Enova FY 2010 Annual Financial Report

FOR IMMEDIATE RELEASE

31st of March 2011

Enova Systems INC., (NYSE Amex: ENA and AIM: ENV and ENVS), a leading developer and manufacturer of electric and hybrid digital power management systems for commercial medium and heavy duty trucks and buses announces annual results for the period ended December 31, 2010.

HIGHLIGHTS

Results of Operations

Years Ended December 31, 2010 and 2009

Net Revenues. Net revenues were $8,572,000 for the year ended December 31, 2010, representing an increase of $2,950,000 or 52% from net revenues of $5,622,000 during the same period in 2009. Revenues in the current year benefited from U.S. government grant programs, resulting in increased sales for fulfillment of orders from Smith Electric Vehicles and Navistar Inc. Smith Electric Vehicles, Navistar and FAW comprised 45%, 26% and 14% of our 2010 revenues, respectively. In the prior year, FAW, Navistar and HCATT comprised 56%, 15% and 13% of our 2009 revenues, respectively. The Company continued its strategy to concentrate support to core customers in 2010 in our migration to a first tier production company, recording sales with several OEMs, including Navistar, Freightliner and Smith Electric Vehicles in the United States and FAW in China. Although we have seen indications for future production growth, there can be no assurance there will be continuing demand for our products and services.

Cost of Revenues. Cost of revenues were $7,159,000 for the year ended December 31, 2010, compared to $5,016,000 for the year ended December 31, 2009, representing an increase of $2,143,000, or 43%. Cost of revenues increased in 2010 compared to the same period in the prior year primarily due to the increase in revenue. The improvement in cost of revenues is primarily attributable to our strategy to concentrate on higher volume production orders and our continuing focus on manufacturing and inventory processes that resulted in tighter control over production costs. Cost of revenues consists of component and material costs, direct labor costs, integration costs and overhead related to manufacturing our products as well as warranty accruals and inventory valuation reserve amounts. Product development costs incurred in the performance of engineering development contracts for the U.S. Government and private companies are charged to cost of sales. Our customers continue to require additional integration and support services to customize, integrate and evaluate our products. We believe that a portion of these costs are initial, one-time costs for these customers and anticipate similar costs to be incurred with respect to new customers as we pursue a greater market share. Typically we do not incur these same types of costs for customers who have been using our products for over one year.

Gross Margin. The gross margin for the year ended December 31, 2010 was 16.5% compared to 10.8% in the prior year; an increase of 53%. The improvement in gross margin is primarily attributable to our focus on key customer production contracts, maturity of our supply chain, and efficiencies gained through focus on manufacturing and inventory processes that resulted in tighter controls over production costs. As we continue to make deliveries on production contracts in 2011, we expect to achieve continued benefit from these initiatives, although we may continue to experience variability in our gross margin.

Research and Development Expenses. Research and development expenses consist primarily of personnel, facilities, equipment and supplies for our research and development activities. Non-funded development costs are reported as research and development expense. Research and development expenses during the year ended December 31, 2010 were $1,838,000 compared to $1,228,000 for the same period in 2009, an increase of $610,000 or 50%. R&D costs were higher in 2010 as we devoted increased engineering personnel resources to the development of our next generation motor control unit and charger, continued testing of our EV vehicles, and testing and integration of new battery technologies and electric motors. In 2009, R&D efforts were focused on development of our new "Ze" all electric vehicle, the initial development of our next generation motor control unit, testing of new battery technologies as well as engine off capability for our post transmission parallel hybrid drive system. We also continued to allocate necessary resources to the development and testing of upgraded proprietary control software, enhanced DC-DC converters and other power management software. We intend to continue to research and develop new technologies and products, both internally and in conjunction with our alliance partners and other manufacturers as we deem beneficial to our global growth strategy.

Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of sales and marketing costs, including consulting fees and expenses for travel, trade shows and promotional activities and personnel and related costs for the quality and field service functions and general corporate functions, including finance, strategic and business development, human resources, IT, accounting reserves and legal costs. Selling, general and administrative expenses increased by $335,000, or 5%, during the year ended December 31, 2010 to $6,558,000 from $6,223,000 in the prior year, mainly due to executive bonuses and share-based compensation charges.

Interest and Other Income (Expense). For the year ended December 31, 2010, interest and other income (expense) was an expense of $437,000, representing an increase of $241,000 or 123%, from an expense of $196,000 in 2009. The increase in 2010 was primarily due to a charge of approximately $328,000 for partial settlement of litigation with Arens, as detailed in Note 18 to these financial statements.

Equity in losses of non-consolidated joint venture. A net loss of $4,000 was recorded in the year ended December 31, 2009, reflecting a loss of $10,000 in our pro-rata share of losses attributable to our forty percent investment interest in the Hyundai-Enova Innovative Technology Center (ITC) and a gain of $6,000 that was recorded upon the dissolution of the joint venture in April 2009. There was no activity attributed to this account in the year ended December 31, 2010.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read this Management's Discussion and Analysis of Financial Condition and Results of Operations in conjunction with our 2010 Financial Statements and accompanying Notes. The matters addressed in this Management's Discussion and Analysis of Financial Condition and Results of Operations may contain certain forward-looking statements involving risks and uncertainties.

Overview

Enova Systems believes it is a leading innovator of proprietary hybrid and electric drive systems propelling the alternative energy industry. Our core competencies are focused on the development and commercialization of power management and conversion systems for mobile applications. Enova applies unique 'enabling technologies' in the areas of alternative energy propulsion systems for medium and heavy-duty vehicles as well as power conditioning and management systems for distributed generation systems. Our products can be found in a variety of OEM vehicles including those from Navistar Corporation, First Auto Works, Freightliner Customer Chassis Corporation, Hyundai Motor Company and Ford Motor Company, trucks and buses for Smith Electric Vehicles, Wright Bus, Optare Plc and the U.S. Military, as well as digital power systems for EDO and other major manufacturers.

We continue to support Navistar in their efforts to maximize exposure in the hybrid school bus market. We have been involved in large shows in St. Louis, MO, Washington, DC and the Principality of Monaco as well as smaller venues throughout the Midwest. The exposure via shows and direct interface were aggressively pursued throughout 2010 in an effort to promote our drive systems production intent for medium and heavy duty applications.

Some notable highlights of Enova's accomplishments in 2010 are:

• Freightliner Custom Chassis Corporation ("FCCC"), a division of Daimler Trucks North America, and Enova entered into the final phase of our all-electric commercial chassis development program. The development program included collaboration and involved the engineering and integration of Enova's 120kW all-electric drive system technology into the MT-45 walk-in van chassis. Freightliner's highest volume MT-45 chassis is used by a range of customers, including UPS and Federal Express. Design, engineering, integration and testing activities were conducted at the FCCC plant in Gaffney, SC and the Enova facility in Torrance, CA. The resulting integration of our all-electric drive system into the MT-45 chassis branded a new, FCCC all-electric product offering: the FCCC MT-EV. The MT-EV chassis boasts a GVWR of 14,000 to 19,500 lbs. The durable steel straight-rail chassis frame reduces flex and bowing to minimize stress while carrying heavy payloads. The quiet operation of the all-electric MT-EV also makes for an enjoyable driver experience. The MT-EV has a flat-leaf spring front and rear suspension, allowing for a smooth, solid ride that minimizes cargo shifts on uneven road surfaces.

• Navistar, one of the largest manufacturer and marketer of medium and heavy trucks and mid-range diesel engines, continued a relationship that started in 2005 by delivering systems in 2010 as part of an intended large scale deployment to hybrid school buses to school districts. Enova supports this commitment by engineering a post-transmission hybrid drive system that integrates easily and non-invasively. Several states and school districts have indicated expressed interest in expanding their hybrid school bus fleets. As a result, Enova delivered 25 charge depleting systems to Navistar in 2010.

• China's FAW, the country's oldest indigenous automaker, also continued its commercial relationship with Enova by integrating its pre-transmission hybrid drive systems for the Jiefang 103 passenger hybrid bus. These buses were first showcased at the 2008 Beijing Summer Olympics and then in 2010 World's Expo in Shanghai. Enova delivered a total of 120 pre-transmission hybrid drive systems to FAW in 2010.

• The U.S. General Services Administration ("GSA") extended its contract with Enova as the exclusive supplier contract of the all-electric step van. GSA procures vehicles for government agencies and the armed forces. Under this contract, Enova will coordinate the supply of MT-EV all-electric walk-in step vans to GSA under the Cargo Vans category. Enova continues to benefit from federal fleet penetration via GSA with the Smith Electric Vehicles' ("Smith") Newton product offering in the Medium and Heavy Duty vehicle category. The Smith Newton is another exclusive, all-electric medium and heavy duty truck offering on the GSA product menu. Moreover, Navistar continued to demonstrate its leadership in the American school bus market with its exclusive GSA contract to supply hybrid school buses. Enova is supplies hybrid electric drive systems to IC Bus, an affiliated division of Navistar.

• Enova and Remy Inc. ("Remy") entered into an agreement to develop a new electric drive system based on Enova's next generation Omni controller and Remy HVH motor. Remy is North America's largest independent manufacturer of advanced electric propulsion motors. Remy's patented design and assembly technology have been in production since 2006 and are currently powering vehicles around the world. The optimized controller-motor solution in development demonstrates the strong technology heritage and commitment to customers that Enova continues to bring to the hybrid and all-electric vehicle market.

• Smith Electric Vehicles N.A. Inc. ("Smith") received a grant of $32 million as part of the American Recovery and Reinvestment Act of 2009, a U.S. Department of Energy program in the form of cost-share grants for supporting the construction of U.S. based manufacturing plants to produce batteries and electric drive components. The program seeks to establish development, demonstration, evaluation, and education projects to accelerate the market introduction and penetration of advanced electric drive vehicles. As production is ramps up, we anticipate the opportunity to continue to supply Smith with our all-electric vehicle drive systems that are used to power Smith's Newton trucks.

• The Company delivered a total of 369 full systems and 48 additional motor controller units of Enova drive systems to its broad range of customers. Enova delivered 149 all-electric drive systems to Smith in 2010. Smith's Newton product offering carries a GVWR of 26,000 lbs. Enova also delivered 120 pre-transmission hybrid drive systems to FAW for their Jiefang 103 passenger hybrid bus and 25 charge depleting bus systems to Navistar during the year.

Enova's product focus is digital power management and power conversion systems. Its software, and hardware manage and control the power that drives a vehicle. They convert the power into the appropriate forms required by the vehicle or device and manage the flow of this energy to optimize efficiency and provide protection for both the system and its users. Our products and systems are the enabling technologies for power systems.

The latest state-of-the-art technologies in hybrid and electric vehicles, fuel cell systems, all require some type of power management and conversion mechanism. Enova Systems supplies these essential components. Enova drive systems are 'fuel-neutral,' meaning that they have the ability to utilize any type of fuel, including diesel, liquid natural gas or bio-diesel fuels. Enova also performs significant research and development to augment and support others' and our internal product development efforts.

Our products are "production-engineered." This means they are designed so they can be commercially produced (i.e., all formats and files are designed with manufacturability in mind, from the start). For the automotive market, Enova designs its products to ISO 9001 manufacturing and quality standards. We believe Enova's redundancy of systems and rigorous quality standards result in high performance and reduced risk. For every component and piece of hardware, there are detailed performance specifications. Each piece is tested and evaluated against these specifications, which enhances and confirms the value of the systems to OEM customers. Our engineering services focus on system integration support for product sales and custom product design.

In light of our efforts to grow market share in our target markets and penetrate emerging ones, the Company continues to acknowledge the principal barrier to commercialization of our drive systems is cost. The cost of engineering proprietary software and hardware for our drive systems is high because economies of production in specialized hybrid drive system component parts, batteries, and vehicle integration have not been achieved. Therefore, the cost of our products and engineering services are currently higher than our gasoline and diesel competitor counterparts. We also believe maturation into commercialization of our drive systems will result in decreases to our long run average costs of materials and services as volume increases over time.

Critical Accounting Policies

The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to product returns, bad debts, inventories, intangible assets, income taxes, warranty obligations, contingencies, and litigation. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances, including current and anticipated worldwide economic conditions, both in general and specifically in relation to the hybrid and electric vehicle markets, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 8 of this Form 10-K. We believe the following critical accounting policies necessitated that significant judgments and estimates be used in the preparation of its consolidated financial statements. We have reviewed these policies with our Audit Committee.

Revenue Recognition - We generally recognizes revenue at the time of shipment when title and risk of loss have passed to the customer, persuasive evidence of an arrangement exists, performance of our obligation is complete, our price to the buyer is fixed or determinable, and we are reasonably assured of collection. If a loss is anticipated on any contract, a provision for the entire loss is made immediately. Determination of these criteria, in some cases, requires management's judgment. Should changes in conditions cause management to determine that these criteria are not met for certain future transactions, revenue for any reporting period could be adversely affected.

The Company also recognizes engineering and construction contract revenues using the percentage-of-completion method, based primarily on contract costs incurred to date compared with total estimated contract costs. Customer-furnished materials, labor, and equipment, and in certain cases subcontractor materials, labor, and equipment, are included in revenues and cost of revenues when management believes that the company is responsible for the ultimate acceptability of the project. Contracts are segmented between types of services, such as engineering and construction, and accordingly, gross margin related to each activity is recognized as those separate services are rendered.

Changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined. Claims against customers are recognized as revenue upon settlement. Revenues recognized in excess of amounts billed are classified as current assets under contract work-in-progress. Amounts billed to clients in excess of revenues recognized to date are classified as current liabilities on contracts.

Changes in project performance and conditions, estimated profitability, and final contract settlements may result in future revisions to engineering and development contract costs and revenue.

Warranty - We warrant our products against defects in materials and workmanship arising during normal use. We service warranty claims directly through our customer service department. Our warranty periods generally range up to eighteen months. We estimate and recognize product warranty costs, which are included in cost of sales, as we sell the related products. Warranty costs are forecasted based on the best available information, primarily historical claims experience and the expected costs. We have not made any material changes in our warranty reserve methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in assumptions we use to calculate the warranty reserve. However, actual claim costs may differ from the amounts estimated. If a significant product defect were to be discovered, our financial statements may be materially impacted.

Allowance for doubtful accounts - The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in the Company's existing accounts receivable; however, changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. Past due balances over 90 days and other higher risk amounts are reviewed individually for collectibility. If the financial condition of the Company's customers were to deteriorate resulting in an impairment of their ability to make payment, additional allowances may be required. In addition, the Company maintains a general reserve for all invoices by applying a percentage based on the age category. Account balances are charged against the allowance after all collection efforts have been exhausted and the potential for recovery is considered remote.

Inventory - Inventories include material, labor, and manufacturing overhead are priced at the lower of cost or market utilizing the first-in, first-out (FIFO) cost flow assumption. We maintain a perpetual inventory system and continuously record the quantity on-hand and standard cost for each product, including purchased components, subassemblies and finished goods. We maintain the integrity of perpetual inventory records through periodic physical counts of quantities on hand (i.e., cycle counts). Finished goods are reported as inventories until the point of transfer to the customer. Generally, title transfer is documented in the terms of sale.

Inventory reserve - We maintain an allowance against inventory for the potential future obsolescence or excess inventory. A substantial decrease in expected demand for our products, or decreases in our selling prices could lead to excess or overvalued inventories and could require us to substantially increase our allowance for excess inventory. If future customer demand or market conditions are less favorable than our projections, additional inventory write-downs may be required and would be reflected in cost of revenues in the period the revision is made.

Property and Equipment - Property and equipment are stated at cost and depreciated over the estimated useful lives of the related assets, which range from three to seven years using the straight-line method for financial statement purposes. The Company uses other depreciation methods (generally, accelerated depreciation methods) for tax purposes where appropriate. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements.

Repairs and maintenance are expensed as incurred. Expenditures that increase the value or productive capacity of assets are capitalized. When property and equipment are retired, sold, or otherwise disposed of, the asset's cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in operations.

Impairment of Long-Lived Assets - The Company assesses the impairment of its long-lived assets periodically in accordance with the provisions of FASB ASC 360-10-35-15, "Impairment or Disposal of Long-Lived Assets". The Company reviews the carrying value of property and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment include current operating results, trends, and prospects, as well as the effects of obsolescence, demand, competition, and other economic factors. Long-lived assets that management commits to sell or abandon are reported at the lower of carrying amount or fair value less cost to sell.

Intangible Assets - Intangible assets consist of patents. Intangible assets with an indefinite life are not amortized. Intangible assets with a definite life are amortized on a straight-line basis over their estimated useful lives ranging up to 20 years. Intangible assets with a definite life are tested for impairment whenever events or circumstances indicate that their carrying amounts may not be recoverable.

Stock-Based Compensation - The Company calculates stock-based compensation expense in accordance with FASB ASC Topic 718, "Compensation-Stock Compensation" ("ASC 718"). This pronouncement requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, to be based on estimated fair values.

The Company's determination of estimated fair value of share-based awards utilizes the Black-Scholes option-pricing model. The Black-Scholes model is affected by the Company's stock price as well as assumptions regarding certain highly complex and subjective variables. These variables include, but are not limited to; the Company's expected stock price volatility over the term of the awards as well as actual and projected employee stock option exercise behaviors.

Deferred Income Taxes - We evaluate the need for a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. We determined that we may not be able to realize all or part of its net deferred tax asset in the future, thus a valuation allowance was recorded against our deferred tax assets.

These accounting policies were applied consistently for all periods presented. Our operating results would be affected if other alternatives were used. Information about the impact on our operating results is included in the footnotes to our financial statements.

Research and Development - Research, development, and engineering costs are expensed in the period incurred. Costs of significantly altering existing technology are expensed as incurred.

Recent Accounting Pronouncements

In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition - Milestone Method (Topic 605): Milestone Method of Revenue Recognition, or ASU 2010-17. ASU 2010-17 allows the milestone method as an acceptable revenue recognition methodology when an arrangement includes substantive milestones. ASU 2010-17 provides a definition of substantive milestone, and should be applied regardless of whether the arrangement includes single or multiple deliverables or units of accounting. ASU 2010-17 is limited to transactions involving milestones relating to research and development deliverables. ASU 2010-17 also includes enhanced disclosure requirements about each arrangement, individual milestones and related contingent consideration, information about substantive milestones, and factors considered in the determination. ASU 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010, with early adoption permitted. The adoption of this standard did not have any impact on our consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06 providing authoritative guidance related to fair value measurements and disclosures. The provisions of the guidance require new disclosures related to transfers in and out of Levels 1 and 2 classifications as well as provisions requiring a reconciliation of the activity in Level 3 recurring fair value measurements. Existing disclosures also were expanded to include Level 2 fair value measurement valuation techniques and inputs. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2009, except for the disclosures for Level 3 activity which is effective for fiscal years beginning after December 15, 2010. The adoption of the guidance did not, and is not expected to, have a material impact on our business, financial position, results of operations or liquidity

In October 2009, the FASB issued ASU No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements - a consensus of the FASB EITF, or ASU 2009-14. ASU 2009-14 changes the accounting model for revenue arrangements that include tangible products and software elements. The amendments of this update provide additional guidance on how to determine which software, if any, relating to the tangible product also would be excluded from the scope of the software revenue recognition guidance. The amendments in this update also provide guidance on how a vendor should allocate arrangement consideration to deliverables in an arrangement that includes tangible products and software as well as arrangements that have deliverables both included and excluded from the scope of software revenue recognition guidance. This standard is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The adoption is not expected to have an effect on the Company's financial position, results of operations, or cash flows.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 650): Multiple-Deliverable Revenue Arrangements - a consensus of the FASB EITF, or ASU 2009-13. ASU 2009-13 will separate multiple-deliverable revenue arrangements. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The amendments of this update will replace the term "fair value" in the revenue allocation guidance with "selling price" to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendments of this update will eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The amendments in this update will require that a vendor determine its best estimated selling price in a manner consistent with that used to determine the price to sell the deliverable on a standalone basis. This standard is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company does not believe that the adoption of the pronouncement will have a material impact on the Company's consolidated financial statements.

Liquidity and Capital Resources

We have experienced losses primarily attributable to research, development, marketing and other costs associated with our strategic plan as an international developer and supplier of electric drive and power management systems and components. Historically cash flows from operations have not been sufficient to meet our obligations and we have had to raise funds through several financing transactions. At least until we reach breakeven volume in sales and develop and/or acquire the capability to manufacture and sell our products profitably, we will need to continue to rely on cash from external financing sources. Our operations during the year ended December 31, 2010 were financed by product sales and working capital reserves. As of December 31, 2010, the Company had $8,631,000 of cash and cash equivalents and short term investments.

On June 30, 2010, the Company entered into a secured a revolving credit facility with a financial institution for $200,000 which was secured by a $200,000 certificate of deposit. The facility is for a period of 3 years and 6 months from July 1, 2010 to December 31, 2013.The interest rate on a drawdown from the facility is the certificate of deposit rate plus 1.25% with interest payable monthly and the principal due at maturity. The financial institution also renewed the $200,000 irrevocable letter of credit for the full amount of the credit facility in favor of Sunshine Distribution LP, with respect to the lease of the Company's corporate headquarters at 1560 West 190th Street, Torrance, California.

Net cash used in operating activities was $4,319,000 for the year ended December 31, 2010, compared to $1,609,000 for the year ended December 31, 2009. Cash used in operating activities was primarily affected by the cost of revenue, R&D, personnel and general operating costs, which were partially mitigated by our utilization of existing inventory balances to fulfill customer orders in 2010. Non-cash items included expenses for stock-based compensation, depreciation and amortization, inventory reserve, impairment loss, and issuance of common stock for services. In 2009, in conjunction with the reduction of our credit facility, as explained above, we redeemed a certificate of deposit for $2,000,000 which included a $200,000 irrevocable letter of credit for the full amount of a credit facility in favor of Sunshine Distribution LP, with respect to the lease of the Company's corporate headquarters. This certificate of deposit for $2,000,000 is shown on the statement of cash flows as $1,800,000 for the year ended December 31, 2009.

Net cash used in investing activities was $317,000 for the year ended December 31, 2010, compared to net cash provided by investing activities of $2,000 for the year ended December 31, 2009. In 2010, capital expenditures were expended mainly for the acquisition and integration of test vehicles and for production test equipment. In 2009, we received proceeds of $137,000 from the dissolution of the Enova-ITC joint venture and had capital expenditures of $135,000.

Net cash used in financing activities totaled $11,000 for the year ended December 31, 2010 and was attributable to proceeds from stock options and payments made to notes payable agreements compared to net cash provided by financing activities of $9,361,000 for the year ended December 31, 2009 from an offering of common stock. We sold 9,024,960 shares of common stock at $1.00 per share to certain accredited investors, resulting in gross proceeds of $9,024,960. In addition, we sold 1,323,200 shares of common stock at 62.5 pence per share (approximately US$1.00 per share) to certain eligible offshore investors resulting in gross proceeds of approximately $1,323,000. Costs related to our December 2009 equity raise were approximately $928,000.

The company maintained the same certificate of deposit with Union Bank with a balance of $200,000 in 2010 and 2009, which is used to secure a credit facility.

Accounts receivable increased by $1,408,000, or 98%, from $1,442,000 as of December 31, 2009 to $2,850,000 as of December 31, 2010 due to increased shipments to Smith Electric Vehicles, Navistar and FAW in the fourth quarter of 2010.

Inventory decreased by $1,150,000, or 21%, from $5,605,000 as of December 31, 2009 to $4,455,000 as of December 31, 2010 due to our utilization of existing inventory balances to fulfill increases in customer orders during the second half of 2010. The decrease resulted from the utilization of existing inventory balances to fulfill increases in customer orders during 2010 and net inventory activity which included receipts of approximately $4,412,000 and normal consumption of approximately $5,562,000, net of inventory write-offs and reserves.

Prepaid expenses and other current assets increased by $219,000, or 83%, to $482,000 as of December 31, 2010 from a balance of $263,000 as of December 31, 2009. The increase was primarily attributable to deposits made to vendors for certain purchase orders.

Long term accounts receivable increased to $100,000 at December 31, 2010 compared to $0 at December 31, 2009. The Company agreed to defer collection of accounts receivable as requested by a customer for the term of the Company's warranty period. The Company has remedied all past and current warranty claims and anticipates full collection of the receivable.

Property and equipment decreased by $191,000 or 14%, net of accumulated depreciation, to $1,172,000 as of December 31, 2010 from a balance of $1,363,000 as of December 31, 2009. The decrease was due to recording of depreciation expense during the year. For the year ended December 31, 2010, the Company recognized depreciation expense of $534,000 and recorded additions to fixed assets totaling $343,000.

Intangible assets decreased by $60,000 as Patents were written off completely during 2010 from $60,000 at December 31, 2009 to zero at December 31, 2010. Enova did not recognize any additional intellectual property assets, including patents and trademarks, during 2010. The Company recognized an impairment loss of $55,000 during 2010 as the Company determined that these patents have no future economic value.

Accounts payable increased by $1,432,000, or 345%, from $415,000 at December 31, 2009 to $1,847,000 at December 31, 2010. The accounts payable balance increased due to purchases of inventory made to support fourth quarter sales and in-line with our short-term sales forecast for 2011.

Enova reported $31,000 of deferred revenue at December 31, 2010 consisting of customer deposits for purchase orders, compared to a deferred revenue balance at December 31, 2009 of $357,000. The Company anticipates recognition of the December 31, 2010 balance into revenue in the first quarter of 2011.

Accrued payroll and related expenses increased by $645,000, or 233%, from $277,000 at December 31, 2009 to $922,000 at December 31, 2010. The change is primarily due to the accrual of 2010 employee and executive incentive bonuses which are expected to be paid in 2011.

Other accrued liabilities increased by $452,000, or 35%, to $1,739,000 at December 31, 2010 from $1,287,000 at December 31, 2009. The increase is primarily attributable to an accrual for the partial settlement of the Arens litigation and an accrual for severance to paid in 2011.

Accrued interest increased by $82,000, or 8%, from $1,074,000 at December 31, 2009 to $1,156,000 at December 31, 2010. The majority of the increase is associated with the interest accrued on the $1.2 million note due the Credit Managers Association of California (CMAC).

Off-Balance Sheet Arrangements

Other than contractual obligations incurred in the normal course of business, we don't have any off-balance sheet financing arrangements or liabilities.

ENOVA SYSTEMS, INC.

BALANCE SHEETS

The accompanying notes are an integral part of these financial statements.

ENOVA SYSTEMS, INC.

STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these financial statements.

ENOVA SYSTEMS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY

The accompanying notes are an integral part of these financial statements.

ENOVA SYSTEMS, INC.

STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these financial statements.

ENOVA SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS

1. Description of Business

General

Enova Systems, Inc., (the "Company"), is a California corporation that develops, designs and produces drive systems and related components for electric, hybrid electric, and fuel cell systems for mobile applications. The Company retains development and manufacturing rights to many of the technologies created, whether such research and development is internally or externally funded. The Company sells drive systems and related components in the United States, Asia and Europe.

Liquidity

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has sustained recurring losses and negative cash flows from operations. Management believes that the Company's losses in recent years have primarily resulted from a combination of insufficient product and service revenue to support the Company's skilled and diverse technical staff believed to be necessary to support exploitation of the Company's technologies. Historically, the Company's growth and working capital needs have been funded through a combination of private equity, debt and lease financing. During 2010, the Company's growth has been funded primarily through a combination of product sales and existing cash reserves. As of December 31, 2010, the Company had approximately $8.4 million of cash and cash equivalents. At December 31, 2010, the Company had net working capital of approximately $11.6 million as compared to $18.0 million at December 31, 2009, representing a decrease of $6.4 million.

Management is focused on managing costs in line with estimated total revenue, including contingencies for cost reductions if projected revenue is not fully realized. However, there can be no assurance that anticipated revenue will be realized or that the Company will successfully implement its plans. Management has implemented measures to conserve cash, including a reduced employee headcount from the peak in 2008, stringent inventory management. The Company will continue to conserve available cash by closely scrutinizing expenditures and extensively utilizing current inventory for sales during 2011. The Company believes that it currently has sufficient cash and financial resources to meet its operating requirements over the next twelve months. The Company has experienced increasing operating margins in 2010 however, it had negative cash flow from operations, and if this trend continues, the Company may have an ongoing requirement for additional capital investment. The Company may need to raise additional capital to accomplish all of its business objectives over the next several years. In addition, the Company may in the future selectively pursue possible acquisitions of businesses, technologies, content, or products complementary to those of the Company in order to expand its presence in the marketplace and achieve operating efficiencies. The Company can make no assurance with respect to either the availability or terms of such financing and capital when it may be required.

2. Summary of Significant Accounting Policies

Basis of Presentation

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States.

Reclassifications

Certain amounts in the prior year have been reclassified to conform to the current year presentation. This change in classification does not affect previously reported cash flows from operating or financing activities in the Company's previously reported Statements of Cash Flows, or the Company's previously reported Statements of Operations for any period.

Revenue Recognition

The Company manufactures proprietary products and other products based on design specifications provided by its customers.

The Company recognizes revenue only when all of the following criteria have been met:

• Persuasive evidence of an arrangement exists;

• Delivery has occurred or services have been rendered;

• The fee for the arrangement is fixed or determinable; and

• Collectibility is reasonably assured.

Persuasive Evidence of an Arrangement - The Company documents all terms of an arrangement in a written contract signed by the customer prior to recognizing revenue. Receipt of a customer purchase order is the primary method of determining that persuasive evidence of an arrangement exists.

Delivery Has Occurred or Services Have Been Rendered - The Company performs all services or delivers all products prior to recognizing revenue. Professional consulting and engineering services are considered to be performed when the services are complete. Equipment is considered delivered upon delivery to a customer's designated location. In certain instances, the customer elects to take title upon shipment.

The Fee for the Arrangement is Fixed or Determinable - Prior to recognizing revenue, a customer's fee is either fixed or determinable under the terms of the written contract. Fees professional consulting services, engineering services and equipment sales are fixed under the terms of the written contract. The customer's fee is negotiated at the outset of the arrangement and is not subject to refund or adjustment during the initial term of the arrangement.

Collectibility is Reasonably Assured - The Company determines that collectibility is reasonably assured prior to recognizing revenue. Collectibility is assessed on a customer-by-customer basis based on criteria outlined by management. New customers are subject to a credit review process, which evaluates the customer's financial position and ultimately its ability to pay. The Company does not enter into arrangements unless collectibility is reasonably assured at the outset. Existing customers are subject to ongoing credit evaluations based on payment history and other factors. If it is determined during the arrangement that collectibility is not reasonably assured, revenue is recognized on a cash basis. Amounts received upfront for engineering or development fees under multiple-element arrangements are deferred and recognized over the period of committed services or performance, if such arrangements require the Company to provide on-going services or performance. All amounts received under collaborative research agreements or research and development contracts are nonrefundable, regardless of the success of the underlying research.

Since some customer orders contain multiple items such as equipment and services which are delivered at varying times, the Company determines whether the delivered items can be considered separate units of accounting. Delivered items are considered separate units of accounting if delivered items have value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of undelivered items, and if delivery of undelivered items is probable and substantially in the Company's control. The recognition of revenue from milestone payments are over the remaining minimum period of performance obligation. As required, the Company evaluates its sales contract to ascertain whether multiple element agreements are present.

The Company recognizes engineering and construction contract revenues using the percentage-of-completion method, based primarily on contract costs incurred to date compared with total estimated contract costs. Customer-furnished materials, labor, and equipment, and in certain cases subcontractor materials, labor, and equipment, are included in revenues and cost of revenues when management believes that the company is responsible for the ultimate acceptability of the project. Contracts are segmented between types of services, such as engineering and construction, and accordingly, gross margin related to each activity is recognized as those separate services are rendered. Changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined. Claims against customers are recognized as revenue upon settlement. Revenues recognized in excess of amounts billed are classified as current assets under contract work-in-progress. Amounts billed to clients in excess of revenues recognized to date are classified as current liabilities under advance billings on contracts. Changes in project performance and conditions, estimated profitability, and final contract settlements may result in future revisions to engineering and development contract costs and revenue.

Deferred Revenues

The Company recognizes revenues as earned. Amounts billed in advance of the period in which service is rendered are recorded as a liability under Deferred revenues. The Company has entered into several production and development contracts with customers. The Company has evaluated these contracts, ascertained the specific revenue generating activities of each contract, and established the units of accounting for each activity. Revenue on these units of accounting is not recognized until a) there is persuasive evidence of the existence of a contract, b) the service has been rendered and delivery has occurred, c) there is a fixed and determinable price, and d) collectability is reasonable assured.

Warranty Costs

The Company provides product warranties for specific product lines and accrues for estimated future warranty costs in the period in which revenue is recognized. Our products are generally warranted to be free of defects in materials and workmanship for a period of 12 to 24 months from the date of installation, subject to standard limitations for equipment that has been altered by other than Enova Systems personnel and equipment which has been subject to negligent use. Warranty provisions are based on past experience of product returns, number of units repaired and our historical warranty incidence over the past twenty-four month period. The warranty liability is evaluated on an ongoing basis for adequacy and may be adjusted as additional information regarding expected warranty costs becomes known.

Shipping and Handling Costs

The Company includes shipping and handling costs associated with inbound and outbound freight in costs of goods sold.

Cash and Cash Equivalents

Short-term, highly liquid investments with an original maturity of three months or less are considered cash equivalents.

Certificate of deposit, restricted

The certificate of deposit matures on June 14, 2011 and is used to secure a revolving credit facility.

Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in the Company's existing accounts receivable; however, changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. Past due balances over 90 days and other higher risk amounts are reviewed individually for collectability. If the financial condition of the Company's customers were to deteriorate resulting in an impairment of their ability to make payment, additional allowances may be required. In addition, the Company maintains a general reserve for all invoices by applying a percentage based on the age category. Account balances are charged against the allowance after all collection efforts have been exhausted and the potential for recovery is considered remote. As of December 31, 2010 and 2009, the Company maintained a reserve of $29,000 and $31,000 for doubtful accounts receivable. There was no bad debt expense recorded in 2010 and 2009, respectively.

Inventory

Inventories and supplies are comprised of materials used in the design and development of electric, hybrid electric, and fuel cell drive systems, and other power and ongoing management and control components for production and ongoing development contracts, finished goods and work-in-progress, and is stated at the lower of cost or market utilizing the first-in, first-out (FIFO) cost flow assumption. The Company maintains a perpetual inventory system and continuously record the quantity on-hand and standard cost for each product, including purchased components, subassemblies and finished goods. The Company maintains the integrity of perpetual inventory records through periodic physical counts of quantities on hand. Finished goods are reported as inventories until the point of transfer to the customer. Generally, title transfer is documented in the terms of sale.

Inventory reserve

The Company maintains an allowance against inventory for the potential future obsolescence or excess inventory. A substantial decrease in expected demand for our products, or decreases in our selling prices could lead to excess or overvalued inventories and could require us to substantially increase our allowance for excess inventory. If future customer demand or market conditions are less favorable than our projections, additional inventory write-downs may be required and would be reflected in cost of revenues in the period the revision is made.

Property and Equipment

Property and equipment are stated at cost and depreciated over the estimated useful lives of the related assets, which range from three to seven years using the straight-line method for financial statement purposes. The Company uses other depreciation methods (generally, accelerated depreciation methods) for tax purposes where appropriate. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements.

Repairs and maintenance are expensed as incurred. Expenditures that increase the value or productive capacity of assets are capitalized. When property and equipment are retired, sold, or otherwise disposed of, the asset's cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in operations.

Impairment of Long-Lived Assets

The Company reviews the carrying value of property and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment include current operating results, trends, and prospects, as well as the effects of obsolescence, demand, competition, and other economic factors. Long-lived assets that management commits to sell or abandon are reported at the lower of carrying amount or fair value less cost to sell.

Patents

Patents are measured based on their fair values. Patents are being amortized on a straight-line basis over a period of 20 years and are stated net of accumulated amortization.

Impairment of Intangible Assets

The Company evaluates the recoverability of identifiable intangible assets whenever events or changes in circumstances indicate that an intangible asset's carrying amount may not be recoverable. Such circumstances could include, but are not limited to: (1) a significant decrease in the market value of an asset, (2) a significant adverse change in the extent or manner in which an asset is used, or (3) an accumulation of costs significantly in excess of the amount originally expected for the asset. The Company measures the carrying amount of the asset against the estimated undiscounted future cash flows associated with it. Should the sum of the expected future net cash flows be less than the carrying value of the asset being evaluated, an impairment loss would be recognized. The impairment loss would be calculated as the amount by which the carrying value of the asset exceeds its fair value. The fair value is measured based on quoted market prices, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including the discounted value of estimated future cash flows. The evaluation of asset impairment requires the Company to make assumptions about future cash flows over the life of the asset being evaluated. These assumptions require significant judgment and actual results may differ from assumed and estimated amounts. For the year ended December 31, 2010, the Company recognized an impairment loss $55,000 on the book value of intangible assets (see Note 7).

Fair Value of Financial Instruments

The carrying amount of financial instruments, including cash and cash equivalents, certificates of deposit, accounts receivable, accounts payable and other accrued liabilities, approximate fair value due to the short maturity of these instruments. The recorded values of notes payable and long-term debt approximate their fair values, as interest approximates market rates.

The Company defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. At December 31, 2010 the Company had no financial assets or liabilities periodically re-measured at fair value.

Stock-Based Compensation

The Company measures and recognizes compensation expense for all share-based payment awards made to employees and directors, including employee stock options based on the estimated fair values at the date of grant. The compensation expense is recognized over the requisite service period.

The Company's determination of estimated fair value of share-based awards utilizes the Black-Scholes option-pricing model. The Black-Scholes model is affected by the Company's stock price as well as assumptions regarding certain highly complex and subjective variables. These variables include, but are not limited to; the Company's expected stock price volatility over the term of the awards as well as actual and projected employee stock option exercise behaviors.

The cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash flows. Due to the Company's loss position, there were no such tax benefits for the years ended December 31, 2010 and 2009.

The Company determines the fair value of the restricted stock awards utilizing the quoted market prices of the Company's shares on the date they were granted.

Research and Development

Research development, and engineering costs are expensed in the period incurred. Costs of significantly altering existing technology are expensed as incurred.

Income Taxes

The Company accounts for income taxes under an asset and liability approach. This process involves calculating the temporary and permanent differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The temporary differences can result in deferred tax assets and liabilities, which would be recorded on the Company's consolidated balance sheets. The Company must assess the likelihood that its deferred tax assets will be recovered from future taxable income and, to the extent the Company believes that recovery is not likely, the Company must establish a valuation allowance. Changes in the Company's valuation allowance in a period are recorded through the income tax provision on the consolidated statements of operations.

Uncertainty in income taxes are recognized in the Company's financial statements based on the recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The Company has recognized no liability for unrecognized income tax benefits.

Loss Per Share

Basic loss per share is computed by dividing loss available to common stockholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. The Company's common share equivalents consist of stock options.

The potential shares, which are excluded from the determination of basic and diluted net loss per share as their effect is anti-dilutive, are as follows:

Commitments and Contingencies

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company's management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company's legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company's financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.

Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.

Estimates

The preparation of financial statements in accordance with U.S. 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 revenue and expenses during the reporting period. Actual results could differ from those estimates.

Concentration of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with high credit, quality financial institutions. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents. With respect to accounts receivable, the Company routinely assesses the financial strength of its customers and, as a consequence, believes that the receivable credit risk exposure is limited.

Recent Accounting Pronouncements

In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition - Milestone Method (Topic 605): Milestone Method of Revenue Recognition, or ASU 2010-17. ASU 2010-17 allows the milestone method as an acceptable revenue recognition methodology when an arrangement includes substantive milestones. ASU 2010-17 provides a definition of substantive milestone, and should be applied regardless of whether the arrangement includes single or multiple deliverables or units of accounting. ASU 2010-17 is limited to transactions involving milestones relating to research and development deliverables. ASU 2010-17 also includes enhanced disclosure requirements about each arrangement, individual milestones and related contingent consideration, information about substantive milestones, and factors considered in the determination. ASU 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010, with early adoption permitted. The adoption of this standard did not have any impact on our consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06 providing authoritative guidance related to fair value measurements and disclosures. The provisions of the guidance require new disclosures related to transfers in and out of Levels 1 and 2 classifications. The provisions also require a reconciliation of the activity in Level recurring fair value measurements. Existing disclosures also were expanded to include Level 2 fair value measurement valuation techniques and inputs. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2009, except for the disclosures for Level 3 activity which is effective for fiscal years beginning after December 15, 2010. The adoption of the guidance did not, and is not expected to, have a material impact on our business, financial position, results of operations or liquidity

In October 2009, the FASB issued ASU No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements - a consensus of the FASB EITF, or ASU 2009-14. ASU 2009-14 changes the accounting model for revenue arrangements that include tangible products and software elements. The amendments of this update provide additional guidance on how to determine which software, if any, relating to the tangible product also would be excluded from the scope of the software revenue recognition guidance. The amendments in this update also provide guidance on how a vendor should allocate arrangement consideration to deliverables in an arrangement that includes tangible products and software as well as arrangements that have deliverables both included and excluded from the scope of software revenue recognition guidance. This standard is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The adoption is not expected to have an effect on the Company's financial position, results of operations, or cash flows.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 650): Multiple-Deliverable Revenue Arrangements - a consensus of the FASB EITF, or ASU 2009-13. ASU 2009-13 will separate multiple-deliverable revenue arrangements. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The amendments of this update will replace the term "fair value" in the revenue allocation guidance with "selling price" to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendments of this update will eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The amendments in this update will require that a vendor determine its best estimated selling price in a manner consistent with that used to determine the price to sell the deliverable on a standalone basis. This standard is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company does not believe that the adoption of the pronouncement will have a material impact on the Company's consolidated financial statements.

Other recent accounting pronouncements issued by the FASB, the American Institute of Certified Public Accountants ("AICPA"), and the SEC did not or are not believed by management to have a material impact on the Company's present condensed consolidated financial statements.

3. Inventory

Inventories, consisting of materials, labor, and manufacturing overhead, are stated at the lower of cost (first-in, first-out) or market and consist of the following at December 31:

Inventory reserve charged to operations amounted to $232,000 and $714,000 during 2010 and 2009, respectively. Inventory valuation adjustments and other inventory write-offs in 2010 and 2009 amounted to $582,000 and $638,000, respectively.

4. Property and Equipment

Property and equipment consisted of the following at December 31:

Fixed assets totaling $0 and $748,000 were retired or disposed of in the years ended December 31, 2010 and 2009, respectively. Depreciation and amortization expense was $534,000 and $600,000 for the years ended December 31, 2010 and 2009, respectively, which included amortization expense of leasehold improvements of $268,000 and $269,000 for the years ended December 31, 2010 and 2009, respectively.

5. Other Accrued Liabilities

Other accrued liabilities consisted of the following at December 31:

Accrued warranty consisted of the following activities for the years ended December 31:

6. Investment in Non-Consolidated Joint Venture - ITC

On April 6, 2009, Enova Systems Inc. and Hyundai Heavy Industries of Korea ("HHI") agreed to dissolve their 60/40 joint venture, Hyundai-Enova Innovative Technology Center, Inc. ("ITC"), by mutual agreement based on their evaluation of the joint venture and its business relationship to each of Enova and HHI.

The Dissolution Agreement required Enova and ITC to enter into a Stock Purchase Agreement, dated as of April 6, 2009. Pursuant to the Stock Purchase Agreement, ITC re-purchased the 2,000,000 shares of common stock of ITC owned by Enova, which represented 40% of the issued shares of ITC, for a purchase price of $1,334,000 with HHI becoming the sole shareholder of ITC immediately subsequent to this transaction. Enova received from ITC a cash payment of $137,000 and, as was agreed under the Dissolution Agreement, the amount of $1,197,000 was paid to HHI to settle open purchase orders that Enova had placed with HHI for electrical component inventory which became part of salable systems; and to settle other payables and receivables between Enova, HHI and ITC. During 2009, Enova received approximately $1,179,000 in inventory from HHI as full settlement for ITC.

The summary of the ITC dissolution is as follows:

HHI continues to be a key strategic supplier of components for Enova, including electric drive motors and control electronic units that are manufactured using Enova specifications.

7. Intangible Assets

Intangible assets consisted of legal fees directly associated with patent licensing. The Company has been granted three patents and in 2010, made an immaterial adjustment to value them at a zero balance. These patents were capitalized and were being amortized on a straight-line basis over a period of 20 years.

Intangible assets consisted of the following as of December 31:

Amortization expense charged to operations was $5,000 for each of the years ended December 31, 2010 and 2009, respectively. As of December 31, 2010, the Company performed an impairment analysis to its intangible assets and determined that the technologies covered by the Company's patents did not have any future economic value. The Company recorded an impairment loss of $55,000 during 2010.

8. Notes Payable

Notes payable at December 31, consisted of the following:

As of December 31, 2010 and 2009, the balance of long term interest payable with respect to the Credit Managers Association of California note amounted to $1,132,000 and $1,054,000, respectively. Interest expense on notes payable amounted to approximately $88,000 and $91,000 during the years ended December 31, 2010 and 2009, respectively.

Future minimum principal payments of notes payable at December 31, 2010 consisted of the following:

9. Revolving Credit Agreement

On June 30, 2010, the Company entered into a secured a revolving credit facility with a financial institution for $200,000 which was secured by a $200,000 certificate of deposit. The facility is for a period of 3 years and 6 months from July 1, 2010 to December 31, 2013.

The interest rate on a drawdown from the facility is the certificate of deposit rate plus 1.25% with interest payable monthly and the principal due at maturity. The financial institution also renewed the $200,000 irrevocable letter of credit for the full amount of the credit facility in favor of Sunshine Distribution LP, with respect to the lease of the Company's corporate headquarters at 1560 West 190th Street, Torrance, California.

10. Deferred Revenues

The Company had deferred $31,000 and $357,000 in revenue related to production and development contracts at December 31, 2010 and 2009, respectively. The Company anticipates that the December 31, 2010 deferred revenue balance will be recognized in the first quarter of 2011.

11. Commitments and Contingencies

Leases

In October 2007, The Company entered into a lease agreement with Sunshine Distribution LP ("Landlord"), with respect to the lease of an approximately 43,000 square foot facility located at 1560 West 190th Street, Torrance, California (the "Lease"). The lease term commenced on November 1, 2007, and expires January 1, 2013. The total base monthly rent is approximately $37,000, and will be increased effective May 1, 2011 based on the increase in the consumer price index. Under the Lease, Enova will pay the Landlord certain commercially reasonable and customary common area maintenance costs of approximately $5,000 per month, increasing ratably as these costs are increased to the Landlord. The Lease is secured by an irrevocable standby letter of credit in the amount of $200,000 and naming the Landlord as the beneficiary. Enova also has an office in Hawaii which is rented on a month-to-month basis at $3,400 per month. Rent expense was $556,000 and $561,000 for the years ended December 31, 2010, and 2009, respectively.

Future minimum lease payments under non-cancelable operating lease obligations at December 31, 2010 were as follows:

12. Stockholders' Equity

Common Stock

On October 29, 2009, Enova entered into a Purchase Agreement ("Purchase Agreement") with certain accredited investors (as such term is defined under Regulation D promulgated by the Securities and Exchange Commission ("SEC")) pursuant to which the Investors agreed to purchase 9,024,960 shares of Common Stock ("Investor Shares") and the Company received $9,024,960 in gross proceeds from the offering.

On October 29, 2009, the Company entered into a Placing Agreement (the "Placing Agreement") to which Investec Bank (UK) Limited ("Investec") acted as Enova's agent to place 1,323,200 shares of the Common Stock (the "Placing Shares") at 62.5 Pence (the "Placing Price"), or approximately the equivalent of $1.00 (U.S. Dollars) per share as of such date based on the exchange rate on October 29, 2009 as reported by Fidessa.

On December 15, 2009, Enova Systems, Inc. completed the sale of the above 10,348,160 shares of the Company's common stock, no par value ("Common Stock"), at $1.00 (U.S.) per share for gross proceeds of approximately $10,348,160 (based on current exchange rates as described above) pursuant in part to a Purchase Agreement and in part to a Placing Agreement as more particularly described above. The transactions contemplated by the Purchase Agreement and the Placing Agreement were approved by shareholders at the company's annual meeting held on December 8, 2009. Costs related to the December 2009 equity raise were approximately $928,000.

During the year ended December 31, 2009, the Company issued 158,000 shares of common stock, respectively, to directors as compensation. The common stock issued to directors in 2009 was valued at $165,000, based upon the trading value of the common stock on the date of issuance. No common stock was issued to directors during 2010.

During the years ended December 31, 2010 and 2009, the Company issued 25,000 and 58,000 shares of common stock, respectively, to employees as compensation. The common stock issued to employees in 2010 and 2009 was valued at $95,000 and $172,000, respectively, based upon the trading value of the common stock on the date of issuance.

Series A Preferred Stock

Series A preferred stock is currently unregistered. Each share is convertible into 1/45 of a share of common stock at the election of the holder or automatically upon the occurrence of certain events including: sale of stock in an underwritten public offering; registration of the underlying conversion stock; or the merger, consolidation, or sale of more than 50% of the Company. Holders of Series A preferred stock have the same voting rights as common stockholders. The stock has a liquidation preference of $0.60 per share plus any accrued and unpaid dividends in the event of voluntary or involuntary liquidation of the Company. Dividends are non-cumulative and payable at the annual rate of $0.036 per share if, when, and as declared by, the Board of Directors. No dividends have been declared on the Series A preferred stock.

Series B Preferred Stock

Series B preferred stock is currently unregistered. Each share is convertible into 2/45 of a share of common stock at the election of the holder or automatically upon the occurrence of certain events including: sale of stock in an underwritten public offering, if the offering results in net proceeds of $10,000,000, and the per share price of common stock is at least $2.00; and the merger, consolidation, or sale of common stock or sale of substantially all of the Company's assets in which gross proceeds received are at least $10,000,000. The Series B preferred stock has certain liquidation and dividend rights prior and in preference to the rights of the common stock and Series A preferred stock. The stock has a liquidation preference of $2.00 per share together with an amount equal to, generally, $0.14 per share compounded annually at 7% per year from the filing date, less any dividends paid. Dividends on the Series B preferred stock are non-cumulative and payable at the annual rate of $0.14 per share if, when, and as declared by, the Board of Directors. No dividends have been declared on the Series B preferred stock.

13. Stock Options

Stock Option Program Description

For the year ended December 31, 2010 the Company had two equity compensation plans, the 1996 Stock Option Plan (the "1996 Plan") and the 2006 equity compensation plan (the "2006 Plan"). The 1996 Plan has expired for the purposes of issuing new grants. However, the 1996 Plan will continue to govern awards previously granted under that plan. The 2006 Plan has been approved by the Company's Shareholders. Equity compensation grants are designed to reward employees and executives for their long term contributions to the Company and to provide incentives for them to remain with the Company. The number and frequency of equity compensation grants are based on competitive practices, operating results of the company, and government regulations.

The maximum number of shares issuable over the term of the 1996 Plan was limited to 65 million shares (without giving effect to subsequent stock splits). Options granted under the 1996 Plan typically have an exercise price of 100% of the fair market value of the underlying stock on the grant date and expire no later than ten years from the grant date. The 2006 Plan has a total of 3,000,000 shares reserved for issuance, of which 104,000 and 903,000 were granted in 2010 and 2009, respectively.

Stock-based compensation expense related to stock options was $704,000 and $387,000 for the years ended December 31, 2010 and 2009, respectively. As of December 31, 2010, the total compensation cost related to non-vested awards not yet recognized is $453,000. The remaining period over which the future compensation cost is expected to be recognized is 15 months.

Stock-based compensation expense recognized in the Statement of Operations for the years ended December 31, 2010 and 2009 has been based on awards ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. If the actual number of forfeitures differs from that estimated by management, additional adjustments to compensation expense may be required in future periods.

The following is a summary of changes to outstanding stock options during the fiscal year ended December 31, 2010 and 2009:

(1) Aggregate intrinsic value represents the value of the closing price per share of our common stock on the last trading day of the fiscal period in excess of the exercise price multiplied by the number of options outstanding or exercisable, except for the "Exercised" line, which uses the closing price on the date exercised.

(2) Number of shares includes options vested and those expected to vest net of estimated forfeitures.

At December 31, 2010, there were 1,607,000 shares available for grant under the 2006 plan. The exercise prices of the options outstanding at December 31, 2010 ranged from $0.21 to $4.95. The weighted-average grant date fair value of the options granted during the years ended December 31, 2010 and 2009 was $1.22 and $0.69, respectively.

Unvested share activity for the year ended December 31, 2010 is summarized below:

The company settles employee stock option exercises with newly issued common shares. The table below presents information related to stock option activity for the fiscal years ended December 31, 2010 and 2009:

Valuation and Expense Information

The fair value of stock-based awards to officers and employees is calculated using the Black-Scholes option pricing model. The Black-Scholes model requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is calculated by using the SAB 107 "simplified method" of estimating the expected term which is derived by taking the average of the time to vesting and the full term of the option. The risk-free rate selected to value any particular grant is based on the bond equivalent yields that corresponds to the pricing term of the grant effective as of the date of the grant. The expected volatility is based on the historical volatility of the Company's stock price. These factors could change in the future, affecting the determination of stock-based compensation expense in future periods.

The fair values of all stock options granted during the fiscal years ended December 31, 2010 and 2009 were estimated on the date of grant using the following range of assumptions:

The estimated fair value of grants of stock options to nonemployees of the Company is charged to expense, if applicable, in the financial statements. These options vest in the same manner as the employee options granted under each of the option plans as described above.

Restricted Stock 

During the year ended December 31, 2010 and 2009, the Company issued 25,000 and 216,000 restricted shares of the Company's common stock to its employees and directors, respectively. The Company recorded compensation expense of $95,000 and $337,000 in 2010 and 2009, respectively. There are no unvested restricted stock awards granted to employees or directors as of December 31, 2010.

14. Income Taxes

Significant components of the Company's deferred tax assets and liabilities for federal and state income taxes as of December 31, consisted of the following:

The Tax Reform Act of 1986 limits the use of net operating loss carryforwards in certain situations where changed occur in the stock ownership of a company. In the event the Company has had a change in ownership, utilization of the carryforwards could be restricted.

Deferred taxes arise from temporary differences in the recognition of certain expenses for tax and financial reporting purposes. The deferred tax assets have been offset by a valuation allowance since management does not believe the recoverability of these in future years is more likely than not to occur. The valuation allowance increased by $2,809,000 and decreased by $9,247,000 during the years ended December 31, 2010 and 2009, respectively. As of December 31, 2010, the Company had net operating loss carry forwards for federal and state income tax purposes of approximately $71,121,000 and $45,305,000, respectively. These operating loss carry forwards will expire in 2011 through 2030.

The provision for income taxes differs from the amount computed by applying the U.S. federal statutory tax rate (34% in 2010 and 2009) to income taxes as follows:

The Company files federal income tax returns in the U.S. and in various state jurisdictions. The Company has not been audited by the Internal Revenue Service or any state for income taxes. The Company reviews its recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. The Company reviews all material tax positions for all years open to statute to determine whether it is more likely than not that the positions taken would be sustained based on the technical merits of those positions. The Company did not recognize any adjustments for uncertain tax positions as of and during the years ended December 31, 2010 and 2009.

15. Employee Benefit Plan

The Company has a 401(k) profit sharing plan covering substantially all employees. Eligible employees may elect to contribute a percentage of their annual compensation, as defined, to the plan. The Company may also elect to make discretionary contributions. For the years ended December 31, 2010 and 2009, the Company did not make any contributions to the plan.

16. Geographic Area Data

The Company operates as a single reportable segment and attributes revenues to countries based upon the location of the entity originating the sale. Revenues by geographic area are as follows:

17. Concentration

During the year ended December 31, 2010, the Company's sales were concentrated to with a few large customers. Sales to three customers comprised 45%, 26% and 14% of total revenues and accounted for 42%, 20% and 21% of gross accounts receivable, respectively. During the year ended December 31, 2009, the Company had sales to three customers that comprised 56%, 15% and 13% of total revenues and accounted for 77%, 4% and 11% of gross accounts receivable, respectively. The Company performs ongoing credit evaluations of certain customers' financial condition and generally requires no collateral from its customers.

18. Subsequent Events

As previously reported in an 8-K filed January 20, 2011 with date of earliest event reported being January 14, 2011, on January 6, 2011, we entered into a Partial Settlement Agreement, dated January 5, 2011 (the "Settlement Agreement"), with Arens Controls Company, L.L. C. ("Arens") to resolve certain claims made by Arens in connection with its action captioned Arens Controls Company, L.L.C. v. Enova Systems, Inc., filed in 2008 with the Northern District of Illinois of the U.S. District Court (the "Legal Action"). The Settlement Agreement was amended by Amendment No. 1 to Partial Settlement Agreement (the "Amendment") dated January 14, 2011. In the Legal Action, Arens asserted eight counts against Enova, including certain claims regarding inventory asserted by Arens to be valued at $1,671,000 (the "Inventory Claim"), a claim for payment under certain invoices, and claims for certain other monetary obligations of Enova to Arens.

Under the terms of the Settlement Agreement, we paid $327,000 directly to Arens and Arens dismissed with prejudice all but two of the counts under the Legal Action. Additionally, under the Settlement Agreement (as amended), on January 14, 2011, we acquired the inventory that was the subject of the Inventory Claim (the "Inventory") for a payment of $1,498,000, representing an agreed upon reduction of $173,000 for the acquisition price of such Inventory. In return, Arens was deemed to have released us from any further liability on the Inventory Claim. However, per the terms of the Settlement Agreement (as amended), Arens is not deemed to have released us from (but instead is deemed to have preserved its claims under) two of the counts in the Legal Action. We intend to vigorously defend such remaining claims. For the year ended December 31, 2010, the Company recorded a loss totaling $328,000 for the Partial Settlement with Arens, consisting of losses of $167,000 for settlement of certain claims and $161,000 for inventory valuation and acquisition costs.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

None.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As required by SEC Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2010. Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2010.

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) promulgated under the Exchange Act. We maintain internal control over financial reporting designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of management, including the Company's Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included an assessment of the design of the Company's internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Based on this evaluation, management has concluded that the Company's internal control over financial reporting was effective as of December 31, 2010.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.