**SECURITIESAND EXCHANGE COMMISSION**

 

**Washington,D.C. 20549**

 

**FORM 10-QSB**

 

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

 

**For the quarterly period ended:September 30, 2005**

 

**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**

** **

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

 

| **Delaware**                     |       | **22-3337365**                        |
|----------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction of |       | (I.R.S. Employer  Identification No.) |
| Incorporation or  Organization)  | ** ** |                                  |

 

| **3900  Paradise Road, Suite 283**        | ** ** | **(702)  697-0377**               |
|-------------------------------------------|------------|-----------------------------------|
| **Las  Vegas, NV 89109**                  |       | (Issuer’s Telephone  Number, |
| (Address of Principal  Executive Offices) | ** ** | Including Area Code)              |

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes   o  No   o  

 

Thenumber of shares outstanding of the Issuer’s Common Stock, $.001 Par Value, asof October 31, 2005 was 23,439,266.

 

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

 

 

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**POWEREFFICIENCY CORPORATIONFORM 10-QSB INDEX**

 
| PART I  – FINANCIAL INFORMATION                              |
|------------------------------------------------------------------------|
|                                                                   |
| ITEM 1.  Financial Statements                                     |
|                                                                   |   |
|                                                                   | Condensed Balance Sheet as of September 30, 2005 |
|                                                                   |   |
|                                                                   | Condensed Statements of Operations for the three months ended September 30, 2005 and 2004 and nine months ended September 30, 2005 and 2004. |
|                                                                   |   |
|                                                                   | Condensed Statements of Cash Flows for the nine months ended September 30, 2005 and 2004 |
|                                                                   |   |
|                                                                   | Notes to Condensed Financial Statements |
|                                                                   |
| ITEM 2. Management’s Discussion and Analysis or Plan of Operation |
|                                                                   |
| ITEM 3. Controls and Procedures                                        |
|                                                                   |
| Part II — OTHER INFORMATION                                       |
|                                                                   |
| ITEM 1. Legal Proceedings                                              |
|                                                                   |
| ITEM 2. Changes in Securities and Use of Proceeds                      |
|                                                                   |
| ITEM 3. Defaults Upon Senior Securities                                |
|                                                                   |
| ITEM 4. Submission of Matters to a Vote of Security Holders            |
|                                                                   |
| ITEM 5. Other Information                                              |
|                                                                   |
| ITEM 6. Exhibits and Reports on Form 8-K                               |
|                                                                   |
| Signatures                                                             |
|                                                                   |
| Certification of Chief  Executive Officer as Adopted                   |
|                                                                   |
| Certification of Chief  Financial Officer as Adopted                   |

** **

**2**

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** **

**PART I. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**POWER EFFICIENCYCORPORATION**CONDENSED BALANCE SHEET

Unaudited

 
| ** **                                                                                                          | ** ** | **September 30,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ASSETS                                                                                                              |       |                    |       |
| CURRENT ASSETS:                                                                                                     |       |                    |       |
| Cash                                                                                                                |       | $                       | 1,626,826  |   |
| Accounts receivable, net                                                                                            |       | 92,172                  |       |
| Inventory, net of reserve                                                                                           |       | 162,444                 |       |
| Prepaid expenses and other current assets                                                                           |       | 90,602                  |       |
| Total Current Assets                                                                                                |       | 1,972,044               |       |
|                                                                                                                |       |                    |       |
| PROPERTY AND EQUIPMENT, Net                                                                                         |       | 15,845                  |       |
|                                                                                                                |       |                    |       |
| OTHER ASSETS:                                                                                                       |       |                    |       |
| Patents, net                                                                                                        |       | 12,221                  |       |
| Goodwill                                                                                                            |       | 1,929,963               |       |
| Website, net                                                                                                        |       | 4,887                   |       |
| Deferred financing costs, net                                                                                       |       | 98,193                  |       |
| Total Other Assets                                                                                                  |       | 2,045,264               |       |
|                                                                                                                |       |                    |       |
| Total Assets                                                                                                        |       | $                       | 4,033,153  |   |
|                                                                                                                |       |                    |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                          |       |                    |       |
| CURRENT LIABILITIES:                                                                                                |       |                    |       |
| Accounts payable and accrued expenses                                                                               |       | $                       | 456,623    |   |
| Accrued salaries and payroll taxes                                                                                  |       | 65,574                  |       |
| Notes payable                                                                                                       |       | 79,236                  |       |
| Notes payable — former officers                                                                                |       | 43,918                  |       |
| Total Current Liabilities                                                                                           |       | 645,351                 |       |
|                                                                                                                |       |                    |       |
| LONG TERM LIABILITIES                                                                                               |       |                    |       |
| Notes payable — Pali Capital,  net                                                                             |       | 1,288,532               |       |
| Notes payable                                                                                                       |       | 14,617                  |       |
| Total Long Term Liabilities                                                                                         |       | 1,303,149               |       |
|                                                                                                                |       |                    |       |
| Total Liabilities                                                                                                   |       | 1,948,500               |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                      |       |                    |       |
| STOCKHOLDERS’ EQUITY:                                                                                          |       |                    |       |
| Series A-1 Convertible Preferred Stock, $.001 par value, 10,000,000  shares authorized, none issued and outstanding |       | —                  |       |
| Common stock, $.001 par value, 100,000,000 shares authorized,  23,439,266 issued and outstanding                    |       | 23,439                  |       |
| Additional paid-in capital                                                                                          |       | 19,146,792              |       |
| Accumulated deficit                                                                                                 |       | (17,085,578             | )          |
| Total Stockholders’ Equity                                                                                     |       | 2,084,653               |       |
|                                                                                                                |       |                    |       |
| Total Liabilities and  Stockholders’ Equity                                                                    |       | $                       | 4,033,153  |   |

 

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

 

3

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**POWER EFFICIENCYCORPORATION**CONDENSED STATEMENTS OFOPERATIONS

Unaudited

 
| ** **                                    | ** ** | **For the three months  ended Sept 30,** | ** ** | **For the nine months  ended Sept 30,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                      | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| REVENUES                                      |       |                                          |       |                                         |       |   |   |   |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| Product, net                                  |       | $                                             | 75,952     |                                         | $          | 46,585 |   | $ | 221,737 |   | $ | 188,005 |   |
| Miscellaneous                                 |       | —                                        |       | 18,130                                       |       | — |   | 30,855 |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| Total Revenues                                |       | 75,952                                        |       | 64,715                                       |       | 221,737 |   | 218,860 |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| COMPONENTS OF COST OF PRODUCT REVENUES:       |       |                                          |       |                                         |       |   |   |   |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| Material and labor                            |       | 56,092                                        |       | 20,712                                       |       | 167,924 |   | 88,505 |   |
| Allocated costs                               |       | 4,353                                         |       | 5,285                                        |       | 19,059 |   | 41,815 |   |
| Inventory obsolescence and other write-offs   |       | —                                        |       | —                                       |       | — |   | 29,484 |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| Total Cost of Product Revenues                |       | 60,445                                        |       | 25,997                                       |       | 186,983 |   | 159,804 |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| GROSS MARGIN                                  |       | 15,507                                        |       | 38,718                                       |       | 34,754 |   | 59,056 |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| COSTS AND EXPENSES:                           |       |                                          |       |                                         |       |   |   |   |   |
| Research and development                      |       | 186,668                                       |       | 82,469                                       |       | 313,318 |   | 290,766 |   |
| Selling, general and administration           |       | 461,317                                       |       | 378,030                                      |       | 1,073,528 |   | 1,288,327 |   |
| Depreciation and amortization                 |       | 5,032                                         |       | 18,007                                       |       | 17,360 |   | 55,510 |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| Total Costs and Expenses                      |       | 653,017                                       |       | 478,506                                      |       | 1,404,206 |   | 1,634,603 |   |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| LOSS FROM OPERATIONS                          |       | (637,510                                      | )          | (439,788                                     | )          | (1,369,452 | ) | (1,575,547 | ) |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| OTHER (EXPENSE) INCOME                        |       |                                          |       |                                         |       |   |   |   |   |
| Interest (expense) income - net               |       | (130,217                                      | )          | (8,858                                       | )          | (391,398 | ) | (16,454 | ) |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| Total Other (Expense) Income                  |       | (130,217                                      | )          | (8,858                                       | )          | (391,398 | ) | (16,454 | ) |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| NET LOSS                                      |       | $                                             | (767,727   | )                                            | $          | (448,646 | ) | $ | (1,760,850 | ) | $ | (1,592,001 | ) |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| BASIC AND FULLY DILUTED LOSS PER COMMON SHARE |       | $                                             | (.03       | )                                            | $          | (.09 | ) | $ | (.16 | ) | $ | (.36 | ) |
|                                          |       |                                          |       |                                         |       |   |   |   |   |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING    |       | 23,258,497                                    |       | 5,020,447                                    |       | 11,122,128 |   | 4,426,976 |   |
|                                               |            |                                               |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

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

 

4

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**POWER EFFICIENCY CORPORATION**

CONDENSED STATEMENTS OF CASH FLOWS

Unaudited

 
| ** **                                                                                                                                                                                                                                    | ** ** | **For the nine months ended Sept 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                                                                                                                    | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                                                                                                                                                         |       |                                   |       |   |   |
|                                                                                                                                                                                                                                          |       |                                   |       |   |   |
| Net loss                                                                                                                                                                                                                                      |       | $                                      | (1,760,850 | ) | $ | (1,592,001 | ) |
| Adjustments to reconcile net loss to net cash used for operating  activities:                                                                                                                                                                 |       |                                   |       |   |   |
| Depreciation and amortization                                                                                                                                                                                                                 |       | 17,360                                 |       | 55,510 |   |
| Amortization of deferred financing costs                                                                                                                                                                                                      |       | 63,982                                 |       | — |   |
| Bad debt expense                                                                                                                                                                                                                              |       | 4,530                                  |       | 5,493 |   |
| Inventory obsolescence reserve and other write-offs                                                                                                                                                                                           |       | —                                 |       | 29,484 |   |
| Loss on sale of fixed assets                                                                                                                                                                                                                  |       | —                                 |       | 31,226 |   |
| Debt discount related to issuance of debt securities                                                                                                                                                                                          |       | 181,726                                |       | — |   |
| Settlement of litigation                                                                                                                                                                                                                      |       | 93,853                                 |       | — |   |
| Warrants and options issued in connection with the issuance of debt  securities, employment agreements, and consulting fees                                                                                                                   |       | 27,549                                 |       | — |   |
| Changes in assets and liabilities:                                                                                                                                                                                                            |       |                                   |       |   |   |
| (Increase) Decrease in:                                                                                                                                                                                                                       |       |                                   |       |   |   |
| Accounts receivable                                                                                                                                                                                                                           |       | (65,165                                | )          | 14,010 |   |
| Inventory                                                                                                                                                                                                                                     |       | 25,373                                 |       | 40,518 |   |
| Prepaid expenses and other current assets                                                                                                                                                                                                     |       | (20,916                                | )          | (13,481 | ) |
| Restricted cash for interest escrow                                                                                                                                                                                                           |       | 165,416                                |       | — |   |
| Increase(Decrease) in:                                                                                                                                                                                                                        |       |                                   |       |   |   |
| Accounts payable and accrued expenses                                                                                                                                                                                                         |       | (180,742                               | )          | 298,236 |   |
| Customer deposits                                                                                                                                                                                                                             |       | —                                 |       | 6,983 |   |
| Accrued salaries and payroll taxes                                                                                                                                                                                                            |       | (62,893                                | )          | 386,383 |   |
| Net Cash Used for Operating Activities                                                                                                                                                                                                        |       | (1,510,777                             | )          | (737,639 | ) |
|                                                                                                                                                                                                                                          |       |                                   |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                                                                                                                                                                          |       |                                   |       |   |   |
| Purchase of property and equipment                                                                                                                                                                                                            |       | (1,373                                 | )          | (21,576 | ) |
| Net Cash Used for Investing Activities                                                                                                                                                                                                        |       | (1,373                                 | )          | (21,576 | ) |
|                                                                                                                                                                                                                                          |       |                                   |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                                                                                                                                         |       |                                   |       |   |   |
| Deferred financing costs                                                                                                                                                                                                                      |       | (63,457                                | )          | — |   |
| Proceeds from line of credit — related party                                                                                                                                                                                             |       | 300,000                                |       | 300,000 |   |
| Proceeds from issuance of equity securities                                                                                                                                                                                                   |       | 2,741,378                              |       | 184,800 |   |
| Proceeds from issuance of debt securities                                                                                                                                                                                                     |       | 125,000                                |       | — |   |
| Payments on line of credit — related party                                                                                                                                                                                               |       | (300,000                               | )          | — |   |
| Payments to former officers                                                                                                                                                                                                                   |       | (56,416                                | )          | (10,000 | ) |
| Net Cash Provided by Financing Activities                                                                                                                                                                                                     |       | 2,746,505                              |       | 474,800 |   |
|                                                                                                                                                                                                                                          |       |                                   |       |   |   |
| Increase(Decrease) in cash                                                                                                                                                                                                                    |       | 1,234,355                              |       | (284,415 | ) |
|                                                                                                                                                                                                                                          |       |                                   |       |   |   |
| Cash at beginning of period                                                                                                                                                                                                                   |       | 392,471                                |       | 285,508 |   |
|                                                                                                                                                                                                                                          |       |                                   |       |   |   |
| Cash at end of period                                                                                                                                                                                                                         |       | $                                      | 1,626,826  |   | $ | 1,093 |   |
| NON-CASH FINANCING TRANSACTIONS- Common stock issued in conjunction  with the settlement of accounts payable and accrued salaries\ payroll\other  expenses settlement of acounts payable and accrued salaries\payroll\other  accrued expenses |       | $                                      | —     |   | $ | 37,400 |   |
|                                                                                                                                                                                                                                               |            |                                        |            |  |  |  |  |  |

 

**Accompanying notes are an integral part of the financial statements**

 

5

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**NOTE 1 -BASIS OF PRESENTATION**

 

Theaccompanying financial statements have been prepared by the Company, without anaudit. In the opinion of management, all adjustments have been made, whichinclude normal recurring adjustments necessary to present fairly the condensedfinancial statements. Operating results for the nine months ended September 30,2005 are not necessarily indicative of the operating results for the full year.Certain information and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted. The Companybelieves that the disclosures provided are adequate to make the informationpresented not misleading. Certain amounts in the financial statements have beenreclassified from prior period presentations. These unaudited condensedfinancial statements should be read in conjunction with the audited financialstatements and related notes included in the Company’s Annual Report for theyear ended December 31, 2004 on Form 10-KSB, Form 10-KSB/A 1, Form 10-KSB/A 2and SB-2.

 

Thepreparation of condensed financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the dates of the financial statements and the reported amounts of revenueand expenses during the reporting period. Actual results could differ fromthose estimates.

 

**NOTE 2 - GOING CONCERN:**

** **

The accompanying financial statements have beenprepared assuming the Company is a going concern, which assumption contemplatesthe realization of assets and satisfaction of liabilities in the normal courseof business.  The Company sufferedrecurring losses from operations, a recurring deficiency of cash fromoperations, including a cash deficiency of approximately $1,510,000 fromoperations for the nine months ended September 30, 2005, and lacks sufficientliquidity to continue its operations.

 

On July 8, 2005 and on August 31, 2005, the Companyclosed a private offering of Common Stock which grossed $2,900,000, andproduced net proceeds of $2,232,750, from which the Company will use to fundits operations (see Note 5).  It is anticipated that such net proceeds willlast for up 15 months.  When itsoperations require additional financing, if the Company is unable to obtain iton reasonable terms, the Company will be forced to restructure, file forbankruptcy or cease operations.

 

These factors raise substantial doubt about theCompany’s ability to continue as a going concern.  The financial statements do not include anyadjustments relating to the recoverability and classification of recorded assetamounts or the amount of liabilities that might be necessary should the Companybe unable to continue in existence. Continuation of the Company as a going concern is dependent uponachieving profitable operations in the long-term and raising additional capitalto support existing operations for at least the next twelve months.  Management’s plans to achieve profitabilityinclude developing new products, obtaining new customers and increasing salesto existing customers.

 

6

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**NOTE 3 - NOTES PAYABLE**

 

On February 24, 2005, the Company entered into afinancing transaction in which the Company issued $125,000 in senior securednotes under the same offering through which the Company issued $1,464,806 insenior secured notes in October 2004. This offering was originallyintended to close on December 31, 2004, however, the placement agent and theCompany agreed to keep the offering open past the original closing date. Afterthe February 24 closing the offering was terminated.  Under the original terms, all of the seniorsecured notes were to become due one year after issuance, but on March 28,2005, the Company received consent, from all of the senior secured note holdersof the first and secondary offering, to extend the maturity date for anadditional year.  Accordingly, thesenotes will now mature in October 2006 and February 2007, respectively.

 

The holders of the $125,000 in notes issued inFebruary were issued 144,232 warrants, with an exercise price of $0.65 pershare.  The value of such warrants approximates $24,000 and was reflectedas debt discount which is being amortized to interest expense over the term ofthe notes.  The Company paid a placementagent a commission of $12,500 and 14,423 warrants which are being amortizedover the life of the notes, with the same rights and provisions as the warrantsissued to the holders of the notes.

 

**NOTE 4 — RELATED PARTY TRANSACTIONS**

 

On June 9, 2005 and on June 16, 2005, the Companyentered into financing transactions in which the Company issued a $200,000convertible, unsecured note, and a $100,000 convertible, unsecured noterespectively (collectively, the “Bridge Notes”) to Summit Energy Ventures LLC,an entity owned entirely by the Company’s current Chief Executive Officer, andChief Operating Officer and Chief Financial Officer that is also one of theCompany’s principal stockholders.  TheNotes bear interest of 10% per annum. The Bridge Notes’ accrued interest and principal were due on July 23,2005.  The Bridge Notes were convertedinto equity on July 8, 2005 (see Note 5).

 

**NOTE 5 - STOCKHOLDERS’ EQUITY**

 

On July 8, 2005 the Company completed the firstclosing of private offering of Common Stock (the “Offering”) for $2,430,000,which netted approximately $1.8 million. On August 31, 2005 the Company completed the second and final closingunder the Offering for $470,000, which netted approximately $400,000.  In this offering, the Company issued a totalof 14,500,000 shares of Common Stock and 7,250,000 Common Stock Warrants (the “InvestorWarrants”).  The per share purchase priceof the Common Stock was $0.20 (the “Common Stock Purchase Price”). The InvestorWarrants have a per share exercise price of $0.44 and expire 5 years from thedate of issuance.  The value of theInvestor Warrants was approximately $990,000.

 

Joseph Stevens & Company, Inc. (the “PlacementAgent”), a registered broker dealer, acted as the sole placement agent for theOffering.  For its services, the PlacementAgent received commissions and non-accountable fees totaling $237,900 and3,450,000 warrants (the “Placement Agent Warrants”). The Placement AgentWarrants have a per share exercise price of $0.20 and expire five years fromthe date of issuance.  The value of thePlacement Agent Warrants was approximately $832,000.

 

7

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Two convertible notes (the “Bridge Notes”) issued bythe Company, to Summit Energy Ventures, LLC, on June 9, 2005 and June 16, 2005,in the aggregate principal amount of $300,000, were converted into 1,500,000shares of common stock and 750,000 Investor Warrants on the same terms as thoseoffered to investors in the Offering and no commissions, fees or securitieswere issued to the Placement Agent in connection with such conversion.

 

On July 8, 2005, the Company’s 4,714,279 shares ofoutstanding Series A-1 Preferred Stock were converted into 3,918,848 shares ofcommon stock.

 

In conjunction with the Offering, the Companyentered into an agreement with the Placement Agent (the “Placement AgencyAgreement”). The Placement Agency Agreement requires, among other things, theCompany to pay certain fees related to the Offering; provides the PlacementAgent a right of first refusal to manage any private or public offering ofequity securities of the Company, under certain defined conditions, for aperiod of one year after the Offering; requires the Company to enter Lock-UpAgreements (as defined below) with all of the Company’s directors, officers andsignificant shareholders; grants the investors in the Offering and thePlacement Agent certain registration rights, which require the Company toregister their common stock as well as the common stock underlying the InvestorWarrants and Placement Agent Warrants through filing a registration statementwithin sixty (60) days of closing the Offering, and make the registrationstatement effective (the “Effective Date”) within one hundred and twenty days(120) of closing the Offering; and grants the common stock, Investor Warrantsand Placement Agent Warrants issued through the Offering “weighted average”anti-dilution protection for subsequent issuances of common stock (orsecurities convertible into common stock) at less than the Common StockPurchase Price.

 

On various dates preceding July 8, 2005, the Companyentered into lock-up agreements (the “Lock-Up Agreements”) with all of theCompany’s officers, members of the board of directors and shareholders thatheld, prior to the Offering, more than 5% of the outstanding shares of theCompany’s common stock.  Specifically,the persons entering Lock-Up Agreements with the Company included: NicholasAnderson, Leonard Bellezza, John (BJ) Lackland, Rick Pulford, RaymondSkiptunis, Steven Strasser, Commerce Energy Group, and Summit Energy VenturesLLC.  The Lock-Up Agreements restrict allof these Persons from selling any shares of common stock for a period of twelvemonths from the Effective Date (the “Lock-Up Period”); provided, however, thatthe Lock-Up Period shall terminate if at any time after the date which isninety days after the Effective Date, the 20-day average of the closing bidprice of the shares of common stock on the OTC Bulletin Board exceeds twohundred percent of the Common Stock Purchase Price of $0.20, or $0.40.

 

8

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**NOTE 6 - SUBSEQUENT EVENTS**

 

OnSeptember 15, 2005, the Board of Directors of the Company unanimously voted torecommend to the shareholders that the Articles of Incorporation be amended toincrease the Company’s authorized shares of Common Stock from 50,000,000 sharesto 100,000,000 shares.  On October 13,2005, a majority of the shareholders voted to amend the Articles ofIncorporation to increase the Company’s authorized shares.

 

OnOctober 17, 2005, the Company settled litigation with the owner of the formeroffice space in Livonia, Michigan.  TheCompany vacated these facilities in 2004. Under the settlement the Company paidits former landlord $50,000 in cash on October 17, 2005, and will pay theformer landlord an additional $50,000 in 18 monthly installments of$2,778.  After application of the Company’saccrued loss contingency reserve, it recognized a loss of approximately $65,000on its September 30, 2005 financial statements.

 

9

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

 

**OVERVIEW**

 

The Registrant generatesrevenues from a single business segment: the design, development, marketing andsale of proprietary solid state electrical components designed to reduce energyconsumption in alternating current induction motors.  The Registrant began generating revenues fromsales of its patented *Power Commander*®line of motor controllers in late 1995.

 

**RESULTSOF OPERATIONS: FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004.**

 

**SPECIALNOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

We may, in discussions of our future plans, objectives and expectedperformance in periodic reports filed by us with the Securities and ExchangeCommission (or documents incorporated by reference therein) and written andoral presentations made by us, include projections or other forward-lookingstatements within the meaning of Section 27A of the Securities Exchange Act of1933 or Section 21E of the Securities Act of 1934, as amended. Such projectionsand forward-looking statements are based on assumptions, which we believe arereasonable but are, by their nature, inherently uncertain. In all cases,results could differ materially from those projected. Some of the importantfactors that could cause actual results to differ from any such projections orother forward-looking statements are discussed below, and in other reportsfiled by us under the Securities Exchange Act of 1934, including under thecaption “Risk Factors” in our Annual Report on Form 10-KSB. Our forward lookingstatements are based on information available to us today, and except asrequired by law, we undertake no obligation to update any forward lookingstatement, whether as a result of new information, future events or otherwise.

 

**REVENUES**

 

Total revenues for thethree months ended September 30, 2005, were approximately $76,000, compared to$65,000 for the three months ended September 30, 2004, an increase of $11,000or 17%. This increase is mainly attributable to an increase in sales inthe elevator and escalator market segment. Sales to a new internationalcustomer totaled approximately $20,000 during the three months ended September30, 2005.  Sales to two new internationaldistributors totaled approximately $1,500 during the three months endedSeptember 30, 2004. Revenue of $18,000 was recognized for a government grantreceived associated with development expenses related to a mediumvoltage product application during the three months ended September 30,2004.  For the three months endingSeptember 30, 2005, there was no revenue from the government agency.

 

Total revenues for thenine months ended September 30, 2005, were approximately $222,000, compared to$219,000 for the nine months ended September 30, 2004, an increase of $3,000 or1%.   This increase is mainlyattributable to an increase in sales in the elevator and escalator marketsegment. Sales to a government agency totaled approximately $50,000, and salesto a new international customer totaled approximately

 

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$20,000 during the ninemonths ended September 30, 2005.  Salesto three international distributors totaled approximately $41,000 during thenine months ended September 30, 2004. Revenue of $30,725 was recognized for agovernment grant received associated with development expenses relatedto a medium voltage product application during the nine months ended September30, 2004.  During 2005, there was nogrant money received.

 

**COSTOF PRODUCT REVENUES**

 

Total cost of productrevenues, which includes material and direct labor, allocated costs, andinventory obsolescence and other write-offs for the three months endedSeptember 30, 2005 were approximately $60,500 compared to $26,000 for the threemonths ended September 30, 2004, an increase of $34,500 or 133%.  As a percentage of product revenues, totalcost of revenues increased to approximately 80% for the three months ended September30, 2005 compared to approximately 56% for the three months ended September 30,2004.  The increase in the costs as apercentage of product revenues was primarily due an increase in the productionof higher costing units in 2005.  Also,allocated costs were approximately $4,400 for the three months ended September30, 2005 compared to $5,300 for the three months ended September 30, 2004, adecrease of $900 or 17%.  As a percentageof product revenues allocated costs were 6% for the three months endedSeptember 30, 2005 compared to 11% for the three months ended September 30,2004.  The allocated costs as apercentage of product revenues decreased as the allocated costs were absorbedby a higher volume of product revenues. Material and labor costs as a percentage of product revenues increasedto 74% for the three months ended September 30, 2005 compared to 44% for thethree months ended September 30, 2004. This increase was largely due tooutsourcing a greater portion of the manufacturing process, resulting in higherdirect labor costs per unit and lower allocated costs as a whole in 2005.

 

Total cost of productrevenues, which includes material and direct labor, allocated costs, andinventory obsolescence and other write-offs for the nine months ended September30, 2005 were approximately $187,000 compared to approximately $160,000 for thenine months ended September 30, 2004, an increase of $27,000 or 17%.  As a percentage of product revenues, totalcosts of product revenues decreased to approximately 84% for the nine monthsended September 30, 2005 compared to approximately 85% for the nine monthsended September 30, 2004.  The decreasein the costs as a percentage of product revenues was primarily due to nocharges to inventory for obsolescence and other write-offs for the nine monthsended September 30, 2005 compared to $30,000 for the nine months endedSeptember 30, 2004, offset by the Company utilizing an outsourced manufacturerfor production in 2005. Also, allocated costs were approximately $19,000 forthe nine months ended September 30, 2005 compared to approximately $42,000 forthe nine months ended September 30, 2004, a decrease of $23,000 or 121%.  As a percentage of product revenue allocatedcosts were 9% for the nine months ended September 30, 2005 compared to 22% forthe nine months ended September 30, 2004. The allocated costs as a percentage of product revenues decreased as theallocated costs were absorbed by a higher volume of product revenues andbecause the Company began the use of a turnkey manufacturer.

 

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**OPERATINGEXPENSES**

 

**Researchand Development Expenses**

 

Research and developmentexpenses were approximately $187,000 for the three months ended September 30,2005, as compared to approximately $82,000 for the three months ended September30, 2004, a $105,000 or a 128% increase.  This increase is mainlyattributable to the Company’s laboratory testing done for further productdevelopment which incurred a charge of $76,000 during the three months endedSeptember 30, 2005.

 

Research and developmentexpenses were approximately $313,000 for the nine months ended September 30,2005, as compared to approximately $291,000 for the nine months ended September30, 2004, a $22,000 or an 8% increase. This increase is mainly attributable tothe Company’s reorganizing and cost reduction program implemented in August andSeptember of 2004, offset by a $76,000 charge during the nine months endedSeptember 30, 2005, related to laboratory testing done for further productdevelopment.

 

**Selling,General and Administrative Expenses**

 

Selling, general andadministrative expenses were approximately $427,000 for the three months endedSeptember 30, 2005, as compared to $378,000 for the three months endedSeptember 30, 2004 an increase of $49,000 or 13%. The increase in selling,general and administrative expenses over the prior year was due primarily to anincrease in payroll and payroll related costs, as well as recruiting fees fornew employees in the third quarter, offset by the elimination of some fixedcosts related to the reduction in workforce and the Company’s decision torestructure its operations in August and September of 2004.

 

Selling, general andadministrative expenses were approximately $1,039,000 for the nine months endedSeptember 30, 2005, as compared to $1,288,000 for the nine months endedSeptember 30, 2004 a decrease of $249,000 or 19%. The decrease in selling,general and administrative expenses over the prior year was due primarily to adecrease in payroll and payroll related costs for the whole year, as well asthe elimination of some fixed costs related to the reduction in workforce andthe Company’s decision to reorganize its operations in August and September of2004.

 

**FinancialCondition, Liquidity, and Capital Resources: For the Nine Months EndedSeptember 30, 2005**

 

Since inception, theRegistrant has financed its operations primarily through the sale of its equitysecurities, debt securities and using available bank lines of credit. As ofSeptember 30, 2005, the Registrant had cash of $1,626,826.

 

Cash used for operatingactivities for the nine months ended September 30, 2005 was $1,510,777 whichconsisted of: a net loss of $1,760,850; less depreciation and amortization of$17,360, amortization of deferred financing costs of $63,982, bad debt expensesof $4,530, amortization of debt discount related to issuance of debt securitiesof $181,726, the settlement of a litigation for $93,853, warrants issued inconnection with the issuance of debt, employment agreements, and consultingfees of $27,549; offset by increases in accounts receivable of $65,165,and  prepaid expenses and other currentassets of $20,916 and decreases in inventory of $25,373, restricted cash of$165,416, accounts payable and accrued expenses of $180,742 and accruedsalaries and payroll taxes of $62,893.

 

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Cash used for operatingactivities for the nine months ended September 30, 2004 was $737,639, whichconsisted of: a net loss of $1,592,001; less depreciation and amortization of$55,510, bad debt expense of $5,493, inventory obsolescence reserve of $29,484,loss on sale of fixed assets of $31,226, decreases in accounts receivable of$14,010, inventory of $40,518, increases in prepaid expenses and other assets of$13,481, accounts payable and accrued expenses of $298,236, customer depositsof $6,983 and  accrued salaries andpayroll taxes of $386,383.

 

Cash used in investingactivities for the nine months ended September 30, 2005 was $1,373 comparedwith $21,576 in the nine months ended September 30, 2004.  The amounts forboth years consisted of the purchase of fixed assets.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2005 was $2,746,505which consisted of: proceeds from the issuance of debt securities and notespayable of $125,000 and $300,000, respectively; proceeds from the issuance ofequity securities of $2,741,378, partially offset by repayments of loans toformer officers of $56,416 and the conversion of a note payable to equity of$300,000, and an increase in deferred financing costs of $63,457.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2004 was $474,800,which primarily consisted of proceeds of $174,800 from the issuance of equitysecurities related to the Company’s Regulation “S” stock offering and $300,000of proceeds from the Summit Energy Ventures line of credit. Net cash providedby financing activities for the nine months ended September 30, 2004 was$474,800, which primarily consisted of proceeds of $184,800 from the issuanceof equity securities related to the Company’s Reg “S” stock offering and$300,000 of proceeds from the Summit Energy Ventures line of credit.  Thiswas partially offset by payments to a former officer of $10,000.

 

The Registrant expects toexperience growth in its operating expenses, particularly in research anddevelopment and selling, general and administrative expenses, for theforeseeable future in order to execute its business strategy. As a result, theRegistrant anticipates that operating expenses will constitute a material useof any cash resources.

 

Since capital resourcesare insufficient to satisfy the Registrant’s liquidity requirements, managementintends to sell additional equity or debt securities or obtain debtfinancing.   The Registrant believesit can raise additional funds through private placements of equity.  However, there are no assurances that sufficientcapital can be raised.

 

**CashRequirements and Need for Additional Funds**

 

The Registrantanticipates a substantial need for cash to fund its working capitalrequirements.  In accordance with theRegistrant’s prepared expansion plan, it is the opinion of management thatapproximately $2.0 million will be required to cover operating expenses,including, but not limited to, marketing, sales and operations during the next twelvemonths. On July 8, 2005 and on August 31, 2005 the Company completed, in twophases, a stock offering for approximately $2.9 million in gross proceeds (seeNote 5 to the Financial Statements), which netted approximately $2.2 million.

 

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**ITEM 3. CONTROLS AND PROCEDURES**

 

**(a) Evaluation of Disclosure Controls and Procedures.**  Under the supervision and with the participationof its Chief Executive Officer, and Chief Operating Officer and Chief FinancialOfficer, management has evaluated the effectiveness of the Company’s disclosurecontrols and procedures as of the end of the period covered by this reportpursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (theExchange Act).  Based on that evaluation,the Chief Executive Officer, and Chief Operating Officer and Chief FinancialOfficer 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 thatinformation required to be disclosed in the Company’s Exchange Act reports is(1) recorded, processed, summarized and reported in a timely manner, and (2)accumulated and communicated to the Company’s management, including its ChiefExecutive Officer, and Chief Operating Officer and Chief Financial Officer, asappropriate to allow timely decisions regarding required disclosure.

 

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

 

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**PART II —OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

The Registrant has recently settled litigation withthe owner of the former office space in Livonia, Michigan.  The Registrant vacated the office space in2004. Under the settlement the Registrant has paid their former landlord$50,000 in cash on October 17, 2005, and will pay the former landlord anadditional $50,000 in 18 monthly installments of $2,778.

 

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

 

**Recent Sales of Unregistered Securities**

 

Thefollowing details several recent sales of unregistered securities theRegistrant made to Summit Energy Ventures, LLC, a private equity firmspecializing in energy related technologies owned by the Chief ExecutiveOfficer, and Chief Operating Officer and Chief Financial Officer (“Summit”) andCommonwealth Energy Corporation. All of the sales were exempt from theregistration requirements of the Securities Act pursuant to Section 4(2) of theSecurities Act.

 

OnApril 28, 2005, the Registrant issued 1,204,819 shares of Series A-1Convertible Preferred Stock, convertible into 1,000,000 shares of Common Stock,and Warrants to purchase 500,000 shares of Common Stock to Summit for anaggregate purchase price of $200,000 in cash. The requisite percentage of current holders consented and waived theanti-dilution provisions.

 

OnApril 28, 2005, the Registrant issued 180,723 shares of Series A-1 stock,convertible into 150,000 shares of Common Stock, and Warrants to purchase75,000 shares of Common Stock, to Commerce Energy Group, Inc., the parent ofCommonwealth Energy Corporation, in consideration of Commerce Energy Group’scancellation of a license agreement with the Registrant.  The requisite percentage of current holdersconsented and waived the anti-dilution provisions.

 

OnJuly 8, 2005, the Registrant issued 3,000,000 shares of Common Stock and1,500,000 Stock Purchase Warrants to Summit for $300,000 in cash and theconversion of a $300,000 note payable.

 

OnJuly 8, 2005, the Registrant converted all 4,714,279 outstanding shares of its Series A-1 Convertible PreferredStock into 3,918,848 shares of Common Stock owned by Summit and CommonwealthEnergy Corporation.

 

**ITEM 3.DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None

 

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**ITEM 5. OTHER INFORMATION**

 

None

 

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

 

(a) Exhibits

 
| **Number** | ** ** | **Description of Document**                                                                                                                                                                                         | ** ** | **Location**   |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------|
|       |       |                                                                                                                                                                                                                |       |           |
| 31.1       |       | Certification by the Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                            |       | Filed herewith |
| 31.2       |       | Certification by the Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                            |       | Filed herewith |
| 32.1       |       | Certification by the Chief Executive Officer  pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code  (18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002. |       | Filed herewith |
| 32.2       |       | Certification by the Chief Financial Officer  pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code  (18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002. |       | Filed herewith |

 

(b) Reports on Form 8-K.

 

On July 13, 2005, theCompany filed a current report on Form 8-K reporting an Item 8 event.  The Item 8 event involved the Companyentering into employment contracts with its Chief Executive Officer, ChiefFinancial and Operating Officer, and Chief Technology Officer.

 

On July 15, 2005, theCompany filed a current report on Form 8-K reporting an Item 1 and an Item 3event.  The Item 1 event involved theCompany entering into a material definitive agreement in connection with theissuance of 12,150,000 shares of Common Stock. The Item 3 event involved an unregistered sale of equity securities inconnection with the issuance of 12,150,000 shares of Common Stock and 6,075,000warrants.

 

On September 8, 2005, theCompany filed a current report of Form 8-K reporting an Item 3 event.  The Item 3 event involved an unregisteredsale of equity securities in connection with the issuance of 2,350,000 sharesof Common Stock and 1,175,000 warrants.

 

On October 11, 2005, theCompany filed a current report on Form 8-K reporting an Item 5 event.  The Item 5 event involved the election of anew Director to the Board of Directors of the Company.

 

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**SIGNATURES**

 

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

 
|                                | POWER  EFFICIENCY CORPORATION |                                                                                                    |
|-------------------------------------|-------------------------------|---------------------------------------------------------------------------------------------------------|
|                                | (Registrant)                  |                                                                                                    |
|                                |                          |                                                                                                    |
|                                |                          |                                                                                                    |
| Date:  November  11, 2005 | By:                      | /s/   Steven Strasser                                                                              |   |
|                                |                          | Chief  Executive Officer                                                                                |   |
|                                |                          |                                                                                                    |
|                                |                          |                                                                                                    |
| Date:  November  11, 2005 | By:                      | /s/   John Lackland                                                                                |   |
|                                |                          | Chief  Operating Officer and Chief Financial Officer (Principal Financial and  Accounting Officer) |   |

 

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