SECURITIES AND EXCHANGE COMMISSION




Washington, D.C. 20549




FORM 10-Q




x QUARTERLY REPORT UNDER SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934




For the quarterly period ended: March 31, 2011




OR




 ̈ TRANSITION REPORT UNDER SECTION 13 OR 15 (d)


OF THE SECURITIES EXCHANGE ACT OF 1934




For the transition period from ___________ to ___________




Commission File No.  0-31805




POWER EFFICIENCY CORPORATION


(Exact Name of Issuer as Specified in its Charter)




Delaware

(State or Other Jurisdiction of

Incorporation or Organization)

22-3337365

(I.R.S. Employer Identification No.)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 x  No  ̈




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





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




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




The number of shares of common stock outstanding as of May 13, 2011 was 50,255,733.




Transitional Small Business Disclosure Format (check one):   Yes   ̈ No  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  ̈ No  ̈








POWER EFFICIENCY CORPORATION


FORM 10-Q INDEX





PART I - FINANCIAL INFORMATIONITEM 1. Financial Statements (Unaudited)
3Condensed Balance Sheets as of March 31, 2011 and December 31, 2010
3Condensed Statements of Operations for the three months ended March 31, 2011 and 2010
4Condensed Statements of Cash Flows for the three months ended March 31, 2011 and 2010
5Notes to Condensed Financial Statements
6-10ITEM 2. Management's Discussion and Analysis Of Financial Condition and Results of Operations
11-22ITEM 3. Quantitative and Qualitative Disclosure About Market Risk
22ITEM 4T. Controls and Procedures
22Part II — OTHER INFORMATIONITEM 1. Legal Proceedings
23ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
23ITEM 3. Defaults Upon Senior Securities
23ITEM 4. Reserved
23ITEM 5. Other Information
23ITEM 6. Exhibits
23Signatures
24Certification 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 SHEETS


Unaudited


March 31, 2011


December 31, 2010ASSETSCURRENT ASSETS:Cash

$
1,674,174


$
2,567,607Accounts receivable, net


110,136



106,066Inventory


173,485



217,119Prepaid expenses and other current assets


72,784



22,550Total Current Assets


2,030,579



2,913,342PROPERTY AND EQUIPMENT, Net


113,017



64,847OTHER ASSETS:Patents, net


145,183



141,907Deposits


92,243



36,971Goodwill


1,929,963



1,929,963Total Other Assets


2,167,389



2,108,841Total Assets

$
4,310,985


$
5,087,030LIABILITIES AND STOCKHOLDERS' EQUITYCURRENT LIABILITIES:Accounts payable and accrued expenses

$
716,409


$
687,168Total Current Liabilities


716,409



687,168LONG TERM LIABILITIESDeferred rent


10,230



11,282Deferred tax liability


461,999



449,513Total Long Term Liabilities


472,229



460,795Total Liabilities


1,188,638



1,147,963COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS' EQUITY:Series B, C-1 and D Convertible Preferred  Stock, $.001 par value, 10,000,000 shares authorized, 488,377 and 500,877 issued and outstanding in 2011 and 2010, respectively


488



501Common stock, $.001 par value, 350,000,000 shares authorized, 50,255,733 and 49,005,733 issued and outstanding in 2011 and 2010, respectively


50,256



49,006Additional paid-in capital


47,062,441



46,737,632Accumulated deficit


(43,990,838
)


(42,848,072
)Total Stockholders' Equity


3,122,347



3,939,067Total Liabilities and Stockholders' Equity

$
4,310,985


$
5,087,030





Accompanying notes are an integral part of the financial statements


3


POWER EFFICIENCY CORPORATION


CONDENSED STATEMENTS OF OPERATIONS


Unaudited





For the three months ended

March 31,2011


2010REVENUES

$
158,605


$
110,030COST OF REVENUESMaterials, labor and overhead


108,513



92,270Inventory obsolescence


20,394



-Total Cost of Revenues


128,907



92,270GROSS PROFIT


29,698



17,760COSTS AND EXPENSES:Research and development


293,009



169,679Selling, general and administrative


588,238



614,078Depreciation and amortization


10,471



14,437Total Costs and Expenses


891,718



798,194LOSS FROM OPERATIONS


(862,020
)


(780,434
)OTHER INCOME (EXPENSE):Interest income


3,840



5Change in fair value of warrant liability


-



514,882Total Other Income (expense)


3,840



514,887LOSS BEFORE PROVISION FOR INCOME TAXES


(858,180
)


(265,547
)PROVISION FOR INCOME TAXES


12,486



16,821NET LOSS

$
(870,666
)

$
(282,368
)DIVIDENDS PAID OR PAYABLE ON SERIES B, SERIES C-1 AND SERIES D PREFERED STOCK


272,100



208,110NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS

$
(1,142,766
)

$
(490,478
)BASIC AND FULLY DILUTED LOSS PER COMMON SHARE

$
(0.02
)

$
(0.01
)WEIGHTED AVERAGE COMMON SHARES  OUTSTANDING OUTSTANDING, BASIC


49,826,217



44,825,883





Accompanying notes are an integral part of the financial statements


4


POWER EFFICIENCY CORPORATION


CONDENSED STATEMENTS OF CASH FLOWS


Unaudited


For the three months ended March 31,2011


2010CASH FLOWS FROM OPERATING ACTIVITIES:Net loss

$
(870,666
)

$
(282,368
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


10,471



14,437Warrants and options issued to employees and consultants


53,946



64,192Change in fair value of warrant liability


-



(514,882
)Inventory obsolescence


20,394



-Changes in assets and liabilities:Accounts receivable, net


(4,070
)


(16,840
)Inventory


23,240



64,303Prepaid expenses and other current assets


(50,234
)


(20,084
)Deposits


(55,272
)


-Accounts payable and accrued expenses


29,241



165,731Deferred tax liability


12,486



12,487Deferred rent


(1,052
)


(2,051
)Net Cash Used in Operating Activities


(831,516
)


(515,075
)CASH FLOWS FROM INVESTING ACTIVITIESCosts related to patent applications


(3,912
)


(1,284
)Purchases of property and equipment


(58,005
)


-Net Cash Used in Investing Activities


(61,917
)


(1,284
)CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from issuance of equity securities


-



175,000Proceeds from issuance of note payable


-



125,000Net Cash Provided by Financing Activities


-



300,000Decrease in cash


(893,433
)


(216,359
)Cash at beginning of period


2,567,607



247,564Cash at end of period

$
1,674,174


$
31,205




Accompanying notes are an integral part of the financial statements


5




NOTE 1 - BASIS OF PRESENTATION




The accompanying financial statements have been prepared by the Company, without an audit. In the opinion of management, all adjustments have been made, which include normal recurring adjustments necessary to present fairly the condensed financial statements. Operating results for the three months ended March 31, 2011 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, 2010 on Form 10-K.




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 an $831,516 deficiency of cash from operations for the three months ended March 31, 2011, and expects significant cash deficiencies from operations until the Company’s sales and gross profit grow to exceed its expenses.





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 or accessing sufficient operating capital.  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 it on reasonable terms, we would be forced to restructure, file for bankruptcy or significantly curtail 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, 2010.


6


New Accounting Pronouncements:


Management does not believe that any recently issued, but not yet effective, accounting standards could have a material effect on the accompanying financial statements. As new accounting pronouncements are issued, the Company will adopt those that are applicable under the circumstances.





NOTE 4 – CONCENTRATIONS OF CREDIT RISK





Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and temporary cash investments and accounts receivable.





Cash is maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. All of our non-interest bearing cash balances were fully insured at March 31, 2011 and December 31, 2010 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may again exceed federally insured limits. Interest-bearing amounts on deposit in excess of federally insured limits at March 31, 2011 and December 31, 2010 approximated $1.5 million and $2.1 million, respectively.





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 recorded an inventory obsolescence charge of $20,394 during the three months ended March 31, 2011.  Management determined a reserve for inventory obsolescence was not necessary at March 31, 2011 or December 31, 2010.





Inventories are comprised as follows:





March 31,

2011


December

31, 2010Raw materials

$
162,012


$
170,251Finished goods


11,473



46,868Inventories

$
173,485


$
217,119





NOTE 6 – GOODWILL





On January 1, 2011, the Company adopted FASB ASU No. 2010-28, Intangibles (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.  The Guidance calls for reporting units with zero or negative carrying amounts to perform Step 2 of the goodwill impairment test.  As of March 31, 2011, the Company’s fair value exceeded its book value, which was positive, therefor; the Company is not required to perform Step 2.


7


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 2011 and 2010 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 (a Level 1 input), management determined that the estimated fair market value exceeded the company’s book value as of March 31, 2011 and December 31, 2010.  Based on this, no impairment exists as of March 31, 2011 and December 31, 2010.





NOTE 6 – EARNINGS PER SHARE





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





Three Months

Ended March

31, 2011


Three Months

Ended March

31, 2010Net loss attributable to common shareholders

$
(1,142,766
)

$
(490,478
)Basic weighted average number of common shares outstanding


49,826,217



44,825,883Dilutive effect of stock options


-



-Diluted weighted average number of common shares outstanding


49,826,217



44,825,883Basic and diluted loss per share

$
(0.02
)

$
(0.01
)





For the three months ended March 31, 2011 and 2010, warrants and options to purchase 71,128,324 and 47,644,959 shares of common stock, respectively, 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.


8





NOTE 7 – STOCK-BASED COMPENSATION





At March 31, 2011, the Company had two stock-based compensation plans.  There were 2,650,000 options granted in the three months ended March 31, 2011.  The fair value of these options was approximately $318,000 at issuance.  There were 825,000 options granted in the three months ended March 31, 2010.  The fair value of these options was approximately $225,000 at issuance.  No stock options were exercised in the periods ending March 31, 2011 and 2010.  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 $53,946 and $64,192 for the periods ended March 31, 2011 and 2010, respectively.





NOTE 8 – 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 provided that the exercise price of these warrants shall be reduced if, through a subsequent financing, the Company issued common stock below the lowest per share purchase price of the offering.  In each subsequent period, the Company adjusted the warrant liability to equal the fair value of the warrants at the balance sheet date.  The Company recorded a non-cash expense related to these warrants of $0 and $514,882 for the three months ended March 31, 2011 and 2010, respectively, which was recorded in other income (expense).  Changes in the fair value of warrants classified as a liability were recognized in earnings.  All of these warrants have expired as of December 31, 2010.





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





2011


2010Beginning balance, January 1,

$
-


$
828,827Change in fair value


-



(514,882
)Ending balance, March 31,

$
-


$
313,945


9


NOTE 9 – INCOME TAXES





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





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





NOTE 10 – SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION





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





2011


2010Income/franchise taxes

$
2,579


$
4,335





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





2011


2010Preferred stock dividend recognized for beneficial conversion features of preferred stock issuances

$
-


$
41,309Preferred stock dividends paid or payable in common stock

$
272,100


$
166,801





NOTE 11 – SUBSEQUENT EVENTS





In March 2011, the Company entered into a lease for office space, engineering and manufacturing facilities.  The new lease calls for an initial base rent of $9,298 per month, plus operating costs, and annual increases equal to 3% of the base rent.  For the first 11 months of the lease term, the company is only required to pay one-half of the initial base rent per month.  The term of the lease is 48 months and commenced on April 1, 2011.


10


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.


11





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 three existing patents and one patent pending on E-Save Technology® in the US, and has made numerous international patent filings.  These patents primarily focus on algorithms and other control methods to optimize motor energy use while maintaining the stability and speed of the motor.





Analog Three-phase MEC


The Company began generating revenues from sales of its patented analog three-phase MEC line of motor controllers in the late 1990’s.  The Company sold this product through the second quarter of 2009, and is currently providing repair services and parts for units in the field.





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 digital signal processor. The digital MEC is a complete motor control device, meaning is can start, stop, soft start and protect a motor, and is therefore capable of replacing standard motor starters and soft starts that do not save energy. The product can be installed by 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 if 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 working with independent sales representatives and distributers, as well as directly with OEMs, to penetrate the industrial markets.





In the first quarter of 2011, the Company launched its 2nd generation digital three-phase MEC for products ranging from 22 to 80 amps.  These are the Company’s highest volume three-phase products.  The 2nd generation digital three-phase MEC uses a more powerful processor, and has generally enhanced capabilities.  The 2nd generation products also incorporate numerous cost saving advantages over the 1st generation products.  The Company expects these cost savings to have a significant impact on the average cost of these products in the second half of 2011.


12





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.





Capitalization


As of March 31, 2011, the Company had total stockholders’ equity of $3,122,347 primarily due to the Company’s sale of 326,252 shares of Series D Convertible Preferred Stock in a private offering in June and July of 2010.





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





The Company’s results of operations for the quarter ended March 31, 2011 were marked by a increase in revenues and in its loss from operations that are more fully discussed in the following section, “Results of Operations for the Three Months Ended March 31, 2011 and 2010”.  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.


13


RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010.





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





Three Months

Ended March

31, 2011


Three Months

Ended March

31, 2010Revenues


100.0
%


100.0
%Cost of revenues


81.3



83.9Gross profit


18.7



16.1Costs and expenses:Research and development


184.7



154.2Selling, general and administrative


370.9



558.1Depreciation and amortization


6.6



13.1Total expenses


562.2



725.4Loss from operations


(543.5
)


(709.3
)Other income (expense)


2.4



468.0Loss before provision for income taxes


(541.1
)


(241.3
)Provision for income taxes


7.9



15.3Net loss


(549.0
)


(256.6
)Dividends paid or payable on Series B, Series C-1 and Series D Preferred Stock


171.6



189.1Net loss attributable to common shareholders


(720.5
)


(445.8
)





REVENUES





Total revenues for the three months ended March 31, 2011 were approximately $159,000, compared to $110,000 for the three months ended March 31, 2010, an increase of $49,000, or 45%. This increase is mainly attributable to an increase in sales in the elevator and escalator market and the industrial market in the first quarter of 2011.  Specifically, elevator and escalator sales grew to approximately $120,000 for the three months ended March 31, 2011, from approximately $69,000 for the three months ended March 31, 2010, and sales in the industrial market grew to approximately $39,000 for the three months ended March 31, 2011, from $28,000 for the three months ended March 31, 2010.  The increase in elevator and escalator sales in the three months ended March 31, 2011 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 2009 and 2010.  The digital product has been tested and approved for use on a retrofit and OEM basis by two elevator and escalator OEMs and on a retrofit basis by a third OEM.  Industrial and other sales increased during the three months ended March 31, 2011, due to an increase in international sales, which generally have higher margins than domestic sales.  For the three months ended March 31, 2011, industrial and other sales were approximately 23% of total sales, and escalator and elevator sales were approximately 77% of total sales.  For the three months ended March 31, 2010, industrial and other sales were approximately 29% of total sales, and escalator and elevator sales were approximately 71% of total sales.


14





COST OF REVENUES





Total cost of revenues, which includes materials, direct labor and overhead and inventory obsolescence for the three months ended March 31, 2011, was approximately $129,000 compared to approximately $92,000 for the three months ended March 31, 2010, an increase of $37,000, or 40%.  This increase is mainly attributable to an overall increase in sales of 45%, as described above, as well as an inventory obsolescence charge of approximately $20,000.  There was no comparable inventory obsolescence charge during the three months ended March 31, 2010.  As a percentage of revenue, total cost of revenues decreased to approximately 81%, which included 13% of inventory obsolescence charges, for the three months ended March 31, 2011 compared to approximately 84% for the three months ended March 31, 2010.





The inventory obsolescence charge is related to the Company’s switch from its 1st generation digital MECs to its 2nd generation digital MECs, for products ranging from 22 to 80 amps.  These are the Company’s highest volume products.   As of March 31, 2011 most but not all customers were accepting shipments of the 2nd generation digital MECs.  The Company expects the cost savings associated with the switch to its 2nd generation product to have a significant impact on the average per unit cost of the 22 to 80 amp units in the 2nd half of 2011.





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.  Also, the Company’s production costs have decreased due to the switch from analog products to digital products, and the Company has planned product cost reductions that it expects will continue to reduce the cost of revenue in 2011.  Finally, the Company made one large sale with extremely reduced pricing to a marquee end user who was considered a strategic customer during the three months ended March 31, 2010.  No such sale occurred during the three months ended March 31, 2011.





GROSS PROFIT





Gross profit for the three months ended March 31, 2011, was approximately $30,000 compared to approximately $18,000 for the three months ended March 31, 2010, resulting in an increase of $12,000, or 67%.  This increase is mainly attributable to increases in sales in both the elevator and escalator and the industrial markets during the three months ended March 31, 2011 as described above.  As a percentage of revenue, gross profit increased to approximately 19%, which included inventory obsolescence charges of 13%, for the three months ended March 31, 2011 compared to approximately 16%, which included one large sale with extremely reduced pricing to a marquee end user, for the three months ended March 31, 2010.




15




OPERATING EXPENSES





Research and Development Expenses


Research and development expenses were approximately $293,000 for the three months ended March 31, 2011, as compared to approximately $170,000 for the three months ended March 31, 2010, an increase of $123,000 or 72%.  This increase is mainly attributable to an increase in salaries and payroll related costs of $50,000, product development and certification costs related to the Company’s digital controller for both its single-phase and three-phase products of $19,000, tools and supplies of $14,000, consulting fees of $11,000 and travel expenses of $8,200, during the three months ended March 31, 2011.





Selling, General and Administrative Expenses





Selling, general and administrative expenses were approximately $588,000 for the three months ended March 31, 2011, as compared to $614,000 for the three months ended March 31, 2010, a decrease of $26,000 or 4%. The decrease in selling, general and administrative expenses compared to the prior year was primarily due to decreases in payroll, and payroll related costs of $37,000, and investor and stockholder relations of $35,000.  These decreases were partially offset by increases in travel of $27,000 and samples and trial unit expenses of $7,000.





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 were being accounted for as liabilities in accordance with FASB ASC 820-10, Fair Value Measurements and Disclosures(Prior authoritative literature: FASB EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF 07-5”),issued January 2009), based on an analysis of the terms and conditions of the warrant agreements.





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





Financial Condition, Liquidity, and Capital Resources





The Company has suffered recurring losses from operations, and experienced a deficiency of cash of approximately $832,000 and $515,000 from operations for the three months ended March 31, 2011 and 2010, respectively.  For the three months ended March 31, 2011 and 2010, we had net losses of $871,000 and $282,000, respectively, and expect significant cash deficiencies from operations until the Company’s sales and gross profit grow to exceed its expenses. These factors raise substantial doubt about the Company's ability to continue as a going concern.  Our 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 we be unable to continue in existence.


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The Company’s continuation as a “going concern” is dependent upon achieving profitable operations and related positive cash flow and satisfying our immediate cash needs by external financing until we are profitable.  Our plans to achieve profitability include developing new products, obtaining new customers and increasing sales to existing customers.  We are seeking to raise additional capital through equity issuance, debt financing and other types of financing, but we cannot guarantee that sufficient capital will be raised.





Since inception, the Company has financed its operations primarily through the sale of its securities.  In 2010, the Company received a total of approximately $5,395,000 in gross proceeds from private placements of its Series D preferred stock, Secured Notes and Series C-1 preferred stock and warrants to purchase common stock.  In 2009, the Company received a total of approximately $1,210,000 in gross proceeds from a private placement of its Series C preferred stock and Series C-1 preferred stock and warrants to purchase common stock.





Cash used for operating activities for the three months ended March 31, 2011 was $831,516, which consisted of a net loss of $870,666, less depreciation and amortization of $10,471, warrants and options issued to employees and consultants of $53,946, inventory obsolescence of $20,394, and a decrease in inventory of $23,240, offset by increases in accounts receivable of $4,070, prepaid expenses and other current assets of $50,234, and deposits of $55,272.  In addition, these amounts were offset by a decrease in deferred rent of $1,052 and increases in accounts payable of $29,241 and deferred tax liability of $12,486.





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





Net cash used in investing activities for the three months ended March 31, 2011 was $61,917, compared to $1,284 for the three months ended March 31, 2010. The amount for the first quarter of 2011 consisted of $3,912 of capitalized costs related to patent applications and $58,005 for the purchase of equipment.  The total amount for the first quarter of 2010 consisted of capitalized costs related to patent applications.





Net cash provided by financing activities was $300,000 for the three months ended March 31, 2010.  Of this amount, $175,000 was from the proceeds from the issuance of equity securities, and $125,000 was from the proceeds from the issuance of debt securities.  There was no cash provided by or used for financing activities for the three months ended March 31, 2011.





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.




17





Cash Requirements and Need for Additional Funds





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




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





Critical Accounting Policies and Estimates





Management’s discussion and analysis of Power Efficiency Corporation’s financial condition and results of operations are based upon the condensed financial statements contained in this 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.





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.  The Company recorded an inventory obsolescence charge of $20,394 for the three months ended March 31, 2011 associated with its switch from its 1st generation digital three-phase products to its 2nd generation three-phase digital products, ranging from 22 to 80 amps.  Management has determined a reserve for inventory obsolescence is not necessary at March 31, 2011 or December 31, 2010.




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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:


FASB ASC 820-10 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 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 to measure the amount of 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 that the Company has the ability to access. 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, 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 8).  Total gains resulting for this fair value measurement are recorded as a component of other income in the statement of operations for the years ended December 31, 2010 and 2009.  There were no purchases, sales, issuance or settlements, nor were there any transfers in and/or out of a Level 3 classification.  In accordance with FASB ASC 820-10, the warrant liabilities were being remeasured to fair value each quarter until they all expired.  The warrants were valued using the Black-Scholes option pricing model, using observable and unobservable assumptions (Level 3) consistent with our application of FASB ASC 718.





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Revenue Recognition


Revenue from product sales is recognized when pervasive evidence of an arrangement exists, delivery has occurred, the price to the buyer is fixed or determinable, and collectability is reasonably assured.  Returns and other sales adjustments (warranty accruals, discounts and shipping credits) are provided for in the same period the related sales are recorded.  The Company does not have any post shipment obligations nor customer acceptance provisions, but it does provide its customers a limited right of return for defective products under its two year warranty.  Shipping and handling fees and related freight costs and supplies associated with shipping products to customers are included as a component of cost of goods sold. The Company accounts for sales returns as a component of its estimated warranty accrual, discounts as a reduction in revenue, and shipping credits as a reduction in its cost of goods sold.  The Company does not grant price concessions to its OEMs, resellers or distributors.





Accounting for Stock Based Compensation


The Company accounts for employee stock options as compensation expense, in accordance with FASB ASC 718.  FASB ASC 718 requires companies to expense the value of employee stock options and similar awards, and applies to all outstanding and vested stock-based awards.





In computing the impact, the fair value of each option is estimated on the date of grant based on the Black-Scholes options-pricing model utilizing certain assumptions for a risk free interest rate; volatility; and expected remaining lives of the awards.  The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates, but these estimates involve inherent uncertainties and the application of management’s 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 significantly different from what we have recorded in the current period.  The impact of applying FASB ASC 718 approximated $54,000 and $64,000 in additional compensation expense during the periods ended March 31, 2011 and 2010, respectively.  Such amounts are included in research and development expenses and selling, general and administrative expense on the statement of operations.





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.


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Accrued warranty expenses at December 31, 2010 and March 31, 2011 consist of the following:





Balance, January 1, 2010

$
2,648Additions


6,327Deductions


(6,895
)Balance, December 31, 2010

$
2,080Additions


2,452Deductions


(796
)Balance, March 31, 2011

$
3,736





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,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 additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets.  We have reported net operating losses for consecutive years, and do not have projected taxable income in the near future.  This significant evidence causes our management to believe a full valuation allowance should be recorded against the deferred tax assets.





Goodwill


On January 1, 2011, the Company adopted FASB ASU No. 2010-28, Intangibles (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.  The Guidance calls for reporting units with zero or negative carrying amounts to perform Step 2 of the goodwill impairment test.  As of March 31, 2011, the Company’s fair value exceeded its book value, which was positive, therefor; the Company is not required to perform Step 2.





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 2011 and 2010 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.


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The Company has no accumulated impairment losses on goodwill.  The Company’s impairment analysis is performed on December 31 each year, on the Company’s single reporting unit.  Using the Company’s market capitalization (based on Level 1 inputs), management determined that the estimated fair market value substantially exceeded the company’s book value as of March 31, 2011 and December 31, 2010.  Based on this, no impairment was recorded as of March 31, 2011 or December 31, 2010.





New Accounting Pronouncements:


Management does not believe that any recently issued, but not yet effective, accounting standards could have a material effect on the accompanying financial statements. As new accounting pronouncements are issued, the Company will adopt those that are applicable under the circumstances.





ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.





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




ITEM 4T. CONTROLS AND PROCEDURES




(a) Evaluation of Disclosure Controls and Procedures.  Under the supervision and with the participation of its 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 (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 effective in ensuring that information required to be disclosed in the Company’s Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to the Company’s management, including its Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.





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


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PART II — OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS




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




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




None.




ITEM 3. DEFAULTS UPON SENIOR SECURITIES




None.




ITEM 4. RESERVED




None.





ITEM 5. OTHER INFORMATION





None.





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.


23




SIGNATURES




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





POWER EFFICIENCY CORPORATION(Company)Date:  May 16, 2011
By:
/s/  Steven StrasserChief Executive OfficerDate:  May 16, 2011
By:
/s/  John LacklandChief Financial Officer (Principal

Financial and Accounting Officer)


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