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 March 31 ,2003 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 identification number) incorporation or organization) 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 May 13, 2003, there were 345,394,000 shares of Common Stock, no par value, 2,824,000 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. -------- PART 1. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited)..................................3 Balance Sheets: March 31, 2003 and December 31, 2002..............................3 Statements of Operations: Three months ended March 31, 2003 and 2002........................4 Statements of Cash Flows: Three months ended March 31, 2003 and 2002........................5 Notes to Financial Statements: Three months ended March 31, 2003 and 2002........................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...............................9 Item 3. Quantitative and Qualitative Disclosure about Market Risk........15 Item 4. Control and Procedures...........................................15 PART II. OTHER INFORMATION Item 1. Legal Proceedings ...............................................16 Item 2. Changes in Securities and Use of Proceeds........................17 Item 3. Defaults upon Senior Securities..................................16 Item 4. Submission of Matters to a Vote of Security Holders..............16 Item 5. Other Information................................................16 Item 6. Exhibits and Reports on Form 8-K.................................17 SIGNATURE ........................................................18 CERTIFICATIONS ........................................................19 2 PART 1. FINANCIAL INFORMATION - ------------------------------ ITEM 1. FINANCIAL STATEMENTS ENOVA SYSTEMS, INC. BALANCE SHEETS (In thousands, except for share and per share data) - -------------------------------------------------------------------------------- As of As of March 31, 2003 December 31, 2002 -------------- ----------------- ASSETS (Unaudited) CURRENT ASSETS: Cash $ 894 $ 1,868 Accounts receivable, net 1,554 1,256 Inventory 1,608 1,652 Stockholder receivable 32 32 Prepaids and other current assets 95 107 -------- -------- Total Current Assets 4,183 4,915 PROPERTY, PLANT AND EQUIPMENT - NET 779 811 OTHER ASSETS 480 498 -------- -------- TOTAL ASSETS $ 5,442 $ 6,224 ======== ======== LIABILITIES AND SHAREHOLDERS' (DEFICIT) CURRENT LIABILITES: Accounts payable $ 1,250 $ 1,192 Line of credit 11 14 Accrued payroll and related expense 119 240 Other accrued expenses 78 95 Bonds and notes payable 120 120 -------- -------- Total Current Liabilities 1,578 1,661 ACCRUED INTEREST PAYABLE 942 889 CAPITAL LEASE OBLIGATIONS 46 55 LONG TERM DEBT 3,332 3,332 -------- -------- TOTAL LIABILITIES $ 5,898 $ 5,937 -------- -------- SHAREHOLDERS' (DEFICIT): Series A convertible preferred stock - No par value; 30,000,000 shares authorized; 2,824,000 shares issued and outstanding at 3/31/03 and 12/31/02 liquidating preference at $0.60 per share aggregating $1,695,000 1,842 1,842 Series B convertible preferred stock - No par value; 5,000,000 shares authorized; 1,217,000 shares issued and outstanding at 3/31/03 and 12/31/02 2,434 2,434 liquidating preference at $2.00 per share aggregating $2,434,000 Common Stock - No par value; 500,000,000 shares authorized; 345,394,000 and 345,194,000 shares issued and outstanding at 3/31/03 and 12/31/02 84,156 84,026 Common stock subscribed 0 130 Stock notes receivable (1,203) (1,203) Additional paid-in capital 6,949 6,949 Accumulated deficit (94,634) (93,891) -------- -------- Total Shareholders' equity (deficit) (456) 287 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 5,442 $ 6,224 ======== ======== Note: The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date. See notes to financial statements. 3 ENOVA SYSTEMS, INC. STATEMENTS OF OPERATIONS (UNAUDITED) (In thousands, except for per share and share data) - -------------------------------------------------------------------------------- Three Months Ended March 31, ------------------------------ 2003 2002 ------------- ------------- NET REVENUES Research and development contracts $ 323 $ 465 Production $ 1,016 $ 476 ------------- ------------- 1,339 941 ------------- ------------- COST OF REVENUES Research and development contracts $ 212 $ 372 Production $ 765 $ 330 ------------- ------------- 977 702 ------------- ------------- GROSS MARGIN 362 239 ------------- ------------- OTHER COSTS AND EXPENSES: Research & development 208 275 Engineering 280 0 Selling, general & administrative 567 615 Interest and financing fees 55 55 Interest income (5) (2) ------------- ------------- Total other costs and expenses 1,105 943 ------------- ------------- LOSS FROM CONTINUING OPERATIONS $ (743) $ (704) ------------- ------------- NET LOSS $ (743) $ (704) ============= ============= NET LOSS PER COMMON SHARE: $ (0.01) $ (0.01) ============= ============= WEIGHTED AVERAGE SHARES OUTSTANDING 345,394,000 302,532,000 ============= ============= 4 ENOVA SYSTEMS, INC. STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands) - -------------------------------------------------------------------------------- Three Months Ended March 31, ---------------------------- 2003 2002 -------------- ------- OPERATIONS Net loss $ (743) $ (704) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and Amortization 82 38 Stock issued for Services 0 18 Change in operating assets and liabilities: Accounts Receivable (298) 359 Inventory 44 (420) Prepaids and other assets 3 31 Accounts payable and accrued expenses (30) 434 ------- ------- Net cash used by operating activities (942) (263) ------- ------- INVESTING: Purchases of property, plant and equipment, net of disposals (23) (174) ------- ------- Net cash used by investing activities (23) (174) ------- ------- FINANCING: Borrowing (Repayments) on leases (9) 47 Proceeds from issuance of common stock 0 3 ------- ------- Net cash provided by financing activities (9) 50 ------- ------- NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (974) (387) CASH AND EQUIVALENTS: Beginning of period 1,868 1,179 ------- ------- End of period $ 894 $ 792 ======= ======= 5 ENOVA SYSTEMS, INC. STATEMENTS OF CASH FLOWS (Continued) SUPPLEMENTAL CASH FLOW INFORMATION (UNAUDITED) (In thousands) - -------------------------------------------------------------------------------- Three Months Ended March 31, --------------------------------- 2003 2002 ------------- ------------- Cash paid for interest $ -- $ -- NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock for services $ 12 $ -- 6 ENOVA SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS (Unaudited) For the Three Months Ended March 31, 2003 and 2002 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 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 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 March 31, 2003 and the interim results of operations and cash flows for the three months ended March 31, 2003 have been included. The balance sheet at December 31, 2002, 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 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 December 31, 2002 and March 31, 2003 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 accrued expenses are based upon an analysis of future costs expected to be incurred in meeting contracted obligations. 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, 2002. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States 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, 2002, which are included in the our Form 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 as filed with the Securities and Exchange Commission. 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 months ended March 31, 2003 presented herein are not necessarily indicative of the results to be expected for the full year. 7 NOTE 2 - Notes Payable, Long-Term Debt and Other Financing Notes payable and long-term debt is comprised of the following (in thousands): March 31, 2003 December 31, 2002 -------------- ----------------- (unaudited) ----------- Secured subordinated promissory note - CMAC as exclusive agent for Non-Qualified Creditors; interest at 3% through 2001, 6% in 2002 and 2003, and then at prime plus 3% thereafter through the date of maturity; interest payments are made upon payment of principal, with principal and interest due no later than April 2016; with an interest in a sinking fund escrow with a zero balance as of December 31, 2002 and March 31, 2003. The sinking fund escrow requires the Company to fund the account with 10% of future equity financing, including convertible debt converted to equity, based upon approval of the new investors per the terms of the note. 3,332 3,332 Other 120 120 ------ ------ 3,452 3,452 Less current maturities 120 120 ------ ------ Total $3,332 $3,332 ====== ====== NOTE 3 - Subsequent Events In April 2003, one of our customers, Advanced Vehicle Systems, Inc., filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. At the time of filing, AVS had an outstanding account balance with Enova of approximately $595,000 of which approximately $564,000 is for components delivered during the first quarter of 2003. Enova has reached a tentative agreement with AVS to be granted `critical vendor' status in order to receive a majority of these payments due as AVS's various vehicle manufacturing contracts are completed, all subject to bankruptcy court approval and the cooperation of various AVS customers involved with Enova's AVS programs. Enova's Audit Committee chairman is representing the Company's interest on the creditor's committee formed by the Bankruptcy Court to administer the payment of claims. While Enova believes it will recover a majority of the funds now owed by AVS, there are no assurances that we may recover any or all of these amounts owed. As of March 31, 2003, we have reserved $52,000 against these balances owed as an allowance for uncollectible receivables. There are no assurances that we will not be required to take additional reserves for uncollectible receivables in subsequent quarters as we learn more during the bankruptcy proceedings. 8 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 consolidated 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 Form 10-K for the year ended December 31, 2002. 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. 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 The first-in, first-out (FIFO) method to value our inventories; o The intrinsic value method, or APB Opinion No. 25, to account for our stock options; o Review of customers' receivable to determine the need for an allowance for credit losses based on estimates of customers' ability to pay. If the financial condition of our customers were to deteriorate, additional allowances may be required. These accounting policies are 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 consolidated 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. All year references refer to fiscal years. Enova believes it is a leader in the development and production of commercial digital power management 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 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 9 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. Enova develops and produces advanced 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 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. 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. During the quarter ended March 31, 2003, we continued to develop and produce electric and hybrid electric drive systems and components for Ford Motor Company (Ford), Hyundai Motor Company (HMC) and several domestic and international vehicle and bus manufacturers, including Advanced Vehicle Systems (AVS) of Tennessee, Malaysia and Japan. Our various electric and hybrid-electric drive systems, power management and power conversion systems are being used in applications including Class 8 trucks, monorail systems, transit buses and industrial vehicles. Enova has furthered its development and production of systems for both mobile and stationary fuel cell powered systems with major companies such as Ford, ChevronTexaco and UTC Fuel Cells, a division of United Technologies. We also are continuing on our current research and development programs with ChevronTexaco, HMC and the U.S. Department of Transportation (DOT) as well as developing new programs with Hyundai Heavy Industries (HHI), the U.S. government and other private sector companies. This quarter, we entered into a joint venture agreement with HHI to create a separate research and development corporation, domiciled in the U.S., which will develop new technologies for mobile and stationary applications for both developing markets for Enova and HHI. The new company will be initially domiciled at our Torrance headquarters with operations intended to commence during the second quarter of 2003. Ford Motor Company - Fuel Cell Technology The High Voltage Energy Converter (HVEC) development program with Ford Motor Company for their fuel cell vehicle continues to advance on schedule. This converter is a key component in Ford's Focus Fuel Cell Vehicle. It converts high voltage power from the fuel cell into a lower voltage for use by the drive system and electronic accessories. The system is completing advanced testing in its final prototype phase prior to production. We anticipate receiving an order for limited production in mid 2003; however, we can give no assurance at this time that such sales will occur. For the quarter ended March 31, 2003, we billed approximately $331,000 for this Ford program. 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. As part of our corporate strategy to outsource manufacturing, Hyundai Heavy Industries produces the Panther 90kW drive system for Enova. 10 The City of Honolulu Hawaii has contracted with Enova to upgrade several S-10 trucks in its electric vehicle fleet. Initially, we will upgrade 3 trucks to our Panther 90kW drive system. This program is expected to generate approximately $100,000 for Enova and will be completed by mid 2003. We continue to cross-sell our systems to new and current customers in the light and medium duty vehicle markets both domestically and globally. Heavy-Duty Drive Systems - Buses and Truck for Urban operators A major focus of Enova's is the heavy-duty vehicle, buses and trucks, for urban operators. Our PantherTM 120kW and PantherTM 240kW drive systems are in production and operating above performance expectations in global markets. Sales of our PantherTM 120kW and 240kW drive systems continue to provide increased revenues for our company. We have entered into supplier agreements with OEMs in Europe and Japan, as well as domestically, for sales of our heavy-duty drive systems. Hyundai Heavy Industries has been selected as our outsource manufacturer for the Panther 120kW controller, as well as the manufacturer of the motor and controller for our Panther 240kW drive systems. This is a specific strategy of Enova's to minimize capital outlays and maximize efficiencies by utilizing proven manufacturing partners. Eco Power Technology of Italy purchased and received 27 Panther 120kW electric and hybrid electric drive systems last year and in early 2003 gave notice of its intent to purchase additional systems in 2003. Eco Power is one of the largest integrators of medium size transit buses for the European shuttle bus market, with key customers in Turin and Genoa, Italy. Tomoe Electro-Mechanical Engineering and Manufacturing, Inc. of Japan continues to procure our 120kW and 90kW drive systems for integration into their industrial vehicle platforms. Tomoe is reviewing additional applications for our drive system configurations. Wrights Environment, a division of Wrights Bus, one of the largest low-floor bus manufacturers in the United Kingdom, has integrated into two of its buses our hybrid electric PantherTM 120kW drive system, which utilizes a 30kW Capstone microturbine as its power source. These buses are currently in field service and are performing to specifications. Further, we continue to negotiate with Wrights to purchase our 240kW drive system. Although we anticipate additional orders for both electric and hybrid-electric 120kW drive systems during 2003, at this time there are no assurances that such additional orders will be forthcoming. In the high performance heavy-duty drive system area, Enova's proprietary 240kW drive system has been successfully integrated into several heavy-duty applications including several 38 foot transit buses and a Class 8 urban delivery truck. We are anticipating additional orders in 2003, although no such orders are guaranteed. One of our 240kW systems has also been integrated into a Class 8 urban delivery truck which was displayed at the Electric Drive Transportation Association Symposium in Hollywood Florida in December 2002. This 240kW drive system is capable of providing 3,000 ft-lbs of torque at the drive shaft. Additionally, Enova has modified the Panther 90kW to be used in a dual wheel motor configuration, expanding its potential market penetration with bus and delivery vehicle manufacturers. AVS purchased several of our Panther Dual 90kW drive systems for their 22-foot bus for New York City and other customers. Additionally, in the first quarter, AVS purchased two 240kW drive systems for several of their 38-foot bus programs. In April 2003, Advanced Vehicle Systems, Inc., filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. Enova has reached a tentative agreement with AVS to be granted `critical vendor' status in order to receive a majority of these payments due as AVS's various vehicle manufacturing contracts are completed, all subject to bankruptcy court approval and the cooperation of various AVS customers involved with Enova's AVS programs. Enova's Audit Committee chairman is representing the Company's interest on the creditor's committee formed by the Bankruptcy Court to administer the payment of claims (refer to Part II, Item 1 below). Additionally, we are in discussions with other bus manufacturers, industrial, commercial and military vehicle manufacturers regarding the purchase of our heavy-duty, high performance, 240kW drive systems in 11 2003. There are no assurances, however that these discussions will result in any sales of the Panther 240kW or 120kW drive systems. Ballard Power Systems Our development and production program with Ballard Power Systems for low voltage 30kW electric drive system components for use in Ford's Global Th!nk City was terminated by Ford and Th!nk Nordic in early 2003, as previously reported. Ford Motor Company announced that they have sold the program and its assets to Kamkorp, Ltd, a United Kingdom company. Currently, approximately $450,000 of current inventory is materials purchased for the initial production of the drive system component. There are other additional material, tooling and engineering costs which may become due to our suppliers as a result of the termination of this program of approximately $300,000. Under the terms of our agreement with Ballard and Ford, we believe full reimbursement for these costs is warranted at termination. We have billed Ballard for these amounts; however no final determination or agreement on the total reimbursement from Ballard to Enova has been made. Research and Development Programs The U.S. Air Force and the State of Hawaii have contracted with Enova to integrate a Panther 120kW hybrid drive system into a second 30-foot bus for the Hickman Air Force base. In conjunction with the State of Hawaii, the all-electric Hyundai Santa Fe SUV demonstration project has completed its second year of testing and evaluation. The vehicles are meeting specifications with the results of the project, thus far, meeting the expectations of the State of Hawaii, Hyundai and Enova. All of these programs are funded in conjunction with the Hawaii Electric Vehicle Development Project, the U.S. DOT and the State of Hawaii. Development programs with these agencies have generated revenues of $77,500 for the quarter ended March 31, 2003. We intend to establish new development programs with the Hawaii High Technology Development Corporation in mobile and marine applications as well as other state and federal government agencies as funding becomes available. Stationary Power Applications Enova continues to attract new partners and customers from both fuel cell manufacturers and petroleum companies. It is our belief that utilizing our power management systems for stationary applications for fuel cells will open new markets for our Company. There are no assurances, however, that we will successfully develop such applications or that any such applications will find acceptance in the marketplace. We are currently designing a process controller for ChevronTexaco Technology Ventures (CTTV) for their fuel reformer for a stationary fuel cell application. Due to the milestones met and technologies developed thus far in the initial development on this contract, we are in discussions with CTTV regarding developing other components for this application in the areas of power management and power processing; however, we can make no assurances that these discussions will lead to future contracts at this time. For the three months ended March 31, 2003, Enova has billed ChevronTexaco $95,000. Our Fuel Cell Care (FCU) units are being delivered to UTC Fuel Cells, a division of United Technologies Corp., for use in their stationary fuel cell systems. In the first quarter of 2003, UTC Fuel Cell ordered 24 additional fuel cell care units. Sales to UTC for the three months ended March 31, 2003 totaled $52,000. We believe the stationary power market will play a key role in our future. We continue to pursue alliances with leading manufacturers in this area. There are, however, no assurances that this market will develop as anticipated or that such alliances will occur. 12 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 manufacturer 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 external financing. We anticipate that we may require additional outside financing within the next six months to meet research, development and general operations expenditures through 2003. During the three months ended March 31, 2003, we spent $942,000 in cash on operating activities to fund our net loss of $743,000 resulting from factors explained in the following section of this discussion and analysis. Accounts receivable increased by $350,000 from December 31, 2002 balances due to increased heavy-duty system sales primarily to AVS and additional engineering on the Ford HVEC program. This increase in accounts receivable was reduced by approximately $52,000 as a result of an allowance for doubtful accounts in connection with AVS sales (refer to Part II, Item 1 below) for a net increase of $298,000. Inventory decreased by $44,000 from December 31, 2002 to March 31, 2003 as inventories for products such as our 120kW and 240kW drive system were sold to AVS and other bus manufacturers. Current liabilities decreased by a net of $83,000 from December 31, 2002 to March 31, 2003 as a result of payment of several expense accruals including year-end payrolls and other accrued expenses and payables. Capital lease obligations decreased by $9,000 during the three months ended March 31, 2003 from December 31, 2002, also due to normal reductions of these liabilities. Interest accruing on notes payable increased by $53,000 for the three months ended March 31, 2003 from December 31, 2002 per the terms of our notes payable. The operations of the Company during the first quarter of fiscal 2003 were financed primarily by the funds received on engineering contracts and sales of drive system components as well as cash reserves provided by equity financings. It is management's intention to continue to support current operations through sales of products and engineering contracts, as well as to seek additional financing through private placements and other means to increase inventory reserves and to continue internal research and development. The future unavailability or inadequacy of financing to meet future needs could force the Company to delay, modify, suspend or cease some or all aspects of its planned operations this year. 13 RESULTS OF OPERATIONS Net revenues for the three months ending March 31, 2003 increased to $1,339,000 from $941,000 for the corresponding period in 2002, representing an increase of 42%. Net production sales for the quarter ended March 31, 2003 increased by $540,000 or over 113% compared to the same period in 2002. The increase in revenues is attributable to increased product sales of PantherTM 240kW and Dual 90kW drive systems, engineering services for the ChevronTexaco fuel reformer process controller and development work on the Ford HVEC program. Cost of sales for the three months ended March 31, 2003 increased to $977,000 compared to cost of sales of $702,000 for the same three-month period in 2002 representing a gross margin on revenues of approximately 27% in the first quarter of 2003. An increase in revenues for the comparable period, as noted above, accounted for a majority of the increase in costs of sales over the periods reported. Additionally, adjustments of approximately $195,000, for inventory sold but not booked in prior periods, increased costs of sales and reduced gross margins in the first quarter. Without these one-time adjustments, the gross margin on revenues would be approximately 42%. Internal research, development and engineering expenses increased in the three months ended March 31, 2003 to $488,000 as compared with $275,000 in the same period in 2002. Enova allocated increased personnel to the development of its diesel generation motor as well as other internally funded programs such as its high voltage drive system components and the 18kW on-board charger. Additionally, Enova is enhancing its product line to maintain its competitive advantage in the digital power management. Selling, general and administrative expenses decreased $48,000 to $567,000 for the three months ended March 31, 2003 from the previous year's comparable period. We continue to attempt to reduce general and administrative expenses wherever possible. Interest and financing fees remained the same at $55,000 in the first three months of 2003 and 2002. We incurred a loss from continuing operations of $743,000 in the first quarter of 2003 compared to a loss of $704,000 in the first quarter of 2002. The increase was primarily due to additional one-time costs of revenues incurred in connection with an inventory adjustment, as previously noted. Without this adjustment, the net loss from operations would be approximately $548,000. We will continue to review all costs and develop methods in our efforts to produce our systems more efficiently by utilizing contract manufacturers where applicable. 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 $94,634,000 at March 31, 2003. 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. Continued Losses. For the three months ended March 31, 2003 and 2002, we had losses from continuing operations of $743,000 and $704,000 respectively on sales of $1,339,000 and $941,000, respectively. 14 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 automobile 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. Various companies are also developing improved electric storage, propulsion and control systems. 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. Changed Legislative Climate. 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. 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. Furthermore, several car manufacturers have challenged these mandates in court and have obtained injunctions to delay these mandates. Our products are subject to federal, state, local and foreign laws and regulations, governing, among other things, emissions as well as laws relating to occupational health and safety. Regulatory agencies may impose special requirements for implementation and operation of our products or may significantly impact or even eliminate some of our target markets. We may incur material costs or liabilities in complying with government regulations. In addition, potentially significant expenditures could be required in order to comply with evolving environmental and health and safety laws, regulations and requirements that may be adopted or imposed in the future. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK None. ITEM 4. CONTROLS AND PROCEDURE Within the 90-day period prior to the filing of this report, an evaluation was carried out by Carl Perry, the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, Mr. Perry concluded that these disclosure controls and procedures were effective. No significant changes were made in the Company's internal controls or in other factors 15 that could significantly affect these controls subsequent to the date of their evaluation. 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. In April 2003, one of our customers, Advanced Vehicle Systems, Inc., filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. At the time of filing, AVS had an outstanding account balance with Enova of approximately $595,000 for components delivered during the first quarter of 2003. Enova has reached a tentative agreement with AVS to be granted `critical vendor' status in order to receive a majority of these payments due as AVS's various vehicle manufacturing contracts are completed, all subject to bankruptcy court approval and the cooperation of various AVS customers involved with Enova's AVS programs. While Enova believes it will recover a majority of the funds now owed by AVS, there are no assurances that we may recover any or all of these amounts owed. As of March 31, 2003, we have reserved $52,000 against these balances owed as an allowance for uncollectible receivables. There are no assurances that we will not be required to take additional reserves for uncollectible receivables in subsequent quarters as we learn more during the bankruptcy proceedings. Item 2. Changes in Securities and Use of Proceeds Pursuant to the Joint Venture Agreement with HHI as described above, we have agreed to sell equity to HHI as more fully described in our 8-K filed with the SEC on March 24, 2003 and as set forth in the Stock Purchase Agreement referenced therein and attached hereto as Exhibit 10.25. Item 3. Defaults Upon Senior Securities: None. Item 4. Submission of Matters to a Vote of Securities Holders None. Item 5. Other Information None. 16 Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits: 10.24* Joint Venture Agreement (redacted**) to form advanced research and development corporation, dated as of March 18, 2003, by and between the Registrant and Hyundai Heavy Industries Co. Ltd. 10.25* Securities Purchase Agreement dated as of March 18, 2003, by and between the Registrant and Hyundai Heavy Industries Co. Ltd. 99.1* CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 * - attached herewith ** - Certain information has been redacted as part of a confidential treatment request filed separately with the SEC. (b) Reports on Form 8-K The Company filed on March 24, 2003, a Form 8-K describing the equity to be sold to HHI pursuant to Enova's Joint Venture Agreement entered into with HHI during the quarter ended March 31, 2003. 17 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: May 15, 2003 ENOVA SYSTEMS, INC. (Registrant) /s/ Carl D. Perry - -------------------------------------------------------------------------------- By: Carl D. Perry, Chief Executive Officer and Acting Chief Financial Officer 18 CERTIFICATIONS I, Carl D. Perry, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Enova Systems, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/ Carl D. Perry - -------------------------------------------------------------------------------- By: Carl D. Perry, Chief Executive Officer and Acting Chief Financial Officer 19