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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended February 29, 2012
 
[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
 
For the transition period from _________ to ________
 
Commission file number: 333-91191

 

XZERES Corp.
(Exact name of registrant as specified in its charter)
 
Nevada 74-2329327
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
 
9025 SW Hillman Court, Suite 3126 Wilsonville, OR 97070
(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number: 503-388-7350

 

Securities registered under Section 12(b) of the Exchange Act:

 

Title of each class Name of each exchange on which registered
none not applicable

 

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

 

Title of class
none  

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [ X ]

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ X ] No [ ]

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [ ] No [ X ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [X]

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not 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-K or any amendment to this Form 10-K. [X]

 

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

 

Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [X]

 

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

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $13,986,962

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 26,547,881 as of May 29, 2012.

        

 

TABLE OF CONTENTS

Page

 

PART I

 

Item 1. Business 3
Item 2. Properties 13
Item 3. Legal Proceedings 13

 

PART II

 

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities 14
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 17
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure 22
Item 9A. Controls and Procedures 22
Item 9B. Other Information 23

 

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance 23
Item 11. Executive Compensation 26
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 30
Item 13. Certain Relationships and Related Transactions, and Director Independence 31
Item 14. Principal Accountant Fees and Services 31

 

PART IV


Item 15. Exhibits, Financial Statement Schedules 31
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PART I

 

Item 1. Business

 

Company Overview

 

XZERES Corp. (“XZERES” and the “Company”) is located in Wilsonville, Oregon and was originally incorporated in the state of New Mexico in January of 1984.  The Company was engaged in the natural gas and asphalt businesses until 2007, at which time it liquidated its assets and operations and distributed the net proceeds to its shareholders after paying its debts.  On October 2, 2008, the Company re-domiciled from New Mexico to Nevada and commenced operations in the wind turbine business in the fiscal quarter ended May 31, 2010. The Company is in the business of designing, developing, and marketing small wind turbine systems and related equipment for electrical power generation, specifically for use in residential, small business, rural electric utility systems, other rural locations, and other infrastructure applications.  

 

The Company formed two subsidiaries during the year ended February 28, 2011. XZERES Energy Services Corp. was incorporated in Nevada in January, 2011 and XZERES Wind Europe Limited was formed in Ireland in October, 2010.

 

Our principal offices are located at 9025 SW Hillman, Suite 3126, Wilsonville, OR 97070. Our phone number is (503) 388-7350.

 

Our Business

 

We are in the business of designing, developing, and marketing distributed generation, wind power systems for the small wind (2.5kW-100kW) market as well as power management solutions.  Our grid connected and off grid wind turbine systems, which consist of our 2.5kW and 10kW devices and related equipment, are utilized for electrical power generation for applications and markets such as residential, micro-grid based rural and island electrification, agricultural, small business, rural electric utility systems, as well as other private, corporate infrastructure and government applications. Our wind power systems are focused on distributed energy, where a specific machine's energy output is largely or entirely used on-site where the equipment is installed, as well as grid connected applications. While many of our customers take advantage of their local net-metering rules within the United States and Feed In Tariffs that are often available in Europe and Internationally (to sell power back to the grid), our wind power systems are not dependent on transmission needs to carry the energy produced to another location and are therefore well suited for remote electrification, available with or without a battery coupled solution. Our power management solutions are deployed primarily for commercial and light industrial applications, and secondarily residential usage and target both urban and rural customers.

 

Our wind turbine products integrate with currently available complementary products from other manufacturers, such as inverters, lightning protection equipment and towers.  We do not have any written agreements with these other manufacturers. Our systems comprise several major components including the turbine sub-system (which converts wind energy into electricity), the tower (which holds the turbine high in the wind), a turbine controller (which controls the turbine subsystem and contains monitoring hardware and software), and an inverter (which converts the electricity generated from direct current (DC) to alternating current (AC) to connect to a customer’s electrical load or to the grid). We currently design and engineer the turbine and controller, but contract the manufacturing of the turbine and controller through outside parties. The tower, while designed to specifications suitable to our turbine requirements, is made and sold by separate companies depending on the style that the customer orders.  Similarly, the inverter, which converts the energy generated to a form suitable to connect into the electric grid, is manufactured by another company and is a commercial off-the-shelf product.  We sell a “system” with all of these parts included in the selling price.  The system will not operate as designed without these complementary products.  In the case of the inverter, there are other commercially available products that will integrate with our components, but we perform the system integration design to sell the entire system as a package to the customer.  Going forward, we intend to develop new turbine systems, designed for ease of installation and to certification standards which cover standard testing procedures, power ratings, and structural designs of small wind systems.

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We take a system integrator approach to our turbine business combined with a service-centric vertical integration program in order to provide complete solutions to our customers. We design, develop, manufacture, test, assemble and market our systems. In addition, we provide site assessment, customer financing, assistance with government-based financial incentives and local permitting, application engineering, installation, support and maintenance. And now we offer “tip-to-tower” insurance to our wind turbine customers to enable them to protect their valuable investment over the 20 year useful life of their system.

 

On April 25, 2011, we acquired the assets of Rochester Power Saver Inc. (the “Rochester Power Acquisition”) and now manufacture and sell a family of power efficiency products which are designed to improve the "power factor" and reduce the amount of reactive power being drawn at a location. This acquisition expanded our product offering beyond small wind power generation into the realm of power management and power efficiency solutions. The addition of this complementary and diversified family of products enables us to offer both business and residential customers, in urban and rural locations, the ability to reduce their power consumption, extend the life of their electrical equipment and electronics via central surge suppression, reduce their carbon footprint, and depending upon the type of customer and the application, provide significant energy savings. As a result of this acquisition, we have introduced the new power efficiency product line and have generated initial sales.

 

Wind Power

 

The demand for alternative means of electricity generation has increased due to the rising cost of energy and consumer awareness of environmental issues. According to the American Wind Energy Association (“AWEA”), wind power is second only to natural gas in terms of new capacity added and was the most rapidly growing means of alternative electricity generation at the turn of the 21st century. State and federal incentives have significantly reduced barriers to wind power development as well as the payback period for investments in small wind turbines for homeowners and small businesses.

 

Such incentives take the form of Feed-in-Tariffs, significant tax breaks or even cash incentives to purchasers of wind power systems. As a result of such incentives, the effective price or cost to the user is greatly reduced making the return on investment much more attractive and lowers the time period it takes to generate enough energy to recover the total cost of the system. While many customers are attracted to renewable energy for the positive environmental attributes, the ultimate decision often centers on a cost/benefit and investment return analysis. Governmental and private (utility-sponsored) incentives play an important role by lowering the effective cost to the end user of a wind power system and thereby making a purchase more attractive.

 

Wind is a form of solar energy. Winds are caused by the uneven heating of the atmosphere by the sun, the irregularities of the earth's surface, and rotation of the earth. Wind flow patterns are modified by the earth's terrain, bodies of water, and vegetation.

 

The terms wind energy or wind power, describe the process by which the wind is used to generate mechanical power or electricity. Wind turbines convert the kinetic energy in the wind into mechanical power. A generator can convert this mechanical power into electricity.

 

Modern wind turbines fall into two basic groups: the horizontal-axis variety and the vertical-axis design. Horizontal-axis wind turbines typically either have two or three blades. These three-bladed wind turbines are operated "upwind," with the blades facing into the wind.

 

Single small turbines, below 100 kilowatts, are often used for homes, farms, telecommunications dishes, or water pumping. Small turbines are sometimes used in connection with diesel generators, batteries, and photovoltaic systems. These systems are called hybrid wind systems and are typically used in remote, off-grid locations, where a connection to the utility grid is not available. 

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Wind Power Industry

 

The U.S. Department of Energy's Wind and Hydropower Technologies Program is working with wind industry partners to develop clean, domestic, innovative wind energy technologies that can compete with conventional fuel sources. Program efforts have culminated in some of the industry's leading products today and have contributed to record-breaking industry growth.

 

The U.S. has been a leader in new wind capacity, installing 6,816 Megawatts (MW) in 2011, up just over 30% from 2010 and bringing total installed capacity to 46,916 MW at 2011 year end.

 

Much of the Wind Industry to date is made up of large, utility-scale turbines. However, small wind turbines (<100kW) are now benefitting from many of the same high-growth factors driving large turbines, which include:

 

§Persistent, high energy costs;
§Improved technology leading to significantly more efficient turbines;
§Incentive programs; and
§General improvement in attitudes toward alternative energy solutions.

 

The U.S. and Europe contain approximately 71% of the planet’s existing wind power installations. The U.S., Germany, Spain, India and Denmark have made the largest investments in wind-generated electricity according to the World Wind Energy Association. The World Wind Energy Association estimated total world-wide installed capacity at year-end 2011 of 239 Gigawatts (GW), up from 121.2 GW at the end of 2008, implying a net growth rate of more than 25% per year.

 

The U.S. continues to lead the world as one of the fastest-growing wind power markets, according to a report from the U.S. Department of Energy (DOE) by Lawrence Berkeley National Laboratory (LBNL). The states with the most wind production are Texas, California, Iowa, Minnesota, and Oklahoma.

 

A new assessment from the National Renewable Energy Laboratory showed U.S. wind resources are larger than previously estimated. Highlights of the analysis reveal Onshore U.S. wind resources could generate nearly 37,000,000 gigawatt hours (GWh) annually, more than nine times the current total U.S. electricity consumption.

 

In 2008, the DOE published a report that examined the technical feasibility of using wind energy to generate 20% of the nation’s electricity demand by 2030. The report, "20% Wind Energy by 2030: Increasing Wind Energy's Contribution to U.S. Electricity Supply," includes contributions from DOE and its national laboratories, the wind industry, electric utilities, and other groups. The report examines the costs, major impacts, and challenges associated with producing 20% wind energy or 300 GW of wind generating capacity by 2030.

 

The report's conclusions include:

 

§Reaching 20% wind energy will require enhanced transmission infrastructure, streamlined siting and permitting regimes, improved reliability and operability of wind systems, and increased U.S. wind manufacturing capacity.
§Achieving 20% wind energy will require the number of annual turbine installations to increase nearly 3-fold by 2017.
§Integrating 20% wind energy into the grid can be done reliably for less than 0.5 cents per kWh.
§Achieving 20 percent wind energy is not limited by the availability of raw materials.
§Addressing transmission challenges such as siting and cost allocation of new transmission lines to access the Nation's best wind resources will be required to achieve 20% wind energy.

 

Apart from regulatory issues and externalities, decisions to invest in wind energy generally depend on the cost of alternative sources of energy. Natural gas, oil and coal prices, and the main production technologies with significant fuel costs are often determinants in the choice of the level of wind energy.

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Our Markets

 

Small Wind Turbines

 

According to the World Wind Energy Association (WWEA), total installed capacity of small wind systems around the world reached 443.3 MW at the end of 2010. The United Stated accounted for roughly 40% of that capacity, or 179 MW. The average output of one megawatt of wind power is equivalent to the average electricity consumption of about 250 American households. DOE studies have concluded that onshore wind resources in the U.S. could generate nearly 37,000,000 gigawatt-hours, more than nine times current total U.S. electricity consumption.

 

World-wide, growth in small wind systems has been strong, averaging 30%+ over the past few years, and is expected to continue growing at a similar pace of 35% until 2015 (according to the WWEA). Several developments are contributing to the industry's growth. We feel that the small wind industry is approaching a tipping point, where increased system performance, better incentives, expanded applications, and higher energy costs will combine to make small wind-generated energy increasingly attractive thereby supporting the anticipated growth world-wide . Additionally, we anticipate that the rapid growth will make established companies in this industry attractive acquisition targets for larger companies.

 

The small wind industry is also becoming more organized with respect to standards and certifications. Such efforts by the industry help promote better performing systems as well as enable end customers to better evaluate key metrics, such as performance, across the various product choices on the market. We believe this to be a very positive evolution as we have engineered our systems to the highest standards and performance and have successfully achieved certifications in key markets, such as the U.S. and UK.

 

The foregoing market and industry data was collected from the AWEA and WWEA annual reports, publicly available on their websites. We did not pay for the report and it was not prepared for our use. The AWEA and WWEA allow the data to be used with proper attribution.

 

For the U.S. market, we have focused our sales efforts on rural home owners and rural small businesses, especially farms and ranches. We expect that our typical U.S. customer will have one or more acres of property that consistently experiences at least an average wind speed in the range of 9.8 to 11.5 mph, which is known as a Class 2 Wind. According to the American Wind Energy Association (AWEA), approximately 25 million homes in the U.S. have an acre or more of property and 35% of those homes have Class 2 Winds or better, generating a potential market of 12 million units. We have directed our U.S. efforts on specific states where either state incentives are more attractive and help compliment the federal tax credit incentives and/or where wind resources are better, for example, Oregon, California, Wisconsin, New York, Iowa, and Oklahoma. Both factors help drive market demand as potential customers will experience a better economic return for purchasing a wind turbine.

 

During fiscal year 2012, we also continued to expand our sales and marketing efforts globally. Demand drivers vary around the world. Developed areas, like the United Kingdom (UK), are very similar to the U.S. in that customer economics, such as incentives, paybacks, and internal rates of return, play a central role in a customer’s decision. In less developed or remote areas, access to power is a key diver, generally due to a poor or non-existent utility grid.

 

We have established a wholly-owned subsidiary in Ireland for the purposes of serving the European market, particularly the United Kingdom (UK). We opened a sales office for our subsidiary in Birmingham, England, and have 6 local sales and sales support personnel staffed in this location. We targeted the UK for our initial global expansion due to its outstanding environment for small wind systems, with both high wind speeds and one of the World’s most attractive feed-in-tariff incentive regimes. In September of 2011, we announced an agreement with the largest wind dealer in the UK. We granted this dealer exclusivity for certain parts of the UK in return for specified minimum purchase quantities. This was a culmination of our efforts over the prior 12 months to build a presence in the lucrative UK marketplace. As a result of this effort and new agreement, we have begun to experience significant growth and a substantial increase in new orders from the UK.

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Additionally, we have extended our global efforts into the Asia Pacific region. Our initial efforts in this area have focused on a specific project with a large Vietnam customer. We completed a pilot program for the customer in Fiscal 2012 and expect initial sales to this region will begin in Fiscal 2013.

 

As a result of recent orders from the UK, along with our existing domestic business, the Company has a strong backlog of existing orders. We currently anticipate this trend to continue, which should lead to a significant overall increase in sales for Fiscal 2013 provided we are able to obtain sufficient working capital.

 

Power Management

 

As a result of our Rochester Power acquisition in April 2011, we began initial sales of a power efficiency product line during the fiscal year ended February 29, 2012. These products are designed to help customers reduce their excess power factor penalty and demand charges incurred from their utility providers. When implementing these products, customers that experience these additional charges, can often see reductions in their power bill from 8-20%. We focus our efforts both domestically and internationally on small-to-medium sized businesses in a wide range of vertical markets. While power factor correction and energy management products have been generally available for large businesses for some time, we feel the smaller to medium sized portion of the market has been largely under-served with a technology solution applicable to their specific needs.

 

Our Products

 

Wind Turbines

 

The wind turbine systems we offer for sale are comprised of our own, proprietary design that uses both our own internally engineered components as well as standard third party engineered components integrated into a single system. Leveraging an outsourced manufacturing model, we currently assemble these wind turbine systems from component parts manufactured by third-party suppliers at our leased facility at 9026 SW Hillman in Wilsonville, Oregon. We sell the assembled wind turbine systems, the towers on which the turbines are mounted, and related components and accessories.

 

We currently assemble and offer for sale two wind turbine systems, a 2.5kW system we have branded as the XZERES 110, and a 10kW system we have branded as the XZERES 442. Both systems are tower mounted and generate electrical output for use on site where installed and can also be connected to the electrical grid. When connected to the electrical grid, a configuration referred to as an on-grid application, our wind turbine system is integrated into the site’s existing electrical power connection to the main grid. This configuration allows a customer to draw electrical power from either the wind turbine system or the main grid or both, depending upon the customer’s need and the wind turbine system’s current output. In many jurisdictions, power generated by the wind turbine system in excess of the customer’s current needs can be sent back into the main grid and the customer can receive a credit from their utility provider. Credit is not universally available, however, and specific net-metering rules for local area jurisdictions vary widely.

 

In addition, both our 2.5kW and 10kW systems can be further configured to link to a battery system that will store electrical power generated by the wind turbine system in excess of the customer’s current demands. That stored power can then be drawn from the battery system by the customer when needed.

 

We also offer both our wind turbine systems in a configuration suitable for marine applications. Here the system receives marine-grade protective coatings and components designed to withstand high salinity and high humidity conditions as typically found in coastal environments.

 

Our wind power systems are installed on towers, which can range from 45 feet to 140 feet tall, depending on the specific site characteristics. We source towers from third party tower manufacturers, designed and built to our specifications by our 3rd party tower suppliers.

 

We also offer for sale, but do not manufacture, other products that work with our wind turbine systems and provide value to our customers, including devices to protect our wind turbine systems from lightning strikes and equipment needed to connect our wind turbine systems to the main electrical grid or to battery storage systems.

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At present, our wind turbine systems integrate with standard off-the-shelf equipment needed to connect our systems to the main electrical grid, including those from SMA America, LLC and Outback Power and are provided as part of our overall solution to our customers. Standard off-the-shelf equipment means stock merchandise that is readily available through vendors in the industry.

 

In addition, our 10kW product allows remote access data monitoring of the wind turbine. This allows our customers and us to have an easier time of troubleshooting any problems that may arise with the various systems we sell. We recently introduced this new feature with the launch of the latest version of our model 442 in January 2011.

 

We began taking orders for the current version of our model 442 in February 2011. We believe our current products compare as technology leaders in this market, and we will work to advance this leadership position through the continual development of performance improvements. For example, the power curve, which is a measure of performance of a system, on our 10kW system often exceeds the claimed power curves on similar sized machines from competitors in the field. Every manufacturer states the specifications on performance of its turbines, known as a “power curve” which plots power output verses wind speed, based on product testing. Those specifications are published by each manufacturer in much of the same way a manufacturer details the specifications of an automobile. We are then able to compare the specifications of other manufactured turbines to our own turbines. Our power curve for our model 442 has been independently validated by the National Renewable Energy Laboratory, while many manufacturer curves are only based on internal testing. Using this published data, we can plot our curve on the same graph as competitor curves and can show that our products produce more power at a given wind speed than some other competitors with the same nominal rating. We can also use the same data to predict the annual energy production of competing machines assuming a standard distribution of wind resource availability. This energy production, calculated based on published power curves by multiple manufacturers, is used in conjunction with published pricing of competing machines to show that our product has a superior return on investment. Much of the published data comes from Home Power Magazine which has an annual buyer’s guide issue showing specifications of many of the competing products available on the market.

 

There can be no assurance that we will be able to maintain any technological leadership or successfully exploit that leadership position to the benefit of our shareholders.

 

Power Efficiency

 

Beginning in fiscal year ended February 29, 2012, we introduced a new product line in the power efficiency category as a result of our April 2011 acquisition of Rochester Power. Our power efficiency products are offered both as part of a solution to our existing turbine customers, and as a stand-alone product. These products are designed to improve the "power factor" and reduce the amount of reactive power being drawn at a location. By making this improvement, these power management devices can enhance the efficiency of inductive motors. The significance of power factor lies in the fact that utility companies supply customers with volt-amperes but bill them for watts. Power factors below 1.0 require a utility to generate more than the minimum volt-amperes necessary to supply the real power (watts). This increases generation and transmission costs. Utilities typically charge additional costs to business customers who have a power factor below some limit. Our products are designed to help reduce these added charges and hence save the customer money. We target business customers where the characteristics of their utility bill relative the specific product we are offering for their solution will yield a payback to the customer within 36 months or less. We offer a wide range of product sizes designed to enable us to target businesses with an annual utility spend as low as $34,000 to as high as $500,000.

 

Distribution of Products

 

We sell our products directly to consumers as well as through dealers and distributors. We currently maintain a sales force of 11 people in the U.S. and UK, who focus on direct and indirect channels within their assigned territories. Five of these salespeople are in our Oregon headquarters, with responsibility for the North American and Asian markets, and six are in the UK, with responsibility for Europe.

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Dealers are often contractors who provide various construction services for small business and homeowners and have experience with installing renewable energy systems, such as wind and solar. They provide a vital link to potential end users of renewable energy equipment and alleviate manufacturers from having to provide large field service operations for conducting sales and service. Thus, part of our sales and marketing effort is designed to support, educate, and provide training seminars for dealers.

 

Our dealers can range from small, 1-2 person operations to larger, regional or national companies. We work to establish agreements with dealers already familiar with our products as well as to bring in new dealers. We have signed agreements with 79 dealers for turbines and 35 for our power efficiency products as of May 25, 2012. Although the dealer agreement and terms differ, many of our dealers have signed on to sell both our turbine products and our power efficiency products. With our recent signing of VG Energy as a large dealer in the UK, we expect to generate a significant portion of our sales, above 15%, from this single customer for Fiscal 2013.

 

We employ an additional three personnel assigned to building, maintaining, and enhancing our sophisticated website which we use for marketing and sales purposes and lead generation.

 

Ireland-Based Wholly-Owned Subsidiary

 

In November 2010, we established a wholly-owned subsidiary in Ireland in an effort to support sales and marketing activities in Europe and specifically the United Kingdom. In March of 2011, we received MCS Certification of our 10kW system for the UK marketplace. The MCS certification is important in that it allows our equipment to be eligible for the UK Feed-In-Tariff. We delivered initial product to customers in the U.K. in fiscal year 2012 and expect to see a significant portion of our sales for Fiscal 2013 to occur in the UK.

 

Competition

 

We will compete with a number of established manufacturers, importers, and distributors who sell wind turbine systems and related equipment. These companies enjoy brand recognition which exceeds that of our brand name. We will compete with several manufacturers, importers, and distributors who have significantly greater financial, distribution, advertising, and marketing resources than we do. We have only recently begun selling our wind turbine systems and, at present, represent an insignificant portion of the total number of small wind turbine systems being sold into the target market.

 

Our primary competitors of similarly sized, horizontal access wind turbines that compete in our market and sell 2.5 to 10 kilowatt systems are:

 

§Bergey WindPower (“Bergey”) - The XL.1 (1 kW) is mass-produced in China and is smaller than any of our models. The Excel (10kW) is built in Oklahoma; it is a 25 year old design. Bergey sells to its own network of dealers/installers and directly to consumers.
§Southwest Windpower (“SWWP”) - The Whisper 200 (900 W) and the Whisper 500 (3 kW) are inexpensive wind turbines manufactured in the U.S. The new Skystream (1.8 kW) wind turbine began shipping in 2010. SWWP sells through Renewable Energy distributors such as Conergy and GroSolar.
§Gaia, Ltd. – A European company that sells an 11kW turbine and is well established in the European marketplace.

 

Over the past 24 months, new companies have entered the small wind marketplace, in both horizontal and vertical-access system designs. Many of these newer companies have yet to demonstrate field-tested, proven equipment.

 

Developing successful products for the small wind market requires, among other things, industry knowledge and expertise, which we believe provides a significant barrier to entry. In addition, having proven, field-tested equipment is perhaps the most important factor in customer purchase decisions and an even greater barrier to entry. While numerous small wind providers have emerged more recently, very few meet this requirement of equipment out in the field that has been running for an extended period of time and delivered on the promised energy output. Thus, we believe there are relatively few companies that meet the necessary customer/dealer standards to currently compete in the small wind industry.

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We expect to compete primarily on the basis of quality, technology advantages, ability to timely deliver product, field-proven experience and price (on a per kWh basis). We believe that our success will depend upon our ability to remain competitive in our product areas.

 

In addition to direct competition from other manufacturers of small wind turbine systems, we face indirect competition from other sources of energy, including both traditional delivery of electrical power over the grid and other sources of small renewable energy, such as small solar panel systems. Generally speaking, the strength of one technology over another in a particular instance is a function of the specific application, location, and total cost/benefit characteristics. Whatever technology solution can provide the best electrical output at the lowest cost in a particular environment will tend to be favored.

 

Principal Suppliers and Customers

 

We have elected to outsource the manufacturing on most of the various system components and then conduct assembly and final test internally at our facility in Oregon. Our key suppliers include our alternator, controller, and blade suppliers. We have standard NDA (Non-Disclosure) and IP (intellectual-property) rights agreements in place with each supplier used. There are no written supply agreements in place with any of our key suppliers. We purchase necessary components on a purchase order basis. Although we are dependent on our key suppliers, we also believe each would be replaceable if necessary.

 

We consider our agreement with VG Energy Ltd. (VG), in the UK to be a key customer. Our agreement provided VG with exclusive territory in certain parts of the UK, in exchange for minimum purchase quantities per year. Based on VG’s minimum purchase quantities, we expect they will represent a substantial portion of our business in Fiscal 2013.

 

Intellectual Property

 

We own the rights to four applications filed in the United States for patent protection on key technology innovations and twelve applications for trademark registrations. We do not currently hold any patents or registered trademarks. We will also apply for copyright protection in the United States and other jurisdictions where appropriate. We also may elect to avoid filing for patent protection on other aspects of our systems because of difficulty protecting the patent or disclosure of proprietary information that would result from the patent process, which is determined to be better remaining as trade secrets. There can be no assurance that we will receive any patents in the United States or elsewhere. Further, even if we receive patents, there can be no assurance that the patents will be enforceable.

 

We will continue to obtain confidentiality agreements where necessary from our various suppliers. We will also seek confidentiality agreements with any consultants that we use.

 

We intend to assert our rights under trade secret, unfair competition, trademark and copyright laws to protect our intellectual property, including product design, proprietary manufacturing processes and technologies, product research and concepts and recognized trademarks. These rights will be protected through the acquisition of patents and trademark registrations, the maintenance of trade secrets, the development of trade dress, and, where appropriate, litigation against those who are, in our opinion, infringing these rights.

 

While there can be no assurance that patents, copyrights, registered trademarks or other measures will protect our proprietary information, subject to our financial, legal and business constraints, we intend to assert our intellectual property rights against infringers.

 

We estimate we will spend approximately $25,000 on counsel and filing fees in the next twelve months on intellectual property protection regarding the designs for our residential wind turbine systems and related equipment.

 

Regulatory Matters and Government Incentives

 

Many state and local governments have implemented a diverse set of initiatives and incentive programs for wind equipment purchases. State incentives can take the form of net metering, rebates, tax credits, and feed in tariffs:

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Net metering allows customers to connect renewable generation equipment to their utility power system. The utility takes any excess energy produced and credits it back to the customer on a net basis. The utility in essence banks your energy for free. There are over 40 states that have net metering in all or part of the state. All public utilities are required to make net metering available as defined by the Energy Policy Act of 2005.

 

§Rebates are cash payments that are usually given to the customer, who must wait until the project is completed and inspected to get paid. The rebate is deducted from the project cost billed to the customer. Rebates can be based on rated power, swept area, blade length, installed cost, or projected energy generation.
§Tax credits can be based on project cost or per kW of rated capacity. Some tax credit programs have caps on maximum dollars per project or year. Some must be taken over several years and some are transferable.
§Feed in tariffs, or production incentives as they are often called, are above-market payments for energy generated from renewable energy. These are common in Europe and interest levels are growing in the United States. There are many states with some form of feed-in tariff on the utility or state level. Seven of these states are covered by a feed in tariff offered by the Tennessee Valley Authority which pays $1,000 plus $0.12/kWh. California offers a state-level feed in tariff, but utilities are required to have it approved by the CA Public Utilities Commission. Hawaii, Maine, Washington and Nevada have a feed in tariff as well on the state level.

 

As of May 2012, most states have tax or other financial incentives of some type, such as credits, sales tax exemption, property tax exemption, productivity incentives such as grants or rebates, loan programs, or other subsidies to support wind energy development and use. Newer incentive programs such as New York’s, Wisconsin's and Oregon’s are designed so they favor higher production machines such as our 2.5kW and 10kW systems. Many states continue to streamline permitting processes and incentive programs.

 

Under present law, a federal-level investment tax credit (ITC) is available to help consumers purchase small wind turbines for home, farm, or business use. Owners of small wind systems with 100 kilowatts (kW) of capacity or less can receive a credit for 30% of the total installed cost of the system.

 

The ITC, written into law through the Emergency Economic Stabilization Act of 2008, is available for equipment installed from October 3, 2008 through December 31, 2016. The value of the credit is now uncapped, through the American Recovery and Reinvestment Act of 2009.

 

The Energy Independence and Security Act of 2007, passed in December 2007, contained benefits for renewable energy systems in general, of which wind power systems would qualify. Those provisions included Technical Assistance Grants, Renewable Energy Construction Grants, and Express Loans for Renewable Energy and Energy Efficiency (Small Businesses). Each of those programs could further benefit customers that install a wind power system. We view such policy initiatives as generally positive for the wind industry and the company, but do not expect that this particular piece of legislation is immediately material to our business prospects. The ITC is the government program that has the greatest impact on our domestic sales.

 

State Regulations Governing Power Produced

 

Each state is responsible for regulating the sale, installation and interconnection of alternative energy within their state. Currently, there is no Federal-level regulation that specifically controls the sale, distribution and installation of small wind turbines beyond general small business regulations. The Public Utility Regulatory Policies Act of 1978 or PURPA, requires utilities to interconnect and purchase energy from small wind systems. Individual utilities are permitted to regulate that process.

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Local Regulations Surrounding Small Wind Turbine Use

 

Individuals and small businesses interested in small wind turbine use are subject to local regulations and involve public utility companies, inspectors, permits, site evaluation for placement, tower height and aesthetic concerns, and restrictions regarding professional versus do-it-yourself installation. The AWEA offers a Model Zoning Ordinance to help local officials update ordinances governing small wind turbine installations. However, states often have unique subsidies or other programs designed to encourage on-site electricity generation. Existing state laws and local regulations continue to evolve in order to encourage and maintain safe, effective and efficient use of small wind energy systems.

 

Environmental Studies and Regulations

 

Overall, studies have shown wind energy has a low impact on the environment and does not generate air, or water pollution, global warming pollutants or waste. According to the American Wind Energy Association, although wind turbines have positive impacts, there are a few studies indicating negative impacts on the environment.

 

Wind turbines and energy plants are generally known to be quiet, unobtrusive and non-threatening to both humans and wildlife. Recent studies that indicate negative impacts on humans and wildlife include: birds and bats colliding with wind turbines, noticeable “whooshing” or low frequency sounds and shadow flicker. Shadow flicker occurs when the blades of a turbine pass in front of the sun to create a recurring shadow on an object.

 

The wind energy industry is partnering with conservation groups and government agencies and conducts ongoing land use and avian studies at wind sites across the country. Pre- and post-construction efforts to protect land and wildlife include wildlife consultants, surveys, and various state, federal land use, fish and wildlife agencies.

 

We have not incurred and do not anticipate incurring any expenses associated with environmental laws. In addition, many of the above mentioned environmental concerns are more applicable to large, utility-scale turbines, rather than small wind turbines.

 

Research and Development Expenditures

 

We incurred a research and development expense of $2,825,688 incurred in the fiscal year ended Feb 29, 2012 compared to $1,480,585 for the prior fiscal year. This expense was largely associated with compensation paid to our engineering staff as well as outside consultants and fees associated with the release of our latest 10kW system. While we expect these costs to remain significant as we focus on improving our existing products as well as designing and developing new wind turbine systems, we also anticipate the expenditures to be significantly lower in Fiscal 2013 as compared to Fiscal 2012. We expect that our research and development expense over the next twelve months will approximate $1.0 million, none of which will be borne directly by our customers.

 

Subsidiaries

 

We currently have two, wholly-owned, subsidiaries. Our XZERES Wind Europe Ltd., headquartered in Dublin, Ireland was established to support sales and marketing activities throughout Europe. XZERES Energy Services Corp., our domestic subsidiary, was established to support our direct-sales efforts in the U.S. market where we participate in the project management and coordination of the system installation for the customer.

 

Employees

 

We commenced active operations during the first quarter of fiscal year 2011 and added a number of employees to execute on our business plan. As of May 25, 2012, we have 38 full time employees, including 7 technical and engineering personnel, 14 sales and marketing personnel, and the balance in executive, manufacturing or general administration. Additional individuals have been and may continue to be engaged as outside consultants to provide additional assistance in our operations on an as-needed basis.

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We may further expand our current management team and employee headcount in the future to retain skilled directors, officers, and employees with experience relevant to our business focus. Specifically, we are actively seeking to hire additional personnel for both sales and for technical and engineering.  

 

There are no collective bargaining contracts covering any of our employees. We believe our relationship with our employees is satisfactory.

 

Item 2. Properties

 

We maintain our corporate office at 9026 SW Hillman, Suite 3126, Wilsonville, OR 97070.

 

On April 27, 2010, we entered a lease for the use of approximately 13,558 square feet located at 9025 SW Hillman Court, Bldg. 31, Suites #3126 and 3122 in Wilsonville, Oregon. We use approximately 3,960 square feet as office space and the balance, approximately 9,598 square feet, as shop floor space to conduct final testing of components, product assembly, and shipping and receiving.

 

Our lease for these two suites expires in July 2013 with an option for an additional three (3) years. As of February 29, 2012, our rent for both suites was $10,290 per month. Our total rent expense on both suites for the next 12 months is anticipated to be $123,480. We also rent excess office and storage space in that same office park, on a month-to-month basis, at a monthly rate $6,047, which we intend to keep for at least the next six months.

 

In addition, we rent office space, on a month-to-month basis in Birmingham UK to support our sales team in the UK. We pay a monthly rate of £1,296 for the UK office.

 

Item 3. Legal Proceedings

 

On May 21, 2012, we were served with a lawsuit by XC Associates, Inc. (XC), which was filed in U.S. District Count, Northern District of New York on May 16, 2012. XC was a vendor we had prepared to bring on as a key supplier of blades in early 2011. After numerous delays in delivering initial product to us, we disengaged from XC as a potential supplier. XC initially claimed we owed a balance of approximately $50,000 for initial tooling. We refused the claim. XC has now filed a suit claiming lost business among other damages, totaling approximately $729,000. We intend to vigorously contest these claims, and may assert counterclaims seeking damages for business disruption caused by XC’s failure to perform.

 

On Feb 22, 2012, we were served with a lawsuit by Hobbes & Towne Inc, an employee recruiting firm, seeking damages in the amount of $105,000. The suit was filed on February 22, 2012 in the Court of Common Please Chester County, PA. The dispute arises out of an employee recruiting contract for engineering staff. We have answered the suit and intend to vigorously contest the plaintiff’s claims.

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PART II

 

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

Our common stock is currently eligible to be quoted on the Financial Industry Regulatory Authority’s Over the Counter Bulletin Board (“OTCBB”) under the symbol “XPWR.” At present there is a very limited public market for our common stock.

 

The following table sets forth the range of high and low bid quotations for our common stock for each of the periods indicated as reported by the OTCBB. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

 

Fiscal Year Ending February 29, 2012
Quarter Ended  High $  Low $
 February 29, 2012   $0.60   $0.34 
 November 30, 2011   $0.79   $0.33 
 August 31, 2011   $0.92   $0.55 
 May 31, 2011   $2.21   $0.60 

 

Fiscal Year Ending February 28, 2011
Quarter Ended  High $  Low $
 February 28, 2011   $2.35   $1.19 
 November 30, 2010   $1.80   $1.01 
 August 31, 2010   $1.30   $0.50 
 May 31, 2010   $5.35   $1.00 

 

Penny Stock

 

The SEC has adopted rules that regulate broker-dealer practices in connection with transactions in penny stocks. Penny stocks are generally equity securities with a market price of less than $5.00, other than securities registered on certain national securities exchanges or quoted on the NASDAQ system, provided that current price and volume information with respect to transactions in such securities is provided by the exchange or system. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock, to deliver a standardized risk disclosure document prepared by the SEC, that: (a) contains a description of the nature and level of risk in the market for penny stocks in both public offerings and secondary trading; (b) contains a description of the broker's or dealer's duties to the customer and of the rights and remedies available to the customer with respect to a violation of such duties or other requirements of the securities laws; (c) contains a brief, clear, narrative description of a dealer market, including bid and ask prices for penny stocks and the significance of the spread between the bid and ask price; (d) contains a toll-free telephone number for inquiries on disciplinary actions; (e) defines significant terms in the disclosure document or in the conduct of trading in penny stocks; and (f) contains such other information and is in such form, including language, type size and format, as the SEC shall require by rule or regulation.

 

The broker-dealer also must provide, prior to effecting any transaction in a penny stock, the customer with (a) bid and offer quotations for the penny stock; (b) the compensation of the broker-dealer and its salesperson in the transaction; (c) the number of shares to which such bid and ask prices apply, or other comparable information relating to the depth and liquidity of the market for such stock; and (d) a monthly account statement showing the market value of each penny stock held in the customer's account.

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In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from those rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written acknowledgment of the receipt of a risk disclosure statement, a written agreement as to transactions involving penny stocks, and a signed and dated copy of a written suitability statement.

 

These disclosure requirements may have the effect of reducing the trading activity for our common stock. Therefore, stockholders may have difficulty selling our securities.

 

Outstanding Options, Warrants or Convertible Debt

 

As of May 20, 2012, we have issued warrants to purchase a total of 9,041,967 shares of our common stock. 1,775,225 of the warrants had an original strike price of $1.25, which was subsequently reset per the terms of that specific warrant to a new strike price of $0.50 per share and expire on May 14, 2013. None of our other warrants are subject to a price re-set. 3,188,967 warrants have a $1.50 per share strike price and expire March 18, 2016. 656,250 warrants have a $1.00 per share strike price and expire October 21, 2016. 3,419,525 warrants have a $0.80 per share strike price and expire February 27, 2017. The exercise price will be adjusted for any stock splits. In the case of the warrants that expire on May 14, 2013, the subsequent issuance of convertible securities with a strike price below $0.50 per share or the issuance of common stock at less than $0.40 per share would cause a re-set while the warrants remain outstanding.

 

As of May 25, 2012, we have also issued a total of 2,475,000 options to employees with an average strike price of $1.13 per share.

 

Holders of Our Common Stock

 

As of May 25, 2012, there were 26,547,881 shares of our common stock issued and outstanding held by 364 stockholders of record based upon a shareholder list provided by our transfer agent. Our transfer agent is Corporate Stock Transfer, Inc. located at 3200 Cherry Creek Drive South, Suite 430, Denver, CO 80209 and their telephone number is (303) 282-5800. We have not issued any shares of preferred stock.

 

Dividends

 

There are no restrictions in our articles of incorporation or bylaws that prevent us from declaring dividends.  The Nevada Revised Statutes, however, do prohibit us from declaring dividends where after giving effect to the distribution of the dividend:

 

1.  we would not be able to pay our debts as they become due in the usual course of business, or;

2.  our total assets would be less than the sum of our total liabilities plus the amount that would be needed to satisfy the rights of shareholders who have preferential rights superior to those receiving the distribution.

 

We did not declare any dividends in the fiscal year ended February 29, 2012, and we do not plan to declare any dividends in the foreseeable future.

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Securities Authorized for Issuance under Equity Compensation Plans

 

On May 25, 2011, we updated our existing stock option plan to provide for both qualified and non-qualified stock options equal to a maximum of fifteen percent (15%) of our total issued and outstanding shares of common stock as of May 20, 2011, which is equal to 2,823,199 total shares available to be optioned. Previously, the options available under our Plan were calculated as fifteen percent (15%) of our shares issued and outstanding as of July 1, 2010. As of May 25, 2012, we have granted a total of 2,475,000 options under the Plan.

 

Plan Category Number of Securities to be Issued upon Exercise of Outstanding Options Weighted-Average Exercise Price of Outstanding Options Number of Securities Remaining Available for Future Issuance Under Current Equity Compensation Plan
Issued Options 2,475,000(1) $1.13 348,199(2)

 

(1)Represents outstanding options issued (both vested and unvested) granted pursuant to our amended 2011 Equity Incentive Plan.
(2)Represents shares remaining available for future issuance under our 2011 Equity Incentive Plan.

 

Recent sales of unregistered securities

 

During the fiscal year ending February 29, 2012, the following equity-related transactions occurred concerning securities which were sold or issued by us without the registration of the securities under the U.S. Securities Act of 1933, as amended (the “Securities Act”) in reliance on exemptions from such registration requirements:

 

  • 3,277,637 common shares were sold to unrelated third parties in a private placement at $1.05 per share for net proceeds of $3,164,611.
  • 304,721 common shares were issued to acquire assets with a total cost of $450,000.
  • 466,310 common shares were sold to unrelated third parties in a private placement at an average of $1.02 per share for net proceeds of $474,000.
  • 1,250,000 common shares were sold to unrelated third parties in a private placement at an average of $0.80 per share for net proceeds of $1,000,000.
  • 625,000 common shares were sold to unrelated third parties in a private placement at an average of $0.40 per share for net proceeds of $250,000.
  • 3,714,050 common shares were sold to unrelated third parties in a private placement at an average of $0.40 per share for net proceeds of $1,485,620.
  • 479,880 common shares were issued for consulting services to multiple providers. The shares were valued at various market prices ranging between $0.49 and $1.05 per share. The combined value of the shares totaled $290,434.

 

None of the above listed private sales was a public offering based upon the following factors: (i) each issuance of securities was an isolated private transaction; (ii) a limited number of securities were issued to a limited number of offerees; (iii) there was no public solicitation; (iv) each offeree was an “accredited investor”, (v) the investment intent of the offerees; and (vi) the restriction on transferability of the securities issued. The proceeds from the private offerings will be used for working capital, general corporate expenses and acquisitions.

 

All the foregoing securities were issued in reliance upon exemption from registration pursuant to section 4(2) of the Securities Act and/or Rule 506 of Regulation D.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

Certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles. These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.

 

Results of Operations for the Years Ended February 29, 2012 and February 28, 2011

 

Fiscal year 2012, which closed February 29, represented the Company’s second year of operations within the wind industry. We grew revenues over 150% during the year from 2011 and accomplished a number of key objectives that help position the Company for continued rapid growth in Fiscal 2013. We also completed additional private equity offerings, totaling approximately $6.5 million, to support our progress. As we enter Fiscal 2013, the Company has experienced the strongest order rates in its history. In addition, we have lowered our operating expenses and have set a goal of reaching profitability during the current year. Our biggest financial challenges are very limited liquidity and insufficient working capital.

With the combination of an expanded dealer network along with our direct sales personnel, the Company is experiencing a rapid increase in orders for turbines and the pipeline of potential customers.   While it can be difficult to predict when a potential customer may purchase one of our turbine systems or when a newly closed customer will have their site ready for product delivery, we believe that the growing sales backlog and potential pipeline along with the greater overall interest in our products will contribute to higher revenues in fiscal year 2013.  Based on our recent trends and our forward outlook, we have set an objective of achieving $20 million in sales for the current fiscal year ending February 28, 2013. Potential risks to this outlook include: meeting our working capital needs to be able to fulfill the orders, closed customers taking longer to prepare their sites for installation, since we do not recognize revenue until we deliver the system to the customer; negative changes in available incentives for renewable energy; increased restrictions on obtaining permits; and a deterioration in sentiment toward wind energy.   With respect to incentives (a key driver in developed areas), there is a tendency for programs to be adjusted periodically. Our experience is that while one region may cut incentives, another area expands incentives. We would expect this ebb and flow of incentives around the world to continue and our global positioning positions us to take advantage of such trends.

 

As opposed to our wind turbine systems, our power efficiency products generally do not receive incentives and are not subject to lengthy permitting processes or installation needs. However, it does often take time to educate a potential customer about the benefits of this technology. We are experiencing a growing pipeline of activity in our power efficiency business and now have 35 dealers representing these products. As a result, we expect this business to experience rapid growth in Fiscal 2013, albeit from a low base.

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Income. We recorded $3,969,129 in revenues for the year ended February 29, 2012, compared with $1,489,061 in revenues for the year ended February 28, 2011. Our revenue growth during fiscal year 2012 was attributable to our efforts to expand our selling efforts globally of our wind turbine systems and our initial efforts with our new product line of power efficiency products.  Our turbine products represented the bulk of the revenue at 97%.  

 

Operating Expenses and Net Loss. Our Operating Expenses during fiscal year 2012 equaled $9,508,611, consisting of $1,523,001 in sales expense, $321,868 in marketing costs, $2,825,688 in R&D/Engineering expenses, and $4,838,054 in general and administrative expenses. Our total operating expenses included $643,086 of non-cash expenses in the form of expensed employee options and shares issued to consultants during the year for various services provided. We had other expenses of $37,428 for the period.  Therefore, we recorded a net loss of $8,612,853 for the fiscal year ended February 29, 2012. Our operating expenses during the fiscal year ended February 28, 2011 equaled $5,439,341, consisting of $629,580 in sales expense, $172,158 in marketing costs, $1,480,585 in R&D/Engineering expenses, and $3,157,018 in general and administrative expenses. We therefore, recorded a net loss of $5,097,640 for the fiscal year ended February 28, 2011.  The substantial increase in our net loss for the period ended February 29, 2012 over the same period in 2011 is attributable to the significant investments made regarding the launch of our upgraded 10kW turbine as well as expanding our business operations as a small wind turbine manufacturing and sales company.  

 

For fiscal year 2013, we anticipate a substantial reduction in operating expenses as compared to fiscal year 2012, primarily as a result of an expected reduction in R&D spending. Our R&D expense in the fiscal year ended February 29, 2012, was unusually high because of the upgrade of our 10kW wind turbine system and we do not anticipate that those extraordinary R&D expenses will recur in the current fiscal year. In addition, with an anticipated increase in sales for fiscal year 2013, we expect to significantly reduce our net losses.

 

Liquidity and Capital Resources

 

At February 29, 2012, we had $2,631,653 in current assets, consisting primarily of $236,682 in cash and cash equivalents, $1,036,778 in accounts receivable, $828,188 in inventories, and $334,361 in prepaid expenses. Our total current liabilities as of February 29, 2012 were $3,235,006. Thus, we have negative working capital of $603,353.  As of February 29, 2012 we had total assets of $4,853,553.

 

Cash Flows from Operating Activities. Operating Activities used $6,099,536 in cash for the fiscal year ended February 29, 2012. Our net loss of $8,612,853, our inventory purchasing of $325,640, an increase in accounts receivable of $426,081, and an increase in prepaid expenses of $87,805 were the primary components of our negative operating cash flow for the period. Operating activities used cash of $5,003,529 in the prior fiscal year.

 

Cash Flows from Financing Activities. Investing Activities used $244,431 in cash during the fiscal year ended February 29, 2012 as a result of the purchase of computers, machinery and equipment.  Investing activities used $400,988 in cash in the prior fiscal year.

 

Cash Flows from Financing Activities. Financing Activities generated $6,216,581 and $5,572,595 in cash for the fiscal year ended February 29, 2012 and February 28, 2011, respectively, consisting of proceeds from the issuance of new common shares and warrants and for fiscal year 2011 the issuance of a related party note payable in the principal amount of $197,500.

 

As of February 29, 2012, the ability to continue the implementation of our business plan over the next twelve months is contingent upon us either generating sufficient revenues from our ongoing operations to fund our business, obtaining additional financing, or some combination of revenues and additional financing. In particular, at present we lack sufficient working capital to be able to timely satisfy our current order backlog. Our management has made obtaining additional working capital, whether equity or debt capital, a high priority for the next twelve months as the lack thereof constitutes a significant present constraint on our ability to satisfy our existing backlog of orders or to grow further. In addition, we also lack sufficient working capital to meet all our current obligations to existing vendor trade payables and have delayed payments to most vendors. Three of our former vendors have filed suit seeking payment as a result of these delays.

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There can be no assurance that we will be able to acquire this working capital on favorable terms, or at all. If we are unable to do so, the execution of our business plan will be adversely impacted.

 

On May 25, 2012 we entered into a purchase order (PO) financing agreement which has provided $510,000 in debt financing, and which we will seek to increase up to a total of $750,000 in debt financing.  This agreement will enable us to receive a portion of the funds owed by customers in advance of when the customer is required to pay the balance (usually prior to shipment or delivery).  We will be required to submit customer orders as collateral for the funds received under the agreement.  Once the products are shipped and the end customer pays the remaining balance, those funds are then used to pay back the amount of the particular PO financed.  The amount repaid is then available for us to borrow against other of our accounts receivable. The agreement calls for a 12% annual interest rate on any funds outstanding.  As additional consideration for the financing agreement, we issued the financing parties warrants to purchase up to 100,000 shares of our common stock, exercisable at any time during three years from the date of issue, at an exercise price of $0.80 per share.   As orders continue to increase, we may seek to further increase the amount under this financing.  There are no guarantees we will be successful at increasing the amounts available under this PO Financing agreement. This summary description is qualified by the text of the agreement, attached hereto as an exhibit.

 

We do not anticipate paying dividends into the foreseeable future.

 

Off Balance Sheet Arrangements

 

As of May 25, 2012, there were no off balance sheet arrangements.

 

Acquisition Activities

 

On April 25, 2011, the Company entered into an Asset Purchase Agreement (the “Acquisition”) to acquire substantially all of the assets of Rochester Power Saver Inc., consisting primarily of intellectual property and product designs for surge suppression and power conditioning devices. Under the terms of the Acquisition, the Company paid 304,721 shares of its restricted common stock, $50,000 in cash and will pay a 5% royalty on gross profits to the founders up to a maximum of $150,000 over the next 24 months.

 

In additional to the Acquisition, the Company entered into a three year Consulting Agreement with Rochester Power Saver, Inc. and its principal, Mike Dana, to assist the Company in the manufacture, sale and continued development of the products the Company acquired from Rochester Power Saver, Inc. As compensation, the Company has agreed to pay $105,000 per year as a fee, in bi-weekly installments, plus sales commissions.  The Company terminated the consulting agreement on November 17, 2011.

 

Going Concern

 

Our financial statements have been prepared assuming that we will continue as a going concern which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. We have incurred a loss of $8,612,853 and have incurred cumulative losses of $13,979,668 for the fiscal year ended February 29, 2012, and expect to incur further losses in the development of our business and have been dependent on funding operations through the issuance of convertible debt and private sale of equity securities. These conditions raise substantial doubt about our ability to continue as a going concern. Management’s plans include continuing to finance operations through the private or public placement of debt and/or equity securities and the reduction of expenditures. However, no assurance can be given at this time as to whether we will be able to achieve these objectives. The financial statements do not include any adjustment relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

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Critical Accounting Policies

 

In December 2001, the SEC requested that all registrants list their most “critical accounting polices” in the Management Discussion and Analysis. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of a company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

 

Warranty Reserve – We currently reserve 2% on all new equipment sales to cover potential future warranty claims. There can be no assurance that such provision for estimated product warranty expenses will be sufficient to cover our warranty exposure in the future. We cannot ensure that our efforts to reduce our risk through warranty disclaimers will effectively limit our liability. Any significant incurrence of warranty expense in excess of estimates could have a material adverse effect on our business, including our operating results, financial condition and cash flow. In addition, if our warranty reserve is understated, it would affect (overstate) net income.

 

Revenue Recognition - The Company recognizes revenue when products are shipped from the factory and collection is reasonably assured. XZERES sells wind turbines to dealers and end users directly. Dealers are required to sign an agreement with XZERES that requires the dealer to sell one unit the first year and three units per year, thereafter. Dealers receive dealer pricing, a discount to the suggested retail price of the product. Products sold directly to end users are sold at the retail price. To date, the Company has not offered any other price concessions to its dealers, and has no post shipment obligations other than the warranty it provides.

 

Intellectual Property - Intellectual property consists of product designs with an infinite life. The Company annually evaluates the fair value of the intellectual property to determine whether events and circumstances warrant a revision to the fair value of these assets. If the intellectual property requires an impairment adjustment, it would affect the balance sheet and statement of operations as assets would be overstated and income would be either overstated or understated depending on a negative or positive adjustment.

 

Fair Value - Stock-based compensation is accounted for at fair value in accordance with SFAS No. 123 and 123 (R) (ASC 718). The Company’s financial instruments consist of cash and cash equivalents, loans to a related party, accrued expenses and credit card payables. The carrying amount of these financial instruments approximates fair value due either to length of maturity or interest rates that approximate prevailing market rates unless otherwise disclosed in these financial statements. If the fair values of our assets are overstated, it would affect the balance sheet and statement of operations as assets would be overstated and income would be overstated.

 

Recently Issued Accounting Pronouncements

 

None.

20

Item 8. Financial Statements and Supplementary Data

 

Index to Financial Statements Required by Article 8 of Regulation S-X:

 

Audited Financial Statements:

 

F-1 Report of Independent Registered Public Accounting Firm
F-2 Consolidated Balance Sheets as of February 29, 2012 and February 28, 2011;
F-3 Consolidated Statements of Operations and Comprehensive Loss for the Years ended February 29, 2012 and February 28, 2011;
F-4 Consolidated Statement of Stockholders’ Equity as of February 29, 2012;
F-5 Consolidated Statements of Cash Flows for the Years ended February 29, 2012 and February 28, 2011;
F-6 Notes to Consolidated Financial Statements
21

Silberstein Ungar, PLLC CPAs and Business Advisors

Phone (248) 203-0080

Fax (248) 281-0940

30600 Telegraph Road, Suite 2175

Bingham Farms, MI 48025-4586

www.sucpas.com

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors

XZERES Corp.

Portland, Oregon

 

We have audited the accompanying consolidated balance sheets of XZERES Corp. as of February 29, 2012 and February 28, 2011, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of XZERES Corp. as of February 29, 2012 and February 28, 2011 and the results of its operations and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States.

 

The accompanying consolidated financial statements have been prepared assuming that XZERES Corp. will continue as a going concern. As discussed in Note 18 to the financial statements, the Company has incurred losses from operations, has negative working capital, and is in need of additional capital to grow its operations so that it can become profitable. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with regard to these matters are described in Note 18. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

/s/ Silberstein Ungar, PLLC

Silberstein Ungar, PLLC

 

Bingham Farms, Michigan

June 12, 2012

F-1

XZERES CORP.

CONSOLIDATED BALANCE SHEETS

AS OF FEBRUARY 29, 2012 AND FEBRUARY 28, 2011

 

ASSETS  2012  2011
           
Current Assets          
Cash and cash equivalents  $236,682   $364,068 
Accounts receivable, net   1,036,778    633,669 
Subscription receivable   80,000    —   
Notes receivable - current portion   45,552    —   
Inventories   828,188    502,548 
Inventory deposits   70,092    40,066 
Prepaid expenses   334,361    110,281 
Total Current Assets   2,631,653    1,650,632 
           
Property and Equipment, net   347,007    375,115 
           
Other Assets          
   Notes receivable - net of current portion   43,309    —   
   Intellectual property   1,802,210    1,320,226 
   Website development costs, net   11,176    18,234 
   Deposits   18,198    18,198 
Total Other Assets   1,874,893    1,356,658 
           
TOTAL ASSETS  $4,853,553   $3,382,405 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
LIABILITIES          
Current Liabilities          
Accounts payable  $2,177,351   $600,451 
Due to factor - related party   303,806    0 
Accrued expenses   113,551    107,277 
Customer deposits   520,458    48,228 
Warranty reserve   87,018    16,601 
VAT & sales tax payable   32,822    —   
Notes payable - related party   —      97,500 
Notes payable   —      100,000 
Total Liabilities   3,235,006    970,057 
           
STOCKHOLDERS’ EQUITY          
Preferred stock, par $0.01, 5,000,000 shares authorized, no shares issued and outstanding   0    0 
Common stock, par $0.001, 100,000,000 shares authorized, 25,500,414 and 15,382,816 shares issued and outstanding, respectively   25,501    15,383 
Stock warrants   3,791,031    1,565,054 
Additional paid in capital   11,790,160    6,207,203 
Accumulated other comprehensive income (loss)   (8,477)   —   
Accumulated deficit   (13,979,668)   (5,375,292)
Total Stockholders’ Equity   1,618,547    2,412,348 
           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $4,853,553   $3,382,405 

 

See accompanying notes to consolidated financial statements.

F-2

XZERES CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

FOR THE YEARS ENDED FEBRUARY 29, 2012 AND FEBRUARY 28, 2011

 

   Year Ended
February 29, 2012
  Year Ended
February 28, 2011
           
GROSS REVENUES  $3,969,129   $1,489,061 
           
COST OF GOODS SOLD   3,035,943    1,099,456 
           
GROSS PROFIT   933,186    389,605 
           
OPERATING EXPENSES          
   General and administrative expenses   4,838,054    3,157,018 
Marketing   321,868    172,158 
   Sales expense   1,523,001    629,580 
   Engineering/R&D expense   2,825,688    1,480,585 
TOTAL OPERATING EXPENSES   9,508,611    5,439,341 
           
LOSS FROM OPERATIONS   (8,575,425)   (5,049,736)
           
OTHER INCOME (EXPENSE)   (28,951)   (47,904)
           
LOSS BEFORE PROVISION FOR INCOME TAXES   (8,604,376)   (5,097,640)
           
PROVISION FOR INCOME TAXES   0    0 
           
NET LOSS   (8,604,376)   (5,097,640)
           
OTHER COMPREHENSIVE LOSS          
Foreign currency translation adjustment gain (loss)   (8,477)   0 
           
COMPREHENSIVE LOSS  $(8,612,853)  $(5,097,640)
           
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING: BASIC AND DILUTED   19,845,813    12,447,305 
           
NET LOSS PER SHARE: BASIC AND DILUTED  $(0.43)  $(0.41)

 

 

See accompanying notes to consolidated financial statements.

F-3

XZERES CORP.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

AS OF FEBRUARY 29, 2012

 

   Shares  Amount  Warrants  Capital  Accumulated Other Comprehensive Income (Loss)  Accumulated Deficit  Total
                                    
Balance, February 28, 2010   4,682,602   $4,683   $   $40,641   $0   $(277,652)  $(232,328)
                                    
Correction of shares outstanding   3    —      —      —      —      —      —   
                                    
Shares issued for consulting services   688,375    689    —      453,299    —      —      453,988 
                                    
Shares issued in payment of an accrued expense   320,000    320    —      82,061    —      —      82,381 
                                    
Shareholder loans converted to shares   226,850    227    —      90,513    —      —      90,740 
                                    
Shares issued to acquire assets   3,192,150    3,192    —      1,273,669    —      —      1,276,861 
                                    
Shares issued in connection with private placements   6,272,836    6,272    1,565,054    4,393,327    —      —      5,964,653 
                                    
Equity issuance costs        —      —      (589,558)   —      —      (589,558)
                                    
Stock options issued to employees   —      —      —      463,251    —      —      463,251 
Net loss for the year ended February 28, 2011   —      —      —      —      —      (5,097,640)   (5,097,640)
                                    
Balance, February 28, 2011   15,382,816    15,383    1,565,054    6,207,203    0    (5,375,292)   2,412,348 
                                    
Shares issued in connection with private placements   9,332,997    9,333    1,633,464    5,008,342    —      —      6,651,139 
                                    
Equity issuance costs   —      —      207,854    (444,912)   —      —      (237,058)
                                    
Shares issued to acquire assets   304,721    305    —      449,695    —      —      450,000 
                                    
Shares issued for consulting services   479,880    480    —      289,954    —      —      290,434 
                                    
Warrants issued for advisory services   —      —      189,875    —      —      —      189,875 
Warrant modification   —      —      194,784    (194,784)        —      0 
                                    
Stock options issued to employees   —      —      —      474,662    —      —      474,662 
Cumulative translation adjustment   —      —      —      —      (8,477)   —      (8,477)
Net loss for the year ended February 29, 2012   —      —      —      —      —      (8,604,376)   (8,604,376)
                                    
Balance, February 29, 2012   25,500,414   $25,501   $3,791,031   $11,790,160   $(8,477)  $(13,979,668)  $1,618,547 

 

See accompanying notes to consolidated financial statements.

F-4

XZERES CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED FEBRUARY 29, 2012 AND FEBRUARY 28, 2011

 

   Year Ended
February 29, 2012
  Year Ended
February 28, 2011
Cash Flows from Operating Activities:          
Net loss for the year  $(8,612,853)  $(5,097,640)
Adjustments to Reconcile Net Loss to Net Cash Used in Operating Activities:          
Depreciation and amortization expense   83,889    45,676 
Allowance for doubtful accounts   22,972    0 
Share-based compensation   474,662    463,251 
Issuance of common shares for services   168,424    453,988 
Tooling write-off   61,762    0 
Loss on disposal of property and equipment   13,101    400 
Changes in Assets and Liabilities          
Accounts receivable   (426,081)   (633,669)
Subscription receivable   (80,000)   0 
Prepaid expenses   87,805    (110,281)
Inventory   (325,640)   (502,548)
Inventory deposit   (30,026)   (40,066)
Accounts payable   1,880,706    600,451 
Accrued expenses   6,274    (147,920)
Customer deposits   472,230    48,228 
VAT & sales tax payable   32,822    0 
Warranty reserve   70,417    (83,399)
Net Cash Used in Operating Activities   (6,099,536)   (5,003,529)
           
Cash Flows from Investing Activities:          
Proceeds from sale of property and equipment   2,640      
Net increase in notes receivable   (88,861)   0 
Acquisitions of property and equipment   (126,226)   (361,615)
Net assets acquired   (31,984)   0 
Capitalized software development   0    (21,175)
Deposit paid   0    (18,198)
Net Cash Used in Investing Activities   (244,431)   (400,988)
           
Cash Flows from Financing Activities:          
Proceeds from issuance of common shares   6,651,139    5,964,653 
Equity issuance costs   (237,058)   (589,558)
Loans from shareholder   (197,500)   197,500 
Net Cash Provided by Financing Activities   6,216,581    5,572,595 
           
Net Increase (Decrease) in Cash and Cash Equivalents   (127,386)   168,078 
           
Cash and Cash Equivalents - Beginning   364,068    195,990 
           
Cash and Cash Equivalents - Ending  $236,682   $364,068 
           
Supplemental Cash Flow Information:          
Cash paid for interest  $0   $0 
Cash paid for income taxes  $0   $0 


See accompanying notes to consolidated financial statements.

F-5

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Business

XZERES Corp. (“XZERES” and the “Company”) is located in Wilsonville, Oregon and was originally incorporated in the state of New Mexico in January of 1984.  The Company was engaged in the natural gas and asphalt businesses until 2007, at which time it liquidated its assets and operations and distributed the net proceeds to its shareholders after paying its debts.  On October 2, 2008, the Company re-domiciled from New Mexico to Nevada in anticipation of pursuing the wind turbine business. The Company commenced operations in the wind turbine business in the fiscal quarter ended May 31, 2010.

 

The Company formed two subsidiaries during the year ended February 28, 2011. XZERES Energy Services Corp. was incorporated in Nevada in January, 2011 and XZERES Wind Europe Limited was formed in Ireland in October, 2010.

 

The Company is in the business of designing, developing, and marketing small wind turbine systems and related equipment for electrical power generation, specifically for use in residential, small business, rural electric utility systems, other rural locations, and other infrastructure applications.  The Company employs proprietary technology, including power electronics, alternator design, and blade design to increase performance, reliability, and sound suppression.  The Company also works with manufacturers of inverters, lightning protection equipment and towers to integrate their equipment into the Company’s products.

 

Principles of Consolidation

The financial statements reflect the consolidated results of XZERES Corp. and its wholly-owned subsidiaries XZERES Energy Services Corp. (a Nevada corporation) and XZERES Wind Europe Limited (formed in Ireland). All material inter-company transactions have been eliminated in the consolidation.

 

Basis of Presentation

The accompanying annual financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission (“SEC”), and should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Form 10-K filed with the SEC as of and for the period ended February 29, 2012. In the opinion of management, all adjustments necessary in order for the financial statements to be not misleading have been reflected herein.

 

Accounting Basis

The Company uses the accrual basis of accounting and accounting principles generally accepted in the United States of America (“GAAP” accounting).  The Company has adopted a February 28 fiscal year end.

 

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

F-6

 

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Concentration of Credit Risks

The Company maintains its cash in institutions insured by the Federal Deposit Insurance Corporation (FDIC). All deposit accounts at FDIC-insured institutions are insured up to at least $250,000 per depositor. At certain times the Company’s balances exceed the insured amount.

 

Recent Accounting Pronouncements

The Company does not expect the adoption of recently issued accounting pronouncements to have a significant impact on the Company’s results of operation, financial position or cash flows.

 

Revenue Recognition

The Company recognizes revenue when products are shipped from the factory and collection is reasonably assured.

 

XZERES sells wind turbines and power efficiency products to dealers and end users directly. Dealers are required to sign an agreement with XZERES that requires the dealer to sell one unit the first year and three units per year, thereafter. Dealers receive dealer pricing, a discount to the suggested retail price of the product. Products sold directly to end users are sold at the retail price. To date, the Company has not offered any other price concessions to its dealers, and has no post shipment obligations other than the warranty it provides.

 

Cash and Cash Equivalents

XZERES considers all highly liquid investments with maturities of three months or less to be cash equivalents. The Company had cash of $236,682 and $364,068 at February 29, 2012 and February 28, 2011, respectively.

 

Advertising Costs

The Company’s policy regarding advertising is to expense advertising when incurred. XZERES incurred advertising expense of $130,022 and $70,849 during the fiscal years ended February 29, 2012 and February 29, 2012, respectively.

 

Fair Value of Financial Instruments

The Company’s financial instruments consist of cash and cash equivalents, accounts and notes receivable, inventories, inventory deposit, prepaid expenses, accounts payable, accrued expenses, customer deposits, and warranty reserve and taxes payable. The carrying amount of these financial instruments approximates fair value due either to length of maturity or interest rates that approximate prevailing market rates unless otherwise disclosed in these financial statements.

 

Dividends

The Company has not adopted any policy regarding payment of dividends. No dividends have been paid during any of the periods shown.

F-7

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Stock-Based Compensation

The Company accounts for employee stock-based compensation in accordance with the guidance of FASB ASC Topic 718, Compensation – Stock Compensation which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In 2012, the Company issued 775,000 options, net of terminations, vesting over periods ranging from immediate to five years. Stock-based compensation expense recognized in 2012 and 2011 totaled $472,662 and $463,251, respectively, for these options. Unrecognized expense of $1,158,977 remains to be recognized over the vesting terms of the options.

 

The Company follows ASC Topic 505-50, formerly EITF 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services,” for stock options and warrants issued to consultants and other non-employees. In accordance with ASC Topic 505-50, these stock options and warrants issued as compensation for services provided to the Company are accounted for based upon the fair value of the services provided or the estimated fair market value of the option or warrant, whichever can be more clearly determined. The fair value of the equity instrument is charged to expense over the period during which services are rendered.

 

Income Taxes

Income taxes are accounted for under the assets and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. It is the Company’s policy to classify interest and penalties on income taxes as interest expense or penalties expense. As of the fiscal year ended February 29, 2012, there have been no interest or penalties incurred on income taxes.

 

Basic Income (Loss) Per Share

Basic income (loss) per share is calculated by dividing the Company’s net loss applicable to common shareholders by the weighted average number of common shares during the period. Diluted earnings per share is calculated by dividing the Company’s net income available to common shareholders by the diluted weighted average number of shares outstanding during the year. The diluted weighted average number of shares outstanding is the basic weighted number of shares adjusted for any potentially dilutive debt or equity. Common share equivalents totaled 19,845,813 at February 29, 2012. Outstanding warrants and options were not included in the computation of diluted earnings per share for the fiscal year ended February 29, 2012, as their effect would have been anti-dilutive.

 

Reclassifications

Certain accounts and financial statement captions in the prior periods have been reclassified to conform to the current period financial statements.

F-8

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 2- ACQUISITION

 

On April 25, 2011, the Company entered into an Asset Purchase Agreement (the “Acquisition”) to acquire substantially all of the assets of Rochester Power Saver Inc., consisting primarily of intellectual property and product designs for surge suppression and power conditioning devices. Under the terms of the Acquisition, the Company paid 304,721 shares of its restricted common stock, $50,000 in cash for a total consideration of $500,000 and will pay a 5% royalty on gross profits to the founders up to a maximum of $150,000 over the next 24 months.

 

The purchase price was allocated as follows:

 

Description  Amount
Bank account  $2,686 
Accounts receivable   9,850 
Inventory and equipment   4,479 
Intellectual property – product designs   482,985 
Total  $500,000 

 

NOTE 3- ACCOUNTS RECEIVABLE

 

Accounts receivable is generated from sales of wind turbine systems and power efficiency products. At February 29, 2012, accounts receivable were substantially comprised of balances due from end customers and dealers.

 

As of the February 29, 2012, the Company has created an allowance for doubtful accounts equal to 2% of accounts receivable. While the Company has not experienced any customer defaults to date, it has elected to begin reserving for potential bad debts.

 

   February 29, 2012  February 28, 2011
Accounts receivable  $1,059,750   $633,669 
Less: Allowance for doubtful accounts   (22,972)   (0)
Accounts receivable, net  $1,036,778   $633,669 

 

Notes receivable is generated from sales of wind turbine systems. At February 29, 2012, notes receivable were comprised of balances due from end customers. The term of the notes receivable is seven years at an annual interest rate of 4.5%. Payments are received on a monthly basis.

 

NOTE 4 – PREPAID EXPENSES

 

Prepaid expenses consisted of the following:

 

   February 29, 2012  February 28, 2011
Software licenses  $38,299   $59,219 
Interest   0    11,687 
Consulting   296,062    39,375 
Total prepaid expenses  $334,361   $110,281 

 

 

F-9

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 5 – SUBSCRIPTION RECEIVABLE

 

The subscription receivable was collected on March 21, 2012.

 

NOTE 6 – INVENTORIES

 

Inventories consist of parts and supplies used in the development, manufacture and installation of wind turbines as well as finished goods. Inventories are stated at the lower of cost, computed using the average cost, or market.

 

Inventories consisted of the following:

 

   February 29, 2012  February 28, 2011
Finished goods  $690,682   $434,959 
Parts and supplies   137,506    67,589 
Total Inventories  $828,188   $502,548 

 

NOTE 7 – PROPERTY AND EQUIPMENT

 

Property and equipment are being depreciated over their estimated useful lives using the straight-line method of depreciation for book purposes.

 

   February 29, 2012  February 28, 2011
Furniture  $48,624   $38,907 
Computer equipment   171,318    123,922 
Shop machinery and equipment   232,100    224,748 
Vehicles   10,998    30,273 
Subtotal   463,040    417,850 
 Less: accumulated depreciation   (116,033)   (42,735)
Property and equipment, net  $347,007   $375,115 

 

Depreciation expense totaled $76,831 and $42,735 for the years ended February 29, 2012 and February 28, 2011, respectively.

 

NOTE 8 – INTELLECTUAL PROPERTY

 

Intellectual property consists of product designs with an infinite life, including the designs for the recently acquired power efficiency products.

 

The Company annually, or more frequently if events or changes indicate that the asset might be impaired, evaluates the fair value of the intellectual property to determine whether events and circumstances warrant a revision to the fair value of these assets.

F-10

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 9 – WEBSITE DEVELOPMENT COSTS

 

The Company has capitalized certain costs incurred in developing their website, which consisted of the following: 

 

   February 29, 2012  February 28, 2011
Website development costs  $21,175   $21,175 
Less: Accumulated amortization   (9,999)   (2,941)
   Website development costs, net  $11,176   $18,234 

 

The Company began amortizing the website costs, using the straight-line method over the estimated useful life of 3 years, once it was put into service in September 2010. Ongoing updates to the website are expensed as incurred.

 

Amortization expense totaled $7,058 and $2,941 for the years ended February 29, 2012 and February 28, 2011, respectively.

 

NOTE 10 – ACCRUED EXPENSES

 

Accrued expenses consisted of the following:

 

   February 29, 2012  February 28, 2011
Wages  $113,551   $107,277 
Total Accrued Expenses  $113,551   $107,277 

 

NOTE 11 – CUSTOMER DEPOSITS

 

A customer deposit of 50% of the selling price is sometimes made at the time a wind turbine is ordered. Deposits are reclassified to revenue once the unit is completed and delivered. Customer deposits were $520,458 at February 29, 2012 and $48,228 at February 28, 2011.

 

NOTE 12 – WARRANTY RESERVE

 

The Company accrues for estimated future warranty costs by establishing a reserve of 2% of fiscal year wind turbine sales and tower sales. The reserve is reduced over the five year warranty period as follows:

 

Year 1   0.1%
Year 2   0.3%
Year 3   0.4%
Year 4   0.5%
Year 5   0.7%
      
Total Warranty Reserve as  a % of Sales   2.0%

 

F-11

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 12 – WARRANTY RESERVE (CONTINUED)

 

Warranty reserve activity for the fiscal year ended February 29, 2012 and February 28, 2011 was as follows:

   February 29, 2012  February 28, 2011
Reserve balance, beginning of year  $16,601   $0 
Added to reserve   129,029    126,758 
Charges against reserve   (58,612)   (110,157)
    Reserve balance, end of year  $87,018   $16,601 

 

NOTE 13 - FACTORING AGREEMENT-RELATED PARTY

 

On August 25, 2011, the Company entered into a purchase and sale factoring agreement with a related party whereby the Company sells certain international accounts receivable to the factor. Under the terms of this agreement, the factor makes advances to the Company based on certain international accounts receivable. Interest is computed at 8% of the factored amount for the period the factored accounts receivable remain outstanding. Based on this arrangement, the Company is liable to the factor if the accounts receivable are not collected. Payments are due on the Note as receivables are collected. The agreement was initially due to expire on January 15, 2012, and was extended to December 15, 2012.

 

Factor expense charged to operations for the year ended February 29, 2012 was $3,806.

 

NOTE 14- NOTE PAYABLE-RELATED PARTY

 

On February 4, 2011, the Company entered into a short-term note payable from a related a related party. This note was subsequently repaid on March 28, 2011 out of the proceeds from the equity raise closed around that same time.

 

NOTE 15 – STOCKHOLDERS’ EQUITY

 

In October, 2008, the Company amended its Articles of Incorporation to increase the authorized common stock from 10,000,000 to 100,000,000 shares, and changed the par value of the common stock from no par to $0.001 par value.   The Company also reverse split the outstanding shares of common stock at a ratio of 7.7 to 1, leaving a total of 150,079 shares of common stock issued and outstanding following the split.

 

During the period ended February 28, 2009, the Company issued 4,501,899 shares of our common stock at a price of $0.01 per share. The Company conducted the offering as a private placement, exempt from the registration requirements of the Securities Act of 1933 under Section 4(2) and/or Rule 506 of Regulation D there under.

 

During the year ended February 28, 2010 an additional 30,545 shares of common stock were issued for cash totaling $305. There was also a correction to the shares outstanding of 82 additional shares during the fiscal year ended February 28, 2010.

F-12

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 15 – STOCKHOLDERS’ EQUITY (CONTINUED)

 

During the fiscal year ending February 28, 2011, the following share-related transactions occurred:

 

  • 200,000 common shares were issued for consulting services. The shares were valued at $.01 per share, which in the opinion of management, approximates the value of the services rendered.
  • 320,000 common shares were issued to an unrelated third party in payment of an accrued expense. The shares were valued at $82,381, representing the fair value of the accrued expense.
  • 226,850 common shares were issued in exchange for $90,740 of shareholder loans. The shares were issued at $.40 per share.
  • 3,192,150 common shares were issued to acquire assets with a total cost of $1,276,864. The shares were issued at $.40 per share.
  • 648,150 common shares were sold to unrelated third parties in a private placement at $.40 per share for total proceeds of $259,260.
  • 4,010,500 common shares were sold in a private placement at $1.00 per share for net proceeds of $3,611,949.
  • 488,375 common shares were issued for consulting services to multiple providers. The shares were valued at various market prices ranging between $0.75 and $1.50 per share. The combined value of the shares totaled $451,988. Of the total value, $358,296 was expensed during the fiscal year end February 28, 2011.
  • 1,614,186 common shares were sold to unrelated third parties in an ongoing private placement at $1.05 per share for net proceeds of $1,503,887.

During the fiscal year ending February 29, 2012, the following share-related transactions occurred:

 

  • 3,277,637 common shares were sold to unrelated third parties in a private placement at $1.05 per share for net proceeds of $3,164,611.
  • 304,721 common shares valued at $450,000 were issued to acquire assets.
  • 466,310 common shares were sold to unrelated third parties in a private placement at an average of $1.02 per share for net proceeds of $474,000.
  • 1,250,000 common shares were sold to unrelated third parties in a private placement at an average of $0.80 per share for net proceeds of $1,000,000.
  • 625,000 common shares were sold to unrelated third parties in a private placement at an average of $0.40 per share for net proceeds of $250,000.
  • 3,714,050 common shares were sold to unrelated third parties in a private placement at an average of $0.40 per share for net proceeds of $1,485,620.
F-13

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 15 – STOCKHOLDERS’ EQUITY (CONTINUED)

 

  • 479,880 common shares were issued for consulting services to multiple providers. The shares were valued at various market prices ranging between $0.49 and $1.05 per share. The combined value of the shares totaled $290,434. Of the total value, $168,454 was expensed during the year end February 29, 2012, and $121,980 was recorded as prepaid consulting and is being written off over the remaining terms of the contracts.

Total common shares issued and outstanding at February 29, 2012 were 25,500,414.

 

NOTE 16 – STOCK WARRANTS AND OPTIONS

 

The Company has granted 5,207,649 and 2,584,318 stock warrants in connection with private placements during fiscal 2012 and fiscal 2011, respectively and an additional 1,250,000 warrants in fiscal 2012 to advisors for a total of 9,041,967 warrants issued. The Company has accounted for these warrants as equity instruments in accordance with ASC 815-40, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and as such, were classified in stockholders’ equity. The Company has estimated the fair value of the warrants issued at $3,791,031 as of the grant dates using the Black-Scholes option pricing model.

 

The Company has also granted 775,000 and 1,700,000 stock options, net of terminations, to employees during fiscal 2012 and fiscal 2011, respectively. The Company has estimated the fair value of the options as of the grant dates at $2,096,889 using the Black-Scholes option pricing model. Compensation expense is being recognized over the vesting periods of the options which range from immediate vesting to vesting over four years. Fifteen percent of total issued and outstanding common shares are available for stock options.

 

Key assumptions used by the Company are summarized as follows:

 

    Private Placement Warrants   Employee Stock Options
Stock Price   $0.45-$1.05   $0.45-$2.20
Exercise Price   $0.80-$1.50   $.80-$1.25
Expected volatility   73.4% - 98%   73.4% - 98%
Risk-free rate   0.16% - 2.62%   2.0-3.37%
Vesting period   —     0-4 years
Expected term   3-5 years   7 years

 

A Stock Price of $0.45 to $1.05 was used in valuing the warrants and a range of $0.45-$2.20 for valuing the options. The stock price was based on the per share issuance prices from recent unrelated third party private placements. Volatility was computed based on the average volatility of similar companies in the wind turbine business. The risk-free interest rate is the Treasury Constant Maturity Rate on the date of grant for a period equivalent to the expected term of the instrument. The expected term is the same as the contractual term for the above valuations.

 

The warrants issued in connection with the private placement were valued at $3,601,156 and have been accounted for as an equity transaction. Options issued to employees are classified as compensation expense. Stock option expense recognized in net earnings amounted to $474,662 for the fiscal year ended February 29, 2012, and $463,251 for fiscal year ended February 28, 2011. As of February 29, 2012, there was $ 1,158,977 of unrecognized compensation expense related to non-vested share awards that we expect to recognize over a weighted average period of 3.5 years.

F-14

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 17 – INCOME TAXES

 

For the period ended February 29, 2012, Xzeres has incurred net losses from continuing operations and, therefore, has no tax liability. The net deferred tax asset generated by the loss carry-forward has been fully reserved. The cumulative net operating loss carry-forward is approximately $13,980,000 at February 29, 2012, and will expire beginning in the year 2029. The cumulative tax effect at the expected rate of 34% of significant items comprising our net deferred tax amount is as follows:

 

The provision for Federal income tax consists of the following:

 

   February 29, 2012  February 28, 2011
Federal income tax benefit attributable to:          
Current operations  $2,925,000   $1,733,000 
Less: valuation allowance   (2,925,000)   (1,733,000)
Net provision for Federal income taxes  $0   $0 

 

The cumulative tax effect at the expected rate of 34% of significant items comprising our net deferred tax amount is as follows:

 

   February 29,2012  February 28, 2011
Deferred tax asset attributable to:          
Net operating loss carryover  $4,753,000   $1,828,000 
Less: valuation allowance   (4,753,000)   (1,828,000)
Net deferred tax asset  $0   $0 

 

Due to the change in ownership provisions of the Tax Reform Act of 1986, net operating loss carry forwards of $13,980,000 for Federal income tax reporting purposes are subject to annual limitations. Should a change in ownership occur net operating loss carry forwards may be limited as to use in future years.

 

NOTE 18 – GOING CONCERN

 

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has sustained substantial losses since inception, has negative working capital, and is in need of additional capital to grow its operations so that it can become profitable.

 

In view of this matter, the ability of the Company to continue as a going concern is dependent upon growth of revenues and the ability of the Company to raise additional capital. Management believes that its successful ability to raise capital and increases in revenues will provide the opportunity for the Company to continue as a going concern.

F-15

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 19 – SUPPLEMENTAL NON-CASH INVESTING AND FINANCING INFORMATION

 

   2012  2011
Shares issued to acquire assets  $450,000   $1,276,861 
Warrants and options issued for prepaid consulting   311,885    0 
Modification of warrants   194,784    0 
Shares issued in payment of accrued expense   0    82,381 
Loans from shareholder converted to common shares   0    90,740 
Warrants issued in connection with private placements   1,633,464    1,565,054 
Warrants issued for equity issuance costs   207,854    0 

 

NOTE 20 – COMMITMENTS AND CONTINGENCIES

 

Operating Leases

The Company leases its office and manufacturing facilities under a lease which expires in July, 2013. The lease provides for the payment of taxes and operating costs, such as insurance and maintenance in addition to the base rental payments. The lease is renewable for an additional three year term. Aggregate minimum annual rental payments under the non-cancelable operating lease are as follows:

 

 Year ended February 29, 2012   $70,448 
 February 28, 2013    72,564 
 February 28, 2014    37,152 
 Total   $180,164 

 

Rent expense totaled $297,716 and $102,269 for the fiscal years ended February 29, 2012 and February 28, 2011, respectively.

 

Lawsuit

On Feb 22, 2012, we were served with a lawsuit by Hobbes & Towne Inc, an employee recruiting firm, seeking damages in the amount of $105,000. The suit was filed on February 22, 2012 in the Court of Common Pleas Chester County, PA. The dispute arises out of an employee recruiting contract for engineering staff. We have answered the suit and intend to vigorously contest the plaintiff’s claims.

 

NOTE 21 – SUBSEQUENT EVENTS

 

On May 25, 2012, the Company entered into a purchase order (PO) financing agreement which has provided $510,000 in debt financing, and which we will seek to increase up to a total of $750,000 in debt financing.  This agreement will enable us to receive a portion of the funds owed by customers in advance of when the customer is required to pay the balance (usually prior to shipment or delivery).  We will be required to submit customer orders as collateral for the funds received under the agreement.  Once the products are shipped and the end customer pays the remaining balance, those funds are then used to pay back the amount of the particular PO financed.  The amount repaid is then available for us to borrow against other of our accounts receivable.  The agreement calls for a 12% annual interest rate on any funds outstanding.  As additional consideration for the financing agreement, we issued the financing parties warrants to purchase up to 100,000 shares of our common stock, exercisable at any time during three years from the date of issue, at an exercise price of $0.80 per share.   As orders continue to increase, we may seek to further increase the amount under this financing.  There are no guarantees we will be successful at increasing the amounts available under this PO Financing agreement. 

F-16

 

XZERES CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEBRUARY 29, 2012

 

NOTE 21 – SUBSEQUENT EVENTS (CONTINUED)

 

On May 21, 2012, the Company was served with a lawsuit by XC Associates, Inc. (XC), which was filed in U.S. District Count, Northern District of New York on May 16, 2012. XC was a vendor we had prepared to bring on as a key supplier of blades in early 2011. After numerous delays in delivering initial product to us, we disengaged from XC as a potential supplier. XC initially claimed we owed a balance of approximately $50,000 for initial tooling. We refused the claim. XC has now filed a suit claiming lost business among other damages, totaling approximately $729,000. We intend to vigorously contest these claims, and may assert counterclaims seeking damages for business disruption caused by XC’s failure to perform.

 

In accordance with ASC Topic 855-10, the Company has analyzed its operations subsequent to February 29, 2012 to the date these financial statements were issued, and has determined that it does not have any material subsequent events to disclose in these financial statements other than those disclosed above.

F-17

Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

 

No events occurred that require disclosure under Item 307 and 308 of Regulation S-K during the fiscal year ending February 29, 2012.

 

Item 9A. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “1934 Act”), as of February 29, 2012, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act). This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer (our principal executive officer) and our Chief Financial Officer (our principal financial officer), who concluded, that as of February 29, 2012, our disclosure controls and procedures are effective.

 

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. This rule defines internal control over financial reporting as a process designed by, or under the supervision of, the Company’s Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that:

 

§Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
§Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
§Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
22

Limitations on the Effectiveness of Internal Controls

 

Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving our objectives and our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective at that reasonable assurance level.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the internal control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

 

Item 9B. Other Information

 

On May 25, 2012 we entered into a purchase order (PO) financing agreement which has provided $510,000 in debt financing, and which we will seek to increase up to a total of $750,000 in debt financing.  This agreement will enable us to receive a portion of the funds owed by customers in advance of when the customer is required to pay the balance (usually prior to shipment or delivery).  We will be required to submit customer orders as collateral for the funds received under the agreement.  Once the products are shipped and the end customer pays the remaining balance, those funds are then used to pay back the amount of the particular PO financed.  The amount repaid is then available for us to borrow against other of our accounts receivable. The agreement calls for a 12% annual interest rate on any funds outstanding.  As additional consideration for the financing agreement, we issued the financing parties warrants to purchase up to 100,000 shares of our common stock, exercisable at any time during three years from the date of issue, at an exercise price of $0.80 per share.   As orders continue to increase, we may seek to further increase the amount under this financing.  There are no guarantees we will be successful at increasing the amounts available under this PO Financing agreement. This summary description is qualified by the text of the agreement, attached hereto as an exhibit.

 

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

 

The following information sets forth the names, ages, and positions of our current directors and executive officers as of May 25, 2012.

 

Name  Age  Position(s) and Office(s) Held
Frank Greco   57   Chief Executive Officer, President, Director
Steve Shum   41   Chief Financial Officer and Director
David Baker   43   Director

 

Set forth below is a brief description of the background and business experience of each of our current executive officers and directors.

23

Frank Greco joined us as our Chief Executive Officer and a member of our Board of Directors on August 25, 2010. Effective May 3, 2011, Mr. Frank Greco also assumed the office of president. Mr. Greco is responsible for all aspects of XZERES Corp.’s business and his initial focus will be on domestic and global sales growth, product portfolio expansion and optimization of products and channels. We first hired Mr. Greco July 1, 2010, to serve as our executive vice president of business development. Previously, from April 2004 to March 2010, Mr. Greco was Chief Executive Officer and a Director of Southwest Windpower Inc., a manufacturer of small wind turbines competitive with our smaller product, 2.5kW wind turbine system. As CEO of Southwest Windpower, Mr. Greco oversaw all aspects of the business, including operations, material planning, marketing and sales, plant engineering and human resources. It is Mr. Greco’s general industry experience and his experience while serving as CEO of Southwest Windpower, Inc., including his participation its launch of two new product platforms, its establishment of European operations and a joint venture in China, and its establishment of domestic and international patents and trademarks, that led us to conclude that Mr. Greco should be our CEO and a director. Mr. Greco holds bachelor’s degrees in Business Administration & Behavioral Science, awarded by the University of Illinois in 1984, and in Plant Engineering, awarded by St. Joseph’s College in 1988.

 

David N. Baker joined our Board of Directors as its Chairman on March 26, 2010 and is responsible for working with our Board and management on various strategic initiatives. Mr. Baker has extensive experience in financing start-up companies. He has led, as an investment principal, originating, structuring and investing in reverse merger, self registration and other non-traditional or alternative public transactions for companies in the asset recovery, consumer products, solar integration and technology, gaming, broadcast media, e-commerce, information services, video content, mobile hardware, video game, Internet media, information technology, automotive and biotechnology sectors. In addition, his career has included positions as principal and owner in two hedge funds, other investment management capacities, technology and healthcare merchant banking, proprietary trading and securities brokerage.

 

Since 2007, Mr. Baker has also been employed as the Managing Member of Cascade Summit, LLC, a private advisory firm focused upon advising small and micro-capitalization public and private companies regarding capital strategy, business strategy and restructurings, with an emphasis on alternative going public transactions. Mr. Baker is also the CEO of Coin Mercantile, Inc., a private company engaged in the retail and wholesale global trade of precious metal modern world coins, which he co-founded in 2009. Mr. Baker is also a non-managing principal of Core Fund Management, L.P., which is the general partner of Core Fund, L.P. a special situations, non-correlated, hedge fund that focuses on making investments in early stage, micro and small capitalization companies, across all sectors. Mr. Baker founded Core Fund, L.P. and Core Fund Management, L.P. in 2003 and was active in its management until 2007, when he stepped aside in favor of Mr. Steven Shum. Mr. Baker earned a B.A. in 1989 from the University of Colorado and received a J.D. in 1992 from Golden Gate University, with a focus on securities.

 

There was no particular or specific experience, qualification, attribute or skill that led us to the conclusion that Mr. Baker should serve as a member of our board of directors.

 

Steven Shum is our CFO, corporate secretary, and a member of our Board of Directors. Mr. Shum first joined us October 21, 2008. From October 2008 through March 26, 2010, Mr. Shum was our sole director, at which time Mr. David Baker joined our board. From October 21, 2008, through April 12, 2010, Mr. Shum was our sole officer, at which time he resigned all offices except for his current roles as CFO and corporate secretary.

 

Since 2004, Mr. Shum has been a Managing Principal of Core Fund Management, L.P. and the Fund Manager of Core Fund, L.P. Mr. Shum's tenure includes 15 years in the financial services industry where he has an extensive background in equity research, macroeconomics, and management. Prior to joining Core Fund, he spent four years as founder and Executive Vice President of Revere Data, which created a patented equity research application. In addition to Revere Data, from 1999 to 2003, Mr. Shum was the senior investment analyst and co-portfolio manager with DNB Capital Management. Mr. Shum earned a BS in both Finance and General Management from Portland State University, awarded in 1992.

 

There was no particular or specific experience, qualification, attribute or skill that led us to the conclusion that Mr. Shum should serve as a member of our board of directors.

24

Directors

 

Our bylaws authorize no less than one (1) director. We currently have three Directors.

 

Family Relationships

 

There are no family relationships between or among the directors, executive officers or persons nominated or chosen by the Company to become directors or executive officers.

 

Involvement in Certain Legal Proceedings

 

To the best of our knowledge, during the past 10 years, none of the following occurred with respect to our present or former director, executive officer, or employee: (1) any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time; (2) any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); (3) being subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his or her involvement in any type of business, securities or banking activities; and (4) being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.

 

Term of Office

 

Our Directors are appointed for a one year term to hold office until the next annual general meeting of our shareholders or until removed from office in accordance with our bylaws. Our officers are appointed by our board of directors and hold office until removed by the board.

 

Committees of the Board

 

Audit Committee

 

We do not have a separately-designated standing audit committee. The entire Board of Directors performs the functions of an audit committee, but no written charter governs the actions of the Board when performing the functions of what would generally be performed by an audit committee. The Board approves the selection of our independent accountants and meets and interacts with the independent accountants to discuss issues related to financial reporting. In addition, the Board reviews the scope and results of the audit with the independent accountants, reviews with management and the independent accountants our annual operating results, considers the adequacy of our internal accounting procedures and considers other auditing and accounting matters including fees to be paid to the independent auditor and the performance of the independent auditor.

 

Compensation Committee

 

We do not have a separately-designated standing compensation committee. The entire Board of Directors performs the functions of a compensation committee. During the fiscal year ended February 29, 2012, all our directors during that period participated in all deliberations concerning executive officer compensation. Mr. Baker joined our board on March 26, 2010, and has participated in all deliberations concerning executive officer compensation since that date. Mr. Greco joined our board on August 25, 2010, and has participated in all deliberations concerning executive officer compensation since that date.

 

Code of Ethics

 

As of February 29, 2012, we had not adopted a Code of Ethics for Financial Executives, which would include our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions.

25

Item 11. Executive Compensation

 

On August 25, 2010, Frank Greco became our Chief Executive Officer pursuant to a written employment agreement dated August 25, 2010. As our President and Chief Executive Officer, Mr. Greco is responsible for all aspects of XZERES Corp.’s business and his initial focus will be on domestic and global sales growth, product portfolio expansion and optimization of products and channels.

 

Our written employment agreement with Frank Greco provides for an initial term of approximately four years and further provides for a compensation package that includes a base salary at an initial annual rate of Two Hundred Thousand Dollars ($200,000), payable bi-weekly, plus increases and performance bonuses to be awarded in the event the Company hits certain milestones as stated in the written agreement. On or about March 1, 2012 we amended the agreement to extend the initial term for an additional two years, which provides for an increase in the annual base salary to Two Hundred Thirty-Seven Thousand and Nine Hundred Dollars ($237,900), payable bi-weekly, plus performance bonuses in those additional two years (Fiscal 2016 and 2017). We also granted Mr. Greco a qualified option to purchase a total of 320,000 shares of our common stock at a strike price of $1.25. This option vests at a rate of 25% per year, starting on the first anniversary of the grant. We have also granted Mr. Greco a non-qualified option to purchase an additional 655,000 shares of our common stock at a strike price of $1.25 per share. The non-qualified option as to 55,000 shares vests at a rate of 25% per year, starting on the first anniversary of the grant. The non-qualified option as to the remaining 600,000 shares vests at a rate of 150,000 per year at the end of each of the next four fiscal years, starting with February 29, 2012, but only in the event the Company achieves certain performance milestones as stated in the written Stock Option Agreement. Also on August 25, 2010, we granted Mr. Greco a second qualified option to purchase 20,000 shares of our common stock at a strike price of $1.25 per share, which option vests immediately. On May 25, 2011, we granted Mr. Greco options to purchase a total of 125,000 shares of our common stock at an exercise price of $1.25 per share, all of which vested immediately, and which will expire if not exercised on or before five years from the date of grant.

 

Mr. Greco is also entitled to other ancillary employment benefits such as vacation time and health insurance as stated in his written employment agreement. We also agreed to make a one-time contribution to Mr. Greco’s relocation, personal living and personal travel expenses in the amount of Ten Thousand ($10,000) Dollars.

26

Summary Compensation Table

 

The table below summarizes all compensation awarded to, earned by, or paid to each named executive officer for our last two completed fiscal years for all services rendered to us.

 

SUMMARY COMPENSATION TABLE 

 

Name and

principal position

Year

Salary

($)

Bonus

($)

Stock Awards

($)

Option

Awards

($)3

Non-Equity

Incentive Plan

Compensation

($)

Nonqualified

Deferred

Compensation

Earnings ($)

All Other

Compensation

($)

Total

($)

Frank Greco, CEO, President and Director1

2012

2011

$200,466

$123,540

39,600

0

0

0

$195,924

$106,074

0

0

0

0

0

0

$435,990

$229,614

S. Clayton Wood Former Executive Vice President of Operations

2012

2011

$82,853

$137,642

0

0

0

0

$0

$53,978

0

0

0

0

0

0

$82,853

$191,620

Steven Shum, CFO and Director

2012

2011

$144,000

$42,000

0

0

0

0

$0

$164,280

0

0

0

0

0

0

$144,000

$206,280

David Baker, Chairman2

2012

2011

$195,000

$113,100

39,600

0

0

0

$211,803

$113,261

0

0

0

0

0

0

$446,403

$226,361

 

(1) Mr. Greco joined our Board of Directors on August 25, 2010.
(2) Mr. Baker joined our Board of Directors as its Chairman on March 26, 2010. 
(3) The Company has estimated the fair value of the options as of the grant dates using the Black-Scholes option pricing model. Compensation expense is being recognized over the vesting periods of the options which range from immediate vesting to vesting over four years.  The calculations and underlying assumptions are found at note 16 to our audited financial statements.

 

Narrative Disclosure to the Summary Compensation Table

 

The Board of Directors, in its sole discretion, may award bonuses to our employees, including officers and directors, from time to time.

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Outstanding Equity Awards At Fiscal Year-end Table

 

The table below summarizes all unexercised options, stock that has not vested, and equity incentive plan awards for each named executive officer outstanding as of the end of our last completed fiscal year.

 

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 

 

OPTION AWARDS

Name

 

 

 

Number of

Securities

Underlying

Unexercised

Options

(#)

Exercisable

Number of

Securities

Underlying

Unexercised

Options

Unexercisable

Equity

Incentive

 Plan

Awards:

Number of

Securities

Underlying

Unexercised

Unearned

Options

(#)

Option

Exercise

 Price

 ($)

Option

Expiration

Date 

Frank Greco 388,750 0 606,250 $1.25 August 25, 2015
David Baker 633,333 0 66,667 $1.25 July 15, 2015
Steven Shum 200,000 0 0 $0.85 March 25, 2015

 

Stock Option Grants

 

On March, 25, 2010, we granted Steven Shum, our current CFO, corporate secretary and member of our Board of Directors, options that will allow him to purchase up to 200,000 shares of our common stock at an exercise price of $0.85 per share.  The options are fully vested.

 

On July 15, 2010, we entered into a written employment agreement with David N. Baker, chairman of our board of directors, which includes options to purchase up to 200,000 shares of our common stock.  The option to purchase 100,000 shares is fully vested and is exercisable at $1.10 per share.  The option to purchase the remaining 100,000 shares vests one-third per year over each of the next three years and is exercisable at $1.00 per share.  All of the options granted to Mr. Baker will expire if not exercised within five years. On May 25, 2011, we granted Mr. Baker options to purchase a total of 500,000 shares of our common stock at an exercise price of $1.25 per share, 277,777 of which vested upon grant and the remaining 222,223 of which will vest on May 26, 2012, which options will expire if not exercised on or before five years from the date of grant.

 

On August 25, 2010, we executed a written stock option agreement that granted Mr. Greco a qualified option to purchase a total of 320,000 shares of our common stock at a strike price of $1.25.  This option vests at a rate of 25% per year, starting on the first anniversary of the grant.  We have also granted Mr. Greco a non-qualified option to purchase an additional 655,000 shares of our common stock at a strike price of $1.25 per share.  The non-qualified option as to 55,000 shares vests at a rate of 25% per year, starting on the first anniversary of the grant.  The non-qualified option as to the remaining 600,000 shares vests at a rate of 150,000 per year at the end of each of the next four fiscal years, starting with February 29, 2012, but only in the event the Company achieves certain performance milestones as stated in the written Stock Option Agreement.  Also on August 25, 2010, we granted Mr. Greco a second qualified option to purchase 20,000 shares of our common stock at a strike price of $1.25 per share, which option vests immediately. On May 25, 2011, we granted Mr. Greco options to purchase a total of 125,000 shares of our common stock at an exercise price of $1.25 per share, all of which vested immediately, and which will expire if not exercised on or before five years from the date of grant.

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Director Compensation

 

The table below summarizes all compensation of our directors as of the fiscal year ended February 29, 2012.

 

DIRECTOR COMPENSATION 

 

Name 

Fees Earned or

Paid in

Cash

($)

 

Stock Awards

($)

 

Option Awards

($)

 

Non-Equity

Incentive

Plan

Compensation

($)

 

Non-Qualified

Deferred

Compensation

Earnings

($)

 

All

Other

Compensation

($)

 

Total

($)

Frank Greco  0  0  0  0  0  0  0
Steven Shum  0  0  0  0  0  0  0
David Baker  0  0  0  0  0  0  0

 

Narrative Disclosure to the Director Compensation Table

 

Our directors do not currently receive any compensation from the Company for their service as members of the Board of Directors of the Company.  

 

On July 15, 2010, we entered into a written employment agreement with David N. Baker.  Mr. Baker is the chairman of our board of directors. We paid Mr. Baker the sum of $12,000 per month from April 2010 through December 2011 pursuant to that written agreement, which payment increased to $15,000 per month effective January 1, 2011.  Mr. Baker is also eligible for any performance bonus that our board may, in its discretion, determine to award him.  For Fiscal 2013, we amended the agreement, which provides for an increase in the monthly base salary to $19,825. We also granted Mr. Baker options to purchase up to 200,000 shares of our common stock.  The option to purchase 100,000 shares is fully vested and is exercisable at $1.10 per share.  The option to purchase the remaining 100,000 shares vests one-third per year over each of the next three years and is exercisable at $1.00 per share.  All of the options granted to Mr. Baker will expire if not exercised within five years. On May 25, 2011, we granted Mr. Baker options to purchase a total of 500,000 shares of our common stock at an exercise price of $1.25 per share, 277,777 of which vested upon grant and the remaining 222,223 of which will vest on May 26, 2012, which options will expire if not exercised on or before five years from the date of grant.

 

On March, 25, 2010, we granted Steven Shum, our current CFO, corporate secretary and member of our Board of Directors, options that will allow him to purchase up to 200,000 shares of our common stock at an exercise price of $0.85 per share.  The options are fully vested.

 

Mr. Shum continues to serve as our interim CFO until such time we find a permanent CFO. We did not meet our original expectation of hiring a permanent CFO in the Fiscal year 2012, but we anticipate completing the search in the current fiscal year. We do not have a written employment or consulting agreement with Mr. Shum, but he has agreed to remain our interim CFO until the permanent replacement is hired. In late 2010, we agreed to partially compensate Mr. Shum in cash of not more than $12,000 per month for his continued service as our interim CFO, which we expect to continue until the replacement is hired.

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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The following table sets forth, as of May 29, 2012, the beneficial ownership of our common stock by each executive officer and director, by each person known by us to beneficially own more than 5% of the our common stock and by the executive officers and directors as a group. Except as otherwise indicated, all shares are owned directly and the percentage shown is based on 26,547,881 shares of common stock issued and outstanding on May 29, 2012:

 

 

Name and address of beneficial owner (1)

  Title of Class  Amount of beneficial ownership  Percent of class
Executive Officers & Directors:

David Baker4

PO Box 16282201

Sioux Falls, SD 57186

   Common    4,019,520    14.79%

Steven Shum2,3

9025 SW Hillman, Suite 3126

Wilsonville, OR 97070

   Common    3,645,888    13.71%

Frank Greco5

9025 SW Hillman, Suite 3126

Wilsonville, OR 97070

   Common    388,750    1.44%
Total of All Directors and Executive Officers:   Common    8,54,158    29.00%
                
More Than 5% Beneficial Owners:               

Suncreek, LLC 6

10785 W Twain Ave, Suite 200

Las Vegas, NV 89135

   Common    6,401,785    21.70%

Core Fund, L.P.

1500 SW 1st Ave. Suite 910

Portland, OR 97201

   Common    2,941,382    11.08%

 

 

 

1. As used in this table, "beneficial ownership" means the sole or shared power to vote, or to direct the voting of, a security, or the sole or shared investment power with respect to a security (i.e., the power to dispose of, or to direct the disposition of, a security). In addition, for purposes of this table, a person is deemed, as of any date, to have "beneficial ownership" of any security that such person has the right to acquire within 60 days after such date.

2. Includes the 2,941,382 shares held by Core Fund, L.P.  Mr. Steven Shum is the manager of Core Fund, L.P. and, in that capacity, is the sole beneficial owner of the shares.  Mr. David Baker is a passive non-managing member and principal of Core Fund Management, L.P., the general partner and Fund Manager to Core Fund, L.P.

3. On March 25, 2010, as compensation for services rendered, we awarded Mr. Shum fully vested options to purchase up to 200,000 shares of our common stock, all of which are fully vested and, therefore, may be exercised immediately.

4. On July 15, 2010, we entered into a written employment agreement with David N. Baker, chairman of our board of directors, which includes options to purchase up to 200,000 shares of our common stock, of which 133,333 are now fully invested and, therefore may be exercised immediately.   On May 25, 2011, we granted Mr. Baker options to purchase a total of 500,000 shares of our common stock at an exercise price of $1.25 per share, of which are now fully vested and, therefore, may be exercised immediately. Subject to shareholder approval of a revised option plan to be voted on at the next annual meeting, on May 20, 2012, we have intend to grant Mr. Baker options to purchase a total of an additional 975,000 shares of our common stock on precise terms yet to be determined.

5. On August 25, 2010, we entered into agreements with Frank Greco, CEO and member of our board of directors, which include options to purchase up to 995,000 shares of our common stock, 263,750 of which are fully vested and, therefore, may be exercised immediately. On May 25, 2011, we granted Mr. Greco options to purchase a total of 125,000 shares of our common stock, all of which are fully vested and, therefore, may be exercised immediately.

6. Includes warrants to purchase 2,950,595 shares at various prices ranging from $0.80 per share to $1.50 per share. 

30

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

Except as disclosed herein, none of our directors or executive officers, nor any proposed nominee for election as a director, nor any person who beneficially owns, directly or indirectly, shares carrying more than 5% of the voting rights attached to all of our outstanding shares, nor any members of the immediate family (including spouse, parents, children, siblings, and in-laws) of any of the foregoing persons has any material interest, direct or indirect, in any transaction since our incorporation or in any presently proposed transaction which, in either case, has or will materially affect us. We currently do not have any independent directors on our board.

 

We and certain members of senior management have entered into employment agreements and option agreements. The terms and conditions of these agreements are more fully described in the section of this annual report titled “Executive Compensation” above.

 

The tenant improvement portion of the lease is guaranteed by one of our shareholders, Core Fund, L.P. Although we are not required to do so, we have agreed to replace this guarantee with a bank letter of credit, but we have not done so as of May 20, 2012. We expect to replace the guarantee with a letter of credit by the end of the July 2012.

 

Item 14. Principal Accounting Fees and Services

 

Below is the table of Audit Fees (amounts in US$) billed by our auditor in connection with the audit of the Company’s annual financial statements for the years ended:

 

Financial Statements for the
Year Ended
  Audit Services  Audit Related Fees  Tax Fees  Other Fees
 February 29, 2012   $33,000    —      44,800    —   
 February 28, 2011   $12,000    —      43,500    —   

 

PART IV

 

Item 15. Exhibits, Financial Statements Schedules

 

(a) Financial Statements and Schedules

 

The following financial statements and schedules listed below are included in this Form 10-K.

 

Financial Statements (See Item 8)

 

(b) Exhibits

 

Exhibit Number Description
3.1 Articles of Incorporation (1)
3.2 Bylaws(1)
10.1 First Amendment to Employment Agreement for Frank Greco, dated March 28, 2012
10.2 Purchase Order Financing Agreement, dated May 25, 2012
31.1 Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(1) Incorporated by reference to Registration Statement on Form S-1 filed

31

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

XZERES Corp.

 

By: /s/ Frank Greco
Frank Greco 
Title: President, Chief Executive Officer, Principal Executive Officer and Director

Date: June 13, 2012

 

By: /s/ Steven Shum
Steven Shum 
Title: Chief Financial Officer, Principal Financial Officer, Principal Accounting Officer and Director
Date:   June 13, 2012

  

 

32