---

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C.
20549

FORM 10-QSB

[X]  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2007

[   ]  TRANSITION REPORT UNDER SECTION 13 OR
15(d) OF THE EXCHANGE ACT

For the transition period from _______to _______

Commission File Number: 000-51256

POWER AIR CORPORATION(Exact name of small business issuer as specified in its
charter)

|Nevada                                                               | Not applicable                   
|-------------------------------------------------------------------- | ---------------------------------
|(State or other jurisdiction of incorporation or
      organization) | (IRS Employer Identification No.)

4777 Bennett Drive, Suite E, Livermore, California,
94551(Address of principal executive offices)

(925) 960-8777(Issuers telephone number)

Not applicable(Former name, former address
and former fiscal year, if changed since last report)

Check whether the issuer (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 [X]  
  No [   ].

Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act). Yes [  
]   No [X]  .

State the number of shares outstanding of each of the issuers
classes of common equity, as of the latest practicable date:
66,453,675 shares of Common Stock as of February 11, 2008.

Transitional Small Business Disclosure Format (Check one): Yes
[   ]   No [X]

---

POWER AIR CORPORATION

Quarterly Report On Form 10-QSBFor The Quarterly
Period Ended December 31, 2007

FORWARD-LOOKING STATEMENTS

This Form 10-QSB for the quarterly period ended December 31,
2007 contains forward-looking statements that involve risks and uncertainties.
Forward-looking statements in this document include, among others, statements
regarding our capital needs, business plans and expectations. Such
forward-looking statements involve assumptions, risks and uncertainties
regarding, among others, the success of our business plan, availability of
funds, government regulations, operating costs, our ability to achieve
significant revenues, our business model and products and other factors. Any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as may, should, expect,
plan, intend, anticipate, believe, estimate, predict, potential or
continue, the negative of such terms or other comparable terminology. In
evaluating these statements, you should consider various factors, including the
assumptions, risks and uncertainties set forth in reports and other documents we
have filed with or furnished to the SEC, including, without limitation, our
annual report on Form 10-KSB for the year ended September 30, 2007. These
factors or any of them may cause our actual results to differ materially from
any forward-looking statement made in this document. While these forward-looking
statements, and any assumptions upon which they are based, are made in good
faith and reflect our current judgment regarding future events, our actual
results will likely vary, sometimes materially, from any estimates, predictions,
projections, assumptions or other future performance suggested herein. The
forward-looking statements in this document are made as of the date of this
document and we do not intend or undertake to update any of the forward-looking
statements to conform these statements to actual results, except as required by
applicable law, including the securities laws of the United States.

2

---

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Power Air Corporation (A Development Stage Company)
Consolidated Balance Sheets

|                                                            |  | December 31, |   |  | September 30, |  
|----------------------------------------------------------- |  | ------------ | - |  | ------------- | -
|                                                            |  | 2007         |   |  | 2007          |  
|                                                            |  | $            |   |  | $             |  
|                                                            |  | (unaudited)  |   |  | (audited)     |  
|                                                            |  |              |   |  |               |  
|ASSETS                                                      |  |              |   |  |               |  
|Current Assets                                              |  |              |   |  |               |  
|Cash and cash equivalents                                   |  | 1,367,497    |   |  | 2,260,326     |  
|Other
      current assets                                  |  | 90,664       |   |  | 138,513       |  
|Total current assets                                        |  | 1,458,161    |   |  | 2,398,839     |  
|Property and
      Equipment (Note 3)                       |  | 389,522      |   |  | 296,510       |  
|Total Assets                                                |  | 1,847,683    |   |  | 2,695,349     |  
|                                                            |  |              |   |  |               |  
|LIABILITIES AND STOCKHOLDERS EQUITY                        |  |              |   |  |               |  
|Current Liabilities                                         |  |              |   |  |               |  
|Accounts payable                                            |  | 84,388       |   |  | 143,209       |  
|Accrued liabilities (Note 4(a) and 7(f))                    |  | 65,045       |   |  | 16,666        |  
|Total current liabilities                                   |  | 149,433      |   |  | 159,875       |  
|Commitments and Contingencies (Note 7)                      |  |              |   |  |               |  
|                                                            |  |              |   |  |               |  
|Stockholders Equity                                        |  |              |   |  |               |  
|Common Stock (Note 6), 375,000,000 shares
      authorized, |  |              |   |  |               |  
|$0.001 par value; 66,453,675 shares issued and outstanding, |  |              |   |  |               |  
|respectively                                                |  | 66,453       |   |  | 66,453        |  
|Additional Paid-In Capital                                  |  | 20,592,631   |   |  | 20,592,631    |  
|Deficit Accumulated During the Development Stage            |  | (18,960,834  | ) |  | (18,123,610   | )
|Total
      Stockholders Equity                            |  | 1,698,250    |   |  | 2,535,474     |  
|Total Liabilities and Stockholders Equity                  |  | 1,847,683    |   |  | 2,695,349     |  

F-1

(The Accompanying Notes are Integral Part of These Financial
Statements)

---

Power Air Corporation (A Development Stage Company)
Consolidated Statement of Operations (unaudited)

|                                                              |  |                   |   |  |                   |   |  | From                |  
|------------------------------------------------------------- |  | ----------------- | - |  | ----------------- | - |  | ------------------- | -
|                                                              |  |                   |   |  |                   |   |  | October 15, 1997    |  
|                                                              |  | Three Months      |   |  | Three Months      |   |  | (Date of Inception) |  
|                                                              |  | Ended             |   |  | Ended             |   |  | to                  |  
|                                                              |  | December 31, 2007 |   |  | December 31, 2006 |   |  | December 31, 2007   |  
|                                                              |  | $                 |   |  | $                 |   |  | $                   |  
|                                                              |  |                   |   |  |                   |   |  |                     |  
|Expenses                                                      |  |                   |   |  |                   |   |  |                     |  
|                                                              |  |                   |   |  |                   |   |  |                     |  
|Depreciation of
      property and equipment                  |  | 21,773            |   |  | 9,429             |   |  | 87,182              |  
|Development and engineering                                   |  | 319,556           |   |  | 348,400           |   |  | 4,346,110           |  
|General and
      administration                              |  | 330,981           |   |  | 522,170           |   |  | 9,152,050           |  
|License fees                                                  |  | 25,000            |   |  | 25,000            |   |  | 461,363             |  
|Marketing and selling                                         |  | 139,914           |   |  | 137,532           |   |  | 1,474,614           |  
|Interest and finance fees                                     |  |                   |   |  |                   |   |  |                     |  
|(Notes 5 and 6 (f))                                           |  |                   |   |  | -                 |   |  | 3,439,515           |  
|Total Expenses                                                |  | 837,224           |   |  | 1,042,531         |   |  | 18,960,834          |  
|                                                              |  |                   |   |  |                   |   |  |                     |  
|Net Loss                                                      |  | (837,224          | ) |  | (1,042,531        | ) |  | (18,960,834         | )
|                                                              |  |                   |   |  |                   |   |  |                     |  
|Net Loss Per Share
       Basic and Dilutes                  |  | (.01              | ) |  | (.02              | ) |  |                     |  
|                                                              |  |                   |   |  |                   |   |  |                     |  
|Weighted Average
      Shares Outstanding  Basic and Diluted |  | 66,453,675        |   |  | 45,523,000        |   |  |                     |  

F-2

(The Accompanying Notes are Integral Part of These Financial
Statements)

---

Power Air Corporation (A Development Stage Company)
Consolidated Statement of Cash Flows (unaudited)

|                                                                  |  | Three Months      |   |  | Three Months      |  
|----------------------------------------------------------------- |  | ----------------- | - |  | ----------------- | -
|                                                                  |  | Ended             |   |  | Ended             |  
|                                                                  |  | December 31, 2007 |   |  | December 31, 2006 |  
|                                                                  |  | $                 |   |  | $                 |  
|Operating Activities                                              |  |                   |   |  |                   |  
|Net loss                                                          |  | (837,224          | ) |  | (1,042,531        | )
|Adjustments to reconcile net loss to cash
      used in operating |  |                   |   |  |                   |  
|activities:                                                       |  |                   |   |  |                   |  
|Deferred finance costs
      written-off                          |  | -                 |   |  | 28,047            |  
|Depreciation of property and equipment                            |  | 21,773            |   |  | 9,429             |  
|Stock-based
      compensation                                    |  | 34,897            |   |  | 201,318           |  
|Changes in operating assets and liabilities:                      |  |                   |   |  |                   |  
|Other current assets                                              |  | 47,849            |   |  | 35,305            |  
|Accounts payable and accrued liabilities                          |  | (45,339           | ) |  | 5,599             |  
|Net Cash Used in Operating Activities                             |  | (778,044          | ) |  | (762,833          | )
|Investing Activities                                              |  |                   |   |  |                   |  
|Purchases of property and equipment                               |  | (114,785          | ) |  | (19,231           | )
|Net Cash Used in
      Investing Activities                       |  | (114,785          | ) |  | (19,231           | )
|Increase (Decrease) in Cash and Cash
      Equivalents            |  | (892,829          | ) |  | (782,064          | )
|Cash and Cash
      Equivalents, Beginning of Period              |  | 2,260,326         |   |  | 924,928           |  
|Cash and Cash Equivalents, End of Period                          |  | 1,367,497         |   |  | 142,864           |  
|                                                                  |  |                   |   |  |                   |  

F-3

(The Accompanying Notes are Integral Part of These Financial
Statements)

---

Power Air Corporation (A Development Stage Company)
Consolidated Statement of Stockholders Equity From October 15, 1997
(Date of Inception) to December 31, 2007 (unaudited)

|                                                                            |                    |   |  |        |   |  |            |   |  |              |   |  | Accumulated |   |  |            |  
|--------------------------------------------------------------------------- | ------------------ | - |  | ------ | - |  | ---------- | - |  | ------------ | - |  | ----------- | - |  | ---------- | -
|                                                                            | Common
      Stock |   |  |        |   |  | Deficit    |   |  |              |  
|                                                                            | Number             |   |  |        |   |  | Additional |   |  |              |   |  | During the  |   |  |            |  
|                                                                            | of                 |   |  |        |   |  | Paid-In    |   |  | Subscription |   |  | Development |   |  |            |  
|                                                                            | Shares             |   |  | Amount |   |  | Capital    |   |  | Receivable   |   |  | Stage       |   |  | Total      |  
|                                                                            |                    |   |  | $      |   |  | $          |   |  | $            |   |  | $           |   |  | $          |  
|Balance from October 15, 1997 (date of inception)
      to June 30, 2005    | 10,000             |   |  | 1,000  |   |  |           |   |  |             |   |  | (4,105,418  | ) |  | (4,104,418 | )
|Adjustment for change in par value                                          |                   |   |  | (990   | ) |  | 990        |   |  |             |   |  |            |   |  |           |  
|Re-capitalization transactions (Note 1)                                     |                    |   |  |        |   |  |            |   |  |              |   |  |             |   |  |            |  
|Shares of Power Air Corporation                                             | 18,750,000         |   |  | 18,750 |   |  |           |   |  |             |   |  |            |   |  | 18,750     |  
|Cancellation of founders
      stock                                        | (1,550,000         | ) |  | (1,550 | ) |  | 1,550      |   |  |             |   |  |            |   |  |           |  
|Shares issued to shareholders of Power
      Air Tech, Inc. to effect       |                    |   |  |        |   |  |            |   |  |              |   |  |             |   |  |            |  
|the reverse merger                                                          | 14,693,423         |   |  | 14,693 |   |  | (14,693    | ) |  |             |   |  |            |   |  |           |  
|Shares issued for compensation                                              | 4,545,456          |   |  | 4,545  |   |  | 2,506,819  |   |  |             |   |  |            |   |  | 2,511,364  |  
|Shares acquired by legal
      parent                                       | (10,000            | ) |  | (10    | ) |  |           |   |  |             |   |  |            |   |  | (10        | )
|Shares issued to settle debt                                                | 3,378,396          |   |  | 3,378  |   |  | 1,864,180  |   |  |             |   |  |            |   |  | 1,867,558  |  
|Forgiveness of related
      party debt of PAT as a condition               |                    |   |  |        |   |  |            |   |  |              |   |  |             |   |  |            |  
|precedent to the
      reverse merger                                       |                   |   |  |       |   |  | 2,173,045  |   |  |             |   |  |            |   |  | 2,173,045  |  
|Net liabilities assumed
      in recapitalization                           |                   |   |  |       |   |  | (89,482    | ) |  |             |   |  |            |   |  | (89,482    | )
|Unit private placement - $0.65 (Note 6(d))                                  | 2,077,454          |   |  | 2,078  |   |  | 1,348,267  |   |  |             |   |  |            |   |  | 1,350,345  |  
|Share subscription                                                          |                   |   |  |       |   |  |           |   |  | (161,850     | ) |  |            |   |  | (161,850   | )
|Share issuance costs                                                        |                   |   |  |       |   |  | (155,035   | ) |  |             |   |  |            |   |  | (155,035   | )
|Net loss                                                                    |                   |   |  |       |   |  |           |   |  |             |   |  | (2,625,261  | ) |  | (2,625,261 | )
|Balance, September 30, 2005                                                 | 41,894,729         |   |  | 41,894 |   |  | 7,635,641  |   |  | (161,850     | ) |  | (6,730,679  | ) |  | 785,006    |  
|Subscription received                                                       |                   |   |  |       |   |  |           |   |  | 161,850      |   |  |            |   |  | 161,850    |  
|Unit private placement - $0.65 (Note 6(d))                                  | 1,105,917          |   |  | 1,106  |   |  | 717,740    |   |  |             |   |  |            |   |  | 718,846    |  
|Unit private placement - $1.10 (Note 6(e))                                  | 1,792,572          |   |  | 1,793  |   |  | 1,970,036  |   |  |             |   |  |            |   |  | 1,971,829  |  
|Shares issued for share issuance costs                                      | 17,600             |   |  | 18     |   |  | (18        | ) |  |             |   |  |            |   |  |           |  
|Shares issued for employee bonuses                                          | 300,000            |   |  | 300    |   |  | 254,700    |   |  |             |   |  |            |   |  | 255,000    |  
|Shares issued for consulting services (Note 6(a))                           | 87,500             |   |  | 87     |   |  | 61,163     |   |  |             |   |  |            |   |  | 61,250     |  
|Shares issued for options exercised (Note
      6(g))                       | 150,000            |   |  | 150    |   |  | 97,350     |   |  |             |   |  |            |   |  | 97,500     |  
|Share issuance costs                                                        |                   |   |  |       |   |  | (250,241   | ) |  |             |   |  |            |   |  | (250,241   | )
|Fair value of vested stock options                                          |                   |   |  |       |   |  | 1,819,298  |   |  |             |   |  |            |   |  | 1,819,298  |  
|Net loss                                                                    |                   |   |  |       |   |  |           |   |  |             |   |  | (4,508,029  | ) |  | (4,508,029 | )
|Balance, September 30, 2006                                                 | 45,348,318         |   |  | 45,348 |   |  | 12,305,669 |   |  |             |   |  | (11,238,708 | ) |  | 1,112,309  |  
|Shares issued for consulting services (Note 6(a))                           | 262,500            |   |  | 262    |   |  | 100,363    |   |  |             |   |  |            |   |  | 100,625    |  
|Shares issued pursuant to a private placement
      (Note 6(c))             | 200,000            |   |  | 200    |   |  | 79,800     |   |  |             |   |  |            |   |  | 80,000     |  
|Shares issued for employee bonuses                                          | 100,000            |   |  | 100    |   |  | 32,900     |   |  |              |   |  |             |   |  | 33,000     |  
|Shares issued pursuant to a unit private placement
      at $0.35 per share |                    |   |  |        |   |  |            |   |  |              |   |  |             |   |  |            |  
|(Note 6(b)                                                                  | 14,285,714         |   |  | 14,286 |   |  | 4,985,714  |   |  |             |   |  |            |   |  | 5,000,000  |  
|Shares issued pursuant to conversion of equity
      certificates at a fair |                    |   |  |        |   |  |            |   |  |              |   |  |             |   |  |            |  
|value of $0.345 per share (Note 6(f))                                       | 6,257,143          |   |  | 6,257  |   |  | 2,152,993  |   |  |             |   |  |            |   |  | 2,159,250  |  
|Warrants issued pursuant to conversion of
      equity certificates (Note   |                    |   |  |        |   |  |            |   |  |              |   |  |             |   |  |            |  
|6(f))                                                                       |                   |   |  |       |   |  | 736,709    |   |  |             |   |  |            |   |  | 736,709    |  
|Fair value of vested stock options                                          |                   |   |  |       |   |  | 198,483    |   |  |             |   |  |            |   |  | 198,483    |  
|Net loss                                                                    |                   |   |  |       |   |  |           |   |  |             |   |  | (6,884,902  | ) |  | (6,884,902 | )
|Balance, September 30, 2007                                                 | 66,453,675         |   |  | 66,453 |   |  | 20,592,631 |   |  |             |   |  | (18,123,610 | ) |  | 2,535,474  |  
|Net loss                                                                    | -                  |   |  | -      |   |  | -          |   |  |              |   |  | (837,224    | ) |  | (837,224   | )
|Balance, December 31, 2007                                                  | 66,453,675         |   |  | 66,453 |   |  | 20,592,631 |   |  |              |   |  | (18,960,834 | ) |  | 1,698,250  |  

F-4

(The Accompanying Notes are Integral Part of These Financial
Statements)

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|1. | Nature of Operations and Continuance of
Business                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | Power Air Corporation (the Company or PAC) (formerly
      Fortune Partners, Inc. or FPI) was incorporated in the State of Nevada
      on August 26, 2004. Pursuant to a Share Exchange Agreement (the
      Agreement) dated September 30, 2005, the Company acquired all of the
      issued and outstanding shares of Power Air Tech, Inc. (PAT) and issued,
      in total, 22,617,275 common shares to the shareholder of PAT, the Chief
      Operating Officer of PAT and the majority of creditors of PAT resulting in
      PAT shareholders and related parties and creditors gaining a 57% control
      position of PAC (collectively the PAT Acquisition). Prior to the PAT
      Acquisition, the Companys principal business was the acquisition and
      exploration of mineral properties. The Company had not determined whether
      its mineral properties contained mineral reserves that were economically
      recoverable and had not been active exploring these properties since July,
      2005. As such, the PAT Acquisition by the Company was considered a
      re-capitalization of PAT and PAT is considered the acquirer for accounting
      and financial reporting purposes. The consolidated financial statements
      include the accounts of the Company since the PAT Acquisition on September
      30, 2005, and the historical accounts of PAT since the date of its
      inception, October 15, 1997. All significant inter-company balances and
      transactions have been eliminated upon consolidation. The name of the
      combined company was changed on December 21, 2005 to Power Air Corporation
      pursuant to a Form 14A proxy/consent statement, which was filed by the
      Company with the United States Securities and Exchange Commission (the
      SEC) on November 9, 2005 and approved by a majority of the Companys
      shareholders on December 20, 2005.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | PAT was incorporated in the State of Delaware on October
      15, 1997 and operated its business in the State of California. PAC,
      through its acquisition of PAT, is in the business of developing,
      manufacturing and marketing fuel cell based commercial products. PAT has
      the exclusive worldwide license to the Zinc-Air Fuel Cell (ZAFC)
      Technology that was developed at the Lawrence Livermore National
      Laboratory (LLNL), in Livermore, California, for all fields of use
      (stationary, portable and mobile applications) and
    commercialization.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The ZAFC uses a combination of oxygen and zinc pellets in
      a liquid alkaline mixture that generates electricity and at the same time
      creates residual zinc oxide that can be recycled back into reusable zinc,
      via electrolysis, so that it can again be fed into the ZAFC
  stack.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The Company is a development stage company as defined by
      Statement of Financial Accounting Standards (SFAS) No. 7 Accounting and
      Reporting by Development Stage Enterprises. In a development stage
      company, management devotes most of its activities in developing a market
      for its products. The Company is presently in its developmental stage and
      currently has no sources of revenue to provide incoming cash flows to
      sustain future operations. The ability of the Company to emerge from the
      development stage with respect to any planned principal business activity
      is dependent upon its successful efforts to enter into Original Equipment
      Manufacturer (OEM) joint venture agreements, to raise additional equity
      financing and generate revenue, cash flow and attain profitable
      operations. Management has plans to seek additional capital through equity
      offerings. There is no guarantee that the Company will be able to complete
      any of the above objectives. These factors raise substantial doubt
      regarding the Companys ability to continue as a going concern. These
      consolidated financial statements have been prepared on a going concern
      basis, which implies the Company will continue to realize its assets and
      discharge its liabilities in the normal course of business. As at December
      31, 2007, the Company has working capital of $1,308,728 and accumulated
      losses of $18,960,834 since inception. These financial statements do not
      include any adjustments to the recoverability and classification of
      recorded asset amounts and classification of liabilities that might be
      necessary should the Company be unable to continue as a going
    concern.                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|2. | Summary of Significant Accounting Policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

F-5

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|2. | Summary of Significant Accounting Policies
    (continued)
|-- | ----------------------------------------------------------

| | b) | Variable Interest Entity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Financial Accounting Standards Board (FASB)
      finalized FASB Interpretation No. 46R, Consolidation of Variable Interest
      EntitiesAn Interpretation of ARB51 (FIN46R) in December 2003. FIN46R
      expands the scope of ARB51 and can require consolidation of "variable
      interest entities (VIEs). Once an entity is determined to be a VIE, the
      party with the controlling financial interest, the primary beneficiary, is
      required to consolidate it. On May 31, 2006 the Companys inactive
      Canadian subsidiary, Power Air (Canada) Corp. was 50% owned by a Canadian
      resident individual and 50% owned by the Company. On June 1, 2006 this
      subsidiary became active and Power Air (Canada) Corp. began conducting
      scientific research and experimental development activities in Canada and
      will apply for Canadian Scientific Research and Experimental Development
      tax credits. The Company funds 100% of the expenditures and is at risk for
      100% of its losses and as a result is the party with the controlling
      financial interest and the primary beneficiary. Power Air (Canada) Corp.
      has no other financing other than amounts received from Power Air
      Corporation. As a result of the above, accumulated losses for the period
      from June 1, 2006 to December 31, 2007 of $1,249,010 has been included in
      the consolidated financial statements.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | c) | Use of Estimates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The preparation of financial statements in conformity
      with U.S. generally accepted accounting principles requires management to
      make estimates and assumptions that affect the reported amounts of assets
      and liabilities and disclosure of contingent assets and liabilities at the
      date of the financial statements and the reported amounts of fair value of
      stock based compensation and other stock based payments, revenues and
      expenses during the reporting period. Actual results could differ from
      those estimates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | d) | Basic and Diluted Net Income (Loss) Per Share                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Company computes net income (loss) per share in
      accordance with SFAS No. 128, "Earnings per Share". SFAS No. 128
      requires presentation of both basic and diluted earnings per share (EPS)
      on the face of the income statement. Basic EPS is computed by dividing net
      income (loss) available to common shareholders (numerator) by the weighted
      average number of shares outstanding (denominator) during the period.
      Diluted EPS gives effect to all dilutive potential common shares
      outstanding during the period using the treasury stock method and
      convertible preferred stock using the if-converted method. In computing
      diluted EPS, the average stock price for the period is used in determining
      the number of shares assumed to be purchased from the exercise of stock
      options or warrants. Diluted EPS excludes all dilutive potential shares if
      their effect is anti-dilutive.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | e) | Comprehensive Loss                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | SFAS No. 130, Reporting Comprehensive Income,
      establishes standards for the reporting and display of comprehensive loss
      and its components in the financial statements. For all periods presented
      the Company has no items that represent a comprehensive loss and,
      therefore, has not included a schedule of comprehensive loss in the
      financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | f) | Research and Development Expenditures                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Due to the Companys lack of revenues and forecast of
      significant capital required to develop a market for its products, the net
      realizable value of prototype material and intangible assets is not
      reasonably determinable. Accordingly, all research and development
      expenditures under Cooperative Research and Development Agreement (CRADA)
      contracts, including the costs of prototype material and the cost of
      obtaining intangible assets such as patents, have been charged to
      operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | g) | Cash and Cash Equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Company considers all highly liquid instruments with
      maturity of three months or less at the time of issuance to be cash
      equivalents.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | h) | Financial Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Financial instruments, which include cash, other current
      assets, accounts payable and accrued liabilities were estimated to
      approximate their carrying values due to the immediate or short-term
      maturity of these financial instruments. Currently, the Company does not
      use derivative instruments to reduce its exposure to foreign currency
      risk.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

F-6

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|2. | Summary of Significant Accounting Policies
    (continued)
|-- | ----------------------------------------------------------
|   |                                                           
|   | i)                                                        
|   |                                                           
|   |                                                           
|   |                                                           
|   |                                                           
|   |                                                           
|   | j)                                                        
|   |                                                           
|   |                                                           
|   |                                                           
|   | k)                                                        
|   |                                                           
|   |                                                           
|   |                                                           
|   | l)                                                        
|   |                                                           
|   |                                                           
|   |                                                           
|   | m)                                                        
|   |                                                           
|   |                                                           

F-7

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|2. | Summary of Significant Accounting Policies
    (continued)
|-- | ----------------------------------------------------------

| | n) | Foreign Currency Translation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The Companys functional and reporting currency is the
      United States dollar. Foreign currency transactions mainly occur in
      Canadian currency, and management has adopted SFAS No. 52, Foreign
      Currency Translation. Monetary assets and liabilities denominated in
      Canadian dollars are translated into United States dollars at rates of
      exchange in effect at the balance sheet date. Non-monetary assets,
      liabilities and items recorded in income arising from transactions
      denominated in Canadian currencies are translated at rates of exchange in
      effect at the date of the transaction. Any gain or loss on foreign
      currency translation is included in operations. To date, such amounts have
      not been significant.                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | o) | Property and Equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | Depreciation is provided on all property and equipment
      utilizing the straight-line method over their estimated useful lives of
      five years, except leasehold improvements, which are amortized over the
      term of the lease.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | p) | Recent Accounting Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | In December 2007, the FASB issued SFAS No. 141 (Revised)
      Business Combinations. SFAS 141 (Revised) establishes principles and
      requirements for how the acquirer of a business recognizes and measures in
      its financial statements the identifiable assets acquired, the liabilities
      assumed, and any noncontrolling interest in the acquiree. The statement
      also provides guidance for recognizing and measuring the goodwill acquired
      in the business combination and determines what information to disclose to
      enable users of the financial statements to evaluate the nature and
      financial effects of the business combination. The guidance will become
      effective for the fiscal year beginning after December 15, 2008. The
      management is in the process of evaluating the impact SFAS 141 (Revised)
      will have on the Companys financial statements upon adoption.                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | In December 2007, the FASB issued SFAS No. 160
      Noncontrolling Interests in Consolidated Financial Statements-an
      amendment of ARB No. 51. SFAS 160 establishes accounting and reporting
      standards for the noncontrolling interest in a subsidiary and for the
      deconsolidation of a subsidiary. The guidance will become effective for
      the fiscal year beginning after December 15, 2008. The management is in
      the process of evaluating the impact SFAS 160 will have on the Companys
      financial statements upon adoption.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | In February 2007, the Financial Accounting Standards
      Board (FASB) issued SFAS No. 159, The Fair Value Option for Financial
      Assets and Financial Liabilities  Including an Amendment of FASB
      Statement No. 115. This statement permits entities to choose to measure
      many financial instruments and certain other items at fair value. Most of
      the provisions of SFAS No. 159 apply only to entities that elect the fair
      value option. However, the amendment to SFAS No. 115 Accounting for
      Certain Investments in Debt and Equity Securities applies to all entities
      with available-for- sale and trading securities. SFAS No. 159 is effective
      as of the beginning of an entitys first fiscal year that begins after
      November 15, 2007. Early adoption is permitted as of the beginning of a
      fiscal year that begins on or before November 15, 2007, provided the
      entity also elects to apply the provision of SFAS No. 157, Fair Value
      Measurements. The adoption of this statement is not expected to have a
      material effect on the Company's financial
statements.

|3. | Property and Equipment
|-- | ----------------------

| |                                    |  |         |  |  |              |  |  | Net Carrying |  |  | Net Carrying | 
| | ---------------------------------- |  | ------- |  |  | ------------ |  |  | ------------ |  |  | ------------ | 
| |                                    |  |         |  |  |              |  |  | Value        |  |  | Value        | 
| |                                    |  |         |  |  | Accumulated  |  |  | December 31  |  |  | September 30 | 
| |                                    |  | Cost    |  |  | Depreciation |  |  | 2007         |  |  | 2007         | 
| |                                    |  | $       |  |  | $            |  |  | $            |  |  | $            | 
| |                                    |  |         |  |  |              |  |  |              |  |  |              | 
| | Computer hardware                  |  | 52,893  |  |  | 15,447       |  |  | 37,446       |  |  | 36,937       | 
| | Computer software                  |  | 12,422  |  |  | 3,002        |  |  | 9,420        |  |  | 7,924        | 
| | Furniture, equipment and machinery |  | 344,609 |  |  | 58,182       |  |  | 286,427      |  |  | 194,643      | 
| | Leasehold
      improvements       |  | 66,779  |  |  | 10,550       |  |  | 56,229       |  |  | 57,006       | 
| |                                    |  |         |  |  |              |  |  |              |  |  |              | 
| |                                    |  | 476,703 |  |  | 87,181       |  |  | 389,522      |  |  | 296,510      | 

F-8

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|4. | Related Party Transactions and Balances                                                                                                                                             
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                     
|   | (a)                                                                                                                                                                                 
|   |                                                                                                                                                                                     
|   | (b)                                                                                                                                                                                 
|   |                                                                                                                                                                                     
|   | (c)                                                                                                                                                                                 
|   |                                                                                                                                                                                     
|5. | Promissory Notes and Equity Certificates                                                                                                                                            
|   |                                                                                                                                                                                     
|   | On March 5, 2007 and April 5, 2007, the Company completed
      a debt financing (the Financing) consisting of the following
      consideration for gross proceeds of $2,190,000:
|   |                                                                                                                                                                                     
|   | (a)                                                                                                                                                                                 
|   |                                                                                                                                                                                     
|   | (b)                                                                                                                                                                                 
|   |                                                                                                                                                                                     
|   |                                                                                                                                                                                     
|   |                                                                                                                                                                                     
|   |                                                                                                                                                                                     

These Equity Consideration
Certificates were considered a separate and direct finance fee and the estimated
fair values were based on the estimated number of shares to be issued, 5,500,000
common shares valued at a combined average fair value of $0.3926 per share for
$2,159,250 and the estimated value of the warrants to be issued, 5,500,000
warrants valued at a combined average fair value of $0.134 per warrant for
$736,709. The warrants were valued pursuant to the Black-Scholes option pricing
model using the following combined average input variables: fair value of stock
price on grant date - $0.39; exercise price - $0.50; expected life  1 year;
volatility  105%; annual expected dividends  nil; risk-free interest rate -
4.63% . The total value of the underlying shares and warrants totalling
$2,895,959, a placement commission of $219,000, and expenses of $122,608 were
included in deferred financing costs which totalled $3,237,567 which were
subsequently charged to operations in the quarter ended June 30, 2007.

F-9

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|6. | Common Stock
|-- | ------------
|   |             
|   | a)          
|   |             
|   | b)          
|   |             
|   |             
|   |             
|   | c)          
|   |             
|   |             
|   |             
|   | d)          
|   |             
|   |             
|   |             
|   |             
|   |             
|   | e)          
|   |             
|   |             
|   |             
|   | f)          
|   |             
|   |             

F-10

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|6. | Common Stock (Continued)
|-- | ------------------------
|   |                         
|   | g)                      
|   |                         
|   |                         
|   |                         
|   |                         

| |                                  |  |           |   |  | Weighted | 
| | -------------------------------- |  | --------- | - |  | -------- | 
| |                                  |  |           |   |  | Average  | 
| |                                  |  |           |   |  | Exercise | 
| |                                  |  | Number of |   |  | Price    | 
| |                                  |  | Options   |   |  | $        | 
| |                                  |  |           |   |  |          | 
| | Balance, September 30, 2007      |  | 3,115,000 |   |  | 0.62     | 
| | Expired                          |  | (550,000  | ) |  | 0.68     | 
| |                                  |  |           |   |  |          | 
| | Balance, December
      31, 2007 |  | 2,565,000 |   |  | 0.61     | 

The following table summarizes stock
options outstanding at December 31, 2007:

Outstanding
    
    
    ExercisableWeighted
    WeightedAverage
    Average
    
    
    WeightedRemaining
    Exercise
    
    
    AverageNumber of
    Contractual
    Price
    
    Number of
    Exercise PriceShares
    Life (years)
    
    
    Shares2,565,000
    0.48
    0.61
    
    2,560,000
    0.61


| | h) | Warrants                                                                       
| | -- | -------------------------------------------------------------------------------
| |    |                                                                                
| |    | The following table summarizes warrants outstanding at
      December 31, 2007:

Number of
    
    Exercise PriceWarrants
    
      
    
    Expiry Date20,542,857
    
    0.50
    
    June 5, 200915,385
    
    1.00
    
    March 15, 2008896,286
    
    1.50
    
    June 28, 200821,454,528


|   | Warrants outstanding having a weighted average remaining
      life of 1.62 years and a weighted average exercise price of $0.54. On
      November 30, 2007 a total of 1,090,532 warrants expired
  unexercised.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                  
|7. | Commitments and Contingencies                                                                                                                                                                                    
|   |                                                                                                                                                                                                                  
|   | a)                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                  
|   | b)                                                                                                                                                                                                               
|   |                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                  

F-11

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|7. | Commitments and Contingencies
  (continued)
|-- | -------------------------------------------

| |       | 2006 was $7,000 per month and effective November 1, 2007
      will be $7,933 per month and the estimated monthly operating charge is
      $2,050 per month. On July 23, 2007 the Company entered into a long-term
      laboratory premises lease adjacent to the premises above. The term is for
      36 months expiring July 31, 2010. The monthly base rent is $4,518 per
      month and the estimated monthly operating charge is $1,100. Effective
      August 1, 2008 the base rent is $4,800 per month and effective August 1,
      2009 the base rent is $5,083 per month.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | (ii)  | On January 20, 2006 the Company entered into a long-term
      housing lease in Pleasanton, California. The term is for 24 months
      expiring January 31, 2008. The monthly rent is $2,595. The house is used
      by Canadian employees working in Livermore for long-term stays.                                                                                                                                                                                                                                                                                                  
| |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | (iii) | On March 30, 2007 the Company entered into a short-term
      premises lease at the National Research Council in Vancouver, Canada. This
      lease expires March 31, 2008. The monthly rent is CND$2,165 per
    month.                                                                                                                                                                                                                                                                                                                                                               

| | c) | As at December 31, 2007 the Company is committed pursuant
      to five employment contracts including four officers and one employee of
      the Company. In total the annual commitment is $720,000, each having a
      90-day termination clause.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | d) | On September 27, 2006 the Company entered into a four
      phase Development and Pre-Manufacturing Agreement (the Agreement) with
      Mid States Tool and Machine Inc. of Decatur, Indiana (Mid States).
      Pursuant to the Agreement, Mid States will re-design, cost-reduce, tool
      and manufacture the ZAFC. The Company paid $25,000 upon execution of this
      Agreement and will issue 350,000 stock options, in phases, exercisable at
      $0.755 per share. Upon completion of Phase 1 (Planning) a total of 50,000
      stock options will be granted. Upon starting Phase 2 (Engineering
      Prototype) a cash payment of $25,000 made and upon completion of Phase 2
      an additional 100,000 stock options will be granted. A final payment of
      $27,000 will be made upon Mid States delivering 4 demonstration prototypes
      at the end of Phase 2. A total of 100,000 stock options will be granted at
      the completion of Phase 3 (Manufacturing Prototype) and Phase 4 (Pilot
      Production). The cash payments do not include the costs of materials,
      labour (at Mid States cost) or moulds. There have been no triggering
      events for the granting of the above options and the Company is in the
      process of renegotiating the time-lines and deliverables for the
      Mid-States Agreement to include Zinc Air Powerpacks (ZPAC) and ZAFC
      cells. It is still intended that Mid States will be the Companys contract
      manufacturer for the initial ZPAC and ZAFC cells for use in the Companys
      first commercial products in North America.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | e) | The Company signed a Letter of Intent on December 6, 2006
      with H-Plus Eco Ltd., a Korean based company focused on environment and
      alternative energy. This Letter of Intent defines the structure and scope
      of the Asian Joint Venture between the companies. This Joint Venture will
      develop, manufacture and commercialize back-up power systems for Korean
      and Asian markets. H-Plus Eco Ltd. will contribute up to KRW 5 billion
      (US$5 million) to the Joint Venture and the Company will license its
      technology to the Joint Venture. The Joint Venture will include a
      shareholder agreement, a license agreement, a territory agreement and a
      supply agreement. The Letter of Intent expired 6 months after signing,
      however, it is referenced as part of a Heads of Agreement signed by the
      Company and its six largest shareholders on May 15, 2007. This Heads of
      Agreement extends the intent of the original document indefinitely with
      the support of the majority shareholders of the Company and the Chairman
      and Chief Executive Officer of H-Plus Eco Ltd.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | f) | The Company entered into an agreement with Elite Financial
        Communications Group, LLC (Elite) to manage all aspects of
        the Companys investor and media relations program. The Company has
        paid Elite $21,000 for the period July 1, 2007 to September 30, 2007 and
        thereafter will pay a monthly amount of $8,500 to December 31, 2007 and
        thereafter will pay a monthly amount of $10,000. Elite will also receive
        a warrant to purchase up to 150,000 common shares at $0.45 per share vesting
        on July 16, 2007 and the right to acquire an additional 150,000 common
        shares vesting on January 13, 2008 at $0.60 per share. These warrants
        will expire July 16, 2009. These warrants have not been issued to date
        and accordingly their fair value has been recorded in accrued liabilities
        and charged to operations as a marketing and selling expense. The warrants
        were valued pursuant to the Black-Scholes option pricing model using the
        following input variables: fair value of stock price on grant date - $0.32;
        exercise price - $0.45; expected life  2 years; volatility 
        111%; annual expected dividends  nil; risk-free interest rate 
        4.87%; and fair value of stock price on grant date - $0.20; exercise price
        - $0.60; expected life  1.5 years; volatility  130%; annual
        expected dividends  nil; risk-free interest rate  2.58%. The
        resulting values were recorded as $24,587 and $10,310 respectively for
        a total of $34,897.          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | g) | On November 3, 2007 the Company signed a Collaborative
      Development Agreement (CDA) with the National Research Council of Canada
      (NRC) with an effective date of January 1, 2008 expiring December 31,
      2009. Under the                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

F-12

---

Power Air Corporation (A Development Stage Company)
Notes to the Consolidated Financial Statements December 31, 2007
(unaudited)

|7. | Commitments and Contingencies (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | terms of the CDA; the Company and NRC will develop an
      optimal non-noble catalyst, a support structure for the catalyst and a low
      cost process suited to mass production of the related air cathodes. The
      Company will have the exclusive right to commercially exploit the
      Intellectual Property arising from this collaboration in relation to Zinc
      Air- based energy systems and the first right of refusal in fields of use
      other than Zinc Air-based energy systems. The Company will pay NRC
      $256,840 over 18 months for services in 4 equal payments of $64,210
      starting January 1, 2008. Both parties will review progress after 12
      months to determine if results are promising enough to warrant
      continuation.

|8. | Segment Disclosures                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The Company operates as one operating segment which is in
      the business of developing, manufacturing and marketing fuel cell based
      commercial products. The Chief Executive Officer is the Companys Chief
      Operating Decision Maker (CODM) as defined by SFAS 131, Disclosure
      about Segments of an Enterprise and Related Information. The CODM
      allocates resources and assesses the performance of the Company based on
      the results of operations.

F-13

---

Item 2. Plan of Operation

As used in this quarterly report: (i) the terms we, us,
our and the Company mean Power Air Corporation and its wholly-owned
subsidiaries, Power Air Tech, Inc. and Power Air (Canada) Corporation, unless
the context otherwise requires; (ii) SEC refers to the Securities and Exchange
Commission; (iii) Securities Act refers to the United States Securities Act of
1933, as amended; (iv) Exchange Act refers to the Unites States Securities
Exchange Act of 1934, as amended; and (v) all dollar amounts refer to United
States dollars unless otherwise indicated.

The following discussion of our plan of operations, results of
operations and financial condition as at and for the three months ended December
31, 2007 should be read in conjunction with our unaudited consolidated interim
financial statements and related notes for the three months ended December 31,
2007 included in this quarterly report, as well as our annual report on Form
10-KSB for the year ended September 30, 2007 and Form 10-QSB for the quarterly
periods ended March 31, 2007 and June 30, 2007.

Overview

Name and Incorporation

Our Company was formed under the laws of the State of Nevada on
August 26, 2004 under the name Fortune Partners, Inc. By an amendment to our
Articles of Incorporation we changed our name to Power Air Corporation
effective on December 22, 2005.

Our principal business offices are located at 4777 Bennett
Drive, Suite E, Livermore, California, 94551, our telephone number is (925)
960-8777 and our facsimile number is (925) 960-9197.

We own 100% of the issued and outstanding share capital of
Power Air Tech, Inc., which was formed under the laws of the State of Delaware
in October of 1997, together with 50% of the issued and outstanding shares of
Power Air (Canada) Corp. (Power Air Canada), which was formed under the laws
of the Province of British Columbia, Canada, on December 12, 2005. Power Air
(Canada) Corp. is considered a variable interest entity due to the Companys
control over the operations and 100% funding of costs to date, thus, is
considered a 100% consolidated subsidiary.

Our Corporate History

On September 30, 2005, we acquired all of the issued and
outstanding shares of Power Air Tech, Inc. As a result of such acquisition, we
are a development stage company engaged in the business of developing,
manufacturing and marketing of fuel cell based commercial products.

This acquisition represented a change in control of our
Company. The change in control, for accounting purposes, constitutes a
re-capitalization of our Company and, therefore, the transaction has been
accounted for as a reverse merger whereby Power Air Corporation is considered
the acquired entity and the operations of Power Air Tech, Inc. have become the
continuing operations of the Company.

Prior to the completion of the acquisition, the operations of
Power Air Tech, Inc. focused on raising funds through a reverse merger with a
public company, settling outstanding debt and maintaining its license with
Lawrence Livermore National Laboratory (LLNL) in Livermore, California.
Accordingly, we did not have any significant operating results in the year ended
September 30, 2005.

Our Business

We hold the exclusive world-wide license for the development
and commercialization of the zinc air fuel cell (ZAFC) technology developed
through an extensive joint collaboration effort with Lawrence Livermore National

14

---

Laboratory (LNLL) and the United States Department of Energy
(DOE). We also have exclusive world-wide rights to a second LLNL patent
pertaining to a low-cost process for recovering zinc and converting it to pellet
form for reuse in the ZAFC system. LLNL is a leading United States Government
research and development facility located in Livermore, California.

Our ZAFC technology is a metal oxide fuel cell using simple
physical chemistry. It uses a combination of atmospheric oxygen and zinc pellets
in a liquid alkaline electrolyte mixture referred to as an electrolyte to
generate electricity. The by-products from the chemical reaction are zinc oxide
and potassium zincates. The electrolyte used in the ZAFC fuel cells is potassium
hydroxide, a chemical which is readily available in commercial quantities. In
operation, the fuel cell consumes all of the zinc; and is operationally quiet,
providing instantaneous stable electrical energy with zero greenhouse gas
emissions.

Our objective is to commercialize the ZAFC technology to the
stage where the technology can be incorporated into ZAFC products that can be
manufactured and sold for use in power supply commercial applications. We have
completed initial development work on a prototype zinc air fuel cells
incorporating our technology. We plan to continue this development work in order
to develop products incorporating our ZAFC technology that can be commercially
marketed to consumers and businesses. In pursing this objective, we plan to
undertake strategic relationships with original equipment manufacturers (OEMs)
who would incorporate our ZAFC technology into fuel cell products to be
manufactured and sold by the OEM.

We have determined to focus our initial development efforts on
the design and development of one ZAFC product that we envision would be
manufactured and marketed by an OEM. This initial ZAFC product will be a small,
pocket-sized ZPAC that will allow end-users to recharge their portable
electronics devices (cell phones, PDAs, etc.) anywhere, anytime. In parallel, we
will develop a ZAFC based portable emergency generator designed for back-up or
emergency use in homes and small businesses. We have developed prototypes of
both of these products using our ZAFC technology. In order to complete
development of a commercial products, we will have to complete the following
phases of development:

- completion of the design, manufacture and testing of engineering
  prototypes;
- completion of the design, manufacture and testing of manufacturing
  prototypes; and
- pilot production of commercial products.

We anticipate that our working capital at December 31, 2007
together with a planned equity financing in early 2008 of a minimum of $2.4
million will be sufficient to enable us to complete the design, manufacture and
testing of engineering prototypes and the design of a manufacturing prototype
for the ZPAC. Our ability to complete the certification and pilot production of
commercial ZPAC products, the commercial introduction of our ZPAC product, and
the continued development of our ZAFC product will require that we obtain
additional financing of a further $2.6 million before January 30, 2009.

Our long-term goal is to be a commercially viable fuel cell
company, powering low cost, silent, zero emission fuel cell based products
developed with OEM partners for portable, stationary, light mobility and
transportation markets. However, we have not yet completed the development of
any products incorporating our ZAFC fuel cell technology that can be
commercially marketed and sold. Further, we have not achieved any revenues to
date and we do not anticipate achieving any revenues over the next twelve
months. As a result, we are considered a development stage company. We will
require substantial additional financing for us to achieve our business
objectives.

Industry Background

Generic Fuel Cells

A fuel cell is an electrochemical device, which cleanly
converts chemical energy of a fuel and oxidant directly into low voltage direct
current (DC) electricity. A fuel cell produces electricity and heat using a
fuel source and oxygen. There is no conversion into heat by combustion of the
fuel, and no conversion into mechanical energy, as is

15

---

the case of a heat driven generator system. Thus, the
efficiency of fuel cells is not a function of operating temperature.

The principal components of a fuel cell are catalytically
activated electrodes for the fuel (anode) and the oxidant (cathode) plus an
electrolyte to conduct between the two electrodes. In its operation the fuel
cell creates DC power, which can be converted to AC power through an inverter.
The fuel cell offers an alternative to existing power plants as a source of
electrical power.

Commercialization of Fuel Cells

While generic fuel cells have been in existence for over a
century, a recent expansion in demand for more efficient, stable and continuous
supply of power, which can operate cleanly and quietly, has led to attempts to
commercialize fuel cells as a source of power. Currently, batteries and engines
provide reasonable power solutions in a broad number of markets and
applications. However, each of these power solutions has its own inherent
disadvantages. Engines are not suitable for many applications as they are noisy,
polluting and unreliable as a power source. Batteries are not suitable for many
applications as they are heavy, have to be recharged, have a variable life span
and gradually lose power.

Fuel cells have been presented as an alternative technology for
power solutions as they do not possess some of the limitations of batteries and
engines. Fuel cells offer an alternative solution as they can operate without
the noise and emissions associated with hydrocarbon combustion and can provide a
continuous source of electrical power.

Initial commercialization efforts have focused on polymer
electrolyte membrane (PEM) fuel cells that use hydrogen as a source of fuel.
While PEM fuel cell prototypes have been tested in a variety of applications,
conventional PEM fuel cells are costly to produce and operate, and the fuel
(hydrogen) is difficult to distribute and store. These limitations have made
commercialization of products powered by conventional PEM fuel cells difficult
at present.

Our ZAFC Technology Solution

We believe that fuel cells incorporating our ZAFC technology
offer the opportunity to deliver a fuel cell solution without the limitations of
commercial products powered by conventional PEM fuel cells. We believe that our
ZAFC technology offers the ability to develop and manufacture a fuel cell that
has lower manufacturing and operating costs than conventional PEM fuel cells and
that uses inexpensive, abundant and non-volatile zinc as its fuel, rather than
hydrogen which is volatile and is difficult to distribute and store.
Accordingly, our business objective is to develop ZAFC fuel cells that we will
target for those segments of the power generation market that we believe will be
most ready to accept a ZAFC fuel cell as an acceptable alternative to
conventional sources of power. Based on our initial mapping of market
opportunities, two markets show an immediate need that can be addressed in the
near to medium term:

- Mobile electronic devices are an emerging $6.5 Billion application
  opportunity for fuel cells. As devices increase in functionality, the larger
  screens, faster processors and extended RAM all require more power. This
  applies to cell phones, smart phones, laptop PCs and almost every portable
  device. For the more than 50 Million mobile workers in the US, these energy
  hungry devices have become mission critical and running out of power is not an
  option.
- Power outages are becoming more and more frequent and widespread. Too often
  we are witnessing apartment and home occupants inconvenienced and in fact put
  into dangerous situations due to power outages caused by storms and technical
  failures. Residents are forced to cope with no lights, no heat, no
  information, spoiled food, and no working appliances for hours, days or even
  weeks at a time. Back-up generators are the current solution, but these
  generators cannot be used indoors, are noisy and polluting, heavy and messy.
  No back-up solution is offered whatsoever for apartment residents unless the
  whole building is backed up with a large diesel or natural gas generator.

16

---

Anticipated Markets for Fuel Cells

Fuel cells have not yet reached the stage where they have
achieved widespread commercial adoption. As such, we believe that the market for
fuel cells is in its early stages and is still developing. Based on industry
experience to date, we believe that the markets for fuel cell based products
will evolve as follows:

Learning from the experience of other fuel cell manufacturers,
particularly PEM fuel cell based companies where prototypes have been tested in
a variety of applications, PAC believes that the markets will evolve as follows:

First-to-Market

Occasional use products, such as
generator and battery substitutes for industrial, residential, and personal
back-up power solutions, with low operating lifetime requirements:

- Emergency and portable power packs
- Emergency generators for residential and small business
- Uninterruptible Power Supply (UPS) back-up (PCs, Servers, Data Centres)
- Telecom, Utility, Cable TV and Commercial Building back-up

Next-to-Market

Intermittent use products, such as
longer running generators and light mobility vehicles, requiring longer
operating life (ie: 10,000 hours and over) and on-board fuel storage and
re-fuelling logistics:

- Alternate Power Units (APUs) that power non-drive train functions for
  trucks, boats, RVs, and Military vehicles.
- Seasonal (ie: cabins, cottages) and special events power supply units.
- Light mobility fleet units such as forklifts, golf carts, scooters,
  airport ground support vehicles, military vehicles, small hybrid vehicles.

Last-to-Market

Continuous use products, requiring
operating lifetimes to 40,000 hours and fuel infrastructure support in place:

- Co-Generation  residential or commercial heating and electricity supply
  using the existing natural gas (or other) infrastructure and reformers.
- Grid replacement and peaker products.
- Automobiles
- Large and Heavy Vehicles  e.g. Buses

Our Technology License Agreement

We hold our rights to the ZAFC technology pursuant to a limited
exclusive patent license agreement between Power Air Tech and the Regents of the
University of California (the Regents) dated March, 2001 (the License
Agreement). Under the terms of the License Agreement, the Regents granted to
Power Air Tech an exclusive, non-transferable, royalty-bearing license to make,
use, sell, offer for sale and import products that incorporate the licensed
patents in the United States and worldwide where the patent rights to the
technology exist. The license rights are limited to a field of use described
as the zinc air fuel technology for stationary and mobile applications. The
Regents also granted to Power Air Tech the right to issue royalty-bearing
sublicenses to third parties to the zinc air fuel technology for stationary and
mobile applications.

The licensed patents are those inventions with respect to the
ZAFC technology that are summarized as follows:

17

---

United States Patents Granted

Invention Disclosure
      Number
      US Patent Number
      Title
      Inventors
      Issue Date8776
      5,434,020
      Continuous-feed 
        Electrochemical Cell with
      Non-Packing Particulate Electrode
      John F. Cooper
      7/18/959407
      5,578,183
      Production of Zinc Pellets
      John F. Cooper
      11/26/96


Foreign Patents Granted

Invention Disclosure
      Number
      AU Patent Number
      Title
      Inventors
      Issue Date9407
      714879
      Production of Zinc Pellets
      John F. Cooper
      5/4/00


Foreign Patent Applications

Invention Disclosure
      Number
      International Serial Number
      Title
      Inventors
      Issue Date9407
      Europe  96916453.2 
        Japan  534285/1996
      Production of Zinc Pellets
      John F. Cooper
      5/10/96


The United States government retained the rights to practice
the licensed patents for its own purposes. The Regents retained the right to use
the licensed patents for educational and research purposes.

In order to maintain our license rights, we are required to:

- pay royalty payments on net sales of end-use, stand-alone products that
  incorporate the licensed technology equal to 0.8% in 2006 and 1.2% in any year
  after;
- pay royalty payments on net sales of individual zinc air fuel cells equal
  to 2.3% for any sales made in 2006 and 3.3% in any year thereafter; and
- pay royalty payments on net sales by any sub-licensees equal to the earned
  royalty that would be payable by us had the sales been made by us, provided
  that we will also pay an additional 0.25% royalty on net sales to foreign
  entities by any sub-licensees.

We have also agreed to pay a minimum royalty to the Regents
which will equal $100,000 for each remaining year of the license. This minimum
royalty amount is payable on February 28th of each year of the
License Agreement.

Power Air Tech is obligated to diligently proceed with the
development, manufacture and sale of products incorporating the licensed
technology. The Regents have also maintained mandatory sublicensing rights that
may require us to grant sublicenses to third parties if (i) we fail to meet
market demand for prospective licensed products not included in our business
plan projections, or (ii) we fail to introduce into the marketplace licensed
products listed in our business plan within two years of an agreed upon schedule
of product introduction dates. The License Agreement also specifies performance
obligations that must be met by us. These performance obligations are measured
in terms of gross sales revenues from sales of licensed products. If we fail to
meet these performance

18

---

obligations, the Regents may, at their sole option: (i)
converted the limited exclusive license to a non-exclusive license, (ii)
negotiate a new schedule of performance obligations and conditions for
continuation of the limited exclusive license, or (iii) terminate the License
Agreement. We are in the process of renegotiating certain provisions of the
License Agreement with the Regents and, at present, the Regents have not claimed
that Power Air Tech is in default of the License Agreement or taken any action
to enforce its rights under the License Agreement.

The term of the License Agreement commenced March 13, 2001 and
will remain in effect until the expiration or abandonment of the last of the
licensed patents, unless terminated earlier in accordance with the terms of the
License Agreement.

Our Fuel Cell Technology

The Zinc Air Fuel Cell

Our fuel cell technology is a metal oxide fuel cell using
simple physical chemistry. It uses a combination of atmospheric oxygen and zinc
pellets in a liquid alkaline electrolyte mixture referred to as an electrolyte
to generate electricity. The by-products from the chemical reaction are zinc
oxide and potassium zincates. The electrolyte used in the ZAFC fuel cells is
potassium hydroxide, a chemical which is readily available in commercial
quantities. In operation, the fuel cell consumes all of the zinc; and is
operationally quiet, providing instantaneous stable electrical energy with zero
greenhouse gas emissions.

LLNL scientists and engineers achieved significant
breakthroughs in the design of the ZAFC which were subsequently patented and now
exclusively licensed to PAC. The current, self-feeding design incorporates a
hopper from which the zinc pellets, less than 1mm in size, feed through a
restricted opening into a wedge shaped cell to react with the flowing
electrolyte during operation. The size of the lightweight fuel cell stack
determines power (measured in kilowatts); and the electrolyte reserve tank
(together with the amount of zinc in the hopper) determines, the total energy
capacity (measured in kilowatt-hours) and operational cycle of the device.

The ZAFC Stack

The zinc-air fuel cell is constructed in a modular form of unit
cells known as a ZAFC stack. The ZAFC stack forms the base platform component of
our planned products. The ZAFC stack incorporates individual unit cells into a
stack of fuel cells in a configuration that will enable us to specifically
design, engineer, package and brand a range of products that can be targeted at
a range of applications suitable for the customers requirements. By designing
and incorporating ZAFC stacks into our products, we will be able to provide
customized power/energy requirements.

The ZAFC stack is constructed in a modular form of unit cells,
each of which is made up of a hopper, a self-feeding galvanic cell with air and
refuelling ports. The hoppers in each cell act as buffers to protect the air
electrodes during refuelling and handling. The cells are joined or moulded
together in a fuel stack module that is connected to an electrolyte storage tank
that contains the electrolyte and discharge products. Each cell contains a
lightweight plastic frame, a current collector/mesh, and a paper-thin air
electrode. The plastic frame extends upwards to create a hopper which can hold
additional zinc pellets that are fed into the cell as the zinc is used up in the
cell. The lightweight cells generate the power from the ZAFC stack. The size of
the lightweight fuel cell stack determines power (measured in kilowatts); and
the electrolyte reserve tank (together with the amount of zinc in the hopper)
determines, the total energy capacity (measured in kilowatt-hours) and
operational cycle of the device.

The ZAFC system components are divided into five categories:

- air cathodes
- cell frames and stand-offs
- current collector, metal plates and discs
- controllers, pumps and blowers
- containers and filters

19

---

The current, self-feeding design incorporates a hopper from
which the zinc pellets, less than 1mm in size, feed through a restricted opening
into a wedge shaped cell to react with the flowing electrolyte during operation.
The stack module is connected to an electrolyte storage tank containing
electrolyte and discharge products, a blower to circulate air, a pump to
circulate the electrolyte through the cells and over the zinc, and several other
ancillary components depending on the specific application. A diagram presenting
a cross-section view of a ZAFC fuel cell within a ZAFC stack is presented below:



In operation zinc pellets, less than 1 mm in diameter, are
pushed along the base of horizontal fill tubes by the flowing electrolyte. The
zinc pellets flow through slots to load each individual cell situated above the
reaction cell.

The very narrow (less than 3mm wide) cell openings allow the
particles to feed informally into the cell to form an open, loosely packed
structure, which permits the oxidation of the zinc and easy flow of electrolyte.
The electrolyte flows upward through the cell and hopper to remove heat and
reaction by products.

The ZAFC based devices are self-contained and the electric
power required to drive the ancillary air and electrolyte pumps is negligible,
consuming less than four percent of the fuel cell stacks gross output.

The ZAFC has refuelling capability in that the invariant
materials (zinc and electrolyte) can be replaced during the discharge cycle.
Topping up of ZAFCs electrolyte storage tank and zinc hopper can be performed
in minutes. The residual zinc oxide can be recycled.

Recycling and Recovery of Fuel

During operation, zinc is converted into zinc oxides that are
retained in the electrolyte. At any period during discharge zinc can be
recovered from the electrolyte and recycled for later re-use. The zinc is not
consumed, in the sense of gasoline or diesel; rather, it operates as a carrier
of electrical energy. Residual zinc oxide created during this process can be
recycled back into reusable zinc (via electrolysis) so that it can again be fed
into the ZAFC stack.

Zinc oxides can be recycled to form new zinc by electrolysis
using a simple process, which may be incorporated in the overall system or sited
at a central or service station location.

Our license rights include exclusive world-wide rights to the
second LLNL patent pertaining to a low-cost process for recovering zinc and
converting it to pellet form for reuse in the ZAFC system. We may pursue the
development

20

---

of a zinc recovery and recycling unit in conjunction with a
zinc partner; however, there are zinc recovery systems using other processes
that may be adaptable to our purposes with less development.

Advantages of our Zinc Air Fuel Cell Technology

We believe that our ZAFC technology offers a unique combination
of advantages over alternative competing technologies and power solutions. These
advantages include:

- Economical Energy Source.We currently estimate that fuel cell
  products based on our ZAFC technology offer can be manufactured and marketed
  at lower costs than can be achieved for conventional PEM fuel cell power
  solutions. We believe that lower manufacturing and marketing costs will result
  in products based on our ZAFC technology being able to be competitively priced
  against incumbent technologies. The low capital cost of the ZAFC is as a
  result of its simple design and low operating temperature which allow the
  majority of components to be conventionally sourced and combined with low-cost
  fabrication techniques. In addition, the consumables used comprise zinc and
  potassium hydroxide, both of which are inexpensive and easily sourced.
- High Specific Energy.The ZAFC has an energy output of approximately
  five to six times that of lead acid batteries of the same weight.
- Rapid Refuelling and Continuous Use. Products incorporating our ZAFC
  technology can be designed to be rapidly refuelable through an exchange of
  electrolyte and addition of zinc pellets, rather than being slowly recharged
  using electricity. This will allow products incorporating our ZAFC technology
  to be used for applications requiring near continuous use.
- Environmental.Zero Airborne Emissions. Products incorporating our
  ZAFC technology will not produce any significant airborne emissions. The
  reaction by-product, zinc-oxide, is retained in the electrolyte and can be
  recycled via electrolysis.
- Technology Safety Issues.Products incorporating our ZAFC technology
  will not face the safety, storage and siting issues inherent in competing
  technologies, such as PEM fuel cells and generators that rely on explosive
  fuel types such as hydrogen or gasoline.

The ZPAC Cells

The Zinc Air Power PAC (ZPAC) cell forms the base platform
component of the small scale portfolio of PAC products, which will be
specifically designed, engineered, packaged and branded in a range of
applications suitable for the electronic mobile and portable device
requirements. For selected applications, the lightweight cells will provide the
power/energy requirements (measured in watts) and the total energy capacity
(measured in watt-hours).

The ZPAC cell leverages the high energy density of Zinc and
robustness of the larger format Air Cathode used in the ZAFC to allow for higher
powered yet simple designs and construction. The result is a product that can be
lower cost and/or higher energy than the best Lithium-based primary batteries
and is easily configurable to meet the minimal space requirements of users. In
the case of a ZPAC cell, zinc pellets may be replaced by a fine zinc powder
which, together with a gelled form of electrolyte, forms a paste. The
configuration of the current collector also changes.

In operation, the air cathode side of the device is simply
exposed to air (similar to zinc air button cells used in hearing aids), allowing
for the immediate production of electricity. A charge-pump (low cost DC-DC
converter) allows a single 1V cell to step up to 5V or even higher.

21

---

Development of our Zinc Air Fuel Cell Technology

Historical Development

Our ZAFC technology was developed through a joint collaboration
effort between Lawrence Livermore National Laboratory and the United States
Department of Energy. LLNL is a leading United States Government research and
development facility located in Livermore, California. LLNL created the ZAFC
using internal support and additional support from the International Lead Zinc
Research Organization and the U.S. Department of Energy. Prior to September 30,
2005, over $6.0 million had been invested in the technology. From 1992 to 1997
LLNL and the DOE spent over $1 million on the original research concept and
development of the ZAFC. Between 1998 and 2005, the Companys now largest
shareholders invested a further $5 million to bring the ZAFC to the prototype
level. In the fiscal year ended September 30, 2006, approximately $772,000 was
spent in the development, engineering and testing of the technology.

LLNL scientists and engineers achieved significant
breakthroughs in the design of the ZAFC which were subsequently patented by LLNL
and exclusively licensed to Power Air Tech. LLNL developed prototypes of the
ZAFC stack that were designed to prove power and energy assumptions. Power Air
Tech continued this development by updating the ZAFC stack in order to reduce
weight and design costs, improve robustness and simplify the assembly
process.

Current State of Development

The following development of the technology and product
concepts for ZAFC and ZPAC has been completed to date:

Phase
    Description
    Development Work Completed
      by:
    Dates Work Completed0
    Initial Development of Zinc Air unit
    LLNL, the Department of Energy and the
      International Lead Zinc Research Organization
    19951
    Patenting of cell design
    LLNL
    1995 and 19962
    Experimentation with various air cathodes
      and sealants
    LLNL and PAT
    19983
    Completion of multi-cell ZAFC unit for
      demonstration
    LLNL and PAT
    20004
    Proof of Power Curve - successful testing
      of ZAFC
    LLNL, PAT and Argonne National Laboratories
    20015
    Product Concept - ZAFC-based Emergency
      Backup Generator - ZPAC-based Portable Power Pack
    Power Air Corporation
      Q3/2006 Q3/2007


22

---

Phase
      Description
      Development Work Completed
      by:
      Dates Work Completed6
      Program Concept - ZAFC-based Emergency
      Backup Generator - ZPAC-based Portable Power Pack
      
      Ongoing Q4/2007


As a result of the completion of this development work, we have
developed and configured initial prototypes based on individual ZPAC cells and
ZAFC cell stacks with an electrolyte storage tank to form a six-cell or
twelve-cell basic unit. We have established in principal that a single ZPAC cell
can be configured with off-the-shelf electronics to provide 5V output at up to 2
W and with a 40 Wh capacity. In addition, stacks of six or twelve full-size ZAFC
cells can be linked together (or scaled) to provide the desired power and energy
capacity for a particular application. We have not experienced any adverse
chemical or electrical side-effects as a result of combining fuel cells into
stacks, however we plan to continue testing and monitoring of these issues as we
proceed with further development

Plan of Operations

Smaller and shorter run-time products are, in general, easier
to bring to market provided that miniaturization is not required. As such, PAC
will focus on delivering products to the growing Emergency Mobile Power markets
first. All products will require a rigorous prototyping, testing and
certification process before final tooling for manufacturing can be completed.
At the same time, once product specifications are finalized and can be
demonstrated, it is reasonable to begin building an order book.

ZPAC  Project Zorro

Under an internally separate project (internally-named Zorro)
two versions of the Emergency ZPAC, one for mobile devices and one for laptops,
will be developed. Both products are being designed as packages with protective
casing, connectors for the device (mobile or laptop) being charged, electronics
to meet the minimum voltage requirements of the device, and any other
customizable parts.

The unit will be activated by the presence of oxygen and can be
stored by stopping oxygen from reaching the air cathode.

We plan to complete the following development work in order to
  achieve this objective:

Phase
    Description of Development
      Phase
    Description of Development Work
    Planned Timing7
    Engineering Prototype
    With input of OEM and Channel partners, we plan
      to complete the design, manufacture and testing of an engineering
      prototype based on our ZPAC design
    May 20088
    Engineering Verification
    This phase will consist of further construction
      and field testing of engineering prototypes
    July 20089
    Manufacturing Prototype
    With input from a manufacturing partner, we
      plan to design a commercial product with product design freeze and quality
      plan
    October 2008


23

---

Phase
    Description of Development
      Phase
    Description of Development Work
    Planned Timing10
      Manufacturing Verification
    This phase will consist of the construction and
      beta testing of manufacturing prototypes and completion of plan for
      launching the product into the market-place including product
      certifications
    November 200811
    Pilot Production
    This phase will consist of manufacturing pilot
      units of the product for shipping to channels and confirmation that our
      initial required cost and quality targets have been met
    Fourth quarter of 2008


The above timetable is an estimate prepared by PAC management
based on our plans and objectives as they presently exist, and there are a
number of contingencies that could cause our timetable not to be met.

ZAFC Portable Emergency Generator

In parallel to the commercialization of ZPAC products, we will
continue to focus technology resources on the development of our core ZAFC
product. We envision ZAFC products would be manufactured and marketed by an
original equipment manufacturer under agreement with us. Our initial ZAFC
product will initially be targeted to OEMs delivering power solutions to the
business and residential backup and emergency power segment.

We will design our initial prototype for OEM integration into a
ZAFC based portable emergency generator designed for back-up or emergency use in
homes and small businesses. This generator will be designed to be suitable for
use both indoor use, as it will not generate emissions, and outdoor use. The
generator will be designed to generate AC power at a rated power output of 1.25
or 2.5 Kilowatts, and to run for four to six hours continuously at fully rated
power when fully fuelled.

We plan to complete the following development work in order to
  achieve this objective:

Phase
    Description of Development
      Phase
    Description of Development Work
    Planned Timing6
    Program Concept
    We plan to complete the matching of engineering
      requirements and performance on key areas including electrolyte capacity
      and air cathode life  in parallel market opportunities will less
      stringent requirements will be evaluated and pursued if attractive;
    Fourth quarter of 20087
    Engineering Prototype
    With input of an OEM, we plan to complete the
      design, manufacture and testing of an engineering prototype incorporating
      our ZAFC fuel cell technology
    Mid-20098
    Engineering Verification
    This phase will consist of further construction
      and field testing of engineering prototypes
    2009


24

---

Phase
    Description of Development
      Phase
    Description of Development Work
    Planned Timing9
    Manufacturing Prototype
    With input from a manufacturing partner, we
      plan to design a commercial product with product design freeze and quality
      plan
    201010
    Manufacturing Verification
    This phase will consist of the construction and
      beta testing of manufacturing prototypes and completion of plan for
      launching the product into the market-place
    201011
    Pilot Production
    This phase will consist of manufacturing pilot
      units of the product and confirmation that our initial required cost and
      quality targets have been met
    2010


The above timetable is an estimate prepared by company
management based on our plans and objectives as they presently exist, and there
are a number of contingencies that could cause our timetable not to be met.

It should be noted that certain core technology development
projects will be conducted in parallel with the core ZAFC stack
commercialization to ensure the ongoing development of intellectual property,
reduce the reliance on third party suppliers for key components, and extend the
potential applications for ZAFC technology. One such project that has been
identified is the Zinc Air Cathode project. The output of such projects may be
2 to 3 years in the future but will open up additional market sectors through
extended lifetime and lower costs. In all cases, direct spending by the Company
on such projects will be minimized through the use of government grants, tax
incentives and co-development.

Zinc Air Cathodes

Historically, Air Cathodes for all of PACs development have
been sourced from various third party vendors . The Air Cathode is a critical
component in terms of performance, reliability and cost of any Zinc Air system.
To date, PAC has found at least two vendors whose initial performance and
projected costs meet target specifications. Concerns arise when looking at
end-of-life and lifetime requirements, and being dependent on third parties for
supply of a critical component of our end-user products. It is therefore seen as
strategic to invest in the design of an Air Cathode specifically suited to PACs
Zinc Air environment. In addition, this Air Cathode would be a product unto
itself, giving PAC Intellectual Property protection and an additional revenue
stream  through licensing or product sales.

As such, PAC has established an Air Cathode development project
in collaboration with the National Research Councils Institute for Fuel Cell
Innovation in Vancouver. The two year project will be partially subsidized by
the NRC, the Industrial Research Assistance Program (IRAP) and Scientific
Research & Experimental Development tax credits. It will deliver a
specialized electrode design (catalyst and support structure) that meets all of
target product specs for Portable Emergency and UPS & Telecoms backup and
also represents patentable Intellectual Property (IP). The project will also
attempt to incorporate recent advances by National Laboratory partners in
development of a reversible air cathode technology. Ideally both a lower cost,
better performing, and longer lifetime primary Air Cathode and a revolutionary
secondary Air Cathode would result.

The NRC Air Cathode project will not deliver a final result for
at least 24 months and these outputs will still require 9 to 12 months of
production design, test, and implementation before being ready for
commercialization. As a result, production of prototypes (and the less demanding
Emergency ZPACs) will continue using Air Cathodes from existing suppliers.

25

---

Subsequent Product Development

Assuming successful implementation of the 1.25 and 2.5 kW
Portable Emergency Generator units, work will begin on a parallel path to
develop UPS & Telecoms as well and Small Fleet products, as per OEM
specifications/requirements.

In addition, work on the rechargeable versions of the ZPACs
will be undertaken in parallel with the Portable Emergency generator assuming
the Air Cathode project is able to deliver the necessary performance in a
reversible configuration.

Our ability to undertake our current development work and this
future development work will be subject to our ability to obtain the necessary
financing to fund this development work. Further, our success in developing our
initial product will be critical in enabling us to proceed to future development
work. We may be forced to abandon plans for future development work if our
initial product is not successful or we do not achieve the required financing.

In undertaking our development work, it will be our intention
to continuously enhance our product range and to develop new generations of
products. However, we do not plan to divert resources from the initial OEM
module development unless significant investment in an alternative application
is provided by an OEM. We plan to retain a strategic role in the assembly and
distribution of products, which will ensure continuity of product service and
quality for customers.

In undertaking our development work, we plan to outsource
materials handling and manufacturing of components to existing component
manufacturers. The aim of this strategy is to alleviate capital costs in the
setting up of manufacturing plants, and this will provide flexibility in
sourcing of components and compliance of design specification rules in each
country.

Prototyping and Testing

As we update the ZAFC design and complete our development work,
we anticipate that many of the core components and materials will change. Each
variation will require extensive single-cell and unit testing as well as
forensic work. While it is reasonable to acquire some test and lab apparatus
(load banks, etc.), we believe that many of the environmental tests may be more
cost effectively undertaken in conjunctions with a third party. This is another
of the reasons we have established a presence at the NRCs Institute for Fuel
Cell Innovation facility in Vancouver, Canada.

Manufacturing

We anticipate that manufacturing of any commercial products
incorporating our core ZAFC stack technology will be undertaken by an OEM under
agreement with us. At the same time, design of the products, especially design
of the core ZAFC stack for the manufacturing prototype, will require extensive
input from not only experienced designers and engineers, but also from
experienced production staff. On September 27, 2006 the Company entered into a
four phase Development and Pre-Manufacturing Agreement (the Mid States
Agreement) with Mid States Tool and Machine Inc. of Decatur, Indiana (Mid
States). Mid States is an established plastics tooling and machining company
that has advanced computer aided design and manufacturing capability to allow
for the easy iteration of designs during the prototyping phase. Pursuant to the
Mid States Agreement, Mid States will re-design, cost-reduce, tool and
manufacture the ZAFC. The Company is in the process of renegotiating the
time-lines and deliverables for the Mid-States Agreement to include ZPAC cells.
It is still intended that Mid States will be the Companys contract manufacturer
for the initial ZPAC and ZAFC cells for use in the Companys first commercial
products in North America.

26

---

Development, Engineering and Testing Facilities

Our primary facility is located in Livermore, California within
close proximity of the LLNL laboratories. This facility accommodates personnel
required to implement the application designs, development, and
commercialization phases of the ZAFC system. We plan to carry out the majority
of our development and engineering work at our Livermore facility.

National Research Council of Canadas Institute for Fuel
Cell Innovation

PAC has also established a Canadian subsidiary, Power Air
(Canada) Corporation. On March 31, 2007 our Canadian subsidiary extended a
premises lease for office and laboratory space at the National Research Council
of Canadas Institute for Fuel Cell Innovation (NRC-IFCI) in Vancouver, British
Columbia, Canada. The NRC-IFCI is widely considered to have the worlds most
advanced cluster of companies and organizations focused on fuel cell
technologies. The lease expires on March 31, 2008 and the rent is CAD$2,165 per
month. We believe that our presence at the NRC will provide us with the
opportunity to interact with other leading companies and leverage both NRC
resources (for testing and project development) and the vast pool of local
talent to reduce cost and time to market.

The NRC-IFCI is home to the NRC Fuel Cell Program which, in
collaboration with industry, universities, and other government agencies,
provides research and innovation support in areas critical to the growth of the
sector, such as fuels research, system integration and manufacturing, and
component development.

The NRC has funded major capital projects to expand the number
of labs and to provide testing facilities specialized for different fuel-cell
sizes and different fuel-cell types. Infrastructure includes demonstration
facilities to showcase new technology, incubation space for start-ups, and
access to specialized information resources. As such, the NRC IFCI provides us
with access to critical product development systems and provides an ideal
setting for presenting to prospective OEM and fuel cell partners.

Marketing & Sales

We plan to focus on delivering ZPAC and ZAFC based products and
systems to the market in collaboration with OEMs. Our plan is to identify and
enter into strategic relationships with OEMs that are interested in pursuing the
commercialization of products incorporating our ZAFC technology. Partnering with
OEMs is expected to reduce the time required to commercialize our technology as
it offers the ability to:

- leverage the OEMs market intelligence, specifications requirements,
  systems integration, and product development expertise;
- leverage the OEMs customer base for field trial activities and feedback;
- leverage the OEMs product design, certification, and regulatory approval
  expertise; and
- leverage the OEMs marketing, sales, distribution, installation, and
  service capabilities.

By partnering with OEMs, our objective will be to avoid
duplicating costly, already existing OEM manufacturing, distribution, service
and support infrastructures, thus enabling us to focus on cost reduction and
improvement of our core technology offering.

For the ZPAC products, we will look to OEMs for packaging,
end-user testing and certification expertise. For the more complex ZAFC
products, we plan to support the OEM systems integration, product development,
codes and standards, testing, and siting activities and participate with OEMs in
end-user field trials.

We also plan to continue developing strategic relationships
with a fuel solution business partner, and to collaborate with this partner to
implement a fuel supply, distribution, siting, re-fueling logistics, and
re-cycling business model.

Commercialization of our zinc based product may be an important
development for the zinc industry. Our product may represent a substantial new
fuel market for zinc that zinc companies could supply to. The process of
recycling

27

---

the zinc, through electrolysis, could also offer a major
sustainable revenue producing opportunity to companies in the zinc industry.

We also plan to develop market awareness for the ZAFC through
identifiable brand imaging by introducing our logo (with or without text) on all
systems, similar to INTEL inside. The logo itself was derived by stylizing the
companys initials PAC in to a linked P for Power and A for Air inside a
circulating C for Corporation, which also represents an electron or energy
being released in the chemical process.



We plan to focus our marketing efforts on establishing
relationships with major organizations and we will target trade shows and trade
press in order to promote these relationships. We also plan to promote our
technology via press releases and editorial write-ups in trade publications. We
plan to undertake limited media advertising. We plan to retain the services of
an advertising agency to assist in public relations and marketing
communications. This will be subject to review during the product launch phase.
We anticipate that the primary promotional and marketing effort will be
performed in conjunction with our OEM and zinc strategic partners.

Patents and Licences

As described above, we hold the exclusive world-wide license
from LLNL for the development and commercialization of the ZAFC technology. We
also have exclusive worldwide rights to a second LLNL patent pertaining to a
low-cost process for recovering zinc and converting it to pellet form for reuse
in the ZAFC system.

We have been granted one provisional patent and have identified
several additional patentable designs in the course of developing our core ZPAC
and ZAFC technology, and are in the process of filing additional patent
applications, but there can be no assurance that any of these patents will be
issued or that patents will not be challenged.

Government Approvals

One of our objectives will be to establish relationships with
relevant regulators, government and industry agencies in regard to the
endorsement of our technology and products. In particular, we plan to seek to
align our technology and products in order to qualify for grants and assistance
programs directed at end-users wishing to adopt clean power alternatives.

Government Regulation

If we are to introduce products incorporating our ZPAC and ZAFC
designs into the marketplace, we will have to obtain Underwriters Laboratory
and/or CSA International certifications for North America, and CE certifications
for Europe prior to being able ship or install any product. Accordingly, we plan
to design all products that we develop so that they will be able to pass all
major certifications (North America, Europe, Asia) with the same design. The
expense associated with this government regulatory compliance will be
incorporated into the costs for the design and development of our products.

At this time, we do not know what additional requirements, if
any, each jurisdiction will impose on our product or its installation. We also
do not know the extent to which any new regulations may impact our ability to
distribute, install and service our product. Once our product reaches the
commercialization stage and we begin distributing our systems to our early
target markets, the federal, state or local government entities may seek to
impose regulations.

28

---

Competition

The Company faces competition from a number of companies some
of which are larger and have greater resources than PAC. The Companys
competitors in the fuel cell industry include, among others, Fuel Cell Energy,
Inc., Electric Fuel Corporation, and PowerZinc Corporation. In addition, the
Company will be attempting to displace established technology such as alkaline,
lithium and lead-acid batteries and internal combustion engines in many of the
markets it enters, which have many companies that are established in these
markets with greater resources than the Company. See Risk Factors.

ZPAC Portable Power Pack Competition

Unlike generator (which are dominated by fossil fuels including
gasoline and diesel) within the battery sector, there are a number of
alternative chemistries  including Zinc Air. Zinc-Air has some significant
advantages over the nearest competitors in terms of Energy/Volume and
Energy/Weight  this extends to cost since Lithium is scarce and therefore more
expensive. It should be noted that Zinc Air does not currently work well in a
Secondary configuration.

Cell Type
    Capacity at 1A
      (Ah)
    Grav.Cap. (Ah/kg)
    Vol. Cap (Ah/L)
    $ / cell (Best
      Buy)
    No. Cells for 40 Ah
    Volume (cm3)
    Mass (g)
    Retail Price ($)ZPAC (80% U)
    (40)
    (221)
    (837)
    -
    (1)
    96
    190
    $20 est.Max Alkaline
    1
    43
    123
    0.69
    40
    325
    920
    27.20e2 Titanium Alkaline
    1.5
    65
    185
    1.12
    27
    216
    613
    30.00e2 Lithium (Primary)
    3
    207
    375
    2.50
    13.3 (14)
    107 (113)
    194 (209)
    33.33 (35.00)2.3 Ah NiMH
    2.2
    73
    265
    3.25
    14.6 (15)
    120 (123)
    435 (444)
    47.25 (48.75)


ZAFC Emergency Generator Competition

Incumbent portable generators from McCullough, Briggs &
Stratton, Coleman and Honda are well priced at between $120 and $600 per kW for
the end-user product. However, the higher end, quieter models such as the Honda
EU3000 are premium priced and in greatest demand for home use. In addition to
virtually silent operation, Power Airs ZAFC-based products will have the
advantages of indoor siting, no emissions, no fire hazard, no explosion hazard,
no burn hazard (ie: to touch it when in operation), and recyclable fuel. To
compete against incumbent portable generators, the OEM will have to offer the
end-user a product at a reasonable premium, considering the advantages above, to
the higher end portable generator price.

To compete against higher end fossil fuel portable generators,
at an average of about $600 per kW, we believe a Green OEM alternative needs
to deliver 1500+ hours of lifetime, 4 to 6 hours run-time at full load, and an
end user price of:

| | • | Introduction:       | $1000 - $1200 per kW
| | - | ------------------- | --------------------
| | • | Market Penetration: | $800 - $1000 per kW 
| | • | Mass Market:        | $600 - $800 per kW  

29

---

Employees

We currently have 14 full-time employees and 3 part-time
employees.

Subsidiaries

We own 100% of the issued and outstanding share capital of
Power Air Tech, Inc., which was formed under the laws of the State of Delaware
in October of 1997. We also own 50% of the issued and outstanding shares of
Power Air (Canada) Corp., which was formed under the laws of the Province of
British Columbia, Canada, on December 12, 2005. Power Air (Canada) Corp. is
considered a variable interest entity due to the Companys control over the
operations and 100% funding of costs to date, thus, is considered a 100%
consolidated subsidiary.

Results of Operations

Three months ended December 31, 2007 Compared to the
Three months ended December 31, 2006

The following table sets out our consolidated loss during the
three months ended December 31, 2007 and 2006, respectively:

|                                             |  | Three Months      |   |  | Three Months      |  
|-------------------------------------------- |  | ----------------- | - |  | ----------------- | -
|                                             |  | Ended             |   |  | Ended             |  
|                                             |  | December 31, 2007 |   |  | December 31, 2006 |  
|                                             |  | (Unaudited)       |   |  | (Unaudited)       |  
|                                             |  | $                 |   |  | $                 |  
|Expenses                                     |  |                   |   |  |                   |  
|Amortization of property
      and equipment |  | 21,773            |   |  | 9,429             |  
|Development and engineering                  |  | 319,556           |   |  | 348,400           |  
|General and
      administration             |  | 330,981           |   |  | 522,170           |  
|License
      fees                           |  | 25,000            |   |  | 25,000            |  
|Marketing and selling                        |  | 139,914           |   |  | 137,532           |  
|Interest
      and finance fees              |  | -                 |   |  | -                 |  
|Total Expenses                               |  | 837,224           |   |  | 1,042,531         |  
|                                             |  |                   |   |  |                   |  
|Net Loss                                     |  | (837,224          | ) |  | (1,042,531        | )

The Company recorded a net loss of $837,000 for the three
months ended December 31, 2007 as compared to a net loss of $1,043,000 for the
period ended December 31, 2006, a net decrease of $206,000. The decrease in net
loss was due to the following significant components: a reduction in general and
administrative expenses by $192,000, a reduction in investor relations
consulting cost by $176,000 and a reduction of $65,000 in stock based
compensation. Offsetting these reductions was an increase in salaries of $30,000
and an increase in director fees of $10,000. Development and engineering costs
were reduced by from $348,000 to $319,556 primarily by a reduction of spending
on laboratory materials and supplies by $34,000 from $103,000 to $69,000.
Depreciation expenses increased $12,000 due to increased purchase of laboratory
equipment.

Liquidity and Capital Resources

The following table sets forth our cash and working capital as
of December 31, 2007.

30

---

As of
    As ofDecember 31,
    September 30,2007
    2007(Unaudited)
    (Audited)Cash reserves
    $1,367,497
    $2,260,326Working capital (deficiency)
    $1,308,728
    $2,238,964


We plan to spend approximately $3.5 million over the next
twelve months in carrying out our plan of operations.

During the next 12 months we anticipate that we will not
generate any revenue. We had a working capital of $1,308,728 at December 31,
2007.

On March 5, 2007 and April 5, 2007, the Company completed a
debt financing (the Financing) consisting of the following consideration for
gross proceeds of $2,190,000:

| | (a) | Promissory notes totalling $2,190,000, bearing interest
      at 10% per annum payable quarterly in arrears, secured against the
      Companys tangible and intangible assets, repayable on the Maturity Date,
      being the earlier of September 30, 2007 and the third business day
      following the completion of a public offering or private placement
      resulting in gross proceeds of $5,000,000 or more (the Qualified
      Offering). A placement commission of $219,000 and expenses of $20,000
      were included in deferred financing costs.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | (b) | As additional consideration for the loan the Company
      issued Equity Consideration Certificates having an estimated fair value of
      $3,017,099, which allow the holder, at the holders option, to receive
      either:                                                                                                                                                                                                                                                                                                                                        
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |     | (i)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |     | (ii)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

These Equity Consideration
Certificates were considered a separate and direct finance fee and the estimated
fair values were based on the estimated number of shares to be issued, 5,475,000
common shares valued at $0.40 per share for $2,190,000 and the estimated value
of the warrants to be issued, 5,475,000 warrants of $867,849 based on a fair
value price of $0.1585 per warrant using the Black Scholes Option pricing Model
using the following input variables: fair value of stock price on grant date -
$0.39; exercise price - $0.50; expected life  1 year; volatility  121%; annual
expected dividends  nil; risk-free interest rate - 4.63% . The total value of
$3,017,099 was added to deferred financing costs. The Company also issued equity
certificates valued at $14,418, which was added to deferred financing costs for
reimbursement of expenses incurred by the placement agent.

The Company completed an equity
financing of $5,080,000 on June 5, 2007 thus triggering immediate repayment of
the promissory notes totalling $2,190,000 plus interest of $75,794. As the debt
was extinguished the Company charged deferred finance costs of $3,270,517 to
operations.

31

---

On June 5, 2007 the Company received $80,000 and will issue
200,000 common shares pursuant to a private placement of common shares at $0.40
per share to an offshore purchaser.

Also on June 5, 2007, we issued an aggregate of 14,285,716
units (each a Unit) at a price of $0.35 per Unit for total gross proceeds of
$5,000,000 in a private placement (the Private Placement Offering), with each
Unit being comprised of one share of common stock and one non-transferable share
purchase warrant (each a Warrant) of the Company, and with each Warrant
entitling the holder to purchase one additional share of common stock of the
Company at an exercise price of $0.50 per share from the date of issuance to the
date of expiry on June 5, 2009. The 14,285,716 Units were sold to purchasers who
were offshore pursuant to Regulation S under the United States Securities Act of
1933, a amended (the Securities Act).

As the Private Placement Offering constituted a Qualified
Offering, on June 5, 2007, we also issued an aggregate of 6,257,118 Units to the
lenders under the Financing on the same terms and conditions as the Private
Placement Offering for no additional consideration.

We anticipate that the above financings that are included in
  our cash on hand at December 31, 2007 of $1,367,497 will be sufficient to enable
  us to complete the product and program concept phase and begin the design, manufacture
  and testing of engineering prototypes. Our cash needs for the next twelve months
  is $3.5 million and we will need to complete a planned equity financing of a
  minimum $2.4 million in early 2008 in order to complete the design, manufacturing
  and testing of engineering prototypes for the ZPAC product and the design, manufacturing,
  and testing of manufacturing prototypes for the ZPAC product. Our ability to
  complete the certification and pilot production of commercial ZPAC products,
  the commercial introduction of our ZPAC product, and the continued development
  of our ZAFC product will require that we obtain additional financing of a further
  $2.6 million before January 30, 2009.

The Company currently has no sources of revenue to provide
incoming cash flows to sustain future operations. The ability of the Company to
emerge from the development stage with respect to any planned principal business
activity is dependent upon its successful efforts to enter into OEM joint
venture agreements, to raise additional equity financing and generate revenue,
cash flow and attain profitable operations. There can be no assurance that the
Company will be able to complete any of the above objectives. These factors
raise substantial doubt regarding the Companys ability to continue as a going
concern. The consolidated financial statements have been prepared on a going
concern basis, which implies the Company will continue to realize its assets and
discharge its liabilities in the normal course of business. As at December 31,
2007, the Company had accumulated losses of $18,960,834 since inception. The
consolidated financial statements do not include any adjustments to the
recoverability and classification of recorded asset amounts and classification
of liabilities that might be necessary should the Company be unable to continue
as a going concern.

Operating Activities

Operating activities in the three months ended December 31,
2007 used cash of $778,044, which reflect our recurring operating losses.

Investing Activities

In the three months ended December 31, 2007 investing
activities used cash of $114,785 to purchase property and equipment.

Financing Activities

There were no financing activities in the three months ended
December 31, 2007.

32

---

Critical Accounting Policies

Our consolidated financial statements and accompanying notes
have been prepared in accordance with United States generally accepted
accounting principles applied on a consistent basis. The preparation of
financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting periods.

We regularly evaluate the accounting policies and estimates
that we use to prepare our consolidated financial statements. In general,
managements estimates are based on historical experience, on information from
third party professionals, and on various other assumptions that are believed to
be reasonable under the facts and circumstances. Actual results could differ
from those estimates made by management.

We believe that our critical accounting policies and estimates
include the accounting for accounts receivable, marketable securities and
long-lived assets reclamation costs, and accounting for legal contingencies.

Use of Estimates

The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of fair value of stock based compensation
and other stock based payments and revenues and expenses during the reporting
period. Actual results could differ from those estimates.

Variable Interest Entity

The Financial Accounting Standards Board (FASB) finalized
FASB Interpretation No. 46R, Consolidation of Variable Interest Entities  An
Interpretation of ARB51 (FIN46R) in December 2003. FIN46R expands the scope
of ARB51 and can require consolidation of variable interest entities (VIEs).
Once an entity is determined to be a VIE, the party with the controlling
financial interest, the primary beneficiary, is required to consolidate it. On
May 31, 2006 the Companys inactive Canadian subsidiary, Power Air (Canada)
Corp. was 50% owned by a Canadian resident individual and 50% owned by the
Company. On June 1, 2006 this subsidiary became active and Power Air (Canada)
Corp. began conducting scientific research and experimental development
activities in Canada and will apply for Canadian Scientific Research and
Experimental Development tax credits. The Company funds 100% of the expenditures
and is at risk for 100% of its losses and as a result is the party with the
controlling financial interest and the primary beneficiary. Power Air (Canada)
Corp. has no other financing other than amounts received from Power Air
Corporation.

Research and Development Expenditures

Due to the Companys lack of revenues and forecast of
significant capital required to develop a market for its products, the net
realizable value of prototype material and intangible assets is not reasonably
determinable. Accordingly, all research and development expenditures under
Cooperative Research and Development Agreement (CRADA) contracts, including the
costs of prototype material and the cost of obtaining intangible assets such as
patents, have been charged to operations.

Revenue Recognition

The Company will recognize revenue in accordance with
Securities and Exchange Commission Staff Accounting Bulletin No. 104 (SAB
104), Revenue Recognition in Financial Statements. Revenue will be recognized
only when the price is fixed or determinable, persuasive evidence of an
arrangement exists, the service is provided and collectibility is reasonably
assured.

33

---

The Company has not generated any revenue since inception on
October 15, 1997. The Company plans to receive funding from OEMs to engineer
products to OEM specifications. The Company then plans to receive license and
product fees under OEM contracts. Revenue recognition will be specific to the
terms of the contracts and will thus be determined in a later period.

Stock-Based Compensation

Prior to January 1, 2006 the Company accounted for stock-based
awards under the recognition and measurement provisions of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees using the
intrinsic value method of accounting, under which compensation expense was only
recognized if the exercise price of the Companys employee stock options was
less than the market price of the underlying common stock on the date of grant.
The Company also had adopted the disclosure-only alternative of SFAS No. 123,
Accounting for Stock-Based Compensation (SFAS 123) and SFAS No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure. In March
2005 the SEC issued SAB No. 107, Share-Based Payment (SAB 107) which provides
guidance regarding the interaction of SFAS 123R and certain SEC rules and
regulations. The Company has applied the provisions of SAB 107 in its adoption
of SFAS 123R.

Effective January 1, 2006, the Company adopted the fair value
recognition provisions of SFAS No. 123R Share Based Payments using the
modified retrospective transition method. SFAS 123R requires companies to
estimate the fair value of share-based payment awards on the date of grant using
an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense ratably over the requisite
service periods. The Company has estimated the fair value of each award as of
the date of grant or assumption using the Black-Scholes option pricing model,
which was developed for use in estimating the value of traded options that have
no vesting restrictions and that are freely transferable. The Black-Scholes
model considers, among other factors, the expected life of the award and the
expected volatility of the Companys stock price. Although the Black-Scholes
model meets the requirements of SFAS 123R and SAB 107, the fair values generated
by the model may not be indicative of the actual fair values of the Companys
awards, as it does not consider other factors important to those share-based
payment awards, such as continued employment, periodic vesting requirements, and
limited transferability.

The Company had no outstanding stock options or unvested share
based payments as of this date and prior to December 31, 2006. Accordingly,
there was no effect on the Companys previously reported loss from operations,
cash flows or loss per share as a result of adopting SFAS No 123R.

On April 1, 2006 the Board of Directors adopted a comprehensive
2006 Stock Incentive Plan to issue stock-based compensation, including stock
options, to officers, directors, employees and consultants of the Company. Also
on April 1, 2006 the Board of Directors passed a resolution to grant 2,550,000
stock options to certain officers, directors, employees and consultants. On June
15, 2006 an additional 200,000 stock options were granted to the Companys new
Chief Executive Officer, which are also exercisable at $0.65 for a period of two
years. On July 31, 2006 and August 16, 2006, the Board of Directors passed a
resolution to grant 135,000 stock options to employees. In addition, on April 1,
2006 and August 15, 2006, 1,000,000 stock options were issued to certain
consultants.

Foreign Currency Transactions/Balances

The Companys functional and reporting currency is the United
States dollar. Foreign currency transactions mainly occur in Canadian currency,
and management has adopted SFAS No. 52, Foreign Currency Translation. Monetary
assets and liabilities denominated in Canadian dollars are translated into
United States dollars at rates of exchange in effect at the balance sheet date.
Non-monetary assets, liabilities and items recorded in income arising from
transactions denominated in Canadian currencies are translated at rates of
exchange in effect at the date of the transaction. Any gain or loss on foreign
currency translation is included in operations. To date, such amounts have not
been significant.

34

---

Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141 (Revised)
Business Combinations. SFAS 141 (Revised) establishes principles and
requirements for how the acquirer of a business recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any non-controlling interest in the acquiree. The statement also provides
guidance for recognizing and measuring the goodwill acquired in the business
combination and determines what information to disclose to enable users of the
financial statements to evaluate the nature and financial effects of the
business combination. The guidance will become effective for the fiscal year
beginning after December 15, 2008. Management is in the process of evaluating
the impact SFAS 141 (Revised) will have on the Companys financial statements
upon adoption.

In December 2007, the FASB issued SFAS No. 160 Non-controlling
Interests in Consolidated Financial Statements-an amendment of ARB No. 51. SFAS
160 establishes accounting and reporting standards for the non-controlling
interest in a subsidiary and for the deconsolidation of a subsidiary. The
guidance will become effective for the fiscal year beginning after December 15,
2008. Management is in the process of evaluating the impact SFAS 160 will have
on the Companys financial statements upon adoption.

In February 2007, the Financial Accounting Standards Board
(FASB) issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities  Including an Amendment of FASB Statement No. 115. This
statement permits entities to choose to measure many financial instruments and
certain other items at fair value. Most of the provisions of SFAS No. 159 apply
only to entities that elect the fair value option. However, the amendment to
SFAS No. 115 Accounting for Certain Investments in Debt and Equity Securities
applies to all entities with available-for-sale and trading securities. SFAS No.
159 is effective as of the beginning of an entitys first fiscal year that
begins after November 15, 2007. Early adoption is permitted as of the beginning
of a fiscal year that begins on or before November 15, 2007, provided the entity
also elects to apply the provision of SFAS No. 157, Fair Value Measurements.
The adoption of this statement is not expected to have a material effect on the
Company's financial statements.

Item 3. Controls And Procedures

As required by Rule 13a-15 under the Exchange Act, we have
carried out an evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures as of the end of the period covered by
this quarterly report. This evaluation was carried out under the supervision and
with the participation of our management, including our principal executive
officer and principal financial officer. Based upon that evaluation, our
principal executive officer and principal financial officer concluded that our
disclosure controls and procedures are effective as at the end of the period
covered by this quarterly report to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
by the rules and forms of the SEC.

Disclosure controls and procedures are controls and other
procedures that are designed to ensure that information required to be disclosed
in our reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported, within time periods specified in the Securities and
Exchange Commissions rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in our reports filed under the Exchange Act
is accumulated and communicated to management, including our principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure.

There have been no changes in our internal controls over
financial reporting that occurred during our most recent quarterly period that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting.

35

---

PART II - OTHER INFORMATION

Risk Factors

Risks Related to Our Operating Results

Because we are currently a development stage company, we
have no products available for sale or use and may lack the financial resources
needed to bring products to market.

We are in the development stage and we have not completed the
development of any products incorporating our ZAFC technology that can be
commercially sold. We will not achieve commercialization of our products until
such time, if ever, that we complete further development of our technology and
design of products that may be commercially marketed and sold. Our long-term
viability growth and profitability will depend upon successful testing, approval
and commercialization of products incorporating our technology resulting from
our research and development activities. Adverse or inconclusive results in the
development and testing of these products could significantly delay or
ultimately preclude commercialization of our technology.

If we are unable to develop any commercially viable ZAFC
fuel cell based products that can be marketed and sold, then we may not be able
to achieve revenues and our business may fail.

We cannot guarantee that we will be able to develop
commercially viable fuel cell based products on the timetable we anticipate, or
at all. The commercialization of our fuel cell products requires substantial
technological advances to improve the efficiency, functionality, reliability,
cost and performance of these systems and products and to develop commercial
volume manufacturing processes for these systems and products. We cannot
guarantee that we will be able to internally develop the technology necessary
for commercialization of our fuel cell products, or that we will be able to
acquire or license the required technology from third parties. Developing the
technology for high-volume commercialization requires substantial capital, and
we cannot assure you that we will be able to generate or secure sufficient
funding on terms acceptable to us to pursue our high-volume commercialization
plans. In addition, before we release any product to market, we subject it to
numerous field tests. These field tests may encounter problems and delays for a
number of reasons, many of which are beyond our control. If these field tests
reveal technical defects or reveal that our products do not meet performance
goals, including useful life and reliability, our commercialization schedule
could be delayed, and potential purchasers may decline to purchase our systems
and products. Our inability to develop commercially viable fuel cell based
products that can be marketed and sold will result in our inability to earn
revenues and achieve profitability, with the result that our business may fail.

Because we have not earned any revenues from operations,
all our capital requirements have been met through financing and it is not
certain we will be able to continue to find financing to meet our operating
requirements.

Our business plan calls for significant expenses in connection
with the development of our ZAFC business. Our capital requirements have been
and will continue to be significant. We will be dependant on future financing to
fund our research and development as well as other working capital requirements.
We estimate that our current working capital will support our activities for no
more than 9 months. After that time we will need additional financing. There can
be no assurance that such additional financing will be forthcoming or that it
will result in sufficient capital for us to meet our expected working capital
needs. It is not anticipated that any of our officers, directors or current
shareholders will provide any significant portion of our future financing
requirements. Furthermore, in the event that our plans change, our assumptions
change or prove inaccurate, or our capital resources prove to be insufficient to
fund operations, we could be required to seek additional financing sooner than
currently anticipated, or in greater amounts than is currently anticipated. Any
inability to obtain additional financing when needed would have a material
adverse effect on us, including possibly requiring us to significantly curtail
or possibly cease our operations. In addition, any future equity financing may
involve substantial dilution to our existing shareholders.

36

---

Our auditors have expressed substantial doubt about our
ability to continue as a going concern.

Our audited financial statements for the period from inception
to December 31, 2007 have been prepared assuming that we will continue as a
going concern. We have incurred operating losses totalling $18,960,834 since
inception and, as a result, our auditors have expressed substantial doubt about
our ability to continue as a going concern. Our financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

Because we have not earned any revenues from operations,
all our capital requirements have been met through financing and it is not
certain we will be able to continue to find financing to meet our operating
requirements.

Notwithstanding the recent completion by us of our private
placement financings, we will need to obtain additional financing in order to
pursue our business plan. As of December 31, 2007, we had cash on hand of
$1,367,497 and working capital of $1,308,728. Our business plan calls for
significant expenses in connection with the development of our ZAFC technology
and new ZPAC product. Our capital requirements have been and will continue to be
significant. We will be dependant on future financing to fund our research and
development as well as other working capital requirements. We estimate that our
current working capital will support our activities for no more than five
months. After that time we will need additional financing. However, there can be
no assurance that such financing will be forthcoming or that it will result in
sufficient capital for us to meet our current and expected working capital
needs. It is not anticipated that any of our officers, directors or current
shareholders will provide any significant portion of our future financing
requirements. Furthermore, in the event that our plans change, our assumptions
change or prove inaccurate, or our capital resources prove to be insufficient to
fund operations, we could be required to seek additional financing sooner than
currently anticipated, or in greater amounts than is currently anticipated. Any
inability to obtain additional financing when needed would have a material
adverse effect on us, including possibly requiring us to significantly curtail
or possibly cease our operations. In addition, any future equity financing may
involve substantial dilution to our existing shareholders.

Because we have only recently commenced business
operations, we face a high risk of business failure and this could result in a
total loss of your investment.

We have not earned any revenues and we have not achieved
profitability as of the date of this annual report. Potential investors should
be aware of the difficulties normally encountered by development stage companies
and the high rate of failure of such enterprises. The likelihood of success must
be considered in light of the problems, expenses, difficulties, complications
and delays encountered in connection with the further commercialization of our
ZAFC technology. These potential problems include, but are not limited to,
unanticipated problems relating to costs and expenses that may exceed current
estimates. We have no history upon which to base any assumption as to the
likelihood that our business will prove successful, and we can provide no
assurance to investors that we will generate any operating revenues or ever
achieve profitable operations. If we are unsuccessful in addressing these risks,
our business will likely fail and you will lose your entire investment.

Because we have only recently commenced business
operations, we expect to incur operating losses for the foreseeable future.

We have never earned revenues and we have never been
profitable. Prior to completing the commercialization of our ZAFC technology and
ZPAC products, we anticipate that we will incur increased operating expenses
without realizing any revenues. We therefore expect to incur significant losses
into the foreseeable future. If we are unable to generate significant revenues
from the commercialization of our technology, our business will likely fail and
you will lose your entire investment.

We have no commercialization or strategic funding
agreements in place.

A key component of our business plan is to enter into strategic
relationships with OEMs with whom we would work to design and develop products
incorporating our ZAFC technology that would be manufactured, marketed and sold
by the OEMs. Although we have collaboration and tooling agreements in place we
currently have no commercialization or strategic partnership agreements in place
to assist in the development and funding of

37

---

additional prototypes. These agreements need to be completed as
soon as reasonably possible. Our growth will depend, in large part, on such
partnerships. If we are unable to develop and maintain these relationships, our
ability to penetrate and compete successfully in the fuel cell market would be
materially adversely affected, which would have a material adverse effect on our
business, results of operations, financial condition and cash flows.

We could lose or fail to attract the personnel necessary
to run our business.

Our success depends in large part on our ability to attract and
retain key management, engineering, scientific, manufacturing and operating
personnel. As we develop additional manufacturing capabilities and expand the
scope of our operations, we will require more skilled personnel. Recruiting
personnel for the fuel cell product industry is highly competitive. We cannot
guarantee that we will be able to continue to attract and retain qualified
executive, managerial and technical personnel needed for our business. Our
failure to attract or retain qualified personnel could delay or result in our
inability to complete our business plan for the commercialization of our ZAFC
fuel cell technology and our ZPAC products.

Our directors may experience conflicts of interest which
may detrimentally affect our profitability.

Certain directors and officers may be engaged in, or may in the
future be engaged in, other business activities on their own behalf and on
behalf of other companies and, as a result of these and other activities, such
directors and officers may become subject to conflicts of interest, which could
have a material adverse effect on our business.

Because our business operations are only two years old,
we may not be able to effectively manage the demands required of a new business
in our industry.

We have never earned revenues and we have never been
profitable. There can be no assurance that we will effectively execute our
business plan or manage any growth of our business, or that our future operating
and financial forecast will be met. Future development and operating results
will depend on many factors, including access to adequate capital, the
completion and regulatory approval of marketable products, the demand for our
products, the level of product and price competition, our success in setting up
and expanding distribution channels and whether we can control costs. Many of
these factors are beyond our control. In addition, our future prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered in establishing a new business in its industry, which is
characterized by intense competition, rapid technological change, highly
litigious competitors, potential product liability and significant regulation.
If we are unable to address these matters, or any of them, then we may not be
able to successfully implement our business plan for the commercialization of
our ZAFC fuel cell technology and development of ZPAC products or achieve
revenues or profitability.

Because we have a history of losses and anticipate
continued losses through our development stage, we may lack the financial
stability required to continue operations.

Since inception we have suffered recurring losses. We have
funded our operations through the issuance of common stock in order to meet our
strategic objectives. We anticipate that our losses will continue until such
time, if ever, as we are able to generate sufficient revenues to support our
operations. Our ability to generate revenue primarily depends on our success in
completing development and obtaining regulatory approvals for the commercial
sale of the products under development. There can be no assurance that any such
events will occur, that we will attain revenues from commercialization of our
products or that we will ever achieve profitable operations.

Even if we are able to successfully develop products
incorporating our ZAFC fuel cell technology or ZPAC design, our inability to
successfully manufacture these products, either ourselves or through OEMs with
whom we may enter into strategic relationships, would result in our inability to
commercialize our technology and achieve revenues .

To successfully commercialize our ZAFC fuel cell technology and
ZPAC products, we must develop, either ourselves or through OEMs with whom we
may enter into strategic relationships, the ability to manufacture our products
in quantities in compliance with regulatory requirements and at an acceptable
cost. We have no long-term

38

---

experience in manufacturing products and could experience
difficulties in development or manufacturing that could impair our ability to
successfully commercialize products incorporating our ZAFC fuel cell technology
or based on our ZPAC design. Moreover, there can be no assurance that we or
OEMs with whom we enter into strategic relationships will be successful in
scaling up manufacturing operations sufficient to produce our products in
sufficient volume and at acceptable manufacturing costs to generate market
acceptance.

A mass market for our products may never develop or may
take longer to develop than we anticipate.

Our zinc air products target emerging markets, and we do not
know whether end-users will want to use them. The development of a mass market
for our zinc air products may be affected by many factors, some of which are
beyond our control, including the emergence of newer, more competitive
technologies and products, the future cost of fuels used by our systems,
regulatory requirements, consumer perceptions of the safety of our products and
related fuels, and consumer reluctance to buy a new product, any of which could
have a material adverse effect on our business, results of operations, financial
condition and cash flows. In the event that consumers do not demand our products
or if the market for our products develops slower than we anticipate, then our
ability to achieve significant revenues and profitability will be impaired or
delayed.

We currently face and will continue to face significant
competition.

As zinc air products have the potential to replace existing
power products, competition for our products will come from current power
technologies, from improvements to current power technologies and from new
alternative power technologies, including other types of fuel cells. Each of our
target markets is currently serviced by existing manufacturers with existing
customers and suppliers. Additionally, there are competitors working on
developing technologies such as other types of fuel cells, advanced batteries
and hybrid battery/internal combustion engines in each of our targeted markets.
The fuel cell product market is becoming more competitive with products from
many companies, many of which are larger with greater financial resources. Many
large competitors may also eventually dominate the marketplace with access to
significantly more financing than our Company. Across the United States, Canada,
Europe and Japan, corporations, national laboratories and universities are
actively engaged in the development and manufacture of fuel cell products and
components. Each of these competitors has the potential to capture market share
in each of our target markets. If competitors are able to introduce competing
products that are more readily accepted by consumers or cost less than the
products incorporating our technology, then a significant consumer demand for
our products may not develop and we may not be able to achieve significant
revenues or profitability.

Because we are significantly smaller than the majority of
our national competitors we may lack the financial resources needed to capture
market share.

The market in which we intend to operate is dominated by
several large firms with established products, and our success will be dependant
upon acceptance of our products by the market as reliable, safe and
cost-effective power solutions. It may be difficult or impossible for us to
achieve such acceptance of our products in view of competitive market
conditions. Many of our competitors have substantial financial resources,
customer bases, manufacturing, marketing and sales capabilities, and businesses
or other resources, which give them significant competitive advantages over us.
Thus it is likely that they will be quicker to market than we will, with
products that will compete with our products, should our products be
successfully approved and commercialized. Moreover, even if we successfully
bring our products to market ahead of our projected competitors, established
competitors may be able to quickly bring products to market that would compete.
In addition, the market is subject to constant introduction of new products and
designs. Market acceptance of our products may be influenced by new products or
technologies that come to market, which could render our products obsolete or
prohibitively expensive. If we are unable to address these matters, or any of
them, then our products may not be able to compete in the marketplace with
products offered by competitors and we may not be able to achieve significant
revenues or profitability.

39

---

Because we may not be able to obtain all of the patents
for the products and processes we are currently developing and testing, we may
not be able to protect our intellectual property rights.

Our success will depend in part on whether we can obtain
additional patent protection for our products and processes, preserve trade
secrets and proprietary technology and operate without infringing upon patent or
other proprietary rights of third parties. We cannot provide any assurance that
any of our existing licensed patents will not be challenged or that we will be
able to achieve any future patent protection for our technology. Established
companies in our industry generally are aggressive in attempts to block new
entrants to their markets, and may allege that our products, if successfully
developed, interfere with the intellectual property rights of these companies.
Our success will depend on our products not infringing patents that belong to
others. Furthermore, the validity and breadth of claims in our licensed
technology patents involve complex legal and factual questions and, therefore,
are highly uncertain. Even if we are successful in obtaining additional patents
for our technology there can be no assurance that we will be able to
successfully assert our patents against competing products.

Moreover, our patent position is subject to complex factual and
legal issues that may give rise to uncertainty as to the validity, scope and
enforceability of a particular patent. Particularly, we cannot assure you that
any of our pending or future patent applications will be issued with the breadth
of claim coverage sought by us, if issued at all.

In addition, effective patent, trademark, copyright and trade
secret protection may be unavailable, limited or not applied for in certain
foreign countries.

We may be involved in intellectual property litigation
that causes us to incur significant expenses or prevents us from selling our
products.

We may become subject to lawsuits in which it is alleged that
we have infringed the intellectual property rights of others or commence
lawsuits against others who we believe are infringing upon our rights. Our
involvement in intellectual property litigation could result in significant
expense to us, adversely affecting the development of sales of the challenged
product or intellectual property and diverting the efforts of our technical and
management personnel, whether or not such litigation is resolved in our favour.
In the event of an adverse outcome as a defendant in any such litigation, we
may, among other things, be required to: pay substantial damages; cease the
development, manufacture, use, sale or importation of products that infringe
upon other patented intellectual property; expend significant resources to
develop or acquire non-infringing intellectual property; discontinue processes
incorporating infringing technology; or obtain licenses to the infringing
intellectual property, any of which could have a material adverse effect on our
business and financial results.

We are dependent on third party suppliers for the supply
of key materials and components for our products.

We have established relationships with third party suppliers,
upon whom we rely to provide materials and components for our products. A
suppliers failure to supply materials or components in a timely manner, or to
supply materials and components that meet our quality, quantity or cost
requirements, or our inability to obtain substitute sources for these materials
and components in a timely manner or on terms acceptable to us, could harm our
ability to manufacture our products. To the extent that the processes which our
suppliers use to manufacture the materials and components are proprietary, we
may be unable to obtain comparable materials or components from alternative
suppliers, and that could adversely affect our ability to produce viable fuel
cell products at a reasonable price or significantly raise our cost of producing
such products. In addition, zinc is a key component of our fuel cells. While we
do not anticipate significant near or long term shortages in the supply of zinc,
increases in the price of zinc could adversely affect our ability to produce
commercially viable zinc air products, or significantly raise our cost of
producing such products.

We anticipate that we will be dependent upon OEMs to
purchase certain of our products.

To be commercially useful, most of our zinc air products must
be integrated into products manufactured by OEMs. We can offer no guarantee that
OEMs will manufacture appropriate products or, if they do manufacture such
products, that they will choose to use our zinc air products. Any integration,
design, manufacturing or marketing

40

---

problems encountered by OEMs could materially adversely affect
our ability to achieve commercialization of products incorporating our ZAFC fuel
cell technology or ZPAC design.

Because product liability is inherent in the Companys
industry and insurance is expensive and difficult to obtain, the Company may be
exposed to large lawsuits.

Our business exposes us to potential product liability risks,
which are inherent in the testing, manufacturing, marketing and sale of its
proposed products. While we will take precautions that we deem to be appropriate
to avoid product liability suits against us, there can be no assurance that we
will be able to avoid significant product liability exposure. Product liability
insurance for our industry is generally expensive, to the extent it is available
at all. We have not yet sought to obtain product liability coverage. We intend
to obtain such coverage when it is apparent that our products will be
marketable. There can be no assurance that we will be able to obtain such
coverage on acceptable terms, or that any insurance policy will provide adequate
protection against potential claims. A successful product liability claim
brought against us may exceed any insurance coverage secured by us and could
require us to pay a judgement or settlement amount that is substantial in terms
of our available financial and capital resources.

Regulatory changes could hurt the market for products
incorporating our zinc air technology.

Changes in existing government regulations and the emergence of
new regulations with respect to zinc air or fuel cell products may hurt the
market for our products. Environmental laws and regulations in the U.S.
(particularly in California) and other countries have driven interest in fuel
cell systems; and the deregulation of the electric utility industry in the U.S.
and elsewhere has created market opportunities for fuel cell products in the
portable, stationary, light mobility and transportation markets. We cannot
guarantee that these laws and policies will not change. Changes in these laws
and other laws and policies or the failure of these laws and policies to become
more widespread could result in manufacturers abandoning their interest in fuel
cell products or favouring alternative technologies. In addition, as products
are introduced into our target markets, the U.S. and other governments may
impose burdensome requirements and restrictions on the use of fuel cells or zinc
air technology that could reduce or eliminate demand for some or all of our
products. Accordingly, changes in government regulation could reduce demand for
products incorporating our zinc air technology.

Risks Related to Our Common Stock

The trading price of our common stock can be volatile.

The price of our common shares may increase or decrease in
response to a number of events and factors, including: trends in the fuel cell
markets in which we operate; changes in the market price of the commodities we
use in our products; current events affecting the economic situation in North
America; changes in financial estimates; our acquisitions and financings;
quarterly variations in our operating results; the operating and share price
performance of other companies that investors may deem comparable; and purchase
or sale of blocks of our common shares. These factors, or any of them, may
materially adversely affect the prices of our common shares regardless of our
operating performance.

A decline in the price of our common stock could affect
our ability to raise further working capital and adversely impact our
operations.

A decline in the price of our common stock could result in a
reduction in the liquidity of our common stock and a reduction in our ability to
raise additional capital for our operations. Because our operations to date have
been principally financed through the sale of equity securities, a decline in
the price of our common stock could have an adverse effect upon our liquidity
and our continued operations. A reduction in our ability to raise equity capital
in the future would have a material adverse effect upon our business plan and
operations, including our ability to continue our current operations. If our
stock price declines, we may not be able to raise additional capital or generate
funds from operations sufficient to meet our obligations.

41

---

Because our stock is traded on the OTCBB and not a larger
or more recognized exchange, investors may find it difficult to sell their
shares or obtain accurate quotations for share prices.

Our common stock is traded on the NASD Over-the-Counter
Bulletin Board (the OTCBB). Investors may find it more difficult to dispose
of, or to obtain accurate quotations as to the market value of our common stock
than would otherwise be the case if our common stock was listed on a more
recognized stock exchange or quotation service. In addition, trading in our
common stock is currently subject to certain rules under the U.S. Securities
Exchange Act of 1934, as amended (the Exchange Act), which require additional
disclosure by broker-dealers in connection with any trades involving a stock
defined as a penny stock. Penny stocks are generally non-NASD equity
securities with a market price less than $5.00 per share. The penny stock rules
require broker-dealers selling penny stocks to make certain disclosures about
such stocks to purchasers thereof, and impose sales practice restrictions on
broker-dealers in certain penny stock transactions. The additional burdens
imposed upon broker-dealers by these rules may discourage them from effecting
transactions in our common stock, which could limit the liquidity of the common
stock and the ability of our stockholders to sell their stock in the secondary
market.

Four of our seven directors and two of our three senior
officers are outside the United States, with the result that it may be difficult
for investors to enforce within the United States any judgments obtained against
us or any of our directors or officers.

Four of our seven directors and two of our three senior
officers are nationals and/or residents of countries other than the United
States, and all or a substantial portion of such persons assets are located
outside the United States. As a result, it may be difficult for investors to
effect service of process on our directors or officers, or enforce within the
United States or Canada any judgments obtained against us or our officers or
directors, including judgments predicated upon the civil liability provisions of
the securities laws of the United States or any state thereof. Consequently, you
may be effectively prevented from pursuing remedies under U.S. federal
securities laws against them. In addition, investors may not be able to commence
an action in a Canadian court predicated upon the civil liability provisions of
the securities laws of the United States. The foregoing risks also apply to
those experts identified in this annual report that are not residents of the
United States.

Our stock is a penny stock. Trading of our stock may be
restricted by the SECs penny stock regulations and the NASDs sales practice
requirements, which may limit a stockholders ability to buy and sell our stock.

Our stock is a penny stock. The Securities and Exchange
Commission (the SEC) has adopted Rule 15g-9 which generally defines penny
stock to be any equity security that has a market price (as defined) less than
$5.00 per share or an exercise price of less than $5.00 per share, subject to
certain exceptions. Our securities are covered by the penny stock rules, which
impose additional sales practice requirements on broker-dealers who sell to
persons other than established customers and accredited investors. The term
accredited investor refers generally to institutions with assets in excess of
$5,000,000 or individuals with a net worth in excess of $1,000,000 or annual
income exceeding $200,000, or $300,000 jointly with their spouse. The penny
stock rules require a broker-dealer, prior to a transaction in a penny stock not
otherwise exempt from the rules, to deliver a standardized risk disclosure
document in a form prepared by the SEC which provides information about penny
stocks and the nature and level of risks in the penny stock market. The
broker-dealer also must 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, and monthly account statements showing the
market value of each penny stock held in the customers account. The bid and
offer quotations, and the broker-dealer and salesperson compensation
information, must be given to the customer orally or in writing prior to
effecting the transaction and must be given to the customer in writing before or
with the customers confirmation. In addition, the penny stock rules require
that prior to a transaction in a penny stock not otherwise exempt from these
rules, the broker-dealer must 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. These disclosure requirements
may have the effect of reducing the level of trading activity in the secondary
market for the stock that is subject to these penny stock rules. Consequently,
these penny stock rules may affect the ability of broker-dealers to trade our
securities. We believe that the penny stock rules discourage investor interest
in and limit the marketability of our common stock. In addition to the penny
stock rules promulgated by the SEC, the NASD has adopted rules that require
that in recommending an investment to a customer, a broker-

42

---

dealer must have reasonable grounds for believing that the
investment is suitable for that customer. Prior to recommending speculative
low-priced securities to their non-institutional customers, broker-dealers must
make reasonable efforts to obtain information about the customers financial
status, tax status, investment objectives and other information. Under
interpretations of these rules, the NASD believes that there is a high
probability that speculative low priced securities will not be suitable for at
least some customers. The NASD requirements make it more difficult for
broker-dealers to recommend that their customers buy our common stock, which may
limit your ability to buy and sell our stock and have an adverse effect on the
market for our shares.

Item 1. Legal Proceedings

We currently are not a party to any material legal proceedings
and, to our knowledge, no such proceedings are threatened or contemplated.

Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds

In March and April of 2007 we completed a private placement
(the Private Placement) by the Company of promissory notes for $2,190,000 (the
Notes) and securities (Equity Consideration Certificates). The Notes have a
interest rate of 10% per annum payable quarterly commencing May 31, 2007 and due
on the earlier of: (i) September 30, 2007 or (ii) the third business day
following the completion of an underwritten public offering or a private
placement by the Company resulting in gross proceeds of $5 million or more (the
Qualified Offering). Repayment of the Notes will be secured by a lien on all
tangible and intangible assets of the Company and each of its subsidiaries to be
evidenced by a security agreement and a security and pledge agreement from the
Company for 100% of the stock in each of its subsidiaries. Each Purchaser also
received an Equity Consideration Certificate in an amount equal to such
purchasers Note. The Equity Consideration Certificate will entitle the
purchaser to receive either Primary Equity Consideration or Alternate Equity
Consideration. The Primary Equity Consideration consists of the identical
securities that the Company will sell in its next Qualified Offering. The number
of such securities to be received by each purchaser shall be the result obtained
by dividing 100% of the original principal amount of the Note purchased by such
purchaser in this offering by the price of the security, or package of
securities, sold by the Company in the Qualified Offering. The Equity
Consideration shall be delivered to the purchaser (or its transferee or
assignee) within three business days following the closing of the Qualified
Offering. The Alternate Equity Consideration consist of that number of shares
of common stock of the Company that equal the principal amount of the Notes
divided by $0.40 plus an equal number of non-callable warrants exercisable at
$0.50 per share for a period of seven years from such issuance, which will have
a cashless exercise feature if, at any time after one year from the first
closing of the Private Placement, the underlying shares of common stock are not
covered by an effective registration statement with a current prospectus
available. The Alternate Equity Consideration will be issued to the Purchasers
on the first business day following the later of September 30, 2007 or an
extended maturity date, if a Qualified Offering shall not have occurred by such
date. The Notes were sold to the purchasers who purchased as accredited
investors as that term is defined in Rule 501(a) of Regulation D under the
Securities Act of 1933, as amended. Pursuant to an agreement (the Financing
Agreement) dated for reference March 5, 2007 among the Company and Paulson
Investment Company, Inc. and High Capital Funding, LLC (together, the Placement
Agents), as amended, the Placement Agents acted as agents of the Company for
the Private Placement.

On June 5, 2007 the Company received $80,000 and will issue
200,000 common shares pursuant to a private placement of common shares at $0.40
per share to an offshore purchaser.

Also on June 5, 2007, we issued an aggregate of 14,285,716
units (as previously defined, each a Unit) at a price of $0.35 per Unit for
total gross proceeds of $5,000,000 in a private placement (as previously
defined, the Private Placement Offering), with each Unit being comprised of
one share of common stock and one non-transferable share purchase warrant (as
previously defined, each a Warrant) of the Company, and with each Warrant
entitling the holder to purchase one additional share of common stock of the
Company at an exercise price of $0.50 per share from the date of issuance to the
date of expiry on June 5, 2009. The 14,285,716 Units were sold to purchasers who
were offshore pursuant to Regulation S under the United States Securities Act
of 1933, a amended (the Securities Act).

43

---

As the Private Placement Offering constituted a Qualified
Offering, on June 5, 2007, we also issued an aggregate of 6,257,118 Units to the
lenders under the Financing on the same terms and conditions as the Private
Placement Offering for no additional consideration.

On July 16, 2007, we entered into an agreement with Elite
Financial Communications Group, LLC (Elite) to manage all aspects of our
investor and media relations program (the Elite Agreement). Pursuant to the
Elite Agreement, an aggregate of 300,000 non-transferable common stock purchase
warrants (each a Warrant) to purchase up to an equivalent number of common
shares of Power Air (each a Warrant Share) has been issued to Elite in the
following manner and with the following exercise and vesting terms as set forth
in the Agreement: (a) an initial 150,000 of the Warrants (the Initial
Warrants) on July 16, 2007, with each such Initial Warrant being exercisable
for one Warrant Share of Power Air for the period commencing on July 16, 2007
and expiring at 5:00 p.m. (Livermore, California, time) on the date which is two
years from the effective date of Power Airs proposed registration statement, if
any, pursuant to which the Warrant Shares underlying the Initial Warrants are to
be proposed for registration under the United States Securities Act of 1933, as
amended (the Securities Act; and such time period, the Warrant Exercise
Period), at an exercise price of $0.45 per Warrant Share during the Warrant
Exercise Period; and (b) the final 150,000 of the Warrants (the Final
Warrants) will be issued to Elite and vest on the 181st day following July 16,
2007 with each such Final Warrant then being exercisable for one Warrant Share
of Power Air during the same Warrant Exercise Period at an exercise price of
$0.60 per Warrant Share. Power Air also agreed to issue to Elite piggyback
registration rights for the common shares underlying the warrants, whereby these
shares will be registered for resale by Elite on the first applicable
registration statement filed by Power Air with the Securities and Exchange
Commission. The term of the Warrants expire 24 months from the date the
registration statement registering the shares underlying the Warrants is deemed
effective. This issuance of the Warrants was completed on a private placement
basis pursuant to the terms of the Agreement by Power Air to Elite as an
accredited investor as that term is defined in Rule 501(a) of Regulation D
under the Securities Act.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to our security holders for a vote
during the three months ended December 31, 2007.

Item 5. Other Information

None.

Item 6. Exhibits

The following exhibits are included with this Quarterly Report
on Form 10-QSB:

|Exhibit |                                                                                                                                                                  
|------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number  | Description of Exhibit                                                                                                                                           
|        |                                                                                                                                                                  
|3.1     | Articles of
      Incorporation(1)                                                                                                                               
|        |                                                                                                                                                                  
|3.2     | Bylaws(1)                                                                                                                                                        
|        |                                                                                                                                                                  
|10.1    | Share Exchange
      Agreement among the Company, the Vendor, Power Air, the HDH Group and Dean
      Haley, dated for reference effective on August 22, 2005.(2)
|        |                                                                                                                                                                  
|10.2    | Stephen Williams
      Services Contract between the Company and Stephen Williams, dated for
      reference effective on October 1, 2005, as amended.(2)(3)     

44

---

|Exhibit |                                                                                                                                                                                                                                                                                                                                                          
|------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                   
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.3    | Sales and Marketing
        Employment Agreement among the Company, Power Air and Donald Ceci, dated
        for reference effective on October 3, 2005.(2)                                                                                                                                                                                              
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.4    | Corporate Development
        Employment Agreement among the Company, Power Air and Remy Kozak, dated
        for reference effective on October 3, 2005, as amended.(2)(3)                                                                                                                                                                              
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.5    | Development
        and Pre-Manufacturing Agreement dated September 27, 2006 between the Company
        and Mid States Tool and Machine Inc.(5)                                                                                                                                                                                                         
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.6    | 2006 Stock Incentive
        Plan(4)                                                                                                                                                                                                                                                                                                                     
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.7    | Financing Agreement
        dated March 4, 2007 among the Company, Paulson Investment Company, Inc.
        and High Capital Funding, LLC (including the form of the Secured Promissory
        Note, the form of the Equity Consideration Certificate, the form of the
        Security Agreement and the form of the Security and Pledge Agreement).(6)
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.8    | Form of the
        Subscription Agreement between the Company and each of the purchasers
        for the Note and the Equity Consideration Certificates.(6)                                                                                                                                                                                             
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.9    | Form of the
        $0.35 Unit Private Placement Subscription Agreement between the Company
        and each of the purchasers of the Units under the Private Placement Offering.(7)                                                                                                                                                                     
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.10   | Form of the
        Non-U.S. Share Purchase Warrant Certificate utilized with the Private
        Placement Offering. (7)                                                                                                                                                                                                                                
|        |                                                                                                                                                                                                                                                                                                                                                          
|10.11   | Service Agreement
        dated July 16, 2007 between the Company and Elite Financial Communications
        Group, LLC regarding the Companys investor and media relations program.(8)                                                                                                                                                                 
|        |                                                                                                                                                                                                                                                                                                                                                          
|21.1    | Subsidiaries
        of the Company:                                                                                                                                                                                                                                                                                                                     
|        |                                                                                                                                                                                                                                                                                                                                                          
|        | Power Air Tech,
        Inc. (Delaware) (100%) Power Air (Canada) Corp. (British Columbia) (50%)                                                                                                                                                                                                                                                         
|        |                                                                                                                                                                                                                                                                                                                                                          
|31.1    | Certifications
        of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
        pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 21,
        2007.                                                                                                                                                          
|        |                                                                                                                                                                                                                                                                                                                                                          
|31.2    | Certifications
        of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
        pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 21,
        2007.                                                                                                                                                          
|        |                                                                                                                                                                                                                                                                                                                                                          
|32.1    | Certification
        of Chief Executive Officer and Chief Financial Officer pursuant to 18
        U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
        Act of 2002, dated May 21, 2007.                                                                                                                               

|(1) | Previously filed with the SEC as an exhibit to our
      Registration Statement on Form SB-2 as originally filed with the SEC on
      December 2, 2004.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                         
|(2) | Previously filed with the SEC as an exhibit to our
      Current Report on Form 8-K as originally filed with the SEC on October 7,
      2005.          
|    |                                                                                                                                                         
|(3) | Previously filed with the SEC as an exhibit to our Form
      SB-2 as originally filed with the SEC on June 12, 2006.                                   
|    |                                                                                                                                                         
|(4) | Previously filed with the SEC as an exhibit to our Form
      S-8 as originally filed with the SEC on July 3, 2006.                                     
|    |                                                                                                                                                         
|(5) | Previously filed with the SEC as an exhibit to our Form
      10-QSB as originally filed with the SEC on February 14, 2007.                             
|    |                                                                                                                                                         
|(6) | Previously filed with the SEC as an exhibit to our Form
      8-K as originally filed with the SEC on April 16, 2007.                                   
|    |                                                                                                                                                         
|(7) | Previously filed with the SEC as an exhibit to our Form
      8-K as originally filed with the SEC on June 5, 2007.                                     
|    |                                                                                                                                                         
|(8) | Previously filed with the SEC as an exhibit to our Form
      8-K as originally filed with the SEC on July 16,
2007.                                    

45

---

SIGNATURES

In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

POWER AIR CORPORATION





/s/ H. Dean Haley H. Dean HaleyExecutive
Chairman, President, Chief Executive Officer Chief Operating Officer and
Principal Executive Officer

Date: February 14, 2008.





/s/ Alan Campbell Alan Campbell Secretary,
Treasurer, Chief Financial Officer and Principal Accounting Officer

Date: February 14, 2008.

46

---