Final Results

27th Mar 2008 07:00

Enova Systems, Inc.27 March 2008 For Immediate Release 27th of March 2008 Enova Systems INC., (AMEX: ENA and AIM: ENV and ENVS), a leading developer andmanufacturer of electric, hybrid and fuel cell digital power management systems,announces annual results for the period ended December 31st 2007 Results of Operations Highlights For The Years Ended December 31, 2007 2006 $ Change % Change Net revenues $ 9,175,000 $ 1,666,000 $ 7,509,000 451%Cost of revenues 9,763,000 2,900,000 6,863,000 237%Gross loss (588,000) (1,234,000) 646,000 52% Net Revenues. The increase was attributed to the largest unit shipment volume inthe history of the Company at 384 units for 2007. In 2007, Tanfield EngineeringSystems Limited and International Truck and Engine Corporation comprised of 52%and 15%, respectively of our revenues. In the prior year 2006, revenues wereprimarily derived from our relationships with Hyundai Motor Company and theState of Hawaii, representing 39% and 16%, respectively. In 2007, Enova focusedon building new customer relationships in an effort to support our migrationinto the first phase of a production company. While we did continue severaldevelopment projects throughout the year, the process by which managementselected which development projects were accepted in 2007 largely depended onour assessment of which contracts had the greatest potential for a productionrelationship. Cost of Revenues. Cost of sales consists of component and material costs,direct labor 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. Our customers continue to require additional integration andsupport services to customize, integrate, and evaluate our products. We believethat a portion of these costs are initial, one-time costs for these customersand anticipate similar costs to be incurred with respect to new customers as wegain additional market share. Customers who have been using our products overone year do not typically incur this same type of initial costs. Cost of salesfor the year ended December 31, 2007 primarily attributable to the increase insales for the year and the associated one-time costs as discussed above. Inquires: Enova Systems Mike Staran, Chief Executive Officer +1(310) 527-2800 x137Jarett Fenton, Chief Financial Officer +1(310) 527-3847 Investec +44 (0) 207 597 5066Michael Ansell Global Equity IR +44 (0) 79 5620 6270Amira Bardichev Gross Profit Margin. The gross profit margin for 2007 was negative 6% comparedto a negative 74% in the prior year. The improved gross profit margin was as aresult of a significant increase in manufacturing benefits associated with theCompany's migration into a production phase. The Company experienced itslargest shipment volume in Company history of 384 units in 2007. Research and Development Expenses. Research and development expenses consistprimarily of personnel, facilities, equipment and supplies for our research anddevelopment activities. Non-funded development costs are reported as researchand development expense. Research and development expense decreased in 2007 to$1,159,000 from $1,363,000 for the same period in 2006, a decrease of $204,000or 15%. The aforementioned was a consequence of migration into productionrevenues and movement away our research and development phase. In 2007, wecontinued to enhance our technologies to be more universally adaptable to therequirements of our current and prospective customers. By modifying our softwareand firmware, we believe we should be able to provide a more comprehensive,adaptive and effective solution to a larger base of customers and applications.We will continue to research and develop new technologies and products, bothinternally and in conjunction with our alliance partners and other manufacturersas we deem beneficial to our global growth strategy. Selling, General and Administrative Expenses. Selling, general andadministrative expenses consist primarily of personnel and related costs ofsales and marketing employees, consulting fees and expenses for travel, tradeshows and promotional activities and personnel and related costs for generalcorporate functions, including finance, accounting, strategic and businessdevelopment, human resources and legal. Selling, general and administrativeexpenses increased by $3,588,000 at 2007 from the balance for the year endedDecember 31, 2006 of $4,178,000, representing an 86% increase in these costs.The predominant reason for the increase is the Company's on-going efforts insales and marketing initiatives, as well as directives to streamline theaccounting, quality, and inventory departments. This includes such things astrade shows, travel, marketing materials, and market consultants. As of December31, 2007, we employed 70 full-time employees compared to 39 full-time employeesas of December 31, 2006. This, combined with an increased in the associatedincreases in wages, health and workers compensation insurance, explain ourincreased selling, general and administrative expenses. Interest and Financing Fees, Net. For the year ended December 31, 2007, interestand other income, decreased by $207,000 from $550,000, down 38% from the 2006balance. The decrease is a result of our comparatively lower average cashbalance through the first seven months of 2007, when compared to the averagecash balance during 2006. Furthermore, decrease in prevailing interest ratesalso attributed to the decrease in comparison to the same period in the prioryear. Equity in losses of non-consolidated joint venture. For the year ended December31, 2007, the ITC generated a net loss of approximately $437,000, resulting in acharge to Enova of $177,000 utilizing the equity method of accounting for ourinterest in the ITC net of our pro-rata share of losses attributable to theinvestment, which reflects our forty percent (40%) interest in the Hyundai-EnovaInnovative Technology Center (ITC) as noted elsewhere in this Form 10-K. Thiswas an increase in the net loss of $174,000 when compared to prior year. Debt and Interest Extinguishment. In 2006, the Company settled $920,000 and$472,000 of debt and interest, respectively. In consideration for thesettlement, we paid the beneficiaries $163,000. No debt or interestextinguishments occurred in 2007. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS You should read this Management's Discussion and Analysis of Financial Conditionand Results of Operations in conjunction with our 2007 Financial Statements andaccompanying Notes. The matters addressed in this Management's Discussion andAnalysis of Financial Condition and Results of Operations, may contain certainforward-looking statements involving risks and uncertainties. Overview Enova Systems believes it is a leading supplier of efficient,environmentally-friendly digital power components and systems products inconjunction with our associated engineering services. Our core competencies arefocused on the development and commercialization of power management andconversion systems for mobile and stationary applications. Enova applies unique'enabling technologies' in the areas of alternative energy propulsion systemsfor light and heavy-duty vehicles as well as power conditioning and managementsystems for distributed generation systems. Our products can be found in avariety of OEM vehicles including those from Hyundai Motor Company and FordMotor Company, trucks and buses for First Auto Works of China, Mack Truck,WrightBus of the U.K. and the U.S. Military, as well as digital power systemsfor EDO, Hydrogenics and UTC Fuel Cells, a division of United Technologies. We continue to support IC Corp. in their efforts to maximize exposure in theHybrid School Bus Market. We have been involved in large shows in Albany, NY andReno, NV, Chicago, IL, Washington, DC as well as smaller venues throughout theMidwest. The exposure via shows and direct interface was aggressively pursuedthroughout the remainder of 2007, in an effort to promote IC Corp.'s productionintent for Hybrid School Buses. IC Corp. claims to be the nation's largestintegrated school bus manufacturer with 60-65% of the school bus market share.As a result of these continued domestic efforts, the Company expanded throughoutthe North American continent and delivered hybrid school buses to Canada andMexico through IC Corp. IC Corp. continued to move to production on Hybrid School Buses. At the sametime, IC Corp. announced that Enova would be their Hybrid drive system supplier.Also in July, Enova and IC Corp. were awarded a contract for nineteen HybridSchool Buses. These buses were delivered to eleven states throughout 2007. Theaward was based on a project coordinated by the Advanced Energy consortium andwas the first major Hybrid School Bus award of its kind. Ford Motor Company continues to evaluate our components in thirty Ford FocusHydrogen Fuel Cell Vehicles being evaluated in three countries. According toFord Motor Company communications, the vehicles have functioned satisfactorily,and they continue to evaluate markets for producing additional vehicles. InAugust 2006, Enova announced that Ford Motor Company has ordered four (4)advanced design High Voltage Energy Converters (HVECs). This award confirmedFord's continued interest in Enova's technology and was delivered to Ford during2007. Throughout 2007 we hosted and visited numerous potential customers from the PickUp and Delivery, Medium Duty and Heavy Duty markets. During the 4th quarter of2007, again, we provided a large fleet operator a functional vehicle forevaluation. Every effort is made to continue to mature these relationships, aswe hope that they will eventually lead to viable business relationships. We also anticipate continuing our work with Tsinghua University of China, andtheir fuel cell bus development program. We believe that China intends to usehybrid-electric buses to shuttle athletes and guests at the 2008 Beijing SummerOlympics and the 2010 World's Expo in Shanghai and China it is seeking up to onethousand full-size hybrid-electric buses to support these global events. MTransof Malaysia has integrated two of our standard HybridPower 120kW drive systeminto a hybrid 10-meter bus with a Capstone microturbine as its power source.This drive system is currently on demonstration in Hong Kong, PRC. Also, Hyundaicontinues to evaluate our converters in their fuel cell hybrid electric vehiclesand we currently expect to deliver an additional sixteen units in 2007. Some notable highlights of Enova's accomplishments are: • Enova increased its personnel by nearly 50% during 2007. The increasewas due to direct strengthening of Enova's Supply Chain Management, Quality,Software and Engineering Departments. • International Truck and Engine (IC Corp), the nation's largest SchoolBus manufacturer, has partnered with Enova to supply the nation's 1st productionHybrid School Buses. IC Corp currently maintains 60% of the School Bus market.In addition to School Buses, IC Corp is teaming with Enova, as early adopters,to supply production hybrid buses to the Commercial Bus Market. Enova and ICrecently broadened their penetration into Canada and Mexico. There are noassurances, however that any purchase orders will be realized. • WrightBus, the largest low-floor and Double Deck bus manufacturer inthe United Kingdom, has taken delivery of our series hybrid diesel genset andintegrated them into its medium and large bus applications. Six of these systemsare now running seven days a week 18 hours a day in London. Enova with WrightBuson projects related to Enova's hybrid drive systems. There are no assurances,however that any purchase orders will be realized. • Tanfield, the World's largest electric vehicle manufacturer, hassigned an arrangement with Enova where Enova will supply electric drive systemsfor Tanfield's 3.5, 7.5 and 12 ton vehicles. Enova expects to supply Tanfieldunits during 2008, and throughout 2009. There are no assurances, however thatany purchase orders will be realized. • First AutoWorks, China's largest vehicle manufacturer has partneredwith Enova whereas Enova will supply its pre transmission hybrid system for busapplications. Enova has recently been awarded an order for 20 systems. There areno assurances, however that any future purchase orders will be realized. • Th!nk and Electric Vehicles OEMs have both utilized Enova as asupplier of primary components/systems for their vehicles. • Verizon has taken, in total, receipt of fifteen (15) service vansincorporating Enova's technology. Verizon is the nation's second largest fleetoperator with 58,000 vehicles. In addition to Verizon, Enova has begundevelopment work with other large fleet operators in both the service van andpick up and delivery sectors. There are no assurances, however that any purchaseorders will be realized. • The Company integrated and delivered two (2) service vehicles withEnova's unique Post-Transmission Parallel Hybrid Drive System to CoxCommunications. The hybrid vehicles are the GM 1500 Silverado Pickup and a FordE250 Cargo Van. This development illustrates Enova's strategic focus to furtherpenetrate the fleet market. • In 2008, the Company was chosen to power four Optare Solo Buses,integrated by UK-based Traction Technology Plc. The Buses will incorporateEnova's 120kW Series Hybrid drive system. There are not assurance, however thatany purchase orders will be realized. Enova's product focus is digital power management and power conversion systems.Its software, firmware, and hardware manage and control the power that driveseither a vehicle or stationary device(s). They convert the power into theappropriate forms required by the vehicle or device and manage the flow of thisenergy to optimize efficiency and provide protection for both the system and itsusers. Our products and systems are the enabling technologies for power systems. The latest state-of-the-art technologies, such as hybrid vehicles, fuel cell andmicro turbine based systems, and stationary power generation, all require sometype of power management and conversion mechanism. Enova Systems supplies theseessential components. Enova drive systems are 'fuel-neutral,' meaning that theyhave the ability to utilize any type of fuel, including diesel, liquid naturalgas or bio-diesel fuels. We also develop, design and produce power managementand power conversion components for stationary power generation - both on-sitedistributed power and on-site telecommunications back-up power applications.These stationary applications also employ fuel cells, microturbines and advancedbatteries for power storage and generation. Additionally, Enova performssignificant research and development to augment and support others' and ourinternal related product development efforts. Our products are "production-engineered." This means they are designed so theycan be commercially produced (i.e., all formats and files are designed withmanufacturability in mind, from the start). For the automotive market, Enovadesigns its products to ISO 9000 manufacturing and quality standards. We believeEnova's redundancy of systems and rigorous quality standards result in highperformance and reduced risk. For every component and piece of hardware, thereare detailed performance specifications. Each piece is tested and evaluatedagainst these specifications, which enhances and confirms the value of thesystems to OEM customers. Our engineering services focus on system integrationsupport for product sales and custom product design. Financial Results As of and for the Year Ended December 31, 2007 2006 2005 2004 2003 (In thousands ,except per share data)Statement of Operations DataNet revenues 9,175 $1,666 $6,084 $2,554 $4,310Cost of revenues 9,763 2,900 6,001 2,239 3,304Gross margin (588) (1,234) 83 315 1,006Operating expensesResearch and Development 1,159 1,363 804 925 799Asset Impairment - - - - 200Selling, general and administrative 7,766 4,178 2,870 2,325 2,919Total Operating Expense 8,925 5,541 3,674 3,250 3,918Other Income and ExpenseInterest and Financing Fees, net 343 550 13 (255) (234)Equity in losses (177) (3) (118) (192) (40)Gain on Debt Restructuring - 1,392 1,569 - -Total Other Income and (Expense) 166 1,939 1,464 (447) (274)Net loss (9,347) $(4,836) $(2,127) $(3,3382) $(3,186)Per common share:Net loss per common share $(0.59) $(0.33) $(0.18) $(0.38) $(0.43)Weighted average number common shares outstanding 15,796,000 14,802,000 11,644,000 8,832,000 7,441,000Balance Sheet DataTotal assets $21,173 $15,730 $21,973 $5,888 $4,870Long-term debt $1,306 $1,295 $2,321 $3,341 $3,347Shareholders' equity (deficit) $14,177 $11,964 $16,604 $103 $(864) Critical Accounting Policies The following represents a summary of our critical accounting policies, definedas those policies that we believe: (a) are the most important to the portrayalof our financial condition and results of operations and (b) involve inherentlyuncertain issues which require management's most difficult, subjective orcomplex judgments. Cash and cash equivalents - Cash consists of currency held at reputablefinancial institutions. Short-term, highly liquid investments with an originalmaturity of three months or less are considered cash equivalents. Inventory - Inventories are priced at the lower of cost or market utilizingfirst-in, first-out (FIFO) cost flow assumption. We maintain a perpetualinventory system and continuously record the quantity on-hand and standard costfor each product, including purchased components, subassemblies and finishedgoods. We maintain the integrity of perpetual inventory records through periodicphysical counts of quantities on hand. Finished goods are reported asinventories until the point of transfer to the customer. Generally, titletransfer is documented in the terms of sale. Inventory reserve - We maintain an allowance against inventory for the potentialfuture obsolescence or excess inventory that is based on our estimate of futuresales. A substantial decrease in expected demand for our products, or decreasesin our selling prices could lead to excess or overvalued inventories and couldrequire us to substantially increase our allowance for excess inventory. Iffuture customer demand or market conditions are less favorable than ourprojections, additional inventory write-downs may be required. Allowance for doubtful accounts - We maintain allowances for doubtful accountsfor estimated losses resulting from the inability of our customers to makerequired payments. The assessment of the ultimate realization of accountsreceivable including the current credit-worthiness of each customer is subjectto a considerable degree to the judgment of our management. If the financialcondition of the Company's customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired. Stock-based Compensation - Effective January 1, 2006, the Company adoptedStatement of Financial Accounting Standards ("SFAS") No. 123(R), Share-BasedPayment ("SFAS 123(R)"), which requires the measurement and recognition ofcompensation expense for all share-based payment awards made to employees anddirectors, including stock options and employee stock purchases related to theCompany's Employee Stock Purchase Plan (the "Employee Stock Purchase Plan")based on their fair values. SFAS 123(R) supersedes Accounting Principles BoardOpinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), which theCompany previously followed in accounting for stock-based awards. In March 2005,the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107") to provide guidanceon SFAS 123(R). The Company has applied SAB 107 in its adoption of SFAS 123(R). Revenue recognition - The Company is required to make judgments based onhistorical experience and future expectations, as to the reliability ofshipments made to its customers. These judgments are required to assess thepropriety of the recognition of revenue based on Staff Accounting Bulletin ("SAB") No. 101 and 104, "Revenue Recognition," and related guidance. The Companymakes these assessments based on the following factors: i) customer-specificinformation, ii) return policies, and iii) historical experience for issues notyet identified. Under FAS Concepts No. 5, revenues are not recognized untilearned. The Company manufactures 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 labor 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 periodspresented. Our operating results would be affected if other alternatives wereused. Information about the impact on our operating results is included in thefootnotes to our financial statements. Several other factors related to the Company may have a significantimpact on our operating results from year to year. For example, the accountingrules governing the timing of revenue recognition related to product contractsare complex and it can be difficult to estimate when we will recognize revenuegenerated by a given transaction. Factors such as acceptance of servicesprovided, payment terms, creditworthiness of the customer, and timing ofdelivery or acceptance of our products often cause revenues related to salesgenerated in one period to be deferred and recognized in later periods. Forarrangements in which services revenue is deferred, related direct andincremental costs may also be deferred. Recent Accounting Pronouncements In February 2007, the FASB issued SFAS No. 159 "Fair Value Option for FinancialAssets and Financial Liabilities" ("SFAS 159") which permits entities to measuremany financial instruments and certain other items at fair value. Companies arerequired to adopt the new standard for fiscal years beginning after November 15,2007. The Company is evaluating the impact of this standard and currently doesnot expect it to have a significant impact on its financial position, results ofoperations or cash flows. In June 2007, the FASB ratified Emerging Issues Task Force ("EITF") Issue No.06-11 ("EITF Issue No. 06-11"), "Accounting for Income Tax Benefits of Dividendson Shared-Based Payment Awards". EITF Issue No 06-11 requires that tax benefitsgenerated by dividends paid during the vesting period on certainequity-classified share-based compensation awards be treated as additionalpaid-in capital and included in a pool of excess tax benefits available toabsorb tax deficiencies from share-based payment awards. EITF Issue No. 06-11 iseffective beginning with the 2009 fiscal year. The Company does not expect it tohave a significant impact on its financial position, results of operations orcash flows. In June 2007 the FASB ratified EITF No. 07-3, "Accounting for NonrefundableAdvance Payments for Goods or Services to Be Used in Future Research andDevelopment Activities" ("EITF 07-3") which requires non-refundable advancepayments for goods and services to be used in future research and developmentactivities to be recorded as an asset and the payments to be expensed when theresearch and development activities are performed. EITF 07-3 is effective forfiscal years beginning after December 15, 2007. The Company is evaluating theimpact of this standard and currently does not expect it to have a significantimpact on its financial position, results of operations or cash flows. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests inConsolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160").SFAS 160 introduces significant changes in the accounting and reporting forbusiness acquisitions and noncontrolling interest ("NCI") in a subsidiary. SFAS160 also changes the accounting for and reporting for the deconsolidation of asubsidiary. Companies are required to adopt the new standard for fiscal yearsbeginning after January 1, 2009. The Company is evaluating the impact of thisstandard and currently does not expect it to have a significant impact on itsfinancial position, results of operations or cash flows. In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS141R") which establishes principles and requirements for how the acquirer of abusiness recognizes and measures in its financial statements the identifiableassets acquired, the liabilities assumed, and any noncontrolling interest in theacquiree. The statement also provides guidance for recognizing and measuring thegoodwill acquired in the business combination and determines what information todisclose to enable users of the financial statement to evaluate the nature andfinancial effects of the business combination. SFAS 141R is effective forfinancial statements issued for fiscal years beginning after December 15, 2008.Accordingly, any business combinations the Company engages in will be recordedand disclosed following existing GAAP until January 1, 2009. The Company doesnot expect SFAS 141R will have an impact on its consolidated financialstatements when effective, but the nature and magnitude of the specific effectswill depend upon the nature, terms and size of the acquisitions the Companyconsummates after the effective date. The Company is evaluating the impact ofthis standard and currently does not expect it to have a significant impact onits financial position, results of operations or cash flows. Liquidity and Capital Resources 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 year ended December 31, 2007 were financed bydevelopment contracts and product sales, as well as from working capitalreserves. During the year ended December 31, 2007, our operations required $10,561,000more in cash than was generated, versus $5,144,000 in 2006. The Companycontinues to increase marketing and development spending as well asadministrative expenses necessary for expansion to meet expected customerdemand. Accounts receivable increased by $3,898,000 from $358,000, orapproximately 1089% from the balance at December 31, 2006 (net of write-offs).The increase was primarily attributable to shipments worth approximately$2,965,000 in the fourth quarter of 2007 and an increase in sales in 2007 incomparison to the prior year. Inventory increased from $1,704,000 at the year ended December 31, 2006 to$3,565,000 at the year ended December 31, 2007, representing a 109% increase inthe balance. The increase was as a result inventory purchases in the fourthquarter of 2007 as the Company was anticipating an increase in sales volume inthe coming periods. The Company experienced its largest shipment volume inCompany history of 384 units and has received production orders for additionalproduction units for shipment in 2008. Prepaid expenses and other current assets decreased by $251,000 during 2007 fromthe December 31, 2006 balance of $708,000 or almost 35%. The decrease is causedprimarily by the decrease in interest receivable on a certificate of deposit andcash held in a short term, cash equivalent, investment account. Furthermore,prepaid expenses decreased in 2007 due to the absence of prepaid integrationcosts associated with the Verizon van project when compared to 2006. Net fixed assets increased by $243,000 or 39%, for the year ended December 31,2007 from the prior year balance of $627,000 primarily due to the purchase ofcomputers, furniture and office equipment, software, production tooling,machinery, and equipment associated with production. These increases areconsistent the Company's migration into a production stage and expansion ofoperations. Investments decreased by $5,000,000 in 2007 when compared to the balance as ofDecember 31, 2006 of $5,000,000. This decrease was a result of cash increasedliquidity requirements to support wages and salaries, supplier payments, andother factors noted as increases in selling, general, and administrativeexpenses. In addition, $2,000,000 of the decrease was attributed to the purchaseof a certificate of deposit held in relation to the lease of a new facilitylocated at 1560 West 190th Street, Torrance, California. Intangible Assets decreased by $4,000 during 2007 from $74,000 in 2006. Enovadid not recognize any additional intellectual property assets, including patentsand trademarks, during 2007. The change in the balance was considered nominal. Accounts payable increased in 2007 by 385% from $382,000 at December 31, 2006 to$1,877,000 at December 31, 2007. At December 31, 2007, the accounts payablebalance represents balances owed to vendors for fourth quarter inventorypurchases made in expectation of increasing sales volume in the coming periods,and is evidenced by an increased inventory balance, as discussed above. Enova reported $101,000 of deferred revenue at December 31, 2007, compared to adeferred revenue balance at December 31, 2006 of $399,000. The decrease in thebalance of $298,000 was due to the recognition of revenue from our customer, theHawaii Center for Advanced Transportation Technologies (HCATT). Accrued interest increased by $139,000 for the year ended December 31, 2007, anincrease of 19%. The increase is associated with the net effect of interestaccrued on the Note due the Credit Managers Association of California (CMAC) for$1.3 million (year end 2006 balance). Per the terms of the Note, unpaid interestand principal is due in April 2016. As such, the increase reflects the accrualof interest over the course of 2007. Other accrued expenses and payables increased by $1,572,000 during 2007, from$664,000 at December 31, 2006. The increase primarily attributable to anincrease in our warranty accrual in proportion with our increase in sales incomparison to the prior year while the remaining portion includes the accrualfor receipt of inventory materials and production supplies. Contractual Obligations As of December 31, 2007, our contractual obligations for the next five years,and thereafter, were as follows (in thousands): Payments Due by Period Less Than 1-3 3-5 More Than Total 1 Year Years Years 5 YearsLong-Term Debt Obligations $1,401 $95 $60 $8 $1,238Capital Lease Obligations - - - - -Operating Lease Obligations 2,195 439 878 878 -Purchase Obligations - - - - -Accrued Interest 874 12 - - 862Total $4,470 $546 $1,066 $886 $2,100 Subsequent Offering On March 26, 2008, the company entered into an agreement with aplacement agent to sell 2,131,274 shares of common stock. Pursuant to theplacing agreement, the placement agent has agreed to use its reasonable effortsto sell, and has conditionally sold, all such shares of Enova common stock at195 pence sterling per share (approximately US$3.91 per share) to certaineligible offshore investors. It is anticipated that the company will receiveapproximately 4,200,000 pounds sterling (approximately US$8,300,000) in grossproceeds from the offering. The placement agent will earn a selling commissionof 5% in addition to reimbursement of expenses. The closing of the offering iscontingent upon, among other things, the listing of such shares for trading oneach of the American Stock Exchange and the Alternative Investment Market (AIM)of the London Stock Exchange. The offer and sale of the shares has been made pursuant toRegulation S under the Securities Act. Among other things, each investorpurchasing shares of Enova's common stock in the offering will represent thatthe investor is not a United States person as defined in Regulation S. Inaddition, neither the company nor the placement agent has conducted any sellingefforts directed at the United States in connection with the offering. Allshares of common stock to be issued in the offering will include a restrictivelegend indicating that the shares are being issued pursuant to Regulation Sunder the Securities Act and are deemed to be "restricted securities." As aresult, the purchasers of such shares will not be able to resell the sharesunless in accordance with Regulation S, pursuant to a registration statement, orupon reliance of an applicable exemption from registration under the SecuritiesAct. Joint Venture - Hyundai-Enova Innovative Technology Center In September 2003, Enova and Hyundai Heavy Industries, Co. Ltd.(HHI) commenced a relationship to establish the Hyundai-Enova InnovativeTechnology Center (ITC) to be located at Enova's Torrance headquarters. The ITCwas originally established as a technical center for specified products thatwould engage Enova as the commercial managers, the ITC as the primaryengineering and development venture, and HHI as the primary components supplier. Although integral to our development and financial stability in prior years,Enova now is more established in the market as a fully functional,self-sufficient entity. To meet the anticipated needs of our core customers, wehave developed resources to supply our products to the medium and heavy dutytruck and bus market segment. Enova, along with HHI, are evaluating therelationship to determine its future role for both companies. As discussed inour Results of Operations, in fiscal year 2006 our relationship with Hyundairepresented our largest customer generating 39% of revenues, but in fiscal year2007 the relationship accounted for less than 10% of our revenues. ENOVA SYSTEMS, INC. BALANCE SHEETS December 31, 2007 2006 ASSETS Current assets: Cash and cash equivalents $ 10,485,000 $ 5,612,000 Short term - 5,000,000 investments Accounts receivable, net 4,256,000 358,000 Inventories and supplies, 3,565,000 1,704,000 net Prepaid expenses and other current assets 457,000 708,000 Total current assets 18,763,000 13,382,000 Property and equipment, 870,000 627,000 net Investment in non-consolidated joint venture 1,470,000 1,647,000 Intangible 70,000 74,000 assets, net Total assets $ 21,173,000 $ 15,730,000 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,877,000 $ 382,000 Deferred 101,000 399,000 revenues Accrued payroll and related obligations 680,000 220,000 Other accrued 2,063,000 664,000 expenses Current portion of notes 95,000 71,000 payable Total current 4,816,000 1,736,000 liabilities Accrued interest payable 874,000 735,000 Notes payable, net of 1,306,000 1,295,000 current portion Total $ 6,996,000 $ 3,766,000 liabilities Commitments and contingencies (Note 10) Stockholders' equity: Series A convertible preferred stock - no par 1,679,000 1,679,000 value, 30,000,000 shares authorized; 2,652,000 issued and outstanding; liquidating preference at $0.60 per share as of December 31, 2007 and 2006 Series B convertible preferred stock - no par 1,094,000 2,432,000 value, 5,000,000 shares authorized; 546,000 and 1,185,000 shares issued and outstanding; liquidating preference at $2 per share as of December 31, 2007 and 2006 Common Stock - no par value, 750,000,000 shares 121,970,000 109,460,000 authorized; 17,156,000 and 14,816,000 shares issued and outstanding as of December 31, 2007 and 2006 Common stock subscribed 30,000 36,000 Stock notes receivable for the sale of preferred (1,149,000) (1,176,000) stock Additional paid-in 7,322,000 6,955,000 capital Accumulated (116,769,000) (107,422,000) deficit Total stockholders' 14,177,000 11,964,000 equity Total liabilities and stockholders' equity $ 21,173,000 $ 15,730,000 The accompanying notes are an integral part of these financial statements. ENOVA SYSTEMS, INC. STATEMENTS OF OPERATIONS For The Years Ended December 31, 2007 2006 Net revenues Research and development contracts $ - $ 439,000 Production 9,175,000 1,227,000 Total net revenues 9,175,000 1,666,000 Cost of revenues Research and development contracts - 1,046,000 Production 9,763,000 1,854,000 Total cost of revenues 9,763,000 2,900,000 Gross loss (588,000) (1,234,000) Operating expenses Research and development 1,159,000 1,363,000 Selling, general & administrative 7,766,000 4,178,000 Total operating expenses 8,925,000 5,541,000 Gross operating loss (9,513,000) (6,775,000) Other income and (expense) Interest and financing fees, net 343,000 550,000 Equity in losses of (177,000) (3,000) non-consolidated joint venture Debt extinguishment - 920,000 Interest extinguishment - 472,000 Total other income, net 166,000 1,939,000 Net loss $ $ (9,347,000) (4,836,000) Basic and diluted loss per share (0.59) (0.33) Weighted average number of shares 15,796,000 14,802,000 outstanding The accompanying notes are an integral part of these financial statements. ENOVA SYSTEMS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY Convertible Preferred Stock Series A Series B Common Stock Shares Amount Shares Amount Shares AmountBalance, 2,674,000 $1,679,000 1,217,000 $2,434,000 14,783,000 $109,323,000December 31, 2005 Conversion of (22,000) - (32,000) (2,000) 1,000 2,000Series A and Series B preferred stock Issuance of 29,000 125,000common stock for director services Director bonus 3,000 10,000Stock Option Expense Subscribed common stock Net loss Balance, 2,652,000 $1,679,000 1,185,000 $2,432,000 14,816,000 $109,460,000December 31, 2006 Conversion of (639,000) (1,338,000) 28,000 1,338,000Series A and Series B preferred stock Exercise of Stock 44,000 193,000Options Issuance of 2,218,000 10,767,000common stock for Cash Issuance of 34,000 144,000common stock for director services Director bonus 16,000 68,000Stock Option Expense Subscribed common stock Cash received for stock note receivable Net Loss Balance, 2,652,000 $1,679,000 546,000 $1,094,000 17,156,000 $121,970,000December 31, 2007 Common Stock Stock Additional Subscribed Note Paid In Accumulated Shares Amount Receivable Capital Deficit TotalBalance, 8,000 $30,000 $(1,176,000) $6,900,000 $(102,586,000) $16,604,000December 31, 2005 Conversion of -Series A and Series B preferred stock Issuance of (8,000) (30,000) 95,000common stock for director services Director bonus 10,000Stock Option 55,000 55,000Expense Subscribed common 12,000 36,000 36,000stock Net loss (4,836,000) (4,836,000)Balance, 12,000 $36,000 $(1,176,000) $6,955,000 $(107,422,000) $11,964,000December 31, 2006 Conversion of -Series A and Series B preferred stock Exercise of Stock 193,000Options Issuance of 10,767,000common stock for Cash Issuance of (12,000) (36,000) 108,000common stock for director services Director bonus 68,000Stock Option 367,000 367,000Expense Subscribed common 6,000 30,000 30,000stock Cash received for 27,000 27,000stock note receivable Net Loss (9,347,000) (9,347,000)Balance, 6,000 $30,000 $(1,149,000) $7,322,000 $(116,769,000) $14,177,000December 31, 2007 The accompanying notes are an integral part of these financial statements. ENOVA SYSTEMS, INC. STATEMENTS OF CASH FLOWS Twelve Months Ended December 31, Cash flows from operating activities 2007 2006 Net loss $ $ (9,347,000) (4,836,000) Adjustments to reconcile net loss to net cash used in operating activities Debt extinguishment - (920,000) Interest extinguishment - (472,000) Depreciation and amortization 300,000 419,000 Loss on asset disposal 52,000 - Inventory reserve 100,000 - Equity in losses of non-consolidated 177,000 3,000 joint venture Issuance of common stock for director 68,000 10,000 bonuses Issuance of common stock for director 138,000 132,000 services Stock option expense 367,000 55,000 (Increase) decrease in: Accounts receivable (3,898,000) 1,815,000 Inventory and supplies (1,961,000) (688,000) Prepaid expenses and other current assets 251,000 (526,000) Increase (decrease) in: Accounts payable 1,495,000 (1,014,000) Accrued expenses 1,856,000 387,000 Deferred revenues (298,000) 399,000 Accrued interest payable 139,000 92,000 Net cash used in operating activities (10,561,000) (5,144,000) Cash flows from investing activities Purchases of short-term investments $ - $ (5,000,000) Maturities of short-term investments 5,000,000 Purchases of property and equipment (515,000) (259,000) Net cash provided by (used) in investing 4,485,000 (5,259,000) activities Cash flows from financing activities Payment on notes payable and capital $ (38,000) $ (172,000) lease obligations Net proceeds from sales of common stock 10,767,000 - Proceeds from the execution of stock 193,000 - options Proceeds from repayment of stock note 27,000 - receivable Net cash provided by (used in) financing 10,949,000 (172,000) activities Net increase (decrease) in cash and cash 4,873,000 (10,575,000) equivalents Cash and cash equivalents, beginning of 5,612,000 16,187,000 period Cash and cash equivalents, end of period $ 10,485,000 $ 5,612,000 Supplemental disclosure of cash flow information Interest paid $ 7,000 $ 1,000 Income taxes paid $ 1,000 $ 1,000 Assets acquired through financing $ 74,000 $ 95,000 arrangements 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 developsdrive trains and related components for electric, hybrid electric, and fuel cellsystems for mobile and stationary applications. The Company retains developmentand manufacturing rights to many of the technologies created, whether suchresearch and development is internally or externally funded. The Companydevelops and sells components in the United States and Asia, and sellscomponents in Europe. Liquidity The Company has sustained recurring losses and negative cash flows fromoperations. Over the past year, the Company's growth has been funded through acombination of private equity, bank debt, and lease financing. As of December31, 2007, the Company had approximately $10.5 million of cash and cashequivalanets. At December 31, 2007, the Company had a net working capital ofapproximately $13.9 million as compared to $11.7 million at December 31, 2006,representing an increase of $2.2 million. The Company believes that it currentlyhas sufficient cash and financing commitments to meet its funding requirementsover the next year. However, the Company has experienced and continues toexperience recurring operating losses and negative cash flows from operations,as well as an ongoing requirement for substantial additional capital investment.The Company expects that it will need to raise additional capital to accomplishits business plan over the next several years. The Company is striving to expandits presence in the marketplace and achieve operating efficiencies. Joint Venture - Hyundai-Enova Innovative Technology Center In June 2003, the Company and Hyundai Heavy Industries of Korea ("HHI")commenced operations of Hyundai-Enova Innovative Technology Center, Inc. (the "ITC"), a 60/40 joint venture to develop hybrid drive technology. ITC is to bedomiciled in Torrance, California. Concurrent with the formation of the jointventure, the Company entered into a stock purchase agreement with HHI. Pursuant to the stock purchase agreement HHI agreed to make a $3 millioninvestment in the Company through the purchase of shares of the Company'sauthorized and unissued common stock pursuant to Regulation D of the SecuritiesAct of 1933. This investment was made in two installments of $1.5 million each.The first installment was made in June 2003 upon incorporation of the ITC and inconsideration for the issuance to HHI by the Company of 23,076,923 shares ofcommon stock at $0.065 per share. The second installment was made in September 2004 in consideration for theissuance to HHI by the Company of 11,335,315 shares of common stock at $0.1323per share. The Company invested $1 million of each installment into the ITC inconsideration for the issuance to the Company of a 40% equity interest in theITC (the balance of the installments, in the amount of $500,000 each, is to beretained by the Company). HHI acquired a 60% equity interest in ITC by investing$3 million in the ITC in two installments of $1.5 million each, to be madeconcurrently with the two installment payments to be paid by HHI for theCompany's common stock. HHI and the Company have invested an aggregate of $5million in the ITC. 2. Summary of Significant Accounting Policies Revenue Recognition The Company manufactures proprietary products and other products based on designspecifications provided by its customers. The Company recognizes revenue only when all of the following criteria have beenmet: • 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 anarrangement in a written contract signed by the customer prior to recognizingrevenue. Delivery Has Occurred or Services Have Been Rendered - The Company performs allservices or delivers all products prior to recognizing revenue. Professionalconsulting and engineering services are considered to be performed when theservices are complete. Equipment is considered delivered upon delivery to acustomer's designated location. In certain instances, the customer elects totake title upon shipment. The Fee for the Arrangement is Fixed or Determinable - Prior to recognizingrevenue, a customer's fee is either fixed or determinable under the terms of thewritten contract. Fees professional consulting services, engineering servicesand equipment sales are fixed under the terms of the written contract. Thecustomer's fee is negotiated at the outset of the arrangement and is not subjectto refund or adjustment during the initial term of the arrangement. Collectibility is Reasonably Assured - The Company determines thatcollectibility is reasonably assured prior to recognizing revenue.Collectibility is assessed on a customer-by-customer basis based on criteriaoutlined by management. New customers are subject to a credit review process,which evaluates the customer's financial position and ultimately its ability topay. The Company does not enter into arrangements unless collectibility isreasonably assured at the outset. Existing customers are subject to ongoingcredit evaluations based on payment history and other factors. If it isdetermined during the arrangement that collectibility is not reasonably assured,revenue is recognized on a cash basis. Additionally, in accordance with theSecurities and Exchange Commission's Staff Accounting Bulletin No. 104 ("SAB 104"), amounts received upfront for engineering or development fees undermultiple-element arrangements are deferred and recognized over the period ofcommitted services or performance, if such arrangements require the Company toprovide on-going services or performance. All amounts received undercollaborative research agreements or research and development contracts arenonrefundable, regardless of the success of the underlying research. Pursuant to Emerging Issues Task Force ("EITF") of the Financial AccountingStandards Board Issue 00-21. EITF Issue 00-21 addressed the accounting forarrangements that may involve the delivery or performance of multiple products,services and/or rights to use assets. Specifically, Issue 00-21 requires therecognition of revenue from milestone payments over the remaining minimum periodof performance obligations. As required, we apply the principles of Issue 00-21to multiple element agreements. The Company recognizes engineering and construction contract revenues using thepercentage-of-completion method, based primarily on contract costs incurred todate compared with total estimated contract costs. Customer-furnished materials,labor, and equipment, and in certain cases subcontractor materials, labor, andequipment, are included in revenues and cost of revenues when managementbelieves that the company is responsible for the ultimate acceptability of theproject. Contracts are segmented between types of services, such as engineeringand construction, and accordingly, gross margin related to each activity isrecognized as those separate services are rendered. Changes to total estimated contract costs or losses, if any, are recognized inthe period in which they are determined. Claims against customers are recognizedas revenue upon settlement. Revenues recognized in excess of amounts billed areclassified as current assets under contract work-in-progress. Amounts billed toclients in excess of revenues recognized to date are classified as currentliabilities under advance billings on contracts. Changes in project performance and conditions, estimated profitability, andfinal contract settlements may result in future revisions to engineering anddevelopment contract costs and revenue. Deferred Revenue The Company recognizes revenues as earned. Amounts billed in advance of theperiod in which service is rendered are recorded as a liability under DeferredRevenue. Comprehensive Income The Company utilizes Statement of Financial Accounting Standards ("SFAS") No.130, "Reporting Comprehensive Income." This statement establishes standards forreporting comprehensive income and its components in a financial statement.Comprehensive income as defined includes all changes in equity (net assets)during a period from non-owner sources. Examples of items to be included incomprehensive income, which are excluded from net income, include foreigncurrency translation adjustments, minimum pension liability adjustments, andunrealized gains and losses on available-for-sale securities. Comprehensiveincome is not presented in the Company's financial statements since the Companydid not have any changes in equity from non-owner sources. Cash and Cash Equivalents Short-term, highly liquid investments with an original maturity of three monthsor less are considered cash equivalents. Short-Term Investments Short-term investments consist of certificates of deposit with maturities ofless than a year. Accounts Receivable Trade accounts receivable are recorded at the invoiced amount and do not bearinterest. The allowance for doubtful accounts is the Company's best estimate ofthe amount of probable credit losses in the Company's existing accountsreceivable; however, changes in circumstances relating to accounts receivablemay result in a requirement for additional allowances in the future. The Companydetermines the allowance based on historical write-off experience, currentmarket trends and, for larger accounts, the ability to pay outstanding balances.The Company continually reviews its allowance for doubtful accounts. Past duebalances over 90 days and other higher risk amounts are reviewed individuallyfor collectibility. In addition, the Company maintains a general reserve for allinvoices by applying a percentage based on the age category. Account balancesare charged against the allowance after all collection efforts have beenexhausted and the potential for recovery is considered remote. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated lossesresulting from the inability of its customers to make required payments. Aconsiderable amount of judgment is required in assessing the ultimaterealization of accounts receivable including the current credit-worthiness ofeach customer. If the financial condition of the Company's customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required. As of December 31, 2007 and 2006, theCompany maintained a reserve of $261,000 and $261,000 of potentially doubtfulaccounts receivable respectively. There was no bad debt expense recorded in 2007and 2006. Inventories and Supplies Inventories and supplies are comprised of materials used in the design anddevelopment of electric, hybrid electric, and fuel cell drive systems, and otherpower and ongoing management and control components for production and ongoingdevelopment contracts, and is stated at the lower of cost (first-in, first-out)or market (net realizable value). Property and Equipment Property and equipment are stated at cost and depreciated over the estimateduseful lives of the related assets, which range from three to seven years usingthe straight-line method for financial statement purposes. The Company usesother depreciation methods (generally, accelerated depreciation methods) for taxpurposes where appropriate. Amortization of leasehold improvements is computedusing the straight-line method over the shorter of the remaining lease term orthe estimated useful lives of the improvements. Repairs and maintenance are expensed as incurred. Expenditures that increase thevalue or productive capacity of assets are capitalized. When property andequipment are retired, sold, or otherwise disposed of, the asset's cost andrelated accumulated depreciation are removed from the accounts and any gain orloss is included in operations. Assets Held as Leasehold Improvements Assets held as leasehold improvements are recorded at cost. Amortization expenseis computed using the straight-line method over the shorter of the estimateduseful lives of the assets or the period of the related lease. Impairment of Long-Lived Assets The Company assesses the impairment of its long-lived assets periodically inaccordance with the provisions of Statement of Financial Accounting Standards ("SFAS") 144, "Accounting for the Impairment and Disposal of Long-Lived Assets". The Company reviews the carrying value of property and equipment for impairmentwhenever events and circumstances indicate that the carrying value of an assetmay not be recoverable from the estimated future cash flows expected to resultfrom its use and eventual disposition. In cases where undiscounted expectedfuture cash flows are less than the carrying value, an impairment loss isrecognized equal to an amount by which the carrying value exceeds the fair valueof assets. The factors considered by management in performing this assessmentinclude current operating results, trends, and prospects, as well as the effectsof obsolescence, demand, competition, and other economic factors. Long-livedassets that management commits to sell or abandon are reported at the lower ofcarrying amount or fair value less cost to sell. Equity Method Investment Investment in ITC, a joint venture (see Note 1,) is accounted for by the equitymethod. Under the equity method of accounting, an Investee company's accountsare not reflected within the Company's Consolidated Balance Sheets andStatements of Operations; however, the Company's share of the earnings or lossesof the Investee company is reflected in the caption "Equity loss - share ofjoint venture company losses" in the Consolidated Statements of Operations. TheCompany's carrying value in an equity method joint venture company is reflectedin the caption "Ownership interests in joint venture" in the Company'sConsolidated Balance Sheets. Patents Patents are measured based on their fair values. Patents are being amortized ona straight-line basis over a period of 20 years and are stated net ofaccumulated amortization of $24,000 and $19,000 at December 31, 2007 and 2006,respectively. Development Agreement In June 2001, the Company entered into an agreement to develop and manufacture ahigh power, high voltage conversion module for Ford Motor Company's (Ford) fuelcell vehicle. The purchase price for the five-year agreement was paid throughthe issuance of warrants, which had a fair vale of $577,000. The fair value wasdetermined using the Black-Scholes option pricing model. This amount wasrecorded as an intangible asset and is being amortized over the period of itsestimated benefit period of 5 years. At December 31, 2007, this agreement hasbeen fully amortized. Impairment of Intangible Assets The Company evaluates the recoverability of identifiable intangible assetswhenever events or changes in circumstances indicate that an intangible asset'scarrying amount may not be recoverable. Such circumstances could include, butare 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 isused, or (3) an accumulation of costs significantly in excess of the amountoriginally expected for the asset. The Company measures the carrying amount ofthe asset against the estimated undiscounted future cash flows associated withit. Should the sum of the expected future net cash flows be less than thecarrying value of the asset being evaluated, an impairment loss would berecognized. The impairment loss would be calculated as the amount by which thecarrying value of the asset exceeds its fair value. The fair value is measuredbased on quoted market prices, if available. If quoted market prices are notavailable, the estimate of fair value is based on various valuation techniques,including the discounted value of estimated future cash flows. The evaluation ofasset impairment requires the Company to make assumptions about future cashflows over the life of the asset being evaluated. These assumptions requiresignificant judgment and actual results may differ from assumed and estimatedamounts. During the year ended December 31, 2007, 2006 and 2005, the Company didnot have any impairment loss related to an intangible asset (see Note 6). Fair Value of Financial Instruments The carrying amount of financial instruments, including cash and cashequivalents, accounts receivable, accounts payable and accrued expenses,approximate fair value due to the short maturity of these instruments. Thecarrying value of all other financial instruments is representative of theirfair values. The Company's short and long term debt may be less than thecarrying value since there is no readily ascertainable market for the debt giventhe financial position of the Company. Stock-Based Compensation On January 1, 2006, the Company adopted SFAS 123 (revised 2004), Share-BasedPayment ("SFAS 123(R)"), which requires the measurement and recognition ofcompensation expense for all share-based awards made to employees and directors,including employee stock options and shares issued through its employee stockpurchase plan, based on estimated fair values. In March 2005, the Securities andExchange Commission issued Staff Accounting Bulletin 107 ("SAB 107") relating toSFAS 123(R). The Company has applied the provisions of SAB 107 in its adoptionof SFAS 123(R). The Company adopted SFAS 123(R) using the modified prospectivetransition method, which requires the application of the accounting standard asof the beginning in 2006. The Company' financial statements as of and for theyear ended December 31, 2006 reflect the impact of SFAS 123(R). In accordancewith the modified prospective transition method, The Company' financialstatements for prior periods do not include the impact of SFAS 123(R). Stock compensation expense recognized during the period is based on the value ofshare-based awards that are expected to vest during the period. Stockcompensation expense recognized in the Company's statement of operations for2006 includes compensation expense related to share-based awards granted priorto January 1, 2006 that vested during the current period based on the grant datefair value estimated in accordance with the pro forma provisions of SFAS 123.Stock compensation expense in 2006 also includes compensation expense for theshare-based awards granted subsequent to January 1, 2006 based on the grant datefair value estimated in accordance with the provisions of SFAS 123(R). The Company' determination of estimated fair value of share-based awardsutilizes the Black-Scholes option-pricing model. The Black-Scholes model isaffected by the Company' stock price as well as assumptions regarding certainhighly complex and subjective variables. These variables include, but are notlimited to, the Company's expected stock price volatility over the term of theawards and actual and projected employee stock option exercise behaviors. Priorto the adoption of SFAS 123(R), the Company accounted for stock-based awards toemployees and directors using the intrinsic value method in accordance withAccounting Principles Board Opinion 25, Accounting for Stock Issued to Employees("APB 25"). Under the intrinsic value method that was used to account forstock-based awards prior to January 1, 2006, which had been allowed under theoriginal provisions of SFAS 123, compensation expense is recorded on the date ofgrant if the current market price of the underlying stock exceeded the exerciseprice. Any compensation expense is recorded on a straight-line basis over thevesting period of the grant. Advertising Expense The Company expenses all advertising costs as they are incurred. Advertisingexpense for the years ended December 31, 2007 and 2006 was $1,000 and $2,000,respectively. Research and Development In accordance with SFAS No. 2, "Accounting for Research Development Costs"research, development, and engineering costs are expensed in the year incurred.Costs of significantly altering existing technology are expensed as incurred. Income Taxes In June 2006, the Financial Accounting Standards Board ("FASB") issuedInterpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").FIN 48 prescribes detailed guidance for the financial statement recognition,measurement and disclosure of uncertain tax positions recognized in anenterprise's financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxes. Tax positions must meet a more-likely-than-notrecognition threshold at the effective date to be recognized upon the adoptionof FIN 48 and in subsequent periods. The Company adopted FIN 48 effectiveJanuary 1, 2007 and the provisions of FIN 48 have been applied to all taxpositions under Statement No. 109, "Accounting for Income Taxes" ("SFAS 109")upon initial adoption. The Company utilizes SFAS No. 109, "Accounting for Income Taxes," which requiresthe recognition of deferred tax assets and liabilities for the expected futuretax consequences of events that have been included in the financial statementsor tax returns. Under this method, deferred income taxes are recognized for thetax consequences in future years of differences between the tax bases of assetsand liabilities and their financial reporting amounts at each year-end based onenacted tax laws and statutory tax rates applicable to the periods in which thedifferences are expected to affect taxable income. Valuation allowances areestablished, when necessary, to reduce deferred tax assets to the amountexpected to be realized. Loss Per Share The Company utilizes SFAS No. 128, "Earnings per Share." Basic loss per share iscomputed by dividing loss available to common stockholders by theweighted-average number of common shares outstanding. Diluted loss per share iscomputed similar to basic loss per share except that the denominator isincreased to include the number of additional common shares that would have beenoutstanding if the potential common shares had been issued and if the additionalcommon shares were dilutive. Common equivalent shares are excluded from thecomputation if their effect is anti-dilutive. The Company's common shareequivalents consist of stock options. The potential shares, which are excluded from the determination of basic anddiluted net loss per share as their effect is anti-dilutive, are as follows: Year Ended Year Ended December 31, December 31, 2007 2006Options to purchase common stock 329,000 162,000Warrants to purchase common stock - -Potential equivalent shares excluded 329,000 162,000 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 whenone or more future events occur or fail to occur. The Company's management andits legal counsel assess such contingent liabilities, and such assessmentinherently involves an exercise of judgment. In assessing loss contingenciesrelated to legal proceedings that are pending against the Company or unassertedclaims that may result in such proceedings, the Company's legal counselevaluates the perceived merits of any legal proceedings or unasserted claims aswell as the perceived merits of the amount of relief sought or expected to besought therein. If the assessment of a contingency indicates that it is probablethat a material loss has been incurred and the amount of the liability can beestimated, then the estimated liability would be accrued in the Company'sfinancial statements. If the assessment indicates that a potentially materialloss contingency is not probable, but is reasonably possible, or is probable butcannot be estimated, then the nature of the contingent liability, together withan estimate of the range of possible loss if determinable and material, would bedisclosed. Loss contingencies considered remote are generally not disclosed unless theyinvolve guarantees, in which case the nature of the guarantee would bedisclosed. Estimates The preparation of financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during the reportingperiod. Actual results could differ from those estimates. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations ofcredit risk consist of cash and cash equivalents and accounts receivable. TheCompany places its cash and cash equivalents with high credit, quality financialinstitutions. The Company has not experienced any losses in such accounts andbelieves it is not exposed to any significant credit risk on cash and cashequivalents. With respect to accounts receivable, the Company routinely assessesthe financial strength of its customers and, as a consequence, believes that thereceivable credit risk exposure is limited. Major Customers During the year ended December 31, 2007, the Company conducted business with twocustomers whose gross sales comprised 52% and 15% of total revenues andaccounted for 60% and 15% of gross accounts receivable, respectively. During theyear ended December 31, 2006, the Company conducted business with two customerswhose gross sales comprised 39% and 16% of total revenues. As of December 31,2006, four customers accounted for 36%, 17%, 13%, and 11% of gross accountsreceivable, respectively. In addition, one of the Company's stockholders accounted for 3% and 39% of totalrevenues during the years ended December 31, 2007 and 2006, respectively. Thisstockholder holds approximately 4% of the total issued and outstanding commonstock as of December 31, 2007. Recent Accounting Pronouncements In February 2007, the FASB issued SFAS No. 159 "Fair Value Option for FinancialAssets and Financial Liabilities" ("SFAS 159") which permits entities to measuremany financial instruments and certain other items at fair value. Companies arerequired to adopt the new standard for fiscal years beginning after November 15,2007. The Company is evaluating the impact of this standard and currently doesnot expect it to have a significant impact on its financial position, results ofoperations or cash flows. In June 2007, the FASB ratified Emerging Issues Task Force ("EITF") Issue No.06-11 ("EITF Issue No. 06-11"), "Accounting for Income Tax Benefits of Dividendson Shared-Based Payment Awards". EITF Issue No 06-11 requires that tax benefitsgenerated by dividends paid during the vesting period on certainequity-classified share-based compensation awards be treated as additionalpaid-in capital and included in a pool of excess tax benefits available toabsorb tax deficiencies from share-based payment awards. EITF Issue No. 06-11 iseffective beginning with the 2009 fiscal year. The Company does not expect it tohave a significant impact on its financial position, results of operations orcash flows. In June 2007 the FASB ratified EITF No. 07-3, "Accounting for NonrefundableAdvance Payments for Goods or Services to Be Used in Future Research andDevelopment Activities" ("EITF 07-3") which requires non-refundable advancepayments for goods and services to be used in future research and developmentactivities to be recorded as an asset and the payments to be expensed when theresearch and development activities are performed. EITF 07-3 is effective forfiscal years beginning after December 15, 2007. The Company is evaluating theimpact of this standard and currently does not expect it to have a significantimpact on its financial position, results of operations or cash flows. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests inConsolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160").SFAS 160 introduces significant changes in the accounting and reporting forbusiness acquisitions and noncontrolling interest ("NCI") in a subsidiary. SFAS160 also changes the accounting for and reporting for the deconsolidation of asubsidiary. Companies are required to adopt the new standard for fiscal yearsbeginning after January 1, 2009. The Company is evaluating the impact of thisstandard and currently does not expect it to have a significant impact on itsfinancial position, results of operations or cash flows. In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS141R") which establishes principles and requirements for how the acquirer of abusiness recognizes and measures in its financial statements the identifiableassets acquired, the liabilities assumed, and any noncontrolling interest in theacquiree. The statement also provides guidance for recognizing and measuring thegoodwill acquired in the business combination and determines what information todisclose to enable users of the financial statement to evaluate the nature andfinancial effects of the business combination. SFAS 141R is effective forfinancial statements issued for fiscal years beginning after December 15, 2008.Accordingly, any business combinations the Company engages in will be recordedand disclosed following existing GAAP until January 1, 2009. The Company doesnot expect SFAS 141R will have an impact on its consolidated financialstatements when effective, but the nature and magnitude of the specific effectswill depend upon the nature, terms and size of the acquisitions the Companyconsummates after the effective date. The Company is evaluating the impact ofthis standard and currently does not expect it to have a significant impact onits financial position, results of operations or cash flows. 3. Inventory Inventories, consisting of material, material overhead, labor, and manufacturingoverhead, are stated at the lower of cost (first-in, first-out) or market andconsist of the following at December 31: 2007 2006Raw materials $3,037,000 $1,285,000Work-in-process 489,000 482,000Finished Goods 139,000 -Reserve for obsolescence (100,000) (63,000) $3,565,000 $1,704,000 For the year ended December, 31 2007 the reserve for obsolescence was increasedby approximately $37,000. For the year ended December 31, 2006 the reserve forobsolescence was reduced, due to inventory written off, by $17,000. 4. Property and Equipment Property and equipment at December 31, 2007 and 2006 consisted of the following: 2006 2005Computers and software $593,000 $464,000Machinery and equipment 1,485,000 1,155,000Furniture and office equipment 269,000 246,000Demonstration vehicles and buses 397,000 421,000Leasehold improvements 70,000 70,000Construction in progress 60,000 -- 2,874,000 2,356,000Less accumulated depreciation and amortization (2,004,000) (1,729,000)Total $870,000 $627,000 Depreciation and amortization expense was $296,000 and $304,000 for the yearsended December 31, 2007 and 2006, respectively. 5. Equity Method Investment - ITC The Company has invested an aggregate of $2,000,000 into ITC. In 2004, theCompany invested $1 million of the proceeds received from a sale of common stockto HHI into a joint venture formed with HHI in 2003 (see Note 1). The Company'sshare of income and losses is 40% as stated in the agreement. During the yearended December 31, 2007, the Company recorded $177,000 as its proportionateshare of losses in the joint venture. The following is the condensed financial position and results of operations ofITC, as of and for the year ended presented below: December December 31, 2007 31, 2006Financial position Current assets $3,635,000 $4,100,000Property and equipment, net 42,000 12,000Liabilities (1,000) -Equity $3,675,000 $4,112,000Operations Net revenues $202,000 $259,000Expenses (159,000) (458,000)Interest income 206,000 192,000Net loss $(437,000) $(7,000)Company's proportionate share of net loss $(177,000) $(3,000) 6. Intangible Assets Intangible assets consist of legal fees directly associated with patentlicensing. The Company has been granted three patents. These patents have beencapitalized and are being amortized over their estimated useful lives. In June 2001, a strategic relationship with Ford Motor Company was entered intoto develop and manufacture a high power, high voltage conversion module forFord's fuel cell vehicle. Warrants were issued to Ford Motor Company in exchangefor Ford's commitment to enter into a five-year agreement. The issuance of thewarrants was recorded as a non-current asset (Value Participation Agreement) atits fair market value of $577,000, which was determined using the Black-Scholesoption pricing model, and is being amortized on a straight-line basis over thelife of the contract. As of December 31, 2007, these warrants were fullyamortized. The following table illustrates the types and carrying values of the Company'sother assets: 2007 2006Patents $93,000 $93,000Valuation Participation Agreement 577,000 577,000 670,000 670,000Less accumulated amortization (600,000) (596,000)Total $70,000 $74,000 Amortization expense charged to operations was $4,000 and $115,000 for the yearsended December 31, 2007 and 2006, respectively. 7. Notes Payable In January and February of 2006, the Company settled $1,083,000 of principal and$472,000 of accrued interest under the secured note payable to the CreditManagers Association of California (CMAC). In consideration for the settlement,the Company paid the beneficiaries $163,000. The Company evaluated thistransaction under the guidance set forth in SFAS 140 "Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities" and notedthat the extinguishment of these liabilities was consistent with the guidance. Notes payable at December 31, consisted of the following: 2007 2006Secured note payable to Credit Managers Association of California, $1,238,000 $1,238,000bearing interest at prime plus 3% (currently 10.75%) and through maturity. Principal and unpaid interest due in April 2016. A sinking fund escrow is required to be funded with 10% of future equity financing, as defined in the Agreement Secured note payable to a financial institution in the original 59,000 88,000amount of $95,000, bearing interest at 6.21%, payable in 36 equal monthly installments of principal and interest through October 1, 2009 Secured note payable to a financial institution in the original 27,000 -amount of $35,000, bearing interest at 10.45%, payable in 30 equal monthly installments of principal and interest through November 1, 2009 Secured note payable to a Coca Cola Enterprises in the original 40,000 40,000amount of $40,000, bearing interest at 10% per annum. Principal and unpaid interest due on demand Secured note payable to a financial institution in the original 28,000 40,000amount of $39,000, bearing interest at 4.99% per annum, payable in 48 equal monthly installments of principal and interest through September 1, 2009 1,401,000 1,366,000Less current portion (95,000) (71,000)Long-term portion $1,306,000 $1,295,000 Future minimum principal payments of notes payable at December 31, 2007consisted of the following: Year Ending December 31, 2008 $95,0002009 50,0002010 10,0002011 8,0002012 -Thereafter 1,238,000Total $1,401,000 8. Revolving Credit Agreement In October 2007, the Company entered into a secured revolving credit facilitywith a financial institution (the "Credit Agreement") for $2,000,000. The CreditAgreement is secured by a $2,000,000 certificate of deposit. The interest rateis the certificate of deposit rate plus 1.25% with interest payable monthly andthe principal due at maturity. The Credit Agreement expires on June 30, 2009. Asof December 31, 2007, the Company had $1,800,000 million available under theterms of the Credit Agreement as the financial institution has issued a $200,000irrevocable letter of credit in favor of Sunshine Distribution LP ("Landlord"),with respect to the lease of an approximately 43,000 square foot facilitylocated at 1560 West 190th Street, Torrance, California (the "Lease"). 9. Deferred Revenues The Company has entered into a development contract with a federally fundedconsortium called the Hawaii Center for Advanced Transportation Technologies(HCATT). The consortium develops vehicles used by the United States Air Force.The Company has been developing vehicles for HCATT for 4 years under severaldifferent contracts. This specific development contract commenced on March 30,2006, and was valued at $955,000. The Company is recording revenues for thiscontract on the basis of the percentage of completion method, with differentdeliverables divided into separate units of accounting based on relative fairvalues, as prescribed in SOP 81-1-"Accounting for Performance of ConstructionType and Certain Production Type Contracts". Receipts of cash in excess of therevenue to be recognized under the percentage of completion is reflected asdeferred on the balance sheet. The Company recognized $700,000 and $273,000 inrevenue from HCATT during the year ended December 31, 2007 and 2006,respectively. At December 31, 2007 and 2006, the Company had deferred $0 and$166,000 in revenue from HCATT, respectively. Additionally, the company has entered into several production and developmentcontracts with other customers. The Company has evaluated these contracts,ascertained the specific revenue generating activities of each contract, andestablished the units of accounting for each activity. Revenue on these units ofaccounting is not recognized until a) there is persuasive evidence of theexistence of a contract, b) the service has been rendered and delivery hasoccurred, c) there is a fixed and determinable price, and d) collectability isreasonable assured. This treatment is consistent with the guidance prescribed inSEC Staff Accounting Bulletin 104 "Revenue Recognition" and FASB Emerging IssuesTask Force Issue 00-21 "Revenue Arrangements with Multiple Deliverables." AtDecember 31, 2007 and 2006, the Company had deferred $101,000 and $233,000 inrevenue related to these contracts, respectively. 10. Commitments and Contingencies Leases Enova's corporate offices were previously located in Torrance, California, inleased office space of approximately 20,000 square feet. This facility housedvarious departments, including engineering, operations, executive, finance,planning, purchasing, investor relations and human resources. This leaseterminated on February 28, 2008. In October 2007, Enova entered into a lease agreement with Sunshine DistributionLP ("Landlord"), with respect to the lease of an approximately 43,000 squarefoot 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 basic monthly rent will be approximately $37,000, and will beincrementally increased each year, based on the increase in the consumer priceindex. Under the Lease, Enova will pay the Landlord certain commerciallyreasonable and customary common area maintenance costs of approximately $5,000per month, increasing ratably as these costs are increased to the Landlord. TheLease is secured by an irrevocable standby letter of credit in the amount of$200,000 and naming the Landlord as the beneficiary. As of February 28, 2008,this facility will house all of Enova's departments. Rent due under the Leasewas abated for the months of November and December 2007. Enova also has a leasedoffice in Hawaii which is rented on a month-to-month basis The Company leases its operating and office facilities in Torrance, Californiaand in Hawaii for various terms under long-term, non-cancelable operating leaseagreements. In the normal course of business, it is expected that these leaseswill be renewed or replaced by leases on other properties. Rent expense was$288,000 and $221,000 for the years ended December 31, 2007, and 2006,respectively. Future minimum lease payments under these non-cancelable operating and capitallease obligations at December 31, 2006 were as follows: Year Ending OperatingDecember 31 Leases2008 $439,0002009 439,0002010 439,0002011 439,0002012 and thereafter 439,000Total $2,195,000 Employment Contracts The Company has employment agreements with its executive officers, the terms ofwhich expire at various times through January 2012. Such agreements, which havebeen revised from time to time, provide for minimum salary levels, adjustedannually for certain changes, as well as for incentive bonuses that are payableif specified management goals are attained. The aggregate commitment for futuresalaries at December 31, 2007, excluding bonuses, was approximately $1,875,000. 11. Stockholders' Equity Common Stock During the years ended December 31, 2007 and 2006, the Company issued 50,000 and32,000 shares of common stock, respectively, to directors as compensation. Thecommon stock issued in 2007 and 2006 was valued at $212,000 and $135,000,respectively, based upon the trading value of the common stock on the date ofissuance. Common Stock Issuable At December 31, 2007 and 2006, the Company was committed to issue 6,000 and12,000 shares of common stock, respectively, to its directors. The value of thiscommon stock issuable at December 31, 2007 and 2006 was $30,000 and $36,000,respectively and represents compensation to its directors. Series A Preferred Stock Series A preferred stock is currently unregistered and convertible into commonstock on a one-to-one basis at the election of the holder or automatically uponthe occurrence of certain events including: sale of stock in an underwrittenpublic offering; registration of the underlying conversion stock; or the merger,consolidation, or sale of more than 50% of the Company. Holders of Series Apreferred stock have the same voting rights as common stockholders. The stockhas a liquidation preference of $0.60 per share plus any accrued and unpaiddividends 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 shareif, when, and as declared by, the Board of Directors. No dividends have beendeclared on the Series A preferred stock. Substantially all of the stock notes receivable stem from a Board of Directorsplan for the sale of shares of Series A preferred stock in 1993 to certainofficers and directors (Participants). In general, the Participants couldpurchase the preferred stock for a combination of cash, promissory notes payableto the Company, and conversion of debt and deferred compensation due to theParticipants. All shares issued under this plan were pledged to the Company assecurity for the notes. The notes provided for interest at 8% per annum payableannually, with the full principal amount and any unpaid interest due onJanuary 31, 1997. The notes remain outstanding. The likelihood of collecting theinterest on these notes is remote; therefore, accrued interest has not beenrecorded since the fiscal year ended July 31, 1997. Series B Preferred Stock Series B preferred stock is currently unregistered and each share is convertibleinto shares of common stock on a two-for-one basis at the election of the holderor automatically upon the occurrence of certain events including: sale of stockin 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 themerger, consolidation, or sale of common stock or sale of substantially all ofthe 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 priorand in preference to the rights of the common stock and Series A preferredstock. The stock has a liquidation preference of $2.00 per share together withan amount equal to, generally, $0.14 per share compounded annually at 7% peryear from the filing date, less any dividends paid. Dividends on the Series Bpreferred stock are non-cumulative and payable at the annual rate of $0.14 pershare if, when, and as declared by, the Board of Directors. No dividends havebeen declared on the Series B preferred stock. In October 2007, approximately639,000 shares were converted into common stock at the election of the holderfor approximately 28,000 shares of common stock. Warrants During the year ended December 31, 2007, the Company issued shares of commonstock from the exercise of options. The agreement with Ford Motor Company (seeNote 6) included issuing warrants to Ford to purchase 4.6% of the fully dilutedcommon stock of the Company over a 66 month period. The number of shares to beacquired will be adjusted from time to time for increases in the Company's fullydiluted common stock. The vesting of these warrants is dependent upon Fordmeeting specific purchase requirements. The fair value of the warrants granted to Ford were estimated on the date ofgrant using the Black-Scholes option-pricing model with the followingassumptions: dividend yield of 0%, expected volatility of 102%, risk-freeinterest rate of 4.76% and an expected life of the warrants of 66 months.Warrants issued and vested under this agreement totaled 2,500,000 at an exerciseprice of $0.29 per share during the year ended December 31, 2001. No warrantswere vested under this program during 2006 and 2005. As of June 30, 2004, Fordwas no longer eligible for further vesting of its warrants per the terms of theValue Participation Agreement. On December 15, 2007, these warrants expired. 12. Stockholders' Equity Stock Option Program Description For the year ended December 31, 2007 the Company had two equity compensationplans, the 1996 Stock Option Plan (the "1996 Plan") and the 2006 equitycompensation plan (the 2006 "Plan"). The 1996 Plan has expired for the purposesof issuing new grants. However, the 1996 Plan will continue to govern awardspreviously granted under that plan. The 2006 Plan has been approved by theCompany's Shareholders. Equity compensation grants are designed to reward employees and executives fortheir long term contributions to the Company and to provide incentives for themto remain with the Company. The number and frequency of equity compensationgrants are based on competitive practices, operating results of the company, andgovernment regulations. The maximum number of shares issuable over the term of the 1996 Plan was limitedto 65 million shares. Options granted under the 1996 Plan typically have had anexercise price of 100% of the fair market value of the underlying stock on thegrant date and expired no later than ten years from the grant date. The 2006Plan has a total of 3,000,000 shares reserved for issuance, of which 215,000have been granted in 2007. 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 over the vesting period for the options granted.Share-based compensation expense related to stock options was $367,000 and$55,000 for the years ended December 31, 2007 and 2006, respectively, and wasrecorded in the financial statements as a component of selling, general andadministrative expense. As of December 31, 2007, the total compensation cost related to non-vestedawards not yet recognized is $278,000. The weighted average period over whichthe future compensation cost is expected to be recognized is 12 months. Theaggregate intrinsic value of total awards outstanding is $188,000. As stock-based compensation expense recognized in the Statement of Operationsfor the twelve months of fiscal 2007 has been based on awards ultimatelyexpected to vest, it has been reduced for estimated forfeitures. SFAS 123(R)requires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates. For the year ended December 31, 2007, the Company applied estimatedaverage forfeiture rates of approximately 3% for non-officer grants, based onhistorical forfeiture experience. For 2007 and 2006, the expected life ranged from 3 to 5 years for non-officergrants. Options granted for the 2007 and 2006 fiscal year did not vest based onthe revenue milestones. SFAS 123(R) requires the cash flows resulting from the tax benefits resultingfrom tax deductions in excess of the compensation cost recognized for thoseoptions to be classified as financing cash flows. Due to the Company's lossposition, there were no such tax benefits for the years ended December 31, 2007and 2006. Prior to the adoption of SFAS 123(R), those benefits would have beenreported as operating cash flows had the Company received any tax benefitsrelated to stock option exercises. The following is a summary of changes to outstanding stock options during thefiscal year ended December 31, 2007: Weighted Weighted Average Number of Average Remaining Aggregate Share Exercise Contractual Intrinsic Options Price Term Value Outstanding at December 31, 2005 458,000 $4.48 6.8 $147,000Granted 46,000 4.60 10 6,000Exercised - - - -Forfeited or expired (342,000) 4.91 - -Outstanding at December 31, 2006 162,000 4.43 7.96 60,000Granted 215,000 4.10 5 151,000Exercised (44,000) 4.36 - -Forfeited or expired (4,000) 4.35 - -Outstanding at December 31, 2007 329,000 4.23 5.85 188,000Vested and expected to vest at December 31, 2007 314,000 4.23 5.66 179,000Options exercisable at December 31, 2007 204,000 4.28 5.85 41,000 The aggregate intrinsic value of $188,000 of options outstanding as ofDecember 31, 2007 is based on Enova's closing stock price of $4.80 on that dateand represents the total pretax intrinsic value, which would have been receivedby the option holders had all option holders exercised their options as of thatdate. At December 31, 2007, there were 2,785,000 shares available for grant under theemployee stock option plan. The weighted-average remaining contractual life of the options outstanding atDecember 31, 2007 was 5.85 years. The exercise prices of the options outstanding at December 31, 2007 ranged from$4.10 to $4.50. The weighted-average remaining contractual life of the optionsoutstanding at December 31, 2006 was 7.96 years. The exercise prices of theoptions outstanding at December 31, 2006 ranged from $4.35 to $4.50. Optionsexercisable were 204,000 and 119,000, at December 31, 2007 and December 31,2006, respectively. The table below presents information related to stock option activity for thefiscal ended December 31, 2007 and 2006 (in thousands): Fiscal Year Ended December 31 2007 2006Total intrinsic value of stock options exercised $29,000 $-Cash received from stock option exercises $193,000 $-Gross income tax benefit from the exercise of stock options $- $- Valuation and Expense Information under SFAS 123 The fair values of all stock options granted during the fiscal year endedDecember 31, 2007 and 2006 were estimated on the date of grant using theBlack-Scholes option-pricing model with the following range of assumptions: 2007 2006Expected life (in years) 3 - 5 5Average risk-free interest rate 3 - 4% 4%Expected volatility 75 - 104% 75%Expected dividend yield 0% 0% The estimated fair value of grants of stock options and warrants to nonemployeesof the Company is charged to expense, if applicable, in the financialstatements. These options vest in the same manner as the employee optionsgranted under each of the option plans as described above. 13. Income Taxes In June 2006, the Financial Accounting Standards Board ("FASB") issuedInterpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").FIN 48 prescribes detailed guidance for the financial statement recognition,measurement and disclosure of uncertain tax positions recognized in anenterprise's financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxes. Tax positions must meet a more-likely-than-notrecognition threshold at the effective date to be recognized upon the adoptionof FIN 48 and in subsequent periods. The Company adopted FIN 48 effectiveJanuary 1, 2007 and the provisions of FIN 48 have been applied to all taxpositions under Statement No. 109, "Accounting for Income Taxes" ("SFAS 109")upon initial adoption. The cumulative effect of applying the provisions of thisinterpretation had no effect on the opening balance of retained earnings for ourfiscal year 2007. Significant components of the Company's deferred tax assets and liabilities forfederal and state income taxes as of December 31, 2007 and 2006 consisted of thefollowing: 2007 2006Deferred tax assets Federal tax loss carry-forward $35,668,000 $34,650,000State tax loss carry-forward 2,057,000 1,548,000Basis difference - 1,610,000Stock based compensation 167,000 -Other, net (222,000) (114,000) 37,670,000 37,694,000Less valuation allowance (37,670,000) (37,694,000)Net deferred tax assets $- $- The Tax Reform Act of 1986 limits the use of net operating loss carryforwards incertain situations where changed occur in the stock ownership of a company. Inthe event the Company has had a change in ownership, utilization of thecarryforwards could be restricted. Deferred taxes arise from temporary differences in the recognition of certainexpenses for tax and financial reporting purposes. The deferred tax assets havebeen offset by a valuation allowance since management does not believe therecoverability of these in future years is more likely than not to occur. Thevaluation allowance decreased by $24,000 and $2,444,000 during the years endedDecember 31, 2007 and 2006, respectively. As of December 31 2007, the Companyhad net operating loss carry forwards for federal and state income tax purposesof approximately $104,904,000 and $23,276,000, respectively. The net operatingloss carry forwards will begin expiring in 2008 to 2022. The provision for income taxes differs from the amount computed by applying theU.S. federal statutory tax rate (34% in 2007 and 2006) to income taxes asfollows: December 31, December 31, 2007 2006Tax benefit computed at 34% $3,178,000 $1,644,000Change in valuation allowance (24,000) (2,444,000)State tax (net of Federal benefit) 543,000 -Change in carryovers and tax attributes (3,697,000) 800,000Net tax benefit $- $- 14. Related Party Transactions During 2007 and 2006, the Company purchased approximately $1,953,000 and$404,000, respectively, in components, materials and services from HHI. TheCompany had an outstanding payable balance owed to HHI of $483,000, net of areceivable of approximately $10,000, and $138,000 at December 31, 2007 and 2006,respectively. A relative of one of the Company's directors is a majority owner of a websiteconsulting firm which provides services (branding) to the Company. The Companypaid consulting fees and expenses to this firm in the amount of approximately$180,000 in 2007 and $149,000 in 2006. 15. Employee Benefit Plan The Company has a 401(k) profit sharing plan covering substantially allemployees. Eligible employees may elect to contribute a percentage of theirannual compensation, as defined, to the plan. The Company may also elect to makediscretionary contributions. For the years ended December 31, 2007 and 2006, theCompany did not make any contributions to the plan. 16. Geographic Area Data The Company operates as a single reportable segment and attributes revenues tocountries based upon the location of the entity originating the sale. Revenuesby geographic area are as follows: 2007 2006United States $3,080,000 $579,000Mexico 59,000 -Italy - 5,000Korea 359,000 753,000Japan 87,000 43,000China - 68,000Malaysia - 21,000Ireland - 115,000United Kingdom 5,138,000 72,000Norway 452,000 10,000Total $9,175,000 $1,666,000 17. Subsequent Events On March 26, 2008, the Company entered into an agreement with Investec Bank (UK)Limited as placement agent to sell approximately 2,131,000 shares of commonstock at approximately 195 pence sterling (approximately US $3.91 per share) tocertain eligible offshore investors. The Company will receive approximately4,200,000 British Pounds Sterling (approximately US $8,300,000) in grossproceeds from the offering. Investec will receive a 5% selling commission. The offer and sale of the shares were made pursuant to Regulation S under theSecurities Act. Among other things, each investor purchasing shares of Enova'scommon stock in the offering represented that the investor is not a UnitedStates person as defined in Regulation S. In addition, neither Enova nor theplacement agent conducted any selling efforts directed at the United States inconnection with the offering. All shares of common stock issued in the offeringincluded a restrictive legend indicating that the shares are being issuedpursuant to Regulation S under the Securities Act and are deemed to be"restricted securities." As a result, the purchasers of such shares will not beable to resell the shares unless in accordance with Regulation S, pursuant to aregistration statement, or upon reliance of an applicable exemption fromregistration under the Securities Act. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURES On January 31, 2007, we dismissed Windes as our registered public accountingfirm and engaged PMB Helin Donovan, LLP as our new independent registered publicaccounting firm. The decision regarding the end of the Windes engagement and thecommencement of the PMB Helin Donovan's engagement was made and approved by theaudit committee of our board of directors after consideration of our currentneeds and position. Concurrent with the change in auditor, we also undertookmanagerial changes to our finance and operations departments, including a changein chief financial officer. In light of these organization changes and given thedisagreement between us and Windes with respect to the filing of our Form 10-Qfor the fiscal quarter ended September 30, 2006 filed November 13, 2006 (the"Form 10-Q"), the audit committee believed that engagement of a new auditorwould lead to enhanced communications with respect to audit matters. During the course of its engagement, Windes did not provide an audit report onour financial statements. Therefore, there is no applicable disclosure withinthe meaning of Item 304(a)(1)(ii). During our two most recent fiscal years, and through the date of Windes'dismissal, we and Windes had the following three "disagreements" within themeaning of Item 304(a)(1)(iv) of Regulation S-K on matters of accountingprinciples or practices, financial statement disclosure, or auditing or reviewscope or procedure, which if not resolved to the satisfaction of Windes wouldhave caused it to make reference to the subject matter of the disagreement inits reports on our financial statements: First, as reflected in the Current Reports on Form 8-K dated November 29 andDecember 5, 2006, Windes and we disagreed whether Windes authorized theForm 10-Q filing. After numerous discussions among Windes and us involvingmanagement and the audit committee, the disagreement was resolved by filing therequisite Item 4.02 Form 8-K and later filing the amended Form 10-Q for thefiscal period ended September 30, 2006 on December 29, 2006 (the "amended Form10-Q"). Second, Windes and we disagreed whether we followed the appropriate accountingpolicy and accounting literature to record revenue. This disagreement wasresolved upon further analysis and by reversing the recorded revenue and relatedexpenses in the amended Form 10-Q. Third, Windes and we disagreed whether adequate documentation had been producedto support a material debt forgiveness transaction which, although negotiated inthe 2005 fiscal year, was completed in the first quarter of the 2006 fiscal yearand therefore included in our year-to-date operations. Consistent with theamended Form 10-Q's Item 4 Controls and Procedures disclosure, we were unable tolocate original documentation to support the accounting treatment for thetransaction. This disagreement was resolved when we obtained replacement copiesto reflect the original documentation and the accounting treatment. Our audit committee discussed the subject matter of all three disagreementsabove with Windes and authorized Windes to respond fully to inquiries of PMBHelin Donovan concerning the subject matter of the disagreements. During our two most recent fiscal years and through the date of Windes'dismissal, the following were "reportable events" within the meaning of Item 304(a)(1)(v) of Regulation S-K: (A) Consistent with the our Item 4 Controls and Procedures disclosure in theamended Form 10-Q, Windes advised that material weaknesses existed in ourinternal controls, and thereby our financial statement preparation anddisclosure, regarding the (i) correct application of relevant accountingstandards; (ii) ability to produce original documentation to support anaccounting treatment; and (iii) internal and external communication by us inensuring there was appropriate independent accountant review and authorizationto file periodic reports such as the Form 10-Q for the fiscal period endedSeptember 30, 2006. (B) Given the three disagreements cited above, Windes expressed concern aboutits ability to rely on management representations. As a result, consistent withthe Item 4 Controls and Procedures disclosure in our amended Form 10-Q, weagreed to dedicate additional time and resources to internal control matters andspecifically agreed to (1) retain a consultant to review our accounting,documentation, and internal control policies and (2) implement more stringentoversight policies to ensure proper auditor authorization is received prior tomaking SEC filings. (C) Given the third disagreement cited above with respect to adequatedocumentation, Windes further advised us that it would need to expandsignificantly the scope of its audit within the meaning of Item 304(a)(1)(v)(C)to ensure that proper and sufficient documentation existed to support accountingconclusions reached in prior fiscal periods including the cited debt forgivenesstransaction. ITEM 9A. CONTROLS AND OTHER PROCEDURES Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this 2007 Form 10-K, we carried out anevaluation, under the supervision and with the participation of our principalexecutive officer and principal financial officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures (as such term isdefined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of1934 (the "Exchange Act"). Based on this evaluation, our principal executiveofficer and principal financial officer concluded that our disclosure controlsand procedures were not effective due to the material weakness identified aspart of our evaluation of internal control over financial reporting discussedbelow. Management's Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internalcontrol over financial reporting, as defined in Exchange Act Rule 13a-15(f).Under the supervision and with the participation of management, including ourChief Executive Officer and Chief Financial Officer, we conducted an evaluationof the effectiveness of its internal control over financial reporting based onthe framework in Internal Control - Integrated Framework issued by the Committeeof Sponsoring Organizations of the Treadway Commission. Based on thisevaluation, management has concluded that the Company's internal control overfinancial reporting was not effective as of December 31, 2007. A material weakness is a deficiency, or a combination of deficiencies, ininternal control over financial reporting, such that there is a reasonablepossibility that a material misstatement of the company's annual or interimfinancial statements will not be prevented or detected on a timely basis. As of December 31, 2007, we identified the following material weakness in ourinventory process due to ineffective controls over the inventory pricing,tracking, and reserve analysis. This control deficiency resulted in an auditadjustment to our 2007 financial statements and could have resulted in amisstatement to cost of sales that would have resulted in a materialmisstatement to the annual and interim financial statements if not detected andprevented. This annual report does not include an attestation report of our registeredpublic accounting firm regarding internal control over financial reporting. Ourmanagement's report was not subject to attestation by our registered publicaccounting firm pursuant to temporary rules of the Securities and ExchangeCommission that permit us to provide only management's report in this annualreport. Remedial Actions and Changes in Internal Control over Financial Reporting We have developed and are in the process of implementing remediation plans toaddress the material weakness identified above and otherwise enhance ourinternal control over financial reporting. During the year ended December 31,2007, the following specific remedial actions have also been put in place: * We created a regulatory compliance department in light of efforts for meeting Section 404 of the Sarbanes-Oxley Act of 2002. The regulatory compliance department, in cooperation and in conjunction with efforts by the Audit Committee and executive management, is responsible for ensuring the operating effectiveness of internal controls over financial reporting with the objective of appropriately addressing the risk of material misstatement in our financial statements. * We enhanced period end internal controls such as robust account balance reconciliations, inspection of documents used to support the substance and form of inventory transactions, including, the summarizing, recording, and processing with warehouse, engineering, and production personnel, and executive management. * We hired a full-time controller to oversee the day-to-day functions of the accounting and finance department. Our Chief Financial Officer had acted in the capacity of the Controller prior to the filling of the position. * We hired a full-time Inventory Control Manager to summarize and manage the movement or tracking of inventory throughout the production process. We also hired a full-time Production Scheduler to manage the production schedule requirements and assist in monitoring the production process. * We hired a full-time Senior/Cost Accountant to assist in the evaluation of the inventory accounts and job costing. * We hired a full-time Shop Supervisor to handle the daily operations of the production process. * We hired a full-time Financial Reporting Manager to manage our external financial reporting processes, including periodic filings with the SEC. * We hired a full-time Director of Supply chain to develop and manage the materials planning function. Other than as described above, there have not been any other changes in ourinternal control over financial reporting as of the quarter ended December 31,2007 that has materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting. RELATED STOCKHOLDER MATTERS Equity Compensation Plan Information For the fiscal year ended December 31, 2007, we had two equity compensationplans: the 1996 Option Plan and the 2006 Equity Compensation Plan. Each plan wasadopted with the approval of our shareholders. The 1996 Stock Option Plan hasexpired for purposes of issuing new grants. The 1996 Stock Option Plan, however,will continue to govern awards previously granted under that plan. The 2006plan, adopted at our annual meeting in November 2006, has a total of3,000,000 shares reserved for issuance. The following table provides informationregarding our equity compensation plans as of December 31, 2007: Equity Compensation Plan Information Number of Securities Remaining Available for Number of Future Securities to Issuance under be Issued Equity upon Exercise Weighted-Average Compensation of Exercise Price Plans Outstanding of Outstanding (Excluding Options, Options, Securities Warrants and Warrants and Reflected in Rights Rights Column (a)) Plan category (a) (b) (c) Equity compensation plans approved by 329,000 $4.23 2,785,000security holders Equity compensation plans not approved by security holders Total 329,000 - 2,785,000 END This information is provided by RNS The company news service from the London Stock Exchange

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