UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(_x_) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2005
or
(___) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From ______________ To __________________.
Commission File No. 0-25184
ENOVA SYSTEMS, INC.
-------------------
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3056150
---------- ----------
(State or other jurisdiction of (IRS employer
incorporation or organization) identification number)
19850 South Magellan Drive Torrance, CA 90502
(Address of Principal Executive Offices and Zip Code)
Registrant's telephone number, including area code (310) 527-2800
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (_X_) No (___)
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of November 14, 2005, there were 14,786,000 shares, post-split, of Common
Stock, no par value, 2,714,000 shares of Series A Preferred Stock, no par value,
and 1,217,000 shares of Series B Preferred Stock, no par value, outstanding.
1
INDEX
ENOVA SYSTEMS, INC.
Page No.
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PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements.....................................................3
Balance Sheets:
September 30, 2005 (unaudited) and December 31, 2004.....................3
Statements of Operations (unaudited):
Three and nine months ended September 30, 2005 and 2004..................4
Statements of Cash Flows (unaudited):
Nine months ended September 30, 2005 and 2004............................5
Notes to Financial Statements (unaudited):...............................7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.....................................13
Item 3. Quantitative and Qualitative Disclosure about Market Risk...............24
Item 4. Control and Procedures..................................................24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ......................................................25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.............25
Item 3. Defaults upon Senior Securities.........................................25
Item 4. Submission of Matters to a Vote of Security Holders.....................25
Item 5. Other Information.......................................................25
Item 6. Exhibits................................................................26
SIGNATURE ........................................................................27
CERTIFICATIONS ........................................................................97
2
ENOVA SYSTEMS, INC.
BALANCE SHEETS
------------------------------------------------------------------------------------------------------------
ASSETS
As of As of
September 30, 2005 December 31, 2004
------------------ -----------------
(unaudited)
Current assets
Cash and cash equivalents $ 17,665,000 $ 1,575,000
Accounts receivable, net 879,000 522,000
Inventories and supplies, net 1,271,000 1,036,000
Prepaid expenses and other current assets 340,000 304,000
------------- -------------
Total Current Assets 20,155,000 3,437,000
Property and equipment, net 543,000 387,000
Equity method investment 1,695,000 1,768,000
Other assets 217,000 296,000
------------- -------------
Total assets $ 22,610,000 $ 5,888,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 576,000 $ 66,000
Deferred revenues 127,000 392,000
Line of credit -- 229,000
Accrued payroll and related expense 172,000 194,000
Other accrued expenses 50,000 13,000
Current portion of notes payable 166,000 166,000
Current portion of capital lease obligations -- 6,000
------------- -------------
Total current liabilities 1,091,000 1,066,000
Accrued interest payable 1,609,000 1,378,000
Notes payable, net of current portion 3,332,000 3,341,000
------------- -------------
Total liabilities $ 6,032,000 $ 5,785,000
------------- -------------
Commitments and contingencies
Stockholders' equity
Series A convertible preferred stock - no par value
30,000,000 shares authorized
2,714,000 and 2,748,000 shares issued and
outstanding
Liquidating preference at $0.60 per share, aggregating
$1,628,000 and $1,649,000 $ 1,734,000 $ 1,774,000
Series B convertible preferred stock - no par value
5,000,000 shares authorized
1,217,000 and 1,217,000 shares issued and outstanding
Liquidating preference at $2 per share aggregating $2,434,000 2,434,000 2,434,000
Common Stock, no par value
750,000,000 shares authorized
14,786,000 and 415,265,000 shares issued and
outstanding (Note 4) 109,268,000 90,465,000
Common stock subscribed -- 165,000
Stock notes receivable (1,176,000) (1,176,000)
Additional paid-in capital 6,900,000 6,900,000
Accumulated deficit (102,582,000) (100,459,000)
------------- -------------
Total stockholders' equity 16,578,000 103,000
------------- -------------
Total liabilities and stockholders' equity $ 22,610,000 $ 5,888,000
============= =============
The accompanying notes are an integral part of these financial statements
3
ENOVA SYSTEMS, INC.
STATEMENTS OF OPERATIONS (Unaudited)
For the Three and Nine Months Ended September 30,
-------------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net revenues
Research and development contracts $ 455,000 $ 217,000 $ 1,160,000 $ 915,000
Production 402,000 189,000 1,711,000 1,317,000
------------ ------------ ------------ ------------
Total net revenues 857,000 406,000 2,871,000 2,232,000
------------ ------------ ------------ ------------
Cost of revenues
Research and development contracts 393,000 113,000 813,000 606,000
Production 336,000 244,000 1,509,000 928,000
------------ ------------ ------------ ------------
Total cost of revenues 729,000 357,000 2,322,000 1,534,000
------------ ------------ ------------ ------------
Gross profit 128,000 49,000 549,000 698,000
------------ ------------ ------------ ------------
Other costs and expenses
Research & development 197,000 198,000 592,000 507,000
Selling, general & administrative 765,000 844,000 1,924,000 1,823,000
Interest and other income/expense, net (59,000) 61,000 83,000 98,000
Equity in losses of equity method investee 7,000 47,000 73,000 134,000
------------ ------------ ------------ ------------
Total other costs and expenses 910,000 1,150,000 2,672,000 2,562,000
------------ ------------ ------------ ------------
Net loss $ (782,000) $ (1,101,000) $ (2,123,000) $ (1,864,000)
============ ============ ============ ============
Basic and diluted loss per common share $ (0.06) $ (0.01) $ (0.20) $ (0.01)
============ ============ ============ ============
Weighted-average number of
shares outstanding 13,372,529 8,664,978 10,628,011 8,664,978
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
4
ENOVA SYSTEMS, INC.
STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended September 30,
--------------------------------------------------------------------------------------
------------------------------
2005 2004
------------ ------------
Cash flows from operating activities
Net loss $ (2,123,000) $ (1,864,000)
Adjustments to reconcile net loss
to net cash used by operating activities
Depreciation and amortization 79,000 268,000
Equity in losses of equity method investee 73,000 135,000
Issuance of common stock for services 237,000 66,000
(Increase) decrease in
Accounts receivable (357,000) 303,000
Inventory and supplies (235,000) 292,000
Prepaid expenses and other current assets (36,000) (244,000)
Increase (decrease) in
Accounts payable 511,000 (431,000)
Accrued expenses 15,000 (10,000)
Deferred revenues (265,000) 262,000
Accrued interest payable 231,000 189,000
------------ ------------
Net cash used by operating activities (1,870,000) (1,034,000)
------------ ------------
Cash flows from investing activities
Purchases of property and equipment $ (155,000) $ (138,000)
------------ ------------
Net cash used in investing activities (155,000) (138,000)
------------ ------------
Cash flows from financing activities
Borrowings (repayments) on line of credit $ (229,000) $ 109,000
Proceeds (repayment) on notes payable and
capital lease obligations (17,000) 16,000
Net proceeds from sale of common stock 18,361,000 2,760,000
------------ ------------
Net cash provided by (used in) financing activities 18,115,000 2,885,000
------------ ------------
Net increase (decrease) in cash and
cash equivalents 16,090,000 1,713,000
Cash and cash equivalents,
beginning of period 1,575,000 530,000
------------ ------------
Cash and cash equivalents,
end of period $ 17,665,000 $ 2,243,000
============ ============
The accompanying notes are an integral part of these financial statements
5
ENOVA SYSTEMS, INC.
STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended September 30,
--------------------------------------------------------------------------------------
------------------------------
2005 2004
------------ ------------
Supplemental disclosure of cash
flow information
Interest paid $ 5,000 $ 4,000
============ ============
Income taxes paid $ -- $ --
============ ============
Supplemental schedule of non- cash
investing and financing activities
Conversion of preferred stock
to common stock $ 40,000 $ 64,000
============ ============
The accompanying notes are an integral part of these financial statements
6
ENOVA SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - Basis of Presentation
The accompanying unaudited financial statements have been prepared from the
records of our company without audit and have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not contain all the information and
notes required by accounting principles generally accepted in the United States
of America for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation of the financial position at September 30, 2005 and the
interim results of operations for the three and nine months ended September 30,
2005 and cash flows for the nine months ended September 30, 2005 have been
included. The balance sheet at December 31, 2004, presented herein, has been
prepared from the audited financial statements of our company for the year then
ended.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make estimates
and assumptions affecting the reported amounts of assets, liabilities, revenues
and expenses, and the disclosure of contingent assets and liabilities. The
September 30, 2005 and December 31, 2004 inventories are reported at market
value. Inventories have been valued on the basis that they would be used,
converted and sold in the normal course of business. Certain reclassifications
have been made to the prior period's financial statements to conform to the
current period's presentation. The amounts estimated for the above, in addition
to other estimates not specifically addressed, could differ from actual results;
and the difference could have a significant impact on the financial statements.
Accounting policies followed by us are described in Note 1 to the audited
financial statements for the fiscal year ended December 31, 2004. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted for purposes of the
interim financial statements. The financial statements should be read in
conjunction with the audited financial statements, including the notes thereto,
for the year ended December 31, 2004, which are included in our Form 10-K and
Form 10-K/A Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 as filed with the Securities and Exchange Commission.
Basic and diluted net loss per common share is computed using the weighted
average number of common shares outstanding. Since a loss from operations
exists, diluted earnings per share number is not presented because the inclusion
of common stock equivalents, consisting of Series A and B preferred stock,
unexercised stock options and warrants, would be anti-dilutive.
The results of operations for the three and nine months ended September 30, 2005
presented herein are not necessarily indicative of the results to be expected
for the full year.
Revenue Recognition
From time to time, the Company enters into arrangements with its customers where
there are multiple deliverables. In accordance with Emerging Issues Task Force
Issue No. 00-21 "Revenue Arrangements with Multiple Deliverables", when a
company enters into these types of arrangements, the contract is divided into
separate units of accounting based on relative fair values, and revenue
recognition criteria are assessed separately for each separate unit of
accounting. These elements will include product sales, service elements, and
fixed-price development elements.
7
NOTE 1 - Basis of Presentation (continued)
Revenues from Component Sales
Revenues from sales of components are recognized when shipped and title passes
to the customer.
Service Revenue
Services revenues are billed and recognized in the period the services are
rendered and earned and the collection of the related receivable is probable.
Method of Accounting for Long-Term Contracts
In accordance with the American Institute of Certified Public Accountant's
Statement of Position 81-1, "Accounting for Performance of Certain
Construction-Type and Certain Product Type Contracts," the Company records its
revenues on long-term, fixed price contracts on the basis of the
percentage-of-completion method applied to individual contracts, commencing when
progress reaches a point where experience is sufficient to estimate final
results with reasonable accuracy and collection of the related receivable is
probable.
That portion of the total contract price is accrued which is allocable, on the
basis of the Company's estimates of the percentage-of-completion, to contract
expenditures and work performed. Operating expenses, including indirect costs
and administrative expenses, are charged to income as incurred and are not
allocated to contract costs.
As these long-term contracts are performed, revisions in cost and profit
estimates during the course of the work are recognized in the accounting period
in which the facts which require the revision become known.
At the time a loss on a contract becomes known, the entire amount of the
estimated ultimate loss on both short- and long-term contracts is accrued.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," establishes and
encourages the use of the fair value based method of accounting for stock-based
compensation arrangements under which compensation cost is determined using the
fair value of stock-based compensation determined as of the date of grant and is
recognized over the periods in which the related services are rendered. The
statement also permits companies to elect to continue using the current implicit
value accounting method specified in Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," to account for stock-based
compensation.
SFAS No. 148 "Accounting for Stock-Based Compensation--Transition and
Disclosure" amends SFAS No. 123 to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of Statement 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
The Company has elected to use the intrinsic value based method and has
disclosed the pro forma effect of using the fair value based method to account
for its stock-based compensation. The Company has adopted only the disclosure
provisions of SFAS No. 123. It applies APB Opinion No. 25 and related
interpretations in accounting for its plans and does not recognize compensation
expense for its stock-based compensation plans other than for restricted stock
and options issued to outside third parties.
8
NOTE 1 - Basis of Presentation (continued)
Stock-Based Compensation (continued)
During the 3rd Quarter the Company adopted an executive compensation plan by
granting to the Company's executives options under our 1996 Stock Option Plan to
purchase a total of 244,000 shares of common stock at an exercise price of $4.35
per share. These options will vest based on the Company achieving certain
revenue milestones for the years ended December 31, 2005 and 2006. If such
milestones are not met, the options with respect to those milestones will
terminate. All of the granted options will remain in effect for a period of 10
years or until 90 days after the employment of the optionee terminates. For
purposes of adjusted pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period. As the measurement date
for these option issuances have been deemed the respective vesting dates, which
have not yet been reached, the Company evaluated the impact of these stock
option issuances using the grant date in the application of APB Opinion No. 25.
As of the grant date and at September 30, 2005, there was no intrinsic value
attributable to these option issuance. Furthermore, the Board granted other
employees options to purchase a total of 66,000 shares of common stock at an
exercise price of $4.35 which will vest in equal installments over 36 months.
All of the granted options will remain in effect for a period of 10 years or
until the employment of the optionee terminates.
If the Company had elected to recognize compensation expense based upon the fair
value at the grant date for awards under this plan consistent with the
methodology prescribed by SFAS No. 123, the Company's net loss and loss per
share would be reduced to the pro forma amounts indicated below for the three
months and nine months ended September 30, 2005 and 2004:
Three Months Nine Months Three Months Nine Months
ended ended ended ended
Sept 30 2005 Sept 30 2005 Sept 30 2004 Sept 30 2004
------------ ------------ ------------ ------------
Loss applicable to
common stockholders $ (782,000) $(2,123,000) $(1,101,000) $(1,864,000)
Stock-based employee compensation
expense determined under
fair value presentation for all options $ (39,000) $ (39,000) $ -- $ --
Pro forma net loss $ (821,000) $(2,162,000) $(1,101,000) $(1,864,000)
Basic and diluted loss per
common share
As reported $ (0.06) $ (0.20) $ (0.01) $ (0.01)
Pro forma $ (0.06) $ (0.20) $ (0.01) $ (0.01)
For purposes of computing the pro forma disclosures required by SFAS No. 123,
the fair value of each option granted to employees and directors is estimated
using the Black-Scholes option-pricing model with the following weighted-average
assumptions for the three months and nine months ended September 30, 2005 and
2004: dividend yields of 0% and 0%; expected volatility of 75% and 75%;
risk-free interest rates of 4% and 2.5%, and expected lives of five years. The
weighted-average fair value of options granted during the quarter ended
September 30, 2005 for which the exercise price equals the market price on the
grant date was $4.30, and the weighted-average exercise price was $4.35. No
options were granted during the quarter ended September 30, 2004.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which do not have vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
9
NOTE 1 - Basis of Presentation (continued)
Recently Issued Pronouncements
In March 2005, the FASB issued FIN 47, "Accounting for Conditional Asset
Retirement Obligations - an Interpretation of FASB Statement No. 143, Accounting
for Asset Retirement Obligations." This interpretation addresses the timing of
liability recognition for legal obligations associated with the retirement of a
tangible long-lived asset when the timing and/or method of settlement of the
obligation are conditional on a future event. The interpretation requires an
entity to recognize a liability for the fair value of a conditional asset
retirement obligation when incurred if the liability's fair value can be
reasonably estimated. The adoption of this interpretation did not have any
impact on our financial statements
In May 2005, the FASB issued Statement of Accounting Standards (SFAS) No. 154,
"Accounting Changes and Error Corrections" an amendment to Accounting Principles
Bulletin (APB) Opinion No. 20, "Accounting Changes", and SFAS No. 3, "Reporting
Accounting Changes in Interim Financial Statements" though SFAS No. 154 carries
forward the guidance in APB No. 20 and SFAS No. 3 with respect to accounting for
changes in estimates, changes in reporting entity, and the correction of errors.
SFAS No. 154 establishes new standards on accounting for changes in accounting
principles, whereby all such changes must be accounted for by retrospective
application to the financial statements of prior periods unless it is
impracticable to do so. SFAS No. 154 is effective for accounting changes and
error corrections made in fiscal years beginning after December 15, 2005, with
early adoption permitted for changes and corrections made in years beginning
after May 2005. The adoption of this interpretation did not have any impact on
our financial statements
NOTE 2 - Notes Payable
Notes payable is comprised of the following:
September 30, December 31,
2005 2004
---- ----
(unaudited)
-----------
Secured note payable to Credit Managers Association of California,
bearing interest at 6% per annum during 2003 and at prime plus 3%
per annum in 2004 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. 3,332,000 3,332,000
Unsecured note payable, bearing interest at 10% per annum. This
note payable is in default. 120,000 120,000
Secured note payable to a Coca Cola Enterprises in the original
amount of $40,000, bearing interest at 5% per annum. Principal and
unpaid interest due in July 2005. This settlement of this note
payable is currently in negotiation. 40,000 40,000
Secured note payable to a financial institution in the original
amount of $33,000, bearing interest at 8% per annum, payable in 36
equal monthly installments. 6,000 15,000
---------- ----------
3,498,000 3,507,000
Less current maturities 166,000 166,000
---------- ----------
Total $3,332,000 $3,341,000
========== ==========
10
NOTE 3 - Tomoe LTA Long-Term Contract
Enova has entered into a development and production contract with Tomoe
Electro-Mechanical Engineering and Manufacturing, Inc. for eight
battery-electric locomotives for the Singapore Land Transport Authority for
service vehicles for the Singapore Mass Rapid Transit Circle Line system for
maintenance, repair, shunting and recovery of passenger trains. Completion of
the contract will take approximately 15-18 months and is valued at approximately
$3,100,000. We are recording revenues for this long-term, fixed price contract
on the basis of the percentage-of-completion method. The contract contains
several deliverables over its life and therefore we will divide these
deliverables into separate units of accounting based on relative fair values.
Revenue recognition criteria will be assessed separately for each separate unit
of accounting. As of September 30, 2005, we recorded revenues of $398,000
related to the development portion of this contract.
NOTE 4 - Shareholders' Equity
On July 19, 2005, we entered into an agreement with a placement agent relating
to the sale of up to 5,350,000 new shares of our common stock. Pursuant to the
agreement, we sold all such shares of common stock at a price of $3.78 per share
to certain eligible investors located outside the United States. The gross
proceeds from the sale are approximately $20,000,000, before fees to Investec
Investment Bank and other costs associated with the listing and placement of
approximately $2,000,000. We received approximately $18,000,000 of net proceeds
from the offering.
We listed our common stock for trading on the AIM Market of the London Stock
Exchange on July 25, 2005.
The sale of common stock described above was conducted pursuant to the
requirements of Regulation S under the Securities Act of 1933. Among other
things, each investor that purchased shares of our common stock in the offering
represented that he or she was not a "U.S. Person" as defined in Rule 902 of
Regulation S. In addition, neither the Company nor the placement agent conducted
any selling effort directed at the United States in connection with the
offering. All shares of common stock issued in the offering were endorsed with a
restrictive legend indicating that the shares were issued pursuant to Regulation
S under the Securities Act and are deemed to be "restricted securities." As a
result, the purchasers of such shares will not be able to resell the shares in
the United States for at least one year following their purchase without
registration under the Securities Act or an applicable exemption from the
registration requirements of the Securities Act.
On September 22, 2005, the Board of Directors authorized the issuance of 25,000
shares of common stock to the executive officers of the Company at a price of
$4.35 per share as bonus compensation for a total expense of $108,750. We relied
on Rule 506 of Regulation D and Section 4(2) of the Securities Act of 1933, as
amended, for the exemption from registration of the sale of such shares.
During the three months ended September 30, 2005, we recorded 15,114 shares,
post-split; of restricted common stock issued to the Board of Directors at an
average price of $4.34 per share for in-person and telephonic board meetings and
committee meetings during the third quarter of 2005. We relied on Rule 506 of
Regulation D and Section 4(2) of the Securities Act of 1933, as amended, for the
exemption from registration of the sale of such shares.
11
NOTE 4 - Shareholders' Equity (continued)
Additionally, on July 20, 2005 (the "Effective Date"), we filed an Amendment to
our Amended and Restated Articles of Incorporation, effecting a reverse 1-for-45
split of our common stock. The number of authorized shares was unchanged. At the
close of business on the Effective Date, each share of the our Common Stock
issued and outstanding immediately prior to the Effective Date was automatically
and without any action on the part of the holder thereof reclassified as and
changed, pursuant to a reverse stock split (the "Reverse Stock Split"), into a
fraction thereof of 1/45th of a share of our outstanding Common Stock, subject
to the treatment of fractional share interests as described below. No
certificates or scrip representing fractional share interests in the new common
stock were issued, and no such fractional share interest will entitle the holder
thereof to vote, or to any rights of a shareholder of the Company. In lieu of
any fractional shares to which a holder of Common Stock would otherwise be
entitled, we paid cash equal to (a) the average of the high-bid and low-asked
per share prices of the Common Stock as reported on the NASDAQ electronic
"Bulletin Board" on the Effective Date multiplied by (b) the number of shares of
Common Stock held by such holder that would otherwise have been exchanged for
such fractional share interest.
As such, the number of issued and outstanding shares of common stock as of
September 30, 2005 reflects the effects of the reverse-split. The number of
shares of common stock authorized remains at 750,000,000. These are reflected in
the financial statements as of September 30, 2005.
NOTE 5 - Related Party Transactions
During the first nine months of 2005, we purchased from HHI approximately
$512,000 in components, materials and services for manufacture of our drive
systems and power management systems. These purchases were made on terms and
conditions equal to or better than our standard commercial terms with other
vendors. At quarter ended September 30, 2005, our outstanding payables balance
due HHI was approximately $382,000. These payables will be paid during the
fourth quarter of 2005 per our terms with HHI.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following information should be read in conjunction with the interim
financial statements and the notes thereto in Part I, Item I of this Quarterly
Report and with Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual report on Forms 10-K and
10-K/A for the year ended December 31, 2004. The matters addressed in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations, with the exception of the historical information presented contains
certain forward-looking statements involving risks and uncertainties. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including the risks discussed in this
Item 2 and specifically discussed in this report under the heading "Certain
Factors That May Affect Future Results" following this Management's Discussion
and Analysis section, and elsewhere in this report.
In the ordinary course of business, the Company has made a number of estimates
and assumptions relating to the reporting of results of operations and financial
condition in the preparation of its financial statements in conformity with
accounting principles generally accepted in the United States of America. Actual
results could differ significantly from those estimates under different
assumptions and conditions. The Company believes that the following discussion
addresses the Company's most critical accounting policies, which are those that
are most important to the portrayal of the Company's financial condition and
results. The Company constantly re-evaluates these significant factors and makes
adjustments where facts and circumstances dictate. Historically, actual results
have not significantly deviated from those determined using the necessary
estimates inherent in the preparation of financial statements. Estimates and
assumptions include, but are not limited to, customer receivables, inventories,
equity investments, fixed asset lives, contingencies and litigation. The Company
has also chosen certain accounting policies when options were available,
including:
o Inventories are priced at the lower of cost or market using standard
costs, which approximate actual costs on a first-in, first-out (FIFO)
basis. We maintain a perpetual inventory system and continuously
record the quantity on-hand and standard cost for each product,
including purchased components, subassemblies and finished goods. We
maintain the integrity of perpetual inventory records through periodic
physical counts of quantities on hand. Finished goods are reported as
inventories until the point of transfer to the customer. Generally,
title transfer is documented in the terms of sale.
Standard costs are generally re-assessed at least annually and reflect
achievable acquisition costs, generally the most recent vendor
contract prices for purchased parts, currently obtainable assembly and
test labor, and overhead for internally manufactured products.
Manufacturing labor and overhead costs are attributed to individual
product standard costs at a level planned to absorb spending at
average utilization volumes.
We maintain an allowance against inventory for the potential future
obsolescence or excess inventory that is based on our estimate of
future sales. A substantial decrease in expected demand for our
products, or decreases in our selling prices could lead to excess or
overvalued inventories and could require us to substantially increase
our allowance for excess inventory. If future customer demand or
market conditions are less favorable than our projections, additional
inventory write-downs may be required, and would be reflected in cost
of revenues in the period the revision is made.
o Stock Based Compensation - we periodically issue common stock or stock
options to employees and non-employees for services rendered. For
common stock issuances, the cost of these services is recorded based
upon the fair value of our common stock on the date of issuance. SFAS
13
No. 123, "Accounting for Stock-Based Compensation," establishes and
encourages the use of the fair value based method of accounting for
stock-based compensation arrangements under which compensation cost is
determined using the fair value of stock-based compensation determined
as of the date of grant and is recognized over the periods in which
the related services are rendered. The statement also permits
companies to elect to continue using the current implicit value
accounting method specified in Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," to account
for stock-based compensation. We have elected to use the intrinsic
value based method and has disclosed the pro forma effect of using the
fair value based method to account for its stock-based compensation.
For issuances of stock options to employees and directors we measure
compensation costs using the intrinsic value method, or APB Opinion
No. 25. Stock options granted to non-employees are accounted for under
the fair value method. The fair value of stock options granted is
calculated using the Black Scholes option pricing model based on the
weighted average assumptions.
o Allowance for Doubtful Accounts - we maintain allowances for doubtful
accounts for estimated losses resulting from the inability of its
customers to make required payments. A considerable amount of judgment
is required in assessing the ultimate realization of accounts
receivable including the current credit-worthiness of each customer.
If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required.
o Contract Services Revenue and Cost Recognition - The Company is
required to make judgments based on historical experience and future
expectations, as to the reliability of shipments made to its
customers. These judgments are required to assess the propriety of the
recognition of revenue based on Staff Accounting Bulletin ("SAB") No.
101 and 104, "Revenue Recognition," and related guidance. The Company
makes these assessments based on the following factors: i)
customer-specific information, ii) return policies, and iii)
historical experience for issues not yet identified. Under FAS
Concepts No. 5, revenues are not recognized until earned.
The Company manufactures proprietary products and other products based
on design specifications provided by its customers. Revenue from sales
of products are generally recognized at the time title to the goods
and the benefits and risks of ownership passes to the customer which
is typically when products are shipped based on the terms of the
customer purchase agreement. Revenue relating to long-term fixed price
contracts is recognized using the percentage of completion method.
Under the percentage of completion method, contract revenues and
related costs are recognized based on the percentage that costs
incurred to date bear to total estimated costs. Changes in job
performance, estimated profitability and final contract settlements
may result in revisions to cost and revenue, and are recognized in the
period in which the revisions are determined. Contract costs include
all direct materials, subcontract and labor costs and other indirect
costs. General and administrative costs are charged to expense as
incurred. At the time a loss on a contract becomes known, the entire
amount of the estimated loss is accrued. The aggregate of costs
incurred and estimated earnings recognized on uncompleted contracts in
excess of related billings is shown as a current asset, and billings
on uncompleted contracts in excess of costs incurred and estimated
earnings is shown as a current liability.
These accounting policies were applied consistently for all periods presented.
Our operating results would be affected if other alternatives were used.
Information about the impact on our operating results is included in the
footnotes to our financial statements.
14
Recently Issued Accounting Standard
-----------------------------------
In March 2005, the FASB issued FIN 47, "Accounting for Conditional Asset
Retirement Obligations - an Interpretation of FASB Statement No. 143, Accounting
for Asset Retirement Obligations." This interpretation addresses the timing of
liability recognition for legal obligations associated with the retirement of a
tangible long-lived asset when the timing and/or method of settlement of the
obligation are conditional on a future event. The interpretation requires an
entity to recognize a liability for the fair value of a conditional asset
retirement obligation when incurred if the liability's fair value can be
reasonably estimated. The adoption of this interpretation did not have any
impact on our financial statements.
In May 2005, the FASB issued Statement of Accounting Standards (SFAS) No. 154,
"Accounting Changes and Error Corrections" an amendment to Accounting Principles
Bulletin (APB) Opinion No. 20, "Accounting Changes", and SFAS No. 3, "Reporting
Accounting Changes in Interim Financial Statements" though SFAS No. 154 carries
forward the guidance in APB No. 20 and SFAS No. 3 with respect to accounting for
changes in estimates, changes in reporting entity, and the correction of errors.
SFAS No. 154 establishes new standards on accounting for changes in accounting
principles, whereby all such changes must be accounted for by retrospective
application to the financial statements of prior periods unless it is
impracticable to do so. SFAS No. 154 is effective for accounting changes and
error corrections made in fiscal years beginning after December 15, 2005, with
early adoption permitted for changes and corrections made in years beginning
after May 2005. The adoption of this interpretation did not have any impact on
our financial statements.
GENERAL
Enova Systems, Inc., a California Corporation ("Enova" or the "Company"), was
incorporated on July 30, 1976. The Company's fiscal year ends December 31.
Enova believes it is a leader in the development and production of proprietary,
commercial digital power management systems for transportation vehicles and
stationary power generation systems. Power management systems control and
monitor electric power in an automotive or commercial application such as an
automobile or a stand-alone power generator. Drive systems are comprised of an
electric motor, an electronics control unit and a gear unit which power an
electric vehicle. Hybrid systems, which are similar to pure electric drive
systems, contain an internal combustion engine in addition to the electric
motor, eliminating external recharging of the battery system. A hydrogen fuel
cell based system is similar to a hybrid system, except that instead of an
internal combustion engine, a fuel cell is utilized as the power source. A fuel
cell is a system which combines hydrogen and oxygen in a chemical process to
produce electricity. Stationary power systems utilize similar components to
those which are in a mobile drive system in addition to other elements. These
stationary systems are effective as power-assist or back-up systems, alternative
power, for residential, commercial and industrial applications.
A fundamental element of Enova's strategy is to develop and produce advanced
proprietary software, firmware and hardware for applications in these
alternative power markets. Our focus is digital power conversion, power
management, and system integration, for two broad market applications - vehicle
power generation and stationary power generation.
Specifically, we develop; design and produce drive systems and related
components for electric, hybrid-electric, fuel cell and microturbine-powered
vehicles. We also develop, design and produce power management and power
conversion components for stationary distributed power generation systems. These
stationary applications can employ hydrogen fuel cells, microturbines, or
advanced batteries for power storage and generation. Additionally, we perform
research and development to augment and support others' and our own related
product development efforts.
15
Our product development strategy is to design and introduce to market
successively advanced products, each based on our core technical competencies.
In each of our product / market segments, we provide products and services to
leverage our core competencies in digital power management, power conversion and
system integration. We believe that the underlying technical requirements shared
among the market segments will allow us to more quickly transition from one
emerging market to the next, with the goal of capturing early market share.
Enova's primary market focus centers on both series and parallel heavy-duty
drive systems for multiple vehicle and marine applications. We believe
series-hybrid and parallel hybrid heavy-duty drive system sales offer Enova the
greatest potential return on investment in both the short and long term.
Additionally, Enova's management believes that this area will see significant
growth over the next several years. As we penetrate more market areas, we are
continually refining and optimizing both our market strategy and our product
line to maintain our expertise in power management and conversion systems for
mobile applications.
Management's strategy is to provide a dual path approach in offering both a
series and parallel hybrid drive systems solution. We have developed or are
developing a variety of heavy-duty drive system solutions, including our series
hybrid drive system featuring our diesel generator set; a post-transmission
parallel hybrid system and two variations of a pre-transmission parallel hybrid
drive system. Many of these systems are currently being utilized in our
customer's trucks and buses such as the Mack R-11 refueler vehicle which
utilizes our post-transmission parallel hybrid, First Auto Group of China's
buses which utilize our pre-transmission hybrid solution and WrightBus of the
United Kingdom's 10m bus which utilizes our series hybrid drive system.
Additionally, we continue to pursue private and government funded development
programs. These programs allow us to enhance our ability to increase our revenue
base, form new alliances with major OEMs and participate in the latest trends in
alternative fuel technologies. Research and development revenues in the third
quarter of 2005 are a result of engineering services for the Hyundai Motor
Company for their fuel cell bus, Ford Motor Company for their fuel cell vehicle,
Tomoe's hybrid train programs and various Hawaii Center for Advanced
Transportation Technologies (HCATT) programs.
In the quarter ended September 30, 2005, we continued with our development
efforts with both new and existing customers. Enova, teaming with Concurrent
Technologies Corporation (CTC), continues to supply product and assist in the
integration of a fuel cell hybrid drive system for a MB4 tow tractor for the
U.S. Air Force. Additionally, we have completed a parallel hybrid drive system
study for HCATT in conjunction with the U.S. Air Force. We are now in
discussions with HCATT for the next phase which will be to develop and fabricate
a parallel hybrid step van based on the results of the study. We continue to
receive greater recognition from both governmental and private industry with
regards to both commercial and military application of our hybrid drive systems
and fuel cell power management technologies. We are also negotiating with the
U.S. Air Force to develop and produce series hybrid. Although we believe that
current negotiations with several parties may result in development and
production contracts during 2005 and beyond, there are no assurances that such
additional agreements will be realized.
During the quarter ended September 30, 2005, we continued to develop and produce
electric and hybrid electric drive systems and components for FAW China, Wright
Bus and Eneco of the United Kingdom, EcoPower Technology (EPT) of Italy,
Tsinghua University of China, MTrans of Malaysia, Tomoe Electro-Mechanical
Engineering and Manufacturing, Inc. of Japan and several other domestic and
international vehicle and bus manufacturers.
Our various electric and hybrid-electric drive systems, power management and
power conversion systems are being used in applications, including Class 8
trucks, train locomotives, transit buses and industrial vehicles as well as in
non-transportation applications such as fuel-cell management and power
management systems, including the EDO minesweeper. We have furthered our
development and production of systems for both mobile and stationary fuel cell
powered systems with major companies such as Ford and Hydrogenics, a fuel cell
developer in Canada.
16
Heavy-Duty Drive Systems - Buses, Trucks, Vans and Other Industrial Vehicle
--------------------------------------------------------------------------------
Applications
------------
In the third quarter of 2005, we continued to market our latest hybrids, the
HybridPower Series Hybrid and Parallel Hybrid, to customers in Europe and Asia.
Enova's new diesel generator set, the power component within the hybrid drive
system, delivers 60 kilowatts volts of continuous power, enabling it to
integrate seamlessly with Enova's 240kW or 120kW drive motors and other digital
power management components. The series hybrid genset consists of a 60kW
electric motor, a motor controller and a diesel engine meeting stringent Euro 3
or Euro 4 emission specifications. The genset is distinctively designed to allow
end users to choose the engine best suited for their commercial needs,
permitting a wide variety of engine choices. The parallel hybrid drive system
comes in a post-transmission and two pre-transmission configurations. Parallel
hybrids are better suited for vehicles which do not have exclusively stop and go
drive cycles as the parallel hybrid system optimizes fuel economy over a greater
range of driving cycles.
During the third quarter of 2005, we received an order from FAW for five
additional pre-transmission parallel hybrid drive systems for their buses to be
delivery in the fourth quarter. The first three vehicles were successfully
integrated and tested. FAW has commenced integrating additional buses with our
drive system. Enova's parallel hybrid drive system solution outperformed the
Chinese competitor's system. Our system is now replacing these Chinese systems.
Management believes that these development and initial production programs will
result in additional production contracts during 2005 and beyond; however at
this time; there are no assurances that such additional contracts will be
consummated.
Our eight drive system contract with Tomoe for Singapore Land Transport
Authority's eight battery-electric locomotives continues on schedule. Over the
last several years, Enova successfully integrated its HybridPowerTM drive
systems into Tomoe's heavy-duty Isuzu dump truck application, three passenger
trams and a mine tunnel crawler. It is anticipated that the hybrid drive train
components will be delivered in December 2005 to Tomoe's Japan-based facilities.
This latest market penetration in Asia enhances not only Enova's alliances with
both Tomoe and HHI, but also advances Enova's hybrid-electric technologies in
high voltage power management components. As part of this contract, Enova will
develop a high voltage charging system to enable the locomotive to receive a
direct battery charge from the high voltage rail. Tomoe and Enova continue to
develop other commercial and industrial applications for our drive systems,
including potential light rail applications. Although we anticipate additional
orders for these systems in 2005 and beyond, there are no assurances that such
additional orders will be forthcoming.
WrightBus, one of the largest low-floor bus manufacturers in the United Kingdom,
is currently integrating our diesel genset-powered, series hybrid drive systems
in their medium and large bus applications. WrightBus will unveil their new
hybrid bus in London in the fourth quarter of 2005 on the 360 route. In late
2004, we entered into an exclusive three-year letter of intent with WrightBus
for the potential sale of certain Enova products for specific vehicles in the
United Kingdom, subject to WrightBus' completing various service and marketing
milestones. WrightBus has notified us of potential additional orders for 2006
through 2007. At this time, however, there are no assurances that such
additional orders will be forthcoming.
We continued to deliver the sixteen 120kW electric drive systems to Eneco of the
United Kingdom, a vehicle integrator which utilizes Enova's HybridPower 120kW
drive systems in its hybrid bus applications. During the 3rd quarter of 2005, we
billed Eneco for approximately $393,000 for these drive systems. The production
system deliveries under this purchase order will continue into the fourth
quarter of 2005. Eneco has notified us of its plans to order additional 120kw
systems for its bus programs. At this time, however, there are no assurances
that such additional orders will be forthcoming.
Additionally, we are in discussions with other bus manufacturers and industrial,
commercial and military vehicle manufacturers regarding the purchase of our
heavy-duty, high performance, parallel and series hybrid drive systems in 2005.
There are no assurances, however, that these discussions will result in any
sales of the HybridPower parallel or series hybrid drive systems.
17
Light-Duty Drive Systems - Automobiles and Delivery vehicles
------------------------------------------------------------
Our 90kW controller, motor and gear unit is utilized in light duty vehicles such
as midsize automobiles and delivery vehicles. The topology of this system is
being adapted to also be utilized as a parallel hybrid motor and controller
system. We are beginning to receive more interest in our light-duty systems from
both European and Asian customers.
Our 90kW motor controller is utilized in the parallel hybrid drive system
designed for FAW. In conjunction with the 90kW motor, FAW and Enova are
evaluating this latest usage of our hybrid technologies. As noted earlier, we
anticipate additional demand for these systems. At this time, however, there are
no assurances that such additional orders will be forthcoming.
For the foreseeable future, we will also continue our efforts to cross-sell our
systems to new and current customers in the light and medium duty vehicle
markets, both domestically and globally.
Fuel Cell Technologies
----------------------
Due to the success of the 20kW High Voltage Energy Converter (HVEC) development
program with Ford Motor Company for their fuel cell vehicle, Ford has entered
into another development contract with Enova for a 30kW converter. Ford
continues to utilize our new 30kW HVEC systems in their development efforts as
they seek to use the HVEC in traditional hybrid vehicle applications which do
not utilize fuel cells. In the third quarter of 2005, Ford extended the
development contract to modify the HVEC for further study. The 20kW HVEC is a
key component in Ford's Focus Fuel Cell Vehicle (FCV) which utilizes the Ballard
fuel cell system. It converts high voltage power from the fuel cell into a lower
voltage for use by the drive system and electronic accessories. There is a
potential for additional production orders for HVEC units from Ford in 2005 and
beyond; however, at this time, there are no assurances that such additional
orders will be forthcoming.
Furthermore, we are applying the technology and components derived from this
program to other applications. The HVEC is a critical component of our Fuel Cell
bus programs and other fuel cell powered systems such as the Hyundai fuel cell
vehicle. Both of these projects are further detailed in the research and
development programs section set forth below.
Our projects with both CTC and HCATT for a fuel cell powered MB-4 tow tractor
and a step-van, respectively, utilize our HVEC units to control and adapt power
between the fuel cells, the batteries and the power electronics of the drive
system. In heavy-duty mobile applications such as these, Enova has developed
firmware to run our HVEC units in parallel for greater power capacity.
Enova's fuel cell enabling components are part of the proposed fleets of fuel
cell vehicles being utilized by both Ford Motor Company (the Ford Focus FCV) and
Hyundai Motor Company (the Hyundai Tucson fuel cell hybrid electric vehicle) in
response to the U.S. Department of Energy's solicitation, entitled "Controlled
Hydrogen Fleet and Infrastructure Demonstration and Validation Project." This
government-funded project, which commenced in late 2004, will last over five
years and evaluate the economic and performance feasibility of fuel cell
vehicles and infrastructure across the U.S.
The Company intends to continue to explore new applications for this versatile
technology in both mobile and stationary systems.
Research and Development Programs
---------------------------------
We continue to pursue government and commercially sponsored development programs
for both ground and marine heavy-duty drive system applications.
18
We commenced a development program with Hyundai Motor Company of Korea for a
heavy-duty fuel cell bus in 2005 and delivered the first of our new high voltage
240kW series hybrid drive systems in the third quarter of 2005. The drive system
integrates with a UTC Fuel Cell unit for Hyundai's newest bus. The contract is
valued at over $750,000 for delivery of three 240kW drive systems in 2005. As of
September 30, 2005, we have billed approximately $368,000 for this program.
We have entered into a joint development program with a major North American
Truck Manufacturer in the third quarter of 2005. This validation project will
feature Enova's new post and pre-transmission 120kW Hybrid Drive Systems. The
drive systems will be integrated into several medium to heavy-duty vehicles for
delivery in the fourth quarter of 2005, with the purpose of leading to
production in mid to late 2006. Although we believe there is potential for
production programs in 2006 and beyond, there can be no assurances at this time
that such orders will be realized.
Our program with Mack Truck, Inc., Powertrain division - a unit of The Volvo
Group, Sweden, for the development and manufacture of a motor controller,
electric motor and battery management systems for a new parallel hybrid drive
system is nearing completion. The new parallel hybrid vehicle program is part of
the Air Force's efforts to improve efficiency, reduce fuel and maintenance
costs, provide re-generative brake energy and reduce emissions. Utilizing this
drive system configuration, Enova is in the final stages to integrate this same
system into refuse trucks for the New York City Transit Authority commencing in
the fourth quarter of 2005. This program will convert a minimum of four to six
trucks to parallel hybrid systems. Although we believe there is potential for
such programs in 2005 and 2006, there can be no assurances at this time that
such orders will be realized.
We received additional orders for our fuel cell power management and conversion
components for Hyundai Motor Company's (HMC) latest fuel cell hybrid electric
vehicle, the Tucson, which was unveiled at the Geneva Auto Show in March 2004.
During the third quarter of 2005, Enova received an order for 2 additional
systems, for a total of 7, for delivery in the fourth quarter 2005. HMC has
notified Enova of its intent to order up to 35 more motors and controllers for
additional vehicles for 2006. Although we believe there is potential for such
production in 2006, there can be no assurances at this time that such orders
will be realized.
Our HCATT fuel cell powered step-van was completed in the third quarter of 2005
now entering an evaluation phase. This vehicle is almost identical to the
Purolator step-van and utilizes the same fuel cell powered drive systems and
components. We are experiencing a notable increase in interest from both
government and military organizations for our products and integration services.
The first of these being the project with CTC for the fuel cell powered MB-4 tow
tractor. For the quarter ended September 30, 2005, we billed approximately
$236,000 for all of our HCATT programs.
Additionally, during the third quarter of 2005, we completed a parallel hybrid
study project with HCATT which may lead to a contract for the development of a
pre-transmission parallel hybrid step-van for the U.S. Air Force in 2006.
Although we believe there is potential for production of this type of drive
system and other development programs in 2005, there can be no assurances at
this time that such contracts will be realized.
We intend to establish new development programs with the Hawaii Center for
Advanced Transportation Technologies in mobile and marine applications as well
as other state and federal government agencies as funding becomes available.
LIQUIDITY AND CAPITAL RESOURCES
We have experienced cash flow shortages due to operating losses primarily
attributable to research, development, marketing and other costs associated with
our strategic plan as an international developer and supplier of electric
propulsion and power management systems and components. Cash flows from
operations have not been sufficient to meet our obligations. Therefore, we have
had to raise funds through several financing transactions. At least until we
reach breakeven volume in sales and develop and/or acquire the capability to
manufacture and sell our products profitably, we will need to continue to rely
on cash from working capital reserves.
19
On July 19, 2005, we entered into an agreement with a placement agent relating
to the sale of up to 5,350,000 new shares of its common stock. Pursuant to the
agreement, we sold all such shares of common stock on July 17, 2005, at a price
of $3.78 per share (post reverse split) to certain eligible investors located
outside the United States (the "AIM Financing"). The gross proceeds from the
sale are approximately $20,000,000, before fees to Investec Investment Bank and
other costs associated with the listing and placement of approximately
$2,000,000. We received approximately $18,000,000 of net proceeds from the
offering. The sale of this common stock was conducted pursuant to the
requirements of Regulation S under the Securities Act of 1933. Among other
things, each investor purchasing shares of our common stock in the offering has
represented that he or she is not a "U.S. Person" as defined in Rule 902 of
Regulation S. In addition, neither the Company nor the placement agent has
conducted any selling effort directed at the United States in connection with
the offering. All shares of common stock issued in the offering were endorsed
with a restrictive legend indicating that the shares were issued pursuant to
Regulation S under the Securities Act and were deemed to be "restricted
securities." As a result, the purchasers of such shares are not be able to
resell the shares in the United States for at least one year after their
purchase without registration under the Securities Act or an applicable
exemption from the registration requirements of the Securities Act.
Our operations during the quarter ended September 30, 2005 were financed by
development contracts and product sales, as well as from working capital
reserves obtained from the AIM financing.
During the nine months ended September 30, 2005, our operations required
$1,870,000 more in cash than was generated. Enova continues to increase
marketing and development spending as well as administrative expenses necessary
for expansion to meet customer demand. Accounts receivable increased by $357,000
to $879,000 from $522,000, or approximately 68% from the balance at December 31,
2004 (net of write-offs). The increase results from additional product sales in
the third quarter as well as continued progress on our development contracts
with HCATT and HMC. Inventory increased by $235,000 to $1,271,000 from
$1,036,000 or 14% from December 31, 2004 balances during the nine months ended
September 30, 2005. The increase was due to increased materials purchases for
orders to be fulfilled in the fourth quarter of 2005 and early 2006.
Prepaid expenses increased by net $36,000 to $340,000 at September 30, 2005 from
the December 31, 2004 balance of $304,000 or 12% due to the renewal of our
various insurance policies and deposits placed for several inventory purchases.
Fixed assets increased by $155,000 or 9%, before depreciation, for the quarter
ended September 30, 2005 from the prior year balance of $1,754,000 on December
31, 2004 due to the purchase of both computer and production equipment.
Investments decreased by $73,000 for the nine months ended September 30, 2005
from $1,768,000 at December 31, 2004, which reflects our pro-rata share of
losses attributable to our forty percent investment interest in the
Hyundai-Enova Innovative Technology Center (ITC). For the nine months ended
September 30, 2005, the ITC generated a net loss of approximately $183,000,
resulting in a charge to Enova of $73,000 utilizing the equity method of
accounting for our interest in the ITC. During the third quarter of 2005, the
ITC began to reduce its losses as it has begun to generate revenues through
royalties and development services.
Other assets decreased by $79,000 over the nine months ended September 30, 2005
from $296,000 at December 31, 2004 as we continued to amortize the asset
relating to the Ford Value Participation Agreement and our other intellectual
property assets. Intellectual property assets, including patents and trademarks
remained relatively unchanged at $93,000 at September 30, 2005.
20
Accounts payable increased over the nine months ended September 30, 2005 by
$510,000 to $576,000 from $66,000 at December 31, 2004. The increase in accounts
payable is due to additional purchases of materials and goods primarily from
Hyundai Heavy Industries (HHI). These payables are routinely incurred and paid
during the ordinary course of business. The balance due HHI is being paid off in
the fourth quarter of 2005 per the terms of our agreement. Deferred revenue
decreased from $392,000 as of December 31, 2005 to $127,000 in the nine months
ended September 30, 2005 as we recognized $328,000 in revenues for the nine
months ended September 30, 2005 on the Tomoe Singapore project based on the
percentage of completion method of revenue recognition and the MTrans drive
system sale. The deferred revenues for the current portion of this contract have
been fully recognized and we will commence billing as we progress on the
development and production phases of that contract in 2005 and 2006. Other
accrued expenses, including accrued payroll, increased by a net of $15,000 for
the nine months ended September 30, 2005 from the balance of $207,000 at
December 31, 2004, from a combination of factors including increases in
insurance contracts payable associated with our liability insurance policies and
quarter-end payroll accruals. During the quarter ended September 30, 2005, we
also paid off our Line of Credit for a total reduction of $229,000 from the
December 31, 2004 balance.
Accrued interest increased by $231,000 for the nine months ended September 30,
2005, an increase of 17% from the balance of $1,378,000 at December 31, 2004.
The increase was due to interest on the Note due the Credit Managers Association
of California for $3.2 million per the terms of the Note as well as the Schulz
note payable as discussed in Note 2 of the financial statements. We have begun
to negotiate settlement terms with each creditor underlying this Note to pay
them off prior to the due date.
RESULTS OF OPERATIONS
Net revenues for the three and nine month periods ending September 30, 2005 were
$857,000 and $2,871,000, respectively, as compared with $406,000 and $2,232,000
for the corresponding periods in 2004, an increase of 111% and 29% respectively.
Net production revenues for the quarter ended September 30, 2005 increased 113%
to $402,000 from $189,000 for the same period in 2004. Net R&D revenues for the
quarter ended September 30, 2005 increased 110% to $455,000 from $217,000 for
the quarter ended September 30, 2004. The increase in production revenues is
primarily the result of delivery of drive systems to our customers as discussed
earlier. Our sources of revenue for the third quarter of 2005 came equally from
product sales and development contracts, however for the nine months ended
September 30, 2005 product sales continue to account for a majority of revenues.
Product sales as a percentage of total revenues were 47% for the three months
ended September 30, 2005, and 60% of total revenues for the nine months ended
therein, with sales of our HybridPower 120kW drive systems accounting for a
majority of our product sales. We believe this trend will continue to accelerate
for the foreseeable future as more current and prospective customers purchase
additional drive systems for their production vehicles. We will continue to seek
out and contract for new development programs with both our current partners
such as WrightBus, Eneco, EPT, FAW, Tomoe, Hyundai and our other U.S., Asian and
European alliance partners, as well as with new alliances with other vehicle
manufacturers and energy companies to enhance our technology and our product
offerings. Research and development revenues for the third quarter of 2005 are a
result of development programs and engineering services for the HMC fuel cell
bus and various HCATT programs.
Cost of revenues consists of component and material costs, direct labor costs,
integration costs and overhead related to manufacturing our products. Product
development costs incurred in the performance of engineering development
contracts for the U.S. Government and private companies are charged to cost of
sales for this contract revenue. Cost of revenues for the quarter ended
September 30, 2005 increased $372,000 to $729,000 from $357,000 for the same
period in 2004. For the nine months ending September 30, 2005, there was an
increase in cost of revenues to $2,322,000 from $1,534,000 for the same
nine-month period in 2004. These increases are primarily attributable to the
increase in sales for the quarter and nine-months, as well as additional support
costs for some of our new product lines. We anticipate there may be additional
increases in cost of sales for products in 2005 due to foreign exchange rate
fluctuations of the U.S. dollar versus those currencies of our primary
manufacturer, Hyundai Heavy Industries. We anticipate this to be offset by a
reduction in costs associated with manufacturing these products due to
increasing purchases, thereby improving our gross margins.
21
Internal research, development and engineering expenses remained constant for
the three months ended September 30, 2005 at $197,000 as compared with $198,000
in the same period in 2004. For the nine months ended September 30, 2005, such
expenses increased 17% to $592,000 from $507,000 in 2004. As the market for
heavy-duty hybrid vehicles continues to evolve and grow, we have increased
allocating engineering resources to the development and enhancement of our new
parallel hybrid drive systems, our series hybrid system, upgrading proprietary
control software, higher power DC-DC converters and advancing our digital
inverters and other power management firmware.
Selling, general and administrative expenses decreased to $765,000 from
$844,000, or 9%, for the three months ended September 30, 2005, from the
previous year's comparable period. For the nine months ended September 30, 2005,
these expenses increased from $1,823,000 to $1,924,000 or 6%. The decrease for
the quarter ended September 30, 2005 was due to lesser professional fees as such
were primarily for the U.K. offering and AIM listing and were charged directly
against equity rather than expensed. The increase for the nine months is
attributable to additional marketing, engineering and technical staff employed
in the first half of 2005 as well as increased expense due to stricter
regulatory oversight in conjunction with the Sarbanes-Oxley Act of 2002 and our
efforts to attract additional capital funding. Management continues to implement
cost reduction strategies in 2005 in its efforts to achieve profitability,
although management cannot assure that profitability will be achieved.
Net interest and other income/expense increased by approximately 200% from a net
expense of $61,000 in the third quarter of 2004 to a net income of $59,000 in
the third quarter of 2005 as interest income from the U.K. offering capital
raise began to be realized. For the nine months ended September 30, 2005, net
interest and other income/expense was $83,000 compared to $98,000 for the same
period in 2004.
We incurred a loss from continuing operations of $782,000 in the third quarter
of 2005 compared to a loss of $1,101,000 in the third quarter of 2004, which
represents a 29% reduction in loss. For the nine months ending September 30,
2005, the loss increased from $1,864,000 to $2,123,000 or a 14% increase. The
increase was attributable to several factors, including higher comparative costs
of revenue due to the type of products sold in the first half of 2005 as
compared to 2004, higher support costs in the third quarter of 2005, increased
internal development efforts and higher general operating costs due to factors
noted above. By increasing sales revenues while maintaining cost management
strategies currently in effect, we believe we will be able to reduce our annual
loss from operations as compared with prior years' results; however, management
cannot assure that these results will be achieved.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
This Form 10-Q contains forward-looking statements concerning our existing and
future products, markets, expenses, revenues, liquidity, performance and cash
needs as well as our plans and strategies. Forward-looking statements may be
identified by the use of terminology such as "may," "anticipate," "estimate,"
"plans," "expects," "believes," "will," "potential" and by other comparable
terminology or the negative of any of the foregoing. These forward-looking
statements involve risks and uncertainties and are based on current management's
expectations and we are not obligated to update this information. Many factors
could cause actual results and events to differ significantly from the results
anticipated by us and described in these forward looking statements including,
but not limited to, the following risk factors.
Net Operating Losses. We experienced recurring losses from operations and had an
accumulated deficit of $102,582,000 at September 30, 2005. There is no
assurance, however, that any net operating losses will be available to us in the
future as an offset against future profits for income tax purposes.
22
Continued Losses. For the three months ended September 30, 2005 and 2004, we had
net losses of $782,000 and $1,101,000 respectively on sales of $857,000 and
$406,000, respectively. For the nine months ended September 30, 2005 and 2004,
we had net losses of $2,123,000 and $1,864,000 respectively on sales of
$2,871,000 and $2,232,000, respectively.
Our independent auditors' opinion on our audited financial statements includes a
going concern qualification. Our independent auditors have included an
explanatory paragraph in their audit report issued in connection with our
financial statements for the year ended December 31, 2004 which states that our
recurring operating losses raise substantial doubt about our ability to continue
as a going concern. Our ability to continue as a going concern is dependent on
its success at obtaining additional capital sufficient to meet its obligations
on a timely basis, and to ultimately attain profitability.
In July 2005, we raised approximately $20,000,000 with net proceeds to the
Company of approximately $18,000,000 in conjunction with a placement of
5,350,000 shares of common stock on the London Stock Exchanges AIM Market as
detailed in Note 4 of our financial statements included in the Form 10-Q.
Nature of Industry. The mobile and stationary power markets, including electric
vehicle and hybrid electric vehicles, continue to be subject to rapid
technological change. Most of the major domestic and foreign vehicle
manufacturers and vehicle component manufacturers: (1) have already produced
electric and hybrid vehicles, and/or (2) have developed improved electric
storage, propulsion and control systems, and/or (3) are now entering or have
entered into production, while continuing to improve technology or incorporate
newer technology. In addition, the stationary power market is still in its
infancy. A number of established energy companies are developing new
technologies. Cost-effective methods to reduce price per kilowatt have yet to be
established and the stationary power market is not yet viable.
Our current products are designed for use with, and are dependent upon, existing
technology. As technologies change, and subject to our limited available
resources, we plan to upgrade or adapt our products in order to continue to
provide products with the latest technology. We cannot assure you, however, that
we will be able to avoid technological obsolescence, that the market for our
products will not ultimately be dominated by technologies other than ours, or
that we will be able to adapt to changes in or create "leading-edge" technology.
In addition, further proprietary technological development by others could
prohibit us from using our own technology.
Our industry is affected by political and legislative changes. In recent years
there has been significant public pressure to enact legislation in the United
States and abroad to reduce or eliminate automobile pollution. Although states
such as California have enacted such legislation, we cannot assure you that
there will not be further legislation enacted changing current requirements or
that current legislation or state mandates will not be repealed or amended, or
that a different form of zero emission or low emission vehicle will not be
invented, developed and produced, and achieve greater market acceptance than
electric or hybrid electric vehicles. Extensions, modifications or reductions of
current federal and state legislation, mandates and potential tax incentives
could also adversely affect our business prospects if implemented.
Changed legislative climate. Because vehicles powered by internal combustion
engines cause pollution, there has been significant public pressure in Europe
and Asia, and enacted or pending legislation in the United States at the federal
level and in certain states, to promote or mandate the use of vehicles with no
tailpipe emissions ("zero emission vehicles") or reduced tailpipe emissions
("low emission vehicles"). Legislation requiring or promoting zero or low
emission vehicles is necessary to create a significant market for electric
vehicles. The California Air Resources Board (CARB) is continuing to modify its
regulations regarding its mandatory limits for zero emission and low emission
vehicles.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the
"Exchange Act"), an evaluation was carried out by the Company's Chief Executive
Officer and its Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as defined in
Rule 13a-14(c) and 15d-14(c) under the Exchange Act) as of the end of the
quarter ended September 30, 2005. Based upon that evaluation of these disclosure
controls and procedures, the Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures were effective as of the
end of the quarter ended September 30, 2005 to ensure that material information
relating to the Company was made known to him particularly during the period in
which this quarterly report on Form 10-Q was being prepared.
Changes in internal controls over financial reporting.
There was not any change in the Company's internal control over financial
reporting that occurred during the quarter ended September 30, 2005 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We may from time to time become a party to various legal proceedings arising in
the ordinary course of business. As of November 14, 2005, the Company was not
involved in any legal proceedings.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
California law prohibits the payment of dividends unless the Company has
sufficient retained earnings or meets certain asset to liability ratios.
During the three months ended September 30, 2005, the Company issued common
stock of Enova to the non-executive board directors in accordance with the
September 1999 Board of Directors compensation package for outside directors.
During the three months ended September 30, 2005, we recorded 15,114 post-split
shares of restricted common stock as common stock subscribed to the Board of
Directors at an average price of $4.34 per share for full and telephonic board
meetings and committee meetings during the third quarter of 2005. We relied on
Rule 506 of Regulation D and Section 4(2) of the Securities Act of 1933, as
amended, for the exemption from registration of the sale of such shares. As of
September 30, 2005, 108,372 shares, post-split, had been issued under the above
compensation plan for Directors.
Item 3. Defaults upon Senior Securities: None.
Item 4. Submission of Matters to a Vote of Securities Holders: None.
Item 5. Other Information:
On July 14, 2005, the Company entered into indemnification agreements with each
of its directors (each an "Indemnitee"). The agreements govern each Indemnitee's
right to indemnification in accordance with the Company's Articles of
Incorporation and applicable law. Pursuant to the agreements, the Company will
maintain Director and Officer Insurance for each Indemnitee. In addition, the
Company will indemnify the Indemnitee against expenses incurred in connection
with any threatened, pending or completed action, suit or other proceeding to
which the Indemnitee is a party by reason of the fact that the Indemnitee is or
was an agent of the Company. The Company is obligated to advance all expenses
incurred by the Indemnitee in connection with a qualifying proceeding within 20
days following a written request by the Indemnitee. The Indemnitee is obligated
to repay such amounts advanced if it is ultimately determined, pursuant to the
terms of the agreement, that the Indemnitee is not entitled to indemnification.
On June 1, 1999, Jagen Pty, Ltd. ("Jagen") and Anthony Rawlinson ("Rawlinson"
and together with Jagen, the "Purchasers"), Carl D. Perry ("Perry") and Enova
Systems., Inc. (formerly U.S. Electricar, Inc.), a California corporation (the
"Company") entered into a Shareholders' Agreement (the "Shareholders'
Agreement") which provided for, among other matters, the granting of certain
preemptive and corporate governance rights to the Purchasers. Effective as of
July 19, 2005 (the "Effective Date"), A Waiver and Termination of Shareholders'
Agreement (the "Shareholders' Termination Agreement") was entered into by and
among the Purchasers, Perry and the Company. Pursuant to the Shareholders'
Termination Agreement, the Purchasers (x) waived their preemptive rights set
forth in Article III of the Shareholders' Agreement effective as of the
Effective Date with respect to the securities to be sold by the Company pursuant
to that certain Placing Agreement by and among Investec Bank (UK) Limited, the
Company and the Directors of the Company (the "Placing Agreement") and (y) along
with Perry and the Company ,agreed to terminate the Shareholders' Agreement (the
"Termination") effective immediately prior to the "Admission" (as defined in the
Placing Agreement). The Termination, which was effective on July 25, 2005,
terminated the Purchasers' rights, among other matters, to submit one designee
for election to the Company's Board of Directors and to have such designee
included in any proxy statement submitted on behalf of the Company. The
Termination also terminated the voting obligation's of both Perry and the
25
Purchasers to vote their shares in favor of such designee and the remaining
Board designees nominated by the Board of Directors. The Termination also
terminated (A) Perry's obligation to vote his shares in favor of Anthony
Rawlinson as the Chairman of the Company's Board of Directors; (B)the Company's
inability to increase the size of the board of directors of the Company above
seven (7) members without the consent of a majority in interest of the
Purchasers; and (C) each Purchaser's restrictions on voting their shares in
favor of and their obligation to vote such shares against any (i) sale, transfer
or other assignment or hypothecation of the Company's assets or merger,
reorganization or similar sale of the Company or (ii) amendment, modification,
change or termination to any provision of this Company's Charter Documents
unless such action was recommended or approved by a majority of the Board of
Directors then in office or pursuant to a unanimous written consent of the Board
of Directors. The Termination also terminated certain registration rights of the
Purchasers.
Upon the request and recommendation of the Company's investment bankers,
Investec, and the Company's desire and need to attract and retain qualified
Directors, for the quarter ending on December 31, 2005 and for each calendar
quarter thereafter, the Company has agreed to pay each non-employee Director of
the Company an annual Director's fee of $40,000, comprised of $16,000 in cash
and $24,000 in restricted Common Stock of the Company vesting and payable as
follows: Each Director who is a Director of the Company on the last business day
of each calendar quarter of the Company shall be entitled to be paid for each
such calendar quarter $4,000 and issued Common Stock of the Company in the
amount of $6,000 valued as of the last business day of such calendar quarter.
The first such Directors' fees payment shall vest and be owed effective as of
December 30, 2005.
During the 3rd Quarter the Company also adopted an executive compensation plan
by granting to the Company's executives options under our 1996 Stock Option Plan
to purchase a total of 244,000 shares of common stock at an exercise price of
$4.35 per share. These options will vest based on the Company achieving certain
revenue milestones for the years ended December 31, 2005 and 2006. If such
milestones are not met, the options with respect to those milestones will
terminate. All of the granted options will remain in effect for a period of 10
years or until 90 days after the employment of the optionee terminates.
Item 6. Exhibits:
10.27* Waiver and Termination of Shareholders Agreement dated July 19, 2005
between Registrant and Jagen Pty, Ltd., Anthony Rawlinson and Carl D.
Perry.
10.28* Placing Agreement in connection with an application to join AIM, dated
July 19, 2005 between Registrant; each of its directors and Investec
Bank (UK) Limited.
10.29* AIM Nominated Adviser Broker Agreement dated July 19, 2005 between
Registrant; each of its directors and Investec Bank (UK) Limited.
31.1* Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act Of 2002
31.2* Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32* Certification Pursuant to 18 U.S.C. Section 1350
______________________
* - filed herewith
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2005
ENOVA SYSTEMS, INC.
(Registrant)
/s/ Larry B. Lombard
---------------------------------------------
By: Larry B. Lombard, Chief Financial Officer
27