our responsibility is to express an opinion on these financial  statements based on our audits. We conducted our audits in accordance with auditing standards generally  accepted in the United States of America.   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 financial statements present fairly, in all  material respects, the financial position of Power Efficiency Corporation at  December 31, 2002 and the results of its operations and its cash flows for the  years ended December 31, 2002 and 2001 in conformity with accounting principles  generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that  the Company will continue as a going concern.   As discussed in Note 3 to the financial statements, the Company has  suffered recurring losses from operations, the balance sheet reflects a  deficiency in tangible net worth, the Company has experienced a deficiency of  cash from operations and continues to have negative cash flows from operations  and lacks sufficient liquidity to continue its operations.  These matters raise substantial doubt as to  the Company’s ability to continue as a going concern.  Management’s plans in regard to these matters are also discussed  in Note 3.  The financial statements do  not include any adjustments that might result from the outcome of these  uncertainties.  /s/ SOBEL & CO., LLC Certified Public AccountantsMarch 5, 2003 Livingston, New Jersey   **POWER  EFFICIENCY CORPORATION****BALANCE  SHEET****DECEMBER  31, 2002** **ASSETS**    CURRENT ASSETS:    Cash and cash    equivalents $257,708 Accounts receivable,    net of reserve of $10,000  87,236 Inventories  504,023 Prepaid expenses  9,628    Total Current Assets  858,595    PROPERTY AND EQUIPMENT, Net  113,801    OTHER ASSETS:    Deposits  15,500 Patents, net  14,994 Goodwill, net  1,929,963 Customer contracts,    manuals and sales literature, net  111,272 Website and customer    list, net  26,930    |