Summary of Significant Accounting Policies

6 Months Ended

Jun. 30, 2012

Notes to Financial Statements

Note 2. Summary of Significant Accounting Policies

Basis of Presentation — Interim Financial Statements

The financial information as of and for the three and six months ended June 30, 2012 and 2011 is unaudited but includes all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair statement of its financial position at such dates and the operating results and cash flows for those periods. The year-end balance sheet data was derived from audited financial statements, and certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules or regulations; however, the Company believes the disclosures made are adequate to make the information presented not misleading.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes these estimates and assumptions are adequate, actual results could differ from the estimates and assumptions used.

The results of operations for the interim periods presented are not necessarily indicative of the results of operations to be expected for the fiscal year. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2011, which are included in the Company’s Annual Report on Form 10-K for the year then ended.

Delisting Notification from the NYSE MKT

On April 17, 2012, Enova Systems, Inc. (the "Company") received notice (the "April Notice") from the NYSE MKT (the "Exchange") indicating that the Company was not in compliance with one of the Exchange's continued listing standards as set forth in Part 10 of the Exchange's Company Guide (the "Exchange Guide"), and the Company was therefore subject to the procedures and requirements of Section 1009 of the Exchange Guide. Specifically, the Company was not in compliance with Section 1003(a) (iii) of the Exchange Guide because the Company reported stockholders' equity of less than $6,000,000 for 2011 and the Company had incurred a loss from continuing operations and/or net losses for five consecutive years.

As required by the April Notice, on May 17, 2012, pursuant to Section 1009 of the Exchange Guide, the Company submitted a plan of compliance (the "Plan of Compliance") advising the Exchange of actions the Company would take to regain compliance with Section 1003(a)(iii) and 1003(a)(ii) of the Exchange Guide over the period ending October 15, 2013 (the "Plan Period").

By letter dated May 22, 2012 (the “May Notice”), the Company received an additional notice from the Exchange stating that a review of the Company's Form 10-Q for the first quarter of fiscal 2012 indicated that the Company did not meet an additional listing requirement. Specifically, the Company was not in compliance with Exchange Guide Section 1003(a)(ii) because the Company reported stockholders' equity of less than $4,000,000 and losses from continuing operations and/or net losses in three of its four most recent fiscal years. Due to the higher stockholders' equity requirement identified in the April Notice, the Company was not required by the Exchange to submit an additional plan of compliance in connection with the deficiency identified in the May Notice.

On June 21, 2012, the Company filed a Form 8-K disclosing the resignation of Chief Executive Officer and Director Michael Staran, Chief Operating Officer John Mullins and Director Richard Davies.

On July 5, 2012, the Company received a further notice (the "July Notice") from the Exchange indicating that the Company no longer complied with the Exchange's continued listing standards as set forth in Section 1003 of the Exchange Guide and that its securities are, therefore, subject to being delisted from the Exchange.  The July Notice stated that the financial projections provided in connection with the Plan of Compliance did not demonstrate an ability to regain compliance with the minimum requirements by the end of the Plan Period and the resignations of Messrs. Staran, Mullins and Davies further reinforced the conclusion that the Company would be unable to regain such compliance by the end of the plan Period. The July Notice further stated that, on June 25, 2012, the Company notified the Exchange that the financial projections provided with the Plan were no longer accurate and did not provide the staff of the Exchange (the "Staff") with updated projections. Following a review of the above-described facts, the Staff advised the Company that the Exchange did not accept the proposed Plan of Compliance and that the Company is therefore subject to delisting pursuant to Section 1009 of the Exchange Guide.

     In accordance with Sections 1203 and 1009(d) of the Exchange Guide, the Company exercised its right to appeal the determination of the Staff by requesting a hearing with the Listing Qualifications Panel. The Company was granted a hearing date in September 2012. There can be no assurance that the Company's request for continued listing will be granted or that, if granted, the Company will be able to continue to meet the minimum listing requirements.

Liquidity and Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. However, historically the Company has experienced significant recurring net losses and operating cash flow deficits. The Company’s ability to continue as a going concern is dependent on many factors, including among others, its ability to raise additional funding, and its ability to successfully restructure operations to lower manufacturing costs and reduce operating expenses.

To date, the Company has incurred recurring net losses and negative cash flows from operations. At June 30, 2012, the Company had an accumulated deficit of approximately $155.1 million, cash and cash equivalents of $233,000 and working capital of approximately $3.4 million and shareholders’ equity of approximately $1.6 million. Until the Company can generate significant cash from its operations, the Company expects to continue to fund its operations with existing cash resources, proceeds from one or more private placement agreements, as well as potentially through debt financing or the sale of equity securities. However, the Company may not be successful in obtaining additional funding. In addition, the Company cannot be sure that its existing cash and investment resources will be adequate or that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to the Company or its stockholders.

        Our ongoing operations and anticipated growth will require us to make necessary investments in human and production resources, regulatory compliance, as well as sales and marketing efforts. We do not currently have adequate internal liquidity to meet these objectives in the long term. To do so, we will need to continue to look for partnering opportunities and other external sources of liquidity, including the public and private financial markets and strategic partners. Having insufficient funds may require the Company to delay or potentially eliminate some or all of its development programs, relinquish some or even all rights to product candidates at an earlier stage of development or negotiate less favorable terms than it would otherwise choose.  Failure to obtain adequate financing also may adversely affect the launch of the Company’s product candidates or its ability to continue in business. If the Company raises additional funds by issuing equity securities, substantial dilution to existing stockholders would likely result. If the Company raises additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations, as well as covenants and specific financial ratios that may restrict its ability to operate its business.

On June 21, 2012, we reported in a Form 8-K filing that, as part of cost cutting measures in response to our decrease in revenue amid continued delays in industry adoption of EV technology resulting from ongoing battery cost and reliability concerns, in excess of 80% of our workforce left our Company. We continue to evaluate strategic opportunities to leverage our resources and assist with continuing operations.

As of June 30, 2012, the Company had approximately $0.2 million in cash and cash equivalents currently and anticipates that its existing cash and anticipated receivables collections will be sufficient to meet its projected operating requirements through December 2012 to continue operations and market trading.        

We have also accessed the capital markets to obtain additional operating funds.  In December 2011, we raised approximately $1,245,000, net of financing costs of $442,500, through an equity issuance to certain accredited investors, which was disclosed in our Form 10-K filed on March 29, 2012.  In addition, as summarized in the liquidity discussion in our Management Discussion, we entered into two Purchase Agreements (the facility) with Lincoln Park Capital Fund in April 2012 to issue up $10,000,000 in shares of our common stock and received proceeds of $132,000, net of financing costs of $152,000, from the initial purchase of shares of Common Stock from Lincoln Park in the second quarter. Access to funding under the facility is dependent upon our share price maintaining a floor price of at least $0.15 per share.  Our share price decreased below that threshold in May 2012 and, until our share price increases above the threshold level, we cannot raise additional funds from the facility.

The Company continues to pursue other options to raise additional capital to fund its operations; however, there can be no assurance that we can successfully raise additional funds through the capital markets.

Significant Accounting Policies

The accounting and reporting policies of the Company conform to US GAAP. There have been no significant changes in the Company's significant accounting policies during the three and six months ended June 30, 2012 compared to what was previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Revenue Recognition

The Company manufactures proprietary products and other products based on design specifications provided by its customers. The Company recognizes revenue only when all of the following criteria have been met:

• Persuasive Evidence of an Arrangement — The Company documents all terms of an arrangement in a written contract signed by the customer prior to recognizing revenue.

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

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

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

The Company recognizes revenue from milestone payments over the remaining minimum period of performance obligations.

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

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

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

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.

Several other factors related to the Company may have a significant impact on our operating results from year to year. For example, the accounting rules governing the timing of revenue recognition related to product contracts are complex and it can be difficult to estimate when we will recognize revenue generated by a given transaction. Factors such as acceptance of services provided, payment terms, creditworthiness of the customer, and timing of delivery or acceptance of our products often cause revenues related to sales generated in one period to be deferred and recognized in later periods. For arrangements in which services revenue is deferred, related direct and incremental costs may also be deferred.

Deferred Revenues

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

Warranty Costs

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

Stock Based Compensation

We measure the compensation cost for stock-based awards classified as equity at their fair value on the date of grant and recognize compensation expense over the service period for awards expected to vest, net of estimated forfeitures.

See Note 9 Stock Options for further information on stock-based compensation expense.