SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549




FORM
10-Q




x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)


OF THE
SECURITIES EXCHANGE ACT OF 1934




For the
quarterly period ended: March 31, 2010




OR




 ̈
TRANSITION REPORT UNDER SECTION 13 OR 15 (d)


OF THE
SECURITIES EXCHANGE ACT OF 1934




For the
transition period from ___________ to ___________




Commission
File No.  0-31805




POWER
EFFICIENCY CORPORATION


(Exact
Name of Issuer as Specified in its Charter)




Delaware
                (State
      or Other Jurisdiction of
                Incorporation
      or Organization)
              
              22-3337365
                (I.R.S.
      Employer Identification No.)3960
      Howard Hughes Pkwy, Suite 460
                Las
      Vegas, NV 89169
                (Address
      of Principal Executive Offices)
              
              (702)
      697-0377
                (Issuer's
      Telephone Number,
                Including
      Area Code)




Check whether the issuer (1) filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the past 12 months (or for such shorter period that the
Company was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YesxNo ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):





Large
Accelerated filer  ̈   Accelerated
filer  ̈  Non-Accelerated
filer  ̈  Smaller
reporting company x




Indicate by check mark whether the
Company is a shell company (as defined in Rule 12b-2 of the Exchange
Act).  Yes ̈Nox




The
number of shares of common stock outstanding as of May 13, 2010 was
45,065,883.




Transitional Small Business Disclosure
Format (check one):   Yes ̈ Nox




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Date File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes ̈No ̈





POWER
EFFICIENCY CORPORATION


FORM
10-Q INDEX




PART
      I - FINANCIAL INFORMATIONITEM
      1. Financial Statements (Unaudited)Condensed
      Balance Sheet as of March 31, 2010 and December 31, 2009
                      3Condensed
      Statements of Operations for the three monthsended
      March 31, 2010 and 2009
                      4Condensed
      Statements of Cash Flows for the three monthsended
      March 31, 2010 and 2009
                      5Notes
      to Condensed Financial Statements
                      6-13ITEM
      2. Management's Discussion and AnalysisOf
      Financial Condition and Results of Operations
                      14-24ITEM
      3. Quantitative and QualitativeDisclosure
      About Market Risk
                      25ITEM
      4T. Controls and Procedures
                      25Part
      II — OTHER INFORMATIONITEM
      1. Legal Proceedings
                      26ITEM
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                      26ITEM
      3. Defaults Upon Senior Securities
                      26ITEM
      4. Reserved
                      26ITEM
      5. Other Information
                      26ITEM
      6. Exhibits
                      27Signatures
                      28Certification
      of Chief Executive Officer as AdoptedCertification
      of Chief Financial Officer as Adopted


2


PART
I. FINANCIAL INFORMATION


Item
1. Financial Statements





POWER
EFFICIENCY CORPORATION


CONDENSED
BALANCE SHEET


Unaudited


March 31, 2010
                      
                      
                      December 31, 2009ASSETSCURRENT
      ASSETS:Cash
                      
                      $
                      31,205
                      
                      
                      $
                      247,564Accounts
      receivable, net
                      
                      
                      82,983
                      
                      
                      
                      66,143Inventory
                      
                      
                      216,950
                      
                      
                      
                      281,253Prepaid
      expenses and other current assets
                      
                      
                      56,521
                      
                      
                      
                      36,437Total
      Current Assets
                      
                      
                      387,659
                      
                      
                      
                      631,397PROPERTY
      AND EQUIPMENT, Net
                      
                      
                      72,732
                      
                      
                      
                      86,533OTHER
      ASSETS:Patents,
      net
                      
                      
                      86,990
                      
                      
                      
                      86,342Deposits
                      
                      
                      26,914
                      
                      
                      
                      26,914Goodwill
                      
                      
                      1,929,963
                      
                      
                      
                      1,929,963Total
      Other Assets
                      
                      
                      2,043,867
                      
                      
                      
                      2,043,219Total
      Assets
                      
                      $
                      2,504,258
                      
                      
                      $
                      2,761,149LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued expenses
                      
                      $
                      887,926
                      
                      
                      $
                      722,195Notes
      payable – related party
                      
                      
                      125,000
                      
                      
                      
                      -Warrant
      liability
                      
                      
                      313,945
                      
                      
                      
                      828,827Total
      Current Liabilities
                      
                      
                      1,326,871
                      
                      
                      
                      1,551,002LONG
      TERM LIABILITIESDeferred
      rent
                      
                      
                      6,867
                      
                      
                      
                      8,918Deferred
      tax liability
                      
                      
                      412,054
                      
                      
                      
                      399,567Total
      Long Term Liabilities
                      
                      
                      418,921
                      
                      
                      
                      408,485Total
      Liabilities
                      
                      
                      1,745,792
                      
                      
                      
                      1,959,507STOCKHOLDERS'
      EQUITY:Series
      B and C-1 Convertible Preferred  Stock, $.001 par value,
      10,000,000 shares authorized, 174,625 and 170,250 issued and outstanding
      in 2010 and 2009, respectively
                      
                      
                      175
                      
                      
                      
                      170Common
      stock, $.001 par value, 140,000,000 shares authorized, 44,825,886 issued
      and outstanding 43,255,441 issued and outstanding in 2010 and
      2009
                      
                      
                      44,826
                      
                      
                      
                      44,826Additional
      paid-in capital
                      
                      
                      37,244,925
                      
                      
                      
                      36,797,628Accumulated
      deficit
                      
                      
                      (36,531,460
                      )
                      
                      
                      (36,040,982
                      )Total
      Stockholders' Equity
                      
                      
                      758,466
                      
                      
                      
                      801,642Total
      Liabilities and Stockholders' Equity
                      
                      $
                      2,504,258
                      
                      
                      $
                      2,761,149





Accompanying
notes are an integral part of the financial statements


3


POWER
EFFICIENCY CORPORATION


CONDENSED
STATEMENTS OF OPERATIONS


Unaudited





For the three months ended
                  March 31,20092010
                
                
                (As Adjusted)REVENUES
                
                $
                110,030
                
                
                $
                47,147COST
      OF REVENUES
                
                
                92,270
                
                
                
                28,808GROSS
      PROFIT
                
                
                17,760
                
                
                
                18,339COSTS
      AND EXPENSES:Research
      and development
                
                
                169,679
                
                
                
                247,044Selling,
      general and administrative
                
                
                614,078
                
                
                
                571,487Depreciation
      and amortization
                
                
                14,437
                
                
                
                19,315Total
      Costs and Expenses
                
                
                798,194
                
                
                
                837,846LOSS
      FROM OPERATIONS
                
                
                (780,434
                )
                
                
                (819,507
                )OTHER
      INCOME (EXPENSE):Interest
      income
                
                
                5
                
                
                
                9,085Change
      in fair value of warrant liability
                
                
                514,882
                
                
                
                (320,498
                )Total
      Other Income (expense)
                
                
                514,887
                
                
                
                (311,413
                )LOSS
      BEFORE PROVISION FOR INCOME TAXES
                
                
                (265,547
                )
                
                
                (1,130,920
                )PROVISION
      FOR INCOME TAXES
                
                
                16,821
                
                
                
                12,486NET
      LOSS
                
                $
                (282,368
                )
                
                $
                (1,143,406
                )DIVIDENDS
      PAID OR PAYABLE ON SERIES B AND SERIES C-1 PREFERED STOCK
                
                
                208,110
                
                
                
                233,333NET
      LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
                
                $
                (490,478
                )
                
                $
                (1,376,739
                )BASIC
      AND FULLY DILUTED LOSS PER COMMON SHARE
                
                $
                (0.01
                )
                
                $
                (0.03
                )WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING OUTSTANDING, BASIC
                
                
                44,825,883
                
                
                
                43,255,441





Accompanying
notes are an integral part of the financial statements


4


POWER
EFFICIENCY CORPORATION


CONDENSED
STATEMENTS OF CASH FLOWS


Unaudited


For
      the three months ended March 31,20092010
                
                
                (As Adjusted)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                
                $
                (282,368
                )
                
                $
                (1,143,406
                )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                
                
                14,437
                
                
                
                19,315Warrants
      and options issued to employees and consultants
                
                
                64,192
                
                
                
                83,399Change
      in fair value of warrant liability
                
                
                (514,882
                )
                
                
                320,498Provision
      for bad debt
                
                
                -
                
                
                
                (11,342
                )Changes
      in assets and liabilities:Accounts
      receivable, net
                
                
                (16,840
                )
                
                
                18,017Inventory
                
                
                64,303
                
                
                
                (114,053
                )Prepaid
      expenses and other current assets
                
                
                (20,084
                )
                
                
                (68,147
                )Accounts
      payable and accrued expenses
                
                
                165,731
                
                
                
                (7,459
                )Deferred
      tax liability
                
                
                12,487
                
                
                
                12,486Deferred
      rent
                
                
                (2,051
                )
                
                
                (942
                )Net
      Cash Used in Operating Activities
                
                
                (515,075
                )
                
                
                (891,634
                )CASH
      FLOWS FROM INVESTING ACTIVITIESCosts
      related to patent applications
                
                
                (1,284
                )
                
                
                -Purchases
      of property and equipment
                
                
                -
                
                
                
                (6,476
                )Net
      Cash Used in Investing Activities
                
                
                (1,284
                )
                
                
                (6,476
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuance of equity securities
                
                
                175,000
                
                
                
                -Proceeds
      from issuance of note payable
                
                
                125,000
                
                
                
                -Net
      Cash Provided by Financing Activities
                
                
                300,000
                
                
                
                -Decrease
      in cash
                
                
                (216,359
                )
                
                
                (898,110
                )Cash
      at beginning of period
                
                
                247,564
                
                
                
                2,100,013Cash
      at end of period
                
                $
                31,205
                
                
                $
                1,201,903




Accompanying notes are an integral part
of the financial statements




5




NOTE
1 - BASIS OF PRESENTATION




The
accompanying financial statements have been prepared by the Company, without an
audit. In the opinion of management, all adjustments have been made, which
include normal recurring adjustments necessary to present fairly the condensed
financial statements. Operating results for the three months ended March 31,
2010 are not necessarily indicative of the operating results for the full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. The Company
believes that the disclosures provided are adequate to make the information
presented not misleading. These unaudited condensed financial statements should
be read in conjunction with the audited financial statements and related notes
included in the Company’s Annual Report for the year ended December 31, 2009 on
Form 10-K and Form S-1.




The
preparation of condensed financial statements in conformity with accounting
principles generally accepted in the United States of America 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 dates of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.




NOTE
2 - GOING CONCERN:





The
accompanying financial statements have been prepared assuming the Company is a
going concern, which assumption contemplates the realization of assets and
satisfaction of liabilities in the normal course of business.  The
Company experienced a $515,075 deficiency of cash from operations for the three
months ended March 31, 2010, and lacks sufficient liquidity to continue its
operations.





These
factors raise substantial doubt about the Company's ability to continue as a
going concern.  The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amount of liabilities that might be necessary should the Company
be unable to continue in existence.  Continuation of the Company as a
going concern is dependent upon achieving profitable
operations.  Management's plans to achieve profitability include
developing new products, obtaining new customers and increasing sales to
existing customers.  Management is seeking to raise additional capital
through equity issuance, debt financing or other types of
financing.  However, there are no assurances that sufficient capital
will be raised.  If we are unable to obtain sufficient capital on
reasonable terms, we would be forced to restructure, file for bankruptcy or
cease operations.





NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Except as
disclosed in Note 10 below, there were no significant changes to the Company’s
significant accounting policies as disclosed in Note 3 of the Company’s
financial statements included in the Company’s Annual Report of Form 10-K for
the year ended December 31, 2009.


6


New
Accounting Pronouncements:





In
October 2009, the Financial Accounting Standards Board issued Accounting
Standards Update 2009-13, “Revenue Recognition (Topic 605) Multiple-Deliverable
Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force (“ASU
2009-13”).  ASU 2009-13 amends existing accounting guidance for
separating consideration in multiple-deliverable arrangements.  ASU
2009-13 establishes a selling price hierarchy for determining the selling price
of a deliverable.  The selling price used for each deliverable will be
based on vendor-specific objective evidence if available, third-party evidence
if vendor-specific evidence is not available, or estimated selling price if
neither vendor-specific evidence nor third-party evidence is
available.  ASU 2009-13 eliminates residual method of allocation and
requires that arrangement consideration be allocated at the inception of the
arrangement to all deliverables using the “relative selling price
method.”  The relative selling price method allocates any discount in
the arrangement proportionately to each deliverable on the basis of each
deliverable’s selling price.  ASU 2009-13 requires that a vendor
determine its best estimate of selling price in a manner that is consistent with
that used to determine the price to sell the deliverable on a stand-alone
basis.  ASU 2009-13 is effective prospectively for revenue
arrangements entered into or materially modified in fiscal years beginning on or
after June 15, 2010, with earlier adoption permitted.  We have not yet
determined the impact of the adoption of ASU 2009-13 on our consolidated
financial statements; however, we do not expect the adoption of the guidance
provided in this codification update to have any material impact on our
financial statements.




In
January 2010, the FASB issued accounting standards update (ASU) No. 2010-06,
Fair Value Measurements and Disclosures (Topic 820)—Improving Disclosures about
Fair Value Measurements (ASU No. 2010-06). ASU No. 2010-06 requires: (1) fair
value disclosures of assets and liabilities by class; (2) disclosures about
significant transfers in and out of Levels 1 and 2 on the fair value hierarchy,
in addition to Level 3; (3) purchases, sales, issuances and settlements be
disclosed on gross basis on the reconciliation of beginning and ending balances
of Level 3 assets and liabilities; and (4) disclosures about valuation methods
and inputs used to measure the fair value of Level 2 assets and liabilities. ASU
No. 2010-06 becomes effective for the first financial reporting period beginning
after December 15, 2009, except for disclosures about purchases, sales,
issuances and settlements of Level 3 assets and liabilities which will be
effective for fiscal years beginning after December 15, 2010. The adoption of
the level 1 and level 2 provisions of ASC No 2010-06 did not have an impact on
our financial statements.  We are currently assessing what impact, if
any, the adoption of the level 3 provision will have on our fair value
disclosures.  However, we do not believe it will have a material
impact on our financial statements





NOTE
4 – INVENTORIES





Inventories
are valued at the lower of cost (first-in, first-out) or market.  The
Company reviews inventory for impairments to net realizable value whenever
circumstances arise.  Such circumstances may include, but are not
limited to, the discontinuation of a product line or re-engineering certain
components making certain parts obsolete.  Management has determined a
reserve for inventory obsolescence is not necessary at March 31, 2010 or
December 31, 2009.


7


Inventories
are comprised as follows:





March 31,
                      2010
                    
                    
                    December
                      31, 2009Raw
      materials
                    
                    $
                    173,096
                    
                    
                    $
                    175,806Finished
      goods
                    
                    
                    43,854
                    
                    
                    
                    105,447Inventories
                    
                    $
                    216,950
                    
                    
                    $
                    281,253





NOTE
5 – GOODWILL





In
accordance with FASB ASC 350, Goodwill and Other Intangible
Assets (Prior
authoritative literature:FASB SFAS No. 142, Goodwill and Other Intangible
Assets (“SFAS 142”), previously recognized goodwill was tested by
management for impairment during 2010 and 2009 utilizing a two-step
test.  At a minimum, an annual goodwill impairment test is required,
or when certain events indicate a possible impairment.





The first
part of the test is to compare the Company’s fair market value to the book value
of the Company).  If the fair market value of the Company is greater
than the book value, no impairment exists as of the date of the
test.  However, if book value exceeds fair market value, the Company
must perform part two of the test, which involves recalculating the implied fair
value of goodwill by repeating the acquisition analysis that was originally used
to calculate goodwill, using purchase accounting as if the acquisition happened
on the date of the test, to calculate the implied fair value of goodwill as of
the date of the test.





The
Company has no accumulated impairment losses on goodwill.  The
Company’s impairment analysis is performed on December 31 each year, on the
Company’s single reporting unit.  Using the Company’s market
capitalization (based on Level 1 inputs), management determined that the
estimated fair market value substantially exceeded the company’s book value as
of March 31, 2010 and December 31, 2009.  Based on this, no impairment
was recorded as of March 31, 2010 or December 31, 2009.





NOTE
6 – NOTES PAYABLE





On March
30, 2010, the Company issued unsecured notes to Steven Strasser, the Company’s
CEO, totaling $125,000.  The notes bear interest at 5%, payable upon
maturity.  The notes mature two months after
issuance.


8


NOTE
7 – CONVERTIBLE PREFERRED STOCK





On
January 20, 2010 and February 24, 2010, the Company issued and sold 4,375 units,
each unit consisting of one share of the Company’s Series C-1 Preferred Stock,
par value $.001 per share, and 50 warrants to purchase shares of the Company’s
common stock at an exercise price of $0.40 per share, resulting in the sale and
issuance of an aggregate of 4,375 shares of Series C-1 Preferred Stock and
warrants to purchase up to 218,750 shares of the Company’s common stock for
$175,000 in cash.  The securities were issued pursuant to Regulation D
of the Securities Act of 1933.  Of the aggregate $175,000 invested, a
value of approximately $58,000 was allocated to the 218,750 Series C-1 warrants
and recorded as a component of paid-in capital.The conversion
feature of the Series C-1 Preferred Stock at the time of issuance were
determined to be beneficial conversion features on January 20, 2010 and February
24, 2010, the dates of the transactions.  The Company recorded
additional preferred stock dividends of approximately $41,000 related to the
beneficial conversion feature.  In this transaction, Steven Strasser,
the Company’s CEO purchased 1,875 units for $75,000 in cash.





NOTE
8 – EARNINGS PER SHARE





The
Company accounts for its earnings per share in accordance with ASC 260, Earnings Per Share, which
requires presentation of basic and diluted earnings per share.  Basic
earnings per share is computed by dividing income or loss attributable to common
shareholders by the weighted average number of common shares outstanding for the
reporting period.  Diluted earnings per share reflect the potential
dilution that could occur if securities or other contracts, such as stock
options, to issue common stock were exercised or converted into common
stock.





Three Months
                      Ended March
                      31, 2010
                    
                    
                    Three Months
                      Ended March
                      31, 2009*Net
      loss attributable to common shareholders
                    
                    $
                    (490,478
                    )
                    
                    $
                    (1,376,739
                    )Basic
      weighted average number of common shares outstanding
                    
                    
                    44,825,883
                    
                    
                    
                    43,255,441Dilutive
      effect of stock options
                    
                    
                    -
                    
                    
                    
                    -Diluted
      weighted average number of common shares outstanding
                    
                    
                    44,825,883
                    
                    
                    
                    43,255,441Basic
      and diluted loss per share
                    
                    $
                    (0.01
                    )
                    
                    $
                    (0.03
                    )


*Refer to
Note 13 – Prior Period Adjustment





For the
three months ended March 31, 2010, warrants and options to purchase 47,644,959
shares of common stock at per share exercise prices ranging from $0.11 to $19.25
were not included in the computation of diluted loss per share because inclusion
would have been anti-dilutive. For the three months ended March 31, 2009,
warrants and options to purchase 45,334,676 shares of common stock at per share
exercise prices ranging from $0.11 to $19.25 were not included in the
computation of diluted loss per share because inclusion would have been
anti-dilutive.




NOTE
9 – STOCK-BASED COMPENSATION





At March
31, 2010, the Company had two stock-based compensation plans.  There
were 825,000 options granted in the three months ended March 31, 2010.  The
fair value of these options was approximately $225,000 at
issuance.  There were 360,000 warrants and 1,400,000 options granted
in the three months ended March 31, 2009.  The fair value of these warrants
and options was approximately $36,000 and $241,000 at issuance,
respectively.  No stock options were exercised in the periods ending
March 31, 2010 and 2009.  The Company accounts for stock option grants
in accordance with ASC 718, Compensation – Stock
Compensation. Compensation costs related to share-based payments
recognized in the Condensed Statements of Income were $64,193 and $83,339 for
the periods ended March 31, 2010 and 2009, respectively.


9


NOTE
10 – MATERIAL AGREEMENTS





In 2007,
the Company entered into a manufacturing service agreement with Sanmina-Sci
Corporation (“Sanmina-Sci”) for the production of digital units and digital
circuit boards.  Pursuant to this agreement, the Company will purchase
an amount of digital units, subject to certain minimum quantities, from
Sanmina-Sci equal to an initial firm order agreed upon by the Company and
Sanmina-Sci and subsequent nine-month requirements forecasts.  The
initial term of the contract was one year, and upon expiration of the initial
term, the contract continues on a year to year basis until one party gives
notice to terminate.  At the present time the Company is not able to
determine if the actual purchases will be in excess of these minimum
commitments, or if any potential liability will be incurred. The Company had
approximately $170,000 in open purchase orders with this subcontractor as of
March 31, 2010.





On March
11, 2009, the Company entered into a consulting agreement with one of the
Company’s directors.  The agreement is for a term of 12 months and
calls for the director to provide investment and marketing related services for
the Company.  The director will receive $3,000 per month and 360,000
warrants to purchase the Company’s common stock, at an exercise price of $0.11
per share, under the terms of this agreement.  The warrants vested
equally over the term of the agreement.  This agreement terminated on
March 10, 2010, and was not renewed by the Company.





NOTE
11 – WARRANT LIABILITY





On
January 1, 2009, the Company adopted FASB ASC 815, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock (Prior authoritative
literature: FASB EITF 07-5, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF
07-5”).The Company issued 5,696,591 warrants in connection
with a private offering of its common stock on July 8, 2005 and August 31,
2005.  The proceeds attributable to the warrants, based on the fair
value of the warrants at the date of issuance, amounted to $1,433,954 and were
accounted for as a liability and valued in accordance with FASB ASC 815 (EITF
07-5) based on an evaluation of the terms and conditions related to the warrant
agreements, which provide that the exercise price of these warrants shall be
reduced, if through a subsequent financing, the Company issues common stock
below the lowest per share purchase price of the offering.  The
warrant liability was valued at $313,945 and $828,827 as of March 31, 2010 and
December 31, 2009, respectively, resulting in non-cash gains in the statement of
operations of $514,882 for the three months ended March 31, 2010.  The
warrant liability was valued at $702,355 and $381,856 as of March 31, 2009 and
January 1, 2009, respectively, resulting in non-cash expenses of $320,499 during
the three months ended March 31, 2009.  In adopting ASC 815 (EITF
07-5), the Company recorded a $1,052,099 cumulative adjustment to opening
accumulated deficit and a reduction to paid-in capital of $1,433,954 on January
1, 2009.  In each subsequent period, the Company adjusted the warrant
liability to equal the fair value of the warrants at the balance sheet
date.  Changes in the fair value of warrants classified as a liability
are recognized in earnings.


10


The
Company has estimated the fair value of its warrant liability using the
Black-Scholes option pricing model (Level 3 inputs) containing the following
assumptions:  volatility 188%, risk-free rate 0.16%, term equivalent
to the remaining life of the warrants.  The Company recorded a
non-cash gain related to these warrants of $514,882 for the three months ended
March 31, 2010, which was recorded in other income (expense).





The
following reconciles the warrant liability for the three months ended March
31:





2010
                    
                    
                    2009Beginning
      balance, January 1,
                    
                    $
                    828,827
                    
                    
                    $
                    381,856Change
      in fair value
                    
                    
                    (514,882
                    )
                    
                    
                    320,499Ending
      balance, March 31,
                    
                    $
                    313,945
                    
                    
                    $
                    702,355




NOTE
12 – INCOME TAXES





The
Company utilizes the asset and liability method of accounting for income taxes
pursuant to ASC 740, Accounting for Income Taxes(“ASC 740 (SFAS109)”).  ASC 740 (SFAS 109) requires the
recognition of deferred tax assets and liabilities for both the expected future
tax impact of differences between the financial statement and tax basis of
assets and liabilities, and for the expected future tax benefit to be derived
from tax loss and tax credit carryforwards.  ASC 740 (SFAS 109)
additionally requires the establishment of a valuation allowance to reflect the
likelihood of realization of deferred tax assets.  The Company has
evaluated the net deferred tax asset taking into consideration operating results
and determined that a full valuation allowance should be
maintained.





The
Company accounts for uncertain tax positions under the provisions of FASB ASC
740-10 (FIN 48).  The Company has not identified any uncertain tax
positions, nor does it believe it will have any material changes over the next
12 months.  Any interest or penalties resulting from examinations will
be recognized as a component of the income tax provision.  However,
since there are no unrecognized tax benefits as a result of the tax positions
taken, there are no accrued interest and penalties.





NOTE
13 – PRIOR PERIOD ADJUSTMENT





During
the year ended December 31, 2009, the Company corrected errors in its warrant
liability valuation, related to its estimated volatility, as well as its
deferred tax liability calculation.





During
the year ended December 31, 2009, the Company recorded its warrant liability
using a warrant valuation model.  The Company calculated its warrant
liability values utilizing an estimated volatility rate.  During the
audit of the Company’s financial statements for the year ended December 31,
2009, the Company determined that the estimated volatility rate used was
incorrect.   The Company reviewed and revised its estimated
volatility rate and warrant valuation model, which resulted in material
differences in the Company’s warrant liability and related fair market value
adjustments on warrant liability for the year ended December 31, 2009 and in the
various quarterly amounts previously reported.  The Company determined
that the error was not material to prior quarters due to the warrant liability’s
non-cash nature and because the errors were qualitatively insignificant to
operations.


11


During
the year ended December 31, 2009, the Company identified errors in the Company’s
tax provision.  Previously, the Company did not recognize a deferred
tax liability related to its amortization of goodwill for tax
purposes.  The Company reviewed and revised its tax provision to
include this deferred tax liability as of January 1, 2009 and for the year ended
December 31, 2009.  The Company determined that the error was not
material to prior years due to the deferred tax provision’s non-cash nature and
because the errors were qualitatively insignificant to operations.





The
following tables set forth the corrected quarterly financial data.





For the
three months ended March 31, 2009:


As
                      Previously
                      Reported
                    
                    
                    Adjustments
                    
                    
                    As AdjustedRevenues
                    
                    $
                    47,147
                    
                    
                    $
                    -
                    
                    
                    $
                    47,147Cost
      of revenues
                    
                    
                    28,808
                    
                    
                    
                    -
                    
                    
                    
                    28,808Gross
      profit
                    
                    
                    18,339
                    
                    
                    
                    -
                    
                    
                    
                    18,339Total
      costs and expenses
                    
                    
                    837,846
                    
                    
                    
                    -
                    
                    
                    
                    837,846Loss
      from operations
                    
                    
                    (819,507
                    )
                    
                    
                    -
                    
                    
                    
                    (819,507
                    )Other
      income and (expense)
                    
                    
                    (476,834
                    )
                    
                    
                    165,421
                    
                    
                    
                    (311,413
                    )Loss
      before provision for taxes
                    
                    
                    (1,296,341
                    )
                    
                    
                    165,421
                    
                    
                    
                    (1,130,920
                    )Provision
      for taxes
                    
                    
                    -
                    
                    
                    
                    12,486
                    
                    
                    
                    12,486Net
      loss
                    
                    
                    (1,296,341
                    )
                    
                    
                    152,935
                    
                    
                    
                    (1,143,406
                    )Dividends
      paid or payable on Series B and Series C Convertible Preferred
      Stock
                    
                    
                    233,333
                    
                    
                    
                    -
                    
                    
                    
                    233,333Net
      loss attributable to common shareholders
                    
                    $
                    (1,529,674
                    )
                    
                    $
                    152,935
                    
                    
                    $
                    (1,376,739
                    )Basic
      and fully diluted loss per common share
                    
                    $
                    (0.04
                    )
                    
                    $
                    0.01
                    
                    
                    $
                    (0.03
                    )Weighted
      average common shares outstanding basic
                    
                    
                    43,255,441
                    
                    
                    
                    43,255,441
                    
                    
                    
                    43,255,441


12


NOTE
14 – SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION





Cash paid
during the three months ended March 31, for:





2010
                    
                    
                    2009Income/franchise
      taxes
                    
                    $
                    4,335
                    
                    
                    $
                    2,801





Non-cash
investing and financing activities during the three months ended March 31,
for:





2010
                    
                    
                    2009Warrants
      and options issued with common stock issued to employees and
      consultants
                    
                    $
                    225,000
                    
                    
                    $
                    241,314Preferred
      stock dividend recognized for beneficial conversion features of preferred
      stock issuances
                    
                    $
                    41,309
                    
                    
                    $
                    -Preferred
      stock dividends paid or payable in common stock
                    
                    $
                    166,801
                    
                    
                    $
                    233,333





NOTE
15 – SUBSEQUENT EVENTS





On April
14, 2010 and April 28, 2010, the Company issued unsecured notes to Steven
Strasser, the Company’s CEO, totaling $125,000.  The notes bear
interest at 5%, payable upon maturity.  The notes mature two months
after issuance.





On April
13, 2010, the Company entered into a financing transaction in which it issued 25
units, each unit consisting of a $50,000 one year, senior, secured note and
217,392 warrants to purchase the Company’s common stock.  In
aggregate, the Company issued $1,050,000 in senior, secured notes, before
discount, and 4,565,232 warrants to purchase the Company’s Common
Stock.  The notes bear interest of 12% per annum, payable
semi-annually.  The notes have a first priority security interest in
all of the assets of the Company.  The warrants to purchase the
Company’s common stock have per share exercise prices of $0.23, and expire on
April 12, 2015.  In addition, noteholders who hold warrants from prior
investments with the Company will have the exercise price of some or all of such
warrants reduced to an exercise price equal to the exercise price of the
warrants sold as part of the units.  All of the investors in the notes
are officers or pre-existing stockholders of the Company.




13




ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION





FORWARD
LOOKING STATEMENTS





This
report and the documents incorporated into this report contain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 (the “PSLRA”), including, but not limited to, statements relating to the
Company’s business objectives and strategy. Such forward-looking statements are
based on current expectations, management beliefs, certain assumptions made by
the Company’s management, and estimates and projections about the Company’s
industry. Words such as “anticipates,” “expects,” “intends,” “plans,”
“believes,” “seeks,” “estimates,” “forecasts,” “is likely,” “predicts,”
“projects,” “judgment,” variations of such words and similar expressions are
intended to identify such forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks, uncertainties
and assumptions that are difficult to predict with respect to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
differ materially from those expressed, forecasted, or contemplated by any such
forward-looking statements.




Factors
that could cause actual events or results to differ materially include, but are
not limited to, the following: continued market acceptance of the Company’s
products; the Company’s ability to expand and/or modify its products on an
ongoing basis; general demand for the Company’s products, intense competition
from other developers, manufacturers and/or marketers of energy reduction and/or
power saving products; the Company’s negative net tangible book value; the
Company’s negative cash flow from operations; delays or errors in the Company’s
ability to meet customer demand and deliver products on a timely basis; the
Company’s lack of working capital; the Company’s need to upgrade its facilities;
changes in laws and regulations affecting the Company and/or its products; the
impact of technological advances and issues; the outcomes of pending and future
litigation and contingencies; trends in energy use and consumer behavior;
changes in the local and national economies; and other risks inherent in and
associated with doing business in an engineering and technology intensive
industry. See “Management’s Discussion and Analysis or Plan of Operation.” Given
these uncertainties, investors are cautioned not to place undue reliance on any
such forward-looking statements.




Unless
required by law, the Company undertakes no obligation to update publicly any
forward-looking statements, whether as a result of new information, future
events or otherwise. However, readers should carefully review the risk factors
set forth in other reports or documents that the Company files from time to time
with the Securities and Exchange Commission (the “SEC”), particularly Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q and any Current Reports on
Form 8-K.


14


OVERVIEW





The
Company generates revenues from a single business segment: the design,
development, marketing and sale of proprietary energy efficiency technologies
and products for electric motors.  The Company’s products, called
Motor Efficiency Controllers (“MEC”), save up to 35 percent of the electricity
used by a motor in appropriate applications.  The Company’s patented
technology platform, called E-Save Technology®, saves energy when a constant
speed alternating current induction motor is operating in a lightly loaded
condition.  Target applications for the Company’s three-phase MECs
include escalators, MG set elevators, grinders, crushers, saws, stamping
presses, and many other types of industrial equipment.  The Company
has also developed a single-phase MEC targeted at smaller motors, such as those
found in clothes washers, dryers, and other appliances and light commercial
equipment.  The Company has one existing patent and three patents
pending on E-Save Technology®.





Analog
Three-phase MEC


The
Company began generating revenues from sales of its patented analog three-phase
MEC line of motor controllers in late 1995.  The Company sold this
product from 1995 through the second quarter of 2009.





Digital
Three-phase MEC


In 2005,
the Company began development of a digital version of its three-phase MEC so
that the product would be capable of high volume sales through existing
distribution channels for motor controls.  The digital version is much
smaller in size and easier to install than the analog product, is driven by a
powerful microprocessor and digital signal processor. As opposed to the Analog
MEC, the digital MEC is also a complete motor control device, meaning is can
start, stop, soft start and protect a motor, and is therefore capable of
replacing standard motor starters and soft starts that do not save energy. The
product can be installed by original equipment manufacturers (OEMs) at their
factories or it can be retrofitted on to existing equipment.





In 2008,
the Company launched limited sales of the digital three-phase MEC and initiated
testing of the digital product by several OEMs, primarily in the
elevator/escalator industry.  In the summer of 2009, the Company
announced its first OEM agreements and that it had received Underwriters’
Laboratories (“UL”) certification on a full line of the Company’s digital
three-phase products.  UL certification enables the Company to sell
its digital three-phase products to industrial markets.  The Company
is developing a network of independent sales representatives to penetrate the
industrial markets.





Digital
Single-phase MEC


In 2006,
the Company began development on its digital single-phase
product.  The digital single phase MEC is targeted at appliances, such
as clothes washers and dryers.  The Company has one patent pending on
its digital single-phase MEC.


15


Capitalization


As of
March 31, 2010, the Company had total stockholders’ equity of $758,466,
primarily due to (i) the Company’s sale of 34,625 shares of Series C-1
Convertible Preferred Stock in a private offering from December 2009 through
March 2010, (ii) the Company’s sale of 140,000 shares of Series B Convertible
Preferred Stock in a private offering from October of 2007 through January of
2008, (iii) the Company’s sale of 12,950,016 shares of common stock in a private
stock offering from November of 2006 through March of 2007, (iv) the Company’s
sale of 14,500,000 shares of common stock in a private stock offering in July
and August of 2005, (v) the Company’s sale of 2,346,233 shares of Series A-1
Convertible Preferred stock to Summit Energy Ventures, LLC in June of 2002 and
(vi) the conversion of notes payable of approximately $1,047,000 into 982,504
shares of Series A-1 Convertible Preferred Stock in October of
2003.  All of the Company’s Series A-1 Convertible Preferred Stock was
converted into Common Stock in 2005.





Because
of the nature of our business, the Company makes significant investments in
research and development for new products and enhancements to existing
products.  Historically, the Company has funded its research and
development efforts through cash flow primarily generated from debt and equity
financings.  Management anticipates that future expenditures in
research and development will continue at current levels.





The
Company’s results of operations for the quarter ended March 31, 2010 were marked
by a significant increase in revenues and a decrease in its loss from operations
that are more fully discussed in the following section, “Results of Operations
for the Three Months Ended March 31, 2010 and 2009”.  Sales cycles for
our products range from less than a month to well over one year, depending on
customer profile.  Larger original equipment manufacturer (“OEM”)
deals and sales to larger end users generally take a longer period of time,
whereas sales through channel partners may be closed within a few days or
weeks.  Because of the complexity of this sales process, a number of
factors that are beyond the control of the Company can delay the closing of
transactions.


16


RESULTS
OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009.





The
following table sets forth certain line items in our condensed statement of
operations as a percentage of total revenues for the periods
indicated:





Three Months
                  Ended March
                  31, 2010
                
                
                Three Months
                  Ended March
                  31, 2009Revenues
                
                
                100.0
                %
                
                
                100.0
                %Cost
      of revenues
                
                
                83.9
                
                
                
                61.1Gross
      profit
                
                
                16.1
                
                
                
                38.9Costs
      and expenses:Research
      and development
                
                
                154.2
                
                
                
                524.0Selling,
      general and administrative
                
                
                558.1
                
                
                
                1,212.1Depreciation
      and amortization
                
                
                13.1
                
                
                
                41.0Total
      expenses
                
                
                725.4
                
                
                
                1,777.1Loss
      from operations
                
                
                (709.3
                )
                
                
                (1,738.2
                )Other
      income (expense)
                
                
                468.0
                
                
                
                (660.5
                )Loss
      before provision for income taxes
                
                
                (241.3
                )
                
                
                (2,398.7
                )Provision
      for income taxes
                
                
                15.3
                
                
                
                26.5Net
      loss
                
                
                (256.6
                )
                
                
                (2,425.2
                )Dividends
      paid or payable on Series B and Series C-1 Preferred Stock
                
                
                253.3
                
                
                
                494.9Net
      loss attributable to common shareholders
                
                
                (509.7
                )
                
                
                (2,920.1
                )




REVENUES




Total
revenues for the three months ended March 31, 2010 were approximately $110,000,
compared to $47,000 for the three months ended March 31, 2009, an increase of
$63,000 or 134%. This increase is mainly attributable to an increase in
sales in the elevator and escalator market and the industrial market in the
first quarter of 2010.  Specifically, elevator and escalator sales
grew to approximately $69,000 for the three months ended March 31, 2010, from
approximately $35,000 for the three months ended March 31, 2009, and sales in
the industrial market grew to approximately $28,000 for the three months ended
March 31, 2010, from $11,000 for the three months ended March 31,
2009.  The increase in elevator and escalator sales in the three
months ended March 31, 2010 is primarily due to the commercialization and
increased market acceptance of the Company’s digital product, specifically
resulting from the OEM agreements the Company signed in the summer of
2009.  The digital product has been tested and approved for use on a
retrofit and OEM basis by two elevator and escalator OEMs.  These
factors lead to the increase in elevator and escalator sales for the three
months ended March 31, 2010.  The increase in industrial sales for the
three months ended March 31, 2010 was primarily due to the Company’s efforts to
build a network of independent sales representatives following receipt of UL
Certification for the Company’s larger digital products in the summer of
2009.  In prior periods, industrial sales were primarily to early
adopters of our technology, as well as specific target accounts, therefore sales
were less consistent.  The Company believes that going forward, with
its growing network of independent sales representatives, industrial sales will
be more consistent and the Company will continue to see increased order flow.
For the three months ended March 31, 2010, industrial and other sales were
approximately 29% of total sales, and escalator and elevator sales were
approximately 71% of total sales.  All sales for the three months
ended March 31, 2010 consisted entirely of digital units.  For the
three months ended March 31, 2009, industrial sales, of which all but one order
consisted of digital units, were approximately 24% of total sales, and escalator
and elevator sales, which consisted of a mix of digital units and analog units,
were approximately 76% of total sales.


17


COST
OF REVENUES




Total
cost of revenues, which includes material and direct labor and overhead for the
three months ended March 31, 2010, was approximately $92,000 compared to
approximately $29,000 for the three months ended March 31, 2009, an increase of
$63,000 or 217%.  This increase is mainly attributable to an overall
increase in sales in the elevator and escalator sales and industrial sales in
the first quarter of 2010, as described above.  As a percentage of
revenue, total cost of sales increased to approximately 84% for the three months
ended March 31, 2010 compared to approximately 61% for the three months ended
March 31, 2009.  The increase in the costs as a percentage of sales
was primarily due to the Company decreasing its prices for both the industrial
market and the escalator and elevator market.  The Company decreased
industrial pricing due to the selling of its product through indirect channels,
primarily its distributor network, during the three months ended March 31, 2010,
rather than through direct sales efforts, as it did during the three months
ended March 31, 2009.  The Company also decreased pricing in the
elevator and escalator market as part of the supply agreements it signed with
the two escalator and elevator OEMs.  Prior to decreasing prices, the
Company has planned product cost reductions that it expects will significantly
reduce the cost of revenue later in 2010. Finally, the Company made one large
sale with extremely reduced pricing to a marquee end user for a strategic
marketing benefit during the three months ended March 31, 2010.  No
such sale occurred during the three months ended March 31, 2009.





GROSS
PROFIT





Gross
profit for the three months ended March 31, 2010, was approximately $18,000
compared to approximately $18,000 for the three months ended March 31,
2009.  As a percentage of revenue, gross profit decreased to
approximately 16% for the three months ended March 31, 2010 compared to
approximately 39% for the three months ended March 31, 2009 for the reasons
explained above.  Long term, the Company’s goal is to have an average
gross profit percentage of at least 30%.





OPERATING
EXPENSES




Research
and Development Expenses




Research
and development expenses were approximately $170,000 for the three months ended
March 31, 2010, as compared to approximately $247,000 for the three months ended
March 31, 2009, a decrease of $77,000 or 31%.  This decrease is mainly
attributable to a decrease in the Company’s product development and
certification costs related to the Company’s digital controller for both its
single-phase and three-phase products during the three months ended March 31,
2010.


18


Selling,
General and Administrative Expenses




Selling,
general and administrative expenses were approximately $614,000 for the three
months ended March 31, 2010, as compared to $571,000 for the three months ended
March 31, 2009, an increase of $43,000 or 8%. The increase in selling, general
and administrative expenses compared to the prior year was primarily due to
increases in payroll, payroll related costs, and travel in the sales department,
as well as increases in investor and stockholder relations and consulting fees,
during the three months ended March 31, 2010.  This increase was
partially offset by a decrease in costs related to stock-based
compensation.





Change
in Fair Value of Warrant Liability





Warrants
issued in connection with a private offering of the Company’s Common Stock
completed on July 8, 2005 and August 31, 2005 are being accounted for as
liabilities in accordance with FASB ASC 820-10, Fair Value Measurements and
Disclosures(Prior
authoritative literature: FASB EITF 07-5, Determining Whether
an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF
07-5”),issued January 2009), based on an analysis of the terms and
conditions of the warrant agreements.





As a
result, the fair value of these warrants (five year warrants to purchase up to
5,696,591 shares of the Company’s common stock at an exercise price of $0.44 per
share), amounting to $828,827 as of December 31, 2009, was reflected as a
liability.  The fair value of these warrants amounted to $313,945 as
of March 31, 2010, primarily due to the approximately 20% decline in the value
of our common stock.  The $514,882 decrease in the fair value of these
warrants during three months ended March 31, 2010 has been reflected as a
non-operating gain in the Statement of Operations for the three months ended
March 31, 2010.  The warrants are being valued at each reporting
period using the Black-Scholes pricing model to determine the fair market value
per share.  We will continue to mark the warrants to market value each
quarter-end until they expire.





Financial
Condition, Liquidity, and Capital Resources





The
accompanying financial statements have been prepared assuming the Company is a
going concern, which assumption contemplates the realization of assets and
satisfaction of liabilities in the normal course of business.  The
Company experienced a $515,075 deficiency of cash from operations for the three
months ended March 31, 2010, and lacks sufficient liquidity to continue its
operations.





These
factors raise substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments relating
to the recoverability and classification of recorded asset amounts or the amount
of liabilities that might be necessary should the Company be unable to continue
in existence. Continuation of the Company as a going concern is dependent upon
achieving profitable operations. Management's plans to achieve profitability
include developing new products, obtaining new customers and increasing sales to
existing customers. Management is seeking to raise additional capital through
equity issuance, debt financing or other types of financing. However, there are
no assurances that sufficient capital will be raised. If we are unable to obtain
sufficient capital on reasonable terms, we would be forced to restructure, file
for bankruptcy or cease operations.


19


Since
inception, the Company has financed its operations primarily through the sale of
its equity securities, debt securities and using available bank lines of credit.
As of March 31, 2010, the Company had cash of $31,205.





On April
14, 2010 and April 28, 2010, the Company issued unsecured notes to Steven
Strasser, the Company’s CEO, totaling $125,000.  The notes bear
interest at 5%, payable upon maturity.  The notes mature two months
after issuance.





Cash used
for operating activities for the three months ended March 31, 2010 was $515,075,
which consisted of a net loss of $282,368; less depreciation and amortization of
$14,437, warrants and options issued to employees and consultants of $64,192,
and a decrease in inventory of $64,303, offset by a change in fair value of
warrant liability of $514,882, increases in accounts receivable of $16,840,
prepaid expenses and other current assets of $20,084.  In addition,
these amounts were offset by a decrease in deferred rent of $2,051, and
increases in accounts payable of $165,731 and deferred tax liability of
$12,487.





Cash used
for operating activities for the three months ended March 31, 2009 was $891,634,
which consisted of a net loss of $1,143,406; less depreciation and amortization
of $19,315, warrants and options issued to employees and consultants of $83,399,
a change in fair value of warrant liability of $320,498, a decrease in accounts
receivable of $18,017, and an increase in deferred tax liability of $12,486,
offset by increases in inventory of $114,053, prepaid expenses and other current
assets of $68,147, and decreases in provision for bad debt of $11,342, accounts
payable of $7,459 and deferred rent of $942.





Net cash
used in investing activities for the three months ended March 31, 2010 was
$1,284, compared to $6,476 for the three months ended March 31, 2009. The total
amount for the first quarter of 2010 consisted of capitalized costs related to
patent applications.  The total amount for the first quarter of 2009
consisted of the purchase of property and equipment.





Net cash
provided by financing activities was $300,000 for the three months ended March
31, 2010.  Of this amount, $175,000 was from the proceeds from the
issuance of equity securities, and $125,000 was from the proceeds from the
issuance of debt securities.  There was no cash provided by or used
for financing activities for the three months ended March 31, 2009.




The
Company expects to experience growth in its operating expenses, particularly in
research and development and selling, general and administrative expenses, for
the foreseeable future in order to execute its business strategy. As a result,
the Company anticipates that operating expenses will constitute a material use
of any cash resources.


20


Cash
Requirements and Need for Additional Funds




The
Company anticipates a substantial need for cash to fund its working capital
requirements.  In accordance with the Company’s prepared expansion
plan, the opinion of management is that approximately $2.5 to $3 million will be
required to cover operating expenses, including, but not limited to, the
development of the Company’s next generation products, marketing, sales and
operations during the next twelve months.  Although we currently have
some working capital, we may nevertheless need to issue additional debt or
equity securities to raise required funds.  If the Company is unable
to obtain funding on reasonable terms or finance its needs through current
operations, the Company may be forced to restructure, file for bankruptcy or
cease operations.





Notable
changes to expenses are expected to include an increase in the Company’s sales
personnel and efforts, and developing more advanced versions of the Company’s
technology and products.





Critical
Accounting Policies and Estimates





Management’s
discussion and analysis of Power Efficiency Corporation’s financial condition
and results of operations are based upon the condensed financial statements
contained in this Annual Report on Form 10-K, which have been prepared in
accordance with accounting principles generally accepted in the United
States.  The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and disclosure of contingent assets
and liabilities.  On an on-going basis, management evaluates
estimates, including those related to the valuation of inventory and the
allowance for uncollectible accounts receivable.  We base our
estimates on historical experience and on various other assumptions that
management believes to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other
sources.  Actual results may differ materially from these estimates
under different assumptions or conditions.  We believe the following
critical accounting policies affect our more significant judgments and estimates
used in the preparation of our condensed financial statements.





Inventories


Inventories
are valued at the lower of cost (first-in, first-out) or market.  The
Company reviews inventory for impairments to net realizable value whenever
circumstances arise.  Such circumstances may include, but are not
limited to, the discontinuation of a product line or re-engineering certain
components making certain parts obsolete.  Management has determined a
reserve for inventory obsolescence is not necessary at March 31 2010 or December
31, 2009.





Accounts
Receivable


The
Company carries its accounts receivable at cost less an allowance for doubtful
accounts and returns.  On a periodic basis, the Company evaluates its
accounts receivable and establishes an allowance for doubtful accounts, based on
a history of past write-offs and collections and current credit
conditions.  Change in customer liquidity or financial condition could
affect the collectability of that account, resulting in the adjustment upward or
downward in the provision for bad debts, with a corresponding impact to our
results of operations.


21


Fair
Value Measurements:


We
measure fair value in accordance with FASB ASC 820-10, Fair Value Measurements
andDisclosures(prior authoritative literature:FASB SFAS No. 157, Fair Value Measurements,issued September 2006) (“FASB ASC 820-10
(SFAS 157)”).  FASB ASC 820-10 (SFAS No. 157)
emphasizes that fair value is a market-based measurement, not an entity-specific
measurement. Therefore, a fair value measurement should be determined based on
the assumptions that market participants would use in pricing the asset or
liability. As a basis for considering market participant assumptions in fair
value measurements, FASB ASC 820-10 (SFAS No. 157) establishes a fair value
hierarchy that distinguishes between market participant assumptions based on
market data obtained from sources independent of the reporting entity
(observable inputs that are classified within Levels 1 and 2 of the hierarchy)
and the reporting entity’s own assumptions about market participant assumptions
(unobservable inputs classified within Level 3 of the hierarchy). The Company
has applied FASB ASC 820-10 (SFAS 157) to recognize the liability related to its
derivative instruments at fair value and to determine fair value for purposes of
testing goodwill for impairment.





Level 1
inputs utilize quoted prices (unadjusted) in active markets for identical
assets or liabilities. Level 2 inputs are inputs other than quoted prices
included in Level 1 that are observable for the asset or liability, either
directly or indirectly. Level 2 inputs may include quoted prices for similar
assets and liabilities in active markets, as well as inputs that are observable
for the asset or liability (other than quoted prices), such as interest rates
and yield curves that are observable at commonly quoted intervals. Level 3
inputs are unobservable inputs for the asset or liability, which is typically
based on an entity’s own assumptions about market participants’ assumptions, as
there is little, if any, related market activity. In instances where the
determination of the fair value measurement is based on inputs from different
levels of the fair value hierarchy, the level in the fair value hierarchy within
which the entire fair value measurement falls is based on the lowest level input
that is significant to the fair value measurement in its entirety. The Company’s
assessment of the significance of a particular input to the fair value
measurement in its entirety requires judgment, and considers factors specific to
the asset or liability.





Liabilities
measured at fair value on a recurring basis include warrant liabilities
resulting from an equity financing in 2005 (see Note 10).  In
accordance with FASB ASC 820-10 (SFAS 157), the warrant liabilities are being
remeasured to fair value each quarter until they all expire.  The
warrants are valued using the Black-Scholes option pricing model, using
observable and unobservable assumptions (Level 3) consistent with our
application of FASB ASC 718 (SFAS 123(R)).





Revenue
Recognition


Revenue
from product sales is recognized when pervasive evidence of an arrangement
exists, delivery has occurred, the price to the buyer is fixed or determinable,
and collectability is reasonably assured.  Returns and other sales
adjustments (warranty accruals, discounts and shipping credits) are provided for
in the same period the related sales are recorded.


22


Accounting
for Stock Based Compensation


The
Company accounts for employee stock options as compensation expense, in
accordance with FASB ASC 718, Share-Based Payments (Prior
authoritative literature: FASB SFAS No. 123(R), Share-Based Payments (“SFAS
123(R)”)).  FASB ASC 718 (SFAS 123(R)) requires companies to
expense the value of all employee stock options and similar
awards.  In computing the impact, the fair value of each option is
estimated on the date of grant based on the Black-Scholes options pricing model
utilizing certain assumptions for a risk free interest rate; volatility; and
expected remaining lives of the awards.  The assumptions used in
calculating the fair value of share-based payment awards represent management's
best estimates, but these estimates involve inherent uncertainties and the
application of management judgment.  As a result, if factors change
and the Company uses different assumptions, the Company’s stock-based
compensation expense could be materially different in the future. In addition,
the Company is required to estimate the expected forfeiture rate and only
recognize expense for those shares expected to vest.  In estimating
the Company’s forfeiture rate, the Company analyzed its historical forfeiture
rate, the remaining lives of unvested options, and the amount of vested options
as a percentage of total options outstanding.  If the Company’s actual
forfeiture rate is materially different from its estimate, or if the Company
reevaluates the forfeiture rate in the future, the stock-based compensation
expense could be materially different from what we have recorded in the current
period.  The impact of applying FASB ASC 718 (SFAS 123(R))
approximated $64,000 and $83,000 in compensation expense during the three months
ended March 31, 2010 and 2009, respectively.  Such amounts are
included in research and development expenses and selling, general and
administrative expense on the statement of operations.  The Company
issues new authorized, unissued shares upon exercise of stock
options.





Product
Warranties


The
Company typically warrants its products for two years.  Estimated
product warranty expenses are accrued in cost of sales at the time the related
sale is recognized. Estimates of warranty expenses are based primarily on
historical warranty claim experience. Warranty expenses include accruals for
basic warranties for products sold.   While management believes
our estimates are reasonable, an increase or decrease in submitted warranty
claims could affect warranty expense and the related current and future
liability.





Provision
for Income Taxes


The
Company utilizes the asset and liability method of accounting for income taxes
pursuant to FASB ASC 740 Accounting for Income Taxes (Prior
authoritative literatureFASB SFAS No. 109, Accounting for Income Taxes (“SFAS
109”)),whichrequires the
recognition of deferred tax assets and liabilities for both the expected future
tax impact of differences between the financial statement and tax basis of
assets and liabilities, and for the expected future tax benefit to be derived
from tax loss and tax credit carryforwards.  FASB ASC 740 (SFAS 109)
additionally requires the establishment of a valuation allowance to reflect the
likelihood of realization of deferred tax assets.  We have reported
net operating losses for consecutive years, and do not have projected taxable
income in the near future.  This significant evidence causes our
management to believe a full valuation allowance should be recorded against the
deferred tax assets.





Goodwill


FASB ASC
350, Goodwill and Other
Intangible Assets (Prior authoritative literature:FASB SFAS No. 142, Goodwill and Other Intangible
Assets (“SFAS 142”), requires that goodwill shall not be
amortized.  At a minimum, goodwill is tested for impairment, on an
annual basis by the Company, or when certain events indicate a possible
impairment, utilizing a two-step test, as described in FASB ASC 350 (SFAS
142).  A significant impairment could have a material adverse effect
on our financial condition and results of operations.  No impairment
charges were recorded during the three months ended March 31, 2010 or
2009.


23


The first
part of the test is to compare the Company’s fair market value to the book value
of the Company as of the date of the test.  If the fair market value
of the Company is greater than the book value, no impairment exists as of the
date of the test.  However, if book value exceeds fair market value,
the Company must perform part two of the test, which involves recalculating the
implied fair value of goodwill by repeating the acquisition analysis that was
originally used to calculate goodwill, using purchase accounting as if the
acquisition happened on the date of the test, to calculate the implied fair
value of goodwill as of the date of the test.





New
Accounting Pronouncements:


In
October 2009, the Financial Accounting Standards Board issued Accounting
Standards Update 2009-13, “Revenue Recognition (Topic 605) Multiple-Deliverable
Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force (“ASU
2009-13”).  ASU 2009-13 amends existing accounting guidance for
separating consideration in multiple-deliverable arrangements.  ASU
2009-13 establishes a selling price hierarchy for determining the selling price
of a deliverable.  The selling price used for each deliverable will be
based on vendor-specific objective evidence if available, third-party evidence
if vendor-specific evidence is not available, or estimated selling price if
neither vendor-specific evidence nor third-party evidence is
available.  ASU 2009-13 eliminates residual method of allocation and
requires that arrangement consideration be allocated at the inception of the
arrangement to all deliverables using the “relative selling price
method.”  The relative selling price method allocates any discount in
the arrangement proportionately to each deliverable on the basis of each
deliverable’s selling price.  ASU 2009-13 requires that a vendor
determine its best estimate of selling price in a manner that is consistent with
that used to determine the price to sell the deliverable on a stand-alone
basis.  ASU 2009-13 is effective prospectively for revenue
arrangements entered into or materially modified in fiscal years beginning on or
after June 15, 2010, with earlier adoption permitted.  We do not
believe the adoption of ASU 2009-13 will have a material impact on our financial
statements.




In
January 2010, the FASB issued accounting standards update (ASU) No. 2010-06,
Fair Value Measurements and Disclosures (Topic 820)—Improving Disclosures about
Fair Value Measurements (ASU No. 2010-06). ASU No. 2010-06 requires: (1) fair
value disclosures of assets and liabilities by class; (2) disclosures about
significant transfers in and out of Levels 1 and 2 on the fair value hierarchy,
in addition to Level 3; (3) purchases, sales, issuances and settlements be
disclosed on a gross basis on the reconciliation of beginning and ending
balances of Level 3 assets and liabilities; and (4) disclosures about valuation
methods and inputs used to measure the fair value of Level 2 assets and
liabilities. ASU No. 2010-06 becomes effective for the first financial reporting
period beginning after December 15, 2009, except for disclosures about
purchases, sales, issuances and settlements of Level 3 assets and liabilities
which will be effective for fiscal years beginning after December 15, 2010. We
are currently assessing what impact, if any, ASU No. 2010-06 will have on our
fair value disclosures; however, we do not believe the adoption of the guidance
provided in this codification update to have any material impact on our
financial statements.


24


ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.





The
information in this Item is not being disclosed by Smaller Reporting Companies
pursuant to Regulation S-K.




ITEM
4T. CONTROLS AND PROCEDURES




(a) Evaluation of Disclosure Controls
and Procedures.  Under the supervision and with the
participation of its Chief Executive Officer and Chief Financial Officer,
management has evaluated the effectiveness of the Company’s disclosure controls
and procedures as of the end of the period covered by this report pursuant to
Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the
“Exchange Act”).  Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of the
period covered by this report, the Company’s disclosure controls and procedures
are effective in ensuring that information required to be disclosed in the
Company’s Exchange Act reports is (1) recorded, processed, summarized and
reported in a timely manner, and (2) accumulated and communicated to the
Company’s management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding required
disclosure.




(b) Changes in Internal
Controls. There were no material changes in the Company’s internal
control over financial reporting as of the end of the period covered by this
report as such term is defined in Rule 13a-15(f) of the Exchange
Act.


25




PART
II — OTHER INFORMATION




ITEM
1. LEGAL PROCEEDINGS




The
Company is currently involved in a lawsuit against a former director and the
company at which he is currently CEO (collectively, the
“Defendants”).  The Company filed this action against the Defendants
for misappropriation of trade secrets, false advertising, defamation/libel and
other claims primarily arising from the Defendants’ use of the Company’s
confidential and proprietary information in the development and marketing of
motor control products.  The Company seeks a temporary restraining
order, preliminary injunction, permanent injunction, damages, exemplary damages,
attorneys’ fees and costs against the Defendants.  The Company’s
complaint was filed on August 6, 2009 in the U.S. District Court, District of
Nevada.




ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS




On
January 20, 2010 and February 24, 2010, the Company issued and sold 4,375 units,
each unit consisting of one share of the Company’s Series C-1 Preferred Stock,
par value $.001 per share, and 50 warrants to purchase shares of the Company’s
common stock at an exercise price of $0.40 per share, resulting in the sale and
issuance of an aggregate of 4,375 shares of Series C-1 Preferred Stock and
warrants to purchase up to 218,750 shares of the Company’s common stock for
$175,000 in cash.  The securities were issued pursuant to Regulation D
of the Securities Act of 1933, as amended.  Of the aggregate $175,000
invested, a value of approximately $58,000 was allocated to the 218,750 Series
C-1 warrants and recorded as a component of paid-in capital.The conversion
features of the Series C-1 Preferred Stock at the time of issuance were
determined to be beneficial conversion features on January 20, 2010 and February
24, 2010, the dates of the transactions.  The Company recorded
additional preferred stock dividends of approximately $41,000 related to the
beneficial conversion feature.  In this transaction, Steven Strasser,
the Company’s CEO purchased 1,875 units for $75,000 in cash.




ITEM
3. DEFAULTS UPON SENIOR SECURITIES




None.




ITEM
4. RESERVED




None.





ITEM
5. OTHER INFORMATION





None.


26


ITEM
6. EXHIBITS





31.1
                Certification
      by the Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                Certification
      by the Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
                Certification
      by the Chief Executive Officer pursuant to Section 1350 of Chapter 63 of
      Title 18 of the United States Code (18 U.S.C. 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002.32.2
                Certification
      by the Chief Financial Officer pursuant to Section 1350 of Chapter 63 of
      Title 18 of the United States Code (18 U.S.C. 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002.99.1
                Press
      Release, dated May 17, 2010, announcing first quarter 2010
      results.


27




SIGNATURES




In
accordance with the requirements of the Securities Exchange Act of 1934, the
Company caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.





POWER
      EFFICIENCY CORPORATION(Company)Date:  May
      17, 2010
              By:
              /s/  Steven
StrasserChief
      Executive OfficerDate:  May
      17, 2010
              By:
              /s/  John LacklandChief
      Financial Officer (Principal
                Financial and
      Accounting Officer)


28