**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-QSB**

 

**ý****QUARTERLY REPORT UNDER SECTION 13OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended: September 30,2004**

 

**OR**

 

**o****TRANSITION REPORT UNDER SECTION 13OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                 to                **

 

**Commission File No.****  0-31805**

 

**POWEREFFICIENCY CORPORATION**

(Exact Name of Small Business Issuer as Specified in its Charter)

 
| **Delaware**                                                    |       | **22-3337365**                                         |
|-----------------------------------------------------------------|------------|--------------------------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) | ** ** | (I.R.S. Employer Identification No.)                   |
|                                                            |       |                                                   |
| **3900 Paradise Road, Suite 283  Las Vegas, NV 89109**          |       | **(702) 697-0377**                                     |
| (Address of Principal Executive  Offices)                       | ** ** | (Issuer’s Telephone Number,  Including Area Code) |

 

Check whetherthe issuer (1) filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the past 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.Yes   ý  No   o

 

The number ofshares outstanding of the Issuer’s Common Stock, $.001 Par Value, as of November 12,2004 was 5,020,477.

 

TransitionalSmall Business Disclosure Format (check one):   Yes    o   No   ý

 

 

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**POWER EFFICIENCY CORPORATIONFORM 10-QSB INDEX**

 
| PART I—FINANCIAL INFORMATION                                                 |                                                                                                                                                  |
|-----------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                              |                                                                                                                                                  |
| ITEM 1.  Financial Statements                                           |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |   |
|                                                                              | Condensed Balance Sheet as of September 30, 2004                                                                                                 |   |
|                                                                              |                                                                                                                                                  |   |
|                                                                              | Condensed Statements of Operations for the three months ended September 30, 2004 and 2003 and nine months ended September 30, 2004 and 2003 |   |
|                                                                              |                                                                                                                                                  |   |
|                                                                              | Condensed Statements of Cash Flows for the nine months ended September 30, 2004 and 2003                                                         |   |
|                                                                              |                                                                                                                                                  |   |
|                                                                              |  Notes to Condensed Financial Statements                                                                                                         |   |
|                                                                              |                                                                                                                                                  |
| ITEM 2.  Management’s Discussion and Analysis or Plan of Operation |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| ITEM 3.  Controls and Procedures                                        |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| Part II—OTHER INFORMATION                                                    |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| ITEM 1.  Legal Proceedings                                              |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| ITEM 2.  Changes in Securities and Use of Proceeds                      |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| ITEM 3.  Defaults Upon Senior Securities                                |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| ITEM 4.  Submission of Matters to a Vote of Security Holders            |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| ITEM 5. Other Information                                                         |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| ITEM 6. Exhibits and Reports on Form 8-K                                          |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| Signatures                                                                        |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| Certification of Chief  Executive Officer as Adopted                              |                                                                                                                                                  |
|                                                                              |                                                                                                                                                  |
| Certification of Chief  Financial Officer as Adopted                              |                                                                                                                                                  |

 

2

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**PART I****. FINANCIAL INFORMATION**

 

**Item 1****.****Financial Statements**

 

**POWER EFFICIENCY CORPORATION**CONDENSED BALANCE SHEET

September 30, 2004

Unaudited

 
| ASSETS                                                                                                               |   |        |      |
|----------------------------------------------------------------------------------------------------------------------|--------|-------------|-----------|
| CURRENT ASSETS:                                                                                                      |   |        |      |
| Cash and cash equivalents                                                                                            |   | $           | 1,093     |   |
| Accounts receivable, net                                                                                             |   | 38,302      |      |
| Inventory, net of reserve                                                                                            |   | 289,868     |      |
| Prepaid expenses and other current assets                                                                            |   | 83,723      |      |
| Total Current Assets                                                                                                 |   | 412,986     |      |
|                                                                                                                 |   |        |      |
| PROPERTY AND EQUIPMENT, Net                                                                                          |   | 29,139      |      |
|                                                                                                                 |   |        |      |
| OTHER ASSETS:                                                                                                        |   |        |      |
| Deposits                                                                                                             |   | 12,647      |      |
| Patents, net                                                                                                         |   | 13,257      |      |
| Goodwill                                                                                                             |   | 1,929,963   |      |
| Customer manuals and sales literature, net                                                                           |   | 17,029      |      |
| Website, net                                                                                                         |   | 11,404      |      |
| Total Other Assets                                                                                                   |   | 1,984,300   |      |
|                                                                                                                 |   |        |      |
| Total Assets                                                                                                         |   | $           | 2,426,425 |   |
|                                                                                                                 |   |        |      |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                            |   |        |      |
|                                                                                                                 |   |        |      |
| CURRENT LIABILITIES:                                                                                                 |   |        |      |
| Accounts payable and accrued expenses                                                                                |   | $           | 802,408   |   |
| Accrued salaries and payroll taxes                                                                                   |   | 401,018     |      |
| Customer deposits                                                                                                    |   | 6,983       |      |
| Note payable—line of credit                                                                                     |   | 300,000     |      |
| Notes payable—former officer                                                                                    |   | 105,000     |      |
|                                                                                                                 |   |        |      |
| Total Current Liabilities                                                                                            |   | 1,615,409   |      |
|                                                                                                                 |   |        |      |
| Total Liabilities                                                                                                    |   | 1,615,409   |      |
|                                                                                                                 |   |        |      |
| STOCKHOLDERS’ EQUITY:                                                                                           |   |        |      |
| Preferred Stock, $.001 par value,  10,000,000 shares authorized authorized, 3,328,737 shares issued and  outstanding |   | 3,329       |      |
| Common stock, $.001 par value, 7,142,857  shares authorized, 5,020,477 issued and outstanding                        |   | 5,020       |      |
| Additional paid-in capital                                                                                           |   | 15,257,830  |      |
| Accumulated deficit                                                                                                  |   | (14,455,163 | )         |
| Total Stockholders’ Equity                                                                                      |   | 811,016     |      |
|                                                                                                                 |   |        |      |
| Total Liabilities and Stockholders’ Equity                                                                      |   | $           | 2,426,425 |   |

 

**Accompanying notes are an integral part ofthe financial statements**

 

3

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**POWER EFFICIENCY CORPORATION**CONDENSED STATEMENTS OF OPERATIONS

Unaudited

 
| ** **                                  | ** ** | **For the three months ended Sept. 30,** | ** ** | **For the nine months ended Sept. 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                  | ** ** | **2004**                                 | ** ** | **2003**                                | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                  | ** ** | ** **                               | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| REVENUES                                    |       |                                     |       |                                    |       |   |   |   |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| Product                                     |       | $                                        | 46,585     |                                    | $          | 112,077 |   | $ | 188,005 |   | $ | 368,203 |   |
| Miscellaneous                               |       | 18,130                                   |       | —                                  |       | 30,855 |   | — |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| Total Revenues                              |       | $                                        | 64,715     |                                    | $          | 112,077 |   | $ | 218,860 |   | $ | 368,203 |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| COMPONENTS  OF COST OF PRODUCT REVENUES:    |       |                                     |       |                                    |       |   |   |   |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| Material and labor                          |       | 20,712                                   |       | 67,364                                  |       | 88,505 |   | 185,629 |   |
| Allocated costs                             |       | 5,285                                    |       | 24,895                                  |       | 41,815 |   | 70,221 |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| Inventory obsolescence and other write-offs |       | —                                   |       | —                                  |       | 29,484 |   | 15,000 |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| Total Cost of Revenues                      |       | 25,997                                   |       | 92,259                                  |       | 159,804 |   | 270,850 |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| GROSS MARGIN                                |       | 38,718                                   |       | 19,818                                  |       | 59,056 |   | 97,353 |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| COSTS AND EXPENSES:                         |       |                                     |       |                                    |       |   |   |   |   |
| Research and development                    |       | 82,469                                   |       | 94,732                                  |       | 290,766 |   | 306,833 |   |
| Selling, general and administration         |       | 378,030                                  |       | 913,174                                 |       | 1,288,327 |   | 1,785,589 |   |
| Depreciation and amortization               |       | 18,007                                   |       | 25,290                                  |       | 55,510 |   | 89,700 |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| Total costs and expenses                    |       | 478,506                                  |       | 1,033,196                               |       | 1,634,603 |   | 2,182,122 |   |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| LOSS FROM OPERATIONS                        |       | (439,788                                 | )          | (1,013,378                              | )          | (1575,547 | ) | (2,084,769 | ) |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| OTHER EXPENSE                               |       |                                     |       |                                    |       |   |   |   |   |
| Interest expense                            |       | (8,858                                   | )          | (31,091                                 | )          | (16,454 | ) | (50,272 | ) |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| Total Other Expenses                        |       | (8,858                                   | )          | (31,091                                 | )          | (16,454 | ) | (50,272 | ) |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| NET LOSS                                    |       | $                                        | (448,646   | )                                       | $          | (1,044,469 | ) | $ | (1,592,001 | ) | $ | (2,135,041 | ) |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| BASIC LOSS PER COMMON SHARE                 |       | $                                        | (.09       | )                                       | $          | (.82 | ) | $ | (.36 | ) | $ | (1.99 | ) |
|                                        |       |                                     |       |                                    |       |   |   |   |   |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING  |       | 5,020,447                                |       | 1,274,433                               |       | 4,426,976 |   | 1,075,263 |   |

 

**Accompanying notes are an integral part ofthe financial statements**

 

4

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**POWER EFFICIENCY CORPORATION**

CONDENSED STATEMENTS OF CASH FLOWS

Unaudited

 
| ** **                                                                                                                                     | ** ** | **For the nine months ended Sept. 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2004**                                | ** ** | **2003** | ** ** |
|                                                                                                                                           |       |                                    |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                                                          |       |                                    |       |   |   |
|                                                                                                                                           |       |                                    |       |   |   |
| Net loss                                                                                                                                       |       | $                                       | (1,592,001 | ) | $ | (2,135,041 | ) |
| Adjustments to reconcile net loss to net  cash used for operating activities:                                                                  |       |                                    |       |   |   |
|                                                                                                                                           |       |                                    |       |   |   |
| Depreciation and amortization                                                                                                                  |       | 55,510                                  |       | 89,700 |   |
| Issuance of stock and options for services                                                                                                     |       | —                                  |       | 451,658 |   |
| Deferred compensation expense                                                                                                                  |       | —                                  |       | 90,127 |   |
| Bad debt expense                                                                                                                               |       | 5,493                                   |       | — |   |
| Inventory obsolescence reserve and other  write-offs                                                                                           |       | 29,484                                  |       | — |   |
| Loss on sales of fixed assets                                                                                                                  |       | 31,226                                  |       | — |   |
| Changes in assets and liabilities  (Increase) Decrease:                                                                                        |       |                                    |       |   |   |
| Accounts receivable, net                                                                                                                       |       | 14,010                                  |       | (19,859 | ) |
| Inventory                                                                                                                                      |       | 40,518                                  |       | 132,058 |   |
| Prepaid expenses and other assets                                                                                                              |       | (13,481                                 | )          | (31,413 | ) |
| Increase (Decrease) in:                                                                                                                        |       |                                    |       |   |   |
| Accounts payable and accrued expenses                                                                                                          |       | 298,236                                 |       | (61,102 | ) |
| Customer deposits                                                                                                                              |       | 6,983                                   |       | — |   |
| Accrued salaries and payroll taxes                                                                                                             |       | 386,383                                 |       | (146,008 | ) |
| Net Cash Used for Operating Activities                                                                                                         |       | (737,639                                | )          | (1,629,880 | ) |
|                                                                                                                                           |       |                                    |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                                                                           |       |                                    |       |   |   |
| Purchase of fixed assets                                                                                                                       |       | (21,576                                 | )          | (10,905 | ) |
| Net Cash Used in Investing Activities                                                                                                          |       | (21,576                                 | )          | (10,905 | ) |
|                                                                                                                                           |       |                                    |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                                          |       |                                    |       |   |   |
| Proceeds from line of credit (Notes  payable)                                                                                                  |       | 300,000                                 |       | 850,000 |   |
| Proceeds from issuance of equity  securities, net of costs                                                                                     |       | 184,800                                 |       | 976,928 |   |
| Payments to stockholders and former  officers                                                                                                  |       | (10,000                                 | )          | — |   |
| Net Cash Provided by Financing Activities                                                                                                      |       | 474,800                                 |       | 1,826,928 |   |
|                                                                                                                                           |       |                                    |       |   |   |
| (Decrease) Increase in cash and cash  equivalents                                                                                              |       | (284,415                                | )          | 186,143 |   |
|                                                                                                                                           |       |                                    |       |   |   |
| Cash and cash equivalents at beginning of  period                                                                                              |       | 285,508                                 |       | 257,708 |   |
|                                                                                                                                           |       |                                    |       |   |   |
| Cash and cash equivalents at end of period                                                                                                     |       | $                                       | 1,093      |   | $ | 443,851 |   |
| NON-CASH INVESTING AND FINANCING:                                                                                                              |       |                                    |       |   |   |
| Common stock issued in conjunction with the  settlement of accounts payable, accrued expenses and the conversion of  stockholders note payable |       | $                                       | 37,400     |   | $ | 466,875 |   |
| Subscription Receivable                                                                                                                        |       | $                                       | —     |   | $ | 148,155 |   |

 

**Accompanyingnotes are an integral part of the financial statements**

 

5

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**POWER EFFICIENCY CORPORATION**

**NOTES TO THE CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1—BASISOF PRESENTATION**

 

The accompanying financialstatements have been prepared by the Company, without an audit. In the opinionof management, all adjustments have been made, which include normal recurringadjustments necessary to present fairly the condensed financial statements.Operating results for the nine months ended September 30, 2004 are notnecessarily indicative of the operating results for the full year. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted. The Company believesthat the disclosures provided are adequate to make the information presentednot misleading. Certain amounts in the financial statements have beenreclassified from prior period presentations. These unaudited condensedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and related notes included in the Company’sAnnual Report for the year ended December 31, 2003 on Form 10-KSB.

 

The priorperiod per share amounts and weighted average number of shares have beenadjusted for the one-for-seven reverse stock split effective March 1,2004.

 

The preparation of condensedfinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the dates of the financial statements and thereported amounts of revenue and expenses during the reporting period. Actualresults could differ from those estimates.

 

**NOTE 2—GOING CONCERN**

** **

Theaccompanying financial statements have been prepared assuming the Company is agoing concern, which assumption contemplates the realization of assets andsatisfaction of liabilities in the normal course of business. The Companysuffered recurring losses from operations, a recurring deficiency of cash fromoperations, including a cash deficiency of approximately $738,000 from operationsfor the nine months ended September 30, 2004, and lacks sufficientliquidity to continue its operations indefinitely. During June 2004, theCompany suspended substantially all payments to employees and vendors untilsuch time as additional financing could be raised. At September 30, 2004,additional financing still had not been raised, raising substantial doubt aboutthe Company’s ability to continue as a going concern. On October 27, 2004additional financing was raised (see Note 8).

 

The financialstatements do not include any adjustments relating to the recoverability andclassification of recorded asset amounts or the amount of liabilities thatmight be necessary should the Company be unable to continue in existence. As ofSeptember 30, 2004 continuation of the Company as a going concern isdependent upon achieving profitable operations in the long-term and raisingadditional capital to support existing operations for at least the next twelvemonths. Management’s plans to achieve

 

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profitability include developing newproducts, obtaining new customers and increasing sales to existing customers.

 

On February 25,2004, the Company signed a formal letter of agreement with an investmentbanker. Under this letter, the Company appointed the investment banker as itsexclusive placement agent through June 24, 2004, in an attempt to raiseadditional capital through equity issuance, debt financing or other types offinancing for the Company. While the formal letter agreement has expired, theinvestment banker continues to represent the company under the same terms asthe original agreement. After September 30, 2004 financing was raisedthrough this placement agent (see Note 8).

 

**NOTE 3—NETLOSS PER SHARE**

 

Basic pershare amounts are computed by dividing the net loss available to commonstockholders by the weighted average number of common shares outstanding duringthe year. Diluted per share amounts incorporate the incremental shares issuableupon the assumed exercise of the Company’s stock options and warrants andassumed conversion of convertible securities. Such incremental amounts havebeen excluded from the calculation since their effect would be anti-dilutive.Such stock options, warrants and conversions could potentially dilute earningsper share in the future.

 

**NOTE 4—LINE OF CREDIT AGREEMENT**

 

On April 20, 2004, the Company executed a $300,000 Note andrelated Security Agreement (the “$300,000 Note”) with Summit Energy Ventures,LLC, the Company’s controlling shareholder at thattime.

 

Pursuant to the terms of the $300,000 Note, the Registrant received a$300,000 line of credit from Summit, all of which was drawn down during thequarter ended June 30, 2004. During June, 2004, the $300,000 Note wasassigned to Commonwealth Energy Corporation (“Commonwealth”), a former memberof Summit Energy Ventures LLC and currently one of the Company’s largestshareholders (see Note 7).

 

The $300,000 Note was intended to be a bridge to additional outsidefinancing in the form of debt or equity. The $300,000 Note is due at theearlier of (i) October 20, 2004, or (ii) at such time that the Borrowerclosed on a debt or equity financing of at least $300,000. Furthermore, the$300,000 Note originally required the Company to close a new round of financingby May 31, 2004. This requirement was later amended to require the Company toclose a financing by August 31, 2004.

 

As of August 31, 2004, the Company had not closed a new round offinancing and was therefore technically in default (see Item 3). Subsequent to September 30,2004, the $300,000 Note was exchanged for notes that the company offeredthrough its placement agent, Pali Capital (see Note 8 “Subsequent Events” aswell as the Form 8-K filed on November 3, 2004). The notes offered throughPali Capital mature one year after

 

7

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issuance. Therefore, as of the date of thisfiling, the $300,000 Note is no longer outstanding and is not in default.

 

**NOTE 5—STOCK OPTION PLAN**

 

In June of 2004 the Board of Directors of the Company approved amodification to the 2000 Stock Option and Restricted Plan (“2000 Plan”). Themodified 2000 Plan increases the number of authorized shares from 614,286 to5,000,000, subject to the approval of the majority of the holders of theCompany’s preferred stock. The increase in options will be used as compensationand incentives for employees, vendors, partners and non-executive directors.

 

**NOTE 6—STOCKHOLDERS’ EQUITY**

 

On various dates during the nine months ended September 30,2004, the Company issued to the Company’s then Chief Executive Officer, RichardKoch (see “Item 2: Management Changes”), shares of common stock totaling 18,001for settlement related to deferred compensation and certain reimbursable expensesamounting to $29,000.

 

During the quarter ended September 30, 2004,the number of outstanding shares of the Company’s common stock rose by 59shares, from 5,020,418 to 5,020,477. The additional 59 shares were the resultof rounding up shares exchanged by shareholders after the Company’s 7 for 1reverse stock split which became effective March 1, 2004. Shareholderswith a number of shares not evenly divisible by seven were given a number ofshares rounded up to the nearest whole shares in the exchange.

 

**NOTE 7—ISSUANCEOF SERIES A-1 CONVERTIBLE PREFERRED STOCK**

 

On June 7, 2004 Summit Energy Ventures notifiedthe Company that it had transferred 1,747,587 of the Company’s preferred stockand 1,645,404 of the Company’s common stock to Commonwealth Energy Corporation,a former member of Summit Energy Ventures LLC. This transfer makes Commonwealth Energy theCompany’s single largest shareholder.

 

**NOTE 8—SUBSEQUENT EVENTS**

 

**Financing**

On October 27, 2004, the Registrant entered into a financingtransaction in which the Registrant issued $1,464,806 in senior, secured notes(collectively the “Notes”, individually a “Note”). The payment for these Notesconsisted of $1,150,000 in cash and the exchange of the $300,000 Note, theprincipal and accrued interest of which totaled $314,806. The Notes bearinterest of 15% per annum. Interest due under the Notes will be payablequarterly, with the principal and final quarterly interest payment being dueone year from the date of issuance. The Notes have a first security interest inall of the assets of the Company. However, the Company may grant a firstsecurity interest in its accounts receivable and inventory in order to obtain aline of credit in the ordinary course

 

8

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of business. In the event of andimmediately upon the occurrence of an Event of Default (as defined in the Note,included in the Form 8-K filed by the company on November 3, 2004), theNotes shall become immediately due and payable without any action by the Holderand the Note shall bear interest until paid at the rate of 18% per annum orsuch amount as shall be allowed by law. The Registrant may issue more Notes (upto $2,500,000 total) under this offering up until December 31, 2004.

 

The holders ofthe Notes will promptly be issued 115,385 warrants for every $100,000 Note.With its issuance of $1,464,806 in Notes, the Registrant has issued, inaggregate, 1,690,168 warrants (the “Warrants”) with an exercise price of $0.65per share. The Company will file a registration statement (the “RegistrationStatement”) to register the common shares issuable upon exercise of theWarrants within 60 days of the closing. The Warrants will have a five-year termand the Company will have the right to compel the exercise of the Warrants ifthe common stock trades at $1.65 for 10 consecutive trading days and theRegistration Statement has been filed and becomes effective.

 

Pali Capital, a registered broker dealer and memberof the National Association of Securities Dealers, Inc., served as theRegistrant’s placement agent for this transaction. The Notes and Warrants soldwere exempt from registration under the Securities Act of 1933, as amended,pursuant to section 4(2) of the Securities Act. For its work as theplacement agent, Pali Capital has received a commission of $115,000 and 132,693warrants with the same rights and provisions as the Warrants issued to theholders of the Notes. Should the Registrant issue more Notes under thisoffering, it will owe Pali a commission of 10% of gross proceeds of the Notesand an amount of warrants equal to 10% of the Warrants issued to investors inthe Notes. However, there will be no fees on Notes and Warrants issued to anypersons or entities that are the Registrant’s directors, affiliates, officersor employees.

 

**Headquarter Changes and Restructuring**

On October 5, 2004 the Company’s board ofdirectors formally approved moving the Company’s headquarters from Livonia,Michigan to Las Vegas, Nevada. As of November 1, 2004, the Company’sfacility in Livonia was vacated entirely and all administrative functions havemoved to Las Vegas, the location of the Company’s CEO and Interim CFO.

 

The Company’s other functions, including researchand development and managing manufacturing, have been moved to Carlstadt, NewJersey, where the company sublets 3,000 square feet of work space for, atpresent, no cash payment. Instead, the Company on November 2, 2004 issued100,000 warrants with an exercise price of $0.65 per share as payment forsubletting its space.

 

The Company’s financial results for the period endedSeptember 30, 2004 reflect a charge of $86,736 for this restructuring andare included in selling, general and administration expenses.

 

9

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**Resignations and Reduction in Force**

With the movement of the Company’s operations out ofMichigan, the Company laid off most of the employees working at the Livoniafacility. Other executives that had been working at the Livonia locationresigned (see “Item 2: Management’s Discussion and Analysis: Management Changes”).

 

**Employee and Vendor Settlements**

Because of a lack of funding, the Company had notpaid any employees for various periods of time before it received fundingthrough the issuance of the Notes, as described above. The Company thereforeowed many employees back salary, reflected on the balance sheet as “AccruedSalaries and Payroll Taxes”. The Company’s officers and directors negotiatedsettlements with some of the former and existing employees for smaller cashpayments than the amount of accrued salaries reflected on the balance sheet on September 30,2004. As of November 5, 2004 the company had reduced the cash paymentsowed to former and current employees by $77,467 in exchange for the issuance of150,500 options and warrants, all with exercise prices of $0.65 per share. Asof November 5, 2004 the Company was still negotiating with some formeremployees regarding accrued salaries, including the Company’s former CEO andanother former officer. Because all employee back pay settlements occurredafter September 30, 2004 or were contingent upon events that occurredsubsequent to September 30, 2004 the accounting for these settlements willbe reflected on the Company’s financials for the quarter ended December 31,2004.

 

On October 18, 2004 the Company entered asettlement agreement with one of its former employees and one of its currentvendors. The Company owed this employee $17,386 for accrued wages, expenses andcommissions. The Company also owed the vendor $4,275 for services previouslyrendered. The Company’s former employee agreed to eliminate the debt owed himand agreed to assume the debt owed to the vendor in exchange for a)establishing the employee as a distributor with standard distributor-levelpricing for the company and b) giving the employee an amount of the Company’sproduct and components worth $21,700, approximately the amounts owed. For thistransaction the Company’s products and components were valued at the Company’scost plus approximately a 30% markup. Because this settlement agreementoccurred after September 30, the accounting for these settlements will bereflected on the Company’s financials for the quarter ended December 31,2004.

 

**Management Stock Options and Compensation**

In its quarterly report for the quarter ended June 30,2004, the Company reported that it planned to grant nearly 4,000,000 options toexecutives, employees and non-executive directors. The company did not grantany of these planned options because executive resignations and layoffsoccurred prior to the time when the options were to be granted. (For moreinformation on management changes, see “Item 2: Management’s Discussion andAnalysis: Management Changes”.)

 

As of November 5, 2004 all of the Company’semployees, including its senior executives, have agreed to accept salaries of$5,000 per month or less. Between September 30 and November 5, 2004,the Company granted a total of 2,375,000 incentive and non-qualified

 

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stock options to six executives and 50,000additional options to two non-executive directors. All these stock options haveexercise prices of $0.65 per share. The Company has not, as of November 5,2004, entered into any new employment agreements with any executives. TheCompany currently only has an employment agreement with its founder and chieftechnology officer. The Company may, however, enter into employment agreementswith other executives in the future.

 

**Single Phase Licensing Agreement**

On October 27, 2004 the Company entered into alicensing agreement (the “Licensing Agreement”) with Commerce Energy Group (“CEG”),the parent of Commonwealth Energy Corporation, the Company’s largestshareholder as of November 5, 2004. The Company agreed to give CEG an exclusivelicense to use its single phase technology to develop,market and sell products based upon this technology. The LicensingAgreement will not be effective until 90 days after October 27, and duringthis period the Company can nullify the Licensing Agreement by returning allprincipal and interest owed to CEG for its Notes. This amount was $314,806 asof October 27. The Licensing Agreement is for ten years with a three yearextension (at which time the Company’s patent expires), and provides the Companyan opportunity to buyout the license in the future for the amount of fundsinvested if CEG has not successfully sold at least 1,000 units within fiveyears of the beginning of the Licensing Agreement. The Licensing Agreementprovides the Company a royalty equivalent to 5% of the net profits from CEG’ssales of products utilizing the single phase technology.

 

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**ITEM 2**. MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION

** **

**OVERVIEW**

** **

TheRegistrant generates revenues from a single business segment: the design,development, marketing and sale of proprietary solid state electricalcomponents designed to reduce energy consumption in alternating currentinduction motors. The Registrant began generating revenues from sales of itspatented *Power Commander*® line ofmotor controllers in late 1995.

 

**RESULTS OF OPERATIONS: FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30,2004 AND 2003.**

** **

**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

We may, in discussions of our future plans, objectives and expectedperformance in periodic reports filed by us with the Securities and ExchangeCommission (or documents incorporated by reference therein) and written andoral presentations made by us, include projections or other forward-lookingstatements within the meaning of Section 27A of the Securities ExchangeAct of 1933 or Section 21E of the Securities Act of 1934, as amended. Suchprojections and forward-looking statements are based on assumptions, which webelieve are reasonable but are, by their nature, inherently uncertain. In allcases, results could differ materially from those projected. Some of theimportant factors that could cause actual results to differ from any suchprojections or other forward-looking statements are discussed below, and inother reports filed by us under the Securities Exchange Act of 1934, includingunder the caption “Risk Factors” in our Annual Report on Form 10-KSB. Ourforward looking statements are based on information available to us today, andexcept as required by law, we undertake no obligation to update any forwardlooking statement, whether as a result of new information, future events orotherwise.

 

**MANAGEMENT CHANGES**

 

The Companymade an 8-K filing on September 27, 2004 regarding management changes. Mr.Richard Koch resigned on August 27, 2004 from his position as CEO and as adirector of the Company. Mr. Keith Collin resigned his position as CFO on August 30,2004. On August 31, 2004 the Company’s board of directors accepted theresignations of these officers and appointed Mr. Leonard Bellezza, a director,to be interim chief executive officer to handle the immediate needs of thecompany and transition it to the new management structure. On September 7,2004, the board added to the management team by appointing Mr. Steven Strasser,Mr. Leonard Bellezza and Mr. John (“BJ”) Lackland to be chief executiveofficer, general manager, and interim chief financial officer, respectively. Allof these new members of the management team had been directors of the Companyfor no less than eighteen months prior to their appointments in managementroles.

 

The Registranthas not, as of the date of this filing, entered into any employment agreementswith Mr. Strasser, Mr. Bellezza or Mr. Lackland. (For more information onmanagement changes and compensation, see “Note 8: Subsequent Events: Management

 

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Stock Optionsand Compensation” and the Form 8-K filed on September 27, 2004.)

 

**REVENUES**

 

Total revenues for the three months ended September 30, 2004, wereapproximately $65,000 compared to $112,000 for the three months ended September 30,2003, a decrease of $47,000 or 42%. This decrease is mainlyattributable to a decrease in sales in the elevator and escalator marketsegment, due to delays in closing several government installations and sales tothe private sector. The decrease in elevator and escalator sales is partiallyoff-set by sales to new international distributors. Sales to two newinternational distributors totaled approximately $1,500 during the three monthsended September 30, 2004. Revenue of $18,000 was recognized for agovernment grant received associated with development expenses relatedto a medium voltage product application during the three months ended September 30,2004.

 

Totalrevenues for the nine months ended September 30, 2004, were approximately$219,000 compared to $368,000 for the nine months ended September 30,2003, a decrease of $149,000 or 40%.  This decrease is mainly attributableto a decrease in sales in the elevator and escalator market segment, due todelays in closing several government installations and sales to the privatesector. The decrease in elevator and escalator sales is partially off-set bysales to new international distributors and revenue from a government grant.Sales to three new international distributors totaled approximately $41,000during the nine months ended September 30, 2004. Revenue of $30,725 wasrecognized for a government grant received associated with developmentexpenses related to a medium voltage product application during the nine monthsended September 30, 2004.

 

**COST OF PRODUCT REVENUES**

 

Totalcost of product revenues, which includes material and direct labor, allocatedcosts, and inventory obsolescence and other write-offs for the three monthsended September 30, 2004 were approximately $26,000 compared toapproximately $92,000 for the three months ended September 30, 2003, adecrease of $66,000 or 72%. As a percentage of product revenues, total costs ofproduct revenues decreased to approximately 56% for the three months ended September 30,2004 compared to approximately 82% for the three months ended September 30,2003. The decrease in the costs as a percentage of product revenues was primarilydue to a non-recurring charge to inventory for obsolescence and otherwrite-offs for the three months ended September 30, 2003. Also, revenuesfor the quarter were comprised mostly of distributor sales as compared todirect sales which command a higher gross profit percentage.

 

Totalcost of product revenues, which includes material and direct labor, allocatedcosts, and inventory obsolescence and other write-offs for the nine monthsended September 30, 2004 were approximately $160,000 compared to approximately$271,000 for the nine months ended September 30, 2003, a decrease of$111,000 or 41%. As a percentage of product revenues, total costs of productrevenues increased to approximately 85% for the nine months ended September 30,2004 compared to approximately 74% for the nine months ended September 30,2003. The increase in the costs as a percentage of product revenues wasprimarily due to charges to inventory for obsolescence and other write-offs ofapproximately $30,000 for the nine months ended September 30, 2004compared to $15,000 for the nine months ended September 30, 2003. Also,allocated costs were

 

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$42,000for the nine months ended September 30, 2004 compared to $70,000 for thenine months ended September 30, 2003, a decrease of $28,000 or 40%. However,as a percentage of product revenue allocated costs were 22% for the nine monthsended September 30, 2004 compared to 19% for the nine months ended September 30,2003. The allocated costs as a percentage of product revenues increased as theallocated costs were absorbed by a lower volume of product revenues.

 

**OPERATING EXPENSES**

 

**Research and Development Expenses**

 

Researchand development expenses were approximately $82,000 for the three months ended September 30,2004, as compared to approximately $95,000 for the three months ended September 30,2003, a decrease of $13,000 or 14%.  This decrease is mainly attributableto closing the New York facility and a cost reduction program implemented in thesecond half 2003, offset by $26,000 related to laboratory testing done forfurther product development.

 

Researchand development expenses were approximately $291,000 for the nine months ended September 30,2004, as compared to approximately $307,000 for the nine months ended September 30,2003, a $16,000 or a 5% decrease. This decrease is mainly attributable toclosing the New York facility and a cost reduction program implemented in thesecond half 2003, offset by $26,000 related to laboratory testing done forfurther product development.

 

**Selling, General and Administrative Expenses**

 

Selling,general and administrative expenses were approximately $378,000 for the threemonths ended September 30, 2004, as compared to $913,000 for the threemonths ended September 30, 2003 a decrease of $535,000 or 59%. Thedecrease in selling, general and administrative expenses over the prior yearwas due primarily to a decrease in sales, consulting and travel relatedexpenses and a reduction in the number of employees. Restructuring costsrepresent approximately $85,000 of the total selling, general andadministrative expenses for the three months ended September 30, 2004.

 

Selling,general and administrative expenses were approximately $1,288,000 for the ninemonths ended September 30, 2004, as compared to $1,786,000 for the ninemonths ended September 30, 2003 a decrease of $498,000 or 28%. Thedecrease in selling, general and administrative expenses over the prior yearwas due primarily to a decrease in sales, consulting and travel relatedexpenses and a reduction in the number of employees. Restructuring costsrepresent approximately $85,000 of the total selling, general andadministrative expenses for the nine months ended September 30, 2004.

 

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**Financial Condition, Liquidity, and Capital Resources: Forthe Nine months ended September 30, 2004**

 

Sinceinception, the Registrant has financed its operations primarily through thesale of its equity securities and using available lines of credit. As of September 30,2004, the Registrant had cash and cash equivalents of $1,093.

 

Cashused for operating activities for the nine months ended September 30, 2004was $737,639 which consisted of: a net loss of $1,592,001; less depreciationand amortization of $55,510, bad debt expense of $5,493, inventory obsolescencereserve of $29,484, loss on sale of fixed assets of $31,226, decreases inaccounts receivable of $14,010, inventory of $40,518, increases in prepaidexpenses and other assets of $13,481, accounts payable and accrued expenses of$298,236, customer deposits of $6,983 and accrued salaries and payroll taxes of$386,383.

 

Netcash used for operating activities for the nine months ended September 30,2003 was $1,629,880, which consisted of: a net loss of $2,135,041; lessdepreciation and amortization of $89,700, deferred compensation expense of$90,127, issuance of stock and options for services of $451,658, increases inaccounts receivable of $19,859, prepaid expenses and other assets of $31,413.In addition, these amounts were partially offset by decreases in inventory of$132,058, accounts payable and accrued expenses of $61,102 and accrued salariesand payroll taxes of $146,008.

 

Cashused in investing activities for the nine months ended September 30, 2004was $21,576 compared with $10,905 in the nine months ended September 30,2003.  The amounts for both years consisted of the purchase of fixedassets.

 

Netcash provided by financing activities for the nine months ended September 30,2004 was $474,800, which primarily consisted of proceeds of $184,800 from theissuance of equity securities related to the Company’s Reg “S” stock offeringand $300,000 of proceeds from the Summit Energy Ventures line of credit. This was partially offset by payments to a former officer of $10,000. Duringthe nine months ended September 30, 2003, net cash provided from financingactivities was $1,826,928, which primarily consisted of proceeds of $976,928from the exercise of stock warrants and the issuance of equity securities and$850,000 of proceeds from the Summit Energy Ventures line of credit.

 

TheRegistrant expects to experience a reduction in overall operating expensesduring the next six months as compared to the prior twelve month period. Thereduction is a result of cost cutting initiatives that include eliminating theLivonia, Michigan facility, reducing the staff headcount, reducing the salariesof several of the existing employees, and hiring personnel at lower salarylevels. However, the registrant anticipates that operating expenses willcontinue to exceed anticipated revenues for at least the next six months, andtherefore constitute a material use of any cash resources.

 

Sincecapital resources are insufficient to satisfy the Registrant’s liquidityrequirements, management has raised $1.15 million in new capital through theissuance of debt securities. The Company may raise additional capital throughthis offering until December 31, 2004. However, there are no assurancesthat sufficient capital or debt can be raised.(See Note 8 to the financial statements, “Financing”.)

 

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**Cash Requirements and Need for Additional Funds**

 

TheRegistrant anticipates a substantial need for cash to fund its working capitalrequirements. In accordance with the Registrant’s prepared expansion plan, itis the opinion of management that as of November 5, 2004, at least$750,000 will be required to cover operating expenses, including, but notlimited to, marketing, sales and operations during the next twelvemonths based on the current sales activity and growth plan.

 

**ITEM 3****.****CONTROLS AND PROCEDURES**

 

**(a) Evaluation of Disclosure Controls andProcedures.** Under the supervision and with theparticipation of its Chief Executive Officer and Chief Financial Officer,management has evaluated the effectiveness of the Company’s disclosure controlsand procedures as of the end of the period covered by this report pursuant toRule 13a-15(b) under the Securities Exchange Act of 1934 (the Exchange Act). Basedon that evaluation, the Chief Executive Officer and Chief Financial Officerhave concluded that, as of the end of the period covered by this report, theCompany’s disclosure controls and procedures are effective in ensuring thatinformation 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 ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

**(b)Changes in Internal Controls.** There were nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect these controls subsequent to the date of theirevaluation, nor were there any significant deficiencies or material weaknessesin the Company’s internal controls. Accordingly, no corrective actions were required or undertaken.

 

**PART II****—OTHER INFORMATION**

 

**ITEM 1****.****LEGAL PROCEEDINGS**

 

The Company isnot currently involved in any material pending legal proceedings. However,subsequent to the end of the quarter ended September 30, 2004, the Companywas involved in litigation with the landlord of its leased office space locatedat 35432 Industrial Road, Livonia, Michigan. The landlord demanded eviction andpayment of prior outstanding rents.  The Company denied the need foreviction, since it had voluntarily vacated the premises pursuant to what itclaimed to be an agreement with the landlord first entered into in September 2004. The landlord denied the existence of such a September agreement forvoluntary evacuation and termination of the lease.

 

The Company filed an Answer, Affirmative Defenses and Brief in Supportof its positions with the Court.  Following negotiation with counsel, theeviction case was dismissed with the payment by the Company of $15,641.16, theamount of the lease

 

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payments for September and October 2004. The premises are now vacated. Under the lease, the Company provided a Securitydeposit of $12,146.66 to the landlord.  The Company’s position is that theentire security deposit is owed to the Company.

 

The landlord may take the position that the Company owes some or allrents for the balance of the original term of the lease, which would have runseveral more years.  The Company would vigorously contest thatposition.

 

**ITEM 2****.****CHANGES IN SECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3****.****DEFAULTS UPON SENIOR SECURITIES**

 

As of the date of this filing, the Company is not in default of anysenior securities.

 

However, during the quarter ended September 30, 2004, the Companywas in technical default on the $300,000 Note mentioned in Note 4 to the financialstatements. The $300,000 Note, as amended, required the Company to close afinancing by August 31. The Company did not close a financing by that dateand was therefore in default. Commonwealth, the owner of the $300,000 Note andone of the Company’s largest shareholders, never sent the Company a notice ofdefault nor made any attempted to foreclose on the Company.

 

On October 27, 2004, Commonwealth exchanged the $300,000 Note for$314,806 in senior notes that the Company offered through its placement agent,Pali Capital (see Note 8 “Subsequent Events” as well as the Form 8-K filed on November 3,2004). The notes offered through Pali Capital mature one year after issuance.Therefore, as of the date of this filing, the $300,000 Note is no longeroutstanding and the Company is not in default upon any senior securities.

 

**ITEM 4.****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5****.****OTHER INFORMATION**

 

None

 

**ITEM 6****.****EXHIBITS AND REPORTS ON FORM 8-K**

 

(a) Exhibits

 
| **Number** | ** ** | **Description of Document**                                                                                   | ** ** | **Location**   | ** ** |
|------------|------------|---------------------------------------------------------------------------------------------------------------|------------|----------------|------------|
|       |       |                                                                                                          |       |           |       |
| 10.1       |       | Licensing Agreement with Commerce Energy Group.                                                               |       | Filed herewith |       |
| 31.1       |       | Certification by the Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. |       | Filed herewith |       |
| 31.2       |       | Certification by the Chief Financial Officer pursuant to Section                                              |       | Filed herewith |       |

 

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|   |   | 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. |   | Filed herewith |   |
| 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. |   | Filed herewith |   |

 

(b) Reports on Form 8-K.

 

On September 27, 2004 the Company filed a current report on Form 8-K announcing a change in directors or principal officers.

 

On November 5, 2004 the Company filed a current report on Form 8-K announcing the creation of a direct financial obligation.

 

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**SIGNATURES**

 

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

 

 
|                                     |   | POWER  EFFICIENCY CORPORATION |
|------------------------------------------|--------|-------------------------------|
|                                     |   | (Registrant)                  |
|                                     |   |                          |
|                                     |   |                          |
| Date:  November 12,  2004 |   | By:                           | /s/   Steven Strasser |   |
|                                     |   |                          | Chief  Executive Officer |
|                                     |   |                          |
|                                     |   |                          |
| Date:  November 12,  2004 |   | By:                           | /s/   John Lackland |   |
|                                     |   |                          | Interim  Chief Financial Officer (Principal  Financial and Accounting Officer) |

 

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