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.

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