SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549




FORM
10-Q




xQUARTERLY REPORT UNDER
SECTION 13 OR 15(d)


OF THE
SECURITIES EXCHANGE ACT OF 1934




For the
quarterly period ended: September 30, 2010




OR




oTRANSITION 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.)839
      Pilot Road, Suite A
              Las
      Vegas, NV 89119
              (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.


Yes xNo  o




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 oAccelerated filer oNon-Accelerated filer oSmaller 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 oNo x




The
number of shares of common stock outstanding as of November 15, 2010 was
45,119,984.




Transitional
Small Business Disclosure Format (check one):


Yes oNo x




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 oNo o









POWER
EFFICIENCY CORPORATION


FORM
10-Q INDEX




PART
      I —
      FINANCIAL INFORMATIONITEM
      1. Financial Statements (Unaudited)Condensed
      Balance Sheet as of September 30, 2010 and December 31,
    2009
              
              
              3Condensed
      Statements of Operations for the three and nine months ended September 30,
      2010 and 2009
              
              
              4Condensed
      Statements of Cash Flows for the nine months ended September 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
              
              
              30ITEM
      4T. Controls and Procedures
              
              
              30Part
      II — OTHER INFORMATIONITEM
      1. Legal Proceedings
              
              
              31ITEM
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
              
              
              31ITEM
      3. Defaults Upon Senior Securities
              
              
              32ITEM
      4. Reserved
              
              
              32ITEM
      5. Other Information
              
              
              32ITEM
      6. Exhibits
              
              
              33Signatures
              
              
              34Certification
      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




September
      30,
                2010
              
              
              December
      31,
                2009ASSETSCURRENT
      ASSETS:Cash
              
              $
              3,393,114
              
              
              $
              247,564Accounts
      receivable, net
              
              
              83,422
              
              
              
              66,143Inventory
              
              
              195,627
              
              
              
              281,253Prepaid
      expenses and other current assets
              
              
              52,928
              
              
              
              36,437Total
      Current Assets
              
              
              3,725,091
              
              
              
              631,397PROPERTY
      AND EQUIPMENT, net
              
              
              60,369
              
              
              
              86,533OTHER
      ASSETS:Patents,
      net
              
              
              106,769
              
              
              
              86,342Deposits
              
              
              36,971
              
              
              
              26,914Goodwill
              
              
              1,929,963
              
              
              
              1,929,963Total
      Other Assets
              
              
              2,073,703
              
              
              
              2,043,219Total
      Assets
              
              $
              5,859,163
              
              
              $
              2,761,149LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued expenses
              
              $
              767,484
              
              
              $
              722,195Warrant
      liability
              
              
              -
              
              
              
              828,827Total
      Current Liabilities
              
              
              767,484
              
              
              
              1,551,002LONG
      TERM LIABILITIESDeferred
      rent
              
              
              2,765
              
              
              
              8,918Deferred
      tax liability
              
              
              437,027
              
              
              
              399,567Total
      Long Term Liabilities
              
              
              439,792
              
              
              
              408,485Total
      Liabilities
              
              
              1,207,276
              
              
              
              1,959,507COMMITMENTS
      (Note 11)STOCKHOLDERS'
      EQUITY:Series
      B, C-1 and D Convertible Preferred  Stock, $.001
    parvalue,
      10,000,000 shares authorized, 500,877 and170,250
      issued and outstanding in 2010 and2009,
      respectively
              
              
              501
              
              
              
              170Common
      stock, $.001 par value, 140,000,000 sharesauthorized,
      45,119,984 and 44,825,886 issued and
                outstanding
      43,255,441 issued andoutstanding
      in 2010 and 2009, respectively
              
              
              45,120
              
              
              
              44,826Additional
      paid-in capital
              
              
              46,415,202
              
              
              
              36,797,628Accumulated
      deficit
              
              
              (41,808,936
              )
              
              
              (36,040,982
              )Total
      Stockholders' Equity
              
              
              4,651,887
              
              
              
              801,642Total
      Liabilities and Stockholders' Equity
              
              $
              5,859,163
              
              
              $
              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
                September
      30,
              
              
              For
      the nine months ended
                September
      30,2010
              
              
              2009
              
              
              2010
              
              
              2009(As
      Restated)
              
              
              
              
              
              (As
      Restated)REVENUES
              
              $
              180,787
              
              
              $
              63,130
              
              
              $
              416,393
              
              
              $
              185,575COST
      OF REVENUES
              
              
              100,733
              
              
              
              49,703
              
              
              
              301,755
              
              
              
              127,306GROSS
      PROFIT
              
              
              80,054
              
              
              
              13,427
              
              
              
              114,638
              
              
              
              58,269COSTS
      AND EXPENSES:Research
      and development
              
              
              230,758
              
              
              
              222,833
              
              
              
              546,377
              
              
              
              737,039Selling,
      general and administrative
              
              
              629,378
              
              
              
              701,902
              
              
              
              1,892,839
              
              
              
              1,898,624Depreciation
      and amortization
              
              
              11,405
              
              
              
              15,677
              
              
              
              37,667
              
              
              
              51,405Total
      Costs and Expenses
              
              
              871,541
              
              
              
              940,412
              
              
              
              2,476,883
              
              
              
              2,687,068LOSS
      FROM OPERATIONS
              
              
              (791,487
              )
              
              
              (926,985
              )
              
              
              (2,362,245
              )
              
              
              (2,628,799
              )OTHER
      INCOME (EXPENSE):Interest
      income
              
              
              7,794
              
              
              
              1,938
              
              
              
              9,451
              
              
              
              14,909Interest
      expense
              
              
              -
              
              
              
              -
              
              
              
              (934,649
              )
              
              
              -Fair
      market value adjustment on warrant liability
              
              
              4,745
              
              
              
              (34,880
              )
              
              
              828,827
              
              
              
              184,102Total
      Other Income (Expense)
              
              
              12,539
              
              
              
              (32,942
              )
              
              
              (96,371
              )
              
              
              199,011LOSS
      BEFORE PROVISION FOR INCOME TAXES
              
              
              (778,948
              )
              
              
              (959,927
              )
              
              
              (2,458,616
              )
              
              
              (2,429,788
              )PROVISION
      FOR INCOME TAXES
              
              
              15,884
              
              
              
              12,486
              
              
              
              50,309
              
              
              
              37,458NET
      LOSS
              
              
              (794,832
              )
              
              
              (972,413
              )
              
              
              (2,508,925
              )
              
              
              (2,467,246
              )DIVIDENDS
      PAID OR PAYABLE ON SERIES B, C-1 AND D PREFERED STOCK
              
              
              358,279
              
              
              
              145,281
              
              
              
              3,259,030
              
              
              
              518,614NET
      LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
              
              $
              (1,153,111
              )
              
              $
              (1,117,694
              )
              
              $
              (5,767,955
              )
              
              $
              (2,985,860
              )BASIC
      DILUTED LOSS PER COMMON SHARE
              
              $
              (0.03
              )
              
              $
              (0.03
              )
              
              $
              (0.13
              )
              
              $
              (0.07
              )WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING, BASIC AND DILUTED
              
              
              45,119,984
              
              
              
              43,255,441
              
              
              
              45,013,643
              
              
              
              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 nine months ended
              September
      30,2010
            
            
            2009(As
      Restated)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (2,508,925
            )
            
            $
            (2,467,246
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
            
            
            37,667
            
            
            
            51,405Warrants
      and options issued to employees and consultants
            
            
            212,619
            
            
            
            298,335Change
      in fair value of warrant liability
            
            
            (828,827
            )
            
            
            (184,102
            )Noncash
      interest expense related to debt discount
            
            
            818,542
            
            
            
            -Provision
      for bad debt
            
            
            -
            
            
            
            (11,342
            )Changes
      in assets and liabilities:Accounts
      receivable, net
            
            
            (17,279
            )
            
            
            3,186Inventory
            
            
            85,625
            
            
            
            (65,150
            )Prepaid
      expenses and other current assets
            
            
            (16,491
            )
            
            
            (9,946
            )Deposits
            
            
            (10,057
            )
            
            
            11,292Accounts
      payable and accrued expenses
            
            
            287,006
            
            
            
            (21,360
            )Deferred
      tax liability
            
            
            37,460
            
            
            
            37,458Deferred
      rent
            
            
            (6,153
            )
            
            
            (2,807
            )Net
      Cash Used in Operating Activities
            
            
            (1,908,811
            )
            
            
            (2,360,277
            )CASH
      FLOWS FROM INVESTING ACTIVITIESCosts
      related to patent applications
            
            
            (22,335
            )
            
            
            (7,892
            )Purchases
      of property and equipment
            
            
            (9,595
            )
            
            
            (9,603
            )Net
      Cash Used in Investing Activities
            
            
            (31,930
            )
            
            
            (17,495
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuance of equity securities
            
            
            3,976,200
            
            
            
            809,569Proceeds
      from issuance of notes payable
            
            
            1,687,083
            
            
            
            -Repayment
      of notes payable
            
            
            (450,000
            )
            
            
            -Fees
      paid for equity financings
            
            
            (126,992
            )
            
            
            -Net
      Cash Provided by Financing Activities
            
            
            5,086,291
            
            
            
            809,569Increase
      (Decrease) in cash
            
            
            3,145,550
            
            
            
            (1,568,203
            )Cash
      at beginning of period
            
            
            247,564
            
            
            
            2,100,013Cash
      at end of period
            
            $
            3,393,114
            
            
            $
            531,810




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 nine months ended
September 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 $1,908,811 deficiency of cash from operations for the nine
months ended September 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
September 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 adoption of ASU 2010-17 did not have
an 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 – CONCENTRATIONS OF CREDIT RISK




The
Company maintains cash accounts with major financial institutions. Cash deposits
are insured by the Federal Deposit Insurance Corporation (“FDIC”)
up to $250,000 at each institution.  From time to time, amounts deposited
may exceed theFDIC limits.





NOTE
5 – 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 September 30, 2010 or
December 31, 2009.





Inventories
are comprised as follows:





September
      30,
              2010
            
            
            December
      31,
              2009Raw
      materials
            
            $
            180,201
            
            
            $
            175,806Finished
      goods
            
            
            15,426
            
            
            
            105,447Inventories
            
            $
            195,627
            
            
            $
            281,253





NOTE
6 – 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 September 30, 2010 and December 31, 2009.  Based on this, no
impairment was recorded as of September 30, 2010 or December 31,
2009.





8





NOTE
7 – 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 of
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 8), 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
8 – 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.





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.  Of the aggregate $200,000
invested, a value of $62,513 was allocated to the 625,000 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 July 30, 2010, the date of the transaction.  The Company recorded
additional preferred stock dividends of $87,513 related to the beneficial
conversion feature.





The
Series D preferred stock has an annual dividend equal to 8% of the stated value
of the preferred stock, payable annually in cash or stock, at the discretion of
the Company’s board of directors.  Upon any liquidation, dissolution,
or winding up of the Company, whether voluntary or involuntary, before any
distribution or payment is made to the holders of any stock of the Company, the
holders of Series D preferred stock are entitled to be paid out of the assets of
the Company, proportionally with any other series of preferred stock, an amount
per share of Series D preferred stock equal to the stated value (as adjusted for
any stock dividends, combinations, splits, recapitalizations and the like with
respect to such shares), plus all accrued but unpaid dividends (whether declared
or not) on such shares of Series D preferred stock for each share
of  Series D preferred stock held by them. The conversion price for
the Series D preferred stock is $0.16 per share, and the Series D preferred
stock is subject to mandatory conversion in the event the average closing price
of the Company’s common stock for any ten day period equals or exceeds $0.50 per
share and the average daily trading volume is at least 50,000 shares of common
stock per day during such ten-day period, such conversion to be effective on the
trading day immediately following such ten day period.  Series D
preferred stock shall vote with the shares of Common Stock on an as converted
basis from time to time, and not as a separate class, at any duly called annual
or special meeting of stockholders of the Company.  The holders of our
Series D preferred stock have no pre-emptive rights, and the Company cannot
amend the Series D preferred stock’s Certificate of Designation without first
obtaining the approval of 75% of the holders of the outstanding Series D
preferred stock.





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.




10





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
9 – EARNINGS PER SHARE





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





Three
      Months Ended
              September
      30,
              2010
            
            
            Three
      Months Ended
              September
      30,
              2009
            
            
            Nine
      Months Ended
              September
      30,
              2010
            
            
            Nine
      Months Ended
              September
      30,
              2009(As
      Restated)
            
            
            
            
            
            (As
      Restated)Net
      loss attributable to common shareholders
            
            $
            (1,153,111
            )
            
            $
            (1,117,694
            )
            
            $
            (5,767,955
            )
            
            $
            (2,985,860
            )Basic
      weighted average number of common shares outstanding
            
            
            45,119,984
            
            
            
            43,255,441
            
            
            
            45,013,643
            
            
            
            43,255,441Dilutive
      effect of stock options
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Diluted
      weighted average number of common shares outstanding
            
            
            45,119,984
            
            
            
            43,255,441
            
            
            
            45,013,643
            
            
            
            43,255,441Basic
      and diluted loss per share
            
            
            (0.03
            )
            
            
            (0.03
            )
            
            $
            (0.13
            )
            
            $
            (0.07
            )





For the
three and nine months ended September 30, 2010, warrants and options to purchase
70,578,324 shares of common stock at per share exercise prices ranging from
$0.11 to $19.25 were not included in the computation of diluted loss per share
because inclusion would have been anti-dilutive. For the three and nine months
ended September 30, 2009, warrants and options to purchase 49,539,426 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.





11




NOTE
10 – STOCK-BASED COMPENSATION





At
September 30, 2010, the Company had two stock-based compensation
plans.  There were 10,500,000 options granted in the nine months ended
September 30, 2010.  The fair value of these options was $1,731,000 at
issuance.  There were 1,035,000 warrants and 4,000,000 options granted
in the nine months ended September 30, 2009.  The values of these grants
were $175,299 and $797,000 at issuance, respectively.  The fair values
of these warrants and options were 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 September 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 $77,646 and $119,044 for
the three months ended September 30, 2010 and 2009, respectively, and $212,629
and $298,335 for the nine months ended September 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 publicly
traded stock) over the estimated life of the stock warrant is used as the basis
for the volatility assumption.





Nine
      months ended September 30,2010
            
            2009Weighted
      average risk-free rate
            
            1.43%
      - 2.46%
            
            1.68%
      - 3.25%Average
      expected life in years
            
            6
            
            10Expected
      dividends
            
            None
            
            NoneVolatility
            
            154.25%
      - 159.29%
            
            294.51%Forfeiture
      rate
            
            46%
            
            46%




NOTE
11 – MATERIAL AGREEMENTS





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 as an exhibit in our Quarterly Report on Form
10-Q for the period ending June 30, 2010, filed with the SEC on August 16,
2010.





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 as an exhibit in our Quarterly Report on Form 10-Q
for the period ending June 30, 2010, filed with the SEC on August 16,
2010.




12





NOTE
12 – 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, was
valued at $0 and $828,827 as of September 30, 2010 and December 31, 2009,
respectively, resulting in non-cash gains in the statement of operations of
$828,827 for the nine months ended September 30, 2010.  The warrant
liability was valued at $303,955 and $381,856 as of September 30, 2009 and
January 1, 2009, respectively, resulting in non-cash gains of $184,102 during
the nine months ended September 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 $828,827 for the nine months ended
September 30, 2010, which was recorded in other income (expense).





The
following reconciles the warrant liability for the nine months ended September
30:





2010
            
            
            2009Beginning
      balance, January 1,
            
            $
            828,827
            
            
            $
            381,856Additions
      to warrant liability
            
            
            -
            
            
            
            106,201Change
      in fair value
            
            
            (828,827
            )
            
            
            (184,102
            )Ending
      balance, September 30,
            
            $
            -
            
            
            $
            303,955





NOTE
13 – 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.




13





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
14 – 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.





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.





14





The
following tables set forth the corrected quarterly financial data.





For the
three months ended September 30, 2009:




As
      Previously Reported
            
            
            Adjustments
            
            
            As
      RestatedRevenues
            
            $
            63,130
            
            
            $
            -
            
            
            $
            63,130Cost
      of revenues
            
            
            49,703
            
            
            
            -
            
            
            
            49,703Gross
      profit
            
            
            13,427
            
            
            
            -
            
            
            
            13,427Total
      costs and expenses
            
            
            940,412
            
            
            
            -
            
            
            
            940,412Loss
      from operations
            
            
            (926,985
            )
            
            
            -
            
            
            
            (926,985
            )Other
      income and (expense)
            
            
            (332,452
            )
            
            
            299,510
            
            
            
            (32,942
            )Loss
      before provision for taxes
            
            
            (1,259,437
            )
            
            
            299,510
            
            
            
            (959,927
            )Provision
      for taxes
            
            
            -
            
            
            
            12,486
            
            
            
            12,486Net
      loss
            
            
            (1,259,437
            )
            
            
            287,024
            
            
            
            (972,413
            )Dividends
      paid or payable on Series B and Series C Convertible Preferred
      Stock
            
            
            145,281
            
            
            
            -
            
            
            
            145,281Net
      loss attributable to common shareholders
            
            $
            (1,404,718
            )
            
            $
            287,024
            
            
            $
            (1,117,694
            )Basic
      and fully diluted loss per common share
            
            $
            (0.03
            )
            
            $
            0.00
            
            
            $
            (0.03
            )Weighted
      average common shares outstanding basic
            
            
            43,255,441
            
            
            
            43,255,441
            
            
            
            43,255,441





For the
nine months ended September 30, 2009:




As
      Previously Reported
            
            
            Adjustments
            
            
            As
      RestatedRevenues
            
            $
            185,575
            
            
            $
            -
            
            
            $
            185,575Cost
      of revenues
            
            
            127,306
            
            
            
            -
            
            
            
            127,306Gross
      profit
            
            
            58,269
            
            
            
            -
            
            
            
            58,269Total
      costs and expenses
            
            
            2,687,068
            
            
            
            -
            
            
            
            2,687,068Loss
      from operations
            
            
            (2,628,799
            )
            
            
            -
            
            
            
            (2,628,799
            )Other
      income and (expense)
            
            
            42,823
            
            
            
            156,188
            
            
            
            199,011Loss
      before provision for taxes
            
            
            (2,585,976
            )
            
            
            156,188
            
            
            
            (2,429,788
            )Provision
      for taxes
            
            
            -
            
            
            
            37,458
            
            
            
            37,458Net
      loss
            
            
            (2,585,976
            )
            
            
            118,730
            
            
            
            (2,467,246
            )Dividends
      paid or payable on Series B and Series C Convertible Preferred
      Stock
            
            
            518,614
            
            
            
            -
            
            
            
            518,614Net
      loss attributable to common shareholders
            
            $
            (3,104,590
            )
            
            $
            118,730
            
            
            $
            (2,985,860
            )Basic
      and fully diluted loss per common share
            
            $
            (0.07
            )
            
            $
            0.00
            
            
            $
            (0.07
            )Weighted
      average common shares outstanding basic
            
            
            43,255,441
            
            
            
            43,255,441
            
            
            
            43,255,441





15




NOTE
15 – SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION





Cash paid
during the nine months ended September 30, for:





2010
            
            
            2009Income/franchise
      taxes
            
            $
            12,849
            
            
            $
            8,286





Non-cash
investing and financing activities during the nine months ended September 30,
for:





2010
            
            
            2009Warrants
      and options issued to employees and consultants
            
            $
            212,619
            
            
            $
            298,335Common
      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
            
            $
            2,643,679
            
            
            $
            -Preferred
      stock dividends paid or payable in common stock
            
            $
            615,352
            
            
            $
            518,614





NOTE
16 – OTHER EVENTS





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.





On
September 14, 2010, at a duly held meeting of the board of directors of the
Company, the board elected Raphael Diamond 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.





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®.




17





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 it 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.




Capitalization




As of
September 30, 2010, the Company had total stockholders’ equity of $4,651,887,
primarily due to (i) the Company’s sale of 326,252 shares of Series D Preferred
Stock in a private offering in June and July 2010, (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 2007 through January 2008,
(iv) the Company’s sale of 12,950,016 shares of common stock in a private stock
offering from November 2006 through March 2007, (v) the Company’s sale of
14,500,000 shares of common stock in a private stock offering in July and August
2005, (vi) the Company’s sale of 2,346,233 shares of Series A-1 Preferred stock
to Summit Energy Ventures, LLC in June 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 2003.  All of the Company’s Series A-1 Preferred
Stock was converted into Common Stock in 2005.




18





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 nine months ended September
30, 2010 were marked by a significant increase in revenues, an increase in gross
profit and an increase in its loss from operations that are more fully discussed
in the following section, “Results of Operations for the Three and Nine Months
Ended September 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 NINE MONTHS ENDED SEPTEMBER 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
              September
      30,
              2010
            
            
            Three
      Months
              Ended
              September
      30,
              2009
            
            
            Nine
      Months
              Ended
              September
      30,
              2010
            
            
            Nine
      Months
              Ended
              September
      30,
              2009(As
      Restated)
            
            
            
            
            
            (As
      Restated)Revenues
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of revenues
            
            
            55.7
            
            
            
            78.7
            
            
            
            72.5
            
            
            
            68.6Gross
      profit
            
            
            44.3
            
            
            
            21.3
            
            
            
            27.5
            
            
            
            31.4Costs
      and expenses:Research
      and development
            
            
            127.6
            
            
            
            353.0
            
            
            
            131.2
            
            
            
            397.2Selling,
      general and administrative
            
            
            348.1
            
            
            
            1,111.8
            
            
            
            454.6
            
            
            
            1,023.1Depreciation
      and amortization
            
            
            6.3
            
            
            
            24.8
            
            
            
            9.0
            
            
            
            27.7Total
      expenses
            
            
            482.0
            
            
            
            1,489.6
            
            
            
            594.8
            
            
            
            1,448.0Loss
      from operations
            
            
            (437.7
            )
            
            
            (1,468.3
            )
            
            
            (567.3
            )
            
            
            (1,416.6
            )Other
      income (expense)
            
            
            6.9
            
            
            
            (52.2
            )
            
            
            (23.1
            )
            
            
            107.2Loss
      before provision for income taxes
            
            
            (430.8
            )
            
            
            (1,520.5
            )
            
            
            (590.4
            )
            
            
            (1,309.4
            )Provision
      for income taxes
            
            
            8.8
            
            
            
            19.8
            
            
            
            12.1
            
            
            
            20.2Net
      loss
            
            
            (439.6
            )
            
            
            (1,540.3
            )
            
            
            (602.5
            )
            
            
            (1,329.6
            )Dividends
      paid or payable on Series B, C-1 and D Preferred Stock
            
            
            198.2
            
            
            
            230.1
            
            
            
            782.7
            
            
            
            279.5Net
      loss attributable to common shareholders
            
            
            (637.8
            )
      %
            
            
            (1,770.4
            )
      %
            
            
            (1,385.2
            )
      %
            
            
            (1,609.1
            )
      %




REVENUES




Total
revenues for the three months ended September 30, 2010 were approximately
$181,000, compared to $63,000 for the three months ended September 30, 2009, an
increase of $118,000 or 187%. This increase is mainly attributable to an
increase in sales in both the elevator and escalator market and the industrial
market during the third quarter of 2010.  Specifically, elevator and
escalator sales grew to approximately $98,000 for the three months ended
September 30, 2010, from approximately $53,000 for the three months ended
September 30, 2009, and industrial and other sales grew to approximately $83,000
for the three months ended September 30, 2010, from $10,000 for the three months
ended September 30, 2009.  The increase in elevator and escalator
sales in the three months ended September 30, 2010 is primarily due to the
commercialization and increased market acceptance of the Company’s digital
products 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 September 30, 2010.  Industrial and other sales increased
during the three months ended September 30, 2010, due to an increase in
international sales, which generally have higher margins than domestic
sales.  For the three months ended September 30, 2010, industrial and
other sales were approximately 46% of total sales, and escalator and elevator
sales were approximately 54% of total sales.  All sales for the three
months ended September 30, 2010 consisted entirely of digital
units.  For the three months ended September 30, 2009, industrial
sales, which consisted totally of digital units, were approximately 16% of total
sales, and escalator and elevator sales, which consisted of a mix of digital
units and analog units, were approximately 84% of total
sales.  Although overall revenue increased during three months ended
September 30, 2010, the Company expects future sales to continue to be
volatile.




20





Total
revenues for the nine months ended September 30, 2010 were approximately
$416,000, compared to $186,000 for the nine months ended September 30, 2009, an
increase of $230,000 or 124%. This increase is mainly attributable to an
increase in sales in both the elevator and escalator market and the industrial
market during the first three quarters of 2010.  Specifically,
elevator and escalator sales grew to approximately $279,000, which included one
large sale to a marquee end user of approximately $52,000 and marked increases
in sales to two escalator and elevator OEMs, for the nine months ended September
30, 2010, from approximately $116,000 for the nine months ended September 30,
2009.  Industrial and other sales grew to approximately $137,000 for
the nine months ended September 30, 2010, from $69,000 for the nine months ended
September 30, 2009.  The overall increases in sales during the nine
months ended September 30, 2010 are primarily due to the same factors described
above.  In the industrial and other market, the Company 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 nine months ended September 30,
2010, industrial and other sales were approximately 33% of total sales, and
escalator and elevator sales were approximately 67% of total
sales.  All sales for the nine months ended September 30, 2010
consisted entirely of digital units.  For the nine months ended
September 30, 2009, industrial sales, of which all but one order consisted of
digital units, were approximately 37% of total sales, and escalator and elevator
sales, which consisted of a mix of digital units and analog units, were
approximately 63% of total sales.  Although overall revenue increased
during nine months ended September 30, 2010, the Company expects future sales to
continue to be volatile.





COST
OF REVENUES




For the
three months ended September 30, 2010, total cost of revenues, which includes
materials, direct labor and overhead, was approximately $101,000 compared to
approximately $50,000 for the three months ended September 30, 2009, an increase
of $51,000 or 102%.  This increase is mainly attributable to an
overall increase in sales in the elevator and escalator sales and industrial
sales in the third quarter of 2010, as described above.  As a
percentage of revenue, total cost of sales decreased to approximately 56% for
the three months ended September 30, 2010 compared to approximately 79% for the
three months ended September 30, 2009.  The decrease in the costs as a
percentage of revenues was primarily due to the increase in international
industrial sales, which generally have higher gross margins.





For the
nine months ended September 30, 2010, total cost of revenues, which includes
materials, direct labor and overhead, was approximately $302,000 compared to
approximately $127,000 for the nine months ended September 30, 2009, an increase
of $175,000 or 138%.  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 73% for the nine months ended September 30, 2010 compared to
approximately 69% for the nine months ended September 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, partially offset by the increase generated by higher margins on
international sales in the third quarter.  The Company decreased
industrial pricing on product sold through indirect channels, primarily through
its distributor network, during the nine months ended September 30, 2010, rather
than through direct sales efforts, as was the case during the nine months ended
September 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 in 2011. Finally, the Company made one large sale
with sharply reduced pricing to a marquee end user for a strategic marketing
benefit during the nine months ended September 30, 2010, which was mitigated by
the increase in high margin international industrial sales.




21





GROSS
PROFIT





Gross
profit for the three months ended September 30, 2010 was approximately $80,000
compared to approximately $13,000 for the three months ended September 30,
2009.  As a percentage of revenue, gross profit increased to
approximately 44% for the three months ended September 30, 2010 compared to
approximately 21% for the three months ended September 30, 2009 driven by higher
margin international sales.





Gross
profit for the nine months ended September 30, 2010 was approximately $115,000
compared to approximately $58,000 for the nine months ended September 30,
2009.  As a percentage of revenue, gross profit decreased to
approximately 28% for the nine months ended September 30, 2010 compared to
approximately 31% for the nine months ended September 30, 2009 driven by lower
prices partially offset by higher margin international sales in the third
quarter.





OPERATING
EXPENSES




Research
and Development Expenses




Research
and development expenses were approximately $231,000 for the three months ended
September 30, 2010, as compared to approximately $223,000 for the three months
ended September 30, 2009, an increase of $8,000 or 4%.  This increase is
mainly attributable to the Company’s product development and certification costs
related to the Company’s next generation digital controller for both its
single-phase and three-phase products.





Research
and development expenses were approximately $546,000 for the nine months ended
September 30, 2010, as compared to approximately $737,000 for the nine months
ended September 30, 2009, a decrease of $191,000 or 26%.  This decrease is
mainly attributable to a reduction in salaries and related payroll expense and
an overall 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 $629,000 for the three
months ended September 30, 2010, as compared to $702,000 for the three months
ended September 30, 2009, a decrease of $73,000 or 10%. The decrease was
primarily due to lower payroll, and payroll related costs in the administrative
department, as well as decreases in investor and stockholder relations,
consulting fees and costs related to stock based compensation, during the three
months ended September 30, 2010.  This decrease was partially offset
by an increase in payroll, payroll related costs and travel in the sales
department.





Selling,
general and administrative expenses were approximately $1,893,000 for the nine
months ended September 30, 2010, as compared to $1,899,000 for the nine months
ended September 30, 2009, a decrease of $6,000 or less than 1%. The decrease in
selling, general and administrative expenses compared to the prior year was
primarily due to decreases in payroll, and payroll related costs in the
administrative department, as well as decreases in investor and stockholder
relations, consulting fees and costs related to stock based compensation, during
the nine months ended September 30, 2010.  This decrease was partially
offset by an increase in payroll, payroll related costs and travel in the sales
department.





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 was reduced to $0, as of
September 30, 2010, due to the expiration of the warrants recorded as
liabilities.  The $4,745 and $828,827 decreases in the fair value of
these warrants during three and nine months ended September 30, 2010,
respectively, has been reflected as a non-operating gain in the Statement of
Operations for the three and nine months ended September 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.





Financial
Condition, Liquidity, and Capital Resources





The
accompanying financial statements have been prepared assuming the Company is a
going concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business.  The Company experienced
a $1,908,811 deficiency of cash from operations for the nine months ended
September 30, 2010.  While the Company appears to have adequate
liquidity at September 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.




23





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 September 30, 2010, the Company had cash of $3,393,114.





Cash used
for operating activities for the nine months ended September 30, 2010 was
$1,908,811, which consisted of a net loss of $2,508,925; less depreciation and
amortization of $37,667, warrants and options issued to employees and
consultants of $212,619, noncash interest expense of $818,542, and a decrease in
inventory of $85,625, offset by a change in the fair value of our warrant
liability of $828,827, and increases in accounts receivable of $17,279, prepaid
expenses and other current assets of $16,490 and deposits of
$10,057.  In addition, these amounts were offset by a decrease in
deferred rent of $6,153, and increases in accounts payable of $287,007 and
deferred tax liability of $37,460.





Cash used
in operating activities for the nine months ended September 30, 2009 was
$2,360,277, which consisted of a net loss of $2,467,246; less depreciation and
amortization of $51,405, warrants and options issued to employees and
consultants of $298,335, a decrease in accounts receivable of $3,186, and a
decrease in deposits of $11,292; offset by a change in the fair value of our
warrant liability of $184,102, increases in inventory of $65,150, prepaid
expenses and other current assets of $9,946.  In addition, these
amounts were offset by a decrease in accounts payable of $21,360, provision for
bad debt of $11,342 and deferred rent of $2,807, and an increase in deferred tax
liability of $37,458.





Net cash
used in investing activities for the nine months ended September 30, 2010 was
$31,930, compared to $17,495 for the nine months ended September 30, 2009. The
total amount for the first three quarters of 2010 consisted of capitalized costs
related to patent applications of $22,335, and the purchase of property and
equipment of $9,595.  The total amount for the first three quarters of
2009 consisted of capitalized costs related to patent applications of $7,892,
and the purchase of property and equipment of $9,603.





Net cash
provided by financing activities was $5,086,291 for the nine months ended
September 30, 2010.  Of this amount, $3,976,200 was proceeds from the
issuance of equity securities, $1,687,083 was proceeds from the issuance of debt
securities, offset by payments on notes payable of $450,000, and fees related to
equity financings of $126,992.  Net cash provided by financing
activities was $809,569 for the nine months ended September 30, 2009, which
consisted solely of net proceeds from the issuance of equity
securities.




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.





24





Cash
Requirements and Need for Additional Funds




While the
Company appears to have adequate liquidity at September 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
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 Quarterly Report on Form 10-Q, 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.





Concentrations
of Credit Risk




The
Company maintains cash accounts with major financial institutions. Cash deposits
are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000
at each institution.  From time to time, amounts deposited may exceed the
FDIC limits.





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 September 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





The
following reconciles the warrant liability for the nine months ended September
30:





2010
            
            
            2009Beginning
      balance, January 1,
            
            $
            828,827
            
            
            $
            381,856Additions
      to warrant liability
            
            
            -
            
            
            
            106,201Change
      in fair value
            
            
            (828,827
            )
            
            
            (184,102
            )Ending
      balance, September 30,
            
            $
            -
            
            
            $
            303,955





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.  Sales discounts
and shipping credits are accounted for as deductions from
revenues.  The Company does not have any special arrangements, post
shipment obligations or acceptance provisions with its OEM reseller and
distributor customers, nor do we grant price concessions to our
distributors.





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 regarding a number of highly complex and
subjective variables. These variables include, but are not limited to, our
expected stock price volatility over the term of the awards and actual and
projected employee stock option exercise behaviors, a risk free interest rate,
and expected remaining lives of the awards. In estimating expected stock price
volatility, we use historical volatility, calculated based on the daily closing
prices of our common stock over a period equal to the expected term of the
option. We believe that the historical volatility of the price of our common
stock over the expected term of the option is a strong indicator of the expected
future volatility.  The Company utilizes the Daily Treasury Yield
Curve Rates published by the US Treasury on the date of grant in determining the
risk free interest rate, and estimates its expected remaining lives of the
awards based on historical actual 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 $213,000 and $298,000 in compensation expense during the nine
months ended September 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.





27





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.





Accrued
warranty expenses at September 30, 2010 consist of the following:





Balance,
      December 31, 2009
            
            $
            2,648Additions
            
            
            4,568Deductions
            
            
            (4,501
            )Balance,
      September 30, 2010
            
            $
            2,715





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.





The
Company maintains a deferred tax liability related to it amortization of
goodwill for tax purposes.  The amount of the deferred tax liability
was $427,027 and $399,567 for the periods ended September 30, 2010 and December
31, 2009, respectively.





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 nine months ended September 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.





28




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 adoption of ASU 2010-17 did not have
an 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.




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.





29








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 our Principal Executive Officer and Principal 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 Principal
Executive Officer and Principal Financial Officer have concluded that, as of the
end of the period covered by this report, the Company’s disclosure controls and
procedures are not 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 our Principal Executive Officer and
Principal Financial Officer, as appropriate to allow timely decisions regarding
required disclosure.  The Company’s disclosure controls and procedures
were not effective because there was a single occurrence where the Company
reported information required to be disclosed in the Company’s Exchange Act
reports in an untimely manner. Notwithstanding the conclusion that our
disclosure controls and procedures were not effective as of the end of the
period covered by this Quarterly Report, the Principal Executive and Financial
Officer believe that the condensed consolidated financial statements and other
information contained in this Quarterly Report present fairly, in all material
respects, our business, financial condition and results of
operations.





The
Company’s Principal Executive Officer and Principal Financial Officer believe
additional training and better communication with our employees and counsel will
be adequate in remedying our disclosure controls and procedures.





(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.




30




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 $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.





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.  Of the aggregate $200,000
invested, a value of $62,513 was allocated to the 625,000 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 July 30, 2010, the date of the transaction.  The Company recorded
additional preferred stock dividends of $87,513 related to the beneficial
conversion feature.





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.




31





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




ITEM
3. DEFAULTS UPON SENIOR SECURITIES




None.




ITEM
4. RESERVED




None.





ITEM
5. OTHER INFORMATION





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 as an exhibit in our Quarterly Report on Form
10-Q for the period ending June 30, 2010, filed with the SEC on August 16,
2010.





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 as an exhibit
in our Quarterly Report on Form 10-Q for the period ending June 30, 2010, filed
with the SEC on August 16, 2010





32





ITEM
6. EXHIBITS


31.1
            Certification
      by the Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
            Certification
      by the Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
            Certification
      by the Chief Executive Officer pursuant to Section 1350 of Chapter 63 of
      Title 18 of the United States Code (18 U.S.C. 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002.32.2
            Certification
      by the Chief Financial Officer pursuant to Section 1350 of Chapter 63 of
      Title 18 of the United States Code (18 U.S.C. 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002.99.1
            Press
      Release, dated November 15, 2010, announcing third quarter 2010 results.




33




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:  November
      15, 2010
              By:
              /s/ 
      Steven StrasserChief
      Executive Officer(principal
      executive officer)Date:  November
      15, 2010
              By:
              /s/ 
      John LacklandChief
      Financial Officer
                (principal
      financial and accounting officer)




34