11th Aug 2006 07:01
Enova Systems, Inc.11 August 2006 For Immediate release 11th of August 2006 Enova Systems INC., (OTCBB: ENOV and AIM: ENV and ENVS), a leading developer andmanufacturer of electric, hybrid and fuel cell digital power management systems,announces quarterly results for the period ended June 30, 2006 Revenue Outlook While customer relationships have continued to move more slowly than originallyanticipated, we believe that commercial relationships will continue to developand will lead to further orders in the second half of 2006 and beyond. Theseorders are expected to exceed the total revenues from the first half of theyear. The revenue outlook for 2006 will depend on securing a number of ordersduring the third quarter of 2006, for which proposals have recently beensubmitted as well as securing further orders where commercial relationships arecurrently at a less developed stage. Highlight • Net revenues for the six months ended June 30, 2006 were $760,000 ascompared to $2,014,000 for the corresponding period in 2005. Net revenues were$452,000 for the three months ended June 30, 2006 as compared to $1,322,000 forthe same period in 2005. • Net production sales for the six months ended June 30, 2006decreased to $341,000 from $1,309,000 in the same period in 2005. Net productionsales for the three months ended June 30, 2006 decreased to $291,000 from$817,000 for the corresponding period in 2005. • Research and development revenues decreased to $419,000 in the firstsix months of 2006, from $705,000 during the same period in 2005. For the threemonths ending June 30, 2006, research and development revenues decreased to$161,000 from $505,000 for the same period in 2005. For further information please contact: Enova SystemsEdwin Riddell, Chief Executive Officer +1(310) 527-2800 x105 Corinne Bertrand, Chief Financial Officer +1(310) 527-2800 x103 InvestecAndrew Chen +44 (0) 207 597 5066 Global Equity IR +44-(0) 79 5620 6270Amira Bardichev RESULTS OF OPERATIONS • In the first quarter and six months of 2006, our revenues derivedmostly from production type contracts with Hyundai Motor Corporation and theState of Hawaii. The decrease in revenues in the first half of 2006 from thefirst half of 2005 was a result of contracts that were completed or nearcompletion in 2005. • During the first six months of 2006, we focused on establishing newcustomer relationships and submitting proposals. As a result, we have beenawarded contracts with, but have not yet recognized revenues from, IC Corp. fornineteen school buses, Phoenix Motor Car for ten sport utility trucks and FordMotor Company for four High Voltage Energy Converters (HVEC). We have additionalproposals with other potential customers who have not yet made final decisions. • Cost of revenues consists of component and material costs, directlabour costs, integration costs and overhead related to manufacturing ourproducts. Product development costs incurred in the performance of engineeringdevelopment contracts for the U.S. Government and private companies are chargedto cost of sales for this contract revenue. • Cost of revenues for the three and six months ended June 30, 2006decreased $110,000 and $220,000, or 14% and 11% respectively from $1,024,000 and$1,594,000 respectively, for the same period in 2005. • As a percentage, cost of revenues did not decrease in the sameproportion as sales when comparing the three and six months ended 2006 to theequivalent period in 2005. This is primarily attributable to continued productdevelopment initiatives. We anticipate there may be an increase in cost of salesfor products due to potential weakening of the U.S. dollar. While we do nottransact in foreign currencies, our suppliers are overseas and may raise ourinput prices in response to a weaker value of our functional currency, which isthe U.S. Dollar. • Internal research, development and engineering expenses increased inthe three and six months ended June 30, 2006 to $308,000 and $632,000 ascompared with $178,000 and $395,000 respectively, for the same period in 2005.We continue to develop several new products such as our post transmissionparallel hybrid drive system and enhancements to our diesel generator set whichaccount for a majority of the increase during the first quarter and half of 2006when compared to the same period in 2005. We continue to allocate increasedresources to the development of our parallel hybrid drive systems, upgradedproprietary control software, enhanced DC-DC converters and advanced digitalinverters and other power management firmware. • Selling, general and administrative expenses increased by $801,000to $1,959,000 for the six months ended June 30, 2006 from the previous year'scomparable reporting period. For the three months ended June 30, 2006, selling,general and administrative expenses increased by $485,000 to $1,035,000 whencomparing with the three months ended June 30, 2005. The increase during thefirst half and quarter of 2006 when compared to the same periods in 2005 isattributable to additional costs associated with marketing, engineering andtechnical staff. • We also have experienced increased expenditures related to stricterregulatory oversight in conjunction with the Sarbanes-Oxley Act of 2002. We haveincurred additional cost in our efforts to remediate certain materialweaknesses, as described in Item 4 "Controls and Procedures." Furthermore, weare in the process of upgrading our accounting and reporting software, thusfurther contributing to the general and administrative cost increase. Managementbelieves that as we move toward sustainable production, our cost structure willbecome more efficient. • Interest income/expense increased by $223,000 for the three monthsended June 30, 2006, up from the same period in 2005, and now shown net asinterest income. The increase in the three months ended June 30, 2006 isillustrated as the net effect of interest income earned on cash and certificatesof deposit, and regular interest expense recognized on the remaining debtoutstanding. For the six months ended June 30, 2006, interest income/expenseincreased by $470,000, primarily related to the settlement of portions of ournote payable to the Credit Managers Association of California. • We incurred net losses of $1,670,000 and $1,526,000 for the threeand six months ended June 30, 2006 compared to a loss of $528,000 and $1,340,000for the three and six months ended June 30, 2005, respectively. The increase innet loss for the three and six months ended 2006 is a result of increasedoperational costs associated with our expanding product and marketinginitiatives. Chairman's Statement We believe we are a leader in the development and production of proprietary,commercial digital power management systems for transportation vehicles andstationary power generation systems. Power management systems control andmonitor electric power in an automotive or commercial application such as anautomobile or a stand-alone power generator. Drive systems are comprised of anelectric motor, an electronics control unit and a gear unit which power anelectric vehicle. Hybrid systems, which are similar to pure electric drivesystems, contain an internal combustion engine in addition to the electricmotor, eliminating external recharging of the battery system. Our HybridPower hybrid electric drive system provides all the functionality ofan internal combustion engine powered vehicle. The HybridPower system consistsof an enhanced electric motor and the electronic controls that regulate the flowof electricity to and from the batteries at various voltages and power to propelthe vehicle. In addition to the motor and controller, the system may include agear reduction/differential unit which ensures the desired propulsion andperformance. The system is designed to be installed as a "drop in," fullyintegrated turnkey fashion. Regardless of power source (battery, fuel cell,diesel generator or turbine) the HybridPower electric motor is designed to meetthe customer's drive cycle requirements. Our light/medium-duty drive systems include: • 30kW, 60kW, 90kW all-electric drives • 90kW series-hybrid drive • Any combination of these systems based on customer requirements. Our heavy-duty electric drive systems include: • 120kW all-electric drive • 120/60kW peak series hybrid system • 240/60kW peak series hybrid system • 90kW peak mild, pre-transmission parallel hybrid system • 100kW peak post-transmission parallel hybrid systems • 100kW peak pre-transmission parallel hybrid system. • Our drive systems, in conjunction with, internal combustion engines,microturbines, fuel cells, flywheels, and generator sets provide state of theart hybrid-electric propulsion systems. Hybrid vehicles are those that utilizean electric motor and batteries in conjunction with an internal combustionengine (ICE), whether piston or turbine. With a hybrid system, a small piston orturbine engine - fueled by gasoline or diesel, CNG, methane, etc., in a tank -supplements the electric motor and battery. These systems are self-charging, inthat the operating ICE recharges the battery. • During the quarter ended June 30, 2006, we continued to develop and/or produce electric and hybrid electric drive systems and components for suchcustomers as First Auto Works of China, Ford Motor Company (Ford), Hyundai MotorCar (Hyundai), the U.S. Military, International Truck and Engine (IC Corp.),Wrightbus Ltd. (Wrightbus), Tomoe of Japan and several other domestic andinternational vehicle and bus manufacturers. We also continue to advance itstechnologies and products for greater market penetration for 2006, and beyond.In addition, we continue to develop independently and in conjunction with theHyundai-Enova Innovative Technology Center (ITC) progress on several fronts toproduce commercially available heavy-duty, series and parallel hybrid drivesystems. • In June of 2006, we delivered a second functional Hybrid Driveschool bus to IC Corp. It is expected that this bus will be displayed innumerous shows throughout the United States during the remainder of 2006, in aneffort to promote IC Corp.'s production intent for Hybrid School Buses. IC Corp.claims to be the nation's largest integrated school bus manufacturer. • Wrightbus, one of the largest low-floor bus manufacturers in theUnited Kingdom, continues to purchase our diesel genset-powered, series hybriddrive systems for their medium and large bus applications. Our systems have beenintegrated into six of Wrightbus' Hybrid Buses and were introduced into London'spublic bus fleet in early February 2006. We understand that these buses continueto operate on a seven day per week, eighteen hour per day schedule. Weanticipate the results of this project will be increased Hybrid volumes in thisarena. • Enova has begun implementing the necessary processes and proceduresto become ISO/QS certified in 2006. The certification will be valuable tooptimize internal processes and efficiencies, as well as secure Enova's positionas a production supplier to major Original Equipment Manufacturers. • Ford Motor Company continues to evaluate our components in thirtyFord Focus Hydrogen Fuel Cell Vehicles being evaluated in three countries.According to Ford Motor Company communications, the vehicles have functionedsatisfactorily, and they continue to evaluate markets for producing additionalvehicles. • In June we announced that Hyundai is using its Hybrid Drivecomponents to power a Fuel Cell Bus and two Hyundai Tucsons being featured atthe World Cup Soccer tournament in Germany. Hyundai is an official sponsor ofthe World Cup Soccer tournament through 2014. At this year's event, Hyundai hasthirty two buses in use. One of the thirty two Hyundai Buses is hybrid poweredby our 240kW Induction Motor and High Voltage Motor Control Unit. In addition tothe bus, the Tucson's contain our 80kW Induction Motor and Control Unit. Ouralliance with Hyundai has been critical to the development of hybrid systemssuch as the ones being used in the fuel cell bus and Tucson's. • Throughout the quarter we hosted and visited numerous potentialcustomers from the Pick Up and Delivery, Medium Duty and Heavy Duty markets.Every effort is made to continue to mature these relationships, as we hope thatthey will eventually lead to viable business relationships. • We also anticipate continuing our work with Tsinghua University ofChina, and their fuel cell bus development program. We believe that Chinaintends to use hybrid-electric buses to shuttle athletes and guests at the 2008Beijing Summer Olympics and the 2010 World's Expo in Shanghai and that it isseeking up to one thousand full-size hybrid-electric buses to support theseglobal events. MTrans of Malaysia has integrated two of our standard HybridPower120kW drive system into a hybrid 10-meter bus with a Capstone microturbine asits power source. This drive system is currently on demonstration in Hong Kong,PRC. Also, Hyundai continues to evaluate our converters in their fuel cellhybrid electric vehicles and we currently expect to deliver an additionalsixteen units in 2006. Anthony Rawlinson Chairman 11.8.06 LIQUIDITY AND CAPITAL RESOURCES as of the six months ended June 30, 2006: We have experienced losses primarily attributable to research, development,marketing and other costs associated with our strategic plan as an internationaldeveloper and supplier of electric propulsion and power management systems andcomponents. Cash flows from operations have not been sufficient to meet ourobligations. Therefore, we have had to raise funds through several financingtransactions. At least until we reach breakeven volume in sales and develop and/or acquire the capability to manufacture and sell our products profitably, wewill need to continue to rely on cash from external financing sources. Our operations during the period ended June 30, 2006 and the year ended December31, 2005 were financed by development contracts and product sales, as well asfrom working capital reserves. During the six months ended June 30, 2006, our operations required $2,764,000more in cash than was generated. We continue to increase marketing anddevelopment spending as well as administrative expenses necessary for expansionto meet customer demand. Accounts receivable at June 30, 2006 decreased by$1,111,000, from $2,173,000, or approximately 51% from the balance at December31, 2005 (net of write-offs). The decrease was primarily due to collections madeon outstanding receivables from Tomoe Manufacturing in the first quarter of2006. Inventory balances decreased by $154,000 from $1,016,000 to $862,000 whencomparing the period end balances at June 30, 2006 and December 31, 2005. Duringthe fourth quarter of 2005, we completed several large development contracts,including the Tomoe project. Conversely, in the first half of 2006, we werefocused more on internal research and development as well as sales and marketingactivities. As such, inventory did not experience significant turnover whencomparing quarter on quarter. Prepaid expenses and other current assets increased by $204,000 net ofamortization at June 30, 2006 from the December 31, 2005 balance of $182,000, or112%. The increase is attributable to interest receivable on two certificate ofdeposits, purchased early in the first quarter of 2006. Fixed assets increased by $38,000, net of depreciation and writeoffs at June 30,2006 from the December 31, 2005 balance of $576,000. In the first half of 2006,we purchased $153,000 in new property and equipment. We recognized $113,000 ofdepreciation expense for the six months ended June 30, 2006. Equity method investments decreased by $42,000 in the first half of 2006 from$1,649,000 at December 31, 2005, which reflects our pro-rata share of lossesattributable to our forty percent investment interest in the Hyundai-EnovaInnovative Technology Center (ITC). For the first half of 2006, the ITCgenerated a net loss of approximately $105,000 resulting in a charge to us of$42,000 utilizing the equity method of accounting for our interest in the ITC. Other assets decreased by $56,000 when comparing the June 30, 2006 balance of$134,000 with the December 31, 2005 balance of $190,000. The decrease isoccurring as a result of amortization of the Ford Value Participation Agreementand our other intellectual property assets. Accounts payable at June 30, 2006 decreased by $1,211,000, to $185,000 from$1,396,000 at December 31, 2005. During the fourth quarter of 2005, the Companycompleted several large development contracts, including the Tomoe project.Conversely, in the first half of 2006, we were focused more on internal researchand development as well as sales and marketing activities. As such, the Companydid not incur significant trade payables resulting from inventory purchases.Meanwhile, we continued to pay our trade payables in the due course. Other accrued expenses decreased by $27,000 when comparing the balance at June30, 2006 from the balance of $302,000 at December 31, 2005. This fluctuation isprimarily due to the net effect of the payment of certain un-invoiced inventoryreceipts, which had been accrued for at December 31, 2005, combined withadditional accrual of costs associated with the first phase of our Great Plainsimplementation project. Accrued interest decreased by $447,000 for the first half of 2006, a decrease of40% from the balance of $1,113,000 at December 31, 2005. The decrease was due tothe settlement of certain components of interest payable the Note due the CreditManagers Association of California, combined with interest accrued on theremaining balance of notes payable. Research and Development Programs We continue to pursue government and commercially sponsored development programsfor both ground and marine heavy-duty drive system applications. In 2006, wecontinued the integration of a fuel cell powered step-van similar to theHydrogenise program for the Hawaii Centre for Advanced TransportationTechnologies (HCATT) and the U.S. Air Force. We intend to establish newdevelopment programs with the Hawaii Center for Advanced TransportationTechnologies in mobile and marine applications, as well as other state andfederal government agencies, as funding becomes available. Our development contract with EDO Corporation of New York for the design andfabrication of a high voltage DC-DC power conversion system utilizing a Capstonemicroturbine as the primary power source for the U.S. Navy unmanned minesweeperproject also continues to progress during 2006. The electronics package willinclude our advanced power components including a new, enhanced 50V, 700A DC-DCpower converter, our Battery Care Unit and Hybrid Control Unit which will powerthe minesweeper's electromagnetic detection system. Our power management andconversion system will be used to provide on-board power to other accessories onthe platform. Current quarter ended June 30, 2006 In conjunction with the adoption of SFAS 123(R), the Company elected toattribute the value of share-based compensation to expense using thestraight-line method, which was previously used for its pro forma informationrequired under SFAS 123. Share-based compensation expense related to stockoptions was $14,000 and $28,000 for the three and six months ended June 30,2006, respectively, and was recorded in the financial statements as a componentof selling, general and administrative expense. Share-based compensation expense reduced the Company's results of operations forthe three months ended June 30, 2006 as follows: Income from continuing operations before income taxes $14,000 Income from continuing operations after income taxes $14,000 Cash flows from operations $14,000 Cash flows from financing activities $ - Basic and Diluted EPS $ - During the quarter ended June, 2006, the Company did not grant any stockoptions. As of June 30, 2006, the total compensation cost related to non-vested awardsnot yet recognized is $124,000. The weighted average period over which thefuture compensation cost is expected to be recognized is 27 months. Theaggregate intrinsic value of total awards outstanding is zero. General Option Information A summary of option activity follows: 1996 Plan Weighted Average Exercise Shares Price Outstanding, December 31, 2004 164,000 $ 5.40 Granted 310,000 $ 4.35Exercised - -Forfeited (38,000) $ 7.64 Outstanding December 31, 2005 436,000 $ 4.46 Granted 46,000 $ 4.6Exercised - -Forfeited (151,000) $ 4.84 Outstanding June 30, 2006 331,000 $ 4.39 Exercisable, June 30, 2006 175,000 $ 4.96 The weighted-average remaining contractual life of the options outstanding atJune 30, 2006 was 7.4 years. The exercise prices of the options outstanding atJune 30, 2006 ranged from $4.35 to $8.10. The weighted-average remainingcontractual life of the options outstanding at December 31, 2005 was 7 years.The exercise prices of the options outstanding at December 31, 2005 also rangedfrom $4.35 to $8.10. Options exercisable were 175,000 and 255,000, at June 30,2006 and December 31, 2005, respectively. Valuation and Expense Information under SFAS 123 Prior to the adoption of Statement of Financial Accounting Standards No. 123(R)"Accounting for Stock-Based Compensation-Revised "(SFAS 123(R)), at March 31,2006, the Company would not have recognized compensation expense for employeeshare-based awards, when the price of such awards equalled the market price ofthe underlying stock on the date of the grant. The Company previously hadadopted the provisions of Statement of SFAS 123 as amended by SFAS 148, "Accounting for Stock Based Compensation, Transition and Disclosure" (SFAS 148)through disclosure only. The Company did not have any share based awards for thethree and six months ended June 30, 2005, and consequently, there is no proforma effect of share based awards for the first two quarters of 2005. ENOVA SYSTEMS, INC. BALANCE SHEETS ASSETS As of June 30, As of December 2006 (unaudited) 31, 2005Current assetsCash and cash equivalents $3,105,000.00 $16,187,000.00Short term investment $10,000,000.00 -Accounts receivable, net $1,062,000.00 $2,173,000.00Inventories and supplies, net $862,000.00 $1,016,000.00Prepaid expenses and other $386,000.00 $182,000.00current assets Total current assets $15,415,000.00 $19,558,000.00 Property and equipment, net $614,000.00 $576,000.00Equity method investment $1,607,000.00 $1,649,000.00Other assets $134,000.00 $190,000.00 Total assets $17,770,000.00 $21,973,000.00 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities Accounts payable $185,000.00 $1,396,000.00Accrued payroll and related expense $202,000.00 $195,000.00Other accrued expenses $275,000.00 $302,000.00Current portion of notes payable $40,000.00 $42,000.00Total current liabilities $702,000.00 $1,935,000.00 Accrued interest payable $666,000.00 $1,113,000.00Notes payable, net of current portion $1,238,000.00 $2,321,000.00 Total liabilities $2,606,000.00 $5,369,000.00 Commitments and contingenciesStockholders' equity (deficit)Series A convertible preferred stock $1,679,000.00 $1,679,000.00- no par value 30,000,000 shares authorized 2,674,000 and 2,674,000 sharesissued and outstanding Liquidating preference at $0.60 pershare, aggregating $1,604,000Series B convertible preferred stock $2,434,000.00 $2,434,000.00- no par value 5,000,000 shares authorized 1,217,000 and 1,217,000 sharesissued and outstanding Liquidating preference at $2 pershare, aggregating $2,434,000Common Stock, no par value 750,000,000 $109,382,000.00 $109,323,000.00shares authorized, 14,797,000 and 14,783,000 shares issued and outstandingCommon stock subscribed $30,000.00 $30,000.00Stock notes receivable -$1,176,000.00 -$1,176,000.00Additional paid-in capital $6,928,000.00 $6,900,000.00Accumulated deficit -$104,113,000.00 -$102,586,000.00 Total stockholders' equity $15,164,000.00 $16,604,000.00 Total liabilities and stockholders' equity $17,770,000.00 $21,973,000.00 Enova Systems INC. STATEMENTS OF OPERATIONS (Unaudited) For the Three and SixMonths Ended June 30, Six Months Three Months 2006 2005 2006 2005Net revenuesResearch and $ 419,000.00 $ 705,000.00 $ 161,000.00 $ 505,000.00development contractsProduction $ 341,000.00 $ 1,309,000.00 $ 291,000.00 $ 817,000.00 Total net revenues $ 760,000.00 $ 2,014,000.00 $ 452,000.00 $1,322,000.00 Cost of revenuesResearch and $ 556,000.00 $ 419,000.00 $ 253,000.00 $ 300,000.00development contractsProduction $ 818,000.00 $ 1,175,000.00 $ 661,000.00 $ 724,000.00 Total cost of revenues $ 1,374,000.00 $ 1,594,000.00 $ 914,000.00 $1,024,000.00 Gross profit (loss) $ -614,000.00 $ 420,000.00 $ -462,000.00 $ 298,000.00 Operating expensesResearch and $ 632,000.00 $ 395,000.00 $ 308,000.00 $ 178,000.00developmentSelling, general and $ 1,959,000.00 $ 1,158,000.00 $ 1,035,000.00 $ 550,000.00administrative Loss from operations $ -3,205,000.00 $-1,133,000.00 $ -1,805,000.00 $ -430,000.00 Other income and(expense)Interest and other $ 329,000.00 $ -141,000.00 $ 151,000.00 $ -72,000.00income/expense, netEquity in losses of $ -42,000.00 $ -66,000.00 $ -16,000.00 $ -26,000.00equity method investeeDebt extinguishment $ 920,000.00 - - -Interest $ 472,000.00 - - -extinguishment Total other income $ 1,679,000.00 $ -207,000.00 $ 135,000.00 $ -98,000.00(expense) Net loss $ -1,526,000.00 $-1,340,000.00 $ -1,670,000.00 $ -528,000.00 Basic earnings (loss) $ $ $ $per share -0.10 -0.14 -0.11 -0.06 Diluted earnings $ $ $ $(loss) per share -0.10 -0.14 -0.11 -0.06 Weighted-average $14,797,000.00 $ 9,263,000.00 $14,797,000.00 $9,263,000.00number of sharesoutstanding ENOVA SYSTEMS, INC. STATEMENTS OF CASH FLOWS (Unaudited) For the Six MonthsEnded June 30, 2006 2005Cash flows from operating activitiesNet loss -$1,526,000.00 -$1,340,000.00Adjustments to reconcile net loss to net cash used in operatingactivitiesDebt extinguishment -$920,000.00 -Interest extinguishment -$472,000.00 -Depreciation and amortization $169,000.00 $146,000.00Equity in losses of equity method investee $42,000.00 $66,000.00Issuance of common stock for services $60,000.00 $63,000.00Equity compensation expense $28,000.00 -(Increase) decrease in: Accounts receivable $1,111,000.00 -$204,000.00 Inventory and supplies $154,000.00 $147,000.00 Prepaid expenses and other current asset -$204,000.00 -$141,000.00Increase (decrease) in: Accounts payable -$1,211,000.00 $252,000.00 Accrued expenses -$20,000.00 $11,000.00 Deferred revenues - -$308,000.00 Accrued interest payable $25,000.00 $150,000.00 Net cash used in operating activities -$2,764,000.00 -$1,158,000.00 Cash flows from investing activities Purchase of short term investment -$10,000,000.00 - Purchases of property and equipment -$153,000.00 -$51,000.00Net cash used in investing activities -$10,153,000.00 -$51,000.00 Cash flows from financing activities Net payments on line of credit - -$229,000.00 Payment on notes payable and capital lease obligations - -$13,000.00Payment to extinguish debt -$165,000.00 $500,000.00 Net cash provided by (used in) financing activities -$165,000.00 $258,000.00 Net decrease in cash and cash equivalents -$13,082,000.00 -$951,000.00 Cash and cash equivalents, beginning of period $16,187,000.00 $1,575,000.00 Cash and cash equivalents, end of period $3,105,000.00 $624,000.00 Supplemental disclosure of cash flow information Interest paid - $4,000.00 Income taxes paid - - Supplemental schedule of non-cash investing and financing activities Conversion of preferred stock to common stock - $13,000.00 Stock Based Compensation Effective January 1, 2006, the Company adopted Statement of Financial AccountingStandards ("SFAS") No. 123(R), Share-Based Payment ("SFAS 123(R)"), whichrequires the measurement and recognition of compensation expense for allshare-based payment awards made to employees and directors, including stockoptions related to the Company's Employee Stock Option Plan (the "EmployeeOption Plan") based on their fair values. SFAS 123(R) supersedes AccountingPrinciples Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB25"), which the Company previously followed in accounting for stock-basedawards. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB107") to provide guidance on SFAS 123(R). The Company has applied SAB 107 in itsadoption of SFAS 123(R). The Company adopted SFAS 123(R) using the modified prospective transition methodas of and for the three and six months ended June 30, 2006. In accordance withthe modified prospective transition method, the Company's financial statementsfor prior periods have not been restated to reflect, and do not include, theimpact of SFAS 123(R). Share-based compensation expense recognized is based onthe value of the portion of share-based payment awards that is ultimatelyexpected to vest. Share-based compensation expense recognized in the Company'sStatement of Operations during the three and six months ended June 30, 2006includes compensation expense for share-based payment awards granted prior to,but not yet vested as of, December 31, 2005 based on the grant date fair valueestimated in accordance with the pro forma provisions of SFAS 123. The Company uses the Black-Scholes option-pricing model for estimating the fairvalue of options granted. The Black-Scholes option-pricing model was developedfor use in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable. In addition, option valuation modelsrequire the input of highly subjective assumptions, including the expected stockprice volatility. The Company uses projected volatility rates, which are basedupon historical volatility rates, trended into future years. Because theCompany's employee stock options have characteristics significantly differentfrom those of traded options, and because changes in the subjective inputassumptions can materially affect the fair value estimate, in management'sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of the Company's options. For purposes of pro formadisclosures, the estimated fair values of the options are amortized over theoptions' vesting periods. Stock Option Program Description As of June 30, 2006, the Company had one stock option plan: the 1996 StockOption Plan (the "1996 Plan"). Stock option grants are designed to reward employees and executives for theirlong-term contributions to the Company and provide incentives for them to remainwith the Company. The number and frequency of stock option grants are based oncompetitive practices, operating results of the Company, and governmentregulations. The maximum number of shares issuable over the term of the 1996 Plan is limitedto 65 million shares. Options granted under the 1996 Plan typically have anexercise price of 100% of the fair market value of the underlying stock on thegrant date and expire no later than ten years from the grant date. Options issued to executives will vest based on the Company achieving certainrevenue milestones for the years ended December 31, 2005 and 2006. If suchmilestones are not met, the options with respect to those milestones willterminate. Options issued to employees will vest in equal instalments over 36months. All of the granted options will remain in effect for a period of 10years or until 90 days after the employment of the optionee terminates. Diluted shares outstanding include the dilutive effect of in-the-money options.As of June 30, 2006, and on December 31, 2005, the Company did not have anyin-the-money options, and therefore, there was no dilutive effect relating tostock options outstanding on the 1996 plan. A summary of option activity follows: 1996 Plan Weighted Average Exercise Shares PriceOutstanding, December 31, 2004 164,000 $ 5.40 Granted 310,000 $ 4.35Exercised - -Forfeited (38,000 ) $ 7.64 Outstanding December 31, 2005 436,000 $ 4.46 Granted 46,000 $ 4.60Exercised - -Forfeited (151,000 ) $ 4.84 Outstanding June 30, 2006 331,000 $ 4.39 Exercisable, June 30, 2006 175,000 $ 4.96 The weighted-average remaining contractual life of the options outstanding atJune 30, 2006 was 7.4 years. The exercise prices of the options outstanding atJune 30, 2006 ranged from $4.35 to $8.10. The weighted-average remainingcontractual life of the options outstanding at December 31, 2005 was 7 years.The exercise prices of the options outstanding at December 31, 2005 also rangedfrom $4.35 to $8.10. Options exercisable were 175,000 and 255,000, at June 30,2006 and December 31, 2005, respectively. Valuation and Expense Information under SFAS 123 Prior to the adoption of Statement of Financial Accounting Standards No. 123(R)"Accounting for Stock-Based Compensation-Revised "(SFAS 123(R)), at March 31,2006, the Company would not have recognized compensation expense for employeeshare-based awards, when the price of such awards equalled the market price ofthe underlying stock on the date of the grant. The Company previously hadadopted the provisions of Statement of SFAS 123 as amended by SFAS 148, "Accounting for Stock Based Compensation, Transition and Disclosure" (SFAS 148)through disclosure only. The Company did not have any share based awards for thethree and six months ended June 30, 2005, and consequently, there is no proforma effect of share based awards for the first two quarters of 2005. Short Term Investments Short term investments consist of highly liquid instruments with originalmaturities greater than three months and current maturities less than twelvemonths from the balance sheet date. NOTE 2 - Notes Payable, Long-Term Debt and Other Financing Notes payable and long-term debt is comprised of the following: 30-Jun-06 31-Dec-05 (unaudited) Secured note payable to Credit Managers Association ofCalifornia, bearinginterest at prime plus 3% per annum in 2005 and throughmaturity. The primerate resets once a year at April 30. At June 30, 2006,interest was being accruedat a rate of 10.75%. Principal and unpaid interest due 1,238,000 2,321,000in April 2016. Secured note payable to Coca Cola Enterprises in theoriginal amount of $40,000, bearing interest at 5% perannum. Principal and unpaid interest due now. 40,000 40,000 Secured note payable to a financial institution in theoriginal amount of $33,000, bearing interest at 8% perannum, payable in 36 equal monthly instalments. -- 2,000 Less current maturities 1,278,000 2,363,000 Long-term portion 40,000 42,000 $1,238,000 $2,321,000 NOTE 3 - Shareholders' Equity During the three months ended June 30, 2006, the Company recorded 8,220 sharesof restricted common stock as common stock subscribed, valued at $30,000, to theBoard of Directors at an average price of $3.65 per share for board meetings andcommittee meetings during the second quarter of 2006. In the second quarter of 2006, and in accordance with the Directors CompensationPlan, the Company issued 5,880 shares of restricted common stock, valued at$30,000, to the Board of Directors as the share based portion of theircompensation. NOTE 4 - Related Party Transactions During the three months ended June 30, 2006, the Company purchased approximately$79,000 in components, materials, and services from Hyundai Heavy Industries(HHI), a joint venture party. The Company did not have any outstanding payablebalances owed to HHI on June 30, 2006. Off-Balance Sheet Arrangements The Company is not engaged in any "off-balance sheet arrangements" within themeaning of Item 303(a)(4)(ii) of Regulation S-K. CRITICAL ACCOUNTING POLICIES In the ordinary course of business, the Company has made a number of estimatesand assumptions relating to the reporting of results of operations and financialcondition in the preparation of its financial statements in conformity withaccounting principles generally accepted in the United States of America. Actualresults could differ significantly from those estimates under differentassumptions and conditions. The Company believes that the following discussionaddresses the Company's most critical accounting policies, which are those thatare most important to the portrayal of the Company's financial condition andresults of operations The Company constantly re-evaluates these significantfactors and makes adjustments where facts and circumstances dictate.Historically, actual results have not significantly deviated from thosedetermined using the necessary estimates inherent in the preparation offinancial statements. Estimates and assumptions include, but are not limited to,customer receivables, inventories, equity investments, fixed asset lives,contingencies and litigation. The Company has also chosen certain accountingpolicies when options were available, including: Cash and Short Term Investments We seek to maximize interest return on our cash reserves while minimizing risk.Therefore, we purchased two certificates of deposit in the first quarter of2006, of equal value, and both from a single financial establishment. The firstcertificate was purchased at the end of January, has a term of 6 months, andearns an annual percentage rate of 5%. The second certificate was purchased atthe beginning of February, has a one year term, and earns an interest rate of5.25%. Cash and short term investments represent 74% of our total assets at June 30, 2006. Allowance for Doubtful Accounts We maintain allowances for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments. The assessment of theultimate realization of accounts receivable including the currentcredit-worthiness of each customer is subject to a considerable degree to thejudgment of our management. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required. Inventory Inventories are priced at the lower of cost or market utilizing first-in,first-out (FIFO) cost flow assumption. We maintain a perpetual inventory systemand continuously record the quantity on-hand and standard cost for each product,including purchased components, subassemblies and finished goods. We maintainthe integrity of perpetual inventory records through periodic physical counts ofquantities on hand. Finished goods are reported as inventories until the pointof transfer to the customer. Generally, title transfer is documented in theterms of sale. We maintain an allowance against inventory for the potential future obsolescenceor excess inventory that is based on our estimate of future sales. A substantialdecrease in expected demand for our products, or decreases in our selling pricescould lead to excess or overvalued inventories and could require us tosubstantially increase our allowance for excess inventory. If future customerdemand or market conditions are less favourable than our projections, additionalinventory write-downs may be required, and would be reflected in cost ofrevenues in the period the revision is made. Warranty We accrue for warranty and claim costs based upon our estimate of futureexposure. Factors such as limited historical experience are considered in ourestimate. In addition, the nature of the product, the limited number of unitsproduced and the research and development nature of the product may increase therisk of warranty obligation. Actual warranty and claims costs are deducted fromthe accrual when incurred. Stock Based Compensation Effective January 1, 2006, we adopted Statement of Financial AccountingStandards ("SFAS") No. 123(R), Share-Based Payment ("SFAS 123(R)"), whichrequires the measurement and recognition of compensation expense for allshare-based payment awards made to our employees and directors, including stockoptions related to our Employee Stock Option Plan (the "Employee Stock OptionPlan") based on their fair values. SFAS 123(R) supersedes Accounting PrinciplesBoard Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), whichwe previously followed in accounting for stock-based awards. In March 2005, theSEC issued Staff Accounting Bulletin No. 107 ("SAB 107") to provide guidance onSFAS 123(R). We have applied SAB 107 in its adoption of SFAS 123(R). We adopted SFAS 123(R) using the modified prospective transition method as ofand for the three months ended March 31, 2006. In accordance with the modifiedprospective transition method, our financial statements for prior periods havenot been restated to reflect, and do not include, the impact of SFAS 123(R).Share-based compensation expense recognized is based on the value of the portionof share-based payment awards that is ultimately expected to vest. Share-basedcompensation expense recognized in our Statement of Operations during the threemonths ended June 30, 2006 includes compensation expense for share-based paymentawards granted prior to, but not yet vested as of, December 31, 2005 based onthe grant date fair value estimated in accordance with the pro forma provisionsof SFAS 123. We use share-based compensation to compensate certain executivesand employees. If we issue stock related to this compensation, it could have adilutive effect on our earnings per share. In addition, factors such as interestrates, the value of our stock and its volatility can significantly impact thecompensation expense. Contract Services Revenue and Cost Recognition We are required to make judgments based on historical experience and futureexpectations, as to the reliability of shipments made to its customers. Thesejudgments are required to assess the propriety of the recognition of revenuebased on Staff Accounting Bulletin ("SAB") No. 101 and 104, "RevenueRecognition," and related guidance. We make these assessments based on thefollowing factors: i) customer-specific information, ii) return policies, andiii) historical experience for issues not yet identified. Under FAS Concepts No. 5, revenues are not recognized until earned. We manufacture proprietary products and other products based on designspecifications provided by its customers. Revenue from sales of products aregenerally recognized at the time title to the goods and the benefits and risksof ownership passes to the customer which is typically when products are shippedbased on the terms of the customer purchase agreement. Revenue relating tolong-term fixed price contracts is recognized using the percentage of completionmethod. Under the percentage of completion method, contract revenues and relatedcosts are recognized based on the percentage that costs incurred to date bear tototal estimated costs. Changes in job performance, estimated profitability andfinal contract settlements may result in revisions to cost and revenue, and arerecognized in the period in which the revisions are determined. Contract costsinclude all direct materials, subcontract and labour costs and other indirectcosts. General and administrative costs are charged to expense as incurred. Atthe time a loss on a contract becomes known, the entire amount of the estimatedloss is accrued. The aggregate of costs incurred and estimated earningsrecognized on uncompleted contracts in excess of related billings is shown as acurrent asset, and billings on uncompleted contracts in excess of costs incurredand estimated earnings is shown as a current liability. These accounting policies were applied consistently for all periods presented.Our operating results would be affected if other alternatives were used. CONTROLS AND PROCEDURES • Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), an evaluation was carried out by our President and ChiefExecutive Officer and our Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined inRule 13a-14(c) and 15d-14(c) under the Exchange Act) as of the six months endedJune 30, 2006. For the financial statements (and corresponding Annual Report onForm 10K) for the year ended December 31, 2005, as well as for the three monthsended March 31, 2006, we have concluded that the Company's disclosure controlswere not effective. As of the quarter ended June 30, 2006, we have identifiedand isolated an internal control deficiency associated with our disclosurecontrols. We identified a clerical error in the preparation of the first quarter2006 financial statements that resulted in a misclassification of certain lineitems within the total revenue and total cost of revenue. The total revenue,total cost of revenue, gross profit and net loss were not affected by themisclassification. Once we identified this deficiency we reviewed our proceduresand modified them to include additional reviews of the financial statements,disclosures, and related regulatory filings. This includes formal reviews bydirectors, audit committee members, executives, and accounting managers. Ourremediation efforts in connection with our material weakness related toseparation of duties identified this issue, and will continue to resolving thisdeficiency. We subscribe to several publications and services that assistmanagement in remaining up to date on all recent disclosure guidance.Furthermore, we expect to achieve additional disclosure controls assurance uponthe successful implementation of a new accounting and reporting system, which isscheduled for the fourth quarter of 2006. We believe that these remediationefforts will be successful. We will soon begin testing to determine that thesecontrols are effective and the associated control weaknesses have beenremediated. • Changes in internal controls over financial reporting. We previously reported in Item 9A- "Controls and Procedures" in our AnnualReport on Form 10-K for the year ended December 31, 2005 and in "Risk Factors"included in this Quarterly Report on Form 10-Q a material weakness in internalcontrol over inventory pricing, tracking, and the reserve analysis. For the sixmonths ended June 30, 2006, we have conducted a detailed risk analysis of theinventory cycle, and identified the specific process deficiencies that arecontributing to the control weaknesses. We have adopted formalized policies andprocedures surrounding the inventory deficiencies. This includes detailedinventory and pricing review, formalized cycle count and resolution procedures,and increased monitoring over the purchasing and inventory requisitionprocesses. We believe that these remediation efforts will be successful. We willsoon begin testing to determine that these controls are effective and theassociated control weaknesses have been remediated. In addition, we reported that we did not have adequate segregation of duties inrelation to the accounting function. We have since established, by policy andaction, separation of critical duties in the accounting and finance areas. Wehave hired a full time Chief Financial Officer and Controller and areconsidering additional personnel additions and reassignments to achieve aneffective segregation of duties. We recognize to do this appropriately we mustsystematically evaluate and document all of our policies and procedures and thatprocess is ongoing. We believe that these remediation efforts will besuccessful. We will soon begin testing to determine that these controls areeffective and the associated control weaknesses have been remediated. Based on the forgoing, we do not believe that these control weaknesses havecontributed to a material financial statement error. Active remediation of thesematerial weaknesses is well in process, and we will soon begin testing in orderto conclude that these controls are effective and the associated controlweaknesses have been remediated. Other than noted above, there were no changes in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) during the quarter and six months ended June 30, 2006 that hasmaterially affected, or is likely to materially affect, our internal controlover financial reporting. PART II. • OTHER INFORMATION Item 1. • Legal Proceedings We may from time to time become a party to various legal proceedings arising inthe ordinary course of business. As of August 11, 2006, we were not involved inany material legal proceedings. Item 1A. • Risk Factors This Quarterly Report on Form 10-Q contains forward looking statementsconcerning our existing and future products, markets, expenses, revenues,liquidity, performance and cash needs as well as our plans and strategies. Theseforward-looking statements involve risks and uncertainties and are based oncurrent management's expectations and we are not obligated to update thisinformation. Many factors could cause actual results and events to differsignificantly from the results anticipated by us and described in these forwardlooking statements including, but not limited to, the following risk factors.You should carefully consider these risk factors as each of these risks couldadversely affect our business, operating results and financial condition. Inthose cases, the trading of our common stock could decline and you may lose allor a part of your investment. • We may not be able to utilize our net losses to offset our futureprofits, if any. We have experienced recurring losses from operations and had an accumulateddeficit of $104,113,000 at June 30, 2006. There is no assurance, however, thatany net operating losses will be available to us in the future as an offsetagainst future profits, if any, for income tax purposes. • The nature of our industry is dependent on technological advancementand highly competitive. The mobile and stationary power markets, including electric vehicle and hybridelectric vehicles, continue to be subject to rapid technological change. Most ofthe major domestic and foreign automobile manufacturers: (1) have alreadyproduced electric and hybrid vehicles, and/or (2) have developed improvedelectric storage, propulsion and control systems, and/or (3) are now entering orhave entered into production, while continuing to improve technology orincorporate newer technology. Various companies are also developing improvedelectric storage, propulsion and control systems. In addition, the stationarypower market is still in its infancy. A number of established energy companiesare developing new technologies. Cost-effective methods to reduce price perkilowatt have yet to be established and the stationary power market is not yetviable. Our current products are designed for use with, and are dependent upon, existingtechnology. As technologies change, subject to our limited available resources,we plan to upgrade or adapt our products in order to continue to provideproducts with the latest technology. We cannot assure you, however, that we willbe able to avoid technological obsolescence, that the market for our productswill not ultimately be dominated by technologies other than ours, or that wewill be able to adapt to changes in or create "leading-edge" technology. Inaddition, further proprietary technological development by others could prohibitus from using our own technology. • Our industry is affected by political and legislative changes. In recent years there has been significant public pressure to enact legislationin the United States and abroad to reduce or eliminate automobile pollution.Although states such as California have enacted such legislation, we cannotassure you that there will not be further legislation enacted changing currentrequirements or that current legislation or state mandates will not be repealedor amended, or that a different form of zero emission or low emission vehiclewill not be invented, developed and produced, and achieve greater marketacceptance than electric or hybrid electric vehicles. Extensions, modificationsor reductions of current federal and state legislation, mandates and potentialtax incentives could also adversely affect our business prospects ifimplemented. • We are subject to increasing emission regulations in a changinglegislative climate. Because vehicles powered by internal combustion engines cause pollution, therehas been significant public pressure in Europe and Asia, and enacted or pendinglegislation in the United States at the federal level and in certain states, topromote or mandate the use of vehicles with no tailpipe emissions ("zeroemission vehicles") or reduced tailpipe emissions ("low emission vehicles").Legislation requiring or promoting zero or low emission vehicles is necessary tocreate a significant market for electric vehicles. The California Air ResourcesBoard (CARB) is continuing to modify its regulations regarding its mandatorylimits for zero emission and low emission vehicles. Furthermore, several carmanufacturers have challenged these mandates in court and have obtainedinjunctions to delay these mandates. • There are substantial risks involved in the development of unprovenproducts. In order to remain competitive, we must adapt existing products as well asdevelop new products and technologies. In fiscal years 2005, 2004 and 2003, wespent collectively in excess of $2.5 million on research and development of newproducts and technology. We continue to incur costs related to such research anddevelopment. Despite our best efforts a new product or technology may prove tobe unworkable, not cost effective, or otherwise unmarketable. We cannot assureyou that any new product or technology we may develop will be successful or thatan adequate market for such product or technology will ever develop. • We may be unable to effectively compete with other companies whohave significantly greater resources than we have. Many of our competitors, in the automotive, electronic and other industries, arelarger, more established companies that have substantially greater financial,personnel, and other resources than we do. These companies may be activelyengaged in the research and development of power management and conversionsystems. Because of their greater resources, some of our competitors may be ableto adapt more quickly to new or emerging technologies and changes in customerrequirements, or to devote greater resources to the promotion and sales of theirproducts than we can. We believe that developing and maintaining a competitiveadvantage will require continued investment in product development,manufacturing capability and sales and marketing. We cannot assure you howeverthat we will have sufficient resources to make the necessary investments to doso. In addition, current and potential competitors may establish collaborativerelationships among themselves or with third parties, including third partieswith whom we have relationships. Accordingly, new competitors or alliances mayemerge and rapidly acquire significant market share. • Future equity financings may dilute your holdings in our Company. We may need to obtain additional funding through public or private equity ordebt financing, collaborative agreements or from other sources. If we raiseadditional funds by issuing equity securities, current shareholders mayexperience significant dilution of their holdings. We may be unable to obtainadequate financing on acceptable terms, if at all. If we are unable to obtainadequate funds, we may be required to reduce significantly our spending anddelay, scale back or eliminate research, development or marketing programs, orcease operations altogether. • Potential intellectual property, shareholder or other litigationcould adversely impact our business. Because of the nature of our business, we may face litigation relating tointellectual property matters, labour matters, product liability or shareholderdisputes. Any litigation could be costly, divert management attention or resultin increased costs of doing business. Although we intend to vigorously defendany future lawsuits, we cannot assure you that we would ultimately prevail inthese efforts. An adverse judgment could negatively impact the price of ourcommon stock and our ability to obtain future financing on favourable terms orat all. • We may be exposed to product liability or tort claims if ourproducts fail, which could adversely impact our results of operations. A malfunction or the inadequate design of our products could result in productliability or other tort claims. Accidents involving our products could lead topersonal injury or physical damage. Any liability for damages resulting frommalfunctions could be substantial and could materially adversely affect ourbusiness and results of operations. In addition, a well-publicized actual orperceived problem could adversely affect the market's perception of ourproducts. This could result in a decline in demand for our products, which wouldmaterially adversely affect our financial condition and results of operations. • We are highly subject to general economic conditions. The financial success of our company is sensitive to adverse changes in generaleconomic conditions, such as inflation, unemployment, and consumer demand forour products. These changes could cause the cost of supplies, labour, and otherexpenses to rise faster than we can raise prices. Such changing conditions alsocould significantly reduce demand in the marketplace for our products. We haveno control over any of these changes. • We are an early growth stage company. Although our Company was originally founded in 1976, many aspects of ourbusiness are still in the early growth stage development, and our proposedoperations are subject to all of the risks inherent in a start-up or growingbusiness enterprise, including the likelihood of continued operating losses.Enova is relatively new in focusing its efforts on electric systems, hybridsystems and fuel cell management systems. The likelihood of our success must beconsidered in light of the problems, expenses, difficulties, complications, anddelays frequently encountered in connection with the growth of an existingbusiness, the development of new products and channels of distribution, andcurrent and future development in several key technical fields, as well as thecompetitive and regulatory environment in which we operate. • We operate in a highly regulated business environment and changes inregulation could impose costs on us or make our products less economical. Our products are subject to federal, state, local and foreign laws andregulations, governing, among other things, emissions as well as laws relatingto occupational health and safety. Regulatory agencies may impose specialrequirements for implementation and operation of our products or maysignificantly impact or even eliminate some of our target markets. We may incurmaterial costs or liabilities in complying with government regulations. Inaddition, potentially significant expenditures could be required in order tocomply with evolving environmental and health and safety laws, regulations andrequirements that may be adopted or imposed in the future. • We are highly dependent on a few key personnel and will need toretain and attract such personnel in a labour competitive market. Our success is largely dependent on the performance of our key management andtechnical personnel, including Edwin Riddell, our Chief Executive Officer,Corinne Bertrand, our Chief Financial Officer and Don Kang, our Vice Presidentof Engineering, the loss of one or more of whom could adversely affect ourbusiness. Additionally, in order to successfully implement our anticipatedgrowth, we will be dependent on our ability to hire additional qualifiedpersonnel. There can be no assurance that we will be able to retain or hireother necessary personnel. We do not maintain key man life insurance on any ofour key personnel. We believe that our future success will depend in part uponour continued ability to attract, retain, and motivate additional highly skilledpersonnel in an increasingly competitive market. • There are minimal barriers to entry in our market. We presently license or own only certain proprietary technology and, therefore,have created little or no barrier to entry for competitors other than the timeand significant expense required to assemble and develop similar production anddesign capabilities. Our competitors may enter into exclusive arrangements withour current or potential suppliers, thereby giving them a competitive edge whichwe may not be able to overcome, and which may exclude us from similarrelationships. • We extend credit to our customers, which expose us to credit risk. Most of our outstanding accounts receivable are from a limited number of largecustomers. If we fail to monitor and manage effectively the resulting creditrisk and a material portion of our accounts receivable is not paid in a timelymanner or becomes uncollectible, our business would be significantly harmed, andwe could incur a significant loss associated with any outstanding accountsreceivable. • We are exposed to risks relating to evaluations of our internalcontrols. In connection with the audit of our financial statements for the year endedDecember 31, 2005, Singer Lewak Greenbaum & Goldstein LLP, our independentregistered public accounting firm at the time, notified our management and auditcommittee of the existence of "significant deficiencies in internal controls,"which is an accounting term for internal controls deficiencies that, in thejudgment of our independent registered public accounting firm, are significantand which could adversely affect our ability to record, process, summarize andreport financial information. Singer Lewak Greenbaum & Goldstein LLP concluded that these significantdeficiencies constituted a "material weakness" in our internal controls.Auditing literature defines "material weakness" as a particularly seriousreportable condition where the internal control does not reduce to a relativelylow level the risk that misstatements caused by error or fraud may occur inamounts that would be material in relation to the financial statements and therisk that such misstatements would not be detected within a timely period byemployees in the normal course of performing their assigned functions. A "material weakness" is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not be preventedor detected. As of December 31, 2005, we did not maintain effective controls over theinventory pricing, tracking, and the reserve analysis process. This controldeficiency resulted in an audit adjustment to our 2005 financial statements andcould result in a misstatement to cost of sales that would result in a materialmisstatement to the annual and interim financial statements that would not beprevented or detected. Furthermore, our management has determined that, as ofDecember 31, 2005, we do not have sufficient segregation of duties in relationto the accounting function. This deficiency could result in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. Accordingly, our management hasdetermined that these deficiencies constitute a material weakness. Because ofthese material weaknesses, our management has concluded that we did not maintaineffective internal control over financial reporting as of December 31, 2005. We previously reported in Item 9A- "Controls and Procedures" in our 2005 AnnualReport on Form 10-K a material weakness in internal control over inventorypricing, tracking, and the reserve analysis. In response to the materialweakness, we have conducted a full review of inventory processes and procedures.Furthermore, we have begun to institute additional control procedures andmonitoring to assure the effectiveness of the controls surrounding the inventoryprocess(es). However, for the six months ended June 30, 2006, management hasconcluded that the Company's disclosure controls are not effective. Althoughmanagement has begun the process of remediation, we can not assure you that wewill be successful in a manner, if at all. See Part I, Item 4, "Controls andProcedures." Under the current SEC rules and regulations as we understand them, for the yearending on or after July 15, 2007, our management will be required to assess, andour independent registered public accounting firm will be required to attest asto our assessment regarding, the effectiveness of our internal controls in orderto satisfy the requirements of Section 404 of the Sarbanes-Oxley Act and therelated SEC rules. While we intend to address these material weaknesses and havebegun efforts to remediate these material weaknesses, including, subsequent tothe filing of our annual report on Form 10-K, the hiring of a Chief FinancialOfficer and a Controller to oversee the remediation process, there is noassurance that this will be accomplished. These efforts may necessitatesignificant time and attention of our management and additional resources. If wefail to satisfactorily strengthen the effectiveness of our internal controls,neither we nor our independent registered public accounting firm may be able toconclude on an ongoing basis that we have effective internal control overfinancial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Other Information Change in Independent Registered Public Accounting Firm On June 12, 2006, Singer Lewak Greenbaum & Goldstein LLP ("SLGG") ceased beingthe registered public accounting firm for Enova Systems, Inc. (the "Company"),and the Company engaged Windes & McClaughry Accountancy Corporation ("W&M") asthe Company's new independent registered public accounting firm for the fiscalyear ending December 31, 2006. The decision regarding the end of the SLGGengagement and the commencement of the engagement of W&M was made and approvedby the Audit Committee of the Company's Board of Directors after a review of theCompany's current needs in light of its listing on the Alternative InvestmentMarket ("AIM") of the London Stock Exchange. Prior to appointing W&M as theCompany's independent registered public accounting firm, W&M previously assistedBaker Tilly, the Company's UK accountants, on Baker Tilly's audit reportprepared on behalf of Investec in connection with the Company's listing on AIM. The reports of SLGG on the Company's financial statements for the fiscal yearsended December 31, 2005 contained no adverse opinion or disclaimer of opinionand were not qualified or modified as to uncertainty, audit scope or accountingprinciple. During the fiscal year ended December 31, 2005, and through June 12, 2006, therewere no disagreements with SLGG on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure, whichdisagreements, if not resolved to the satisfaction of SLGG would have causedSLGG to make reference to the subject matter of the disagreement in its reportson the Company's financial statements for such years. During the fiscal yearsended December 31, 2005 and through June 12, 2006, there were no "reportableevents" within the meaning of Item 304(a)(1)(v) of Regulation S-K. During the fiscal years ended December 31, 2005, and through June 12, 2006, theCompany did not consult with W&M regarding (1) the application of accountingprinciples to a specified transaction, whether completed or proposed, (2) thetype of audit opinion that might be rendered with respect to the Company'sfinancial statements or (3) any matter that was either the subject of a "disagreement" or a "reportable event" (as such terms are defined in Item 304(a)(1)(v) of Regulation S-K). Amendment of the Statement of Operations for the Quarter Ended March 31, 2006 The Company is amending its Statement of Operations for the quarter ended March31, 2006 for a clerical error. The revenue and cost of revenue captions wereinadvertently reversed between research and development contract revenue andcost of revenue and production revenue and cost of revenue. This error did nothave an effect or result in a misstatement of total net revenues, cost ofrevenues or gross profit (loss). Previously As reported correctedNet revenues Research and development contracts $ 45,000 $ 264,000 Production 264,000 45,000 Total net revenues 309,000 309,000 Cost of revenues Research and development contracts 170,000 290,000 Production 290,000 170,000 Total cost of revenues 460,000 460,000 Gross profit (loss) $ (151,000) $ (151,000) Certain statements in this Form 10-Q under Item 2 "Management's Discussion andAnalysis of Financial Condition and Results of Operations" and elsewhereconstitute "forward-looking statements" within the meaning of the Securities Actof 1933 and the Securities Exchange Act of 1934 (the "Exchange Act"). Inaddition, the Company may from time to time make oral forward-lookingstatements. Words such as "may", "will", "should", "could", "expect", "plan", "anticipate", "believe", "estimate", "predict", "potential" or "contribute" orsimilar words are intended to identify forward-looking statements, although notall forward-looking statements contain these words. Such forward-lookingstatements involve known and unknown risks, uncertainties, and other factorswhich may cause the actual results, performance, or achievements of the Companyto be materially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements. Such factors include,among others, the following: general economic and business conditions; theimpact of competitive products and pricing; success of operating initiatives;development and operating costs; advertising and promotional efforts; adversepublicity; acceptance of new product offerings; consumer trial and frequency;changes in business strategy or development plans; availability, terms anddeployment of capital; availability of qualified personnel; commodity, labour,and employee benefit costs; changes in, or failure to comply with, governmentregulations; weather conditions; construction schedules; and other factorsreferenced in this Form 10-Q and in Company's Annual Report on Form 10-K for thefiscal year ended December 31, 2005. Because of these and other factors that mayaffect the Company's operating results, past financial performance should not beconsidered an indicator of future performance, and investors should not usehistorical trends to anticipate results or trends in future periods. The Companyexpressly disclaims any intent or obligation to publicly release the results ofany revisions to these forward-looking statements that may be made to reflectevents or circumstances after the date hereof, or to reflect the occurrence ofunanticipated events. SPECIAL NOTE REGARDING STATEMENTS OF EXPECTED FUTURE PERFORMANCE The fiscal year ended December 31, 2005. Because of these and other factors thatmay affect the Company's operating results, past financial performance shouldnot be considered an indicator of future performance, and investors should notuse historical trends to anticipate results or trends in future periods. TheCompany expressly disclaims any intent or obligation to publicly release theresults of any revisions to these forward-looking statements that may be made toreflect events or circumstances after the date hereof, or to reflect theoccurrence of unanticipated events. This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
Enova Systems Inc