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: June 30, 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 August 10, 2010 was
45,119,984.




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 June 30, 2010 and December 31, 2009
                3Condensed
      Statements of Operations for the three and six months ended June 30, 2010
      and 2009
                4Condensed
      Statements of Cash Flows for the six months ended June 30, 2010 and
      2009
                5Notes
      to Condensed Financial Statements
                6-16ITEM
      2. Management's Discussion and Analysis Of Financial Condition and Results
      of Operations
                17-29ITEM
      3. Quantitative and Qualitative Disclosure About Market
    Risk
                29ITEM
      4T. Controls and Procedures
                29Part
      II — OTHER INFORMATIONITEM
      1. Legal Proceedings
                30ITEM
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                30ITEM
      3. Defaults Upon Senior Securities
                31ITEM
      4. Reserved
                31ITEM
      5. Other Information
                31ITEM
      6. Exhibits
                32Signatures
                33Certification
      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





June 30, 2010
                
                
                December 31, 2009ASSETSCURRENT
      ASSETS:Cash
                
                $
                4,052,378
                
                
                $
                247,564Accounts
      receivable, net
                
                
                92,101
                
                
                
                66,143Inventory
                
                
                200,900
                
                
                
                281,253Prepaid
      expenses and other current assets
                
                
                90,404
                
                
                
                36,437Total
      Current Assets
                
                
                4,435,783
                
                
                
                631,397PROPERTY
      AND EQUIPMENT, net
                
                
                61,542
                
                
                
                86,533OTHER
      ASSETS:Patents,
      net
                
                
                97,785
                
                
                
                86,342Deposits
                
                
                26,914
                
                
                
                26,914Goodwill
                
                
                1,929,963
                
                
                
                1,929,963Total
      Other Assets
                
                
                2,054,662
                
                
                
                2,043,219Total
      Assets
                
                $
                6,551,987
                
                
                $
                2,761,149LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued expenses
                
                $
                944,877
                
                
                $
                722,195Warrant
      liability
                
                
                4,745
                
                
                
                828,827Total
      Current Liabilities
                
                
                949,622
                
                
                
                1,551,002LONG
      TERM LIABILITIESDeferred
      rent
                
                
                4,816
                
                
                
                8,918Deferred
      tax liability
                
                
                424,540
                
                
                
                399,567Total
      Long Term Liabilities
                
                
                429,356
                
                
                
                408,485Total
      Liabilities
                
                
                1,378,978
                
                
                
                1,959,507COMMITMENTS
      (Note 10)STOCKHOLDERS'
      EQUITY:Series
      B, C-1 and D Convertible Preferred  Stock, $.001 par value,
      10,000,000 shares authorized, 488,377 and 170,250 issued and outstanding
      in 2010 and 2009, respectively
                
                
                488
                
                
                
                170Common
      stock, $.001 par value, 140,000,000 shares authorized, 45,119,984 and
      44,825,886 issued and outstanding 43,255,441 issued and outstanding in
      2010 and 2009, respectively
                
                
                45,120
                
                
                
                44,826Additional
      paid-in capital
                
                
                45,783,013
                
                
                
                36,797,628Accumulated
      deficit
                
                
                (40,655,612
                )
                
                
                (36,040,982
                )Total
      Stockholders' Equity
                
                
                5,173,009
                
                
                
                801,642Total
      Liabilities and Stockholders' Equity
                
                $
                6,551,987
                
                
                $
                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
                  June 30,
                
                
                For the six months ended
                  June 30,2009
                
                
                
                
                
                20092010
                
                
                (As Adjusted)
                
                
                2010
                
                
                (As Adjusted)REVENUES
                
                $
                125,575
                
                
                $
                75,393
                
                
                $
                235,605
                
                
                $
                122,540COST
      OF REVENUES
                
                
                108,752
                
                
                
                49,556
                
                
                
                201,022
                
                
                
                77,670GROSS
      PROFIT
                
                
                16,823
                
                
                
                25,837
                
                
                
                34,583
                
                
                
                44,870COSTS
      AND EXPENSES:Research
      and development
                
                
                145,939
                
                
                
                267,161
                
                
                
                315,618
                
                
                
                514,206Selling,
      general and administrative
                
                
                652,388
                
                
                
                632,737
                
                
                
                1,270,552
                
                
                
                1,204,222Depreciation
      and amortization
                
                
                11,826
                
                
                
                16,412
                
                
                
                26,263
                
                
                
                35,727Total
      Costs and Expenses
                
                
                810,153
                
                
                
                916,310
                
                
                
                1,612,433
                
                
                
                1,754,155LOSS
      FROM OPERATIONS
                
                
                (793,330
                )
                
                
                (890,473
                )
                
                
                (1,577,850
                )
                
                
                (1,709,285
                )OTHER
      INCOME (EXPENSE):Interest
      income
                
                
                1,652
                
                
                
                3,886
                
                
                
                1,657
                
                
                
                12,970Interest
      expense
                
                
                (934,649
                )
                
                
                -
                
                
                
                (934,649
                )
                
                
                -Fair
      market value adjustment on warrant liability
                
                
                309,200
                
                
                
                539,479
                
                
                
                824,082
                
                
                
                218,981Total
      Other Income (Expense)
                
                
                (623,797
                )
                
                
                543,365
                
                
                
                (108,910
                )
                
                
                231,951LOSS
      BEFORE PROVISION FOR INCOME TAXES
                
                
                (1,417,127
                )
                
                
                (347,108
                )
                
                
                (1,686,760
                )
                
                
                (1,477,334
                )PROVISION
      FOR INCOME TAXES
                
                
                14,384
                
                
                
                12,486
                
                
                
                27,120
                
                
                
                24,972NET
      LOSS
                
                
                (1,431,511
                )
                
                
                (359,594
                )
                
                
                (1,713,880
                )
                
                
                (1,502,306
                )DIVIDENDS
      PAID OR PAYABLE ON SERIES B, C-1 AND D PREFERED STOCK
                
                
                2,692,641
                
                
                
                140,000
                
                
                
                2,900,751
                
                
                
                280,000NET
      LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
                
                $
                (4,124,152
                )
                
                $
                (499,594
                )
                
                $
                (4,614,631
                )
                
                $
                (1,782,306
                )BASIC
      DILUTED LOSS PER COMMON SHARE
                
                $
                (0.09
                )
                
                $
                (0.01
                )
                
                $
                (0.10
                )
                
                $
                (0.04
                )WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING, BASIC AND DILUTED
                
                
                45,091,830
                
                
                
                43,255,441
                
                
                
                44,959,591
                
                
                
                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 six months ended June 30,20092010
                
                
                (As Adjusted)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                
                $
                (1,713,880
                )
                
                $
                (1,502,306
                )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                
                
                26,263
                
                
                
                35,727Warrants
      and options issued to employees and consultants
                
                
                134,974
                
                
                
                179,292Change
      in fair value of warrant liability
                
                
                (824,082
                )
                
                
                (218,981
                )Noncash
      interest expense related to debt discount
                
                
                818,542
                
                
                
                -Provision
      for bad debt
                
                
                -
                
                
                
                (11,342
                )Changes
      in assets and liabilities:Accounts
      receivable, net
                
                
                (25,958
                )
                
                
                3,152Inventory
                
                
                80,352
                
                
                
                (96,183
                )Prepaid
      expenses and other current assets
                
                
                (53,967
                )
                
                
                (31,681
                )Accounts
      payable and accrued expenses
                
                
                464,402
                
                
                
                34,530Deferred
      tax liability
                
                
                24,973
                
                
                
                24,972Deferred
      rent
                
                
                (4,102
                )
                
                
                (1,865
                )Net
      Cash Used in Operating Activities
                
                
                (1,072,483
                )
                
                
                (1,584,685
                )CASH
      FLOWS FROM INVESTING ACTIVITIESCosts
      related to patent applications
                
                
                (12,716
                )
                
                
                -Purchases
      of property and equipment
                
                
                -
                
                
                
                (9,602
                )Net
      Cash Used in Investing Activities
                
                
                (12,716
                )
                
                
                (9,602
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuance of equity securities
                
                
                3,766,200
                
                
                
                -Proceeds
      from issuance of notes payable
                
                
                1,687,083
                
                
                
                -Repayment
      of notes payable
                
                
                (450,000
                )
                
                
                -Fees
      paid to investment banks for equity financing
                
                
                (113,270
                )
                
                
                -Net
      Cash Provided by Financing Activities
                
                
                4,890,013
                
                
                
                -Increase
      (Decrease) in cash
                
                
                3,804,814
                
                
                
                (1,594,287
                )Cash
      at beginning of period
                
                
                247,564
                
                
                
                2,100,013Cash
      at end of period
                
                $
                4,052,378
                
                
                $
                505,726




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 and six months ended June
30, 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 $1,072,483 deficiency of cash from operations for the six months
ended June 30, 2010, and expects significant cash deficiencies from operations
until the Company’s sales and gross profit grow to exceed its cash needs. 
While the Company appears to have adequate liquidity at June 30, 2010, there can
be no assurances that such liquidity will remain sufficient.





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





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 April
2010, the FASB issued Accounting Standards Update (ASU) 2010-17, Revenue Recognition - Milestone
Method(Topic 605). ASU 2010-17 provides guidance on defining a milestone
and determining when it may be appropriate to apply the milestone method of
revenue recognition for research or development transactions. The amendments
provide guidance on the criteria that should be met for determining whether the
milestone method of revenue recognition is appropriate. The Company can
recognize consideration that is contingent upon achievement of a milestone in
its entirety as revenue in the period in which the milestone was achieved only
if the milestone meets all criteria to be considered substantive. The amendments
in ASU 2010-17 are effective on a prospective basis for milestones achieved in
fiscal years, and interim periods within those years, beginning on or after June
15, 2010. Early adoption is permitted. The Company does not expect the adoption
of this statement to have a material impact on the financial
statements.





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


7





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 June 30, 2010 or December 31,
2009.





Inventories
are comprised as follows:





June 30,
                  2010
                
                
                December
                  31, 2009Raw
      materials
                
                $
                173,527
                
                
                $
                175,806Finished
      goods
                
                
                27,373
                
                
                
                105,447Inventories
                
                $
                200,900
                
                
                $
                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 June 30, 2010 and December
31, 2009.  Based on this, no impairment was recorded as of June 30, 2010 or
December 31, 2009.


8





NOTE
6 – NOTES PAYABLE





On
various dates in May and June, 2010, the Company entered into financing
transactions in which the Company issued $1,637,083, before discount, of its one
year, senior, secured promissory notes (collectively the “Secured Notes”,
individually a “Secured Note”).   The Secured Notes bear interest of
12% per annum.  Interest due under the Secured Notes is payable
semiannually, with the principal and final interest payment becoming due in May
and June, 2011.  The Company may prepay the principal and interest due on
this Secured Note, at any time, in whole or in part without penalty or premium,
plus 8 months of interest at the time of prepayment.  The Secured Notes
have a first priority security interest in all of the assets of the
Company.  Upon the occurrence of an “Event of Default” (as defined in the
Secured Note, included herein as an exhibit) the holder may, upon written notice
to the Company, elect to declare the entire principal amount of the Secured Note
then outstanding together with accrued unpaid interest thereon due and
payable.  Upon receipt of such notice, the Company shall have twenty
business days to cure the Event of Default, and if uncured on the twenty first
business day, all principal and interest shall become immediately due and
payable.  All of the investors in the Secured Notes are officers or
pre-existing stockholders of the Company.  The Company also issued
7,117,762 warrants (the “Debt Warrants”) to purchase common stock of the Company
to the holders of the Secured Notes.  The Debt Warrants have a per share
exercise price of $0.23 and expire on various dates between May and June,
2015.  The common stock issuable upon exercise of the Debt Warrants has
piggyback registration rights, and can be included in the Company’s next
registration statement.  The Debt Warrants have a cashless exercise
provision, but only if the registration statement on which the common stock
issuable upon exercise of the Debt Warrants is not then effective. 
  In addition, the investors of the Secured Notes that held warrants
from prior investments with the Company had the exercise price of some or all of
such warrants reduced to $0.23 per share.  As a result, the Company reduced
the prices on an aggregate 9,993,593 warrants from per share exercise prices
ranging from $0.24 to $0.60, to $0.23.  Of the aggregate $1,637,083
invested, a value of $818,542 was allocated to the Debt Warrants and the warrant
price reduction based upon their relative fair value, recorded as a debt
discount, and was amortized over the life of the Secured Notes.  The
Secured Notes and related accrued interest were paid off or converted into the
Series D Convertible Preferred Stock Offering in full on June 21, 2010 (See Note
7), and all remaining debt discount was expensed as interest
expense.





The
Secured Notes consisted of $200,000 from Steven Strasser, the Company’s
Chairman, Chief Executive Officer and the Company’s largest beneficial
shareholder, and were exchanged from an existing unsecured promissory note of
the Company.





In March
and April 2010 the Company issued unsecured notes (the “Unsecured Notes”) to
Steven Strasser, the Company’s CEO, totaling $250,000.  The Unsecured Notes
bore interest at 5%, payable upon maturity.  The Unsecured Notes were set
to mature two months after issuance.  $200,000 of Unsecured Notes were
converted into Secured Notes on May 13, 2010, and the remaining $50,000 plus
related accrued interest was paid off in full on May 26, 2010.


9





NOTE
7 – CONVERTIBLE PREFERRED STOCK





On June
21, 2010, the Company issued and sold 313,752 units, each unit consisting of one
share of the Company’s Series D Preferred Stock, par value $.001 per share, and
50 warrants to purchase shares of the Company’s common stock at an exercise
price of $0.19 per share, resulting in the sale and issuance of an aggregate of
313,752 shares of Series D Preferred Stock and warrants to purchase up to
15,687,600 shares of the Company’s common stock for $5,020,000, which consisted
of $3,601,200 in cash and $1,418,800 in cancellation of indebtedness.  The
securities were issued pursuant to Regulation D of the Securities Act of 1933,
as amended.  Of the aggregate $5,020,000 invested, a value of $1,573,590
was allocated to the 15,687,600 Series D warrants and recorded as a component of
paid-in capital.  The
conversion feature of the Series D Preferred Stock at the time of issuance was
determined to be beneficial on June 21, 2010, the date of the transaction. 
The Company recorded additional preferred stock dividends of $2,514,856 related
to the beneficial conversion feature.  In this transaction, Steven
Strasser, the Company’s CEO, purchased 34,547 units for $500,000 in cash and
$52,000 in cancellation of indebtedness, and John Lackland, the Company’s CFO,
purchased 1,875 units for $30,000 in cancellation of indebtedness.  In
addition, the issuance of the Series D Preferred Stock also triggered an
anti-dilution provision on a portion of the Company’s existing warrants that
were classified as liabilities on June 21, 2010.  This resulted in an
increase in the fair value of these warrants of $3,858.





Wilmington
Capital Securities, LLC (the “Placement Agent”), a registered broker dealer,
acted as the sole placement agent for the Series D Preferred Stock offering. For
its services, the Placement Agent received commission and non-accountable fees
totaling $113,120 and 113,120 warrants (the “Placement Agent Warrants”). The
Placement Agent Warrants have a per share exercise price of $0.19 and expire
five years from the date of issuance. The value of the Placement Agent Warrants
was $19,494.





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
$57,884 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 was determined to be a
beneficial conversion feature on January 20, 2010 and February 24, 2010, the
dates of the transactions.  The Company recorded additional preferred stock
dividends of $41,309 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.


10





Six Months
                    Ended June
                    30, 2010
                  
                  
                  Six Months
                    Ended June
                    30, 2009*Net
      loss attributable to common shareholders
                  
                  $
                  (4,614,631
                  )
                  
                  $
                  (1,782,306
                  )Basic
      weighted average number of common shares outstanding
                  
                  
                  44,929,591
                  
                  
                  
                  43,255,441Dilutive
      effect of stock options
                  
                  
                  -
                  
                  
                  
                  -Diluted
      weighted average number of common shares outstanding
                  
                  
                  44,929,591
                  
                  
                  
                  43,255,441Basic
      and diluted loss per share
                  
                  $
                  (0.10
                  )
                  
                  $
                  (0.04
                  )


*Refer to
Note 13 – Prior Period Adjustment





For the
six months ended June 30, 2010, warrants and options to purchase 68,128,307
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 six months ended June 30, 2009, warrants
and options to purchase 46,209,676 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 June
30, 2010, the Company had two stock-based compensation plans.  There were
1,325,000 options granted in the six months ended June 30, 2010.  The fair
value of these options was $310,000 at issuance.  There were 435,000
warrants and 2,000,000 options granted in the six months ended June 30, 2009.
 The values of these grants were $56,799 and $357,000 at issuance,
respectively.  The fair value of these warrants and options was calculated
using the Black-Scholes Options Pricing Model, which utilizes both observable
and unobservable assumptions (level 3 inputs).  42,000 and 0 stock options
were exercised in the periods ending June 30, 2010 and 2009, respectively. 
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 $134,974 and $179,292 for
the periods ended June 30, 2010 and 2009, respectively.





The fair
value of options granted is estimated on the date of grant based on the
weighted-average assumptions in the table below.  The assumption for the
expected life is based on evaluations of historical and expected exercise
behavior.  The risk-free interest rate is based on the U.S. Treasury rates
at the date of grant with maturity dates approximately equal to the expected
life at the grant date.  The historical daily stock volatility of the
Company’s common stock (the Company’s only class of publically traded stock)
over the estimated life of the stock warrant is used as the basis for the
volatility assumption.


11





Six months ended June 30,2010
                        
                        2009Weighted
      average risk-free rate
                        2.02%
      - 2.46%
                        
                        1.68%
      - 3.25%Average
      expected life in years
                        6
                        
                        10Expected
      dividends
                        None
                        
                        NoneVolatility
                        157.72%
      - 159.29%
                        
                        294.51%Forfeiture
      rate
                        46%
                        
                        46%





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 $88,000 in
open purchase orders with this subcontractor as of June 30, 2010.





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, including the
effect of the anti-dilution provision (see Note 7), was valued at $4,745 and
$828,827 as of June 30, 2010 and December 31, 2009, respectively, resulting in
non-cash gains in the statement of operations of $824,082 for the six months
ended June 30, 2010.  The warrant liability was valued at $162,875 and
$381,856 as of June 30, 2009 and January 1, 2009, respectively, resulting in
non-cash gains of $218,981 during the six months ended June 30, 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.





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 117%, risk-free rate 0.17%, term equivalent
to the remaining life of the warrants.  The Company recorded a non-cash
gain related to these warrants of $824,082 for the six months ended June 30,
2010, which was recorded in other income (expense).


12





The
following reconciles the warrant liability for the six months ended June
30:





2010
                
                
                2009Beginning
      balance, January 1,
                
                $
                828,827
                
                
                $
                381,856Change
      in fair value
                
                
                (824,082
                )
                
                
                (218,981
                )Ending
      balance, June 30,
                
                $
                4,745
                
                
                $
                162,875





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





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





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 quantitative 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.


13





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


14





For the
three months ended June 30, 2009:





As
                    Previously
                    Reported
                  
                  
                  Adjustments
                  
                  
                  As AdjustedRevenues
                  
                  $
                  75,393
                  
                  
                  $
                  -
                  
                  
                  $
                  75,393Cost
      of revenues
                  
                  
                  49,556
                  
                  
                  
                  -
                  
                  
                  
                  49,556Gross
      profit
                  
                  
                  25,837
                  
                  
                  
                  -
                  
                  
                  
                  25,837Total
      costs and expenses
                  
                  
                  916,310
                  
                  
                  
                  -
                  
                  
                  
                  916,310Loss
      from operations
                  
                  
                  (890,473
                  )
                  
                  
                  -
                  
                  
                  
                  (890,473
                  )Other
      income and (expense)
                  
                  
                  852,108
                  
                  
                  
                  (308,743
                  )
                  
                  
                  543,365Loss
      before provision for taxes
                  
                  
                  (38,365
                  )
                  
                  
                  (308,743
                  )
                  
                  
                  (347,108
                  )Provision
      for taxes
                  
                  
                  -
                  
                  
                  
                  12,486
                  
                  
                  
                  12,486Net
      loss
                  
                  
                  (38,365
                  )
                  
                  
                  (321,229
                  )
                  
                  
                  (359,594
                  )Dividends
      paid or payable on Series B and Series C Convertible Preferred
      Stock
                  
                  
                  140,000
                  
                  
                  
                  -
                  
                  
                  
                  140,000Net
      loss attributable to common shareholders
                  
                  $
                  (178,365
                  )
                  
                  $
                  (321,229
                  )
                  
                  $
                  (499,594
                  )Basic
      and fully diluted loss per common share
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.01
                  )
                  
                  $
                  (0.01
                  )Weighted
      average common shares outstanding basic
                  
                  
                  43,255,441
                  
                  
                  
                  43,255,441
                  
                  
                  
                  43,255,441





NOTE
14 – SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION





Cash paid
during the six months ended June 30, for:





2010
                
                
                2009Income/franchise
      taxes
                
                $
                9,239
                
                
                $
                6,728





Non-cash
investing and financing activities during the six months ended June 30,
for:





2010
                
                
                2009Warrants
      and options issued with common stock issued to employees and
      consultants
                
                $
                134,974
                
                
                $
                179,292Common
      stock issued to vendors
                
                $
                60,000
                
                
                $
                -Senior
      secured notes converted into Series D preferred stock
                
                $
                1,237,083
                
                
                $
                -Accrued
      interest and accrued wages converted into Series D preferred
      stock
                
                $
                181,718
                
                
                $
                -Preferred
      stock dividend recognized for beneficial conversion features of preferred
      stock issuances
                
                $
                2,556,165
                
                
                $
                -Preferred
      stock dividends paid or payable in common stock
                
                $
                344,586
                
                
                $
                280,000


15





NOTE
15 – SUBSEQUENT EVENTS





On August
13, 2010, Steven Strasser, Chief Executive Officer of the Company, entered into
an employment agreement to serve as the Chief Executive Officer of the Company
for a term ending June 1, 2015, unless further extended or earlier
terminated.  Pursuant to the employment agreement, Mr. Strasser will
receive the following compensation: (a) an annual salary of $300,000; (b) bonus
as determined by the compensation committee; (c) a one-time grant of stock
options exercisable for up to 4,000,000 shares of Company common stock at an
exercise price of $0.18 per share; and (d) and such other benefits as described
in the employment agreement filed herewith as an exhibit.





On August
13, 2010, John (BJ) Lackland, Chief Financial Officer and Secretary of the
Company of the Company, entered into an employment agreement to serve as the
Chief Financial Officer and Secretary for a term ending June 1, 2015, unless
further extended or earlier terminated.  Pursuant to the employment
agreement, Mr.Lacklandwill receive
the following compensation: (a) an annual salary of $200,000; (b) bonus as
determined by the compensation committee; (c) a one-time grant of stock options
exercisable for up to 2,000,000 shares of Company common stock at an exercise
price of $0.18 per share; and (d) such other benefits as described in the
employment agreement filed herewith as an exhibit.





On July
30, 2010, the Company sold 12,500 units under its Series D Preferred Stock
offering, resulting in the issuance of an aggregate of 12,500 shares of Series D
Preferred Stock and warrants to purchase up to 625,000 shares of the Company’s
common stock for $200,000 in cash (see Note 7).





On July
16, 2010, Dick Morgan, Gary Rado and George Boyadjieff each delivered a
resignation letter to the Company, resigning from the board of directors of the
Company effective as of the close of business July 16, 2010. Gary Rado and Dick
Morgan were members of the Company's audit committee. Gary Rado and George
Boyadjieff were members of Company's compensation committee.





Messrs.
Morgan, Rado and Boyadjieff's resignations are purely personal in nature and not
as a result of any disagreement with the Company on any matter relating to the
Company's operations, policies or practices.





On July
16, 2010, at a duly held meeting of the board of directors of the Company, the
board elected Marc Lehmann and Herman Sarkowsky to serve on the board of
directors of the Company until the next annual meeting of the Company's
stockholders or such time as his successor is elected.




16




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.


17





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.


18





Capitalization


As of
June 30, 2010, the Company had total stockholders’ equity of $5,183,009,
primarily due to (i) the Company’s sale of 313,752 shares of Series D Preferred
Stock, (ii) the Company’s sale of 34,625 shares of Series C-1 Preferred Stock in
a private offering from December 2009 through March 2010, (iii) the Company’s
sale of 140,000 shares of Series B Preferred Stock in a private offering from
October of 2007 through January of 2008, (iv) 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, (v) the Company’s sale of 14,500,000 shares of common stock in a
private stock offering in July and August of 2005, (vi) the Company’s sale of
2,346,233 shares of Series A-1 Preferred stock to Summit Energy Ventures, LLC in
June of 2002 and (vii) the conversion of notes payable of approximately
$1,047,000 into 982,504 shares of Series A-1 Preferred Stock in October of
2003.  All of the Company’s Series A-1 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 three and six months ended June 30, 2010
were marked by a significant increase in revenues, a decrease in gross profit
and a decrease in its loss from operations that are more fully discussed in the
following section, “Results of Operations for the Three and Six Months Ended
June 30, 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.


19


RESULTS
OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 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, 2009
                
                
                Six Months
                  Ended June
                  30, 2010
                
                
                Six Months
                  Ended June
                  30, 2009Revenues
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %Cost
      of revenues
                
                
                86.6
                
                
                
                65.7
                
                
                
                85.3
                
                
                
                63.4Gross
      profit
                
                
                13.4
                
                
                
                34.3
                
                
                
                14.7
                
                
                
                36.6Costs
      and expenses:Research
      and development
                
                
                116.2
                
                
                
                354.4
                
                
                
                134.0
                
                
                
                419.6Selling,
      general and administrative
                
                
                519.5
                
                
                
                839.3
                
                
                
                539.3
                
                
                
                982.7Depreciation
      and amortization
                
                
                9.5
                
                
                
                21.8
                
                
                
                11.1
                
                
                
                29.2Total
      expenses
                
                
                645.2
                
                
                
                1,215.4
                
                
                
                684.4
                
                
                
                1,431.5Loss
      from operations
                
                
                (631.8
                )
                
                
                (1,181.1
                )
                
                
                (669.7
                )
                
                
                (1,394.9
                )Other
      income (expense)
                
                
                (496.7
                )
                
                
                720.7
                
                
                
                (46.6
                )
                
                
                189.3Loss
      before provision for income taxes
                
                
                (1,128.5
                )
                
                
                (460.4
                )
                
                
                (715.9
                )
                
                
                (1,205.6
                )Provision
      for income taxes
                
                
                11.5
                
                
                
                16.6
                
                
                
                11.5
                
                
                
                20.4Net
      loss
                
                
                (1,140.0
                )
                
                
                (477.0
                )
                
                
                (727.4
                )
                
                
                (1,226.0
                )Dividends
      paid or payable on Series B, C-1 and D Preferred Stock
                
                
                2,144.2
                
                
                
                185.7
                
                
                
                1,231.2
                
                
                
                228.5Net
      loss attributable to common shareholders
                
                
                (3,284.2
                )
                
                
                (662.7
                )
                
                
                (1,958.6
                )
                
                
                (1,454.5
                )




REVENUES




Total
revenues for the three months ended June 30, 2010 were approximately $126,000,
compared to $75,000 for the three months ended June 30, 2009, an increase of
$51,000 or 68%. This increase is mainly attributable to an increase in
sales in the elevator and escalator market in the second quarter of 2010. 
Specifically, elevator and escalator sales grew to approximately $99,000 for the
three months ended June 30, 2010, from approximately $31,000 for the three
months ended June 30, 2009, which was partially offset by a decrease in sales in
the industrial and other market which fell to approximately $28,000 for the
three months ended June 30, 2010, from $44,000 for the three months ended June
30, 2009.  The increase in elevator and escalator sales in the three months
ended June 30, 2010 is primarily due to the commercialization and increased
market acceptance of the Company’s digital products, 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 June 30, 2010.  For
the three months ended June 30, 2010, industrial and other sales were
approximately 21% of total sales, and escalator and elevator sales were
approximately 79% of total sales.  All sales for the three months ended
June 30, 2010 consisted entirely of digital units.  For the three months
ended June 30, 2009, industrial sales, of which all consisted of digital units,
were approximately 59% of total sales, and escalator and elevator sales, which
consisted of a mix of digital units and analog units, were approximately 41% of
total sales.


20





Total
revenues for the six months ended June 30, 2010 were approximately $236,000,
compared to $123,000 for the six months ended June 30, 2009, an increase of
$113,000 or 92%. This increase is mainly attributable to an increase in
sales in the elevator and escalator market in the second quarter of 2010. 
Specifically, elevator and escalator sales grew to approximately $170,000, which
included one large sale to a marquee end user of approximately $52,000 for the
six months ended June 30, 2010, from approximately $65,000 for the six months
ended June 30, 2009, which was partially offset by a decrease in sales in the
industrial and other markets which fell to approximately $52,000 for the six
months ended June 30, 2010, from $56,000 for the six months ended June 30,
2009.  The increase in elevator and escalator sales in the three months
ended June 30, 2010 is primarily due to the same factors described above. 
In the industrial and other market, the Company has continued its 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.  For the six months ended June 30, 2010, industrial and
other sales were approximately 23% of total sales, and escalator and elevator
sales were approximately 77% of total sales.  All sales for the six months
ended June 30, 2010 consisted entirely of digital units.  For the six
months ended June 30, 2009, industrial sales, of which all but one order
consisted of digital units, were approximately 46% of total sales, and escalator
and elevator sales, which consisted of a mix of digital units and analog units,
were approximately 54% of total sales.





COST
OF REVENUES




Total
cost of revenues, which includes material and direct labor and overhead for the
three months ended June 30, 2010, was approximately $109,000 compared to
approximately $50,000 for the three months ended June 30, 2009, an increase of
$63,000 or 118%.  This increase is mainly attributable to an overall
increase in sales in the elevator and escalator sales and industrial sales in
the second quarter of 2010, as described above.  As a percentage of
revenue, total cost of sales increased to approximately 87% for the three months
ended June 30, 2010 compared to approximately 67% for the three months ended
June 30, 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 June 30, 2010,
rather than through direct sales efforts, as it did during the three months
ended June 30, 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 June 30, 2010.  No such sale occurred
during the three months ended June 30, 2009.


21





Total
cost of revenues, which includes material and direct labor and overhead for the
six months ended June 30, 2010, was approximately $201,000 compared to
approximately $78,000 for the six months ended June 30, 2009, an increase of
$123,000 or 158%.  This increase is mainly attributable to an overall
increase in sales in the elevator and escalator sales and industrial sales in
the first and second quarters of 2010, as described above.  As a percentage
of revenue, total cost of sales increased to approximately 85% for the six
months ended June 30, 2010 compared to approximately 63% for the six months
ended June 30, 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 as described above.





GROSS
PROFIT





Gross
profit for the three months ended June 30, 2010 was approximately $17,000
compared to approximately $26,000 for the three months ended June 30,
2009.  As a percentage of revenue, gross profit decreased to approximately
13% for the three months ended June 30, 2010 compared to approximately 35% for
the three months ended March June 30, 2009 for the reasons explained
above.





Gross
profit for the six months ended June 30, 2010 was approximately $35,000 compared
to approximately $45,000 for the six months ended June 30, 2009.  As a
percentage of revenue, gross profit decreased to approximately 15% for the six
months ended June 30, 2010 compared to approximately 37% for the six months
ended June 30, 2009 for the reasons explained above.





OPERATING
EXPENSES




Research
and Development Expenses




Research
and development expenses were approximately $146,000 for the three months ended
June 30, 2010, as compared to approximately $267,000 for the three months ended
June 30, 2009, a decrease of $121,000 or 45%.  This decrease is mainly
attributable to a reduction in salaries and related payroll expense and 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.





Research
and development expenses were approximately $316,000 for the six months ended
June 30, 2010, as compared to approximately $514,000 for the six months ended
June 30, 2009, a decrease of $198,000 or 38%.  This decrease is mainly
attributable to a reduction in salaries and related payroll expense and 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.


22





Selling,
General and Administrative Expenses




Selling,
general and administrative expenses were approximately $652,000 for the three
months ended June 30, 2010, as compared to $633,000 for the three months ended
June 30, 2009, an increase of $19,000 or 3%. 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 June 30, 2010.  This increase was partially
offset by a decrease in costs related to stock-based compensation.





Selling,
general and administrative expenses were approximately $1,271,000 for the six
months ended June 30, 2010, as compared to $1,204,000 for the six months ended
June 30, 2009, an increase of $67,000 or 6%. 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 six months ended June 30, 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 $4,745, including
the effect of the anti-dilution provision (see Note 7), as of June 30, 2010,
primarily due to the approximately 20% decline in the value of our common stock
and the reduced remaining term until expiration of the warrants.  The
$309,200 and $824,082 decreases in the fair value of these warrants during three
and six months ended June 30, 2010, respectively, has been reflected as a
non-operating gain in the Statement of Operations for the three and six months
ended June 30, 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 in July and August 2010.





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 $1,072,483 deficiency of cash from operations for the six months
ended June 30, 2010.  While the Company appears to have adequate liquidity
at June 30, 2010, there can be no assurances that such liquidity will remain
sufficient.


23





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.





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 June 30, 2010, the Company had cash of $4,052,378.





Cash used
for operating activities for the six months ended June 30, 2010 was $1,072,483,
which consisted of a net loss of $1,713,880; less depreciation and amortization
of $26,263, warrants and options issued to employees and consultants of
$134,974, noncash interest expense of $818,542, and a decrease in inventory of
$80,352, offset by a change in fair value of warrant liability of $824,082, and
increases in accounts receivable of $25,958, prepaid expenses and other current
assets of $53,967.  In addition, these amounts were offset by a decrease in
deferred rent of $4,102, and increases in accounts payable of $454,402 and
deferred tax liability of $24,973.





Cash used
in operating activities for the six months ended June 30, 2009 was $1,584,685,
which consisted of a net loss of $1,502,306; less depreciation and amortization
of $35,727, warrants and options issued to employees and consultants of
$179,292, a decrease in accounts receivable of $3,152, and increases in accounts
payable of $34,530, and deferred tax liability of $24,972, offset by a change in
fair value of warrant liability of $218,981, increases in inventory of $96,183,
prepaid expenses and other current assets of $31,681, and decreases in provision
for bad debt of $11,342 and deferred rent of $1,865.





Net cash
used in investing activities for the six months ended June 30, 2010 was $12,716,
compared to $9,602 for the six months ended June 30, 2009. The total amount for
the first and second quarters of 2010 consisted of capitalized costs related to
patent applications.  The total amount for the first and second quarters of
2009 consisted of the purchase of property and equipment.





Net cash
provided by financing activities was $4,900,013 for the six months ended June
30, 2010.  Of this amount, $3,776,200 was from the proceeds from the
issuance of equity securities, $1,687,083 was from the proceeds from the
issuance of debt securities, offset by payments on notes payable of $450,000,
and payments to investment banks for fees related to equity financings of
$113,270.  There was no cash provided by or used for financing activities
for the six months ended June 30, 2009.


24





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.





Cash
Requirements and Need for Additional Funds




While the
Company appears to have adequate liquidity at June 30, 2010, there can be no
assurances that such liquidity will remain sufficient.  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 June 30, 2010 or December 31,
2009.


25





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.





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 11 to the condensed
financial statements).  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)).


26





Revenue
Recognition


Revenue
from product sales is recognized when persuasive 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.





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 $135,000 and $179,000 in compensation expense during the six months
ended June 30, 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.


27





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 six
months ended June 30, 2010 or 2009.





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 April
2010, the FASB issued Accounting Standards Update (ASU) 2010-17, Revenue Recognition - Milestone
Method(Topic 605). ASU 2010-17 provides guidance on defining a milestone
and determining when it may be appropriate to apply the milestone method of
revenue recognition for research or development transactions. The amendments
provide guidance on the criteria that should be met for determining whether the
milestone method of revenue recognition is appropriate. The Company can
recognize consideration that is contingent upon achievement of a milestone in
its entirety as revenue in the period in which the milestone was achieved only
if the milestone meets all criteria to be considered substantive. The amendments
in ASU 2010-17 are effective on a prospective basis for milestones achieved in
fiscal years, and interim periods within those years, beginning on or after 15
June 2010. Early adoption is permitted. The Company does not expect the adoption
of this statement to have a material impact on the financial
statements.





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.


28





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.





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.




29




PART
II — OTHER INFORMATION




ITEM
1. LEGAL PROCEEDINGS




The
Company is currently involved in a lawsuit against a former director (the
“Defendant”), who is now CEO of a company offering motor control products. 
The Company filed this action against the Defendant for misappropriation of
trade secrets, false advertising, defamation/libel and other claims primarily
arising from the Defendant’s 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 Defendant.  The Company’s complaint was filed on August 6, 2009
in the U.S. District Court, District of Nevada.  The litigation is now
proceeding through the discovery phase.




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




On June
21, 2010, the Company issued and sold 313,752 units, each unit consisting of one
share of the Company’s Series D Preferred Stock, par value $.001 per share, and
50 warrants to purchase shares of the Company’s common stock at an exercise
price of $0.19 per share, resulting in the sale and issuance of an aggregate of
313,752 shares of Series D Preferred Stock and warrants to purchase up to
15,687,600 shares of the Company’s common stock for $5,020,000, which consisted
of $3,601,200 in cash and $1,418,800 in cancellation of indebtedness.  The
securities were issued pursuant to Regulation D of the Securities Act of 1933,
as amended.  Of the aggregate $5,020,000 invested, a value of approximately
$2,741,000 was allocated to the 15,687,600 Series D warrants and recorded as a
component of paid-in capital.  The conversion feature of the
Series D Preferred Stock at the time of issuance was determined to be beneficial
on June 21, 2010, the date of the transactions.  The Company recorded
additional preferred stock dividends of approximately $2,515,000 related to the
beneficial conversion feature.  In this transaction, Steven Strasser, the
Company’s CEO, purchased 34,547 units for $500,000 in cash and $52,000 in
cancellation of indebtedness, and John Lackland, the Company’s CFO, purchased
1,875 units for $30,000 in cancellation of indebtedness.





Wilmington
Capital Securities, LLC (the “Placement Agent”), a registered broker dealer,
acted as the sole placement agent for the Offering. For its services, the
Placement Agent received commissions and non-accountable fees totaling $113,120
and 113,120 warrants (the “Placement Agent Warrants”). The Placement Agent
Warrants have a per share exercise price of $0.19 and expire five years from the
date of issuance. The value of the Placement Agent Warrants was approximately
$19,000.





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.


30




ITEM
3. DEFAULTS UPON SENIOR SECURITIES




None.




ITEM
4. RESERVED




None.





ITEM
5. OTHER INFORMATION





On August
13, 2010, Steven Strasser, Chief Executive Officer of the Company, entered into
an employment agreement to serve as the Chief Executive Officer of the Company
for a term ending June 1, 2015, unless further extended or earlier
terminated.  Pursuant to the employment agreement, Mr. Strasser will
receive the following compensation: (a) an annual salary of $300,000; (b) bonus
as determined by the compensation committee; (c) a one-time grant of stock
options exercisable for up to 4,000,000 shares of Company common stock at an
exercise price of $0.18 per share; and (d) and such other benefits as described
in the employment agreement filed herewith as an exhibit.





On August
13, 2010, John (BJ) Lackland, Chief Financial Officer and Secretary of the
Company of the Company, entered into an employment agreement to serve as the
Chief Financial Officer and Secretary for a term ending June 1, 2015, unless
further extended or earlier terminated.  Pursuant to the employment
agreement, Mr. Lackland will receive the following compensation: (a)
an annual salary of $200,000; (b) bonus as determined by the compensation
committee; (c) a one-time grant of stock options exercisable for up to 2,000,000
shares of Company common stock at an exercise price of $0.18 per share; and (d)
such other benefits as described in the employment agreement filed herewith as
an exhibit.


31





ITEM
6. EXHIBITS





10.1
                Employment
      Agreement with Steven Strasser dated August 13, 2010 filed
      herewith10.2
                Employment
      Agreement with John Lackland dated August 13, 2010 filed
      herewith31.1
                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.


32




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:  August
      16, 2010
                By:
                /s/  Steven
StrasserChief
      Executive OfficerDate:  August
      16, 2010
                By:
                /s/  John LacklandChief
      Financial Officer (Principal
                  Financial and
      Accounting Officer)


33