POWER EFFICIENCY CORP - 10-K Annual Report

Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-KSB

	Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the fiscal year ended December 31, 2002

	Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the transition period from ____________ to ____________

Commission File Number: 000-31805

Power Efficiency Corporation
(Name of Small Business Issuer in its Charter)

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

4220 Varsity Drive, Suite E
Ann Arbor, Michigan		48108
(Address of Principal Executive Offices)		(Zip Code)

(734) 975-9111
(Issuer’s Telephone Number, Including Area Code)

Securities Registered under Section 12(g) of the Exchange Act:

Common Stock, $.001 Par Value
(Title of Class)

Check whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such 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 checked box

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. checked box

The issuer’s revenues for the year ended December 31, 2002, were $538,819.

As of March 21, 2003, the aggregate market value of the Common Stock held by non-affiliates of the issuer was approximately $6,851,645. This amount is based on the average of the bid and asked price of $1.04 per share for the registrant’s stock as of such date.

On March 21, 2003 there were 6,580,620 shares of the registrant’s Common Stock outstanding.

The Registrant has incorporated into Part III of Form 10-K by reference portions of its Proxy Statement for its 2003 Annual Meeting of Shareholders.

Transitional Small Business Disclosure Format (check one): Yes checked box

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 Registrant’s business objectives and strategy. Such forward-looking statements are based on current expectations, management beliefs, certain assumptions made by the Registrant’s management, and estimates and projections about the Registrant’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. The PSLRA does not apply to initial public offerings.

Factors that could cause actual events or results to differ materially include, but are not limited to, the following: continued market acceptance of the Registrant’s line of Power Commander® products; the Registrant’s ability to expand and/or modify its line of Power Commander® products on an ongoing basis; general demand for the Registrant’s products, intense competition from other developers, manufacturers and/or marketers of energy reduction and/or power saving products; the Registrant’s negative net tangible book value; delays or errors in the Registrant’s ability to meet customer demand and deliver Power Commander® products on a timely basis; the Registrant’s lack of working capital; the Registrant’s need to relocate and/or upgrade its facilities; changes in laws and regulations affecting the Registrant 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; local and global uncertainties created by the terrorist acts of September 11 and the current war against terrorism; 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 Registrant 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 Registrant files from time to time with the Securities and Exchange Commission (the “SEC”), particularly Annual Reports on Form 10-KSB, Quarterly Reports on Form 10-QSB and any Current Reports on Form 8-K.

GLOSSARY OF TERMS

Set forth below are technical terms used in the discussion in this document and explanations of the meanings of those terms.

Alternating Current (AC)		A type of electrical current, the direction of which is reversed at regular intervals or cycles; in the U.S. the standard is 120 reversals or 60 cycles per second; typically abbreviated as AC.

Ampere (amp)		A unit of measure for an electrical current; the amount of current that flows in a circuit; abbreviated as amp.

Apparent Power (KVA)		The product of volts times amperes in an electric current.

Audit (Energy)		The process of determining energy consumption, by various techniques, of a building or facility.

Current (Electrical)		The flow of electrical energy (electricity) in a conductor, measured in amperes.

Cycle		In an alternating current, the current goes from zero potential (or voltage) to a maximum in one direction, back to zero, and then to a maximum potential (or voltage) in the other direction. The number of complete cycles per second determines the current frequency; in the U.S. the standard for alternating current is 60 cycles.

Efficiency		Efficiency is the ratio of work (or energy) output to work (or energy) input, and cannot exceed 100 percent.

Energy		The capability of doing work.

Hertz		A measure of the number of cycles or wavelengths of electrical energy per second; U.S. electricity supply has a standard frequency of 60 hertz.

Horsepower (HP)		A unit for measuring the power of motors or the rate of doing work. One horsepower equals 33,000 foot-pounds of work per minute or 746 watts.

Induction		The production of an electric current in a conductor by the variation of a magnetic field in its vicinity.

Induction Motor		The simplest and most rugged electric motor, it consists of a wound starter and a rotor assembly. The AC induction motor is so named because the electric current flowing in its secondary member (the rotor) is induced by the alternating current flowing in its primary member (starter). The power supply is connected only to the starter. The combined electromagnetic efforts of the two currents produce the force to create rotation.

Inrush Current		The current that flows at the instant of connection of a motor to the power source. Usually expressed as a multiple of motor full-load current.

Kilowatt (kW)		A standard unit of electrical power equal to one thousand watts.

Load		The demand on an energy producing system. The energy consumption or requirement of a piece or group of equipment.

Losses (Energy)		A general term applied to the energy that is converted to a form that cannot be effectively used (lost) during the operation of an energy producing, conducting, or consuming system.

Motor		A machine supplied with external energy that is converted into force and/or motion.

Motor Speed		The number of revolutions that the motor turns in a given time period (i.e. revolutions per minute, or rpm).

Power		The rate at which work is done, typically measured in Watts or horsepower.

Power Factor		The ratio of watts to volt-amperes of an AC electric circuit.

Soft-start		Soft-start is the regulation of the supply voltage from an initial low value to full voltage during the starting process.

Staring Torque		The torque produced by a motor at rest when power is applied. For an AC machine, this is the locked-rotor torque.

Three-phase Current		Alternating current in which three separate pulses are present, identical in frequency and voltage, but separated 120 degrees in phase.

Torque (Motor)		The rotating force provided by a motor. The units of torque may be expressed as pound-foot, pound-inch (English system), or newton-meter (metric system).

Torque (Starting)		This torque is what is available to initially get the load moving and begin its acceleration.

Total Harmonic Distortion		The measure of closeness in shape between a waveform and its fundamental component.

Transformer		An electromagnetic device that changes the voltage of alternating current electricity; it consists of an induction coil having a primary and secondary winding and a closed iron core.

Voltage		The amount of electromotive force, measured in volts, that exists between two points.

Watt		The amount of power required maintaining a current of one ampere at a pressure of one volt when the two are in phase with each other. One horsepower is equal to 746 watts.

Wattmeter		A device for measuring power consumption.

PART I

Item 1.

Description of Business

(a)

Business Development

Formation

Power Efficiency Corporation (the “Registrant” or the “Company”) was incorporated in Delaware on October 19, 1994. From inception through 1997, the Registrant was a development stage entity that sought to become engaged in the design, development, marketing and sale of proprietary solid state electrical components designed to effectively reduce energy consumption in alternating current induction motors. Alternating current induction motors are commonly found in industrial and commercial facilities throughout the world.

2000 Acquisition/Private Placement.

On August 7, 2000, the Registrant executed an Asset Purchase Agreement (the “Asset Agreement”) with Performance Control, L.L.C., a Michigan limited liability company and formerly the largest distributor of the Registrant’s products (“Percon”). Percon was formed on February 15, 1996. Pursuant to the terms and conditions of the Asset Agreement, the Registrant acquired Percon’s (i) contracts; (ii) inventory; (iii) state and municipal permits, certificates, registrations, licenses and authorizations; (iv) intellectual property, including the name “Performance Control”; (v) goodwill; (vi) accounts receivable; (vii) prepaid expenses; (viii) furniture, fixtures and equipment; (ix) customer lists; and (x) Internet web site located at www.performancecontrol.com (collectively the “Assets”) in consideration for an aggregate of 1,112,245 newly issued shares of the Registrant’s Common Stock, $.001 par value per share. The Registrant also assumed $438,888 of Percon’s liabilities.

The closing of the Registrant’s purchase of the Percon assets was conditioned upon the sale of a minimum of 12 units in the Registrant’s May 16, 2000 private offering of a minimum of 12 ($300,000) units and a maximum of 40 ($1,000,000) units pursuant to the provisions of Rule 506 of Regulation D under the Securities Act of 1933, as amended (the “Securities Act”). Each unit consisted of 25,000 shares of the Registrant’s Common Stock, $.001 par value per share, offered at $1.00 per share; and a five-year warrant to purchase 25,000 additional shares of the Registrant’s Common Stock at an exercise price of $3.00 per share during the first year, $4.00 per share during the second year and $5.00 per share thereafter. As part of the transaction with Percon, the parties entered into a stockholders’ agreement providing the parties with certain rights and obligations. This agreement was subsequently amended in 2002 when Summit Energy Ventures, LLC purchased securities from the Registrant in a private placement. For a description of the Summit transaction and of the provisions in the stockholders’ agreement, see Part II, Item 5, “Recent Sales of Unregistered Securities.”

(b)

Business of the Registrant

The Registrant’s Principal Products

In 1995, the Registrant commenced the sale of the Power Commander®, its principal and proprietary product that reduces energy consumption in alternating current induction motors in industrial applications. In addition, the Power Commander® extends motor life, minimizes maintenance, results in cooler running, reduces stress and strain on the motor, and reduces stress and strain on accompanying electrical and mechanical systems. Technology and circuitry included in the Registrant’s Power Commander® is the subject of a United States Patent granted in 1998. The Registrant offers the Power Commander® in two versions, each of which is a distinctly different product having different applications. These two products are:

	•	the Three-Phase Power Commander® used in industrial and commercial applications; and

	•	the Single-Phase Power Commander® is also used in industrial and commercial applications and is currently in research and development for use in consumer applications such as home appliances and the like.

The Registrant’s motor starter product is designed to soft start a motor, save energy, and protect and conserve the motor. It also has the capacity to act as a remote-switching device.

The Registrant offers the Power Commander® in a Three-Phase version and a Single-Phase version. The Registrant’s marketing efforts have been initially focused on the Three-Phase Power Commander®. Both versions of the Power Commander® reduce energy consumption on electrical equipment by electronically sensing and controlling the amount of energy the motor consumes. A motor with a Power Commander® installed only uses the energy it needs to perform its work task, thereby increasing its efficiency. The result is a reduction of energy consumption of up to 15% to 35% in those applications, which do not always run at peak load levels.

The Registrant’s management believes that the Power Commander® line offers certain advantages over competing products for the following reasons:

	•	The Power Commander® is the result of field and laboratory engineering refinements undertaken since 1994. These refinements enable the Power Commander® to offer a control system which measures and monitors key motor operating conditions and adapts motor operating parameters during rapid changes in motor load, all without excessive vibration, synchronization problems or other material adverse effects to the motor or surrounding electrical and mechanical systems.

	•	Energy savings and motor efficiencies were verified through tests of the Power Commander® performed by three independent laboratories. Oak Ridge National Laboratory tested the Power Commander® and concluded that “significant energy savings due to lower electrical power demand can clearly be obtained in medium-sized and especially large-sized motor applications where the motor is frequently operating with no load.” Oak Ridge’s conclusions were based on tests that examined energy savings, motor temperature, and soft start impact.

	•	Another independent laboratory at Oregon State University determined that the Power Commander® converted electrical energy into mechanical energy at a more efficient rate than a motor without the unit. The test compared energy consumption and torque on a 15HP motor with and without the unit installed.

	•	Finally, Medsker Electric, Inc., an independent electric motor repair and test laboratory, performed a series of inrush current and energy savings tests on the Power Commander®. The tests compared the Registrant’s product to the products of three competitors. In its conclusions, Medsker stated that the Registrant’s Power Commander® “exhibited twice the energy savings of the next nearest competitor.” In addition, Medsker concluded that the Power Commander® “exhibited the best soft-start performance, reducing the motor inrush current by 71%.” Finally, Medsker concluded that the Power Commander® “was the simplest to install and test, and was the best performer in terms of energy savings and inrush current reduction.”

	•	In addition to the tests performed by independent laboratories, the Power Commander® was subjected to a performance case study by one of the Registrant’s customers, Otis Elevator Company. In the Otis Elevator case study, the Power Commander® resulted in reduced energy consumption and lower operating temperatures. The case study examined the effects and energy savings obtained with a Power Commander® installed on a 10 horsepower AC induction motor operating a single width, single level escalator.

Three-Phase Power Commander®

The initial market for the Three-Phase Power Commander® is the elevator and escalator industry, although the Registrant is marketing this product to other industries such as the plastics manufacturing, petroleum and automotive industries. Domestic sales in the elevator and escalator market were $6.5 billion in 2000. Based upon trade journals (e.g. Elevator World Source Book 2001-2002), there are approximately 699,725 elevators and 36,400 escalators currently in operation in North America alone. Additionally, approximately 24,725 new elevators and 1,400 new escalators, respectively, are installed annually in the domestic market. Each existing installation is a potential candidate for the retrofit of the Three-Phase Power Commander®.

Various other markets such as conveyor systems, machine tools, mining equipment, crude oil pumps, weaving machines, etc., are believed to be viable target markets for the Three-Phase Power Commander® and the Registrant is seeking to build an Original Equipment Manufacturer (“OEM”) and distributor base to address these markets.

Single-Phase Power Commander®

Like the Registrant’s Three-Phase Power Commander® described above, the Registrant’s Single-Phase Power Commander® reduces energy consumption in electrical equipment by sensing and controlling the amount of energy the motor consumes. Most motors commonly used in-home appliances and other consumer goods are Single-Phase motors.

Since the Single-Phase Power Commander® is usable in a broad variety of contexts and can be installed when the motor is assembled with little effort and expense, it is a product suitable for installation at the OEM level or large volume sales and installation. Consequently, the Registrant’s marketing plan for the Single-Phase Power Commander® is to identify the major OEMs that can best utilize the Single-Phase Power Commander®.

Registrant’s Motor Starter Product

The Registrant’s motor starter product is designed to soft start a motor, which saves energy and protects the motor, and has the capacity to act as a remote-switching device. The Registrant had hoped to release this product in fiscal 2002 but the product is still under development. The expected release date of this product is uncertain at this time.

Marketing and Sales

The Registrant’s marketing efforts for the Power Commander® have been concentrated in several industries in which the Registrant’s principal stockholders have significant experience. These areas include the elevator and escalator industry; national electrical supply houses; large real estate property management companies; the oilfield supply industry; and to a lesser extent, public transportation systems. From inception through December 31, 2002, a total of 4,471 of the Registrant’s motor controllers were sold to more than 120 customers located throughout the United States and Asia under the following brands: Performance Controller™, Power Commander®, Energy Master, Current Control, and Ecostart. Customer industry profiles include retail outlets, public transportation, hotels, manufacturers and federal government facilities. This unit total includes sales made by Percon’s OEMs and distributors prior to selling its assets to the Registrant.

As the Registrant’s operations are scaled up and revenues from the sale of the Power Commander® grow, the Registrant intends to simultaneously (i) market the Power Commander® through OEMs to other compatible industries such as conveyor and line production systems, machine tools and other industrial applications, and (ii) develop and market its motor starter product line.

The Registrant is a party to one material contract for the sale of Power Commander® products, with two other contracts pending renewal. The first contract is a letter agreement and open master purchase order with Otis Elevator Company, the world leader in elevator sales, for the sale of Power Commander® brand devices containing a safety circuit exclusive to Otis. The master purchase order was executed on May 13, 2002 for purchases up to $100,000, and the Letter Agreement commenced June 1, 2002 and will expire December 31, 2004.

Pending renewal is an annual contract with KONE, Inc., a major escalator and elevator manufacturer and service provider. The contract was executed on December 1, 1998, and was renewed on August 21, 2001, extending the contract until December 1, 2002. It is a requirements contract and covers the sale of motor controllers manufactured under the brand name Ecostart. The Ecostart brand name is exclusive to KONE and contains a safety circuit designed specially for KONE. The Registrant hopes to negotiate and execute a new agreement with this customer in the near future.

Also pending renewal is an annual contract with Schindler Elevator Corporation (which acquired Millar Elevator Corporation). The contract was executed on August 17, 2000, whereby Schindler agreed to purchase Performance Controller^SM motor controllers under the brand name “Current Control.” The contract was renewed on October 5, 2001, extending the contract until September 1, 2002. The Registrant hopes to negotiate and execute a new agreement with this customer in the near future.

Manufacturing

The Registrant has an arrangement with a leading manufacturer in the electronics industry, Q.C. Corporation d/b/a System Controls. System Controls manufactures units for the Registrant on an as-needed basis. Under the arrangement, the Registrant issues a purchase order to System Controls that outlines, among other things, the number of units to be manufactured and the price per unit. System Controls is under no obligation to accept the order and the Registrant is under no obligation to use System Controls for its manufacturing needs. Management believes the arrangement between the Registrant and

System Controls has been mutually beneficial to both and expects that the relationship will continue. System Controls’ production capacity is approximately 1,000 units per month.

Additionally, the Registrant is actively seeking to enter into agreements with additional manufacturers. The Registrant leases space in Ann Arbor, Michigan, where it performs activities such as component assembly, quality assurance, quality control and packaging.

The Registrant has completed the pre-production testing of compact, low cost electronic modules designed to replace other more costly components used in the manufacture of certain Power Commander® models and eliminate several labor-intensive assembly steps. Total per unit cost savings (component cost savings and labor cost savings) are estimated to be approximately 30% of the production cost by current methods.

Product cost-reduction efforts are, and will remain, an objective of the Registrant. One key element of the program includes an aggressive manufacturing and engineering effort to reduce production cycle times as well as material and processing costs. A second element of the program is to out-source production operations. The Registrant outsources the assembly of printed circuit boards to qualified suppliers with automated assembly and test equipment, which reduces costs and ensures quality. As the product volumes increase, the Registrant expects to recognize favorable purchasing economies, increased labor efficiencies and improved overhead absorption. In addition, the Registrant is continuing to evaluate additional domestic, Canadian and offshore sources of contract manufacturing in order to reduce production costs further.

Competition

The principal competitive factors in the Registrant’s markets include innovative product design, product quality, product performance, utility rebate acceptance, established customer relationships, name recognition, distribution and price.

Three-Phase Competition. Although the Registrant has not conducted any formal market study, the Registrant believes its Three-Phase Power Commander® has the following competitive advantages:

	•	The Power Commander® is the only device management is aware of that combines soft start features with energy savings features in a single integrated unit that achieves energy savings levels of up to 15% to 35%;

	•	The Power Commander® analog circuitry is proprietary and protected by a patent; and

	•	Energy saving motor controllers claimed to be competitive with the Power Commander® (i.e., Fairford, Power Boss and Power Planner) utilize technologies inferior to the Registrant’s technology because (i) their products achieve lower levels of energy savings in comparable applications compared to the Power Commander® (see Part I, Item 1 “Description of Business,” for a description of the independent tests performed on the Registrant’s products); and (ii) their digital design produces extensive harmonic distortion.

Single-Phase Competition. There have been several companies that have, with different technologies, attempted to exploit this market due to the enormous opportunity in single-phase motor applications. These products include “Green Plug” (voltage clamping), “Power Planner” (digital microchip) and “Econelectric” (power factor control).

High Efficiency Motors. Insofar as high efficiency motor replacement is concerned, management believes that the energy savings gain attributable to high efficiency motors is materially lower than that of the Power Commander®. In addition, the in-rush amperage needed to start an energy efficient motor is many times higher than that needed to start a conventional motor. This factor is made worse because the purchase of a new motor does not provide a soft starting capability without the purchase of a separate soft start device.

Motor Starter Competition. The Registrant believes that expected competition in the motor starter market will be more intense than that for the Power Commander® because:

	•	The potential market for the Registrant’s motor starter product is much larger than that for motor controllers in general and the Power Commander® in particular;

	•	Competitors in the motor starter field are more numerous and generally much larger compared to competitors in the motor controller field; and

	•	The motor starter is a staple product type and is currently being sold by nearly all companies in the electrical component business.

However, Management believes it has a competitive advantage in this market because the Power Commander® is the only device management is aware of that combines soft start features with energy savings features in a single integrated unit that achieves energy savings levels of up to 15% to 35%.

Source of Supply and Availability of Raw Materials

The Power Commander® motor controller and the Registrant’s motor starter product have both been designed to use standard, off-the-shelf, easily acquired components. Such components are basic items that are readily available worldwide at competitive prices. They come in standard and miniature versions and offer the Registrant large latitude in product design. Both the Power Commander® motor controller and the motor starter use a combination of components. Although the Registrant believes that most of the key components required for the production of its products are currently available in sufficient production quantities from multiple sources, there can be no assurance that they will remain so readily available.

Customers

The Registrant currently does business with approximately 30 customers. Of this number, four, including Otis Elevator Company (Division of United Technologies), KONE, Inc., Schindler Elevator, and ThyssenKrupp Elevator, presently account for approximately 76% of the Registrant’s gross revenues. In light of the Registrant’s intentions to focus its business on OEMs in the elevator, oil field pump and manufacturing industries, the Registrant may be deemed to be and continue to be dependent upon a small number of customers. Accordingly, the loss of one or more of these customers is likely to have a material adverse effect upon the Registrant’s business.

Patents and Proprietary Rights

The Registrant currently relies on a combination of trade secrets, non-disclosure agreements and a patent to establish and protect its proprietary rights in its products. There can be no assurance that these mechanisms will provide the Registrant with any competitive advantages. Furthermore, there can be no assurance that others will not independently develop similar technologies, or duplicate or “reverse engineer” the proprietary aspects of the Registrant’s technology.

The Registrant has one U.S. patent issued with respect to its products. The “Balanced and Synchronized Phase Detector for an AC Induction Motor Controller,” No. 5,821,726, was issued on October 13, 1998 and expires in 2017. This patent covers improvements to the technology under the NASA License Agreement (described below), which were developed by the Registrant. Management believes this patent protects the Registrant’s intellectual property position beyond the expiration of the NASA License Agreement because:

	•	the circuitry covered by the Registrant’s patent more effectively reduces the motor vibration; and

	•	the circuitry eliminates most of the balance and synchronization problems that are created by other energy saving motor controllers, including those that would eventually use the licensed NASA technology upon the expiration of the underlying NASA patents.

The Registrant has additional proprietary technology being assessed for patent filing.

NASA License Agreement

The Registrant had been the exclusive United States licensee of certain Power Factor Controller Technology owned by the United States of America, as represented by NASA. This license agreement covered the USA and its territories and possessions and did not require the Registrant to pay royalties to NASA in connection with the Registrant’s sale of products employing technology utilizing the licensed patents. The Registrant’s rights under the license agreement were non-transferable and were not to be sublicensed without NASA’s consent. The license agreement terminated on December 16, 2002 with the expiration of all of the licensed patents.

The Registrant believes that its products and other proprietary rights do not infringe any proprietary rights known to be possessed by third parties. There can be no assurance, however, that third parties will not assert infringement claims in the future, the defense costs of which could be substantial.

The Registrant has obtained U.S. Trademark registration of the Power Commander® mark.

Government Regulation

The Registrant is not required to be certified by any government agencies. However, the Registrant’s products are manufactured to comply with specific Underwriters’ Laboratory codes that meet national safety standards. Presently, the Registrant’s products comply with UL 508 Industrial Control Equipment and the Registrant has also received certification meeting CSA (Canadian Standards Association) CSA-B44.1-96/ASME-17.5-1996 Elevator and Escalator Electrical Equipment. The Department of Commerce does not require the Registrant’s technology to be certified for export. The Registrant’s industrial code is 421610 and the SIC code is 5063.

Deregulation of Electrical Energy

Sales of the Registrant’s product are not dependant on continued deregulation of the electrical energy market as the Registrant’s product can be sold in regulated and deregulated markets.

Research and Development

The Registrant intends to continue its research and development effort to introduce new products based on the Power Commander® solid-state technology. Towards this end, the Registrant spent $271,634 and $242,243 in fiscal years 2002 and 2001, respectively, on research and development activities, virtually none of which was borne by customers. A major focus of the Registrant’s foreseeable research and development activities will be on consumer applications for the single-phase unit. The Registrant intends to limit its research and development activities on secondary products for Three-Phase industrial and commercial AC induction motors. Two of these products are (i) a soft starting motor starter (without energy saving features) to compete with existing transformer and other electro-mechanical type motor starters; and (ii) a high voltage energy saving motor controller for motors ranging in sizes from 2000 to 6000 volts.

Effect of Environmental Regulations

The Registrant is not aware of any federal, state, or local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment with which compliance by the Registrant has had, or is expected to have, a material effect upon the capital expenditures, earnings, or competitive position of the Registrant.

Employees

At the date of this document, the Registrant employs 12 people on a full time basis. Of this number, one person is engaged in executive management and finance, one in operations management, three in sales and marketing, two in research and development, one in legal counsel, three in engineering and production, and one in clerical and reception. At such time as business conditions dictate, the Registrant expects to hire additional personnel for, among other things, increased production, marketing and sales. The Registrant has no collective bargaining agreements and considers its relationship with its employees to be good. The Registrant utilizes consultants in the areas of electrical and mechanical engineering, manufacturing engineering, and financing and strategy on an ongoing basis.

RISK FACTORS

Limited Capitalization

As of the date of this document, the Registrant continues to have limited working capital and will be dependent upon additional financing to meet its capital needs. There can be no assurance that any additional financing will be available on acceptable terms, if at all. The Registrant needs additional capital to expand its operations and fully implement its business plan.

Limited Operating History, Manufacturing and Distribution Arrangements

To date, and principally attributable to a lack of working capital, the Registrant’s operations have been limited in scale. Although the Registrant has an arrangement with an automated production facility, has established relationships with suppliers, and received contracts for its products, the Registrant may experience difficulties in production scale-up, inventory management, product distribution and obtaining and maintaining working capital until such time as the Registrant’s operations have been scaled-up to normal commercial levels. There can be no assurance that the Registrant will operate profitably.

Registrant’s License From NASA Has Expired

The basic technology upon which the Registrant’s products are based is derived from a patent license agreement by and between the Registrant and NASA, which expired on December 16, 2002. The license expired upon expiration of NASA’s underlying patents, at which time anyone, including the Registrant, became free to use the underlying NASA technology. The Registrant has also made certain improvements to the basic technology covered by the NASA license, which may place the Registrant in a competitively superior position. No assurance can be given, however, that others will not seek to improve the basic technology in a manner similar to that of the Registrant.

Arbitration with Former CEO

The Registrant is involved with certain claims and counterclaims related to arbitration with its former CEO. The claim was filed by the former CEO on October 10, 2002 and is being administrated by the East Providence, Rhode Island office of the American Arbitration Association. The former CEO is claiming the Registrant owes him, and is seeking to recover, approximately $528,659. The amount of his claim is comprised of (i) $116,039 for unpaid salary and expenses, and (ii) $412,620 for a payment owed to him in the case of a change of control of the Registrant. The Registrant has recorded $102,401 at December 31, 2002, related to the unpaid salary and expenses but has not accrued an amount related to the other claims. The Registrant is currently defending these claims.

Supplier Dependence

Although the Registrant believes that most of the key components required for the production of its products are currently available in sufficient production quantities from multiple sources, there can be no assurance that they will remain so readily available. It is possible that other components required in the future may necessitate custom fabrication in accordance with specifications developed or to be developed by the Registrant. Also, in the event that the Registrant, or its contract manufacturer, as applicable, is unable to develop or acquire components in a timely fashion, the Registrant’s ability to achieve production yields, revenues and net income would be adversely affected.

Sales and Marketing Risks

The Registrant’s products are currently distributed primarily through OEMs. The Registrant’s future growth and profitability will depend upon the successful development of business relationships with additional OEMs and upon their ability to penetrate the market with the Registrant’s products.

Competition; Rapid Technological Change

The Registrant competes against a number of companies, many of which have longer operating histories, established markets and far greater financial, advertising, research and development, manufacturing, marketing, personnel and other resources than the Registrant currently has or may reasonably be expected to have in the foreseeable future. This competition may have an adverse effect on the ability of the Registrant to expand its operations or operate profitability. The motor control industry is highly competitive and characterized by rapid technological change. The Registrant’s future performance will depend in large part upon its ability to become and remain competitive and to develop, manufacture and market acceptable products in these markets. Competitive pressures may necessitate price reductions, which can adversely affect revenues and profits. If the Registrant is not competitive in its ongoing research and development efforts, its products may become obsolete, or be priced above competitive levels. Although management believes that, based upon their performance and price, the Registrant’s products are attractive to customers; there can be no assurance that competitors will not introduce comparable or technologically superior products, which are priced more favorably than the Registrant’s products.

Retail Price of Electrical Energy

A customer’s decision to purchase the Power Commander® is primarily driven by the payback on the investment resulting from the increased energy savings. Although management believes that current retail energy prices support an attractive return on investment for the Registrant’s products, there can be no assurances that future retail pricing of electrical energy will remain at such levels.

No Cash Dividends on Common Stock

The Registrant has not paid or declared any dividends on its Common Stock and does not anticipate paying or declaring any cash dividends on its Common Stock in the foreseeable future.

Possible Resales under Rule 144

Of the 6,580,620 shares of the Registrants Common Stock outstanding on March 21, 2003, 3,222,502 shares are freely trading in the market place (the “Free Trading Shares”). The Free Trading Shares are comprised mostly of shares that were originally issued to officers, directors and 10% shareholders (the “Affiliates”) of the Registrant, which shares were, over time, resold pursuant to Rule 144, as set forth below.

The remaining 3,358,118 shares of the Registrant’s Common Stock outstanding are restricted securities as defined in Rule 144 under the Securities Act and under certain circumstances may be resold without registration pursuant to Rule 144. Approximately 7,500 shares of the restricted securities are held by non-Affiliates.

In addition, the Registrant has approximately 949,000 Common Stock purchase warrants outstanding and has approximately 3,433,640 Common Stock options outstanding. Neither the granting of options nor the issuance of warrants have been registered under the Securities Act, but may, under certain circumstances, be available for public sale in the open market pursuant to Rule 144, subject to certain limitations.

In general, under Rule 144, a person (or persons whose shares are aggregated) who has satisfied a one-year holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of Common Stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitation, by a person who is not an Affiliate, as such term is defined in Rule 144(a)(1), of the Registrant and who has satisfied a two-year holding period. Any substantial sale of the Registrant’s Common Stock pursuant to Rule 144 may have an adverse effect on the market price of the Registrant’s shares.

Common Stock Price Volatility.

Since 1996, the Company’s Common Stock has traded in OTCBB under the symbol “PREF”. There can be no assurance that a regular market for the Company’s Common Stock will be sustained. The OTCBB offers less trading liquidity than NASDAQ. Quotes for securities traded on the OTCBB are not as widely available in newspapers as are those for NASDAQ. Therefore, this lack of readily available price information may impair the ability of holders of Common Stock to resell their securities. The trading prices of the Common Stock could be subject to wide fluctuations in response to quarterly variations in the Company’s operating results, announcements by the Company or others, developments affecting the Company, or other events or factors. In addition, the stock market has experienced extreme price and volume fluctuations in recent years. These fluctuations have had a substantial effect on the market price for many companies, often unrelated to the operating performance of such companies, and may adversely affect the market price for the Company’s Common Stock.

Potential Effect of Penny Stock Rules on Liquidity of Shares

If the Registrant’s securities are not listed on The Nasdaq Stock Market or certain other national securities exchanges and the price thereof is below $5.00, then subsequent purchases of such securities will be subject to the requirements of the penny stock rules absent the availability of another exemption. The SEC has adopted rules that regulate broker-dealer practices in connection with transactions in “penny stocks.” Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on The Nasdaq Stock Market). The penny stock rules require a broker-dealer to deliver a standardized risk disclosure document required by the SEC, to provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, monthly account statements showing the market value of each penny stock held in the customer’s account, to make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. The Registrant is currently subject to the penny stock rules and, therefore, these disclosure requirements may have the effect of reducing the level of trading activity in the Registrant’s Common Stock.

Limitation on Directors’ Liabilities under Delaware Law

Pursuant to the Registrant’s Certificate of Incorporation and under Delaware law, directors of the Registrant are not liable to the Registrant or its stockholders for monetary damages for breach of fiduciary duty, except for liability in connection with a breach of the duty of loyalty, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, for dividend payments or stock repurchases illegal under Delaware law or any transaction in which a director has derived an improper personal benefit.

Outstanding Options and Warrants

The Company has reserved 500,000 shares of its Common Stock for issuance upon exercise of stock options or similar awards which may be granted pursuant to the Company’s 1994 Stock Option Plan (hereinafter the “1994 Plan”), of which options to purchase an aggregate of 463,640 shares have been issued. Furthermore, the Company has reserved 4,000,000 shares of its Common Stock for issuance upon exercise of stock options or similar awards which may be granted pursuant to the Company’s 2000 Stock Option and Restricted Stock Plan (hereinafter the “2000 Plan”), of which options to purchase an aggregate of 2,970,000 shares have been issued. The outstanding options have a weighted average exercise price of $2.00 per share. In addition to the Summit warrant described below, the Company has issued warrants exercisable for 949,000 shares of Common Stock to financial consultants, investors and other business partners, having a weighted average exercise price of $2.76 per share and expiring on various dates from August 7, 2003 to June 11, 2007.

In connection with the Summit financing described below, Summit received a stock purchase warrant to purchase such number of additional shares of Series A-2 Convertible Preferred Stock or Common Stock of the Registrant enabling Summit to acquire a 51% fully diluted equity stake in the Registrant. By the terms of the warrant, the number of shares issuable upon exercise of the warrant will adjust with the number of shares of the Company outstanding and issuable pursuant to options and warrants. The exercise price of the warrant is a function of the Company’s earnings. As such, it is possible that the warrant will have an exercise price of zero and will therefore entitle Summit to the additional shares at no cost.

Exercise of these options and warrants and options and warrants issued by the Registrant in the future will reduce the percentage of Common Stock held by the public stockholders. Furthermore, the terms on which the Company could obtain additional capital during the life of the options and warrants may be adversely affected, and it should be expected that the holders of the options and warrants would exercise them at a time when the Company would be able to obtain equity capital on terms more favorable than those provided for by such options and warrants.

Issuance of Preferred Stock with Anti-Dilution Provisions and Superior Liquidation Preference

In 2002, the Registrant issued 2,346,233 shares of Series A-1 Convertible Preferred Stock to Summit Energy Ventures for a purchase price of $2,500,000. The Series A Preferred Stock provides the holders of the Series A Preferred Stock with protection against dilution. In the event that the Registrant issues shares at a price less than the price Summit paid for the Series A Preferred Stock, the conversion rights of the Series A Preferred Stock will be adjusted so that the Series A Preferred Stock can convert into such number of shares that Summit would have received had it bought Common Stock at such lower price. Currently, the conversion rights of the Series A-1 Convertible Preferred Stock entitle the holder of the Series A-1 to receive two shares of Common Stock for each share of Series A-1. In the event of a Liquidation Event (as defined in the Certificate of Designation of the Series A Convertible Preferred Stock which includes a winding up of the Registrant, a sale of substantially all of the Registrant’s assets, and certain mergers and consolidations) the holders of the Series A Convertible Preferred Stock are entitled to two times the price paid by Summit for such stock. Thereafter, the remaining corporate assets would be distributed among the holders of Common Stock and Series A Preferred Stock on a pro rata basis. The existence of the Series A Preferred Stock’s anti-dilution provisions may reduce the percentage of Common Stock held by the public stockholders. Furthermore, the terms on which the Registrant could obtain additional capital may be adversely affected by the Series A Preferred Stock’s anti-dilution provisions and superior liquidation preference.

Dilution of Ownership by Exercise of Summit Warrant

In connection with the Summit financing described above, Summit also received a stock purchase warrant which is exercisable after January 1, 2004 and prior to June 14, 2012, to purchase such number of additional shares of Series A-2 Convertible Preferred Stock, $.001 par value per share, or Common Stock, $.001 par value per share, of the Registrant that would result in Summit owning 51% of the Registrant’s fully diluted equity. By the terms of the warrant, the number of shares issuable upon exercise of the warrant will adjust with the number of shares of the Registrant outstanding and the number of shares issuable pursuant to options and warrants. The exercise price of the warrant is a function of the Registrant’s earnings. As such, it is possible that the warrant will have an exercise price of zero and will therefore entitle Summit to the additional shares at no cost. The existence of the warrant issued to Sumit will likely reduce the percentage of equity held by the public stockholders. Furthermore, the terms on which the Registrant could obtain additional capital may be adversely affected by the existence of such warrant and, in particular, the anti-dilution provisions of such warrant.

Authorization and Discretionary Issuance of Preferred Stock

The Registrant’s Certificate of Incorporation authorizes the issuance of “blank check” preferred stock with such designations, rights and preferences as may be determined from time to time by the Board of Directors. Accordingly, the Registrant’s Board of Directors is empowered, without stockholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the relative voting power or other rights of the holders of the Registrant’s Common Stock. In the event of issuance, the preferred stock could be used, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Registrant, which could have the effect of discouraging bids for the Registrant and thereby prevent stockholders from receiving the maximum value for their shares. Although the Registrant has no present intention to issue any shares of its preferred stock, there can be no assurance that the Registrant will not do so in the future.

Product Liability Risk

The Registrant may be subject to potential product liability claims that could, in the absence of sufficient insurance coverage, have a material adverse impact on the Registrant. Presently, the Registrant has general liability coverage that includes product liability up to two million dollars. Any large product liability suits occurring early in the Registrant’s growth may significantly and adversely affect the Registrant’s ability to expand the market for its Power Commander® line of products.

No Key Man Insurance

The Registrant presently has no key man life insurance policies. As soon as practicable following the commencement of profitable operations (of which there can be no assurance), the Registrant intends to purchase key man life insurance on the lives of its two principal executive officers, Raymond J. Skiptunis and Nicholas Anderson. Upon purchase of such insurance, the Registrant intends to pay the premiums and be the sole beneficiary. The lack of such insurance may have a material adverse effect upon the Registrant’s business.

Line of Credit

At the present time, the Registrant does not have a bank line of credit.

Potential Violation of Section 5 of the Securities Act.

In its original Form 10-SB, filed on October 20, 2000, the Registrant inadvertently filed its Private Placement Memorandum as an Exhibit. This may constitute general solicitation under Rule 502(c) of Regulation D and the Registrant may be in violation of Section 5 of the Securities Act of 1933 and be

unable to avail itself of the exemption found in Rule 506 of Regulation D as to that offering. The Registrant believes it can establish pre-existing connections with all purchasers under the Private Placement Memorandum. If proceedings based on this inadvertent filing were commenced against the Registrant, purchasers under the Private Placement Memorandum, possibly together with other purchasers of the Registrant’s securities, may make a claim for rescission of their investments, which if successful may exceed $725,000. Such claims would be subject to any applicable defenses that the Registrant might assert, including statute of limitations. The last sales under the Private Placement Memorandum were made in March 2001. Therefore, the Registrant believes that the statute of limitations for such claims under the Securities Act has expired.

Item 2.

Description of Property

The Registrant leases office, warehouse and research facilities at three locations. The Registrant leases approximately 5,745 square feet of office and warehouse space located at 4220 Varsity Drive, Suite E, Ann Arbor, Michigan 48108. The Registrant’s lease was due to expire on February 16, 2001 but the Registrant extended the lease until May 31, 2003. The base rent is $5,026.88 per month. The Registrant leases approximately 5,000 square feet of office and research space located at 40 Nassau Terminal Road, New Hyde Park, New York 11040. The base rent is currently $4,652.08 per month with annual increases of 1.5%. The lease expires on June 30, 2004. The Registrant shares office space located at 75-153 Merle Drive, Suite B, Palm Desert, California 92211 with a major investor in the Registrant, Summit Energy Ventures, LLC. Commencing January 2003, the Registrant pays $2,124.63 per month and the lease is on a month-to-month basis.

Item 3.

Legal Proceedings

PART II

Item 5.

Market for Common Equity and Related Stockholder Matters

Market for Common Stock

The Registrant’s Common Stock is thinly traded on the National Association of Securities Dealers’ Over the Counter Bulletin Board (“OTCBB”) under the symbol “PREF”.

The following table sets forth the high and low bid information for quarterly periods in the two twelve month periods ended December 31, 2002 and December 31, 2001, as reported by the National Quotation Bureau:

Twelve months Ended December 31, 2002	High		Low
October 1, 2002 — December 31, 2002	$	1.90	$	0.55
July 1, 2002 — September 30, 2002		3.20		1.45
April 1, 2002 — June 30, 2002		3.25		1.60
January 1, 2002 — March 31, 2002		3.80		2.90

Twelve months Ended December 31, 2001	High		Low
October 1, 2001 — December 31, 2001	$	3.51	$	2.90
July 1, 2001 — September 30, 2001		5.40		3.25
April 1, 2001 — June 30, 2001		8.20		2.65
January 1, 2001 — March 31, 2001